House of Commons Environment, Food and Rural Affairs Committee Milk Pricing in the United Kingdom
Ninth Report of Session 2003–2004
Report, together with formal minutes, oral and written evidence
Ordered by The House of Commons to be printed 26 May 2004
HC 335 Published on 8 June 2004 by authority of the House of Commons London: The Stationery Office Limited £22.00 Environment, Food and Rural Affairs Committee
The Environment, Food and Rural Affairs Committee is appointed by the House of Commons to examine the expenditure, administration, and policy of the Department for Environment, Food and Rural Affairs and its associated bodies.
Current membership
Mr Michael Jack (Conservative, Fylde) (Chairman)* Ms Candy Atherton (Labour, Falmouth and Camborne) Mr Colin Breed (Liberal Democrat, South East Cornwall)* David Burnside (Ulster Unionist, South Antrim) Mr David Drew (Labour, Stroud)* Patrick Hall (Labour, Bedford) Mr Mark Lazarowicz (Labour/Co-op, Edinburgh North and Leith) Mr David Lepper (Labour, Brighton Pavilion) Mr Ian Liddell-Grainger (Conservative, Bridgwater)* Mr Austin Mitchell (Labour, Great Grimsby) Diana Organ (Labour, Forest of Dean)* Joan Ruddock (Labour, Lewisham Deptford) Mrs Gillian Shephard (Conservative, South West Norfolk) Alan Simpson (Labour, Nottingham South) David Taylor (Labour, North West Leicestershire) Paddy Tipping (Labour, Sherwood)* Mr Bill Wiggin (Conservative, Leominster)*
*These Members were nominated as Members of the Sub-committee. Mr David Drew was Chairman of the Sub-committee.
Powers
The Committee is one of the departmental select committees, the powers of which are set out in House of Commons Standing Orders, principally in SO No. 152. These are available on the Internet via www.parliament.uk.
Publications
The Reports and evidence of the Committee are published by The Stationery Office by Order of the House. All publications of the Committee (including press notices) are on the Internet at www.parliament.uk/parliamentary_committees/environment__food_and_rural_ affairs.cfm.
A list of Reports of the Committee in the present Parliament is at the back of this Report.
Committee staff
The current staff of the Committee are Gavin Devine (Clerk), Fiona McLean (Second Clerk), Dr Kate Trumper and Jonathan Little (Committee Specialists), Andy Boyd and Louise Combs (Committee Assistants), Anne Woolhouse (Secretary) and Rebecca Flynn (Intern).
Contacts
All correspondence should be addressed to the Clerk of the Environment, Food and Rural Affairs Committee, House of Commons, 7 Millbank, London SW1P 3JA. The telephone number for general enquiries is 020 7219 3262; the Committee’s e-mail address is: [email protected]. 1
Contents
Report Page
Summary 3
1 Introduction 5
2 Context of the inquiry 6 Deregulation of the dairy market 6 The UK dairy market prior to 1994 6 The UK dairy market after 1994 6 The UK dairy industry today 7 EU dairy regime 7 Government’s role in the dairy industry 7 Industry players 8 The UK milk market 10 Farmgate prices 10
3 Were the retail price increases of 2003 transmitted to farmers? 12 Evidence that increases were transmitted 14 Evidence that increases were not transmitted 14 Some transmission of price increases 16 Why do farmers believe that retail price increases have not been transmitted? 17 Who takes what share of the retail price of liquid milk? 18 Transparency in the dairy supply chain 20
4 The structure of the dairy supply chain: how efficient is the UK dairy industry? 22 Greater efficiency through horizontal integration 24 CAP reform 27 Further horizontal integration in the production sector 29 Greater efficiency through vertical integration 29
5 Conclusions and recommendations 33
Annex : Permanent milk quota held by UK county for 2002–03 37
Formal minutes 41
Witnesses 42
List of written evidence 43
List of unprinted written evidence 43
Reports from the Committee since 2001 44 2 3
Summary
UK dairy farmers are in a financially difficult position and have been experiencing low incomes since the deregulation of the dairy market in 1994. It costs the UK dairy farmer between 18 and 23 pence to produce a litre of milk and yet, since 2000, average farmgate milk prices have varied between 16 and 20 pence per litre. Therefore, on average, farmgate prices are not high enough to cover farmers’ costs.
The thrust of our findings is that the dairy market is not operating properly. The structure of the dairy sector is complex and there is a lack of transparency in the dairy supply chain. This has meant that, although the 2003 increases in the retail prices of liquid milk and cheese in fact appear to have been transmitted to farmers, farmers perceive that they have been treated unfairly. Moreover, despite our best efforts in this inquiry to determine who takes what share of the retail price of a litre of liquid milk, we were unable to account for some 18 pence.
Our recommendations urge the Government to take steps to improve transparency in the dairy supply chain, in part by improving the information about the dairy market that is available and communicating that information to farmers. We also recommend that Government address the engrained adversarialism and blame culture that continues to characterise the dairy industry. Some of the answers we received in the course of taking evidence were at best opaque, if not disingenuous, making this a difficult inquiry to undertake and to conclude.
Given the constraints under which it is operating, the UK dairy industry shows some evidence of being an efficient industry but it would appear that it could benefit from greater horizontal and vertical integration. We urge the Government to take steps to foster an environment that is conducive to such structural change and consolidation and that could result in greater efficiencies still.
5
1 Introduction
1. In the latter half of 2003, dairy farmers took direct action against processors and retailers on a number of occasions, to protest about what they regarded as a failure to transmit to them an increase of 2 pence per litre in the retail prices of liquid milk and cheese, made in July and September 2003 respectively. The lobby group Farmers for Action (FFA), which was responsible for organising the protest action, described the situation in July 2003 as “Processors playing the hokey cokey with our 2p!”1 The FFA website asked:
Why is it every time there is an initiative to try and save [the] primary producers’ dairy industry with the consumer dipping their hand in their pocket to ensure this, supermarkets agree to collect it, but then processors become God and feel they should keep some of it? How many times have farmers been told we are out there working hard trying to get every half penny to pass back to the primary producer, and on this occasion FFA have caught at least one processor with its trousers down!2
2. It was against this background that, in November 2003, we decided to examine the market price and farmgate price of milk and investigate why recent rises in the former had not led to increases in the latter. We appointed a Sub-Committee to carry out the inquiry. The Sub-Committee was chaired by Mr David Drew; its other members were Mr Colin Breed, Mr Michael Jack, Mr Ian Liddell-Grainger, Diana Organ, Paddy Tipping and Mr Bill Wiggin.
3. The Sub-Committee received 24 written memoranda and took oral evidence from: the National Farmers’ Union for England and Wales; the Royal Association of British Dairy Farmers; Farmers for Action; Milk Link Ltd; Robert Wiseman Dairies; Dairy Crest; Arla Foods UK; the British Retail Consortium; the Federation of Milk Groups; the Dairy Industry Association; the Milk Development Council; the Minister for Food, Farming and Sustainable Energy, Lord Whitty of Camberwell, together with Defra officials; the Office of Fair Trading and the Competition Commission. We are grateful to all those who gave evidence or otherwise assisted with our inquiry.
4. Issues relating to the UK dairy industry have been examined by two other parliamentary committees within recent years. Our predecessor Committee, the former Agriculture Committee, reported on the marketing of milk in February 2000.3 In December 2001, the Welsh Affairs Committee took oral evidence from a number of witnesses on farming and food policy in Wales, including the Welsh dairy industry; this evidence was reported to the House in August 2002.4
1 www.farmersforaction.org 2 Ibid. 3 Agriculture Committee, Second Report of Session 1999–2000, The Marketing of Milk, HC 36-I 4 Welsh Affairs Committee, 5 August 2002, Minutes of Evidence for Tuesday 4 December 2001 and Tuesday 11 December 2001: Farming and Food Policy in Wales, HC 427-i-ii 6
2 Context of the inquiry
Deregulation of the dairy market
The UK dairy market prior to 1994 5. Until 1994, there were four Milk Marketing Boards (MMBs) which held a statutory monopoly on the collection and sale of milk in Great Britain. The MMBs were established to resist the downward pressure on producer incomes resulting from the increasing power of dairy companies. They became responsible for all the milk produced by dairy farmers, selling it on their behalf and pooling the returns in order to provide equal returns according to the volume of milk consigned by each farmer.
6. Although the MMBs were typically described as co-operatives, farmers were generally required to sell their milk to them; the MMBs were, in turn, required to buy milk from the producers and find a market for it. This meant that Boards acted not only as sole purchasers but also as monopoly suppliers of milk to the processors in their respective areas. The price of milk was negotiated and agreed by the MMB (on behalf of dairy farmers) and the Dairy Trade Federation (on behalf of the dairy companies).
7. The MMB system was generally regarded as having operated satisfactorily. But the customers of the marketing boards became concerned about pricing policy and its relationship to competition law. Moreover, market developments, including the growth of consumer demand for a widening range of milk products and the intensification of competition from imports, also put pressure on the system. Following a public consultation exercise, the MMBs were abolished in October 1994 and the dairy market was deregulated.
The UK dairy market after 1994 8. Following deregulation, a farmer-owned voluntary co-operative, Milk Marque, was established as the successor to the England and Wales Milk Marketing Boards. The majority of dairy farmers who had previously sold milk through the MMBs switched their allegiance to Milk Marque.
9. In 1999, the Monopolies and Mergers Commission (now the Competition Commission) concluded that Milk Marque had used its monopoly position to increase milk prices over and above what they would have been in a freely competitive market. The Commission recommended that Milk Marque should be broken up, although the Government did not accept that point of view. It also appears that some dairy farmers were dissatisfied with the farmgate price offered by Milk Marque and were withdrawing in ever-increasing numbers. In the event, Milk Marque voluntarily chose to split itself into three roughly equal-sized farmer-owned co-operatives: Milk Link, Axis (now merged with Scottish Milk to form First Milk) and Zenith (now merged with The Milk Group to form Dairy Farmers of Britain). 7
The UK dairy industry today 10. The UK is the seventh largest milk producer in the world, behind the United States of America, the Russian Federation, India, Germany, France and Brazil, and the third largest in Europe, behind Germany and France.5 The UK’s position in the world market is due to the importance of milk to the domestic consumer, and the fact that the UK’s geography and climate makes many parts of the country well-suited to dairy farming.
EU dairy regime 11. The Milk Development Council (MDC) provides a helpful summary of the EU dairy regime:
The EU uses several tools to support the dairy market. These include an intervention buying system to buy in the basic milk product commodities of butter and skimmed milk powder. This provides a guaranteed floor to the market for all dairy products across the EU. Intervention prices keep prices for EU dairy products above world price levels. Intervention prices are set in euros, and hence the UK is susceptible to exchange rate movements as they alter the basic support price for the UK market.
Due to intervention prices keeping dairy product prices higher than world prices, the EU has to use export refunds to help processors and traders sell surplus products on to the world market without making a loss. In addition, the EU uses import tariffs to prevent other countries selling too much of their products into the high supported prices of the EU market.6
12. The fluctuation of the UK pound against the euro affects the farmgate price paid to UK dairy farmers because, as the pound strengthens against the euro, pound- denominated intervention prices for butter and skimmed milk powder fall, pulling down the Intervention Milk Price Equivalent (IMPE), which acts as a marker price in setting milk contract prices. As the pound continues to rise, the sterling value of the IMPE, which is set in euros, falls.
13. Milk production in the UK (as in the rest of the EU) is limited by milk quotas; the current annual quota for the UK is 14.2 billion litres. Data showing permanent quota held in the UK, broken down by county, is attached as an Annex.
Government’s role in the dairy industry 14. Since deregulation, the Government’s role in the dairy industry has been limited. The permanent secretary of Defra, Sir Brian Bender, recently described Defra’s role as follows:
Tackling the issues of supply chain efficiency and adding value is very much for the sector to do itself … However, there is a place for Government to help facilitate supply chain co-operation and Government can also play a role in facilitating industry development …
5 See www.mdcdatum.org.uk/worldtrade.htm 6 Information from the Milk Development Council; available at www.mdcdatum.org.uk 8
Government has no particular view on how much milk the UK should produce or on how many producers or companies there should be. Similarly, we have no view on the most desirable structure of the sector. Government does of course have views on the importance of thriving rural communities and on how land is managed; and it wants a sustainable farming and food sector. But it does not have views on the shape of the industry.7
15. Despite the limitations of the role described by Sir Brian, Defra does retain some key responsibilities in respect of the industry, including UK policy on dairy aspects of the CAP and milk quotas. Defra also has responsibility for sponsorship of the dairy industry in the UK, which brings with it a considerable budget for research and development, and takes the lead in sponsoring the MDC. Defra has made a grant of nearly £0.5 million to the Food Chain Centre to enable it to examine how dairy supply chain efficiency can be improved.8
Industry players
Producers 16. In 2002, there were approximately 29,700 dairy herds in the UK, with an average herd size of 75 cows.9 There is an overall trend towards fewer, larger dairy farms: in 1997, for example, there were approximately 37,300 herds, with an average of 66 cows per herd. In England, there is now less than half the number of dairy holdings that there were twenty years ago: in 1983, dairy was the predominant activity in 30,361 holdings compared with only 14,342 holdings in 2002.10 As average herd sizes have increased, so has performance efficiency: milk yield per cow has steadily increased, from an average of 5,512 litres per cow in the 1996/97 year to 6,467 litres per cow in the 2002/03 year, about a 17% increase in yield.11
17. Despite this trend, there are still a significant number of small dairy farmers in the UK: in 2002, about 40% of UK herds had fewer than 50 cows, as illustrated by the following graph.12 The MDC told us that the 50% of farmers with the smallest herds account for only 25% of milk production.13
7 Speech given by Sir Brian Bender, Defra permanent secretary, to DIAL, 27 November 2003; available at www.dia- ltd.org.uk 8 HC Deb, 8 December 2003, cols 227W–228W 9 Data from the Milk Development Council; available at www.mdcdatum.org.uk 10 HC Deb, 19 January 2004, col 1015W 11 Data from the Milk Development Council; available at www.mdcdatum.org.uk 12 Data from the Milk Development Council; available at www.mdcdatum.org.uk 13 Ev 95 [MDC] 9
Distribution of herds by herd size
14
12
10
8 Thousand herds 6
4
2
0 1 to 49: 12.1 50 to 99: 9.7 100 and over: 7.8 Cows per herd
Purchasers and processors 18. According to Defra, there are 130 milk purchasers and over 100 processors in the UK.14 The five largest purchasers from producers are the farmer-owned co-ops First Milk, Dairy Farmers of Great Britain, Milk Link and United Dairy Farmers and a dairy company, Dairy Crest. The four largest processors in the UK are all dairy companies: Dairy Crest, Glanbia, Arla Foods and Robert Wiseman Dairies.15
19. Many of the purchasers are milk groups, a term which covers both farmer-owned co- operatives and also those groups of farmers who sell their milk to the dairy companies as a bloc; milk groups account for approximately 40% of the raw milk produced in the UK. Although the farmer-owned co-operatives do have some processing capacity, most of the milk they purchase is sold on to the privately-owned dairy companies.
20. The dairy companies purchase raw milk both directly from farmers and via the co- ops. The Dairy Industry Association (DIAL) believes that about 90% of the UK’s raw milk is processed by the privately-owned dairy companies and only about 10% by the producer-owned co-operatives.16
Retailers 21. Liquid milk and commodity products are sold through retailers of all sizes. However, milk and commodity products are now sold primarily through the major supermarkets: around 65% of household consumption of liquid milk is purchased in this way and around 80% of household consumption of other dairy products.17 Other sales are through
14 http://www.defra.gov.uk/foodrin/milk/index.htm 15 Arla Foods merged with Express Dairies in October 2003; the new company is known as Arla Foods. 16 Ev 86 [DIAL] 17 Ev 109 [Defra] 10
middle ground outlets like convenience stores, hospitals and catering outlets or via the doorstep.18
Consumers 22. Consumers’ demand for liquid milk has continued to decline steadily. From the 1950s through to the 1970s, average consumption per person per week was around 2.7 litres; by 2000 that figure had fallen to about 1.8 litres.19 According to the British Retail Consortium (BRC), demand for dairy products is either static or declining, with the exception of yogurt. Increased demand for yogurt is of little benefit to the UK dairy industry, because the market is dominated by German and French brands, and relatively little liquid milk is used in the production process.20 The UK milk market 23. The raw milk produced by UK dairy farmers is processed into a number of different products. In 2002, for example: x 48% of raw milk was processed into liquid milk x 24% into cheese x 13% into milk powder x 12% into other products, including cream, butter, and condensed milk.21
A significant proportion of commodity products such as cheese, cream, butter and milk powders is exported. Liquid milk is sold almost exclusively in the domestic market, although movement of liquid milk between the UK, the Republic of Ireland and France is of increasing importance.22
Farmgate prices 24. UK farmgate prices reached a high soon after deregulation in 1994; since 1996, they have, on the whole, declined. Evidence we have received indicates that it costs the UK dairy farmer anywhere between 19 and 23 pence to produce a litre of milk.23 Since 2000, average farmgate milk prices have varied between 16 pence per litre (ppl) and 20 ppl.24 Average farmgate prices are therefore not high enough to cover farmers’ costs. Milk Link
18 Ev 22 [Milk Link] 19 Environment, Food and Rural Affairs Committee, Ninth Report of Session 2001–02, The Future of UK Agriculture in a Changing World, HC 550-I, p 78 20 Ev 60 [BRC] 21 HC Deb, 19 January 2004, col 1018W; the remaining 3% was accounted for by dairy wastage and stock changes and other on-farm uses. 22 In 1999, the UK exported: 61,000 tonnes of cheese, mostly to other EU Member States and North America; 95,000 tonnes of cream (out of UK production of 272,000 tonnes), mostly to Belgium and France; 43,000 tonnes of butter, almost all to other EU Member States; and 132,000 tonnes of milk powders (out of UK production of 204,000 tonnes), of which 50,000 tonnes went to other EU Member States, with much of the rest going to Africa and the Americas. See http://www.defra.gov.uk/foodrin/milk/dairyindustry.htm. 23 Ev 23 [Milk Link]: independent reports from analysts KPMG and ADAS/HSBC have concluded that it costs the UK dairy farmer between 19 and 21 pence to produce a litre of milk; recent guidelines produced by the RABDF concluded that the breakeven point was just over 20 ppl, and as much as 23 ppl if full account was taken of the cost of unpaid family labour. 24 Ev 23 [Milk Link]; qq 237–238 [FMG] 11
told us that, in the past seven years, most dairy farmers’ income has exceeded the national minimum wage only twice and the effective rate of pay has averaged £2.90 an hour.25 The following table illustrates the low incomes experienced by dairy farmers in recent years:26
Net UK dairy farm income
30
25
20
£ thousand per farm 15
10
5
0 1996/97 1997/98 1998/99 1999/00 2000/01 2001/02 2002/03 2003/04 Year
25. Farmgate prices are influenced by several factors. Prices of liquid milk and other milk products are affected by the value of the EU intervention price, which is itself affected by the sterling to euro exchange rate. Liquid milk is sold almost entirely on the domestic market, whereas other dairy products are sold on the world market and are therefore affected by factors such as currency movements and fluctuations in worldwide supply and demand.
26. UK farmgate prices are not only inadequate to recompense farmers for the cost of milk production, they are also consistently below the EU average. The National Farmers’ Union for England and Wales (NFU) has cited the following figures by way of comparison:27
25 Ev 22 [Milk Link] 26 Data from the Milk Development Council; available at www.mdcdatum.org.uk 27 “How are we to become dairy farmers?”, presentation given by Sir Ben Gill, president of the NFU, to the 13th Cheshire Farming Conference, 13 November 2003. 12
EU average farmgate milk prices by country: € per 100 kg Jan 01 July 01 Jan 02 July 02 Jan 03 July 03
Finland 34.56 32.9 34.38 34.17 34.83 34.95
Denmark 32.29 32.37 32.42 32.44 31.89 31.21
France 31.22 30.23 30.72 29.02 30.32 28.94
Spain 29.59 31.35 29.61 28.77 28.03 27.52
Germany 31.08 32.69 31.57 28.22 28.89 27.25
Netherlands 29.88 29.10 30.27 27.28 27.67 26.7
Ireland 28.82 28.35 28.66 25.95 28.41 25.56
Belgium 29.97 28.33 29.52 24.14 28.55 24.10
UK 26.99 31.13 28.46 24.82 25.26 23.91
27. Several studies have examined farmgate prices in the UK. In the course of our inquiry, frequent reference was made to a report published by the MDC in March 2003, and commissioned from KPMG, Price and profitability in the British dairy chain (the KPMG report).28 We refer to the KPMG report in our commentary below.
3 Were the retail price increases of 2003 transmitted to farmers?
28. In July 2003, the major supermarkets (Tesco, Sainsbury’s, Safeway, Asda, Somerfield, and Kwik Save) raised their prices on liquid milk by 2 ppl. The supermarkets asked the dairy companies to pass the cash increase back to farmers in full.29 In September 2003, the supermarkets again increased their prices: the price of cheese was increased by the equivalent of about £200 per tonne (roughly 2 ppl equivalent), with effect from 1 October 2003. Again, the supermarkets specified that the price increase was to be passed back to farmers in full.
28 Other relevant reports are: a study commissioned by the MDC, DIAL and Defra, with project advice from the NFU, on behalf of the Dairy Supply Chain Forum, and published in February 2004, The Future of UK Dairy Farming, by Professors Colman and Harvey; a report commissioned by Defra and edited by Professor Colman, Phasing out milk quotas in the EU, April 2002; available at www.statistics.defra.gov.uk 29 “Unclear gain from milk price rise”, Farmers’ Weekly, 11 September 2002 13
29. The increase in the retail price of liquid milk was prompted by the financial difficulties being experienced by dairy farmers. As we have noted above, many farmers have struggled to break even, let alone to turn a profit, because the farmgate price of milk is insufficient to cover farmers’ costs and has been for several years. Spurred on by these financial difficulties, some farmers applied pressure to the supermarkets to raise prices. Prior to retailers’ decision to increase the price of liquid milk in July 2003, FFA had threatened to take direct action against retailers unless they agreed to raise milk prices by 2 ppl. FFA had previously protested against the retailer Lidl’s plans to cut retail milk prices; in May, FFA’s chairman, Mr David Handley, commented that retailers should learn a lesson from these protests, saying that they “had better withdraw their horns or they will see what Lidl saw.”30
30. Following the July and September 2003 retail price increases, some farmers became frustrated because they believed that the dairy companies were holding on to the 2ppl increase and not passing it on to farmers. Consequently, between August and November 2003, FFA organised a number of blockades by farmers of the dairy companies’ processing plants around Britain.
31. The evidence we have received indicates that there is still a general perception amongst farmers that they do not receive the full benefit of retail price increases. For example, FFA told us that:
Every time that there has been any form of increase, there seems to be a proportion which has failed to get back to the primary producer, although the retailer has indicated, at every stage of the negotiation, that they wish that money to come back in full but, because we have such a complicated system, that never appears to happen, and when any of the processing sector are asked the question why, all we ever get is a complicated answer which the majority of us find very difficult to understand.31
32. In seeking to establish whether the 2ppl increase in the price increases of July and September 2003 were transmitted back to farmers, in full or in part, it is important to note that any increase in the retail prices of milk or other dairy products sold by the major supermarkets will not result in an equivalent increase in the overall farmgate price of milk. For instance, a 2 ppl increase in the price of liquid milk sold in supermarkets will not result in an increase of 2 ppl in the price of raw milk bought from farmers, because liquid milk sold by supermarkets accounts for only about a quarter of the total UK market. Defra estimates that an increase of 1 ppl in the supermarket price for liquid milk would result in an increase of the average farmgate price of around 0.3 ppl;32 an increase of 2ppl should therefore result in an increase of around 0.6 ppl.
33. We note that Defra’s estimates do not correlate with those given by FFA which, in July 2003, estimated that the dairy companies should be paying the following price increases,
30 “More action over low milk prices?”, Farmers’ Weekly, 30 May 2003 31 Q 47 [FFA] 32 Ev 103 [Defra] 14
on the basis of their percentage share of the retail market: Dairy Crest, 1.4ppl; Arla, 1.4ppl; Express Dairies, 1.5ppl; Robert Wiseman Dairies, 1.7ppl.33
Evidence that increases were transmitted 34. As regards the liquid milk market, Defra believed that retail price increases were fully transmitted to producers, although the department acknowledged the “widespread feeling amongst dairy farmers that they have not received the full benefit” of the recent retail price increases. Defra pointed particularly to the fact that, although retail prices for liquid milk rose by 2 ppl between October 2002 and October 2003, the average farmgate price in fact rose by 1.46 ppl, as against the 0.6 ppl that might be expected. 34
35. Defra did not directly comment on whether the September 2003 increase in the retail price of cheese has been fully transmitted to farmers. However, it appears that the increase in retail price did result in an increase in the price paid for raw milk acquired for the purposes of cheese processing. On 5 December, for example, Dairy Crest increased payment by 2ppl, although it made retrospective payments of only 1 ppl more for October milk and 1.4 ppl more for November milk. Dairy Crest made this offer conditional on other cheese processors making corresponding increases in payments, which they appear, on the whole, to have done.
36. Similarly, the MDC’s analysis was that the majority of price rises had been passed back to farmers.35
Evidence that increases were not transmitted 37. Farmers’ groups do not accept that the 2003 retail price rises were fully transmitted to farmers. The NFU submitted that the increases in the retail price of liquid milk:
… resulted in some improvement in farmgate prices but farmgate price increases varied. Some producers received increases of over 0.5 ppl while other producers received no price increase at all. In the main, this difference can be attributed to the business mix of the purchaser of milk to whom the farmer sells. For example, direct suppliers to a liquid milk only processor did receive a price increase while direct suppliers to a cheese manufacturer did not. For suppliers of co-operatives the price increase would have depended on the amount of business they have with customers who supply into the liquid milk market.36
38. The Federation of Milk Groups (FMG), which represents all of the 30 or so milk groups in the UK, also submitted that the benefits of price increases have not been evenly distributed across all UK dairy farmers. The FMG told us that that farmers supplying directly to liquid dairies had, on average, gained more than those farmers who supply the
33 www.farmersforaction.org 34 Ev 103 [Defra] 35 Ev 92 [MDC] 36 Ev 3 [NFU] 15
co-ops or who supply directly to manufacturing markets.37 The FMG cited the following data to illustrate the varying prices paid to farmers supplying different purchasers:38
Increases in farmgate prices: September 2000 to July 2003
Purchaser Price increase (ppl)
Dairy companies (liquid milk)
Express Dairies (now Arla) 3.0
Arla Foods 3.0
Robert Wiseman Dairies 3.0
Dairy Crest 2.1
Dairy companies (cheese)
Glanbia 1.8
Dairy Crest 1.7
Dansco 1.0
Co-operatives
First Milk 1.9
Dairy Farmers of Britain 1.7
Milk Link 1.5
39. It can be seen from this that those producers supplying directly to processors involved only in the liquid sector have had increases of between 2.1 ppl and 3.0 ppl, whereas those supplying to co-ops who have a range of customers have had lesser increases, of between 1.5 ppl and 1.9 ppl. The FMG expressed concern about this gap, suggesting that it could lead to “an unmanageable, two-tier, dual-price farming sector” and a “very significant exit from the industry” by those farmers who currently supply co-ops.39
37 Ev 70 [FMG] 38 Appendix to memorandum from Federation of Milk Groups (not printed) 39 Q 234 [FMG] 16
Some transmission of price increases 40. We accept Defra’s evidence that, although retail prices for liquid milk rose by 2 ppl between October 2002 and October 2003, the average farmgate price in fact rose by 1.46 ppl, as against the 0.6 ppl that might be expected. We therefore conclude that the July and September 2003 retail price increases were transmitted to farmers.
41. However, we are concerned about the way in which the price increases were achieved: despite the indicators in the dairy market in 2003 suggesting that farmgate prices should increase, the major supermarkets appear to have increased their prices only when political pressure was applied by farmers. We are also concerned about the way in which the price increases were transmitted. The transmission was uneven: some farmers have benefited more than others. The transmission was also delayed: it took some time for increases in the retail price to reach farmers. It remains to be seen how long this price increase will remain sustainable.
Dairy market not operating as it should 42. Both the MDC and the NFU submitted that the indicators in the dairy market in 2003, such as the weakening of sterling since the beginning of 2003 and the general improvements in commodity markets, were such that farmgate prices should have increased before the action of retailers in July and September. 40 The MDC suggested that the fact that retail prices increased only following direct action indicated that, without direct action, the market was slower to react to upward pressure than downward pressure.
43. It is not sustainable for price increases in the dairy market to occur only when prompted by political pressure, such as direct action. The events of 2003 suggest that market-based information which particularly reflected known changes in the cost of production and currency movements had little influence on the pricing decisions of the major milk buyers. If the milk market is to work efficiently, signals on factors affecting price must be responded to without the need for application of external political pressure.
Uneven and delayed price transmission 44. We acknowledge the concerns of the FMG about the gap between the higher prices paid to farmers who supply processors directly and the lower prices paid to those who supply co-ops, and we note its suggestion that this may lead to “an unmanageable, two- tier, dual-price farming sector”. The BRC reinforced this suggestion when it described farmgate prices as having three distinct levels: x a top price, for the direct supply of liquid milk to the dairies x a middle price, for the supply of milk for processing into cheese x a lowest price, typically paid by the co-operatives.41
40 Ev 96 [MDC]; Ev 3 [NFU] 41 Ev 59 [BRC] 17
45. From comments made by DIAL, it is clear that each individual dairy company decides whether to pass on any price increase either exclusively to those farmers supplying it directly or to all its suppliers—that it, the co-ops—and that a company may wish “to restrict any increase to direct suppliers in order to encourage the supply profile that it requires for the liquid market”.42 While this is a legitimate business decision, open to each dairy company to make, we are concerned that the effect of doing so may be to discourage farmers from joining the farmer-owned co-ops and selling their milk through them, or to drive out of business those farmers that do sell through co-ops. While we have heard evidence that some dairy farmers are pulling out of the industry, we have received no evidence about the profiles of these farmers. We note, however, that the proportion of farmers who are members of co-ops has declined in recent years. When the milk market was deregulated in 1994, over two-thirds of farmers joined co-ops whereas, in 2000, only about half of farmers sold their milk to co-ops.43
46. We recommend that the Milk Development Council commission research into the reasons why farmers are pulling out of the dairy industry. In particular, it should ascertain whether farmers who sell their milk through the farmer-owned co-ops, rather than directly to the dairy companies, are over-represented in the group of farmers pulling out of the industry. We consider such information vital in tracking the development of the dairy industry.
47. We understand why some dairy farmers became so frustrated with the delays of the dairy companies in transmitting the price increases to them that they turned to direct action. Supermarkets had specified that the price increases should be transmitted to farmers in full; farmers, understandably, expected to see fairly immediate benefits from these price increases. It is entirely unsatisfactory that the benefits of retail price increases should take so long to reach the producer. We urge the dairy companies to examine the means by which they communicate with their producers and, where they feel that there is a legitimate reason for delaying transmission of price increases on to farmers, to ensure that this is communicated effectively to farmers. Constructive dialogue between dairy companies and producers is obviously to be preferred to direct action. Why do farmers believe that retail price increases have not been transmitted? 48. Although we have concluded that there has been some transmission of the 2003 retail price increases, it is clear that farmers’ perception is generally that price transmission has not occurred. This perception appears to be a consequence of the complex structure of the dairy sector. As discussed above, raw milk is purchased both directly by processors and also by co-ops, who may either process it themselves or sell it on to processors. It is then turned into a wide range of products which are sold for varying prices on both the domestic and international markets and offered for retail sale at prices determined by individual retailers. Prices are affected by currency movements, exchange rates and fluctuations in worldwide supply and demand. All this means that it is extremely difficult
42 Ev 83 [DIAL] 43 http://www.defra.gov.uk/foodrin/milk/index.htm 18
for farmers to track the path of retail price increases as they move down the dairy supply chain.
49. The difficulty in tracking retail price increases is exacerbated by the lack of clarity as to what proportion of the retail price of liquid milk and other dairy products is actually taken by each of the various players in the dairy supply chain. We received some evidence that farmers are receiving a progressively smaller proportion of the retail price of liquid milk: for example, the MDC stated that “the increasingly large percentage of dairy products sold through multiple retailers means that the power of the retailers has increased, leading to a smaller proportion of the retail price being passed back to dairy farmers.”44 With this in mind, we sought to establish the proportion of the retail price that is taken by each of the various players in the dairy supply chain. We focussed particularly on the example of liquid milk, as this should have been more clear cut than focussing on commodity products.
Who takes what share of the retail price of liquid milk?
Retailers’ share 50. Retailers’ costs and profits in respect of liquid milk (and other dairy products) do not appear to be readily available. The Royal Association of British Dairy Farmers (RABDF) criticised retailers for demonstrating “no level of transparency whatsoever” about their costs” in contrast with farmers’ and processors’ costs, which the RABDF considered to be either widely available or readily estimated.45
51. Consequently, we asked the BRC what the profit margins of the major retailers are in respect of milk and dairy products. Mr Hawkins responded on behalf of (what was then) Safeway as follows:
It depends on the volume you do with a given dairy as to what your supply terms are. Can I give you a kind of order of magnitude, at the moment a supermarket of our size and with our volumes might be paying the dairies who supply it 42 pence, 43 pence, 44 pence, 45 pence a litre, it is that kind of range. The average retail price weighted across all pack sizes and weighted by sales across all pack sizes, because that is the only way you can make sense of it, would be somewhere between 50 pence and 52 pence. It gives you a feeling for the magnitudes involved, that is gross. From that you obviously have to deduct wastage before you get to the net [profit]…46
Mr Hawkins estimated that “if you take something between eight pence and ten pence as the gross you have to deduct at least another three pence for overheads and net”, although he said that this amount would vary between different retailers.47
44 Ev 96 [MDC] 45 Ev 11 [RABDF] 46 Q 211 [BRC] 47 Q 214 [BRC] 19
Farmers’ share 52. Since 2000, farmgate milk prices have varied between 16 ppl and 20 ppl. From March 2003 to February 2004, the average price was 18.27 ppl.48
Dairy processors’ share 53. From the evidence we have received, the dairy companies’ profit margins appear to vary from 1.5 ppl to 3 ppl. Robert Wiseman’s told us that its operating profit over the last 6 and a half years has remained between 2.34 ppl and 3.13 ppl.49 Dairy Crest stated that it made about 2 ppl on liquid milk and a similar margin on cheese.50 Arla Foods estimated that it made between 1.5 ppl to 2 ppl on liquid milk.51 We received no clear evidence about the costs to processors of producing a litre of liquid milk.
54. DIAL, which represents the majority of dairy processors and manufacturers, was keen to emphasise that UK dairies are not making profits at the expense of producers. It cited one of the conclusions of the KPMG report that “overall, the net profit margins of UK processors have not increased over the period since 1997 and are in line with the performance of similar organisations in Europe.”52
Processors’ costs appear improbably high 55. If we accept the evidence we have heard, we know the costs and profits taken from the retail price of a litre of liquid milk by retailers, the profits made on a litre of liquid milk by the dairy companies and the average farmgate prices received by farmers. If we assume the cheapest retail price per litre together with the highest estimates of proportion of profit, we can hypothesise that the following shares are taken from the retail price of a litre of liquid milk priced at 50 pence:
48 Defra, United Kingdom milk prices, 13 April 2004; available at www.statistics.defra.gov.uk 49 Ev 32 [Robert Wiseman Dairies] 50 Q 122 [Dairy Crest] 51 Q 154 [Arla] 52 Ev 87 [DIAL] 20
Shares taken of 50 ppl retail price of liquid milk
Processors: 21 pence
Farmers: 19 pence
Retailers: 10 pence
56. Given that we know that dairy companies are making no more than about 3 ppl profit, the evidence we have received suggests that about 18 ppl of the retail price of a litre of liquid milk is being taken up by the dairy companies’ costs. The dairy companies will of course need to use some or all of that 18 ppl in collecting and transporting raw milk and then processing it into liquid milk. We believe that the dairy companies should provide dairy farmers with a detailed justification of why it is that they appear to need to take such a significant chunk of the retail price of liquid milk to cover their costs.
57. What is more, if it is unclear what proportion of the retail price of liquid milk is taken by each of the various players in the dairy supply chain, then the proportions will be even less clear in the case of dairy products, which are more complicated markets.
Transparency in the dairy supply chain 58. The fact that we have been unable to account for the entirety of shares taken of the retail price of liquid milk leads us to agree with the NFU that “the dairy supply chain [is] insufficiently transparent to enable producers to be certain that the price increase from retailers [is] finding its way back to them.”53 When added to the complex structure of the dairy sector, the lack of transparency in the dairy supply chain means that farmers have been unable to identify conclusively what proportion of the 2003 retail price increases has passed back to them by way of increased farmgate prices.
59. Transparency in the dairy supply chain is particularly important because of the fraught relations within the dairy industry. This is not a recent state of affairs: in February 2000, our predecessor committee, the Agriculture Committee, referred to the “institutionalised antagonism between the suppliers and the dairies”.54 From the evidence we have heard in the course of our present inquiry, we are extremely concerned by the
53 Ev 4 [NFU] 54 Agriculture Committee, Second Report of Session 1999–2000, The Marketing of Milk, HC 36-I, para 2 21
poor state of relations in the dairy industry. We have seen evidence of suspicion and mistrust, preoccupied self-interest and a lack of constructive dialogue. Some of the answers we received to our questions were at best opaque, if not disingenuous, making this a difficult enquiry to undertake and to conclude. We can only agree with Dairy Crest’s description of the dairy sector as characterised by an “engrained adversarialism and blame culture”.55 Sadly, there has been no evidence of an improvement since the Agriculture Committee inquiry.
60. Relations within the industry will continue to be poor while there is uncertainty about the proportion of the retail price retained by retailers and processors. Farmers need to have the information to enable them to assess whether increases in the retail price have been fully transmitted; if such information is not made available, they will suspect that a proportion of the price increase has been siphoned off along the way. We are disappointed that the industry itself has not taken greater responsibility for monitoring the situation; for example, we were surprised to learn that DIAL feels able to maintain its belief that the market operates fairly while feeling no need to collect data on matters such as the retail margins on liquid milk and commodity products to support its belief.56
61. We acknowledge that that Government has attempted to show some leadership in this respect, by establishing the Dairy Supply Chain Forum in 2002. The forum is currently chaired by the Minister for Food and Farming and is made up of representatives from all parts of the dairy supply chain as well as the MDC and Government. It meets quarterly and is intended to encourage supply chain co-operation, increase efficiency and promote the sustainable development of the industry. The forum’s primary function appears to be acting as a steering group for the three sub-groups which it has established. The sub- groups are: x the CAP Reform Sub-Group, which aims to assess the implications of CAP reform for the English dairy industry and reviews possible options x the Industry Development Sub-Group, which aims to facilitate the long-term sustainable development of the dairy supply chain x the Innovations Sub-Group, which aims to stimulate and co-ordinate innovation for the development of British dairy products.57
We commend the Government for the initiative it has shown in setting up the Dairy Supply Chain Forum.
62. However, we are concerned that, when we questioned the Minister for Food and Farming about the forum’s terms of reference and agenda, his response was so vague as to convey the sense that the Government has no agenda for the forum other than bringing together representatives of the dairy supply chain.58 What is more, the Government has subsequently told us that, during the course of this year, it foresees itself withdrawing
55 Ev 38 [Dairy Crest] 56 Qq 261–267 [DIAL] 57 See ev 125–127 for a fuller account of each sub-group’s terms of reference. 58 Qq 322–326 [Minister for Food and Farming] 22
from the forum as the forum will, by then, “have shown sufficient progress that participants from across the supply chain will be willing to continue the forum under industry leadership”.59
63. We have serious doubts about the wisdom of the Government’s intention to withdraw from its role as facilitator of the Dairy Supply Chain Forum. We are not confident that relations within the dairy industry are sufficiently advanced as to be capable of constructive dialogue and action without the facilitation of the Government. We recommend that, rather than withdrawing from the forum, the Government should instead continue to chair the forum in order to demonstrate the importance that it places on the dairy sector and the need for further change within the sector. We recommend that the Government use the forum as a means to: x take immediate action to establish what proportion of the retail price of liquid milk and other dairy products is retained by each of the participants in the relevant supply chain in order to improve transparency in the dairy supply chain x improve the information about the dairy market that is available and communicate that information to dairy farmers by way of regular, formal communication; such information should explain how retail price increases are transmitted down the dairy supply chain and provide case-specific data in respect of recent retail price increases x address, in an open and constructive way, the engrained adversarialism and blame culture that continues to characterise the dairy industry.
64. In this context, we note that both FFA and the RABDF have asked that a regulatory body be set up to oversee the dairy industry supply chain, to bring greater transparency to the supply chain.60 We understand the concerns that are prompting farmers’ groups to call for such a body, but we believe that the recommendations we have set out above should go some way towards answering those concerns. We see no compelling evidence in favour of setting up a regulatory body to oversee the dairy industry supply at this stage.
4 The structure of the dairy supply chain: how efficient is the UK dairy industry?
65. So far we have addressed the issue of dairy farmers being unable to identify conclusively what proportion of a retail price increase has been passed back to them along the supply chain. However, there are broader issues about the overall structure and efficiency of the dairy industry which should also be addressed in order to enable dairy farmers to utilise more effectively the share of the retail price that they do currently
59 Ev 125 [Defra] 60 Ev 17 [FFA]; Ev 16 [RABDF] 23
receive. It is in the interests of all players in the dairy industry to address these broader issues so that, ultimately, the dairy supply chain will be more efficient and farmers will be in a position to command a greater share of the retail price.
66. A key conclusion of the KPMG report was that that the dairy industry, at both processing and milk producing levels, was not as efficient as it could be. The report concluded that, while the liquid milk processing sector was probably operating efficiently, other processing sectors were operating less efficiently than some of the UK’s international competitors.61
67. Farmers’ groups rejected the suggestion that dairy production was inefficient. The RABDF believed that the efficiency of milk production in the UK compared very favourably with leading dairying countries.62 The FMG argued that the UK was clearly the most efficient dairy producer in Europe:
We have the largest herd size … [which, in England, is the] top side of 70. In Scotland it is over 100. Ireland is 30 … the average cost of production across 400 England and Wales dairy farms [is] about 18 to 18.5 pence per litre. Three years ago … the cost of production was 21 pence. I think there is no denying the fact that UK dairy farmers have been driven down the efficiency route.63
68. Although the UK is efficient in comparison with the rest of Europe, it does not appear to be as efficient as some of its international competitors. During his time as President of the NFU, Sir Ben Gill presented the following compilation of international farmgate milk prices:64
International farmgate milk prices: € per 100 kg Jan 01 July 01 Jan 02 July 02 Jan 03 July 03
Express Dairies (UK dairy) 26.92 31.75 30.86 27.55 27.26 26.16
First Milk (UK co-op) 26.32 32.08 28.04 24.10 25.17 23.90
EU average 31.96 31.87 30.80 29.42 32.20 29.67
USA 26.48 44.92 33.35 23.72 22.86 25.52
New Zealand 11.09 12.37 13.25 9.83 10.38 13.63
69. Obviously, these figures are not wholly comparable because of lower costs in other economies. However, it is certainly true that the New Zealand dairy herds are much larger than those in the UK. The average New Zealand herd has 251 cows and the trend is
61 Ev 96 [MDC] 62 Ev 11 [RABDF] 63 Qq 237–238 [FMG] 64 “How are we to become dairy farmers?”, presentation given by Sir Ben Gill, president of the NFU, to the 13th Cheshire Farming Conference, 13 November 2003. 24
towards larger herds, with around 26% of herds having 300 or more cows. Herd sizes of fewer than 250 are dwindling.65
70. Consequently, we have received evidence that the UK is the most efficient dairy producer in Europe. Yet, despite this, the UK does not appear to be as efficient as some of its international competitors. The structure of the New Zealand dairy industry is inherently more efficient than that of the UK because, as we saw first-hand when we visited New Zealand in 2002, the industry is almost entirely vertically, and thus horizontally, integrated.66 The New Zealand dairy giant, Fonterra, is owned by the overwhelming majority of New Zealand dairy farmers; it collects all the raw milk sold by its members; processes or manufactures all this raw milk and then markets and sells all the resulting milk and dairy products. By contrast, as we have outlined above, the UK dairy industry is complex and fragmented, and the functions within it are splintered amongst many separate individuals and organisations.
71. Experience to date suggests that the UK dairy sector is yet to exploit fully the benefits that could arise from greater horizontal and vertical integration. Currently, functions in the sector are stratified horizontally—producer, purchaser, processor, retailer—and there are a number of individuals or organisations carrying out each stratum of functions. Within each stratum, there is some limited joining up of functions; greater horizontal integration would involve more merging of these functions, so that there would be fewer players within each stratum. Between the different strata, there is very little joining up of functions; greater vertical integration would involve one or more organisations taking responsibility for carrying out the functions of several—or all— strata. Greater efficiency through horizontal integration 72. In the dairy industry, the most highly horizontally integrated sector is the retail sector. Supermarkets account for the bulk of retail milk sales.67 In the past decade, the market share of the major supermarkets has continued to rise. According to the BRC, in 1995, multiple retailers accounted for 45% of retail sales in 1995, rising to 65% by 2002.68
73. The processing sector also demonstrates a high degree of horizontal integration; about 90% of the UK’s raw milk is processed by the dairy companies, the three or four largest of which dominate the UK liquid milk and cheese market.69 The issues of the efficiency of smaller processors and whether there remains a serious excess capacity within this sector still need to be addressed.
74. By contrast, very little horizontal integration has taken place amongst producers. There are about 25,000 dairy farmers in the UK at present. Each farmer may dispose of his or her milk in a different way, by selling to a dairy company, either individually or as
65 Data from Fonterra New Zealand; available at www.fonterra.co.nz 66 Environment, Food and Rural Affairs Committee, Ninth Report of Session 2001–02, The Future of UK Agriculture in a Changing World, HC550-I 67 See paragraph 21 above. 68 Ev 59 [BRC] 69 Ev 86 [DIAL]; Arla, Dairy Crest and Robert Wiseman Dairies dominate the liquid milk market and Glanbia is significant in the cheese market. 25
part of a milk group, or by becoming a member of a farmer-owned co-op and selling through the co-op. The only horizontal integration that has taken place is by way of the co-ops: estimates of the proportion of the UK’s raw milk production purchased by the co- ops vary from 40% to 50%. However, the clout wielded by the co-ops is limited, because they process only about 10% of the UK’s raw milk (the remainder being sold to the dairy companies).
75. The disparity between the major supermarkets and the primary producers results in an uneven distribution of power along the dairy supply chain, with the balance of power being weighted towards retailers. This uneven distribution of power may account for the dairy market being slow to react to upward pressure on retail prices, as it was in 2003, when prices increased only following direct action by farmers.
76. Farmers’ groups told us that the increased market share of the supermarkets has resulted in the balance of power in the dairy supply chain being weighted strongly against producers. In the course of our inquiry, farmers’ groups suggested to us that the major supermarkets are using their increased market share to maintain or improve their margins on liquid milk and dairy products, by applying pressure to their suppliers to decrease wholesale prices. The NFU stated that, while supermarket margins have remained relatively stable or increased, farmgate milk prices have declined, and suggested that it is retailers who are to blame for this situation.70 The FMG believed that UK retailers “currently retain a significant and disproportionate margin on dairy products” and suggested that the retail price rises of July and September 2003, rather than improving the position of farmers, may in fact have served “to pass further control with regards to milk pricing into the hands of retailers”.71
77. On the other hand, the BRC attributed dairy farmers’ financial difficulties to a tendency to over-produce milk, meaning that supply and demand are out of balance.72 The BRC argued that food retailers have tried to deliver fair returns for farmers via the processors:
but there is a limited amount that we can do. Around 12 billion litres of milk is consumed each year—only a small percentage is purchased via food retailers … other sectors in the chain … include caterers, hospitals and schools and Government institutions.73
78. We have been struck by the divergent views within the dairy industry about what factors do, in fact, determine the price of milk. We recommend that the Dairy Supply Chain Forum take the lead in seeking to build a consensus within the industry about the factors that are determinative in this matter.
70 Ev 4 [NFU] 71 Ev 73 [FMG] 72 Ev 58, 60 [BRC] 73 Ev 61 [BRC] 26
Can the supermarkets’ code of practice redress the uneven distribution of power? 79. When dealing with their suppliers, the major supermarkets are bound by a code of practice, overseen by the Office of Fair Trading (OFT). The code is intended to address certain practices engaged in by the supermarkets that have been found by the Competition Commission to affect adversely some suppliers’ competitiveness.74
80. The code has been in place since March 2002. Many witnesses felt that, during that time, the code had been ineffective in redressing the effects on suppliers of the large supermarkets’ buying power. The farmers’ groups we heard from, in particular the NFU and FFA, submitted that the disproportionate power of the major supermarkets was proof that the code was not working properly; the NFU recommended that the code be given ‘teeth’ by way of legislation.75 The Minister for Food and Farming agreed that the code had not proven effective. He said that the code “has not actually given any security to the suppliers … including the dairy sector”.76
81. The OFT’s recent review of the code found widespread dissatisfaction among industry suppliers about its operation.77 Dissatisfaction centred on the fact that it is not possible to complain anonymously under the code and on the use of the concept of “reasonableness” in many of the code’s provisions, which suppliers felt created uncertainty. Amongst other findings, the OFT concluded that neither the code nor the general behaviour of the supermarkets could be linked to the changes in the fortunes of UK farmers, especially the amounts they are paid for their produce.78 However, the OFT also described its findings as being broadly in line with the findings of the Competition Commission’s September 2003 report on the various bids for Safeway. The OFT pointed specifically to the Competition Commission’s finding that:
… there remained a fundamental imbalance of negotiating strength between supermarkets and most of their suppliers and that the balance of responses to its surveys indicated that suppliers’ negotiating strength across all sectors had weakened since the 2000 CC monopoly report. In its surveys of suppliers, 79% to 94% reported that the code had not changed their dealings with the supermarkets and 6% to 15% said matters had worsened.79
82. In our recent report on Gangmasters, we referred to the “dominant position of supermarkets in relation to their suppliers” and stated that the evidence we had received during that inquiry suggested that the supermarkets’ code of practice had failed to redress
74 The code is binding on supermarkets with 8% or more market share. Currently, this is Asda, Sainsbury and Tesco. Safeway was bound; Morrison’s has apparently indicated to the OFT that it will abide by the code on a voluntary basis: HC Deb, 16 March 2004, col 28WH (statement of the Parliamentary Under-Secretary of State for Trade and Industry, Mr Gerry Sutcliffe MP). 75 Ev 5 [NFU] 76 Q349 [Minister for Food and Farming] 77 The Office of Fair Trading, The supermarkets code of practice: report on the review of the operation of the code of practice in the undertakings given by Tesco, Asda, Sainsbury and Safeway to the Secretary of State for Trade and Industry on 18 December 2001, February 2004. The OFT has announced that will conduct further research to establish how supermarkets deal with suppliers under the code: “OFT publishes supermarkets code review: OFT to conduct compliance audit with supermarkets”, OFT press release, 20 February 2004; available at www.oft.gov.uk 78 Above n 75, para 7.7 79 Above n 75, para 2.8 27
the effects of this dominant position. We welcomed the OFT’s review of the code and suggested that a more interventionist approach might now need to be considered.80 In its response to our report, the Government said that it was awaiting the outcome of the OFT’s review of the code.81
83. We welcome the decisions of the supermarkets to increase the retail prices of liquid milk and cheese last year while specifying that the price increases must be passed along to farmers. However, on the basis of the evidence we have received in this inquiry and the findings of the Office of Fair Trading’s review of the code, we agree with the Office of Fair Trading and the Competition Commission that there remains a fundamental imbalance of negotiating strength between supermarkets and most of their suppliers. The code appears to have been ineffective in redressing this imbalance, at least in respect of the dairy supply chain. Supermarkets should carefully examine the way in which they exploit their buying strength and establish whether this is compatible with their oft-stated aim of supporting British agriculture via supply chain partnerships.
84. We are concerned that supermarkets do not necessarily place sufficient weight on assessin the impact of their pricing policies on dairy farmers. We support comments of the MDC that:
… in the normal terms of businesses supermarkets have been doing what businesses do, they have an opportunity to maximise their profitability and they are seeking to do so within the market place. [However,] I totally agree with you that in their terms of social responsibility and their other moral responsibilities then, yes, there are some failings.82
85. We urge the supermarkets to place more weight upon their social responsibility to ensure, at the least, a sustainable farmgate price for British dairy farmers. In this regard, we note the BRC’s statement that virtually all the major supermarkets’ liquid milk requirements are supplied by the major dairies (Dairy Crest, Robert Wiseman’s and Arla).83 If supermarkets are genuinely concerned about the farmgate prices received by all farmers, we suggest that they aim to establish a balanced spread of suppliers by increasing the proportion of products such as liquid milk that they buy from farmer- owned co-ops.
CAP reform 86. Under the reform of the Common Agricultural Policy (CAP), payments no longer depend on production or quota holdings. Dairy premiums have been decoupled and incorporated into the Single Farm Payment (SFP); the first SFP will be made on 1 January 2005. Our recent report, Implementation of CAP Reform in the UK: Part 1, summarises our views on the way in which the Government has chosen to implement the decoupled
80 Environment, Food and Rural Affairs Committee, Fourteenth Report of Session 2002–03, Gangmasters, HC 691, paras 25 and 27 81 Environment, Food and Rural Affairs Committee, First Special Report of Session 2003–04, Gangmasters: Government’s Reply to the Committee’s Report, HC 122, para 14 82 Q287 [MDC] 83 Ev 59 [BRC] 28
SFP in England to date, and indicates that this is a subject to which we shall return in due course.84
87. The CAP reforms will undoubtedly have implications for the future of the dairy industry, some of which we discussed with witnesses during oral evidence. In the shorter term, the expectation seemed to be that farmgate prices will drop further as a consequence of CAP reforms. The MDC suggested that farmgate prices could potentially fall to around 15 ppl and that such a drop would be likely to impact mostly on raw milk supplied for manufacturing into commodity products, rather than that supplied for processing into liquid milk. The MDC further predicted that a 25% to 30% reduction in milk supply would result in commodities no longer being produced and the lowest value use probably being liquid milk production. Under this scenario, the MDC considered that the UK would import dairy products other than liquid milk from other countries and that processors would need to pay higher prices in order to secure sufficient supplies of raw milk for liquid milk production.85 DIAL also believed that the CAP reforms would “put producer prices under downward pressure”, a conclusion that was supported by all three major dairy companies.86
88. We acknowledge the dairy industry’s concern about the Government’s decision to adopt a ‘dynamic hybrid’ model, under which the SFP scheme in England will eventually be calculated on an area, rather than a historic, basis. This is likely to prove unfavourable to the industry; payments for a typical dairy farm are likely to be lower than they are now. We anticipate that the decision to adopt this model will exacerbate the effect on the dairy industry of the price falls caused by CAP reforms. There has been particular concern expressed by dairy farmers in the south-west of the country and there are specific worries for the future of tenant farmers on smaller holdings.
89. In the medium term, some commentators have suggested that significant numbers of dairy farmers will choose or will be forced to pull out of the industry. One prediction is that, from a current base of just under 25,000 UK dairy farmers, by 2015 the number of producers will have fallen by around 23% under the “best case scenario” and by 40% in the “worst case scenario”.87 At one extreme, therefore, by 2015 the number of dairy farmers in the UK could have fallen by about 10,000 to 15,000. Such a drop in farmer numbers could cause a shortage of raw milk on the UK market and might create a problem for UK processors, who could find themselves with a surplus of processing capacity, particularly for commodity products such as butter, skimmed milk powder and mild cheddar cheese.88 That, in turn, could cause farmgate prices to rise, if demand for raw milk increases.
90. However, CAP reforms will accelerate the current trend in the UK towards fewer, larger herds.89 In order to maintain their profitability, it is probable that those UK dairy
84 Environment, Food and Rural Affairs Committee, Seventh Report of Session 2003–04, Implementation of CAP Reform in the UK, HC 226-I 85 Ev 95 [MDC] 86 Ev 86 [DIAL] 87 Ev 40 [Dairy Crest] 88 Ev 54[Arla] 89 See paragraph 16 above 29
farmers who do remain in the industry will have to increase their herd size well above the current average of 75 cows.90 The prospect of a 40% reduction in numbers of dairy farmers need not mean a corresponding drop in milk production, if those herds that do remain are suitably large.
Continuing milk quotas 91. The Secretary of State for Environment, Food and Rural Affairs has stated that the Government would welcome a phasing out of EU milk quotas.91 Despite this, following negotiations at the European Council in June 2003, the Council agreed that the current quota arrangements should remain in place until 31 March 2015.92
92. There is a strong case in favour of phasing out milk quotas. Professor Colman has concluded that quotas for the dairy sector simply make it more expensive to become and remain a dairy farmer.93 The KPMG report found that, if support for dairy farmers were to be reduced—as it subsequently has been—then the quota constraints should be liberalised as well in order to minimise the costs for the industry to restructure.94
93. We are particularly concerned about the impact on dairy farmers of their financial support being reduced under the CAP reforms while milk quotas remain in place until at least 2015. Necessary restructuring within the industry is likely to be hampered by the inflexibility of quotas. We consider that eliminating milk quotas would be economically worthwhile for the UK and for the EU as a whole and we encourage the Government to continue its pursuit of this policy aim. It is most disappointing that some other EU member states have opposed the initiative to phase out EU milk quotas.
Further horizontal integration in the production sector 94. As we have discussed, the dairy industry is currently characterised by a disparity between the degree of horizontal integration in the retail sector as compared to the production sector. This results in an uneven distribution of power along the dairy supply chain, which operates in favour of the retailers. If dairy farmers were to join together, in order to make the process of raw milk retailing both more unified and more dynamic, it could well go some way towards redressing the uneven distribution of power in the supply chain. We would hope that CAP reforms will spur farmers to greater co- operation and to further development of value-added products. Greater efficiency through vertical integration 95. A theme that emerged strongly from the evidence before us was the generally perceived need, especially amongst farmers, for greater vertical integration to take place within the dairy sector. The evidence we heard suggested that greater vertical integration,
90 Data from Fonterra New Zealand; available at www.fonterra.co.nz 91 Rt Hon Margaret Beckett MP, speech to Agra-Europe conference, 31 March 2003; available at www.defra.gov.uk/corporate/ministers 92 Council Regulation (EC) No 1788/2003 of 29 September 2003 (OJ L 270/123, 21.10.2003) 93 Professor Colman (ed), Phasing out milk quotas in the EU, April 2002 94 Ev 96 [MDC] 30
by linking farmers with processing functions, would give farmers a greater ability to participate in price-setting. It would also make the dairy sector more efficient by cutting down on the number of players along the supply chain who need to take a cut of the retail price.
96. There seemed to be general agreement between witnesses that greater vertical integration within the UK dairy sector would offer the best solution to the difficulties currently faced by dairy farmers. For example, the RABDF noted that “considerably more vertical integration has taken place elsewhere than here, resulting in overseas producers being closer to the end market and thus having greater influence on milk price received”.95 The FMG stated that greater vertical integration was a “fundamental objective” of all of the major co-ops in the UK, but that “at this moment in time opportunities … do not grow on trees, they are exceedingly limited”.96
97. There is a widespread belief amongst farmers that it is pointless to attempt to bring about greater vertical integration in the UK dairy industry because any such attempts are likely to be blocked by UK competition law. The comments of the FMG are representative of farmers’ belief that competition law is likely to act as a ‘wet blanket’ to any attempts to achieve greater vertical integration:
the high cost of pursuing potential vertical integration opportunities is persistently overshadowed with the fear that where opportunity exists to secure and build a more viable future for members/dairy farmers, that the potential opportunity will ultimately be blocked and rejected under current competition rules.97
This fear seems to have arisen, at least in part, because of the fate experienced by Milk Marque.
98. Some comments from witnesses have suggested that it is not necessarily the letter of UK competition law that is at issue, so much as the way in which letter of the law is interpreted and applied by the OFT and the Competition Commission. For example, the MDC implied that, by focussing on structure rather than effect, the OFT placed too much emphasis on applying the technical letter of the law, rather than on assessing the practical implications of its decisions.98 This suggestion was echoed by the NFU:
… frankly, within the British dairy industry, the OFT and the Competition Commission need to look around the rest of the world and see the structures that are developing and need to actually allow structures to develop in the UK that will give us the opportunity to compete with others around the world … all too often they seem to be obsessed with the … relative share of the UK market rather than concerned about how other people, our main competitors around the world, operate.99
95 Ev 11 [RABDF] 96 Q 235 [FMG] 97 Ev 73 [FMG] 98 Q290 [MDC] 99 Q19 [NFU] 31
99. When we put this matter to the Minister for Food and Farming, he told us that he did not believe that UK competition law limits vertical integration in the dairy sector, although:
I think the industry feels that it does … It is not my view that the OFT are unduly negative towards vertical integration, indeed we have a number of recent examples, including now the various acquisitions of Milk Link, the latest one being into Glanbia Food and, of course, The Co-op's joint acquisition of Westbury, which have all been cleared with the OFT which indicates they are not opposed to vertical integration.100
The Government stressed to us that the Commission had reached an adverse finding on the 1999 decision of the Monopolies and Mergers Commission about Milk Marque not because of Milk Marque’s size but because of its anti-competitive actions.101
Does competition law inhibit greater vertical integration? 100. Because of the apparent confusion about how competition law would affect proposals for vertical integration, we decided to take oral evidence from the OFT and Competition Commission about their approach to such matters. The OFT and Competition Commission denied that they were opposed to vertical integration in principle, and said that they were open to approaches from farmers or other groups within the dairy industry.102
101. The Government seems to be doing little or nothing to address farmers’ perceptions about the application of competition law and the “nervousness” and “reluctance” that the MDC considers this has caused within the industry.103 Defra states that the OFT is acting to address farmers’ concerns by meeting with farming interests to explain how competition machinery relates to their sector, planning to post answers to frequently- asked questions on this subject on the OFT website and reiterating its willingness to provide informal and confidential guidance to parties considering specific mergers or joint ventures so that any potential competition problems can be identified at an early stage.
102. We urge the Government to ensure that greater emphasis is placed on communicating directly to the dairy industry, especially to farmers, information about what forms of vertical integration can be carried out under current competition law. The Government must take steps to foster an environment that is conducive to greater vertical integration. In its capacity as chair of the Dairy Supply Chain Forum, the Government should work towards achieving a balance in the dairy industry so that the interests of UK domestic consumers are not protected to such an extent that UK dairy producers are detrimentally affected.
100 Q334 [Minister for Food and Farming] 101 Ev 103 [Defra] 102 Ev 130 103 Q289 [MDC] 32
103. We encourage the Office of Fair Trading and the Competition Commission to take all possible steps to ensure that the dairy sector knows that the competition authorities are not opposed to vertical integration in principle and are open to approaches from within the dairy industry. The Office of Fair Trading and the Competition Commission should be sending clear signals on this point.
104. In the absence of more comprehensive vertical integration in the UK dairy industry, and in the shorter term, farmers will gain more power in their negotiations with retailers only by way of the existing farmer-owned co-ops working towards processing all or most of their members’ raw milk. UK co-ops currently own only 2% of processing capacity compared to around 50% in other EU countries, where vertically integrated co-ops are a much stronger presence.104
105. In this regard, we were impressed by the example set by the farmer-owned co-op, Milk Link. As can be seen from the following table, it processes a significantly higher proportion of the raw milk it purchases than do other leading co-ops:105
Purchasing and processing capacity of farmer-owned co-ops
Co-op Number of Litres of milk purchased Litres of milk member from producers (% of UK’s processed by co-op farms annual milk production) (% of milk purchased)
First Milk 4,000 2.5 billion (20%) 400 million (16%)
Dairy Farmers 3,500 2 billion (15%) 100 million (5%) of Britain
Milk Link 2,400 1.4 billion (10%) 700 million (50%)
106. We are concerned that the proportion of farmers who are members of milk groups has declined in recent years. It is clear to us that farmers must take the initiative in bringing about greater vertical integration if they are to strengthen their position within the dairy supply chain. We urge those dairy farmers who are not members of farmer- owned co-operatives to consider carefully their decision to remain outside the co-op framework. Although co-op membership may be a less financially attractive option for farmers in the short term, it is the most effective long-term option available for farmers to gain greater control over when, to whom and at what price they sell their milk. If farmgate prices are to increase, farmers must act to redress the uneven distribution of power currently in the dairy supply chain.
104 Report of the Milk Task Force to Defra Ministers, December 2001; available at www.defra.gov.uk 105 See: www.first-milk.co.uk; www.dairyfarmersofbritain.co.uk; www.milklink.co.uk 33
5 Conclusions and recommendations
1. We accept Defra’s evidence that, although retail prices for liquid milk rose by 2 ppl between October 2002 and October 2003, the average farmgate price in fact rose by 1.46 ppl, as against the 0.6 ppl that might be expected. We therefore conclude that the July and September 2003 retail price increases were transmitted to farmers. (Paragraph 40)
2. However, we are concerned about the way in which the price increases were achieved: despite the indicators in the dairy market in 2003 suggesting that farmgate prices should increase, the major supermarkets appear to have increased their prices only when political pressure was applied by farmers. We are also concerned about the way in which the price increases were transmitted. The transmission was uneven: some farmers have benefited more than others. The transmission was also delayed: it took some time for increases in the retail price to reach farmers. It remains to be seen how long this price increase will remain sustainable. (Paragraph 41)
3. The events of 2003 suggest that market-based information which particularly reflected known changes in the cost of production and currency movements had little influence on the pricing decisions of the major milk buyers. If the milk market is to work efficiently, signals on factors affecting price must be responded to without the need for application of external political pressure. (Paragraph 43)
4. We recommend that the Milk Development Council commission research into the reasons why farmers are pulling out of the dairy industry. In particular, it should ascertain whether farmers who sell their milk through the farmer-owned co-ops, rather than directly to the dairy companies, are over-represented in the group of farmers pulling out of the industry. We consider such information vital in tracking the development of the dairy industry. (Paragraph 46)
5. We urge the dairy companies to examine the means by which they communicate with their producers and, where they feel that there is a legitimate reason for delaying transmission of price increases on to farmers, to ensure that this is communicated effectively to farmers. Constructive dialogue between dairy companies and producers is obviously to be preferred to direct action. (Paragraph 47)
6. Given that we know that dairy companies are making no more than about 3 ppl profit, the evidence we have received suggests that about 18 ppl of the retail price of a litre of liquid milk is being taken up by the dairy companies’ costs. The dairy companies will of course need to use some or all of that 18 ppl in collecting and transporting raw milk and then processing it into liquid milk. We believe that the dairy companies should provide dairy farmers with a detailed justification of why it is that they appear to need to take such a significant chunk of the retail price of liquid milk to cover their costs. (Paragraph 56) 34
7. When added to the complex structure of the dairy sector, the lack of transparency in the dairy supply chain means that farmers have been unable to identify conclusively what proportion of the 2003 retail price increases has passed back to them by way of increased farmgate prices. (Paragraph 58)
8. From the evidence we have heard in the course of our present inquiry, we are extremely concerned by the poor state of relations in the dairy industry. We have seen evidence of suspicion and mistrust, preoccupied self-interest and a lack of constructive dialogue. Some of the answers we received to our questions were at best opaque, if not disingenuous, making this a difficult enquiry to undertake and to conclude. We can only agree with Dairy Crest’s description of the dairy sector as characterised by an “engrained adversarialism and blame culture”. Sadly, there has been no evidence of an improvement since the Agriculture Committee inquiry. (Paragraph 59)
9. We commend the Government for the initiative it has shown in setting up the Dairy Supply Chain Forum. (Paragraph 61)
10. We have serious doubts about the wisdom of the Government’s intention to withdraw from its role as facilitator of the Dairy Supply Chain Forum. We are not confident that relations within the dairy industry are sufficiently advanced as to be capable of constructive dialogue and action without the facilitation of the Government. We recommend that, rather than withdrawing from the forum, the Government should instead continue to chair the forum in order to demonstrate the importance that it places on the dairy sector and the need for further change within the sector. We recommend that the Government use the forum as a means to:
—take immediate action to establish what proportion of the retail price of liquid milk and other dairy products is retained by each of the participants in the relevant supply chain in order to improve transparency in the dairy supply chain
—improve the information about the dairy market that is available and communicate that information to dairy farmers by way of regular, formal communication; such information should explain how retail price increases are transmitted down the dairy supply chain and provide case-specific data in respect of recent retail price increases
—address, in an open and constructive way, the engrained adversarialism and blame culture that continues to characterise the dairy industry. (Paragraph 63)
11. We see no compelling evidence in favour of setting up a regulatory body to oversee the dairy industry supply at this stage. (Paragraph 64)
12. Experience to date suggests that the UK dairy sector is yet to exploit fully the benefits that could arise from greater horizontal and vertical integration. (Paragraph 71)
13. The disparity between the major supermarkets and the primary producers results in an uneven distribution of power along the dairy supply chain, with the balance of 35
power being weighted towards retailers. This uneven distribution of power may account for the dairy market being slow to react to upward pressure on retail prices, as it was in 2003, when prices increased only following direct action by farmers. (Paragraph 75)
14. We have been struck by the divergent views within the dairy industry about what factors do, in fact, determine the price of milk. We recommend that the Dairy Supply Chain Forum take the lead in seeking to build a consensus within the industry about the factors that are determinative in this matter. (Paragraph 78)
15. We welcome the decisions of the supermarkets to increase the retail prices of liquid milk and cheese last year while specifying that the price increases must be passed along to farmers. However, on the basis of the evidence we have received in this inquiry and the findings of the Office of Fair Trading’s review of the code, we agree with the Office of Fair Trading and the Competition Commission that there remains a fundamental imbalance of negotiating strength between supermarkets and most of their suppliers. The code appears to have been ineffective in redressing this imbalance, at least in respect of the dairy supply chain. Supermarkets should carefully examine the way in which they exploit their buying strength and establish whether this is compatible with their oft-stated aim of supporting British agriculture via supply chain partnerships. (Paragraph 83)
16. We urge the supermarkets to place more weight upon their social responsibility to ensure, at the least, a sustainable farmgate price for British dairy farmers. If supermarkets are genuinely concerned about the farmgate prices received by all farmers, we suggest that they aim to establish a balanced spread of suppliers by increasing the proportion of products such as liquid milk that they buy from farmer-owned co-ops. (Paragraph 85)
17. We are particularly concerned about the impact on dairy farmers of their financial support being reduced under the CAP reforms while milk quotas remain in place until at least 2015. Necessary restructuring within the industry is likely to be hampered by the inflexibility of quotas. We consider that eliminating milk quotas would be economically worthwhile for the UK and for the EU as a whole and we encourage the Government to continue its pursuit of this policy aim. It is most disappointing that some other EU member states have opposed the initiative to phase out EU milk quotas. (Paragraph 93)
18. If dairy farmers were to join together, in order to make the process of raw milk retailing both more unified and more dynamic, it could well go some way towards redressing the uneven distribution of power in the supply chain. We would hope that CAP reforms will spur farmers to greater co-operation and to further development of value-added products. (Paragraph 94)
19. We urge the Government to ensure that greater emphasis is placed on communicating directly to the dairy industry, especially to farmers, information about what forms of vertical integration can be carried out under current competition law. The Government must take steps to foster an environment that is conducive to greater vertical integration. In its capacity as chair of the Dairy Supply 36
Chain Forum, the Government should work towards achieving a balance in the dairy industry so that the interests of UK domestic consumers are not protected to such an extent that UK dairy producers are detrimentally affected. (Paragraph 102)
20. We encourage the Office of Fair Trading and the Competition Commission to take all possible steps to ensure that the dairy sector knows that the competition authorities are not opposed to vertical integration in principle and are open to approaches from within the dairy industry. The Office of Fair Trading and the Competition Commission should be sending clear signals on this point. (Paragraph 103)
21. We urge those dairy farmers who are not members of farmer-owned co-operatives to consider carefully their decision to remain outside the co-op framework. Although co-op membership may be a less financially attractive option for farmers in the short term, it is the most effective long-term option available for farmers to gain greater control over when, to whom and at what price they sell their milk. If farmgate prices are to increase, farmers must act to redress the uneven distribution of power currently in the dairy supply chain. (Paragraph 106) 37
Annex: Permanent milk quota held by UK county for 2002–03
County Distinct producers Quota (million litres)
England
Avon 399 211
Bedfordshire 31 22
Berkshire 68 55
Buckinghamshire 110 71
Cambridgeshire 27 15
Cheshire 1,247 782
Cleveland 109 44
Cornwall 1,026 511
Cumbria 1,700 823
Derbyshire 804 359
Devon 1,870 945
Dorset 656 515
Durham 196 69
East Sussex 103 76
Essex 63 53
Gloucestershire 417 259
Greater London 12 8
Greater Manchester 127 44
Hampshire 211 187
Hereford and 407 210 Worcester
Hertfordshire 48 29
Humberside 88 38
Isle of Wight 46 22 38
County Distinct producers Quota (million litres)
Kent 124 87
Lancashire 1,206 553
Leicestershire 325 209
Lincolnshire 103 66
Merseyside 34 22
Norfolk 133 97
North Yorkshire 1,102 508
Northamptonshire 83 66
Northumberland 84 45
Nottinghamshire 112 77
Oxfordshire 145 107
Scilly Isles 1 0
Shropshire 1,044 582
Somerset 1,104 673
South Yorkshire 195 73
Staffordshire 954 466
Suffolk 86 62
Surrey 74 56
Tyne and Wear 39 23
Warwickshire 195 108
West Midlands 121 56
West Sussex 138 105
West Yorkshire 367 137
Total for England 18,055 9,878 39
County Distinct producers Quota (million litres)
Wales
Clwyd 599 245
Dyfed 2,159 815
Gwent 234 107
Gwynedd 352 86
Mid Glamorgan 45 15
Powys 349 130
South Glamorgan 62 26
West Glamorgan 65 15
Total for Wales 3.865 1,438
Scotland
Borders 24 27
Central 56 35
Dumfries and 595 422 Galloway
Fife 55 32
Grampian 134 94
Highland 27 16
Lothian 52 26
Orkney 27 17
Shetland 6 3
Strathclyde 903 478
Tayside 43 29
Western Isles 2 1
Total for Scotland 1,924 1,180 40
County Distinct producers Quota (million litres)
Northern Ireland
Antrim 1,347 428
Armagh 535 160
Down 1,045 389
Fermanagh 697 112
Londonderry 563 175
Tyrone 1,546 407
Total for Northern 5,731 1,670 Ireland
UK TOTAL 29,575 14,466 41
Formal minutes
WEDNESDAY 26 MAY 2004 Members present:
Mr Michael Jack, in the Chair
Mr Colin Breed Joan Ruddock Mr David Drew Alan Simpson Patrick Hall David Taylor Mr Mark Lazarowicz Paddy Tipping Mr Austin Mitchell Mr Bill Wiggin Diana Organ
The Committee deliberated.
Draft Report [Milk Pricing], proposed by the Chairman, brought up and read.
Ordered, That the draft Report be read a second time, paragraph by paragraph.
Paragraphs 1 to 106 read and agreed to.
Summary read and agreed to.
Annex agreed to.
Resolved, That the Report be the Ninth Report of the Committee to the House.
Ordered, That the Chairman do make the Report to the House.
Ordered, That the provisions of Standing Order No. 134 (Select committees (reports)) be applied to the Report.
Several papers were ordered to be appended to the Minutes of Evidence.
Ordered, That the Appendices to the Minutes of Evidence taken before the Committee be reported to the House.–(The Chairman).
Several memoranda were ordered to be reported to the House.
The Committee further deliberated.
[Adjourned till Wednesday 16 June at a quarter past Two o’clock. 42
Witnesses
Monday 9 February 2004
Tim Bennett, Terrig Morgan and Thomas Hind, National Farmers’ Union of England and Wales Ev 6
Tim Brigstocke, Andrew Chadwick, Robert Clarke and John Sumner, Royal Association of British Dairy Farmers Ev 12
David Handley and Mike Haskew, Farmers For Action Ev 18
Jeremy Pope and Barry Nicholls, Milk Link Ltd Ev 25
Monday 1 March 2004
Billy Keane and Pete Nicholson, Robert Wiseman Dairies Ev 33
Drummond Hall and David Lattimore, Dairy Crest Group Ev 44
Neil Davidson and Peter Walker, Arla Foods UK Ev 55
Kevin Hawkins and Richard Ali, British Retail Consortium Ev 62
Monday 8 March 2004
John Duncan and David Strang, Federation of Milk Groups Ev 74
Alan Hinton, Jim Begg and Peter Dawson, Dairy Industry Association (DIAL) Ev 87
Brian Peacock, Kevin Bellamy and Ken Boyns, Milk Development Council Ev 97
Lord Whitty and Andrew Slade, Department for Environment, Food and Rural Affairs Ev 114
Wednesday 31 March 2004
Penny Boys, Alan Williams and Bob Gaddes, Office of Fair Trading, and Colin Farthing, Competition Commission Ev 130 43
List of written evidence
National Farmers’ Union of England and Wales Ev 1 Royal Association of British Dairy Farmers Ev 10, 16 Farmers For Action Ev 17 Milk Link Ltd Ev 22 Robert Wiseman Dairies Ev 31 Dairy Crest Group Ev 37 Arla Foods UK Ev 49 British Retail Consortium Ev 58, 69 Federation of Milk Groups Ev 70, 73, 77 Dairy Industry Association Ev 80 Milk Development Council Ev 92 Department for Environment, Food and Rural Affairs Ev 102, 125 Robert Millar Ev 144 Pippa Woods Ev 144 Richard Pool Ev 145 Iorwerth Rowlands Ev 147 FW and JM Hart Ev 147 John Tuck Ev 147 Malcolm Ronald Ev 149 Glanbia Foods Limited Ev 149 Nick Holt-Martyn Ev 150 PWR & ARA Gantlett Ev 151 National Farmers’ Union Scotland Ev 152 The Soil Association Ev 154
List of unprinted written evidence
Additional papers have been received from the following and have been reported to the House but to save printing costs they have not been printed and copies have been placed in the House of Commons library where they may be inspected by members. Other copies are in the Record Office, House of Lords and are available to the public for inspection. Requests for inspection should be addressed to the Record Office, House of Lords, London SW1. (Tel 020 7219 3074) hours of inspection are from 9:30am to 5:00pm on Mondays to Fridays.
Farmcare (memorandum) Office of Fair Trading (memorandum) Competition Commission (memorandum) Federation of Milk Groups (appendices to memorandum) 44
Reports from the Committee since 2001
Session 2003–04 Eighth Report Gangmasters (follow up) HC 455 Seventh Report Implementation of CAP Reform in the UK HC 226-I Sixth Report Marine Environment HC 76 Fifth Report The Foods Standards Agency and Shellfish (Reply, HC 601) HC 248 Fourth Report Environmental Directives (Reply, HC 558) HC 103 Third Report Caught in the net: Cetacean By-catch of dolphins and HC 88 porpoises off the UK coast (Reply, HC 540) Second Report Annual Report of the Committee 2003 HC 225 First Report Water Pricing (Reply, HC 420) HC 121
Session 2002–03 Eighteenth Report Conduct of the GM Public Debate HC 220 (Reply, HC 443, Session 2003-04) Seventeenth Report Biofuels (Reply, HC 88, Session 2003-04) HC 929-I Sixteenth Report Vets and Veterinary Services HC 703 Fifteenth Report New Covent Garden Market: a follow-up HC 901 (Reply, HC 123, Session 2003-04) Fourteenth Report Gangmasters (Reply, HC 122, Session 2003-04) HC 691 Thirteenth Report Poultry Farming in the United Kingdom (Reply, HC 1219) HC 79-I Twelfth Report The Departmental Annual Report 2003 (Reply, HC 1175) HC 832 Eleventh Report Rural Broadband (Reply, HC 1174) HC 587 Tenth Report Horticulture Research International (Reply, HC 1086) HC 873 Ninth Report The Delivery of Education in Rural Areas (Reply, HC 1085) HC 467 Eighth Report The Future of Waste Management (Reply, HC 1084) HC 385 Seventh Report Badgers and Bovine TB (Reply, HC 831) HC 432 Sixth Report Rural Payments Agency (Reply, HC 830) HC 382 Fifth Report The Countryside and Rights of Way Act 2000 HC 394 (Reply, HC 748) Fourth Report Water Framework Directive (Reply, HC 749) HC 130 Third Report The Mid-term Review of the Common Agricultural Policy HC 151 (Reply, HC 615) Second Report Annual Report of the Committee 2002 HC 269 First Report Reform of the Common Fisheries Policy (Reply, HC 478) HC 110
Session 2001–02 Tenth Report The Role of Defra (Reply, HC 340, Session 2002-03) HC 991 Ninth Report The Future of UK Agriculture in a Changing World HC 550 (Reply, HC 384, Session 2002-03) Eighth Report Hazardous Waste (Reply, HC 1225) HC 919 Seventh Report Illegal Meat Imports (Reply, HC 1224) HC 968 Sixth Report Departmental Annual Report 2002 (Reply, HC 1223) HC 969 Fifth Report Genetically Modified Organisms (Reply, HC 1222) HC 767 Fourth Report Disposal of Refrigerators (Reply, HC 1226) HC 673 Third Report Radioactive Waste: The Government’s Consultation HC 407 Process (Reply, HC 1221) Second Report The Countryside Agency (Reply, HC 829) HC 386 First Report The Impact of Food and Mouth Disease (Reply, HC 856) HC 323
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Environment, Food and Rural Affairs Committee: Evidence Ev 1 Oral evidence
Taken before the Environment, Food and Rural Affairs Committee
(Milk Pricing Sub-Committee) on Monday 9 February 2004
Members present
Mr David Drew, in the Chair
Mr Colin Breed Mr Bill Wiggin Mr Michael Jack
Memorandum submitted by the National Farmers’ Union of England and Wales (L16)
Executive Summary 1. The NFU considers that it is important that action is taken to provide reassurance to producers that the dairy market can operate normally. We believe that part of the way of achieving this is through giving the current OFT Code of Practice “teeth” to ensure that retailers and their suppliers abide by the code. We also consider that the opportunity for a confidential audit of the price negotiation process should be a part of the code to provide producers with transparency and reassurance in the way in which prices are being established. 2. Ultimately we believe that a market led approach to the problems of the dairy supply chain is the only way forward. Part of this strategy should include greater innovation and adding value to British milk. This, we believe, will only be achieved if there is a less adversarial attitude in the dairy supply chain, particularly between producers and processors. Only through these commercial relationships can a sustainable long- term approach to farm gate milk prices be obtained. 3. It is vital that the dairy market functions in the correct manner before the reforms recently made to the Common Agricultural Policy (CAP) are introduced.
Introduction 4. British farm gate milk prices have not responded to changes in the market fundamentals that have taken place since the beginning of the New Year. The key market determinant that has changed since the beginning of the year is the weakening of sterling against the Euro, which has led to an improvement in support prices reflected in the value of the Intervention Milk Price Equivalent (IMPE). 5. Since 1998, British farm gate milk prices have been on a consistent downward trend. In part the cause of this decline in prices has been attributed to the strength of Sterling against the Euro, which has depressed support prices expressed in the IMPE and made imports into the UK more competitive. In May 2000, average farm gate milk prices reached an historical low of 14.61 p/l. 6. The continuing downward trend in farmgate milk prices led to the first of the retail price initiatives on liquid milk. This move by retailers was precipitated by direct action by farmers and political pressure from farming unions. The retail price initiative in the autumn of 2000 was underpinned by improvements in commodity markets and led to an improvement in prices throughout 2001. 7. In 2002 farm gate milk prices declined once again, reaching 14.85 p/l. This decrease was precipitated by strong Sterling values and declining commodity markets. However since the beginning of 2003 Sterling has weakened against the Euro and this should have led to an increase in farm gate milk prices. However, despite the improvements in the value of support prices, farm gate milk prices had, at the time of the announcement of the inquiry, failed to respond leading to accusations by producers that the market was failing to operate properly. This led to further demonstrations from milk producers outside both dairy processing plants and retail distribution centres. 8. The NFU’s submission will examine the reasons why farm gate milk prices should have risen in 2003 in response to changes in market fundamentals and suggest reasons why price raises to producers did not, initially occur and why eventually price rises did materialise. The submission will go on to suggest potential remedies to some of the causes of the current problems in the dairy supply chain. 9417811001 Page Type [E] 29-05-04 00:58:49 Pag Table: COENEW PPSysB Unit: PAG1
Ev 2 Environment, Food and Rural Affairs Committee: Evidence
What drives farm gate milk prices?
9. Farm gate milk prices in Great Britain have, since 1994, been driven by, amongst other factors, three variables: currency values (Sterling v Euro), supply and demand, especially in dairy commodity markets. Prior to 1994 farm gate milk prices were established according to a system of statutory end use pricing which ensured that the value of the separate markets into which milk was sold was isolated and preserved. The termination of the Milk Marketing Schemes in 1994 ended this system of milk pricing and meant that farm gate milk prices were driven according to standard economic principles. Demand for raw milk is determined by a range of factors including the comparative strength of European and international commodity markets. These have a significant impact on farm gate prices. In turn commodity prices will be determined by the circumstances prevailing in those markets (supply and demand) and by currency movements. 10. The reason that farm gate prices are heavily influenced by commodity prices is because: (i) A significant proportion of raw milk is used directly in the manufacture of commodity products (skimmed milk powder, whole milk powder, butter and commodity cheeses). Since these commodities are traded internationally the return from commodity markets is directly aVected by currency movements. (ii) The returns from liquid milk can be expected to be higher than those for manufactured products due to the “service” element involved (regular supply of a fresh product). However, the price of raw milk for processing into liquid milk for consumption cannot be set separately from the returns available from commodity markets. This is because the industry cannot restrict the end-use to which raw milk is put. Accordingly currency, through commodity prices will also tend to drive the price of raw milk for liquid consumption. 11. The graph below shows the positive link between the £/ƒ exchange rate and farm gate milk prices. However as indicated by the graph this link has not operated since the beginning of this year, when the depreciation of sterling against the Euro did not lead to an improvement in farm gate milk prices. It should be noted that this is not the first time that producer prices have not responded positively to exchange rate movements.
Graph I—Exchange Rates vs Producer Price 0.9 30.00
28.00 0.8 26.00
24.00 0.7
22.00
0.6 20.00
18.00 0.5 16.00
0.4 14.00 Jul-97 Jul-01 Jul-02 Jul-95 Jul-96 Jul-98 Jul-99 Jul-00 Jul-03 Jan-97 Jan-98 Jan-99 Jan-01 Jan-95 Jan-96 Jan-00 Jan-02 Jan-03 Market Exchange Rates Green Exchange Rates Producer Price Excluding bonus payments, pence per litre
Commodity Markets 12. Since the beginning of 2003 international commodity markets for skimmed milk powder, whole milk powder and cheese have improved. In addition domestic wholesale prices for mild and mature cheddar have improved on the back of a lowering of stocks of cheese and a reduced cheese “make” as a result of manufacturers switching from cheese production to skimmed milk powder and whole milk powder production. 9417811001 Page Type [O] 29-05-04 00:58:49 Pag Table: COENEW PPSysB Unit: PAG1
Environment, Food and Rural Affairs Committee: Evidence Ev 3
13. Graph II shows the improvement in international commodity prices. In order to incorporate both the eVect of changes in commodity prices (expressed in US dollars) and the eVect of exchange rate movements, we express international commodity prices in sterling. The graph indicates that since the winter of 2002 and throughout 2003 international commodity prices have improved and as important have remained stable.
Graph II: International Commodity Prices
1600
1400
1200
1000
£ per tonne 800
600
400 Jul-02 Jul-03 Oct-03 Oct-02 Apr-03 Jun-02 Jan-03 Mar-03 Jun-03 Nov-02 Aug-02 Feb-03 May-03 Aug-03 Nov-03 Sep-02 Dec-02 Sep-03
Butter Skimmed Milk Powder Whole Milk Powder Cheddar Cheese
14. This improvement in commodity markets supports the changes in currency that has taken place since the beginning of 2003. The changes in currency and the improvement in commodity markets are reflected in IMPE/AMPE contracts and should feed through to farm gate milk prices. More importantly the weakening of sterling and the improvements in commodity markets should all underpin the market and lead to an improvement in farm gate milk prices.
What happened during the milk price negotiations this autumn/winter?
15. Despite the weakening of sterling since the beginning of 2003 and the general improvements in commodity markets, farmgate milk prices failed to respond accordingly. This led, increasingly, to frustration amongst dairy farmers who considered that the extra money in the supply chain was being denied them. In July of 2003, the major retailers, responding to this pressure, introduced a liquid milk retail price initiative, which increased retail liquid milk prices by the equivalent of 2 p/l.
16. The improvement in retail liquid milk prices resulted in some improvement in farm gate prices but farm gate price increases varied. Some producers received increases of over 0.5 ppl while other producers received no price increase at all. In the main this diVerence can be attributed to the business mix of the purchaser of milk to whom the farmer sells. For example direct suppliers to a liquid milk only processor did receive a price increase while direct suppliers to a cheese manufacturers did not. For suppliers of co- operatives the price increase would have depended on the amount of business they have with customers who supply into the liquid milk market.
17. It is a moot point whether liquid milk retail prices would have increased, irrespective of the pressure on retailers. However the real concern is that it required political pressure to move prices, which if the market was operating as it should, should have moved in line with the changes in the market signals.
18. Farmers welcomed the movement in liquid milk retail prices, particularly as it represented a tacit acceptance by the dairy supply chain that prices had to rise. However it was the cheese market where price rises were expected to improve on the back of the improvements in butter/powder markets brought about by an improvement in support prices and more robust international butter/powder commodity markets.
19. Despite the markets indicating that prices should rise for cheese, it took further political pressure by the NFU and further demonstrations by dairy farmers for prices to begin to move in the cheese sector. 9417811001 Page Type [E] 29-05-04 00:58:49 Pag Table: COENEW PPSysB Unit: PAG1
Ev 4 Environment, Food and Rural Affairs Committee: Evidence
20. In September 2003, retailers paid their suppliers an extra £200/tonne for cheese supplies. Despite this increase, however, it was not suYcient for the major cheese manufacturer in the UK, Dairy Crest, to pay its major supplier, the co-operative First Milk, the extra 2 p/l that was being demanded.
21. To break the impasse that had been reached, retailers were approached once again. In December 2003 retailers paid a further £100/tonne for cheese supplies allowing Dairy Crest to pay an extra 2 p/l to First Milk from the 1 December 2003.
22. The deal brokered with Dairy Crest, precipitated other processors announcing their price increases to their suppliers. For the major co-operatives they were able to announce what producers would be paid for their milk in October. Because of the protracted negotiations milk producers had not known what their milk price increase was.
23. Once again, however, the problem of price increases paid in the manner described above was apparent. While retailers had committed to paying an increase in prices for cheese, it was not known when this extra increase was paid and if it was paid to processors, how much of the extra money was paid to farmers. In other words the dairy supply chain was insuYciently transparent to enable producers to be certain that the price increase from retailers was finding its way back to them.
24. Similarly the structure of the major co-operatives meant that while there was headline increases of the equivalent of 2 p/l for cheese, this did not equate to a farm gate price increase of 2 p/l. As already described above, co-operatives sell milk into a variety of markets. A co-operatives ability to pay a price increase and the size of the increase will depend on whether the co-operative has secured an increase in the markets into which it sells its milk and the amount of business it has in a particular market. These increases are pooled together to pay a similar increase to all producers that supply the co-operative.
25. The description of the price negotiations above serves to highlight the problems of the dairy supply chain. Despite all of the signals to the contrary, the milk market failed to respond accordingly and it required political pressure and demonstrations by dairy farmers to ensure that the market did respond and prices did rise.
26. The failure of the market to respond accordingly raises the question of whether there are other factors, apart from simple market factors, which have a bearing on the setting of farm gate prices.
The relevance of supermarket retailers in the UK dairy supply chain
27. The consolidation and concentration of food retailing and the emergence of large chain-store retailers commanding significant shares of national markets has altered the relations between retailers and suppliers. For instance, the five-firm concentration in grocery and daily goods retailing in the UK increased from 50.2% in 1993 to 63% in 1999.
28. The supermarket share in retail sales of milk and dairy products has increased in line with this concentration of food retailing. For example the supermarket share of retail sales of liquid milk is some 65% of the total, with the rest made up of a declining doorstep market and sales from corner shops and garage forecourts. In cheese the picture is similar with a supermarket share of retail sales of some 72%, with 80% of cheddar sales being accounted for by supermarkets.
29. Retailers can exercise their market power in a variety of ways. Through aggressive bargaining strategies (including the use of de-listing tactics) and the increasing use of auctions for awarding contracts (Both ASDA, J Sainsbury and Tesco have used internet auctions for sourcing cheese), retailers have been able to drive down prices and producer margins. There has also been an increase in the use of vertical restraints placed on producers: restraints aimed at further rent extraction (listing charges, “slotting allowances”, over-riders etc.) and exclusive supply obligations and other “non-compete” clauses.
30. This increase in the influence of retailers, in terms of their share of the milk and dairy market in the UK suggests that it is retailers that have been able to maintain or improve margin on milk and dairy products while at the same time pressurising their suppliers which in turn results in pressure on farm gate milk prices. Graph III below shows that while supermarket margins have remained relatively stable or increased, farm gate milk prices have declined.
31. In an independent report commissioned by the MDC, it was reported that supermarket margins on liquid milk had increased by some 4% since 1995. Similarly retail margins on cheese have continued to improve since 1995 with margin spreads of between 20–70% being reported. 9417811002 Page Type [O] 29-05-04 00:58:49 Pag Table: COENEW PPSysB Unit: PAG1
Environment, Food and Rural Affairs Committee: Evidence Ev 5
Graph III: Farmgate Milk Prices vs. Dairy Retail Prices
70 5.60
60 5.40
50 5.20
40 5.00
30 4.80
20 4.60 £ per kg, cheese pence per litre, milk
10 4.40
0 4.20 Jan-98 Jan-99 Jan-00 Jan-01 Jan-02 Jan-03
Milk Farmgate Prices Milk Retail Prices Cheese Retail Prices Trendline, milk retail prices Trendline, milk farmgate prices Trendline, cheese retail prices
32. The ability of retailers to drive margins down to producers is particularly marked for those who do not possess a strong market power, arising through product identity that appeals directly to final consumers. In the case of undiVerentiated products (of which liquid milk is a prime example) margins can be expected to be driven right down. 33. However it would be erroneous to suggest that it is pure market strength by retailers, which is to blame for the failure of the milk market to work, as it should. Competition amongst processors for available business from retailers also has the eVect of preventing prices from rising where normally that would be the case.
Possible Remedies
34. The NFU’s aim is to ensure that every part of the dairy supply chain is able to return a fair share of the value of the milk and dairy product market. Clearly any supply chain is only as strong as its weakest link. The declining trend in returns to producers over the past four years has meant that it is dairy farmers who have been unable to invest in their businesses leading to many to decide to exit the industry. 35. This restructuring of the dairy farming industry is inevitable but the key question is whether those that are leaving the industry are those very producers that the industry needs to be able to become more eYcient, expand and face the challenges of an even more competitive pricing environment. Anecdotal evidence suggests that this seems to be the case. The question is what can and should be done to ensure that the most eYcient producers stay in business. 36. In principle the NFU does not believe that the Government should or would intervene in the market. We believe that it is far better if there are commercial solutions to the problems in the dairy supply chain. However we do consider that the nature of the trading relationships and as we have stated above, the balance of power in the supply chain is weighted strongly against producers. 37. To this end, farmers may ultimately conclude that there should be a Supermarket regulator to control the power of retailers. As a principle the NFU prefers consensus to legislation. However it is clear that the current Code of Practice established to provide protection to farmers is not working. We therefore consider that legislation is required to give the code “teeth”. 38. We would also recommend that the code be extended to include provision for a confidential audit process to be managed by the OFT. This process would be to ensure that all negotiations by farmers’ co- operatives, processors and retailers were documented to ensure transparency. These measures we believe would provide producers with some comfort that the market is operating normally and that any market signals are being reflected in milk price negotiations. 39. Aside from this legislative remedy we consider that the future sustainability of milk prices are to be achieved mainly through commercial and market solutions. 9417811002 Page Type [E] 29-05-04 00:58:49 Pag Table: COENEW PPSysB Unit: PAG1
Ev 6 Environment, Food and Rural Affairs Committee: Evidence
40. It is vital that where possible every opportunity is taken to add value to British milk whatever it is manufactured into eg butter/powder or cheese. This will become increasingly important as the decline in liquid milk consumption continues. Innovation is a key part of any strategy to add value rather than volume as the industry strives to reduce its exposure to commodity prices. Assistance from Government in supporting innovation would be helpful. 41. Dairy producers must also be able to help themselves. Some have decided that the co-operative route is the way in which they will be able to achieve better returns for their businesses. To that end some co- operatives have decided to invest in processing to add value to the milk supplied by their members. As long as the investment in processing is on the basis of sound economic thought we believe that it should be encouraged. January 2004
Witnesses: Mr Tim Bennett, Deputy President, Mr Terrig Morgan, Chairman Milk and Dairy Produce Committee, and Mr Thomas Hind, Chief Dairy Advisor, National Farmers Union of England and Wales, examined.
Q1 Chairman: Welcome, gentlemen. I think you dairy industry is going wrong. What is particularly understand that we are taking four separate sets of galling for producers is that they look around the evidence this afternoon, so, if you do not mind, we rest of Europe and see that the equivalent product will push on quite promptly. The idea would be that price is higher than producers in the UK receive, and we will give all those giving evidence about half an to use an obvious example, that is, Ireland, they hour, but a number of us have to be somewhere else export commodity cheese and seem to pay their at 6 o’clock, so we aim to keep quite strictly to time. producers on average more than we get for Can I, in advance of starting with the NFU, say the commodity cheese production. We would pose the two main reasons that we are holding this inquiry at question: why? It suggests to me we have a dairy this time. You have all seen the terms of reference, industry that has some fundamental faults, and but it is simply because this is an area where the low probably needs to go more into added value. It price to farmers does cause everybody concern, and certainly needs to be more transparent: half the we want to try to get to the bottom of that, but more problems we have stem from a complete lack of particularly, the second argument is the change in transparency up and down the supply chain. The the Mid Term Review will have a dramatic eVect on first major step to start to rebuild trust in the milk, as it will on some other products. So we felt it industry would be by having everyone feeling they was appropriate, partly to lead into our wider are a partner in that chain, and then you can start to discussions on the Mid Term Review but also to talk about what is needed to get us back to being a make sense of this important sector, that we had the world class dairy industry. Sub-Committee operating at this time. We thank all of those who submitted evidence. There were more willing to see us than we had time to see, but we hope Q3 Chairman: I am not putting words into your there is a flavour of what has been submitted. We are mouth, Tim, but from what you are saying, there are not going to go through that; we are going to ask structural imbalances in this industry. I do not know specific questions. I hope you will understand that. if either of your two colleagues would like to give any Tim, would you like to say who you have with you? further examples or, more particularly, to move into Mr Bennett: Thank you, Chairman, and thank you the area of how that could be gradually overcome. for inviting us to give evidence this afternoon. On my Mr Morgan: The structural imbalance is simple. We right is Terrig Morgan, who is Chairman of my Milk have five large retailers, perhaps the same number of Committee. On my left is my Chief Dairy Advisor, large processors, and 20,000 milk producers. That in Tom Hind. itself shows the diYculties that we have. Each one of those 20,000 producers is an individual business on its own, although we do have co-operatives, where Q2 Chairman: Clearly, the evidence is fairly stark— some producers sell their milk through a co-op, but we were talking about this before we started— nevertheless, we do not have the strength that the V between the di erent parts of the industry. Why do others in the supply chain have. If we look at the Y you think farmers have not had a su ciently fair diVerences in milk as compared with other sectors, reward to enable people to earn a reasonable living we do not have an integrated supply chain, and we from dairying, certainly over the last five years? do not have trust and confidence within the supply There are those who would argue it goes back even chain, with transparency in how the price is formed. further. That, I think, is one of the biggest diYculties we Mr Bennett: I think there are some structural have. problems within the British dairy industry itself. If you look at the evidence, 50% of our milk goes into the liquid market, which no-one else tries to compete Q4 Mr Wiggin: What do you think farmers can do with in the rest of Europe. We do not produce to to redress the perceived power of the retailers, the self-suYciency, though interestingly, we export undue power the retailers have, and why have they commodity and import added-value products, not acted to achieve more vertical integration of the which gives you an idea of one of the reasons why the dairy sector? 9417811003 Page Type [O] 29-05-04 00:58:49 Pag Table: COENEW PPSysB Unit: PAG1
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9 February 2004 Mr Tim Bennett, Mr Terrig Morgan and Mr Thomas Hind
Mr Morgan: Vertical integration is always seen from But there is certainly a need, from our observation— the farmers’ side as being able to process our own and we have given evidence to the OFT on this that milk. That in itself is a very expensive issue for the we are surprised that the review of the code of producer and, of course, every capital retention that practice has taken so long—for some of the the co-op makes out of a producer’s milk cheque is definitions in the code of practice, such as less for him as a producer to build up a processing “reasonableness”, to be redefined. I cannot explain arm. When we do that, of course, we are competing what it means, and it might mean something else to against an existing processing sector which in itself is someone else, so we need to have that resolved. If a plc. What we do need, clearly, is for the processor you have a code of practice, with the OFT involved, to realise that he actually needs our supply. We as you certainly need an ability to complain in a producers, and the processors, are really in the same manner that is confidential if you have a trading position, and we need to work together to fight relationship with someone. against the power of the retailer.
Q5 Mr Wiggin: You say work together, but what Q7 Mr Breed: How do you think that might take action can farmers actually take to redress that eVect? balance? What can they do? Mr Hind: Currently, the code of practice does not Mr Morgan: One of the things they can do is to work contain any kind of individual or point of reference with the processor. We need to talk to the to which people can take their grievances in respect processors, and we need to form strategic alliances of price negotiations. We often hear, as a farmers’ with processors, in order to counter the strength of organisation, complaints from the producer or co- the retailer. operative side of the industry that they feel hard Mr Bennett: The problem is that our competitors in done by in a particular negotiation. I come back to the European market in particular have had 60 years this point about lack of transparency. We feel there to work out how they are going to do this without a is a need to extend the code to include this kind of Milk Marketing Board. We had a Milk Marketing idea of an auditor, an audit system, so people can Board which in a sense decided end use pricing, and say, “We have a grievance over the way the since 1994 we have been trying to develop a model negotiation was carried out. We do not think we that will get us into the position of the marketplace were treated in a fair manner. We would like with the producers heavily involved, and frankly, it somebody to investigate.” That investigator may has not worked too well. If we do not succeed in not necessarily be a legislator, but at the very least he getting a better relationship—and we already need a should have the ability to investigate the course of much stronger code of practice against what are very action that was taken in negotiation and at least give powerful players in the supply chain as opposed to some transparency to the situation. The biggest relatively small businesses at the bottom of the frustration from the farmers’ point of view is they do chain—one might even have to look at a regulator or an ombudsman. not see any transparency in the way negotiations are Chairman: We are going to look at the competitive carried out. basis of the industry and the lack of vertical integration, and I will hand over to Colin to examine some of this. Q8 Mr Breed: Just to finish on this, five years or so ago when I did some work on the supermarkets, I recommended then that there should be a retail Q6 Mr Breed: I think those of us who were in any regulator. Do you think that might be a means by way involved in the supermarkets’ code of practice which the code of practice could be policed, enforced recognised as soon as it was going to be a code of and monitored by a particular individual? practice and not have any force of legislation behind Mr Bennett: I think a regulator is one of the options it that it was going to be pretty ineVective. Whilst if the code of practice cannot be made to work, or if there is a review going on, the outcome of which I indeed the marketplace itself cannot be made to think we all look forward to, I think it will work. It is always better, if possible, to try and find demonstrate that it has been totally ineVective. But you suggest it ought to be given more teeth, perhaps a way of making the relationship within the supply by way of legislation. Do you believe that if that were chain work first. People keep talking about the to happen, it would solve the problem, that if a code retailers; I have to say that the code of practice of practice were enforced, that would actually should be extended, we believe, to the food service address most of the problems relating to the non- sector, because they are becoming virtually our transparency of the product in the chain? biggest customer—they certainly will be in a few Mr Bennett: Not necessarily, but if you have a code years’ time—in some products. We should look at of practice, you might as well have something that how this could work, but if we ended up with a tries to do something rather than the one that is there regulator, I think it would be because those in the at the moment. It is always better for the supply chain, including ourselves, failed to find a marketplace to work, and it is always better for way of doing business. people up and down the supply chain to value each Chairman: We are now going to look at supply and, other and make sure that everyone is profitable, particularly, demand, because the structures and because eventually, if you do not do that, the supply systems are irrelevant unless you can get the demand chain falls apart and you lose one of the partners. for milk up. 9417811003 Page Type [E] 29-05-04 00:58:49 Pag Table: COENEW PPSysB Unit: PAG1
Ev 8 Environment, Food and Rural Affairs Committee: Evidence
9 February 2004 Mr Tim Bennett, Mr Terrig Morgan and Mr Thomas Hind
Q9 Mr Wiggin: We have some evidence here saying related to intervention products. We are very keen that the UK is producing more than the market can that the industry be much more dynamic, much absorb, concentrating output in bigger units, while more forward-focused, looking much more at trying at the same time milk consumption is dropping. to build the value-added side of the industry. The When you have too much supply and too little more you move away from commodities, the less demand, you have a problem. To what extent are the you expose yourself to intervention price cuts. problems of the milk sector the result of falling Second is the question of supply. Supply does not consumer demand, and how do you respond to the just come in relation to producer numbers; it comes suggestion that farmers are producing more milk in relation to the individual producer taking a than the market demands? business decision. We were very supportive of the Mr Bennett: As I indicated at the start, in terms of principle of de-coupling in respect of producer UK production, we are probably not self-suYcient, subsidy payments, because we felt very strongly that in that we import, from memory, about 24% and we that gave producers the opportunity to assess their export about 13% of our output, and the balance business, bearing in mind that they had a payment between added value and commodity shows that one there which they could use as a platform to possibly of the faults is that we probably need to put more do something else if they were not producing milk into added value. I do think that an inevitable profitably. We have to bear this in mind as well. I response to price pressure is that people will produce think it is very dangerous to try and forecast to the maximum, though if you note, we run a quota producer numbers. We are looking at about 25,000 system of 14 billion litres, and you cannot aVord to dairy farmers in this country at the moment, and it produce over that. I think there is a debate to be had is very diYcult to forecast how many there may be in about making sure there is a profitable market for the future. Studies have been done into this, but it is British milk, and that is one I think the industry extremely speculative. What we have to try and needs to have in terms of the relationship to the CAP focus on is delivering an industry that is much more Mid Term Review and the consequences of that. market-oriented, that concentrates on trying to There is no reason why the British milk producer, drive the business forward, that is not fixated by the with his technical eYciency and better farm systems and constraints of the past. structure, should not be able to compete with his European colleagues and obtain a reasonable milk Q12 Chairman: Somebody has to give some market price and produce in most of the areas of milk signal or, dare I say, leadership. Where should that production, whether that be butter, powder, come from? Or will people just, as seems to be commodity cheese or the liquid market. I think, happening in my area, get the feeling that they are given the right conditions, that the British producer not loved any more and they had better go, because can fairly compete and produce to the rest of there must be a life out there that is not getting up Europe. On consumption, there has been some fall at 4 o’clock in the morning to lose money? in liquid milk consumption, but to some extent Mr Bennett: I think there are two aspects in cheese consumption is going up, so there is some sort particular about the CAP reforms that strike me. of a balance in the market. The first is that if the industry does not come together down the supply chain to recognise the Q10 Mr Wiggin: Do we actually produce our full signals that de-coupling creates, it could be in grave quota? Do we produce to it, over it or under it? danger of not getting its milk supply. De-coupling Mr Bennett: We are likely to produce to it or just means people just do not have to do it, and I think over it this year, and we are normally very close to it people will react as the reform comes through or on the mark fairly well year after year. based on the signals through the chain. I think that is a very strong driver for the processors and the Q11 Chairman: If we look at the impact of the CAP rest of the customers to start talking about how we reform, all the anticipated figures would show quite can have better relationships, so I think that is a dramatic fall in price—this is on top, obviously, of positive. If I may say so, it is also about the ability a very low price in the marketplace at the moment. to compete in a European market, and what Presumably, the NFU tracks the number of dairy government does and the way government farmers who are dropping out of the market and implements reform is also critical in its signals in what is happening as a result. Can you give me a feel the first stage. For example, if the Irish take a straightforward historic attitude to de-coupling, for where we are at the moment—perhaps Thomas V will do this—and where, if there are not some ways and we take a di erent one in any part of the UK, in which we can provide at least a dampening eVect, let us say England, then you can immediately put we might be after the Mid Term Review takes eVect? milk producers, by straightforward government Mr Hind: You are starting from a number of decision, at a competitive disadvantage. So the premises, Chairman. One is the degree to which implementation could send a signal, and it is down prices in this country should or will fall as a result of to the way the dairy industry responds and gets its CAP reform. There is no denying that cuts in act together, hopefully before the full impact of the intervention prices, given that intervention holds up reform comes through. the bottom of the market, will have an impact on producer price, but that is gauged by the extent to Q13 Mr Jack: Can I follow that thinking up? The which the industry is producing commodities that go message is very clear that unless you have 17–18 into intervention products or commodities that are pence per litre, it is not worth producing milk; you 9417811003 Page Type [O] 29-05-04 00:58:49 Pag Table: COENEW PPSysB Unit: PAG1
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9 February 2004 Mr Tim Bennett, Mr Terrig Morgan and Mr Thomas Hind cannot be doing it profitably. But in terms of the to pay more. So do not let us talk the market down reform, we may well find that that number, in terms here; let us see what we can do to make sure we of income, reduces below the 17–18 pence. What keep the milk price up. do you think will be either the advice of the NFU or the perception of members who are in dairying Q16 Chairman: Surely, one way in which things as to what they are going to do with their payment. could be made radically diVerent—and there is a Are they going to use it to cross-subsidise the milk, very clear diVerence between ourselves and our or are they going to take, Mr Bennett, your very continental partners—is the balance between liquid realistic and straightforward view and decided it is milk and the value-added uses of milk. This is not worth it and pull out? history, but obviously, in a sense, the history of Mr Bennett: We would all like to know that. In people getting their daily pint and wanting to drink theory, if you de-couple, people stay in production milk has been in decline, as we have said, for some that is profitable to themselves, and the natural considerable time, but other uses of milk are at response would be for farmers to change their least steady, if not increasing. How do farmers get business, with the benefit of the de-coupled access to the value added chain, given that, because payment, to produce what is profitable, and I think of the numbers, they are still in a weak position to a lot of people will do that. be able to influence that value added chain? What can they do? Mr Bennett: Obviously, in terms of the continental Q14 Mr Jack: Is that not part of the problem? In model, producers tend to own a lot of their own another inquiry that this Committee did, we had processing. That has not been the model in this the benefit of hearing from Farmcare, a massive country. But it is vitally important, whether we own dairying organisation, which has made public the processing or not, as producer co-ops, that the statements about pulling out of production plcs in this country get into that added value, altogether. As far as they are concerned, it is not because obviously there is evidence that if they are profitable. There you had one of the biggest selling their milk for more, they can aVord to pay dairying companies in the country saying it was not the producers more. Whether they pay as much as worth doing it because it was not going to pay. If they could do is an issue that we can perhaps it is not worth them doing it, where does the rest debate, but the point is, we all need to be successful of the industry lie? businesses, from the dairy farmer to processors, if Mr Bennett: The point I was making earlier to the we are going to survive in the post-CAP world. Chairman is that it is very important that the signals—even more important now as we are Q17 Mr Jack: Can I just follow up the Chairman’s moving into this de-coupled world and the phasing comments? I am intrigued. If I look at the structure in of the cuts in terms of intervention prices in the of the UK dairy industry, the innovative, high next three years—that the supply chain really does value-added end, for example the company Mu¨ller, give clear signals about the amount of milk it wants there is no way I could see the co-operative and what price it is prepared to pay, and that those structure that we have moving into such a high-tech signals come through. Ultimately, people will not business at this particular time. I would like produce year after year to lose money, so if people somebody to lay down for me in simple terms how want a British dairy industry, they have to be it is that UK dairy producers, farmers, are actually prepared to pay for it. going to move up the value chain, because the structure of our dairy industry is locked into the Q15 Mr Jack: That is fine, but if we are going to fact that we have these three distinct parts— see a reduction in the price of milk because of the retailers, processors and producers—and I do not see, even with the attempts that have been made by de-coupling exercise, does it not mean that it is some co-ops to have a degree of vertical going to be less and less profitable and more and integration, a route leading to high value added, more people will fall oV the edge? innovative production. How is it going to be done? Mr Bennett: That is assuming that the milk price Mr Bennett: You are quite right that most of the has to fall. We are talking about a cut in what I co-ops themselves, in terms of their investments, call the commodity products, the intervention side, tend to be in the commodity end of the market, and the butter and skimmed powder. Surely, if an it is very diYcult from scratch, which is where we industry is moving away from those products and are doing it, if you think about deregulation, to adding value and trying as well as possible to actually get a large percentage of your business into produce products that the consumer and the added value. That is what I think a lot of their customers pay more for, then you can buck that business plans would be. But that is not actually trend. If I may say so, there is a precedent for that, the only model. There is plenty of evidence around and that is the beef reform of some years ago in the world—indeed, in the United States they are the CAP, which was about giving compensation for moving away from the co-op, vertically integrated price cuts. The compensation came and the falling model to joint ventures with large plcs, which work beef price in this country did not equalise the very well. It is about trust and about sharing the compensation that was given, because the benefit that comes through from producer right up marketing and the demand for beef and the quality to the customer. Frankly, I think that is the lesson of the beef was such that the consumer was willing we have to learn in the British dairy industry. 9417811003 Page Type [E] 29-05-04 00:58:49 Pag Table: COENEW PPSysB Unit: PAG1
Ev 10 Environment, Food and Rural Affairs Committee: Evidence
9 February 2004 Mr Tim Bennett, Mr Terrig Morgan and Mr Thomas Hind
Q18 Mr Jack: This concept of sharing is all very type of production with value added that you have well, but of the evidence that we have seen, there described. If that is the case, what is the are many who have, for example, indicated that recommendation of the NFU to its members as to either retailers or processors have not been terribly how that should be done, or is there a message to good about sharing any of the increases in price government that we need to see some structural which have occurred as far as milk is concerned. So changes in the dairy industry to allow this kind of I am intrigued to know how this wonderful, cosy innovation to flourish? world of sharing is going to increase the producers’ Mr Bennett: It is not for the NFU to tell its returns, to give the profitability to which your members how to run their businesses, but it is the earlier comments referred. NFU’s job to make sure that they are not stopped Mr Bennett: You are quite right that the retail by the Government, for example, in restructuring spread, that is, the margin take, has tended to to make sure they can compete with others, and concentrate towards the retail end in the last few frankly, within the British dairy industry the OFT years, and they have taken a larger slice of the milk and the Competition Commission need to look price. But I repeat, we are going to be in a diVerent around the rest of the world and see the structures world post CAP. To some extent, people have been that are developing and need to actually allow given some de-coupled payments to take business structures to develop in the UK that will give us decisions, and people will not produce milk over a the opportunity to compete with others around the period of time unless it is worth them doing so. So world. I do not know what that model is, but all frankly, there is every incentive to make sure people too often they seem to be obsessed with the size value their producers and pay them a price that is relative share of the UK market rather than worth them staying in business. concerned about how other people, our main competitors around the world, operate. I think that applies, incidentally, in terms of producers but also Q19 Mr Jack: Does that then mean that we have processing companies. to revisit the OFT territory about the structure and Chairman: Can I thank you on two counts: one, for the nature of the dairy industry in the United coming to give evidence to us, and secondly, for Kingdom? The message that you are almost giving being so precise that we are on time in our half- is that an individual farmer and a cheque will not hour skirt around the issues. As always, what you be enough to transform their prospects in value have said cannot be undone, but there may be added, unless they have some superb, niche, pieces of supplementary evidence that you wish to localised product which they can move forward. send us, both as a result of today but also on what There are some examples of that taking place, but others may say, which no doubt you will be able that is going to be limited. It will be a co-operative to find out, so that we get the fullest picture eVort of some sort with farmers to take forward the possible. Thank you again.
Memorandum submitted by the Royal Association of British Dairy Farmers (L10)
Executive Summary
The inquiry is welcomed as it takes place against an extremely diYcult economic background for dairy farming which in addition now faces substantial change and challenge as a result of the forthcoming CAP reform. Since de-regulation, the market for milk has not functioned according to the usual “laws” and the structure of the dairy industry has resulted in dairy farmers being reduced to price-takers. The Committee’s attention is drawn to the lack of transparency shown by retailers in milk pricing compared to dairy farmers where the cost of producing a litre of milk is widely published. Traditional methods of calculating milk production costs underestimate the true costs often by 20%. The dairy food chain is urged to better understand the true costs of production as demonstrated by the new RABDF Guidelines for Dairy Costing Schemes.
Issues:
1. The Royal Association of British Dairy Farmers (RABDF) is the only UK independent body representing the interests of specialised dairy farmers and dairy farming generally. Membership is dominated by dairy farmers but includes representatives of the service and supply industries. The Association welcomes the Committee’s inquiry which takes place against a background of dairy farming experiencing serious financial diYculties. 9417811004 Page Type [O] 29-05-04 00:58:49 Pag Table: COENEW PPSysB Unit: PAG1
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2. Since de-regulation in 1994, dairy farmers have had to manage their businesses in a climate of considerable change with much re-structuring taking place within all segments of the dairy industry. In addition, the forthcoming radical changes CAP reform will undoubtedly bring add to the uncertainty and make business planning very diYcult. 3. Over and above all of these challenges has been the issue of milk pricing. Those responsible for the production of milk have had little influence on the price they have received. They have been and remain price-takers. For the vast majority of dairy farmers the last three or even more years have witnessed a milk price below the true costs of production. The word “true” is emphasised in this context and this response will return to the point later. 4. It is puzzling why, in a country with a relatively aZuent population, with milk production areas reasonably close to urban ones, where the eYciency of milk production compares very favourably with leading dairying countries, the UK milk price sits at the base of the EU milk price league table. 5. The Committee will appreciate the diVerences between the UK dairy industry structure and that of most other developed dairying countries, including those within the EU. Considerably more vertical integration has taken place elsewhere than here resulting in overseas producers being closer to the end market and thus having greater influence on milk price received. 6. For historical reasons the UK has three layers within the dairy market structure: producers, processors and retailers. Each requires a share of the milk price, the share being driven by the degree of influence. The size and power of the small number of large retailers is well recognised. They set the retail price, the price- makers, negotiate milk purchase in the main with a handful of processors who in turn deliver a milk price to the UK’s over 20,000 individual producers. It is a wholly unsatisfactory arrangement. 7. The UK lives with a further anomaly. The costs of producing milk are widely available to all within the industry, processors do not declare their costs but they can be estimated, but retailers demonstrate no level of transparency whatsoever. The point has directly or indirectly been made by many studies into the milk industry. 8. It is appropriate to comment that the producing side of the industry has since de-regulation recognised the need for a “trade representative body” to mirror for example the processor’s association, DIAL (Dairy Industry Association Ltd). The Federation of Milk Groups (FMG) has been formed but it has found the pathway to represent all milk selling groups a diYcult one. 9. The Committee will no doubt receive many responses from well-qualified organisations on the economics and dynamics of the milk market and the eVect milk price has had and has on the structure of the industry. The RABDF will leave those issues to others but will focus hereon on a specific issue that has not been fully understood by all involved in the industry, that is, the true costs of milk production. 10. The recent KPMG report, commissioned by the Milk Development Council, on prices and profitability in the British dairy chain, specifically identified problems with the current independent studies of milk production costs. Indeed this Association has for some time expressed serious concern over statements frequently made in the press and elsewhere that producers can still make a profit and have enough to invest at a milk price of about 16 pence per litre. As a result, “The RABDF Independent Guidelines for Dairy Costing Schemes” were published last autumn. The Guidelines were developed in conjunction with and endorsed by the consulting and dairy farm data recording segments of the industry. 11. The dairy farming industry has since the days of the “February Price Review” declared its milk production costs to Government and the industry in general. In doing so it developed a set of criteria, a data set, relevant to the time. The practice continues through the Government commissioned Economics of Milk Production Studies together with reports from a wide range of consultancies, accountants, auditors and other recording bodies. Most have continued to use the same approach. 12. Much of the terminology used is peculiar to this industry and would not be recognised by an average British business outside agriculture. Furthermore, most reports on milk production costs do not adequately take into account paid or unpaid management. It is not uncommon for the costs of producing a litre of milk to be published or stated which exclude the costs of the farmer’s own labour and management inputs. In doing so the true costs of milk production are underestimated by as much as 20% thereby seriously misrepresenting the financial viability of the dairy farming industry. 13. The new guidelines for dairy costing schemes have standardised the data set and included appropriate remuneration for the farmer’s own inputs, before stating the cost of production. 14. It is accepted that milk price should be a feature of supply and demand. However as previously described, in our opinion the structure of the industry does not allow the market to function appropriately. There can be little doubt that those who set the milk price are well aware of the published information on milk production costs which must have a bearing on the price paid. We urge that all in the dairy food chain develop a better understanding of the true costs of milk production. 9417811004 Page Type [E] 29-05-04 00:58:49 Pag Table: COENEW PPSysB Unit: PAG1
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15. The average milk price received by dairy farmers in recent years cannot result in a sustainable dairy farming and therefore wider dairy industry. It is essential that as far as possible everyone involved in the dairy food chain should better understand how much it really costs to produce a litre of milk. This alone would make a contribution to the relationship between market and farm-gate price. January 2004
Witnesses: Mr Tim Brigstocke, Chairman, Mr Andrew Chadwick, Elected Board Member and dairy farmer, Mr Robert Clarke, Elected Board Member and dairy farmer, and Mr John Sumner, Policy Advisor, Royal Association of British Dairy Farmers, examined.
Q20 Chairman: You have the benefit of my earlier really. Whatever parameters you might like to take, remarks, so I hope you understand we will try to including genetic improvement and feeding keep to the same track record, but I think it would be technology, then I think we compare pretty very useful if you would just introduce who is giving favourably with the rest of Europe. evidence, and also, because we do not necessarily take as much evidence from yourselves as we do from the NFU and others, say a couple of things Q22 Mr Breed: What about outside Europe? about the organisation. Mr Sumner: If you look outside Europe at the main Mr Brigstocke: I am Tim Brigstocke, and I am dairying countries, we look at New Zealand as a Chairman of the Royal Association of British Dairy main competitor. If you wish to talk about Japan, I Farmers, which for ease we will call RABDF. On my do not think the comparison is too important. far left is John Sumner, who is our Policy Advisor. On my immediate left is Andrew Chadwick, who is Q23 Mr Breed: Perhaps America and New Zealand. a dairy farmer with 200 cows in Cheshire, and on my Mr Sumner: If you look at America, we have the right is Robert Clarke, who runs a family unit of 120 same sort of herd size and the same sort of structure cows near Preston. Both Andrew and John, as well as they have in America. New Zealand obviously has as myself, are directors of RABDF, and Robert is a larger herd size, but they have quite a diVerent set also a director of Dairy Farmers of Britain. Our of circumstances in terms of production and, I think main activity as far as RABDF is concerned is in terms of technical eYciency, we can probably hold running the Dairy Event, which is the major our heads up and say we are as good as they are. technology transfer event held each year at Stoneleigh, where we have about 14,000 attending a two-day event, with about 400 trade stands. So we Q24 Mr Breed: I know it is very diYcult to make are very much involved as an organisation in strict comparisons because of the diVerent ways that technology transfer as well as responding to they look at butter fat and everything else, and consultations. We have an annual conference, which therefore there will be some slight variations, but is well known and is perceived as the Oxford farming when you look at our prices and what farm gate equivalent for the dairy sector, and we have also prices are here compared to New Zealand, there is an recently done two things which may be of interest: enormous diVerence, yet their dairy farmers are first, we have received funding under the clearly making at least adequate profits. How might Agricultural Development Scheme from Defra to do you explain that? director training in the milk group sector, so that not Mr Sumner: There is a big fundamental diVerence just existing directors but aspiring directors are between the countries you have just described. If you properly trained in how to run farmer-controlled look at New Zealand, most of their milk is produced businesses, and secondly, we have done quite a from grass production; they do not have to provide detailed evaluation of the costs of milk production, winter housing conditions for their cows. They also which has received a number of plaudits from the have an industry that is geared up to exporting most industry. of their product. Eighty-five per cent of milk Chairman: Thank you for that. That is very clear. produced in New Zealand is exported elsewhere, so We are going to stay in the same vein of looking at there is quite a diVerent culture in terms of milk the eYciency of the industry, perhaps with some production to the one that we have in the UK. international comparisons in mind. I will ask Colin Mr Chadwick: I do not think we are ever going to to take up the questions. compete on price with the New Zealanders. Partly because of climate, partly because dairying in New Q21 Mr Breed: In your evidence, you claim that milk Zealand is a very important industry, but they production in the UK compares very favourably cannot supply the whole of the world market, with other leading dairying countries, but how however hard they try. We cannot compete either eYcient really is our milk production, particularly with parts of Australia. We are much more when you compare it to producers outside the competitive with the United States, but the United European Union? States is changing. To over-generalise, it is moving Mr Sumner: Chairman, if you look at any set of from east to west dramatically. If you go to parameters, the structure of the UK dairy farming California, there are several herds of 4,000 cows, all business is strong. We have a higher than average milked in a factory system, with entirely Mexican herd size compared to Europe. We have the same labour, except for the owner, who is normally a first, average as in America, not that that says too much second, or third generation Dutchman. We do not 9417811005 Page Type [O] 29-05-04 00:58:49 Pag Table: COENEW PPSysB Unit: PAG1
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9 February 2004 Mr Tim Brigstocke, Mr Andrew Chadwick, Mr Robert Clarke and Mr John Sumner have the ability to have those very large units, and supply of milk in the UK declining and actually they would not be socially acceptable here. It is threatening the UK’s ability to even feed its own going to be more diYcult to compete with the States. people with the healthy, nutritious food that milk is. Mr Brigstocke: To add to that, Mr Chairman, I think the welfare standards that we have to operate Q28 Mr Breed: Are you entirely happy with the in the UK are quite diVerent to what happens in New current quota? Zealand, and particularly North America. It is Mr Clarke: I think the way that the quota system has interesting that Dick Sibley, who has recently, last been implemented gives a false restriction in the week, won the Princess Royal Award for his marketplace. Supply and demand at the end of the outstanding contribution to the dairy farming sector day should regulate the market. When you have one as a vet, has recently been to North America to look issue like quota, and the perception that you should specifically at cattle health plans, and was horrified produce to the country’s quota, it stifles many of the at how bad the North American situation was. innovative and forward-thinking developments that can go on, particularly in products and in terms of product development. We have to educate—and Q25 Mr Wiggin: Can you tell us how bad it is in New producers have to be educated as well—to Zealand? We hear this a lot, but there is never much understand that “market” is not necessarily evidence. “quota”, and we should be producing to the market Mr Brigstocke: Really, as Mr Chadwick has just and not to quota. said, there are practices that are acceptable over there that would not be acceptable over here, such as tail-docking, for example. The very extensive Q29 Mr Breed: I think you mean by that you would conditions that operate over there, that animals do be quite happy if quotas went? not have to be housed, over here just would not be Mr Clarke: On a personal level, yes. As an acceptable. organisation, yes. Mr Chadwick: Personally, I think, if the MTR comes in, and milk prices fall, as most economists expect, Q26 Mr Breed: As you may be aware, the Committee to about 15 pence a litre, quota, although formally went there not so very long ago and we did look at there, will be irrelevant; we will not be producing to that. They use a very low-cost system, in almost quota. That is my guess. every respect. Chairman: Obviously you heard us ask a number of Mr Brigstocke: They do. It would not be acceptable. questions, understandably, on market structure, which is key to this whole area. I am going to ask Bill to follow those up. Q27 Mr Breed: They have hardly any labour, low concentrate, and it is a totally diVerent system. Q30 Mr Wiggin: To what extent would the problems Nevertheless, I think we are wrong sometimes to try of low farm gate milk price be addressed through and emphasize the animal welfare aspect, which may vertical integration and breaking what you call, I be slightly diVerent, but I think it is the fact that they believe the price taken mould? have a low-cost system and their yields are much Mr Clarke: The important thing to remember is that lower, but at the end of the day they produce more the implementation of the trust that you have heard profit. Can we look at the quota system in terms of previous speakers talk about and the level of the way in which it might distort the market for milk cooperation that we need to achieve is not going to in the EU, such that it may in eVect protect the more Y come about by any political solutions; it is going to ine cient producers in other EU states, which are come about through commercial solutions. It is perhaps kept in business, which may disadvantage important that we do not have any blockages in the UK dairy farmers? Do you have any comment on way of that. We need to look carefully at how that? competition legislation is implemented and how that Mr Clarke: I think it is important to remember that is applied throughout the food chain, because if we the UK market is one of the highest in percentage are going to see producers being able to change their terms of domestic fresh and liquid products, and fortunes by investing in processing, in forming that gives a slightly diVerent relationship between relationships with both retailers and with the producers and their ultimate market, or should established processors, to actually take more part in do. From the point of view of the quota implications the chain, there has to be a level of stability, and the and the way this Government and previous current pricing level does not really give them the governments have implemented quota regulations, ability or the confidence to go forward. we have discrepancies across the various European Mr Sumner: Chairman, if I can support that, if we states as to how they have been implemented. I think look back over the history of the dairy business since we have to concentrate really on protecting the UK deregulation, since 1994 the industry has been market for the British consumer. I am sure the severely constrained by competition law. If we are British Government will want to ensure that their looking forward as to how the industry might electorate has a constant supply of cost-eVective, develop, then we would ask the Government to look safe product. Issues like food security are going to again at the way it applies competition law to the come more into play. There is a great danger if some dairy industry, in that it does not present any of the implications that previous contributors have unnecessary boulders in the way of development of indicated to you could happen in terms of the total the structures that we need within our business. 9417811005 Page Type [E] 29-05-04 00:58:49 Pag Table: COENEW PPSysB Unit: PAG1
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9 February 2004 Mr Tim Brigstocke, Mr Andrew Chadwick, Mr Robert Clarke and Mr John Sumner
Q31 Mr Wiggin: Have you talked to the from the producer side of moving rapidly beyond the Competition Commission about this? Do you think basic commodity-type market into value added. Is it that they would stand in the way of that sort of feasible to do that? integration? Mr Brigstocke: I am going to ask Mr Clarke, as a Mr Sumner: We have not talked direct to the director of Dairy Farmers of Britain, to answer that. Competition Commission about this particular Mr Clarke: Firstly, I am here as a producer, not as issue, but we did give evidence as an organisation a director of Dairy Farmers of Britain, but with the when Milk Marque had its inquiry. We had a slight benefit of some of that experience, you are right that concern that the competition authorities do not the implication of the report was not to stop vertical always carry over one message to another. Another integration. The point I was making earlier was that, competition inquiry that we gave evidence to did not in the interpretation of the legislation, which sets know the outcome of the Milk Marque inquiry, percentages for market share, in the interpretation which gave us a little bit of concern. But no, we have of what constitutes the market when you are not given evidence to them, but we would welcome measuring market share, that is where we need to the opportunity to do so. have a clearer understanding. If you take a very Mr Brigstocke: From some informal discussions, we narrow understanding of what market share is, that have been led to believe that they appreciate that the precludes a lot of the collaborative work that many dairy industry has changed quite appreciably since producers want to see happen. If there is a will to the demise of Milk Marque, and therefore it might have the widest possible understanding of what is be a fair time to re-look at the whole situation. market share, then the market structure in the country would develop in terms of getting producer organisations and selling organisations down, from Q32 Mr Jack: Just refresh my memory. I thought many teams of diVerent organisations not only to that one of the main reasons why we got the changes single figures but down to two or three, to be more that occurred second time round was that the eVective in terms of their equal status relationship Competition Commission, in their report, made with the rest of the chain. adverse comments on the way that Milk Marque abused its market position, and it jumped, if you like, before it was pushed, and we ended up with the Q34 Mr Jack: We got into this inquiry because there three co-op solution. Perhaps you could refresh my was a perception that farmers were not getting a fair memory as to where there are words from the deal out of the existing supply chain, and you can competition authorities to say “Thou shalt not either fix that by getting more of somebody else’s vertically integrate.” share, or by being much more price setters for products than price takers. That is why I am Mr Brigstocke: Mr Sumner’s point was that when we exploring what can be done, and I have to say I have were giving evidence on a diVerent inquiry, the not had a clear indication, structurally speaking, as people asking the questions had been involved in the to why, from the producer point of view, we can go Milk Marque decision and wanted to know our further up the chain. It may well be that there are opinion as an organisation about what had actually capital constraints, but we will come back to that. happened once Milk Marque had disappeared. That Let us talk about the question of profit. Dairy was the point he was trying to make. farmers are very open people. The cost of producing Mr Chadwick: I think you are right. Milk Marque milk is a never-ending topic of conversation, but the was found to have abused the thing. By the time the margin, for example, that other people make, either Competition Commission came to that finding, it on the producer side or on the retailer side, seems to had already lost its power and influence anyway, but be a hidden secret. We did actually get some I think what came out of it was two things: one, the evidence from Robert Wiseman, who claim that Competition Commission makes a decision, largely their take is relatively moderate; they are talking on legal grounds as far as I understand it, and it V about a net margin of 2.2 pence per litre; Arla Foods never returns and looks at the e ect of its decision; quoted us a figure of 1.2 pence per litre. Are those there does not seem to be any mechanism, from our fair returns for those people, or are they being greedy discussions with them, by which five years on they at the expense of the primary producer? can look at their decisions and see what has Mr Clarke: I do not think it is a case of being greedy. happened commercially, however justified legally. I think people need to have a fair share. I am not here The second point is I think they have certainly put to represent the two companies you mention, but the wind up the directors of the co-ops—and I am that would not be excessive, and it would certainly not one—and certainly, rightly or wrongly, it be our view that producers, being at the bottom of stopped them co-operating together. the chain, take basically what is left. If processors are in such a position that they are only able to take that Q33 Mr Jack: I come back to the question I actually sort of margin from the retailer, it obviously asked, which was that I do not recall having read indicates where the remainder of the margin anything that said “Thou shalt not vertically already is. integrate” in terms of looking for this value chain. We will be taking evidence later on from Milk Link, Q35 Mr Jack: Let us explore in a little more detail. who have to a degree climbed out of the bargain When I go into a supermarket and pick up a carton basement producer and are stretching up to do some of milk, I am sometimes quite shocked at how low production, but what I do not see is a lot of evidence the price is. I can buy four pints in my local 9417811005 Page Type [O] 29-05-04 00:58:49 Pag Table: COENEW PPSysB Unit: PAG1
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9 February 2004 Mr Tim Brigstocke, Mr Andrew Chadwick, Mr Robert Clarke and Mr John Sumner newsagent for 89 pence. How much profit is my do talk to retailers, but we do not have any power newsagent making out of that, and how much because as an organisation we do not sell any milk; eventually comes back to you? we just represent the interests of dairy farmers. We Mr Clarke: I do not know what the newsagent is do talk to processors and to retailers, and we try to making out of it. What comes back to me, as a explain to them the mechanics of the dairy business, producer, not quite on the Fylde where many of your but at the end of the day, the five big supermarkets constituents are but close to it, is as follows. We drive the price of milk, and they impose on the currently operate on a margin, before management industry, if you like—and they will obviously have time, of 0.1 of a penny. That is what is left after my very strong reasons for doing so—the price at which milk price. That has not paid for my management they will sell milk. You have described the price of 89 time, and it has not paid for my partner’s labour in pence in your local newsagents. Dairy farmers have the business. In terms of what is coming back to the no contribution to that price at all, and maybe that farm gate price, with me currently receiving 18.89 is part of the reason why we are all here. pence, it is not suYcient for my business to make confident investments for the future. Q40 Mr Jack: That is a piece of description, but I am Q36 Mr Jack: A moment ago when I quoted the intrigued to know from the retailers’ standpoint, figures for Arla and Robert Wiseman you did not given all the attributes that you would say make up balk at it; you did not say “My God, that is the excellent product which is UK milk, that if outrageous!” You said that was supposedly fair. people want to retail—and admittedly milk is a Mr Clarke: If I could have a margin of a penny, or commodity, but we would argue in this country a a penny and a half, on top of my own management very high quality commodity, produced not without income, I would say that was a fair margin as well. certain costs, and therefore that might be a persuasive argument to processors and retailers to Q37 Mr Jack: That is another 0.9 pence a litre, if I recognise that if they want the security of the supply have followed your mathematics. chain, there is a price that has to be paid. Mr Clarke: I said the figure we are at at the moment Mr Brigstocke: Can I just answer that specific was before I paid for myself. I require another 1.5 question? One of the points where we have had a pence to pay for my management time, so we are good dialogue with both the processors and the looking at 3.5 pence. retailers is to do with the costs of production on the farm, because the industry as a whole has rather shot Q38 Mr Jack: Where should that 1.5 pence come itself in the foot by not including the full costs of from? production as far as producing a litre of milk is Mr Clarke: That margin, I believe, can be gained by concerned. The farmers’ own input time has not the processor and the producer working together in been included in many costings, as indeed picked up some sort of relationship to come from the retail by the KPMG study. In our estimation, the costs of sector. There are certain cases where some milk production have been under-estimated by diVerentiation, some better marketing, can grow the about 20 per cent. We have gone and briefed that to various sectors of the dairy industry, and everybody members of DIAL and to the retailers and they have in the chain can have a fairer share. But in certain genuinely not been aware of that. So when we are very competitive areas—and I am sure Robert talking about the costs of production, when we talk Wiseman will give evidence of the fact that he sees about profit figures and things like that, we are not liquid milk as a commodity area, as he has said it comparing like with like compared to us versus the before in public—there should be more margin rest of British industry, and that has been a massive coming out of the supermarkets. problem.
Q39 Mr Jack: What dialogue do you as an organisation have with retailers and processors? Do Q41 Mr Jack: Now you have enlightened them, they have open discussions with you about what what do they do? they are making out of your products? You have Mr Chadwick: Nothing, and there is no legitimate been very open with us in telling us the numbers that mechanism in this country at the moment for raising make sense to your enterprise. What dialogue do milk prices, short of picketing. That is the sad thing. you have with processors and retailers? It is not the market working; it is power. When the Mr Sumner: Chairman, I am not going to answer currency goes in our favour, when the market in your question directly but I would like to make a Europe goes in our favour, the price still does not comment. You were talking about price takers. rise. There is plenty of evidence of that. There is not Dairy farmers are price takers. You made the point a proper market. There is no mechanism for raising very clearly, and Robert Clarke has given his milk prices now. example as a dairy farmer. The price of milk is set by those that put milk on the shelves, and that seems to bear no relationship at all to the costs that might be Q42 Mr Jack: Is it not really the fact that the IMPE incurred in the chain. There are, of course, three puts a floor on the market and that is the price setter? layers in the chain that you have described: the Mr Chadwick: Not altogether. There is plenty of producers, the processors and the retailers. The evidence. We have had milk prices below that. farmer at the end of the day has to take the price. We Why? It is power, basically. 9417811005 Page Type [E] 29-05-04 00:58:49 Pag Table: COENEW PPSysB Unit: PAG1
Ev 16 Environment, Food and Rural Affairs Committee: Evidence
9 February 2004 Mr Tim Brigstocke, Mr Andrew Chadwick, Mr Robert Clarke and Mr John Sumner
Q43 Chairman: Can I just tease out one example? Q44 Mr Jack: Chairman, if I may, in one of the bits Again, in the previous session I was asking the of information the Committee has received there is NFU how they get into the value added chain, but a table of farm gate prices throughout Europe, it is quite interesting, if the figures are to be from a high in July last year for Finland at 34.95 believed, if you look just at cheese. It is estimated euros per 100 kilos down to the United Kingdom that the profit mark-up on cheese is about a third, at 23.91. I do not think Finland and the UK are 33%, of which the retailer takes 28%, the processor directly comparable, but on the other hand, if we 7% and the farmer loses 2%. That is a piece of take Germany, for example, there is a point of research commissioned by the Federation of Milk comparison, or indeed France. France on this Groups, and undertaken by Taylor Nelson Sofres. measure is at 28.94, Germany 27.25. We have a Is that a fair approximation, that farmers on a high common currency argument here. Is it solely value value product are still losing money? One added that makes a diVerence of such magnitude understands they are losing money on the liquid. in these prices, or is it a much more complicated That is not a very good industry to be in, is it? series of issues? What can be done about it? Mr Chadwick: I think there are both elements. Mr Chadwick: Personally, I have decided to get France, for instance, does have a price setting out. I told my colleagues that today, and we told the staV on Friday. We are closing down our final agreement. It is a formalised agreement, so that dairy herd. That is my personal solution to it. For there is a balance of power in a way that we do not the industry, there are two things as far as I see: have at all. either we have a long war of attrition and it comes down to a shortage, or we have some mechanism Q45 Chairman: What about Germany? Any of establishing equilibrium, which I tactfully thoughts on that? suggest to you, although I do not see it happening Mr Chadwick: I do not know. easily, the Government has to concern itself with. Mr Brigstocke: They also have a more complicated Chairman: That is very useful. I am sorry it is a bit price setting formula. The Milk Development stark at the end, but it is probably quite a good Council sponsored a whole report looking at milk point at which to leave things. As I said to the pricing mechanisms elsewhere within Europe and in NFU, I am afraid what you have said will stay said North America as well. but let us know if there are additional points you Chairman: The only other point we would make is would like us to bear in mind, particularly as there that the trend for all countries is downhill, so you will be other evidence sessions, which you will no will have to look at that. Thank you, gentleman, doubt want to read. for your session. Farmers for Action, please.
Supplementary memorandum submitted by the Royal Association of British Dairy Farmers (L10a)
1. We do not wish to present new evidence over and above that given previously in either our written submission or during the hearing. A brief summary of our main position we thought might be helpful in your deliberations.
2. Fundamentally the market price for milk must find its own level based on the usual market forces. However, for a number of reasons, the market is currently not functioning, as markets should.
3. Due to de-regulation in 1994, the producing side of the industry has been re-structuring; a process interrupted by the competition authorities. Mergers and acquisitions have taken place in the processing sector and repeated amongst high street retailers. Further change can be expected in all groups.
4. The likely outcome of the CAP reform dairy package will put considerable downward pressure on milk price and thus dairy farm profitability during the coming years. Further considerable restructuring will be seen. The RABDF urges that, as the producing side of the industry reorganises, Government’s Competition Authorities do not place any further unnecessary barriers in its way.
5. All of this will inhibit the milk market from working in the expected manner. It is our view therefore that a “regulator” should be considered to oversee the dairy food chain for the next five and perhaps as many as ten years. Such a body could bring transparency to the whole chain whereas at present, only producers cost structures are transparent. It would ensure the market is not unduly distorted whilst the industry adjusts. We point out that it some degree of market intervention is already practised by a number of the UK’s dairying competitors, the USA, France and Germany being examples. 9417811006 Page Type [O] 29-05-04 00:58:49 Pag Table: COENEW PPSysB Unit: PAG1
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6. The degree of change should not be underestimated. Although change will always be a feature of this industry, and a necessary one, we believe that a point will come when the market will work correctly according to the laws of supply and demand. 7. It is hoped that these few paragraphs will help to summarise the RABDF’s concerns over the current diYculties associated with milk pricing. John Sumner, Policy Advisor February 2004
Memorandum submitted by Farmers for Action (L24)
1. History Why have we seen the demise of the milk price? In our view it shows a complete lack of understanding by so many who control the so called food chain. One only needs to go back 10 years when all those in the dairy chain were getting a return for their capital invested and labour employed. Why has this changed? In our view the main cause has been a major lack of co-operation by the primary producer. But we also believe competition law has prevented co-operation on a large enough scale by producers to take on the immense power of both retailers and processors.
2. Current Situation We are told by retailers continually we must strive to take cost out of production to become more eYcient. This we think the industry has done but as a business you can only go so far. Unless you take the option most dairy farming families have done, which is to work for nothing, we are seeing an ageing industry in both its people and the equipment which is needed to produce the raw material. This has a dramatic eVect on not only individual families but also the rural infrastructure. Over 30 families can in one way or another be linked to one dairy farm.
3. Why All this is happening yet year in year out, both the processing sector and the retailers turn in substantial profit. Whilst the primary sector collapses, in 1996 four pints of milk at a supermarket retailed for 108p. There was no consumer resistance to this figure. Yet today we see it being sold for between 89p–£1. This has happened just so the retailer can get the shopper through their doors. This then puts pressure on the processing sector who rather than see their profits fall, lower their producer price.
4. What can we do — FFA believes there should be a strong regulatory body controlling the retail sector. — The government of the day needs to look at how it can encourage primary producer co-operation. It must provide some type of new entrant scheme as happens in other EU countries. — This would hopefully encourage young people into the industry as they are so desperately needed. — We as producers need to change the way we market our product. We need to keep more control up to end processing. We also need to integrate more with retailers so again we have some control at final retail sales point. The industry as a whole has to be turned inside out. What we have is not working, we have too many people who are deriving a good living from milk yet put very little back. Our marketing on a global scale is poor. There is little or no generic advertising and we lack innovations of our product. FFA firmly believes dairy farming has a future but only if producers keep more control of their product.
Farmers For Action—WRITTEN EVIDENCE I have deliberately avoided facts and figures from this evidence as I am sure others will have supplied the committee with more than enough. FFA wants to change the current situation being felt by most dairy producers but it is very diYcult for us to go forward when so many people keep building walls to prevent this from happening. David Handley Dairy Farmer Chairman Farmers For Action February 2004 9417811008 Page Type [E] 29-05-04 00:58:49 Pag Table: COENEW PPSysB Unit: PAG1
Ev 18 Environment, Food and Rural Affairs Committee: Evidence
Witnesses: Mr David Handley, Chairman, and Mr Mike Haskew, Vice Chairman, Farmers for Action, examined.
Q46 Chairman: Welcome gentleman. You know the retailers and food service sectors that they were not format. You know what time constraints we are required, it was only a requirement of the five major under. I think it would be useful, David, if you multiples; and we continually see these games day in, would introduce Mike Haskew. day out. In fact, only a week ago, we as an Mr Handley: Yes, Mike is Vice Chairman of organisation approached one member of the middle Farmers for Action, like myself, a tenant dairy ground retailer to ask the question had he passed farmer and has been active with the FFA since its back the money. He produced the memo to show conception. that his processor, supplying processor, said he was not required to do so, they were not looking for any Chairman: We are going to go straight into looking increase but they would like to be sure that their at the issue that you have identified, which is quite volume would continue to go to that particular clear, that the farmers do not get a fair slice of the middle ground retailer. reward. So, I will ask Bill Wiggin if he can ask: why? Q51 Mr Wiggin: The same is not absolutely true for Q47 Mr Wiggin: What proportion of the recent cheese producers, is it, because, of the eVectively 2 increases in milk price on liquid milk are the farmers pence a litre, at least 1p or 1.4p has got back to the getting and what proportion are they not getting? people producing milk for cheese. Is that the case? Mr Handley: Of the most recent, there has been a Mr Handley: That is correct. variation from about 1.4 pence per litre on the 2p back to one co-operative being unable to pay any to Q52 Mr Wiggin: Why is it that the cheese people can their producers. There has been, you know, that get it right and the raw milk for consumption do not? variation, I think, over the last three years. Every Mr Handley: Well, I would argue the point that the time that there has been any form of increase, there cheese processors have not got it all right. There are seems to be a proportion which has failed to get back questions still being asked this day of the last 2p that to the primary producer, although the retailer has we achieved in October, as to where all those monies indicated, at every stage of the negotiation, that they are. There were, in fact, cheese processors who wish that money to come back in full, but because we committed the full 2p in October—that they were have such a complicated system that never appears going to pay it back should that negotiation be able to happen, and when any of the processing sector are to be successful—and when we found that we were asked the question why, all we ever get is a successful, because one processor then decided to set complicated answer which the majority of us find the target level of what he was going to pay his very diYcult to understand. producers, that first processor then went back on his word and said, “Well, I can only pay what the rest Q48 Mr Wiggin: Part of that is because not all of the, are paying.” I think what that really shows is what say, 2p a litre actually translates back. Would you sort of cartels take place out in the market place. I like to say a little bit more as to why this is the case? fail to understand why we have an OFT and a Mr Handley: I find it very diYcult. If you go back to Competition Commission that pounce on us as just over three years ago when there was a producers the minute we try to do anything, and yet substantial milk price increase on both liquid and others, in both the retail sector and the processing the cheese markets of 2 pence per litre, firstly, every sector, seem to be able to get away with it. producer in the country received the benefit of that. Over the last three years there have been at least Q53 Mr Jack: Can I just ask, Mr Handley, you have three initial alternatives where substantial amounts been a stalwart advocate for the dairy farmer, and it of money have been passed back through the chain is a pleasure to see you face-to-face and not just on but do not appear to have come back, as they did the television; but if I listen to the rhetoric from the three years ago. We as an organisation have asked industry, I am left coming to the conclusion, why that question of many, and as yet, today, I could not does anybody bother? If it is so bad and the returns give you a clear and concise answer why that has are not good, as we heard from our previous been. witnesses—proper returns are not being made—you might as well pack up and go. Why carry on? You Q49 Mr Wiggin: Given that liquid milk sold through seem to be defying what I would call financial supermarkets accounts for only about a quarter of gravity. You ought to have gone out of business ages the UK milk market— ago, yet here you are, happy, smiling; you look in a Mr Handley: Correct. prime condition of health. If it is that bad, how do you look so good? Q50 Mr Wiggin: —you could expect that only a Mr Handley: That is a diYcult one to answer. I am quarter of the price increase would come back; but sorry I look so good. If I come again I will try and that is not right either, is it? look a bit rougher. I think the situation is that you Mr Handley: Well, no, because again there is this have to look at farming in a totally diVerent context misconception that this has only ever been the five to any other industry. I think farmers are a diVerent multiple retailer-led initiatives. In fact what we breed—food producers, I like to call them—but they found in July when we pushed forward for a liquid actually take a great deal of pride in what they do milk initiative, we were finding that certain and I think they are very proud people. Certainly in processors were actually telling middle ground those that are owner/occupier, it has probably been 9417811008 Page Type [O] 29-05-04 00:58:49 Pag Table: COENEW PPSysB Unit: PAG1
Environment, Food and Rural Affairs Committee: Evidence Ev 19
9 February 2004 Mr David Handley and Mr Mike Haskew passed down through generations and they feel they nothing to take the industry forward. Whenever we must fight to try and continue that to the next come up with an idea, a brick wall is put in front of generation; but I think also from our perspective— us. I think Mike would probably like to comment on and if you want to take my own personal one idea that we think could the take industry perspective—I strongly believe that there is no forward. necessity for us to be in the position that we are in Mr Haskew: We are not marketeers as farmers; we today. There is enough money in the industry if it are farmers. We have got a back track-record of was to be passed back in a fairer manner. marketeers. We have to accept that. We also have to accept that a lot of the farming industry does not get Q54 Mr Jack: Let me stop you there and be on with one another. I believe that we ought to be provocative and ask this question. I have now heard given corporate marketeers to actually market our two sets of witnesses talk about the concept of products on behalf of farmers, and that is why I fairness. Define for me—going back to my propose, or Farmers for Action propose, that we set newsagent with his 89 pence for four pints of milk— up a professional marketing agency where we get a break down, roughly speaking, what is fair. Who team of corporate marketeers in this agency and we should get what? Have you done any calculations as channel most of the milk through this agency. It puts to what you mean by fairness? us on a level footing with the retailers and processors Mr Handley: I think fairness should be—as Sir Don as far as size is concerned and controlling a lot of the Curry rightly pointed out, this is a food chain—that raw materials in the industry, and we can then get all sectors of the food chain were able to get a return respect from the powerful retailers and processors on their capital invested, their labour employed. We that a fair price can be had by everybody in the have a situation at the moment where two sectors industry. At the moment, what is happening is that appear to be able to do that because they dominate, we have been taken advantage of as farmers because and yet the primary producer, the very individual we are the weakest link—for no other reason than they need, is unable to. It is a very simple question, that. The market is over-competitive. What is as far as I am concerned, to answer why that is. It is happening is that you have got processors going out because producers inherently will not work together. there and trying to increase market share: so they are discounting their products to get an increased Q55 Mr Jack: Let me ask you this question. I used market share but then the producer is being made to to be in the horticulture industry before I came into pay for it. We have got to stop that happening. One Parliament—it was the unsubsidised part of of the ways, as I say, we think that can be stopped is agriculture—and I used to negotiate the price of for British dairy farmers to set up a marketing lettuces with Sainsburys and Marks & Spencer on agency of professional marketeers with “Mr Milk” Wednesdays. I know what it is like to be a price- at the top and channel a lot of the milk through that taker. At the end of the day, you have to make a marketing agency. decision as to whether you sell what you have got or have a field of rotting lettuces. So you therefore say, Q56 Mr Jack: It goes to show that you do read what “I will attend to the bit I can control and accept that you say. I notice that when you announced this you I am, as a small part of a big industry, unable to said, “. . . to establish a national milk agency staVed influence the end selling price.” So the dairy industry with marketing experts to sell all the milk at the best is characterised by people who want to make a lot of price possible and return a fair proportion of that comment about what the retailer is doing and saying that the chain of returns is not good enough for price to producers”. That is a very powerful phrase. How do you think the OYce of Fair Trading would them, and yet I do not hear a lot from you about V what you think you ought to be doing to control the react to what e ectively would be a monopoly bit that you have an influence upon? supplier of milk? Do you really think that all the Mr Handley: Well, if I could be provocative, you people who have got their deals set up now with obviously have not read the piece of information processors and other forms of outlet are going to that we sent in. I think our industry needs turning fling their entire lot in with you? inside out. We strongly believe that. We strongly Mr Handley: Well, number one, we are not asking believe that producers, whether they like it or not, anybody to fling their lot in with us. Number two, we have got to work closer together. We talk about have spoken with the OFT. We are now in very integration with others: we cannot even integrate strong dialogue with the Milk Development amongst ourselves. As for doing something about it, Council, who I understand have also spoken to the again I come back to the primary producer. They OFT and also to Defra, about how a mechanism like seem to be prepared to sit back, the majority, and this could operate. What Mike has described is an accept what is there for them. We have come up with idea. What we need to do is get the industry, and ideas, and have put them forward to producers, as to when I say “the industry” I mean everybody, to sit how we could take our industry forward, and a good down in a room and almost have an inquiry like this, example of how the industry can go forward is what within house, as to why we are not returning a better is happening in the south-west with Milk Link. We farmgate price. That is one of our major problems. see no reason why others should not do that, but, I We will not, as representative bodies, all sit in the say, again in our written evidence, there are a lot of same room and come out with a concise and clear people out there at the moment who are deriving a answer and an indicator as to what producers have damn good living out of milk and yet are doing got to do. 9417811008 Page Type [E] 29-05-04 00:58:49 Pag Table: COENEW PPSysB Unit: PAG1
Ev 20 Environment, Food and Rural Affairs Committee: Evidence
9 February 2004 Mr David Handley and Mr Mike Haskew
Q57 Mr Jack: Can I ask you, given that co- Mr Haskew: Milk has got an added value in the way operation was a key feature of Sir Don Curry’s that it is a magnet to the consumer to come into the commission and now we have a mechanism store on a regular basis. Nothing else drags the established to encourage the type of co-operative consumer into the store more than milk. So it has got activity to which your agency refers, is that body or a value there far and above its basic value to the Sir Don going to try and facilitate the meeting you consumer. have described to us? Mr Handley: Well, we have another meeting with the Chairman: Obviously, where you do part company Milk Development Council coming up at the end of with some other parts of the industry is that you are February, and I would like to think, if it was as renowned for taking direct action, which Colin is favourable as the first one, which was just before going to ask you about, including my own Christmas, that things looked as though we could processing plant whose chimney adorns my window, put something to the industry and let them, so I know quite well when you are down there. Colin. basically, take the meat oV the bones and see if it can be made to work. Q59 Mr Breed: Back in October FFA organised some direct action around the processing plants, and, certainly down in my part of the world, we saw Q58 Mr Jack: Let me just look at the language you the action there. Can you tell us though what action have used. You have talked about the best price you took as an organisation to encourage first the possible. I seem to recall Mr Andrew Dare some time dairy processors to pass on those retail prices before ago in Milk Marque decided he would like to push you actually decided to take the direct action that the margins to get the best price possible. Nobody you did? complained at 26 pence a litre. I remember at the Mr Handley: I do not think we persuaded anyone time saying to myself, “This is all going to end in into passing the monies wherever they were going to tears”, because it went too far with “the best price be passed. What we did, and what we always do is---. possible”. Have you got any thoughts as to what is We are always given the image that we are an this “best price possible”, and how would you organisation that only goes out and pickets dairies distribute the shares of your labour in terms of this or supermarkets. What we try to do with other best price world you have defined? organisations is negotiate, and, as the RABDF Mr Handley: Well, I am not an individual or an rightly pointed out just now, explain to them what the situation is regarding the industry, cost of organisation, I do not think, that wants to look at production, etcetera, etcetera, and try and get them what has happened in history. We can spend far too to understand that, you know, this situation that we much time on that. On the issue of how we define have got at the moment cannot continue. When that what a fair price will be, I think, at the end of the day, falls on deaf ears, it appears there is only one thing we may need to look at the history and we may need they understand—and that is probably where I to look at the consumer. We had a situation in 1996/ would say maybe government influence could be 1997 where you described that you could buy four brought to bear—and that is, when somebody starts pints at 89 pence at your newsagent where that milk to crack a whip which actually aVects their would have cost you 1.08, and we were seeing no profitability, they sit up and take notice; and that is consumer resistance, no fall in consumption other the reason behind what we did. It was purely and that what had been the norm. We have to ask the simply a push to make something happen. question why we have got down to where we are now and could we get back to where we need to be to Q60 Mr Breed: So you did actually have some debate pay—your words—a fairer price to all those in the and discussion with the processors? chain. I think that issue has been an issue where a Mr Handley: Very much so. retail body is required, or a retail—what’s the word I am looking for—I suppose some sort of body that Q61 Mr Breed: So they were aware that when you is going to control what the retailer is doing. The took that action it was something that may happen only reason that that has happened is because they to them because they had failed to respond to this have wanted increased market share throughout situation where you felt that the full 2p was not being their retail sector, and the way they have done that properly passed on and therefore farmers had no is used milk. We have challenged any of the major alternative, in a way, but to protest and demonstrate retailers to move milk from the back of the store to in that way? up by the check-out, so that the consumer can come Mr Handley: That is correct. One point, Mr in on a daily basis or a weekly basis, buy their milk, Chairman, that has been raised earlier is this issue of bread and eggs and go again. Not one of them will transparency. We have continually over the last take that challenge up. So why is it that the dairy three years asked the industry for transparency, to sector, and may be the cereal and poultry sector, has open their books up for independent analysis so that got to be used as a tool for the retail sector to make we can all see where the transparency is. As Mr Jack massive profit? I think there are a number of issues rightly put earlier, we are very good at giving out that the Competition Commission could be looking everything that we do—in fact I think we are too free at rather than looking at what primary producers are with it—but it would be very interesting to see true up to at the moment, and certainly without looking and actual transparent documentation of where the at an agency. money goes, where their cost of production lies, so 9417811008 Page Type [O] 29-05-04 00:58:49 Pag Table: COENEW PPSysB Unit: PAG1
Environment, Food and Rural Affairs Committee: Evidence Ev 21
9 February 2004 Mr David Handley and Mr Mike Haskew that we can all have a good look at that and then sector that we are meeting with on a regular basis maybe, as an industry, find where the problems are telling us that if they come in and ask for justification and bring them together. for it, it will be paid, but they are not going in asking; and the reason they will not go in and ask is, as Mike Q62 Mr Breed: I hope that as part of this inquiry we rightly showed just now, they are all petrified that may be able to search out some of that information they are going to lose market share. The first one as well. If we can, I am sure it will be welcomed by that goes in, somebody else will come in and take you. Do you think that perhaps taking direct action that business away. That, I think—if ever there was like you did might undermine the wider public anything needed—says that we need a body to watch support for farmers? I think they were certainly what these people are doing. getting a sympathetic ear by many people who began to understand the economics, as such. Do you think Q64 Chairman: The other suggestion you have come direct action might undermine that wider support? up with is this idea for an industry watchdog, very Mr Handley: I would like to give you a comment that much an equivalent of Ofwat. The problem with this was put to me by the ex-president of the Scottish industry though, as the three sessions so far have NFU during some of the action that was taken. He demonstrated to us, is that it is a complex industry. said that he could not quite understand how the If it was just the liquid milk, one could see that if FFA had managed to put so much national debate there were people taking unfair advantage, on both radio and television over the dire straights exploiting others, it would be fairly straightforward, that the industry was in. That is what direct action but part of the problem here is you are not dealing achieved. Certainly, in my role as Chairman of the with like with like—you know, cheese, buttermilk. V V FFA, I meet with a lot of consumer groups—we try All these di erent parts involve di erent prices to V and talk to as many people as we can—and we got di erent parts of the industry: so who is going to the exact opposite reaction that a lot of people said actually be capable of delivering the regulatory we would get. In fact they were delighted to see that powers without it being taken, if you like, back to farmers were getting up oV their rear end and doing pre-1994? Y something about the critical situation that faced Mr Handley: One of the things that the O ce of Fair their industry. Also, a lot of consumers do not realise Trading indicated to us about a milk agency (which the implications of what will happen when the dairy they liked) was the fact that they saw some self- sector—if it carries on the way it is—does collapse. regulation within that, because it gave any form of We have done some research recently to show that watchdog an opportunity to be looking at one there are a minimum of 30 families associated in the marketing outlet although all the other co-ops and rural environment with one dairy farm. What we are quota holding groups would continue to trade as facing here in the future is, I think, the loss of an normal, but the agency would almost be acting as a industry that is needed by consumers, but also there regulator. Again, in the written evidence we have are a lot of other things that are tagged on to that stated, quite clearly, we think this industry has been from which the consumer also benefits which they made complicated. It suits certain people to have it are going to lose as well. complicated. At the end of the day, we have got a product called milk. It is diverse in what can be done with it. Why then is it unique to the UK that we have Q63 Mr Breed: I think many of us agree with you, all these problems? I think you will find that if the particularly the whole aspect of food security industry was turned inside out, if it was streamlined, generally. Finally, I think you gave an indication last if it was brought up to the year 2004 being run by week that there may be some further direct action in people bred to do that job, then I think, as I said the not too distant future. Can you give us any earlier, we have seen with Milk Link—where we update on that situation? have some extremely good corporate people—what Mr Handley: If you ask others in the room to put you can do with milk and there is no necessity to their fingers in their ears, I would probably give you make it very complicated. So I think the industry the date and the time. We had very protracted again has to look at the whole system and why it has discussions with the processing sector on the liquid made it as complicated as it is. I can remember the side following the increase in the price of cheese Milk Marketing Board, and it was never milk. It was indicated to us that because we had complicated then. It is in the last 10 years that it has closed the gap between cheese milk and liquid, there been made complicated. was definitely room for manoeuvring in an upward direction of liquid. We were told that that would Chairman: Okay. We hear what you have to say very hopefully happen in January. The reason for the clearly. As I have said with previous sessions, what comments in the farming press last week were purely you have said cannot be unsaid, but there may be and simply that, having discussed it again with them supplementary evidence from the other parts of the at the end of January, nothing had happened, and industry that you may wish to comment on. Can I with the same excuse as to why it has not happened thank you on our behalf for coming along. Could I as we got pre the Christmas period, we have decided ask Milk Link, who have been mentioned on to tell them, “Unless you move very quickly . . .” numerous occasions, to now come and sing for What we have got here at the moment is a retail their supper. 9417811009 Page Type [E] 29-05-04 00:58:49 Pag Table: COENEW PPSysB Unit: PAG1
Ev 22 Environment, Food and Rural Affairs Committee: Evidence
Memorandum submitted by Milk Link Ltd (L12)
1. Summary 1.1 The Curry Commission referred to a vision for a sustainable farming and food industry, but it stressed that unless farming could be returned to profit none of that vision was deliverable. 1.2 The dairy industry is in crisis because the milk price paid to primary producers is not sustainable. The current cost of production means farmers are struggling to break even. In the last seven years, most dairy farmers’ income has only exceeded the national minimum wage twice and through this period the eVective rate of pay has averaged just £2.90 per hour.1 1.3 Further downward pressure on farm gate milk prices will see an exit of producers leading to pressure on raw material supplies and questions over continuity of supply. 1.4 For dairy farming to survive and therefore to ensure the supply of fresh liquid milk in this country is maintained, the industry must be profitable. This means securing a sensible and sustainable price for the producer. 1.5 This is the challenge facing the industry as a whole and, accordingly, it makes sense for producers, processors and retailers to work together building partnerships and trust which result in long-term stable relationships and collaboration. 1.6 Dairy co-operative Milk Link has forged more eYcient links between producers and processors and retailers as a result of its strategy of vertical integration. 1.7 With a 10% UK market share, Milk Link can’t buck UK and worldwide market trends but it can influence the prosperity of the 2,400 dairy farmers it represents by returning a greater and fairer proportion of the margins in the supply chain to its members—primary producers. 1.8 In an era of change with the probable removal of milk quotas and the continued erosion of milk subsidies, there is a significant opportunity for growth in a global marketplace for dairy businesses with their own processing and marketing resources. 1.9 The dairy industry of the future must be one in which multiple activities and diversity create the potential for the best, sustainable returns to farmers by allowing them to participate in more of the value- adding process as milk is turned into products.
2. The UK Milk Market 2.1 The UK is the 7th largest milk producer in the world and the 3rd largest in Europe. The current UK milk quota is 14.2 billion litres. 2.2 The raw milk sold in the UK is manufactured into a number of diVerent products2, summarised below:
Liquid Milk 49% Cheese 26% Milk powders 11% Other 14% (includes cream, butter, yogurt, condensed milk, other products and disposals) 2.3 The marketplaces in which these products are sold are complex. 2.4 Products such as cheese, butter and skim milk powders are eVectively sold in a world marketplace and are therefore subject to a range of factors influencing price such as currency movements and worldwide supply and demand balances — factors the UK market can do little to control. 2.5 Sales of liquid milk to our domestic market are subject to a diVerent range of pricing factors that the UK market has a greater amount of control over. Around half of all the liquid milk sales in the UK are to the major retailers. The remainder is to middle ground outlets like convenience stores, hospitals and catering outlets as well as being sold via the “doorstep”.
3. Milk Pricing and its Effect on the Industry
3. The dairy industry is in crisis because the milk price paid to primary producers is not sustainable. 3.2 In 2002 the average farm gate price of milk was 17.1 pence per litre compared to 24.9 pence per litre in 1995. Provisional Defra statistics for 2003 show an average farm gate price ranging from 16.0 pence per litre in May 2003 to 19.6 pence per litre in November 2003.
1 Promar National Finance Consultant. 2 Source: Defra, SEERAD, DARD. 9417811009 Page Type [O] 29-05-04 00:58:49 Pag Table: COENEW PPSysB Unit: PAG1
Environment, Food and Rural Affairs Committee: Evidence Ev 23
3.3 The raw milk price paid to the primary producer is aVected by a number of market related factors, for example: — A demand profile for milk during the year that doesn’t match the production profile, which has lead to a negative eVect on returns. — Currency has an impact on the price of both imported and exported dairy products—cheese, butter and powders and aVects the value of Intervention prices for both skimmed milk powder and butter. — Retailers have supported farmers by the introduction of “price initiatives” where consumers are asked to pay a higher price so the increase can be passed directly back to the farmer. However, this can be negated in practice by profit improvement teams and aggressive purchasing policies. — Processors, quite naturally, under pressure from retailers wanting to maintain their own margins. 3.4 But little or no account is taken of how much it really costs to produce a litre of milk. 3.5 Independent reports from analysts KPMG and ADAS/HSBC concluded that it costs the UK dairy farmer between 19 and 21 pence to produce a litre of milk. 3.6 The recent (July 2003) independent guidelines produced by the Royal Association of British Dairy Farmers (RABDF)3concluded that the breakeven point is just over 20 pence per litre and as much as 23 pence per litre if full account is taken of the cost of unpaid family labour. 3.7 Primary producers endeavor to improve their profitability by cost control and performance eYciency improvement in terms of herd size and yield. But although herd sizes and yields have increased (Appendix 1, graph 1), profits remain stubbornly low (Appendix 1, graph 2). 3.8 Primary producers have no eVective mechanism to pass genuine cost increases back up the supply chain, for example, feed, fuel or additional costs resulting from consumer driven measures such as farm assurance schemes. 3.9 The existing milk price is already driving producers out of milk and without some upward, sustained price movement, decoupling is likely to compound this trend. Then the producer can take the money and realise the capital tied up in his/her herd without producing a single litre of milk. 3.10 The real challenge is how to re-address the balance and reduce conflict within the supply chain.
4. The UK Dairy Supply Chain 4. The UK dairy supply chain is fragmented with a number of diVerent players—producers, processors and retailers, in direct competition with each other. This has tended to lead to protracted price negotiations with all parties endeavoring to protect or improve their margin. 4.2 Whilst Milk Link has a strategy of vertical integration the majority of processors in the UK are not producer co-ops unlike many other European and worldwide countries. 4.3 Milk Link’s strategy also aims to reduce conflict in the supply chain. Combining producer and processor elements of the supply chain has helped forge better relationships with retailers. 4.4 Operating in the spirit of Sir Don Curry’s recommendations Milk Link is proving it is possible to work together to build partnerships and trust which result in long-term stable relationships, better understanding and collaboration. 4.5 By operating in both milk marketing and milk processing, Milk Link has enhanced the commercial interests of its dairy farming members. Importantly, it has meant an increase in return to Milk Link members of over 16% (April 2000 milk price: 15.94 pence per litre, September 2003 milk price: 18.53 pence per litre).
5. A Sustainable UK Dairy Industry 5.1 For dairy farming to survive the industry must be profitable and this means securing a sensible and sustainable price for the producer. All players need to understand and appreciate how much it costs to produce a litre of milk and in accordance with Article 33 of the Treaty of Rome “for the producer to receive a fair price for his produce, for the interests of the supply chain be that processor or retailer to operate eVectively and equitably and lastly that the consumer should expect to pay a reasonable price for that produce.” 5.2 Significantly, the increases achieved in the milk price in 2002 (only a matter of 2ppl) had a dramatic impact on farm profitability, which shows that to begin to restore confidence it is not necessary to achieve an enormous increase in the milk price. (Appendix 1, graph 2) 5.3 The concept of sustainability has three pillars, economic, environmental and social.
3 RADBF Independent Guidelines for Costing Schemes. 9417811009 Page Type [E] 29-05-04 00:58:49 Pag Table: COENEW PPSysB Unit: PAG1
Ev 24 Environment, Food and Rural Affairs Committee: Evidence
5.4 The independent evidence suggests that the dairy industry is not economically sustainable given the existing pricing structure. The average age of most dairy units reinforces the fact that there is a lack of investment in milking. There are not the economic returns to support new plant and this is badly needed to cope with aspects of environmental sustainability especially where the handling and treatment of animal waste and silage eZuent are concerned.
5.5 To tackle the consequences of increased herd size towards which producers are being driven requires investment and without appropriate returns this is simply not going to be forthcoming.
5.6 Equally important is what dairy farmers do “for” the environment. Farming maintains over 18 million hectares of diverse landscapes, habitats and food sources for farmland wildlife. The use of inputs, soil, water, waste, nutrient and land management, all aVect the quality of our rural environment.
5.7 CAP reform intends to sever the link between subsidy and production, moving towards payments based on the delivery of agri-environmental targets. Whilst this reform is welcome, change should be implemented in a proportionate and incremental manner. As it stands, dairy farmers simply cannot aVord to deliver increased environmental standards unless the industry returns to profitability.
5.8 Farming is the mortar that binds the social and economic fabric of rural communities with the rural economy. There has been a steady decline in the number of men and women working in the farming industry. In England alone, dairy farm holdings accounted for over 65,000 jobs in 1992, which ten years later stands at less than 45,0004. This threatens to undermine the strength of rural communities across Britain.
5.9 Foot and Mouth Disease (FMD) demonstrated the integrated nature of the rural economy—it is not simply about farming alone but also many related activities. Farming accounts for circa 10% of GDP when food, related leisure and tourism and agriculture service sectors are included. In some regions eg the South West, this figure is greater.
6. About Milk Link
6.1 Between them, the 2,400 dairy farmer members of Milk Link produce around 1.4 billion litres of milk every year, accounting for about 10% of the entire UK’s milk production. On behalf of its members, Milk Link collects, markets and distributes this milk to more than 70 customers, including its own processing sites.
Milk Link processes more than 700 million litres of milk per year and produces more long life milk than anyone else in the UK.
The processing business directly supplies customers ranging from the major multiple retailers right through to specialist retail outlets with products such as long life milk, long life and fresh cream, long life and fresh custard, soft cheese, yoghurt, flavoured milk drinks and a range of milk powders.
6.2 However, with only a 10% UK market share, Milk Link can’t buck UK and worldwide market trends. What it can do is influence the prosperity of the 2,400 dairy farmers it represents by returning a greater and fairer proportion of the margins in the supply chain to its members—primary producers.
6.3 Working with a co-operative provides Milk Link’s customers with a direct link to the farming community, as farmers are both suppliers to, and owners of, the business. Its integrated business structure provides a secure market for members’ milk and generates an additional revenue stream over and above milk production, as raw milk is turned into added-value products. As a co-operative, Milk Link is run on an equitable basis and therefore takes all decisions in the interests of the majority of its members.
6.4 Milk Link intends to continue to develop its processing operations to develop the business interests of these members. Evidence of the success of the restructuring is strong, not least because the two other major UK dairy co-operatives have followed Milk Link’s lead by introducing new constitutions along similar lines.
6.5 For dairy businesses with their own processing and marketing resources there is a great opportunity for growth. The dairy industry of the future must be one in which multiple activities and diversity create the potential for the best, sustainable returns to farmers by allowing them to participate in more of the value- adding process as milk is turned into products.
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Appendix 1 Graph 1 Average Herd Trends 150 7,200
7,000 140 6,800
130 6,600
6,400 Herd size 120
6,200 (litres) per cow Yield 110 6,000
100 5,800 1997 1998 1999 2000 2001 2002 2003 Herd size Yield per cow (litres) Graph 2 Average milk price & profitability £35,000 26.0
25.0 £30,000 24.0
£25,000 23.0
22.0 £20,000 21.0 £15,000 20.0
£10,000 19.0 Milk price (pence/litre) Profits (after depreciation) 18.0 £5,000 17.0
£0 16.0 1997 1998 1999 2000 2001 2002 2003
Profit (after depreciation) Milk price (ppl) 12 January 2004
Witnesses: Mr Jeremy Pope, Chairman, and Mr Barry Nicholls, Chief Executive, Milk Link Ltd, examined.
Q65 Chairman: Welcome, gentlemen. I know, Mr Mr Pope: Thank you, Chairman. I am not sure Pope, certainly you were not here at the beginning. whether I am grateful or rather daunted by that We are trying to keep to half an hour per session. introduction. My name is Jeremy Pope. I am Obviously we are trying as well not to go back over Chairman of Milk Link. I think I perhaps ought to ground which covers your written submission declare one or two other interests. I sit on Don because of the shortage of time, but we hope that you Curry’s implementation group, Sustainable will still feel able to contribute as fully as possible. I Farming Food, and I am also chairman of English think it would be very useful if you briefly introduce Farming Food Partnerships, which is designed to yourself and your colleague and say a few things promote collaboration and co-operation, both about Milk Link, even though, I think, we are fairly horizontally and vertically, within this country. clear what you do and certainly all the other sessions Barry Nicholls is our chief executive, and his have seemed to defer to yourselves. antecedent history was in the food industry rather 9417811010 Page Type [E] 29-05-04 00:58:49 Pag Table: COENEW PPSysB Unit: PAG1
Ev 26 Environment, Food and Rural Affairs Committee: Evidence
9 February 2004 Mr Jeremy Pope and Mr Barry Nicholls than in the dairy industry. Chairman, just by way of Q67 Mr Jack: So, if I have understood you correctly, summary, as you know, Milk Link was established these were increases in farmgate prices that, with in the year 2000 on the break-up of Milk Marque. your thirteenth payment, if one added that back in, We handle about 1.4 billion litres of milk. We have the number would not be one and a half, it would be approximately 2,400 members. In August 2001 we a number greater than that and would move you reorganised the structure of the co-operative along nearer to the dairy processors to whom I referred? continental lines, rather than what one might Mr Pope: The answer is not yet, because we still have describe as the Rochdale pioneer principles, and a substantial amount of debt which we are having to under that system we arranged for there to be a repay over a period of time in order to enable us to diVerential voting system according to the amount develop the business in the way that is ultimately, we of milk consigned to the co-operative. We believe, in the best interests of our members. What I established members’ capital accounts and we would really like to do is to let Barry add some withhold .5p per litre of the milk cheque which is comments to what I have already said. paid into that individual member’s account; it bears Mr Nicholls: A couple of points I would like to make interest and is a fund which is available to them when there. First of all, we do not publish the price that we they leave or retire; and we also established a actually pay our members. The league tables would financial agreement with all our members, under make an assumption on butter-fat and protein which there is a contingent liability if we, the thereby calculating a price that we would, in theory, management, make us mess of it, under which they pay our members. It happens to be that our quality could theoretically have 5 pence clawed back as is diVerent to the national average, so we are in fact security. With those funds we have raised finance paying our members a higher price as a first price and we have purchased a number of outlets initially, mainly in the longlife milk market, where we now than perhaps the league tables would suggest we do. have a leading position, in business to business That is the first point. The second point is that, ingredients and, more recently, we have bought two generally speaking, I think our price is very, very fresh liquid milk dairies in the south-west, which is close to the price that certainly the very close where the preponderance of our milk is produced, proximity major Plc processors to us are actually where it is particularly high quality. I can leave it paying their members. The third point is that our there, if I may. whole strategy is not only about getting our members a fair first price for their monthly milk check, but to be able to move into vertical Q66 Mr Jack: If it is so good to co-operate, how do integration, to be able to earn the 2p that was being you react to the data which has been put before the referred to that perhaps Wiseman are saying the net Committee by the Federation of Milk Groups, who margins are, for us to be able to pay that back to our have stated to us that farmers supplying direct to members as a thirteenth payment or a dividend at liquid dairies have, on average, gained more than the end of the year by way of their milk price. those farmers who supply co-ops? By way of illustration, on the period September 2000 to July 2003 they provided us with a table showing the price Q68 Mr Jack: So your argument would be that there increase in pence per litre, and top of the tree is are some long-term advantages, in terms of moving Express Dairies (Arla, as they are now) and the farmer up the value chain, to working with you Wisemans at 3p, and there is Milk Link, according in co-operation. Even if today in absolute pence per to this table, at the bottom, at 1.5p. Why, if co- litre there might be a small disadvantage, in the long- operation is such a good deal, are you at half the term, if you are in it for the long-term, it is better to level of the increase of the others? co-operate with you? Mr Pope: I think you need to understand the structure of the industry. The direct supply Mr Nicholls: Correct. arrangements operate usually on the basis that that Mr Pope: We believe it is essential. supplier or that processor buys in perhaps 75 or 80% of its milk requirements and buys the balance either on contract or on spot. We have to collect all milk Q69 Mr Jack: Is there any indication, in terms of the that is produced by our members and we have to find ebbs and flows of where farmers are selling their a home for it. If we have our own processing, then, milk, to show that that message has got through to in a sense, we will be placed in exactly the same farmers—to pick up a point that David Handley was situation as some other milk processors, and that is making earlier about the need for people throughout the whole ethos of what we are seeking to try and the industry to co-operate more—that they are establish so that the profitability from those moving to you as a market outlet? activities goes back to our members under a Mr Pope: What I would say there is that we have not thirteenth payment. What we have already done— lost members. I think that as we unfold our strategy and I think it is frequently misunderstood—is that and people see it working, then one would hope that we buy on quality and we sell on volume. That, I am there would be a flow of people towards us; but the afraid, is the way that the industry has been objective is to process a substantial amount, maybe established, and a lot of what we are trying to do is 80 to 90% of our milk, rather than necessarily getting to break the fractions of milk so that we do not bigger for its own sake, so that we can actually eVectively give away the quality for which we have return those benefits to the members who wish to paid at a price which is volume-related only. work with us and through us. 9417811010 Page Type [O] 29-05-04 00:58:49 Pag Table: COENEW PPSysB Unit: PAG1
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9 February 2004 Mr Jeremy Pope and Mr Barry Nicholls
Q70 Mr Jack: Why have you in your processing so research that we have been doing within England far restricted yourselves—and I ask this in Farming Food Partnerships says that at the retail ignorance—seemingly to the commodity end of the end of the market there is increasing consolidation. dairy market? If that is the situation, then, in order to react to that Mr Nicholls: We have not actually. process, the farmers need, in my judgment, to co- operate in order to facilitate that process; and I think Q71 Mr Jack: I am glad I said seemingly? it is interesting that already the relationships that Mr Nicholls: The supply and demand curve of our team have developed with major retailers is of a milk—as you know, the supply peaks in the spring very diVerent sort and much less confrontational and then falls away. The demand for milk is pretty when they know that what we are seeking to try and flat. So the first thing we needed to do in moving into do is add to value for everybody in the supply chain, processing was to be able to balance the supply and them and us included. demand, which we do through our powder business, and we have also developed an ingredients business on the side of that, which is pretty high added value Q75 Mr Jack: Can I ask one final question at this ingredients: yoghurts, soft-cheese, fromage frais— stage? We have heard from our previous but one those types of products—which we sell to companies witnesses that one is going out of milk, and we have like Heinz, Geest, Northern Foods, etcetera. We heard other examples of that. Given your have also acquired the major share of the longlife achievements to date, have there been any serious milk business in this country, so we are supplying withdrawals from your supply side that, in spite of UHT longlife milk to the trade. In addition, we have your eVorts to give what you would regard as a good recently moved into fresh liquid milk. We have a return to your members, that has not paid oV as far joint venture with Arla Foods, whereby we produce as some are concerned? for the joint venture at Staplemead (of which we own Mr Pope: I think I am very worried what will happen 50%) probably about 50% of the country’s fresh when the CAP reforms come in and single farm clotted-cream as well as added value favoured milks payments replace direct subsidy. I think that there and those types of products. We believe quite are really quite a number of people who, at that strongly that the way to get our members a better point, will conclude, as you yourself said earlier on, milk price is to move the milk in product form as that there is not suYcient cash to sustain their close to the consumer as we can get it and add value business and that they can take the single farm in that way. payment without producing a single drop of milk. I think, ironically, one of the problems of the market Q72 Mr Jack: So let me just be clear. You have taken in this country is what ought to be a parcel of shining the approach that the market place ultimately will gem in the Crown—and that is fresh, liquid milk— determine the price, but you are determined to get because of its perishability has to be sold, as you more of that price for your members by the product were saying about your lettuces earlier on, to where range which you are developing? you can get it. So unless you can convert it into a less Mr Nicholls: Yes; absolutely right. Can I give you an perishable product, you are very much at the whim example? Liquid milk is, to an extent, a commodity, of the commoditisation of what should be a value but we have recently launched a product—we licence added and a high value added product. work with Nestle— Q76 Chairman: Can I just make a quick point on Q73 Mr Jack: Free advertising! Mr Nicholls: Well, no, there is an important point that and hand over to Bill to ask about the CAP. We here actually. If Liquid milk in a supermarket per have all seen the operation of the Meat Livestock litre is 50p per litre, if you can put it into an added Commission, and one could be critical about the V value form, you can brand it, add flavour, etcetera, degree to which it has e ected change in the to it, we charge £1.20 a litre for it and consumers provision of meat, but the one thing that always really like the product. So it is in the format you put stands out with regard to the MLC is it does a lot of the product that is user-friendly in terms of what the number crunching, it does a lot of work in terms of consumer wants to buy that will bring you added what the public’s perception is of red meat compared value. So innovation is really important. to white meat, and so on, and looks at issues like elasticity of demand. I am not in any way being Q74 Mr Jack: Are you saying that innovation critical of the Milk Development Council, but I together with co-operation moves you from the cannot recall seeing the same level of, if you like, debate of arguing about fair shares into something intricate analysis of what the consumer will really where, you would argue, dictating more of your own bear in terms of milk prices and would be prepared policy is a better line of attack to the problem of to pay more if there were better value-added good returns or proper returns to the producer, products. Is that a criticism that you would feel— rather than arguing about fairness up and down the Mr Pope: I would not like, necessarily, directly to value chain? criticise the Milk Development Council, but I do Mr Pope: That is the policy that we have adopted in think it is quite interesting that, on the back of the our particular instance. We do not have a monopoly formation of the red meat forum, there is an of original thought in this area, but one other feature equivalent now, a dairy forum, emerging which all that I would say has emerged from some of the branches of the industry are involved with, and it 9417811010 Page Type [E] 29-05-04 00:58:49 Pag Table: COENEW PPSysB Unit: PAG1
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9 February 2004 Mr Jeremy Pope and Mr Barry Nicholls seems to me having a sensible debating forum that Q79 Mr Breed: Do you have any information at all, can look at these issues is a more constructive way can you give us any idea, what proportion of dairy forward for the future for us. farmers actually sell their product to co-operatives Chairman: Can we now look at the CAP? as a whole? There has been a lot of rationalisation in the last few years. You yourself have been involved in that. Q77 Mr Wiggin: Can I just ask you: have you made Mr Nicholls: About 45% of the milk produced in this any assessment of the number of dairy farmers likely country is sold through co-operatives. to withdraw from dairy farming once we have direct— Q80 Mr Breed: So it is getting up to nearly half? Mr Pope: I think, unless and until we know what the Mr Nicholls: Yes. basis of the single farm payment is going to be—is it Mr Pope: I think one has to qualify that. going to be historic, is it going to be regional, is it Traditionally a lot of the smaller producers have going to be hybridised—I find it very diYcult to been in the co-ops. know what exactly will occur. What I can say is that we would be very worried if it became a regional only based payment, certainly initially, given that many Q81 Mr Breed: When you are talking about shake- eVective and eYcient dairy farmers have actually out, that is a sort of euphemism for losing the smaller geared up their business in the anticipation of what farmer, is it? is going to happen, and I think that if they had a Mr Pope: Well, not necessarily. What I feel very diVerential—I cannot remember what the figure is. strongly about is that in creating an organisation It is £300, or so, from memory, a hectare, on a such as Milk Link, notwithstanding the fact that V historic basis, for many of these people down to there are di erential voting rights according to how about £130, if I have got the figures correct. There is much milk is consigned to the co-op, those smaller a substantial diVerential, which is probably less farmers who wish to stay in production actually significant in relation to arable farming, but in most enjoy the benefits of working with larger producers of the livestock—and obviously that includes the at the same time because the dividend, if you will, is dairy sector—it could be very significant. expressed exclusively through the returns that they get on their milk, expressed as either a first price at 17p plus per litre a thirteenth payment. Q78 Mr Wiggin: Will that create a shortage of milk? Mr Pope: I cannot answer that, but I think that when Q82 Mr Breed: You are obviously great enthusiasts we are a bit farther advanced. We need to try and get for the co-operative way. In your opinion, supposing some sort of handle on what will happen to our everybody, all dairy farmers, decided to sell through membership generally. Anecdotally, a number of the co-operatives as such, what eVect would that people who are at or near retirement age have have on the whole balance of power within the total certainly indicated that they will probably get out; industry? and that is an issue that we have raised quite Mr Pope: Can I answer that? I think it is quite specifically with government: because I think that salutary to look at the position in continental there is a tendency to think that farmers will hold on Europe and, indeed, elsewhere in the world. At the come hell or high water, and I do not believe that present time co-ops through their turnover account that is necessarily going to be the case when the basis for about 50% of agricultural production. In Sweden of subsidy change is so dramatic. that figure would rise to 250% of the agricultural Mr Nicholls: Could I add a point here? There are two production. So the opportunity for adding value issues. One is the number of farmers farming. The there, I believe, is huge by vertically integrating in other is the volume of milk produced. We have had that way. For instance, in Denmark and Sweden, a number of members who have retired or left Milk Arla are controlling, I think, over 90% of the market; Link, but we have produced more milk this year than Danish Crown, in the pig market, about 95% of all in our whole history. I think there will have to be a the meat and 100% of slaughtering; and there are shake-out of the industry, but, if a lot of farmers do analogues all the way round the world where, for leave, that does not necessarily mean to say there will dairy produce particularly, the co-operative be less milk produced. We have 21,000 milk model—and the co-operative model, incidentally, production factories in this country, all going which is organised on the basis of profit and not, as through to more or less supplying five or six retailers. I was saying, on the ideas of equality as per the So I think one of the issues will be, and our currency Rochdale pioneers, the industrial model—works within Milk Link is, the volume of milk. So it really very, very eVectively. depends on price as to whether there will be a major reduction in terms of the volume of milk produced, Q83 Mr Breed: They have been going at that a lot even if a number of dairy farmers leave or longer than perhaps after the MMB and such. Why amalgamate or work together with other farmers to do you think that vertical integration is not just make more eYcient units. getting going as quickly as I suspect you would want Chairman: Could we look now at the structure of the and everything else? What are the barriers to that? industry and your role as co-operatives, and, more Mr Nicholls: Well, a couple of points. Firstly, particularly, what may or may not help the vertical Fonterra is a vertically integrated farming integration which seemingly everyone is calling for. business—probably the largest dairy organisation in I will ask Colin to lead on this. the world. 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9 February 2004 Mr Jeremy Pope and Mr Barry Nicholls within the dairy industry is because milk is a unique Q86 Mr Jack: Can I just ask for a commentary from commodity unlike any other commodity in the food you about some of the forces that have shaped the industry. You cannot stop its supply on a daily basis, price of milk? We are inquiring into this because the and you have got to process it within 24 hours. There dairy industry in recent times, particularly from are very few products like that. Therefore, you need farming stand-points, had a diYcult period to go to be able to couple your milk production very through, but in some evidence that the Committee closely to your processing operation. Of course, received from Robert Wiseman they said, “Since the vertical integration is nothing new in this country, deregulation of the milk industry in the autumn of because Dairy Crest was the processing wing of the 1994, prices have been determined on the open Milk Marketing Board. I sold, along with others, 19 market.” So their thesis, in that one sentence, would creameries from Unigate to the Milk Marketing suggest it is market forces which have determined Board, which formed Dairy Crest. Dairy Crest was the price. Yet, if I look at the commentary in terms originally, as I say, the processing arm of a co- of evidence, we have had a variety of perceptions on operative. that, some of which say “retailers being greedy”, some say “processors being greedy”, some say “farmers not fully in control of what they are doing”, Q84 Mr Breed: We know the history of the Milk some others say “co-operation with strength leads to Marketing Board and where we are now. You must a better price than we are getting”. What is your have had some discussions with the Competition perception of the forces that shape the price of milk? Commission in terms of how they are beginning to Mr Pope: I think that my perception of that—and view this whole thing. You talk about Fonterra, 90 Barry might like to add to this in a moment—is the odd %, and Arla and everything else. Do you think fact that there has been surplus capacity. If I could the Competition Commission would currently stand read you one issue out of a broker’s note on Express in the way of further clear vertical integration? Arla in September of last year: “The industry is in Mr Pope: I think it would be very diYcult for me to dire need of this deal. Margins have been headed one comment on that, but what we have regularly way only and the retailers have seized upon the pointed out to government is that the provisions of processors desperate battle for volume in this over- Article 33 of the Treaty of Rome has four aspects to supplied market, often playing them oV against each it, that is to say that the producer should receive a other to secure better deals for themselves. At the fair price for his produce, that the interests of the end of the day the retailers still have considerable supply chain, be it that of processor or retailer, power in the UK and they too are consolidating should operate eVectively and equitably, and, lastly, further.” I do not subscribe to the view that we the consumer should expect to pay a reasonable should go in for retail bashing. The fact of the matter price for that produce. What appears to happen in is that the retailers had that opportunity and they competition policy in this country is that there is a used it; and that is what business is about and the mesmeric preoccupation with the consumer, and the free market is about. So I think one can complain other three arms of the supply chain, shall we say, about that, but I do think that getting the supply are imperfectly represented. chain equation or the supply demand equation into better equilibrium is likely to have a significant eVect, positively, one would hope, across the whole Q85 Chairman: Can I come in. I know Michael piece. wants to come back in. When we went to New Mr Nicholls: One of the diYculties that the three co- Zealand and talked to Fonterra, I think the one ops had when Milk Marque was disbanded, and thing that interested us—I will not say surprised us even the problem that Milk Marque had, was that but really did interest us—is the degree to which they the negotiation for the milk price in selling milk were ruthless with their members, and said, “Either contracts for the year ahead tended to happen at the you pay, as farmers, into this, and we will build the end of March, beginning of April when there was capital base of this organisation, or we will all go massive over-supply versus demand. So given that down the Swanny together.” So it was a question of, somewhere between 60 and 80% of his direct costs “You either back us or sack us; and if you sack us, are the raw material milk, clearly it is in a processor’s you sack yourselves.” Are you being ruthless enough interest to have the lowest raw material cost in order with your suppliers? to be able to maximise the profit. What has tended Mr Pope: I think we have been very clear. I to happen has been that the profit within the supply remember when we had the extraordinary meeting chain tended to be balanced back on the farmer; and to introduce our new constitution, somebody said to the way to turn that around is to do what we are me, “This is your last chance”, and I said, “No, as a doing, and that is to become vertically integrated so matter of fact, it is your last chance, because if we do as to be able to sell our products on a balanced not get this right, you will continue to be simply a portfolio of products to the retailer in order to get broking agency and the ability to add value will be our prices up. But clearly milk brokers are at a zero or very, very limited.” So we are not in a disadvantage negotiating a price in the market place situation as happens in quite the same way as New when supply dramatically outstrips demand. Zealand, but I subscribe absolutely to the fact that, by being open and honest with our members, we are much more likely to carry them with us than being Q87 Mr Jack: Can I ask, finally, we read in our platitudinous about it; and I say all the time, “If you evidence that there is a need for more innovation in do not like what we are doing, you sack us.” the UK dairy industry. What are the main areas 9417811010 Page Type [E] 29-05-04 00:58:49 Pag Table: COENEW PPSysB Unit: PAG1
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9 February 2004 Mr Jeremy Pope and Mr Barry Nicholls where you have spotted that we could be more sort of lateral thought process that we think that we innovative? What are we missing out on? What are have got to develop. Where we are at the moment is British consumers not getting that others are getting having to move, not against the interests of our that seems to have the holy grail that, if we can only members, but from being a member centric get there, there will be lots of money, lots of value organisation into something which is much more added and lots of happy, smiling faces? market orientated and market driven; and there, it Mr Pope: I do not think you would expect us to lay seems to me, the ultimate benefits flow through to bare to you all our proposals for product our members. If we are constantly thinking about development, but we have talked about licensing membership issues, which are very important and products from elsewhere—the Nesquik quick need to be communicated and so on, I think we product—we have talked about trying to get some would fail. category management into the longlife milk market Mr Nicholls: It is also about adding other things to milk: fruit to yoghurt, juice to milk, or even soya to which has been seriously misunderstood; we have a milk. If you look at the spreads market, one of the series of other issues that we are looking at, highest added value markets, it is the one area in the specifically not to try and take on the world but to dairy industry in which milk has met margerine, so look for the issues that really enable us to develop a to speak, butter has met margerine. leading position: because all the evidence that I have Chairman: Thank you gentleman. You have been seen in relation to this is that, unless you are at or especially good, precise and to the point. As I have very near the top of a sector or a category, then you said to previous witnesses, what you have said are following the whole time. I suppose that the cannot be unsaid, but if you wish to supplement classic case would be yoghurt, where the UK what you have said, particularly after we have heard industry has really largely lost out to Mu¨ller, and the from other witnesses in other parts of the industry, second biggest supplier to the retail trade, Yeo it will be very useful. Can I also thank my sub- Valley, down in Somerset, who have been committee for keeping to time. We are only a minute fantastically innovative in the way that they have over, which is a miracle in the history of Efra. developed their production range; and I admire that Mr Jack: Brilliant chairing, Chairman! 9484161008 Page Type [SO] 28-05-04 23:58:54 Pag Table: COENEW PPSysB Unit: PAG1
Environment, Food and Rural Affairs Committee: Evidence Ev 31
Monday 1 March 2004
Members present
Mr David Drew, in the Chair
Mr Colin Breed Paddy Tipping Mr Michael Jack Mr Bill Wiggin Diana Organ
Memorandum submitted by Robert Wiseman Dairies (L23)
Summary Robert Wiseman Dairies’ primary concern is to support the economic stability of its own business, and by implication, the sustainability of its raw milk supply. We recognise the need for profitability throughout the industry, to allow for reinvestment and growth. The advent of CAP reform measures will undoubtedly put downward pressure on raw milk prices, which will lead to a significant restructuring of the dairy farming sector. We have always paid raw milk prices which command significant premiums over the average and will continue to do so in order to help our suppliers achieve profitability in the post CAP reform environment.
1. Robert Wiseman Dairies This document is the response by Robert Wiseman Dairies to the inquiry by the Environment, Food and Rural AVairs Committee into the market price and farm gate price of milk. Robert Wiseman Dairies is a milk processing company based in East Kilbride, Glasgow, Scotland. We process just over 1 billion litres of milk per annum for the liquid market of the United Kingdom. Over 80% of our product is sold to the major multiples, with only 4% on the doorstep and the balance into the independent “middle ground” sector. We have processing sites in Aberdeen, Glasgow, East Kilbride, Manchester and Droitwich. We buy the majority of our raw milk from three direct supply groups and the balance from two farmer co-operatives. Because of our business profile and our eYciency, we have consistently paid milk prices within the top quartile of any league table. We have worked closely with major supermarkets and farming unions in recent times to facilitate where possible increases in milk prices to dairy farmers.
2. Terms of Reference The terms of reference for the inquiry are: “The Committee will examine the market price and farm-gate price of milk, and will investigate why recent rises in the former have not led to increases in the latter”. As members of the Dairy Industry Association Ltd (DIAL), we support the submission made by them in respect of this inquiry and in the interest of brevity, in this submission purely refer to additional points or clarify points of particular interest to our specific marketplace. Until prompted, we were happy that the DIAL submission was a fair reflection of the industry position and thus felt no need to comment further.
3. Utilisation of Milk and Producer Return With a business dedicated to processing milk for liquid consumption, predominately to the major multiples, we have been able to reflect recent transparent milk price increases from the multiple sectors back to our direct suppliers and the co-operatives. The only element of complexity has related to the degree to which all our customer prices have increased, and the pooling eVect this has had on our raw milk price. For information, we detail below the mix of our business expressed in a similar manner to the table on page 4 of the DIAL submission. 9484161001 Page Type [E] 28-05-04 23:58:54 Pag Table: COENEW PPSysB Unit: PAG1
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% of Producer Income Accounted for by: Liquid Doorstep 5 Top six multiples 60 Other multiples 22 Independents 13 As a result of this mix, we were able to pass back a 2.8ppI increase to all our suppliers from retailer initiatives announced between October 2002 and July 2003.
4. Price Determination and the Role of Commodity Products
Since the de-regulation of the milk industry in the autumn of 1994, prices have been determined on the open market, with the exception of the intervention of retailer initiatives most recently in October 2002 and July 2003. The strength or weakness of that market was determined by the commodity product sector. Any market changes observed in that sector are reflected in the liquid sector, milk prices rising or falling accordingly. The diVerence in the price of milk for commodity products and milk for the liquid markets will vary both between companies and between products. But in general short shelf life products have paid a premium for raw milk over longer life products due to the necessity for fresh milk, and the service or profile required. The variability of this diVerential is a function of competition to prevent the undermining of the marketplace as referred to in the DIAL submission—page 5: paragraph 38.
5. Fairness of the Raw Milk Market
Determining the value of a product by the strength of the market into which it is sold, and the value of any additional service required, is an acceptable method of trading throughout the dairy industry. The raw Milk market should be no diVerent. Recent problems have occurred as a result of sectors of the market moving away from this principle in the interest of boosting returns to farmers. Whilst a worthwhile gesture and one that could be sustained within the retail price levels, it has caused confusion and mistrust in the way in which such increases have been passed back to farmers. Such a principle could only be sustained with regulatory intervention or unparalleled Industry agreement, which could create OFT concerns.
6. Wiseman Financial Returns
Annexed is a graph setting out Wiseman’s operating profit per litre over the last six and a half years. Net margins have stayed within a range of 2.34–3.13 pence per litre. We believe this demonstrates clearly that certainly Wiseman has not profiteered at expense of milk price to farmer. February 2004 Pence per Litre Operating Profit 3.13 3.2 3.08
2.56 2.53 2.5 2.34 2.44 2.4
1.6
0.8
0
97/98 98/99 99/00 00/01 01/02 02/03 03/04* * six months 9484161002 Page Type [O] 28-05-04 23:58:54 Pag Table: COENEW PPSysB Unit: PAG1
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Witnesses: Mr Billy Keane, Group Financial Director and Company Secretary, and Mr Pete Nicholson, Milk Procurement Director, Robert Wiseman Dairies, examined.
Q88 Chairman: Good afternoon, everyone. Firstly, associated directly to a particular product. I think apologies for the slight lateness. The Committee that is what has caused some of the confusion that was in Poland and Hungary last week, and we are reigns, and indeed the mistrust. still overcoming the jetlag. More particularly in my case I now have the Committee’s cold, so we are starting under something of a cloud. We are going Q91 Chairman: The final question from me is: given to keep questions very precise, and the aim is for that the price of milk either goes up or goes down, each of the sessions to last about half-an-hour. You just tell me the mechanics of how you actually are no diVerent to the producers, who we also kept explain the fact that the price to the producer is V to a very tight timeframe, just so that we can make likely to be di erent from the retail price. What are the most of the evidence session. It would be the mechanics of actually dealing with your helpful if you could introduce yourselves and say suppliers? what your particular role is within the organisation. Mr Nicholson: We hold discussions with our Mr Nicholson: My name is Pete Nicholson. I am suppliers on a regular basis and keep them abreast Milk Procurement Director for Robert Wiseman of movements in the market values, and indeed our Dairies. basis of determining milk prices to our producers Mr Keane: I am Billy Keane, Finance Director for is on those market mechanics as opposed to the Robert Wiseman. retail price increases or decreases. Until quite recently when there were some retail initiatives, most recently in July of last year, and previous to Q89 Chairman: Welcome. Can we go straight into that in October of the year before, there was an the questions. You know the basis of the inquiry, agreement from some of the major multiples that and no doubt even if you were not present at the an increase in retail price should then result in an first session, you have had reports. How fair is the equal increase to the producers’ price. That is an accusation of the farmers that whatever the exception to the rule. Since deregulation, the increase, it is never passed on to them, and they majority of milk price movements have been blame equally yourselves as processors and dependent on the overall market, which in that obviously retailers. How would you answer that period of time has been related to movement of accusation? commodity price. Mr Nicholson: Obviously we can only speak for ourselves, and our belief is that we have done all we can to ensure that as much of the raw milk price Q92 Paddy Tipping: You told us that this was a gained from the customers is passed back to the fairly complicated, complex area. In rough terms, farmers in the form of their increased milk price. what profit do you as a processor make on a litre of milk?
Q90 Chairman: But is it fair to say—and this is very clear to us from both the evidence we have received Mr Keane: I think as part of our submission we put and also the nature of who we can get to give in a lot of the track record there has been over the evidence to us, and who will sit with whom—that past five or six years, and between 2.3 and 3 pence this industry is plagued by a lack of trust, and per litre is roughly the spread. At the moment in certainly a lack of transparency? What would you the first six months of our financial year, which was do to overcome those two features? to the end of September 2003, it was around 2.5 Mr Nicholson: I think certainly there is mistrust pence per litre. and there is a lack of transparency within the milk price, and that understanding of the way the milk Q93 Paddy Tipping: Mr Nicholson talked about the industry works is probably the result of that. I price increase of two pence last year. Did that help suppose we need to go back to the Milk Marketing you? Did that increase your profit margin? Board days when end-use pricing created clear Mr Keane: No. In actual fact the two retail transparency as to what price milk was for initiatives Peter mentioned, the first one was particular products. Since deregulation in 1994 probably negative for us. In October 2002 we V milk has been traded in a slightly di erent way, and passed a full two pence a litre across our whole milk the way in which milk is purchased is no longer supply chain, but during an in-fight then set about dependent on where that milk is used. As a trying to recover that from the marketplace, and consequence, a load of milk consigned into a dairy we under-recovered that by about 0.45 pence a litre. is at a certain price, and where that dairy actually So last financial year our numbers were impacted chooses to use that milk, whether it be for liquid, down the way as a result of that retail initiative. Is whether it be for cheese, or whether it be for a that helpful for you? skimmed milk powder, is dependent on the portfolio of the particular processor. The complexity of the dairy industry as far as the Q94 Paddy Tipping: You have been very helpful in various products that are produced within it creates telling us what your profit margins are. What can that lack of transparency as far as what that raw you tell us about the supermarkets? They are seen milk is used for, so consequently it is complex to as the villains of the piece amongst certain people. understand how the raw milk price actually can be What do you think they make on a litre of milk? 9484161002 Page Type [E] 28-05-04 23:58:54 Pag Table: COENEW PPSysB Unit: PAG1
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1 March 2004 Mr Billy Keane and Mr Pete Nicholson
Mr Keane: From independent analysis rather than Q98 Diana Organ: In reply to the Chairman’s our own perspective, there has been a lot of time question about what happens along the chain and eVort spent analysing that, and I think the best about who is getting what share of the money from place to point you to would be the KPMG report, it, you gave some general view about how you talk which was commissioned by MDC, and they to your producers. I wonder if you could make any reckon around a 25–30% margin—I think that is more comment in a little more detail about why the gross margin—that the supermarkets were making. proportion of the retail price made up by the I am sure you are aware that the statement was that farmgate price has gone down really consistently they felt that that was generally in line with other over the last three to four years? products in the supermarkets’ portfolio. So that is Mr Keane: I think all we can say is that obviously the best place I can point you to. the retail selling price—and you go back to the KPMG report over the last three or four years— has increased. I think their analysis is that Q95 Paddy Tipping: Some people say that it is sold supermarkets have rebuilt margins on milk, and as a loss leader, at a cut price, to bring people in to that is again the point that was made about it being buy other goods. Is there any truth in that analysis? a loss leader a number of years ago. They have Mr Keane: I think historically, if you look back restored margins, and therefore as a result of that, over time, there were instances when milk was sold and none of that passing down the chain, then the as a loss leader. I would say over the last three or share that the farmer has got has dropped. Judging four years that has not been the case with the major the fairness of that, it would be diYcult to come retailers. You will still find instances of independent to a definite conclusion, because of what Peter said shops trying to gain an advantage, trying to draw earlier about what are the dynamics that set the in customers, and using milk as a loss leader, but price for the overall commodity value of milk. looking at the market as a whole—Tesco, ASDA, Safeway—you will generally find that the price point of milk very similar. Q99 Diana Organ: It does seem interesting, though, that over quite a long period it is never the processor section that gets diminished, or the Q96 Diana Organ: How much profit do farmers retailer section that gets diminished; it always seems make on the sale of liquid milk, do you think? to be the farmgate price that gets squeezed. I will Mr Nicholson: Every individual farmer will have a just leave that with you. diVerent price on that, based on the eYciency of Mr Keane: Yes. the farm and where that farm is. There are reported figures from various consultants and banks which indicate that the majority of farmers in the country Q100 Diana Organ: I wonder if we could just talk are actually not making a profit as a result of dairy about milk sold to processors to make cheese, farming, and that is as much a concern to us as I because many of the farmers tell me that farmers am sure it is to them. There are undoubtedly some lose out on this, and they are saying that a figure very big diVerences in eYciency between the of about 2% of the retail price of cheddar cheese— bottom 25% of milk producers and the top 25%, is that about accurate for what they are losing? and so there are huge variations in eYciency as well Mr Nicholson: We are not involved in cheese making. The dynamics of the cheese industry are as advantages and disadvantages in the areas that V they are in, and the price they are receiving for their di erent to those of our own, and I think it would milk; so it is not something you can be categoric on. be wrong of us to comment in detail on that.
Q97 Diana Organ: I realise that, and it will depend Q101 Chairman: Can I just ask you very quickly on on the diVerence. Do you think that the message is that: why have you just been in liquid milk? Have you ever been in processing? clear, that farmers do understand that they have to be more eYcient, that they probably therefore have Mr Keane: No. The company’s roots go back 55 to be larger, that their herd sizes have to be years to a small dairy farm in East Kilbride, and all we have ever done is liquid milk. We have used increased in order to maintain profitability, and that from a strategy point of view as being a benefit that in the end we are going to have fewer dairy to us, that all we do is focus on liquid milk, and farms? Do you think farmers have got that do not allow ourselves to be distracted by message? commodities—cheeses, yogurts, butters. We Mr Nicholson: Yes, I believe they do. Again I think specialise in liquid milk to supply shops and the critical situation for the future, and for the supermarkets. future prosperity of dairy farming, is not necessarily the number of milk producers that are producing milk; it is the amount of milk that Q102 Mr Jack: Can I just follow that up, because number is producing. Whilst obviously the loss of one of the themes that came out of our previous a number of dairy farms is regrettable, it is the fact evidence session was the need to involve dairy that farms are getting bigger, and the amount of farmers in the whole value chain, which included milk that is being produced overall is remaining the processed products. You have just said “No, we’re same. We are in an over-supply situation, and as a not going to be involved in that. We’ll stick to result of that supply prices are weak. liquid milk; that’s what we are good at. We don’t 9484161002 Page Type [O] 28-05-04 23:58:54 Pag Table: COENEW PPSysB Unit: PAG1
Environment, Food and Rural Affairs Committee: Evidence Ev 35
1 March 2004 Mr Billy Keane and Mr Pete Nicholson want to get involved in it”. Does that put you at own opinion is that perhaps it will start reducing odds with others who have gone down the diVerent before it reaches that level; but everybody obviously route of wanting to vertically integrate? has their own opinion. Undoubtedly, if milk prices Mr Keane: I think we would see the key going fall to those kinds of levels, then it will have an eVect forward would be to have an involvement with our on the total amount of milk produced in this country. supplying farmers. We do oVer them a small That may well be a part of the answer, on the basis shareholding when they join the company as a that in that circumstance we may move from a supplier, and we see them as an important part then supply-led market to a demand-led market, and that down the chain. We firmly believe that the future in itself will hold prices up a little bit further. for them is who they supply their milk to, and given our track record in terms of paying one of the Q104 Mr Breed: So first of all you think perhaps the fairest and highest milk prices in the country, the next 18 months to two years is the critical period, and dairy farmers who supply us are certainly very that major decisions by most people will be made happy with their choice. So, no, we have quite a within that period of time? number of producers very keen to join us, and we Mr Nicholson: I believe so, yes. do have a waiting list of suppliers ready to join us. Chairman: Colin, can we go on to look at the basis Q105 Mr Breed: Secondly, that yes, it will have an of the CAP reform. eVect on the actual levels of milk production; there areboundtobealotofpeoplegoingout?Isthatgoing to be your view? I know you are only in liquid milk, Q103 Mr Breed: You must have done quite a lot of but in your view is that likely to fall to such a level that modelling over what you think is going to happen this will then mean that we will be importing milk to with CAP. None of us really knows, of course. Can supply at least some of the processing requirements? you give us some sort of idea of what you think in Mr Nicholson: I do not believe so. At the moment we termsofperhapsthenexttenyearsorso?Iknowithas import product, which is obviously a part of the got all around farmers, numbers pulling out, but problem; but our own opinion is that it will not come there will be inevitably not only numbers, but a to the situation of importation of raw milk. There reduction in the amount of actual milk produced; might be more product being imported, certainly, in there is likely to be. Have you made any assessment as order to take up the vacuum, but not the importation to the numbers of actual farms that will go out, but of raw milk. also, perhaps almost more importantly, the amount of production that is likely to be reduced? Mr Nicholson: We have been involved in a number of Q106 Chairman: What happens if the price drops to national projects with regard to CAP reform, and 14 pence a litre, as is being predicted by MDC? No- indeed we have actually contracted somebody to do one can make any money, so what happens? Is it some work specifically on ourown milk fields and our catastrophic, or will the price bounce back? own producers—supply producers—as far as the MrNicholson:Ithinkitwillbebeforethen,butIthink eVect on them with regard to the CAP reform. There that is when the dynamics of the industry will kick in is no doubt that whether you look at it positively or and actually self-regulate it, and we will get a negatively, therewill bea downwardpressure onmilk situation where the demand for milk, as a result of the prices as a result of CAP reform, and there is a need volumeofmilk inthecountryfalling,will kickbackin for dairy farmers to become more eYcient in order to and pull prices up. be able to keep their head above water. No doubt people will need to get bigger in order to be able to Q107 Chairman: In your model, which Colin achieve that. Exactly what eVect it will have on the mentioned, have you looked at a 14 pence per litre dairy industry is something that is pure conjecture. price? The recent announcements with regard to the Mr Nicholson: We have not, no. allocation of entitlement will have an eVect, and there is no doubt that there will be many people looking at Q108 Chairman: So you do not agree with that? the position over the next 18 months and determining Mr Nicholson: We, looking at our particular sector, whether remaining in dairying through to the CAP do not believe that it will go to those kinds of levels. reform is worth their while or not. Certainly the recentannouncementsdisadvantagedlargerfarmers, Q109 Mr Jack: You said a second ago that you could more intensive farmers, who have looked forward to see opportunities for more eYciency. Where and afuture inthe dairyindustry.I amtalking myselfwith how, and what diVerence would it make to the level at some of the large farmers within our direct supply which your farmer suppliers could stay in business? chainabout theeVectthatthese decisionsbyDEFRA MrNicholson: Again,lookingata numberofprojects willhaveontheirbusinesses.Undoubtedlytheyareat that have been undertaken, there is a clear three to a crossroads as to whether to continue and get bigger, four pence a litre diVerence between the bottom 25% or whether to step away. I think over the next 12 or 18 of milk producers’ eYciency and the top 25%. As a months when we see the reaction on this, we will be consequence there is therefore a big diVerence much clearer as to whether the amount of milk between— produced in this country will fall. At the moment people believe the Colman report that has just come Q110 Mr Jack: What are the factors that account for out, that milk prices will need to fall to around 15 or what is quite a sizeable diVerence? What are the 16 pence a litre, for actual production to reduce. Our factors? 9484161002 Page Type [E] 28-05-04 23:58:54 Pag Table: COENEW PPSysB Unit: PAG1
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1 March 2004 Mr Billy Keane and Mr Pete Nicholson
Mr Nicholson: There are numerous factors, for milk; and, as you say, still make a satisfactory depending on the circumstances of where you are sum—it is all about eYciency. Just as we talked farming, how you use your labour, whether it is earlier about eYciency on the farm side, you cannot employed labour or whether it is own labour. A lot of talk about wanting them to make that sort of the variable costs—feed costs, et cetera—some investment, that sort of return. Our side of the farmers are actually buying very competitively, and industry has to do that as well, and I think you others arenot buyingvery competitively.Quota costs would see not just the liquid side, lots of activity areakeyelement.Somepeoplehavetoleasequotasin on the process side, driving eYciency, knowing the order to be able to keep production within quota, and future has got to be much more eYcient in terms othersdo notneedto dothat,soconsequently theydo of the scale; it is about the establishment of super- not have that on-cost associated. dairies on the liquid side, and the manufacturing side too, big investments. You are going to hear Q111 Mr Jack: In your reply to my earlier question— from Dairy Crest about some of their investments I wrote it down because it is unusual in the world of on the processor side—the three co-ops coming dairying to find the word “happy”—you said “They together to own that powder plant at Westbury. So are very happy with their choice”, and you have a there has been a whole load of investment, so that waiting list of people who would like to supply you. both sides ultimately, looking out four or five years, Yet in some evidence that we have received from unless we are both very eYcient none of us will Dairy Crest, they remind us of a phrase that has been survive. used by both our predecessor committee and what they say in their evidence, that the industry is typified Q114 Mr Jack: You describe the workings of a by institutional antagonism. We had Mr Handley in dynamic marketplace. I presumed from what you here as a witness last time, and he is the lightning said that you would prefer market forces to conductoroftotaldiscontent abouteverythingthatis determine the shape of the dairy market, rather in the industry. So if you listen to the supply side, they than some kind of regulatory body, as some have are all very grumpy, unhappy bunnies out there, and suggested. you on the other hand seem to have cornered the Mr Keane: I think we are open to suggestion about market in happy people. How have you achieved this the regulatory body, but I think it is fraught with nirvana in the world of dairy supply? problems when you start looking at competition law in this country. I think you would have real Q112 Chairman: They probably drink it. problems about sitting around a table trying to Mr Nicholson: I suppose the simple answer is we agree prices and not having competition. I think in pay the best milk price in the league table, so our view that would come unstuck, either at the consequently as a result of portfolio that we have— OFT or at Competition Commission level. ie the majority of our milk, all our milk, goes to the liquid sector, and the majority of it going into Q115 Mr Jack: So you would not see a regulator the multiple sector—our ability to be able to return as a sort of peacemaker to get rid of the grumpiness a higher price because of the product that we sell in the industry? our milk into is better. Mr Keane: We can see the attractions, but I think it would be fraught with problems. Q113 Mr Jack: Is that, going back to the comments that Mr Keane was making about the margin Q116 Chairman: Can I just pick you up on that information that you have given, because you start issue, in as much as if there were to be this demand from a standpoint that says: “This is the plan. This for a regulator, how would that come about? is the return that we want to get on our capital that Would this be entirely up to government to make is employed, and therefore we can aVord to pay a that proposal, or would you actually listen to the certain premium”, or is it that it just falls out that producer, which Jack has quite carefully alluded way? Is it by a design plan, or is it just that that is to? Are you in the game of negotiating this, or what the way your business operates, because you do stage are you at? You have looked at the proposal. seem to have got into a virtuous and positive circle Mr Keane: We have not looked at it in any detail, as opposed to a negative position. because I do not think it has ever been elaborated Mr Keane: I think we see it primarily that it does in any detail, to my knowledge, in terms of how not just fall out, it stems from the market. There that agency would work. I think we were very is obviously a market price for the supply side of happy under the Milk Marketing Board days, the supply of milk to supermarkets, a price level. where the price for liquid was set, and that allowed We have to operate within that, and we have to a liquid premium to be generated and paid through operate in terms of what we get down to, the Milk Marketing Board out to farmers; but purchasing our milk within a range. So although given that the milk boards are gone, and the we pay a premium, in terms of the comparison of industry has since then fragmented, we do not see the size of that premium over some of our how that can be created outside some sort of competitors, it is probably no more than about a statutory requirement. So, much as we like the idea ha’penny a litre. We believe, because of the eYcient of a milk agency, I personally believe that it would nature of our plant and our distribution network, be caught up in competition law about setting fixed that we can operate within that structure and still prices for milk through the various parts of the pay the top price and work within the market price chain. It would be artificial. 9484161002 Page Type [O] 28-05-04 23:58:54 Pag Table: COENEW PPSysB Unit: PAG1
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1 March 2004 Mr Billy Keane and Mr Pete Nicholson
Chairman: Gentlemen, thank you very much for write our report, we are only too willing to receive your evidence. What you have said cannot be that. Thank you for giving evidence. We will ask unsaid, but if there are issues that you want to raise you to move over, and ask Dairy Crest to take with us as a supplementary comment to help us your place.
Memorandum submitted by Dairy Crest Group Plc (L21)
Executive Summary
1. This inquiry is taking place against the backdrop of a series of high profile campaigns by farming groups over recent months, representing the culmination of many years of debate on milk pricing. 2. Our submission demonstrates that these campaigns overlook many of the basic realities facing the dairy industry as a whole—challenges which need to be addressed on a collaborative, collective basis by the industry as a whole, rather than through ongoing conflict within an overall culture of blame. 3. Dairy Crest relies on producers for the high quality “raw materials” that allow the company to innovate and add value, while farmers depend on a sustainable processing sector to ensure an assured route to market, economic returns for their products and the protection of employment in the UK dairy industry. It is this commonality of interest that should underpin industry collaboration going forward. 4. Our core business strategy of focusing on eYciency, capital investment, brand innovation and added- value, while keeping costs under tight control, is, therefore, partly a recognition of the symbiotic relationship between a sustainable processing sector and successful producers. 5. As DIAL and doubtless many other organisations will show in their submissions, the recent campaigns do not fully reflect many of the basic market economics, which determine the farm-gate price of milk. We do not, therefore, intend to duplicate that work here. 6. SuYce it to say that with expert opinion united on the likelihood—against the backdrop of CAP reform—of market prices falling further over the years ahead in the absence of collaborative action on innovation and added-value, positing a mono-causal basis for the current situation is misleading and unproductive. 7. On the specific issue of pricing, Dairy Crest has consistently paid amongst the best contract prices to producers in relation to both other processors and co-operatives, with two Dairy Crest contracts regularly topping the milk price league tables. 8. This trend of paying market-leading prices has been reflected in the discussions regarding milk for cheese pricing over recent months, with Dairy Crest showing very considerable flexibility notwithstanding the major margin pressures in the cheese market over the past 18 months, which has seen commodity cheese prices fall to a 10 year low. Despite the ongoing diYcult margin position in commodity cheese Dairy Crest has in fact returned the full price increase negotiated with customers to both its direct farm and co-operative suppliers. 9. The dairy industry faces a number of very real economic, structural, competitive and market challenges—both European and global—from which it cannot shy away. The need for greater eYciencies across the supply chain, including the production sector, is only the most obvious example of the way in which the industry as a whole will need to respond. 10. There is also a clear consensus among industry experts and commentators that the only way forward is to move away from the “the institutionalised antagonism” of recent years and to focus on genuine partnership, collaboration and co-operation on the key issues of innovation, investment, added-value, integration, rationalisation and consolidation. 11. Dairy Crest has a working knowledge of developing and operating successful supplier/retailer/ processor partnerships. Our business is committed to working with its partners across the supply chain to define and drive forward a collective approach to the challenges facing the entire industry. We have outlined a series of very practical suggestions for change as a “starter for 10” and look forward to working with our industry partners to rise to the challenges facing all of us. 12. These range from improving farm-gate economics, removing costs from the supply chain and tailoring milk types to consumer requirements to improving marketing information and communications, and most importantly, driving forward the added-value and innovation agendas. 9484161003 Page Type [E] 28-05-04 23:58:54 Pag Table: COENEW PPSysB Unit: PAG1
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1. Introduction—An Unproductive Culture of Blame 1.1 Dairy Crest Group Plc (Dairy Crest) welcomes the opportunity to provide a submission to the House of Commons Environment, Food and Rural AVairs Committee as part of its inquiry into Milk Pricing, announced in Press Notice 102 on 20 November 2003. 1.2 Our submission notes the Committee’s terms of reference, which are as follows: “The Committee will examine the market price and farm-gate price of milk, and will investigate why recent rises in the former have not led to increases in the latter.” 1.3 The issue of milk pricing has long been an issue of debate and contention, dating back to the de- regulation of the Industry in 1994. However, this debate has peaked in the last six months, with considerable media and Parliamentary interest over recent months—perhaps one of the reasons behind this inquiry. October 2003 saw the roll-out of a vocal and well-organised campaign, led by Farmers for Action (FFA), together with the National Farmers Unions of England, Scotland and Wales, generating considerable media coverage. 1.4 At the same time, the House of Commons held a two-hour debate on the Dairy Industry in late-2003, while Early Day Motion 1803 (tabled on 22 October 2003) on the “Farm-Gate Price of Milk” (together with the subsequent amendment by Simon Thomas MP) has attracted a total of 91 signatures. Equally, the Opposition parties, most notably Liberal Democrat Rural AVairs Secretary, Andrew George MP, have called on the Government to intervene in a way that safeguards market sustainability, noting, “the unfortunate fact is that you cannot set a sustainable price for milk purely on the basis of bad publicity for processors.” (20 November 2003.) 1.5 In this submission, we will argue—in line with the views of the overwhelming majority of dairy industry experts and the industry’s leading trade association—that the emotively appealing campaign ignores some basic realities that face the entire dairy supply chain. 1.6 A recent study of the UK dairy industry—the in-depth “Prices and Profitability in the British Dairy Chain”, commissioned from KPMG by the Milk Development Council—makes specific reference to the role of various players in the dairy supply chain. In particular, the report noted that: “The Competition Commission identified the major supermarkets as a complex monopoly. Because of this structure, the supermarkets have a significant level of buyer power in the dairy sector and a substantial influence on wholesale market prices because of their size relative to processors, the transparency of information on alternative supply sources and the low costs of switching. The buying power of the supermarkets has been beneficial to consumers, because the retail prices of fresh liquid milk have been relatively constant over the period, which represents a fall of about 25% in real terms since the mid-1990s. Milk is seen as a Key Value Indicator by the multiples and prices are constrained by intense competition between the supermarkets. The position on other dairy products is similar.” 1.7 The report also noted that: “overall, the net profit margins of UK processors have not increased over the period since 1997 and are in line with the performance of similar organisations in Europe.” 1.8 We will also suggest that given the challenges facing the industry as a whole, the best way forward is to move away from what the former Agriculture Select Committee, in its February 2000 report on the Marketing of Milk, described as “the institutionalised antagonism between the suppliers and the dairies”, to a more collaborative and partnership-oriented approach. 1.9 Without the investment and innovation—in which Dairy Crest has arguably led the way—that will add value to the entire supply chain, it will be challenging to move beyond the engrained adversarialism and blame culture that, sadly, continues to characterise the dairy sector.
2. Dairy Crest—An Overview 2.1 Dairy Crest—a FTSE 250 plc with an annual turnover of £1.3 billion—is the UK’s premier chilled dairy foods company with leading brand positions across the dairy market—dairy spreads, cheese, liquid milk, fresh flavoured milk drinks, fresh dairy products (yoghurt, fromage frais, chilled desserts), through our Yoplait/Dairy Crest joint venture, and dairy-based ingredients. Dairy Crest was originally set up as the marketing arm of the Milk Marketing Board in 1981 and was floated as a plc on the Stock Exchange in 1996. It is interesting to note that at that time of Dairy Crest’s Stock Market Flotation in 1996, dairy farmers owned 70% of the company’s shares, while today the figure is in the region of 30%. 2.2 Dairy Crest is one of the UK’s two largest purchasers of raw milk, processing and adding value to around 2.2 billion litres pa and is the market leader in doorstep deliveries in southern England. Dairy Crest supplies liquid milk (including fresh flavoured milk drinks) to the major multiples, medium and small retailers, and the food service industry in the south Midlands, southern England and Wales. Of this 2.2 billion litres pa c 50% is processed for liquid milk, c 30% for cheese and c 20% for ingredients. 9484161003 Page Type [O] 28-05-04 23:58:54 Pag Table: COENEW PPSysB Unit: PAG1
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2.3 Dairy Crest’s key proposition is that the company continues to be successful by delivering growing brands and value added products, by working in partnership with the retailers and by investing in state-of- the-art facilities. This approach delivers both competitive advantage and aims to establish Dairy Crest as the premier chilled dairy food group, while delivering benefits to all of its stakeholders. 2.4 This, of course, means providing attractive returns to shareholders, but also to its employees (of which there are now c 7,000 within Dairy Crest Group in the UK—many in rural locations such as Davidstow (Cornwall), Severnside (Gloucestershire) and Maelor (North Wales) and stakeholders, most notably in the farming and retail communities. 2.5 The dairy farmers who Dairy Crest work with are of particular importance to the company. There is, in reality a symbiotic relationship between Dairy Crest and farmers—Dairy Crest needs a strong dairy farming base able to provide the high quality “raw materials” that allow the company to innovate and add value, while farmers need successful processors such as Dairy Crest to add value to their products before they reach consumers. The DCPA provides an important foundation that supports this principle. The Waitrose and M&S farmer partnerships provide examples of successful integrated approaches. 2.6 Indeed, the sustainability of the processing sector is a pre-requisite for an assured route to market, economic returns for producers and the protection of employment in the UK dairy industry, preventing jobs being exported abroad. 2.7 The company serves the retail grocery trade, the food service industry and major food manufacturers, and focuses on building leadership positions in branded and added-value markets. Its portfolio of brands, which are sold throughout the UK, includes: — Cathedral City and Davidstow cheese brands. The company is also the UK’s largest producer of Stilton. — Dairy Crest manufactures and distributes packet butter, spreadable butter and spreads under its Country Life, Clover, Argento and Willow brands. Dairy Crest acquired the St Ivel Spreads Business in November 2002 with its strong portfolio of well-known brands including Utterly Butterly, St Ivel Gold, Vitalite and Carapelli. — Frijj is the leading brand in the fresh flavoured milk drinks market. — Dairy Crest is a leading supplier of fresh dairy products through the Yoplait Dairy Crest joint venture with its brands Petit Filous and Frubes, together with ranges including Wildlife and Weight Watchers. — Emerging brands such as Rachel’s Organic and Hartington. 2.8 As we will outline further in section 6, in the four years to March 2004, Dairy Crest will have invested c £200 million in capital projects, including a £49 million upgrade of the company’s Davidstow creamery and the £54 million development of “super-dairies”. In addition, the company continues to invest in brand innovation, consolidation and rationalisation; and acquisitions totaling c £330 million—such as Unigate Dairy in 2000 and the acquisition of St Ivel family of brands in 2002. Taken together such initiatives allow Dairy Crest to play its part in rising to the challenges facing the company and the industry more broadly.
3. The Realities of the Marketplace 3.1 Dairy Crest supports the submission made by the Dairy Industry Association (DIAL) and we do not feel it would be productive to duplicate the correct analysis of the realities of the dairy market the DIAL submission outlines. 3.2 In particular, the DIAL submission correctly outlines the complexities, which determine the price of raw milk, as well as the impacts of over-production, international competition (most notably within the EU Single Market framework), commodity prices and currency fluctuations. 3.3 As the Minister for Rural AVairs and Local Environmental Quality, Alun Michael MP, noted in his response to the Dairy Industry debate secured by Peter Duncan MP last October, with liquid milk sales by the major multiple retailers using only 25% of raw milk in the UK, a 2p increase in supermarket prices only leads to a 0.5p increase in prices paid at the farm gate. 3.4 Moreover, as Professor Sean Rickard of the Cranfield School of Management—a recognised expert in this field—has argued, WTO developments, EU enlargement and the extension of EU Single Market principles will only add to over-production and competition, with real implications for the UK dairy industry and the rural economy as a whole. Collaboration, technological rationalisation, innovation, consolidation and added-value, he argues, will be a pre-requisite for success in the future. 3.5 If evidence is needed for the very real challenges that our industry will have to face up to collectively over the coming years, it is the recent draft report “The Future of UK Dairy Farming” by Professor David Coleman from the University of Manchester and Professor David Harvey from the University of Newcastle, jointly commissioned by Defra, DIAL and the MDC. 9484161004 Page Type [E] 28-05-04 23:58:54 Pag Table: COENEW PPSysB Unit: PAG1
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3.6 In a very thorough analysis, the report concludes that, all else being equal, all expert studies point to a likely average milk price of 15 ppl by 2007 and beyond, resulting in an incentive price (taking into account direct payments) in the region of 17 ppl. It should be an issue of real concern for the whole industry that the report also suggests that 16 ppl can be seen as a “cost competitive price at the industry level” . 3.7 Therefore, the report predicts that from a current base of just under 25,000 UK dairy farmers, the number of producers will fall by around 16% by 2010 (23% by 2015) under a best case scenario and by 33% by 2010 (40% by 2015) in the worst case. 3.8 Crucially, the report concludes, “the unequivocal conclusion to be drawn is that herd size is the key to eYciency, with herd size increases critical to further cost reductions”, and posits larger herds as “the [future] backbone of the UK milk producing sector”. It also makes specific reference to the considerable diVerence in margins between the top-25% and bottom-25%, particularly for small herd sizes. Perhaps on this basis, the report describes as “a surprisingly optimistic scenario for the industry” the finding that 56% of producers in their study intend to increase production by an average of 28%. 3.9 These complex realities have been conveniently ignored by the recent campaigns, leading to an unrealistic and unbalanced debate about milk pricing. 3.10 In addition to the issues raised in the DIAL submission and these overall realities, we would make two specific points:
(i) The Realities of Competition 3.11 In a modern, competitive world, no part of the supply chain can be insulated from the eVects of competition. Certainly, added-value brands—the focus of Dairy Crest’s business— can sustain a premium to commodity products, with beneficial implications for the entire supply chain. 3.12 However, with the Single Market now in full operation and cheese imports having grown over the past year by 14.6%—against a background of rising UK milk prices, a strong Pound and falling prices in the many other EU member states—the eVects of international competition on UK prices simply cannot be ignored. 3.13 To exemplify this point further, elsewhere in Europe Sweden has recently seen the first imports of liquid milk from Germany into what was believed to be a “safe from imports” home market. Similarly, the view held by many commentators that the UK’s island status would make this country safe from imports has proved to be manifestly untrue. 3.14 Within this competitive context, the concept of a price “Regulator”, that has been floated by some, is problematic to say the least. The operation of such a regulator in controlling import levels and prices would be inconsistent with the Single Market legal framework. Equally, if controls were only applied to UK dairy companies, forcing them to charge uncompetitive prices, this would lead to the demise of the bulk of the UK dairy Industry.
(ii) The Implications of CAP Reform 3.15 We do not intend to embark on a detailed analysis of this highly complex topic in relation to the pricing issue—important though it is. SuYce it to say that leaving to one side the ultimate benefits of de- coupling post-2005 for the dairy sector, CAP reform is certain to lead to further falls in producer prices across the EU. In reality, this means that the producers who will thrive will be those that are highly eYcient and can play a role in adding real customer value through their involvement in innovation, brands and investment. 3.16 While suggesting that “UK milk production should be less seriously aVected by the CAP policy reforms than some other countries”, the David Coleman/David Harvey report notes the “[clear] general principles and implications of decoupling” which are that “as support is removed from prices, so production tends to concentrate among the most eYcient producers”. 3.17 The report goes on to explain that in this context “most eYcient” is largely synonymous with “larger herds”. Again, these factors are part of the reality that the UK dairy sector will have to face up to collectively over the coming years.
4. Dairy Crest and Milk Prices 4.1 Dairy Crest is one of the two biggest buyers of raw milk in the UK, purchasing c 2.2 billion litres of milk every year. Milk is bought from two sources, either directly from individual dairy farmers (about 60%) or from milk co-operatives (about 40%). 4.2 Dairy Crest has c 1,450 direct farmer suppliers who are contracted to supply milk for either manufacturing (cheese and other dairy products) or fresh liquid milk. Farmer co-operatives supplying Dairy Crest are First Milk and Dairy Farmers of Britain. 9484161004 Page Type [O] 28-05-04 23:58:54 Pag Table: COENEW PPSysB Unit: PAG1
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4.3 The price of milk supplied to Dairy Crest is negotiated on a quarterly basis with co-operative suppliers and the Dairy Crest Producers’ Association (DCPA) which represents the “directs”. Dairy Crest has consistently paid amongst the best contract prices to producers in relation to both other processors and co- operatives, with two Dairy Crest contracts regularly topping the milk price league tables. 4.4 Turning to the specific pricing issue, which engendered so much debate in autumn 2003, this can only be clearly understood when set in its historical context. The price margin relationship on cheese had been relatively stable until May 2001 when a combination of circumstances resulted in a dramatic slump in cheese prices. Taking as an example the price of mild cheddar, the mid-bulk cheddar PTF quotation shows a fall of £600 per tonne (roughly equivalent to 6ppl) between May 2001 and May 2002. A fall in farm-gate prices during this period of around 3ppl, has created a continuing need for processors to restore margins to sustainable levels in order to maintain the viability of UK mild cheese making. This is clearly critical for both processors and farmers, particularly given the likely eVects of the CAP changes. To date, the industry dynamics have left commodity cheese making in an uncertain long-term position. 4.5 Following this slump, in October 2002 the major multiples oVered £200 per tonne increase in cheese prices equivalent to 2ppl, which they also oVered for liquid milk. Dairy Crest then negotiated increases with its other customers with varying levels of success. Following discussions with the DCPA it was agreed that the increase should be passed back in full to all suppliers. This resulted in Dairy Crest suppliers receiving an extra 1.3ppl for their milk. 4.6 In July 2003, ASDA led another retail initiative, oVering a further 2ppl increase on liquid milk. Other retailers followed this lead and Dairy Crest passed back this increase in full to farmers, paying an extra 1ppl to all liquid milk suppliers (retail liquid accounts for c 50% of total Dairy Crest liquid business). 4.7 Meanwhile in the cheese market, a tightening of UK cheese stocks gave Dairy Crest the opportunity to increase its selling prices and regain some of the lost margin. Selling prices increased by an average of around £140/tonne equivalent to an extra 1.4ppl. This figure reflects the range of selling prices received by Dairy Crest—from £200 in some retail accounts to zero in exports and traded cheese. This also takes account of volume lost from other customers. 4.8 At the same time, Dairy Crest made a commitment to its milk for cheese suppliers to strive for an increase in cheese pricing. Discussions with milk suppliers, farmer groups and retailers led to an initial oVer of 0.8ppl, which was subsequently increased, to 1.4ppl. No improvement could be made on this oVer without further eroding Dairy Crest’s margins on top of the falls seen in 2002. Following further discussions with its retail customers, an additional price increase of £100 tonne was agreed. As this sector accounts for approximately 60% of Dairy Crest’s cheese business, the increased selling price equated to an additional 0.6ppl. This allowed the company to meet its milk suppliers’ demands for 2ppl. 4.9 Dairy Crest’s ability to pay farm-gate prices at the top-end of the UK market to the majority of our milk suppliers, is a direct result of our central focus on the constant development of added value brands, generating benefits, which can be shared across the supply chain—most notably with producers. These market-leading prices are also facilitated by Dairy Crest being more eYcient in terms of its operations, including the costs of farm milk collection. The Committee will be aware that this focus on innovation, added value and eYciency is not replicated in large parts of the rest of the market. 4.10 Dairy Crest has engaged in a number of initiatives based on intra-industry collaboration. In conjunction with its direct supplying milk producers, Dairy Crest has developed added value partnerships with two major retailers which are currently paying 1.5 ppl more than the existing premium Dairy Crest prices—added value that is passed back to producers. 4.11 Dairy Crest has initiated joint collection initiatives, sharing knowledge and expertise, with two major co-operatives, generating significant benefits for all involved. Moreover, the First Milk co-operative is a 20% shareholder in the Haverfordwest Cheese Production facility. 4.12 In short, within the context of an open, competitive, international market—that both the Government and its Milk Taskforce have indicated is the only realistic means of establishing prices—Dairy Crest has led the way in providing producers with market-leading prices. We will continue to work in partnership with the rest of the supply chain in this way. However, we believe strongly that in the absence of genuine collective movement on some of the issues outlined in the next section, the debate over pricing will continue to be misleading and unrealistic.
5. Broader Issues—The Importance of Innovation and Partnership 5.1 We have already outlined our support for the central premise of the DIAL submission—one supported in Parliament by the Minister for Rural AVairs—that suggesting a mono-causal basis for farm gate milk prices is both simplistic and mis-leading. 5.2 The reality is that for farmers’ aspirations to be realised to any meaningful extent will require the supply chain as a whole to face up to some very real structural challenges in the way our industry operates. 9484161004 Page Type [E] 28-05-04 23:58:54 Pag Table: COENEW PPSysB Unit: PAG1
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5.3 In particular, genuine collective consideration and action will be required—ideally building on the work of the both the Food Chain Centre and Lord Whitty’s Supply Chain Forum—in terms of the inter- related issues of innovation, investment, added-value, integration, rationalisation, consolidation, partnership and co-operation. Both expert and oYcial opinion are united on the need for these issues to be tackled head on. 5.4 For example, the Commons Agriculture Select Committee in its February 2000 report on the Marketing of Milk noted that despite the description by MAFF of the UK milk industry as “an ideal agricultural industry for our country”, witnesses, “did not oVer any plans or solutions to help reshape the industry in order to meet its future challenges by ensuring a plentiful supply of milk to be turned into market-oriented products.” 5.5 The report also talked of “widespread complacency throughout the industry”, the lack of “the incentive to create the integrated structure to add value to milk” and co-ordinated activities as “the only way the industry can succeed”. 5.6 Equally, while noting that “profits among processing companies are not high by food industry standards” and that “pricing at all points in the milk chain must be a matter for market forces rather than formula pricing”, the Government’s Milk Taskforce indicated that, “it is clear to us that the key for the future of the sector as a whole is appropriate investment—in the production, processing and retailing sectors”. 5.7 At the same time, the Taskforce noted that “better understanding between diVerent parts of the food chain would clearly promote greater co-operation in achieving eYciencies” and that “the industry could benefit from greater collaboration”. The Defra news release of 22 April 2002 accompanying the Government’s Response to the Milk Taskforce Report, placed specific emphasis on the report’s focus on “the need for greater co-operation and communications between participants in the dairy supply chain”. 5.8 This is echoed in the central finding in Sir Donald Curry’s “Policy Commission on the Future of Farming and Food” relating to the need to reconnect farmers with their market and the rest of the food chain. The Commission placed a strong emphasis on the importance of reducing ineYciencies and improving competitiveness among farmers. 5.9 Finally, the important report “Prices and Profitability in the British Dairy Chain”, commissioned from KPMG by the Milk Development Council, bemoaned the lack of innovation, added-value and intra- industry collaboration, noting, — “thelowgrowth...ofoverall chain value”; — “the low rate of innovation and new product launches” (particularly in relation to other EU countries); —“ineYciencies within the value chain”; and, — “the growing consensus within the sector of the need for greater collaboration to overcome the issues in what has been seen as a confrontational industry”. 5.10 In short, with expert opinion united on the need to look collectively at the issues of innovation, investment, added-value, integration, rationalisation, consolidation, partnership and co-operation, to suggest that farm gate milk prices can be put down to a single cause, is both unrealistic and unproductive.
6. Dairy Crest—Investing in Innovation 6.1 Dairy Crest, of course, recognises the importance of cost-control and eYciency, and as a responsible business, this sits at the heart of our operations. However, a one-dimensional, purely cost and eYciency based approach will only accelerate the commoditisation of the market sector that is already seeing volumes decline. 6.2 In addition, Dairy Crest’s core business strategy is focused on adding value and brand and product development, while at the same time, investing in capital projects to deliver this strategy to the benefit of the entire supply chain. 6.3 As an indication of Dairy Crest’s commitment to investment and innovation, capital expenditure (net of grants) totalled: — £28.6 million in the year to March 2001. — £60.2 million in the year to March 2002. — £61.6 million in the year to March 2003. — £45.0 million (forecast) in the year to March 2004. 6.4 This commitment to dairy processing has included a number of major projects, including an ongoing £49 million upgrade of the company’s Davidstow creamery. This has led to Davidstow Milk Producers, the home of Cathedral City consistently commanding a premium price for its cheddar in the market place. Building on this success, in conjunction with the Davidstow Farmer Group, a unique new producer contract matching creamery needs to producers’ milk constituents has been developed jointly. 9484161005 Page Type [O] 28-05-04 23:58:54 Pag Table: COENEW PPSysB Unit: PAG1
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6.5 Other developments include £54 million “super-dairies” at Chadwell Heath, London, and Severnside, Gloucestershire, and a state-of-the-art distribution plant at Nuneaton, Warwickshire 6.6 In line with our business strategy, examples of Dairy Crest’s commitment to innovation and added- value include reclosable Cathedral City Dip and Go cheese dippers, Country Life Spreadable, Diced and Sliced Cathedral City, Little Moos organic cheese for children and Limited-edition Frijj drinks eg with The Simpsons. 6.7 On the basis of this commitment to high added-value brands and processing, Dairy Crest has, for example, seen its Cathedral City cheese brand achieve a 5-year volume growth of 109%, with about 9% share of all UK cheddar (set against an overall growth in the cheese sector of only 8.2% and an overall fall in cheddar sales of 0.6% over this period). 6.8 Over the same period, Frijj has seen 71% volume growth and accounts for c60% of all flavoured drinks, while Clover’s 49% volume growth means it accounts for 30% of all spreads. 6.9 On the basis of this focus on partnership and brand innovation, Dairy Crest has been able to pass on real benefits to suppliers. For example, the company has successfully formed partnerships with retail customers and direct suppliers, connecting producers directly with the marketplace. This has delivered benefits for the whole supply chain, with producers having a clear first-hand understanding of marketplace needs, enabling them to manage their businesses to meet those needs and maximise the opportunities open to them. 6.10 Examples of this successful model include the farm partnership groups links with Marks & Spencer and Waitrose through Dairy Crest. Through this collaboration, Dairy Crest has identified added-value markets, which are currently paying 1.5ppl more than the existing premium Dairy Crest prices—added— value that is passed back to producers. Dairy Crest is the leading supplier of organic milk to the fresh dairy market in both retailer own label and brand formats. For example, Rachel’s brand of organic milk is growing at around 38% each year. 6.11 Investment, innovation, added-value and partnership are not only a pre-requisite for the future health of the industry, but are also core to the way in which Dairy Crest runs its business. It is on this basis that we believe strongly the industry needs to move forward collectively and we look forward to working with our partners across the supply chain to drive this approach forward.
7. Conclusions—From a Culture of Blame to Productive Collaboration
7.1 Recent months have seen a series of highly vocal and high-profile campaigns which, sadly, ignore many of the pragmatic realities that the dairy industry as a whole will have to face up to over the years ahead. 7.2 For some to suggest that the “blame” for lower than desired farm gate prices of milk can be put down to any single factor—and in particular to inaccurate inferences of exploitative and profiteering behaviour within the supply chain—is both inaccurate and misleading. The conflictual and adversarial nature of the supply chain characterised by a blame culture is in no one’s interests. 7.3 Equally, the UK’s dairy sector simply cannot wish away the realities of international competition, imports, commodity markets, production ineYciencies, CAP reform, currency fluctuations and seasonal over-production. 7.4 Faced with the realities of the coming years and the factors outlined in this submission, we believe strongly that the entire supply chain must work together on the inter-related issues of innovation, investment, added-value, integration, rationalisation, consolidation, partnership and co-operation. Expert opinion is united on the importance of collective eVort in these areas as the only way to deal with the pragmatic realities facing the industry. 7.5 As we have outlined, Dairy Crest places the adding of value to milk through brand development, innovation and capital expenditure at the heart of our business, and we have the resources and commitment to continue to do so. This is one model for the operation of the dairy market in the UK which generates mutual benefits for all involved. 7.6 However, unless the entire supply chain—and indeed the rest of the processing sector—is able to pull together in the areas of innovation, investment and added-value, the dairy sector will not be in a position to rise to the collective challenges facing it and importers will continue to exploit the opportunities generated by this disunity. 7.7 By contrast, our existing partnerships across the supply chain have worked and allow all parties to concentrate on their areas of expertise. Success in the retailer/processor/producer relationship will depend on the realisation that the way forward must be true co-operation, which adds value and maximises the opportunities from this. A good example of this is the collaboration between the company, the “Sovereign” group of Dairy Crest farmer suppliers, M&S and Waitrose. 9484161005 Page Type [E] 28-05-04 23:58:55 Pag Table: COENEW PPSysB Unit: PAG1
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7.8 Certainly Dairy Crest can play its part in driving forward a processing model that places a premium on investment, innovation, brand development and co-operation. However, given the magnitude of the challenges facing the entire UK dairy industry, taking responsibility in rising to these challenges must be a shared endeavour, encompassing Government, farmer representative organisations, producers themselves, the processing sector, co-operatives and the retailers. 7.9 Real opportunities do exist for true collaboration up and down the supply chain, as Dairy Crest has demonstrated. However, these opportunities will not be realised unless the industry can move beyond the current blame culture and work on a genuinely collective basis. Talk of the need for a Regulator is certainly not the solution. 7.10 We conclude with a range of practical suggestions that—if delivered individually and collectively by all parts of the supply chain—could make a real diVerence to the health of the UK’s dairy industry. This agenda for change includes greater individual and collective action to: — Work together to improve farm-gate economics, including looking carefully at on-farm costs and herd sizes, benchmarking processes against best practice and “smoothing” seasonal production relative to market demand. — Remove costs from the supply chain eg by route sharing to reduce ex-farm haulage costs; — Tailor the types of milk provided to manufacturer and consumer requirements, for example, Dairy Crest’s work with the Davidstow Farmer Group where there are joint plans to optimize the milk fat and protein profile in order to meet producer and creamery needs; — Add value to the entire supply chain through a vibrant and evolving dairy market, branding, new product development and innovation in the areas of sales and marketing to change demand patterns, rather than simply react to them—the core of Dairy Crest’s approach; — Improve logistics eYciency throughout the supply chain; — Improve market information and communications with producers, to ensure the best possible understanding of market dynamics and where mutual interest truly resides; — Build on the work of the Milk Development Council in acting as a catalyst for development of milk markets for the benefit of producers—witnessed by the White StuV and Milk in Schools campaigns. January 2004
Witnesses: Mr Drummond Hall, Chief Executive, and Mr David Lattimore, Director of Specialist Businesses, Dairy Crest Group plc, examined.
Q117 Chairman: Gentlemen, could you just on the return we get from each of those introduce yourselves. marketplaces. I think in the case of the recent price Mr Hall: I am Drummond Hall; not a stately home, increases which you were talking about earlier, again it is my Scottish ancestry. I am Chief Executive of we can only talk from our own experience, but we Dairy Crest. On my left is David Lattimore. David did pass all of those on 100% to our farming has been in the dairy industry for the last 30 years, suppliers. I can see you furrowing your brow, so with Unigate and then Dairy Crest. He was perhaps I could ask David to elucidate on that. previously a member of the Milk Development Council, and he now sits on Lord Whitty’s supply chain and South-West Food & Drink, so hopefully Q119 Chairman: I would never furrow my brow. he can cast a little light on some of these discussions. David? Mr Lattimore: I think there are probably a couple of points I would make on this. First of all, the question Q118 Chairman: You have the advantage of going second, that you know the format, and the questions of transparency and whether the money gets passed will not necessarily come as a total shock to you; but through. One of the ways we deal with that within knowing how this Committee works, they will not be Dairy Crest is through our communications with the same questions again. Can I give you a nice one our direct suppliers, and they have a body called the to lead into. Given the basis of this inquiry, that the Dairy Crest Producers’ Association. We share with farmers do not need to allege—they can prove—that them in some cases confidential marketing and the retail price of milk, where it increases, is not pricing information, and we agree with them the necessarily passed on to anything like the full extent level of prices, certainly as far as producers are to them as producers, why is that so? receiving them at the time. That allows us to have Mr Hall: I think from our experience we would more confidence in the process from both sides. I make a couple of observations. Firstly, we operate in think the other thing I commend to you, with my a number of diVerent markets, so we sell product not MDC hat on, is the activities at MDC, particularly only to the major retailers, but we sell it to food through their datum group, where they are service operators, food manufacturers, and in the providing producers now—farmers—with a lot case of cheese there is quite an extensive trade in the more information in terms of market prices, what is export market, so the ultimate returns will depend going on out there, and actually making sure that 9484161006 Page Type [O] 28-05-04 23:58:55 Pag Table: COENEW PPSysB Unit: PAG1
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1 March 2004 Mr Drummond Hall amd Mr David Lattimore farmers are as well equipped to discuss and negotiate Mr Hall: You do, don’t you? with processors and retailers as the other parts are in the supply chain. Q122 Paddy Tipping: Can we talk about profit margins on liquid milk. I know these are commercial Q120 Chairman: You heard my question to matters, but can you give us an indication of what Wiseman, this issue of trust and transparency; and I profit you are making on a litre? suppose also, given the diversified nature of your Mr Hall: As Billy Keane has led the way, I suppose business, there is the one about eYciency. What has we had better not be shy. If you look at our profit Dairy Crest done to deal with those three issues? margins on our liquid business, expressed in pence Mr Lattimore: If I can pick up the issue of eYciency per litre, we make about two pence a litre. The other to start with, one of the things that we have done is big diVerence, of course, with us compared to that the best-paying contracts are contracts with Wiseman, is we are a broadly-based business, so we Waitrose and M&S, where all three parties work have leading positions in all sectors of the dairy together on the issues facing us, and the returns. One market, so we have a range of margins. The margin of the things we do as part and parcel of that is on our cheese business, which would be the other big actually benchmark costs between individual business, is pretty similar, actually. If I take the half- producers, so that producers can see what year we reported on, it was 2.1 pence per litre. An opportunities they have to improve their eYciency. important point within that, however—and these That again is some work that the Milk Development issues have been well publicised, for those who may Council is doing in terms of eYciency. If I can just not have read our financial report and accounts—is talk you through the processes in terms of perhaps that the cheese business consists of a very large slug setting prices with our direct producers in Dairy of commodity cheese—mild cheddar, unbranded Crest, what happens is that they initially will come cheddar, which operate very much at the bottom end to us with a view of the marketplace, including of the market—and I have to say that the margins producer needs, which we sit and discuss. We take it there are extremely slim, and we make more margin away and then we come back and respond to them, on about the 30% of our business which is in branded and then following negotiations the prices are set at and added-value cheese. So within that 2.1 pence, it the end of that particular process. So we put a lot of ranges from almost nothing to four or five pence. eVort into trying to make sure that the producers The other big chunk of our business is the have an equal amount of information as we do, so ingredients business for bulk skimmed commodity that they do not feel the process is not working for products. Essentially that operates pretty much at them. I think this may be a way for the whole break-even. It is a very small positive margin. industry to try and make sure that there is more information there, and openness, recognising that a Q123 Paddy Tipping: So it is the added-value part of lot of pricing information will be, by its nature, the business that is the best bit for you? commercially sensitive. Mr Hall: Absolutely. We are very clear on that. That Mr Hall: Chairman, might I add a supplementary, is what we invest in, and that is what generates our which may not be absolutely germane to your point. returns and our farmer’s returns. We have a very strong belief that the future of the industry is not just about eYciency, although that is Q124 Paddy Tipping: There has been an increase in very important in terms both of on-farm eYciency milk prices, two pence per litre. What diVerence has and our own eYciency as manufacturers. We believe that made to your profit margins? one of the fundamentals is adding more value to the Mr Hall: In terms of our profit margins over the last market through investment in brands, through 12 months, nothing; it has been a straight pass-back. product innovation. Yes, we have spent, as we put in That two pence per litre was designated to go to our submission, a very large amount of money on farmers on liquid milk, and that has been passed capital investment from the point of view of back to those farmers. Leading up to Christmas eYciency. What we have also done is over a very there was also a similar move after a lot of tough long time now invested in building very significant negotiation and discussion on cheese, and we were brands, which both command a premium and able to pass back two pence per litre on milk for provide us with some sustainability of business cheese, but again with support back from the going forward. I would just like to give you an marketplace, so that made no diVerence to our example of that. By way of example, we pay the margins. producers—the farmers who supply our Davidstow site, which produces our Cathedral City, which is a Q125 Paddy Tipping: You are very involved with the brand of mature cheese—a significant premium multiples, and there is a lot of criticism of price in versus the average milk price, typically 1.5 pence per supermarkets. What is your take on this? What do litre, and that is really on the back of the returns that you think they are making per litre? we are able to make through that added value. We Mr Hall: If you go back to the previous session— think that is absolutely central to the future of the because we have access to the same report, industry moving forward. obviously—the KPMG view was that they were making 25 to 30% gross margin on milk. That of Q121 Chairman: I declare an interest, as you know, course translates, if you look at their net margins, to because I see the investment from my bedroom 4 to 5%, so obviously some would say that is not window. excessive. In terms of our relationships with the 9484161006 Page Type [E] 28-05-04 23:58:55 Pag Table: COENEW PPSysB Unit: PAG1
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1 March 2004 Mr Drummond Hall amd Mr David Lattimore major multiples, obviously the pricing in milk is set changes to prices because retailers are very price- by a variety of diVerent factors—commodity point conscious, and there does come a point at pricing, stocks of cheese, capacity of the industry, which they say “Well, no, we are not prepared to sell currency—and negotiation with those multiples. that item beyond that particular price point; we will Where you have a diVerentiated product or a get customer resistance”, and therefore you are left diVerentiated brand you are in a better position, and in some diYculty in trying to meet the pressures of therefore you are in a better position to both get a the supply side against a barrier from the retail side premium return and support your farmer base on to change key price-points? that premium return. Mr Hall: Your point is well made. It is never easy to get price increases from retailers. Our view would be Q126 Paddy Tipping: Some people say that these that you have more ability to do so if you have a negotiations are not equal; that the supermarket has brand than if you are entirely in an own-label all the clout, and that the producer has very little business, because in a sense the equity sits with you clout. You are somewhere in the middle in this. How as a manufacturer. Again you are right that with the do you see this David and Goliath contest? move to everyday low pricing there is increasing Mr Hall: I guess it is fair to say that we have pretty emphasis on that end price, and therefore it is more robust conversations with retailers. diYcult to move the price forward. I think that poses a couple of challenges for us. One is we obviously Y Q127 Paddy Tipping: You should be a politician. need to become more and more e cient in running Mr Hall: We do. The retailers do tend to get a lot of our businesses. The second thing we need to do is get V flak because they are pictured as the ultimate baddie. more and more e ective in our marketing in terms of I have to say we have built our business through the kinds of products we introduce, and—if I can be working closely with retailers, which is how spared a small commercial—you know we have just Wiseman built his business. We have pretty vigorous spent a lot of time on our Cathedral City brand. We sessions with them, but we have built a strong and have introduced new easy-open packaging, growing business over time on the back of a range of reclosable packaging. We have extended it into products. We provide the right quality of service and ready-sliced and dip products, and it is through we provide the products that the customer wants. At those sorts of initiatives over a period of time that we the end of the day the end customer is not the can start to address all those cost issues. retailer; the end customer is you and me as consumers. So in terms of the balance of power, perhaps David could talk about that. Q130 Diana Organ: You said that you obviously Mr Lattimore: If you look at it, there are probably, have a very close relationship with your suppliers, say, five major retailers and five major processors, the Dairy Crest members, and that you try to keep there are three major co-ops and perhaps five major them informed, and you work with them and so the direct selling groups, so the balance of power is a bit information that you have, you pass on to the more equal than if you start saying there are 25,000 suppliers, and so on. One of the messages we are individual dairy farmers. One can discuss the quality wondering whether farmers really do understand is of the organisation as you go on down the chain, but that in order to become really profitable they have to the balance is potentially relatively equal. be eYcient; in order to be eYcient they need to have larger dairy herds than maybe many of them have Q128 Mr Jack: Do you benchmark yourself against got, but eventually that will mean fewer dairy farms, any of the major continental dairy producers to see because it is going to be more eYcient, bigger herds. how you are performing? Do you think your members really understand that? Mr Hall: I can take that one. No, we do not. We run Mr Hall: Ask David; he sees them on a weekly basis. our business on a number of key ratios. We work Mr Lattimore: I think I would agree with you, there very hard at making sure we get the right is a challenge facing perhaps not only our own productivity out of our capital investment. We look members but the whole of the dairy industry, in to make a proper return on our marketing making sure that everybody is aware of the investment, so we spend a lot of time on econometric challenges facing them in the future. I think one of analysis of our advertising eVectiveness—I am not the problems is there are a lot of producers out there sure it tells us very much, but we spend a lot of time that would recognise what the situation is and what on it. The continental dairy producers are in a the future holds for them, and we communicate with diVerent position from us. They are either very large those people regularly. However, there are still little vertically-integrated cooperatives, in terms of mass groups of people that do not really engage in the users of milk, or alternatively they are very big multi- process properly, and it is up to us to make sure that nationals—Danone or Nestle—who operate very we try and get through to those. That is why we hold much in the band of added-value. So perhaps it is a regular series of meetings with them; we have even something we should look at, but it is not something had special sessions dealing with CAP, et cetera, et that we have historically looked at, no. cetera, to try to get them to engage. They do say that the only bit of correspondence you will ever Q129 Mr Jack: Can I just ask you, clearly because guarantee that a farmer will read will be the milk there is a spread of activities, in the branded sector cheque, so we usually send these messages through is it not a fact that it is more diYcult to secure there. 9484161006 Page Type [O] 28-05-04 23:58:55 Pag Table: COENEW PPSysB Unit: PAG1
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1 March 2004 Mr Drummond Hall amd Mr David Lattimore
Q131 Mr Jack: What, on a cheque? Q134 Diana Organ: At any time? Mr Lattimore: I think one of the things that we can Mr Lattimore:—of the 1,400 are, it is diYcult to tell. do is to make sure that what we are asking them to There are bound to be ones within there that would produce, we are quite clear about exactly the not be making a profit, but on average currently, yes, specification of milk that we want from them. We they are. have just launched two new contracts, one for liquid, one for manufacturing, which is cheese, and these Q135 Diana Organ: What do you think, on average, contracts have been developed with producers. If I people that are supplying you are making at present can give you an idea of the one that we have on sales of liquid milk per litre, profit? produced for the Davidstow cheese factory, we have Mr Lattimore: Certainly in excess of a penny a litre come up there with what would be the ideal litre to at the moment. Our average-sized producer would produce a ton of cheese out of that factory. With be larger than the national average. Our average- producers we have come up with a matrix, and if the sized producer is about a million litres. We do have producers can hit that matrix they will get a much, specialist contracts with Waitrose and Marks & much better price than they would by just sending Spencer, and those producers would get an milk on a random basis. That is not Dairy Crest additional 1.6 pence per litre over and above that. handing over money altruistically; that is money They do have to do some additional work for that, coming out of better eYciencies out of the supply but it does not add up to the premium that they are chain, and that is the sort of thing that we need to do getting. Uniquely with these two particular across the whole of the industry, in our view. contracts, we seem to have been able to find almost an ideal, insofar as the retailer seems to be getting a product that works for them and works for their Q132 Diana Organ: Having established that consumers; it delivers a premium through to the obviously Dairy Crest, although it might be a good producer, and it works for Dairy Crest as well, thing, is not a totally altruistic organisation—it is in because, I have to say, having happy customers and business for profit, as many others are—why do you happy suppliers does tend to make for a happier think it is, therefore, that the proportion of the retail processor. price made up by the farmgate price has gone down consistently over the last three or four years? In Q136 Diana Organ: Outbreaks of happiness all other words, you are taking your fair share as a around us again. processor, and the retailers are, but the farmer, the Mr Lattimore: Yes. producer, seems to be losing out consistently. Mr Hall: I think if we take it over the last three years Q137 Diana Organ: I realise of course that the there has been a fall in the percentage of the retail previous people I spoke to, they quite correctly put price of milk accounted for by the farmgate price. I me right that they are not, of course, producing think the key reason for that is, remember, about cheese, you are, and many people will know you for 50% of milk in the UK goes into what we call cheese, and particularly cheddar, which is obviously manufactured products, not just liquid milk, so it the main one; it is 62% of all cheese produced in the goes into cheese and it goes into butter powder. In UK. However, we know from the Federation of the last three years we have seen an absolute slump Milk Groups that research indicates that actually in commodity markets, so we have seen 10- or 12- farmers are losing on the profitability of milk that year lows in world pricing, and it has been they are giving for cheese. They are saying it is a particularly diYcult in the cheese market, where figure of about 2% of the retail price of cheddar prices pretty much collapsed—which is not too cheese that farmers are losing on the milk sold to dramatic a word—three years ago now. So that has processors to make this cheese. Is that true in your put a lot of pressure into the farmgate price, and case? therefore by definition it has come down relative to Mr Hall: In terms of our experience that would not the liquid milk revenue coming in at the top. I think be the case. I think that probably partly reflects our the other thing is that retailers have increased their mix of business, where we have much more cheese in margins on liquid milk, as Billy Keane was saying, the premium and added-value sector. If you take our over that period of time, because they had moved best price of milk for cheese which is published, and from a position where perhaps they had pretty go through it, we would pay an average of 20 pence limited profitability to the sort of 25, 30% that we per litre of milk going to cheese. If you take the talked about earlier. average cost of production it is probably about 18 pence, so the farmers who are supplying us with milk for cheese are making on average about two pence a Q133 Diana Organ: You were talking in answer to litre. I should qualify that and say that if you wind Paddy Tipping’s questions about price and the clock back 12 months ago when conditions in the profitability on a litre and everything. Do all of your cheese market were particularly diYcult— farmers, your producers selling to you, make a profit? You know them well. You must know what Q138 Diana Organ: Which is presumably when this you are paying them for their milk, and what their research was done? costs are. Mr Hall: Which is presumably when the research Mr Lattimore: We would say that on average they was done—they would have been at about break- will be. Whether every individual— even on average. 9484161006 Page Type [E] 28-05-04 23:58:55 Pag Table: COENEW PPSysB Unit: PAG1
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1 March 2004 Mr Drummond Hall amd Mr David Lattimore
Q139 Diana Organ: So you are saying the situation well ahead of the game in terms of that investment. might be a little ameliorated from when the research However, we will have to continue to take cost out. figures were coming in? Probably the next area is going to be areas like Mr Hall: It has been, yes. distribution, particularly ex-farm milk haulage, Chairman: Colin, do you want to say something? where we are working with one or two of the co-ops to take out milk collection from on-farm. Also—I Q140 Mr Breed: You have rather helpfully put a am sorry for sounding like a broken record—I come point in your evidence to us, a section on the back to the fundamentals: we have to add more implications of CAP, although you said you are not value. If we simply become more and more eYcient embarking on a detailed analysis of this highly in taking cost out, that will be necessary, but it will complex topic in relation to the pricing issue, which not be suYcient, so we have got to have a better mix of course is the fundamental thing that we are of added-value product in the country. talking about. Nevertheless, the last bit I just want to perhaps expand on. The report goes on to explain Q144 Chairman: You heard the question I asked that in this context “most eYcient is largely Wisemans about the 14 pence proposal that has been synonymous with larger herds. Again, these factors made by MDC. What is your view on that? are part of the reality that the UK dairy sector will Obviously farmers would say that is completely have to face up to collectively over the coming unsustainable. Is that your view? years”. Do you have an idea of what you believe the Mr Lattimore: I think if you look at our experience optimum sort of average-sized herd is likely to be? historically, where we had major shocks—BSE, foot Mr Lattimore: No, I do not think there is a standard and mouth, or whatever—that has done serious model for that, because you have to look at the damage to the whole of the industry. One of the individual circumstances of the farmer concerned. things about the supply chain forum, where However, there is some evidence in our personal everybody is coming together to try and find some experience that producers, farmers, will get to a longer solutions, is that that body in my view and certain level and then find that they actually do not our view can actually start to get some of these get any further eYciency gains. figures together and put these scenarios out, so that price does not have to dip to let us say to 14 pence, Q141 Mr Breed: The law of diminishing returns? cause a lot of damage, and then bounce back, so that Mr Lattimore: Not necessarily diminishing, but we have some knowledge about how we might be static, so it is hardly worth them investing more, but able to influence and manage some of these issues in it does depend very much on where they are, how the future, as an industry, not as individuals. they operate, and also to some extent the markets Historically it shows that with processors, retailers that they are supplying. and farmers separate, we do not do as good a job as potentially we could do if we were together and, as Q142 Mr Breed: Whilst not getting down to the we see with colleagues on the continent, how better exact number of cows, could you give us a range that they sometimes do things because they tend to work might be the optimum level? together, particularly farmers and processors. Mr Lattimore: That is an extremely diYcult question Chairman: That takes us directly into what Michael to answer. There are producers that can operate at will no doubt ask you. 500/600 cows and seem to benefit from the eYciencies at that level, but there is some doubt as to Q145 Mr Jack: This cosy, nice warm world of whether, moving on to perhaps 1,000 cows, the partnership and transparency in discussion sounds benefits would show at that sort of level. all well and good, but the impression I gained from reading the evidence to date is that we would not Q143 Mr Breed: That is fine. Just briefly, again, if we actually be talking about higher prices for milk, had are talking about the eYciencies of farmers having to it not been for that grumpy minority of farmers who get together, some going out and selling their demonstrated and made a big fuss. Eventually it was holdings, all that sort of thing, what about the more the moral of the situation than the economics processors? I suspect you are going to be under a bit that seemed to decide that supermarkets would pay of pressure as well. So what sort of plant are you more in the first instance for liquid milk, and then going to close down, and what sort of eYciencies are there had to be a second round of sabre rattling you going to have to undertake in terms of a before they came to the party for cheese. So if you response to this? want to see—as you say in paragraph 10 of your Mr Hall: Can I make two replies to that question. evidence—a move away from the institutionalised One is, in terms of eYciency, undoubtedly we will antagonism, how do you achieve that, against the have to become more eYcient in our operations. most recent background, where what price increases Without sounding complacent, we have already have occurred seem only to have resulted from a invested a huge amount of money in our business to good old bout of antagonism? get ourselves in shape for that. In the last four years Mr Hall: Perhaps I can deal with that, then ask we would have invested £200 million in capital David to supplement it. The price increases that investment; we have constructed two very large have occurred have actually occurred on the back of super-dairies. We are currently just finishing market fundamentals. The reason that the prices investing £50 million in a very large cheese creamery have been able to move up is that the floor price at Davidstow in Cornwall; so we believe that we are moved up on the back of intervention, milk pricing 9484161006 Page Type [O] 28-05-04 23:58:55 Pag Table: COENEW PPSysB Unit: PAG1
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1 March 2004 Mr Drummond Hall amd Mr David Lattimore having moved up and setting the floor in the market, trust and confidence going forward, looking at and a base from which prices could rise. The cheese history is not going to help us at all because that issue was entirely down to the tightening of cheese clearly does not work. We believe the Supply Chain stocks. If you were to go back three years, as I say, Forum does present with an opportunity to try and we had a collapse in cheese prices. Cheese prices in build that trust if we are going to make this work fact fell by something like £600 a ton, which, going forward. expressed in milk equivalent, would be about six pence a litre, and we did not take our prices down to Q148 Mr Jack: You would suggest that the Supply farmers by anything like that, because we wanted a Chain Forum is the antidote to the suggestion of sustainable future. The main driver for that was a those who put forward an idea of a regulator body very, very high level of cheese stock, it took a very for the industry? long time for industry cheese stocks to work their Mr Lattimore: As far as the regulator is concerned way out of the system. What you then saw going into there are two points Dairy Crest would make, first of September was increasing tightening of that cheese all regulators do not always operate in the way that stock, that first happened in the earlier part of that you might expect them and they may seek to take a year. It is fair to say Mr Handley popped in on the view more in terms of markets and consumers rather back of that. than in terms of farmers and invariably it will involve everybody in more bureaucracy rather than in marketing the products and perhaps making Q146 Mr Jack: You would suggest that he and those Y who follow his line have been opportunists? ourselves more e cient. Mr Hall: If the market conditions had been diVerent Mr Hall: From our perspective we must remember a those price increases would not have happened. large element of our competition sits abroad, with a large amount of cheese imported into the UK, and what we could not have is one rule for us here in the Q147 Mr Jack: In terms of the dialogue which you United Kingdom and a diVerent set of rules in the advocate to get rid of this institutionalised rest of Europe. antagonism when there was a fall in the market because the currency changed, started to alter who Q149 Mr Jack: Can you just say a bit about the made the first phone call, was it you to your Supply Chain Forum, who is on it? What does it do? customers saying the market is now shifting we need When does it meet? What powers does it have? to discuss price, because it is unusual for buyers in Mr Lattimore: I am sure Defra would answer this supermarkets to pick up the phone and volunteer more eYciently than we can. It represents a broad out of a spirit of generosity, recognising the church of the supply chain within the dairy industry irresistible forces of the market place, to want to pay from retailers to producers’ organisations to you more? processes and to individual groups. They have set up Mr Hall: If you take the example of cheese that is a number of individual sub groups on marketing and exactly the role of our cheese traders and our cheese innovation, industry development and the idea is sales force, to read the market, judge whether it is that these sub groups meet, come up with initiatives, moving and go and have those first conversations ways forward, examine opportunities and then with retail buyers to get the price moving, and that report back to the main group. I think in the longer is exactly what happened in this case. term it is envisaged that the group rather than being Mr Lattimore: Can I come back to you on the chaired by Lord Whitty or a representative of the fundamental point, if you were to talk to anybody Government would actually become an industry representing the farmers side of the industry they body and that would mean the industry working would agree—and I would include David Handley together. in this—industrial action of one sort or another is Chairman: If you wish to contribute to anything that not a long-term solution, and they are seeking long- you think needs further explanation feel free to do term solutions as much as anybody. We have a so, however what has been said must remain said. vehicle in the Supply Chain Forum to try and build Thank you for your evidence.
Memorandum submitted by Arla Foods UK plc (L15)
2. The Structure of the UK Market
EU support structures within the CAP
2.1 In the dairy sector support for milk producers is provided by intervention values for butter and skimmed milk powder which since the introduction of the single currency are calculated in euros. These values have not changed since February 1995, although they will be significantly reduced in stages commencing from 1 July 2004 as a result of the agreement reached on the mid term review of CAP 9484161007 Page Type [E] 28-05-04 23:58:55 Pag Table: COENEW PPSysB Unit: PAG1
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Reform last year. The majority of member states therefore have experienced a stable floor price for the base commodity products of butter and skimmed milk powder for many years. In the UK since our withdrawal from the ERM and the decision not to join the euro and the abolition of the Green £ protection, the UK has been faced with daily changes in the intervention values reflecting movements in the value of the £ sterling against the euro.
2.2 To illustrate this point, since deregulation in November 1994 and the abolition of the Milk Marketing Boards, the daily delivered milk price for intervention products at intervention values derived from the European support prices has ranged from a high of around 24ppl to a low just below 16ppl. Current values over the last few months have been around 19ppl. Given the purpose of intervention was to give European dairy farmers a stable base value and create an eVective floor in the market, it can be seen that the UK’s decision not to join the single currency has left UK dairy farmers with a volatile, unstable base milk price.
A brief explanation of the how the UK raw milk market has operated in recent years
2.3 Changes in raw milk prices since deregulation have been driven by four factors; firstly movements in currency as the relative strength of the £ has varied significantly against the ecu and more recently the euro. This has clearly been the single most important factor.
2.4 Secondly, the commodity markets for butter and skimmed milk powder. At times one or both of these markets has performed well ahead of intervention values for considerable periods. As a consequence this has led to those manufacturing butter and skimmed milk powder to those willing to pay a higher price for milk than the intervention support levels. This has put an upward pressure on raw milk prices generally as those requiring milk for higher value markets and demand markets have needed to pay higher prices for their milk to avoid an increased movement of milk into butter and skimmed milk powder. There have been periods of time since deregulation when strength in either or both of these markets has led to raw milk prices moving significantly ahead of those based purely on intervention values.
2.5 The third factor has been supply and demand of raw milk. The UK consistently produces around 14 billion litres per year in line with its quota allocation. This factor has only been of minimal importance with one notable exception. In 2001 the major outbreak of foot and mouth disease in Great Britain created an expectation that there would be a significant fall in the amount of milk produced in the UK, which put upward pressure on milk prices. Events showed that milk production was unaVected and the eVects and this concern for lack of supply ceased to be reflected in milk prices during the following 12 months.
2.6 The fourth factor is the impact of the UK supermarkets. They have increasingly become the dominant force in the liquid milk market and the cheese and cream markets. Inevitably as they now take at least 40% of the UK’s milk production within the range of dairy products they sell, their buying power does give them a level of influence over the market. In significant sectors of the market such as liquid milk and cheese due to a combination of substantial over capacity with processors and in the case of commodity cheddar cheese and UHT milk the ability for ready import substitution. Although all the UK supermarkets have shown a desire to get closer to dairy farmers, their buyers obviously seek to buy well in what for them has also been a very competitive market place. In more recent times supermarkets have been responsible for generating additional revenue by raising their retail prices which they have specifically requested be passed back to dairy farmers.
2.7 The attached quote from the Competition Commission report into the Arla Express merger (October 2003) confirms the buying power of UK supermarkets.
2.8 “Although this also means that the national multiples are increasingly reliant on the major processors for supply, we view the relationship as being asymmetric. As noted above, the national multiples have the ability to switch volumes easily between suppliers, and can also seek to foster alternative sources of supply. In contrast, a processor cannot readily find another avenue to market if it loses sales to a national multiple”.
2.8 The chart below tracks movements since 1994 in intervention prices (converted into pence per litre delivered to dairy) as a result of currency changes between the ecu/euro and the £ sterling. The relative strength and weakness of commodity markets of butter and skimmed milk powder throughout the same period and the milk price paid to producers based on the price paid by Express Dairies to members of the Express Milk Partnership. Note: The EMP price is typically at least 1ppl above the price paid by Milk Marque and its successor co-ops. 9484161007 Page Type [O] 28-05-04 23:58:55 Pag Table: COENEW PPSysB Unit: PAG1
Environment, Food and Rural Affairs Committee: Evidence Ev 51
IMPE, AMPE & EMP 30
28
26 24
ppl 22
20
18 16
5 5 5 6 6 6 7 7 2 2 3 3 3 9 9 9 9 9 9 9 9 7 8 8 8 9 9 9 0 0 0 1 1 1 2 0 0 0 0 0 - - t- - - t- - - -9 -9 -9 -9 -9 -9 -9 -0 -0 -0 -0 -0 -0 -0 - t- - - t- b n c b n c b n t b n t b n t b n t b n t b n c b n c e u e u e u c e u c e u c e u c e u c e u e u F J O F J O F J O F J O F J O F J O F J O F J O F J O
EMP Delivered IMPE AMPE
IMPE = Intevention values for rew milk delivered to dairy for butter and skimmed milk powder in ppl.
AMPE = Values for raw milk delivered to dairy based on actual butter and skimmed milk powder market values in ppl. Source: Dairy Markets Weekly 2.9 One point to note is that there is typically a time lag between movements in currency and/or commodity markets and movements in the raw milk price. This arises because for many contracts milk prices are set for 6 or 12 month period. The usual anniversary dates being 1 April, which coincides with the beginning of the European milk year, and 1 October being the mid point in the milk year. It is also true that even commodities such as butter and skimmed milk powder are often sold forward for periods between 3–6 months and will not instantly respond to changes in the currency position.
Historic view regarding the range of milk prices 2.10 Since deregulation the typical range of farmer milk prices, based on published information, has been between 1.0 to 1.5ppl. The higher prices have consistently been paid by those whose milk predominantly went into the fresh and added value markets such as the fresh liquid sector. The bottom end of the pricing scale has tended to be paid to those producers whose milk predominantly went into the commodity sectors such as butter and skimmed milk powder. The formal end use pricing structure that existed in the days of the Milk Marketing Board ceased at deregulation in 1994. Not surprisingly those processors supplying the liquid market require a fairly level supply for 365 days of the year and pay a premium against milk going into the commodity markets to ensure consistency of supply. Also reflected in the range of milk prices is the diVerence in costs from one organisation to another. The biggest single item here being collection from farm to dairy. Such costs vary significantly according to whether the milk is going into the dairy direct from the farm or whether it needs to be reloaded and transhipped. Inevitably higher haulage costs do in part tend to lead to a lower producer price. For relatively short periods of time the range of prices has either widened or narrowed, but where it narrows processors in demand markets increase prices to ensure the continuity of the supply that their markets demand, before the gap widens again back to the more traditional levels. Beyond 1.5ppl it would tend to ease downwards as those selling into the bottom end of the market seek to move milk into better markets such as liquid typically tending to pull those prices down until prices fall to within the more typical 1.0 to1.5ppl range.
Arla Foods UK Plc’s Direct Milk Supplies 2.11 Prior to the merger both Arla Foods and Express Dairies each bought a substantial amount of milk direct from producers contracted to both companies. In the case of Arla Foods whilst there was broadly one contract some of the producers were in formal groups and others were grouped more informally broadly on a geographical basis. The company met periodically with representatives of the formal groups but on a group by group basis. They discussed issues including milk price, but ultimately milk prices were determined by the company and then notified to producers. 9484161007 Page Type [E] 28-05-04 23:58:55 Pag Table: COENEW PPSysB Unit: PAG1
Ev 52 Environment, Food and Rural Affairs Committee: Evidence
2.12 In the case of Express prior to deregulation the company with its milk producers formed a separate company currently known as the Express Milk Partnership. All farmers supplying direct to Express had to be a member of the Express Milk Partnership. The Partnership was a limited company, 50% owned by the company and 50% owned by the producer members. There was one contract and one price schedule for all members. The price was negotiated between the company and the producer representatives, as is the structure of the payment system and any other changes to the contractual arrangements that may be felt necessary from time to time. The Chairman of the Partnership is always a producer and there are 10 other producer directors all of whom are elected on a regional basis by the producer members. Express currently has three further directors appointed to the Board of EMP. The Partnership has been in the forefront of developments in farm assurance and farm auditing, and contributes actively to the key issues aVecting the industry. For example, it retains regular direct contact with oYcials at Defra and recently put in a formal submission as part of the consultation process on the mid term review of CAP Reform. The Express Milk Partnership is funded on a 50/50 basis with a small levy to producers on a litreage basis which is matched pound for pound by the company. 2.13 Following the merger, discussions are at an advanced stage with producers representatives with an objective to bring all the direct supplying producers to Arla Foods UK plc into one group broadly building on the framework of the Express Milk Partnership.
3. Recent Price Movements
Recent retailer impact on producers’ milk prices 3.1 As the £ strengthened against the Euro support prices fell substantially when converted to £ Sterling. By 2001–02 changes in currency alone had led to typical producer prices, excluding seasonality payments, to have dropped to between 16–17ppl, a level that would generally be recognised within the industry as to be below the cost of production for the typical UK dairy farmer. This created great pressure on dairy farmers that led to an increase in the numbers leaving the industry and for the first time in many years militant action by a small but significant number of dairy farmers. This took the form of picketing processors’ premises and selected retailers’ chilled distribution depots. As a consequence on three occasions over the past two years supermarkets have increased their retail selling prices for liquid milk and then asked their supplying processors to increase their transfer prices to the producer by broadly the equivalent amount and to pass the additional revenue in full back to the producers. The last occasion that this occurred was in July 2003, when the increase was the equivalent of 2ppl on the UK supermarkets’ liquid milk sales. This level of increase was in line with what might have been expected to come had normal market fundamentals kicked in but on this occasion that failed to happen. The background is as follows: 3.2 During the early part of 2003 there was a significant correction with the £ sterling weakening against the Euro which led to the value of milk delivered to dairies going into butter and skimmed milk powder for intervention levels to rise from around 17ppl to 19ppl. Other than forward sales this began to be immediately reflected in the circa 12.5% of national milk supplies going into these two commodity areas. Normally over time such an event would have been expected to put upward pressure on milk prices generally. The next stage in the chain is the cheese market, and on this occasion typically prices for hard pressed cheeses produced in the UK, such as cheddar remained weak, with values in ppl remaining below those achieved for butter and skimmed milk powder. Although Arla Foods are not cheese manufacturers in the UK, we understand the reason for this situation would appear to be that in the previous milk year 2002–03 cheese production in the UK rose substantially to soak up surplus milk and as a consequence the UK started the 2003–04 milk year with unusually high stocks of mild and mature cheddar cheese, and in the case of mild cheddar with significant levels of imported product coming into the country, particularly from Ireland, but also from other states such as South Africa, Australia and New Zealand. The mature cheddar market would also appear to have been in significant over-supply and it has apparently taken the majority of 2003 for the situation on stocks to broadly come back into balance. 3.3 UK supermarkets have increased retail selling prices for UK produced cheese during the last quarter of 2003 and monies are beginning to flow back to producers from this source as additional revenues are passed on by processors. 3.4 Processors in the liquid market have also typically increased prices to their middle ground customers during the autumn of 2003. This sector includes small shops, convenience chains, institutions such as hospitals and schools and the now very substantial catering, fast food and restaurant trade. Again some or all of these revenues being passed back to producers in terms of improvements in raw milk prices.
How do monies recovered in the market place get reflected in improvements in raw milk prices to producers? 3.5 The UK market is not typical of Europe in that approximately 50% of all milk produced finds its way into the liquid market of which well over 90% is sold as fresh pasteurised product, with the major retailers now accounting for something just in excess of 50% of that market. Detailed below is a breakdown of the various sectors of the UK market showing the proportion of milk going to the liquid market, cheese, condensed milk, cream, yoghurt, butter and skimmed milk powder. 9484161008 Page Type [O] 28-05-04 23:58:55 Pag Table: COENEW PPSysB Unit: PAG1
Environment, Food and Rural Affairs Committee: Evidence Ev 53
Utilisation of Raw Milk by UK Processors, 2002 Cheese
25.3%
Milk Powders 12.5%
3 .6% Condensed Milk 2% 49.1% 1.8% Butter 3 2. .2 4% Cream Liquid Milk % Yoghurt Other products & Disposals
Source: CC based on data from MDC Datum/Defra
3.6 To illustrate the complexity of producer pricing, in the current market climate where price moves as illustrated above have not been caused by market fundamentals but by the pass back of monies recovered from the market place to producers. However welcome the eVect this could be seen as a distortion of the market. The following is based on the experience of Express Dairies and Arla Foods plc in July 2003, prior to the pass back of monies recovered from their major retailer customers. This was prior to the merger in October 2003 and after this event there were further recoveries from the middle ground market with additional monies passed back to supplying producers from the newly merged business from November 2003. Both Express Dairies and Arla Foods plc were predominantly players in the liquid milk market. In the case of Express some 50% of their business was in liquid milk to the UK supermarkets. In the case of Arla Foods somewhere between 55-60% of their business was in liquid milk to the UK supermarkets. Therefore in the case of Express 2ppl increase in revenues from their major retail customers was on 50% of their milk purchases enabled them to pay back 1ppl to all of their raw milk suppliers. In the case of Arla Foods on the same basis they were able to pay back 1.15ppl on all of their raw milk suppliers.
3.7 Both companies had a substantial part of their milk supply from producers with direct supply contracts with the company. Therefore all of those producers received an increase in the case of Express of 1ppl, in the case of Arla 1.15ppl. The majority of both companies’ remaining milk suppliers were sourced from two of the three major UK milk co-ops being Milk Link in the Southern part of England and Dairy Farmers of Britain in the Midlands and Northern part of England. The third co-op, First Milk, was only a very small supplier to Arla Foods. Both companies passed back in full either 1ppl in the case of Express or 1.15ppl in the case of Arla to their supplying co-ops, but as was evidenced in the market place this did not result in increases of this magnitude to the co-op members. To illustrate this point the three major co-ops, Milk Link, First Milk and Dairy Farmers of Britain currently produce around 6 billion litres of milk per year. It is estimated that approximately one third of their milk, around 2 billion litres, is sold onto processors for the liquid market. Last July therefore following increases in retail selling prices by the UK supermarkets, it is reasonable to assume that processors typically increased the price they paid to the co-ops for milk for the liquid milk market by around 1ppl. On the basis that a third of their milk goes to the liquid market this move on its own would have generated additional revenues of between 0.3-0.35ppl on average for the co- ops. Further improvements in their prices would then depend on monies recovered from other customers in other sectors of the market and as had already been mentioned it was clear during this period that additional monies from the cheese market for example were not forthcoming.
3.8 If raw milk prices are to move forward because of additional revenues recovered from the market place rather than driven by market fundamentals, then the raw milk market will not function as one market because diVerent sectors would clearly recover monies at diVerent times with some sectors perhaps recovering no additional revenues at all. The increase therefore that the producer sees will be dependant on the markets that its processor or its co-op sells milk into. UK supermarkets account for just over 50% of sales in the liquid market and the liquid market in total is 49% of total UK milk market. Therefore a much heralded 2ppl on liquid milk sales, being passed back by UK supermarkets, given this is only some 25% of the total raw milk market could lead to increases of 0.5ppl across the total market. However not all processors are in the liquid milk market and those that are have various proportions of their trade with the UK supermarkets. Co-ops likewise have diVering amounts of milk sold onto customers in the UK 9484161008 Page Type [E] 28-05-04 23:58:55 Pag Table: COENEW PPSysB Unit: PAG1
Ev 54 Environment, Food and Rural Affairs Committee: Evidence
supermarket sector of the liquid milk market. There will inevitably be significant diVerences in movements in specific raw milk prices. For example on this occasion in July 2003 the highest were 1.15ppl paid by Arla Foods and the 1p paid by Express Dairies. There were cases in July 2003 with some cheesemakers where there were no increases at all because there had been no movement in their market place. 3.9 During the summer and independently both Express Dairies and Arla Foods UK had decided to move forward their prices in the middle ground market. This process was still ongoing at the point of the merger and therefore subsequent change which took eVect from 1 November in raw milk prices was made as one move across the business. In total the middle ground market represents between 15–20% of the new company’s business. Recoveries achieved from the market place enabled the merged company, Arla Foods UK plc, to pay an additional 0.35ppl to all milk suppliers from 1 November 2003 and has brought the total increases paid since 1 April to 1.35ppl in the case of suppliers historically to Express Dairies and 1.5ppl to suppliers historically to Arla Foods UK. 3.10 Shortly prior to the merger both companies increased the price of milk sold by doorstep delivery by 1p per pint. Additional revenues in this sector which is about 15% of the total business has been shared between those providing the service, mainly bottled milk buyers and franchisees and with some money for the first time in three years being retained within the business to defray some of the additional costs that have been taken in the doorstep operation during that period. These cost changes are as a result of the normal increases in costs but also reflect the continued decline of the doorstep business generally. Declines over the last two years in excess of 10% per annum.
4. The Current Position in the Raw Milk Market in the UK 4.1 In the second half of 2003 the liquid milk sector and the cheese sold through retailers has seen typically increases in selling prices which have resulted in improvements in producer prices as monies from these increases have been passed to producers. The outcome has been patchy for the reasons illustrated above and as a consequence producers’ raw milk prices on the basis of a standard litre of 4.1% fat, 3.25% protein, achieving top band quality premiums and with a producer volume of 1,664 litres per day— ranges from 20.0- 20.1 ppl down to as low as 17.5-17.6ppl, a range of 2.5ppl. This is a much wider range than has been typical since de-regulation. The range of 1-1.5ppl has been the norm, as explained above. 4.2 Historically where the gap widens above this norm it has not proved to be sustainable. The main reason for the gap to close is that sellers achieving the weaker milk prices will attempt to gain a bigger share of those markets achieving better returns. In so doing they will tend to undercut the current prices being paid in the market place and as consequence bring the top end of the market down until the market achieves a better balance. Alternatively if there are pressures in the commodity sector of the market and returns improve raw milk prices at the bottom end of the market rise again closing the gap until it achieves its more normal range. 4.3 It is worth noting that the co-ops are increasingly investing on behalf of their members in the commodity areas. For example the recent long term leasing by the three co-ops of the Westbury butter/SMP factory and Milk Link’s declared interest in Glanbia’s British cheese assets.
Prospective Future Changes 4.4 CAP Reform over the next 3–4 years will substantially reduce support prices for butter and skimmed milk powder. In the case of butter by 25%, in the case of powder by 15% bringing down support prices by the equivalent of around 4.2ppl. Compensatory decoupled payments will be available to dairy farmers but up to a maximum of around 2.5ppl. Therefore if production remains stable and there are no fundamental shifts in milk uses in the UK milk market place, subject to any further realignment of the £ sterling versus the euro, then UK dairy farmers can expect to see a further significant reduction in their incomes. The benefit to them of decoupled payments will be that they may choose to produce less milk or go out of milk production and still be able to claim those payments as long as they retain their land holding. If other producers do not increase their production to fill this gap, then the UK could face a significant problem on the processing side with a surplus of capacity, particularly in commodity products such as butter, skimmed milk powder and mild cheddar cheese leading to a further inevitable shake out on the processing side of the industry. Production is therefore likely to become more responsive to real demand for these products. So whilst raw milk prices to producers are a very important factor in the future of the UK dairy industry, they are not the only critical issue that faces the industry over the next five years as it continues to re-structure to meet the changing market place and to address the significant impact of the mid term review on the Common Agricultural Policy. January 2004 9484161009 Page Type [O] 28-05-04 23:58:55 Pag Table: COENEW PPSysB Unit: PAG1
Environment, Food and Rural Affairs Committee: Evidence Ev 55
Witnesses: Mr Neil Davidson, Chief Executive OYcer and Mr Peter Walker, Director for Milk Buying and Ingredients, Arla Foods UK plc, examined
Q150 Chairman: Gentlemen, you know the process Mr Davidson: Not dissimilar. If you take our you are entering into now, you have seen the accounts for last year and divide by the number of previous two evidence sessions. If you can litres that we bought then one and a half to two introduce yourselves then we will get into the pence a litre is what we made on milk. session. Mr Davidson: I am Neil Davidson, Chief Executive Q155 Paddy Tipping: Why is there a variation of Arla Foods UK plc. between the diVerent companies we have seen? Mr Walker: I am Peter Walker, Milk Buying Dairy Crest told us that they made their profit out Director for Arla Foods UK plc. of added-value. You are at the lower end of the figures we have been given, why would that be? Q151 Chairman: Let me start with the question I Mr Davidson: We would have to say whether we have asked the other two processors, which is the are comparing apples with pears and I cannot allegation or the fact that has been presented to us answer that question. DiVerent companies have by the producers, the farmers that when there is this diVerent product mixes. We are predominantly in increase in the retail price it does not backwash in the liquid milk market but not totally, Dairy Crest terms of a better position for the farmers, why is have a wider spread in this country. There will be that so? variations based on product mix. Mr Davidson: We can only say that we have passed back everything we have received from the retailer, Q156 Paddy Tipping: You mentioned there have equally you can see a rise in milk price over the last been price rises in liquid milk I got the impression two and a half years as a result of that. Our milk you passed that all back to your producers? price is three pence a litre higher than it was one Mr Davidson: That is correct. and a half years ago to our farmers. Q157 Paddy Tipping: It has not made any Q152 Chairman: You tracked this, it would be diVerence to your profit margins? interesting to let us know how you communicate Mr Davidson: Margins have gone down. In with your farmers. absolute cash terms, no, it has made no diVerence Mr Davidson: We have a unique organisation at all. within our relationship with farmers, we have two unique relationships, one with our direct suppliers Q158 Paddy Tipping: How are the retailers doing, who since deregulation have been members of what the big supermarkets? What do you think they are is now the Express Milk Partnership and soon to making per litre? become the Arla Milk Partnership, that is a body Mr Davidson: I think the figures which were talked where we sit round the table virtually every month about earlier are accurate, they have come out with with our farmers and discuss industry issues. They the same report and I think they are accurate. Milk negotiate every aspect of the contract, including the takes up chilled space in the supermarket which is price on behalf of their members and you cannot expensive space for the retailer. I think the figures have a direct supply contract with us unless you are are there and net margins are also as described. a member of the partnership. It is akin to a closed- shop arrangement, if you like, and it has worked Q159 Paddy Tipping: You would not subscribe to V very e ectively over the last 10 years. We also have the view of some producers in eVect that producers a unique relationship with one of the co-ops, Milk are being ripped oV by the supermarkets? Link, with whom we have a strategic alliance. In Mr Davidson: No, I would not at all. There are terms of communication and working with farmers separate markets, there is the market for raw milk, we have established the mechanisms and the there is the market to sell liquid milk to retailers structures in place to enable that to take place. and then there is the market for retailers to sell to their consumers. The dynamics of each leg in the Q153 Chairman: Can you say more about the chain are diVerent. In the raw milk end there is strategic alliance, why did you form that and what clearly the CAP, CAP has the biggest single advantage did you get? influence on milk pricing in this country, which I Mr Davidson: We had a set of assets which Milk think we included in our submission. To put some Link particularly wanted and we agreed to sell meat on those bones then the floor price them those assets, but there is far more to that determined in euro has not changed since February partnership. We made them preferred suppliers to 1995 but the translation in sterling has been our business, particularly in the south alongside anywhere between 14 pence and 22 pence a litre, our Express Milk Partnership members and we set that is purely currency based. Our farmers are up a joint venture where we are starting to develop uniquely exposed to that currency risk, nowhere value-added products for the UK retail market on else in Europe, except perhaps Sweden, is any other a joint basis. group of farmers exposed to that risk. The CAP just simply does not work in this country protecting Q154 Paddy Tipping: Talk to us a bit about liquid farmers’ income, which is what it is supposed to do. milk and the profit you are making per litre, you have heard the other people, are you comparatively Q160 Paddy Tipping: You are tempting me into a in that position? wide arena but I will resist. 9484161009 Page Type [E] 28-05-04 23:58:55 Pag Table: COENEW PPSysB Unit: PAG1
Ev 56 Environment, Food and Rural Affairs Committee: Evidence
1 March 2004 Mr Neil Davidson and Mr Peter Walker
Mr Davidson: It is a fault line in the CAP. The CAP for farmers to aim for. It is a rare event, it is an is there to put floor pricing in the farmers price but unusual event for farmers not to produce up to it does not work here because of currency. quota, there have been a couple of reasons over the Denmark are in the EMU, Sweden float, we are the last couple of years when they have not done so but only one that genuinely floats up and down and our this year it looks like we are going to be into full farmers have paid the price. It could have worked quota position again. It does give them a target to the other way, if the pound had remained weak as aim for and there is no evidence that they are not it was in the late 80s and early 90s then farmers going to hit that figure, but whether it is a good would have enjoyed very high milk prices and we thing economically or not is the question. would not be having this conversation today. Q166 Chairman: You said that you were Q161 Diana Organ: You have talked about the predominantly into liquid milk although you did profits that you make as a company, how much have some milk you use for processing to make profit do the farmers make on the sale of liquid cheese. milk? Mr Davidson: We do not make any cheese in this Mr Davidson: A lot depends on their own country. Our partners we have just merged with are economics, and as we heard earlier on the cheese manufacturers in Scandinavia but we do not economics of farmers do vary an enormous produce cheese in this country. amount. The evidence is even amongst the larger Diana Organ: I will not ask you that question, farmers there is a huge variation between the top thank you very much. 25% and the bottom 25%. It is frustrating, if you get 10 farmers in a room they will give you 10 diVerent best ways of producing milk. Q167 Mr Breed: You have very helpfully provided in your evidence some comments about the future Q162 Paddy Tipping: Just 10? perspective changes that we agree with, going back Mr Davidson: There are only 10 farmers there. to this whole idea of farmers moving out you indicate, quite rightly, with the decoupled payment some farmers will decide to hang on to their land, Q163 Diana Organ: And they will all be happy? take the payment and come out of milk because Mr Davidson: Will they all be happy? they cannot make any money. Have you made any assessment as to the numbers of your customers or Q164 Diana Organ: I was being facetious. suppliers that are likely to do that? Mr Davidson: Farmers do not have a habit of being Mr Walker: We are talking to our suppliers, happy under any circumstances. particularly in the Milk Partnership, it is a little early and we have some serious concerns about the Q165 Diana Organ: There is a little joke we were structure that CAP reform is going to take, told in Parliament about farmers and their children particularly the decision about the balance moving and how you know you are going to have one, it towards historic payment to area payment, over is to do with a child crying all of the time so it time that is going to work against the eYcient would be a farmer, would it not? I will not go into farmer and the progressive farmer who has been that! The other question which I asked the previous developing his business and we have some concerns witnesses was about farmers, did they understand that that might lead to producers who we would in order to be profitable they had to be eYcient and have hoped would have remained in in diVerent in order to be eYcient they had to have larger dairy circumstances exiting over the next few years. I herds, and that would means less dairy herds than think it is quite early in this process to understand we have now. Do you think for the farmers you the precise outcome of that. work with this is a message they really fully Mr Davidson: We think it was a mistake to go understand and understand what the implications down that route in England. of that are? Mr Davidson: Since losing the protection of the Q168 Mr Breed: You do as a general rule, for some Milk Marketing Scheme farmers have had some it would be sensible. pretty chilly winds to cope with so it would be Mr Walker: It is not good news for dairy, it amazing if they did not now understand the particularly aVects the large, more eYcient realities of life as it is post the Milk Marketing producer who has been investing over the last five Scheme. Herd sizes are getting larger, the herd sizes or 10 years. have increased by 10 cows from 80 to 90 since deregulation 10 years ago, farmers going out of the industry is nothing new, in 1951 there were 150,000 Q169 Mr Breed: The demand for milk as a product dairy farmers in this country, today there is has been falling progressively over a long period of probably about 25,000, that is seven or eight time, 20 years, or so, the whole thing about supply farmers who have left this industry every day for and demand is we are getting supply coming down the last 50 years .It is not unusual. The average age but demand is also falling, are we going to have an of a farmer is still towards the top end of the 60s, excess of processing capacity fairly quickly if we are it seems to be an inevitable process. The level of not careful? milk has generally not fallen during that time Mr Davidson: We have had an excess of processing because the quota system actually provides a target capacity in the liquid market for the last 10 years. 9484161009 Page Type [O] 28-05-04 23:58:55 Pag Table: COENEW PPSysB Unit: PAG1
Environment, Food and Rural Affairs Committee: Evidence Ev 57
1 March 2004 Mr Neil Davidson and Mr Peter Walker
Q170 Mr Breed: Another area where you are going Mr Davidson: They have started, as we understand to have to make major decisions about the capacity it, to buy shares in the business so that they build of the plant and everything else is shifting out the up a significant share holding in the business rather most ineYcient or most costly. than, as some other companies or other co-ops Mr Davidson: The fall in demand for liquid milk have done which is to put new investment into the has been a long-term factor over 20 years, 1% or industry in the form of kit and equipment. 2% per annum and that will continue and we do not see that accelerating. In terms of factory rationalisation they have been going on in this Q175 Mr Jack: Can I ask you, we have heard from industry for the last five to 10 years in major our previous line of questioning as to whether there amounts. should be some regulatory body for the industry to try and deal with some of the problems, let me ask that point in a slightly diVerent way: we had the The Committee suspended from 4.50 pm until competition inquiry into the industry now two or 5.00 pm for a Division in the House three years ago and there was a lot of criticism about the outcome of that because it did not Q171 Mr Jack: In paragraph 2.12 of your evidence recognise the European and world competitive you give the Committee an interesting insight into dimension of the dairy industry, do you think we the Express Milk Partnership which perhaps have the right regulatory framework for the milk indicates a level of dialogue and understanding industry as such or does our competition policy or between the processing side and the farmer. As you Competition Authority’s view of the industry still have heard from previous evidence that this mitigate against the types of eYciency which the committee has received there still seems to be industry would wish to see by virtue of closer grumpy farmers out there. Have you managed to integration? find through the partnership dialogue a way of Mr Davidson: I do not think the Competition taking the steam out of what has been a very Authority gets in the way of closer integration, I diYcult trading period over the last two or three do not see that at all. Clearly 10 years ago when years for dairy farmers? the industry was deregulated the whole principle Mr Davidson: I think the honest answer is yes was not to have any form of statutory regulation because of the dialogue and the trust that has been of the industry. Would farmers have been better oV built up over ten years. We meet on a monthly basis had the Milk Marketing Board continued, no and we discuss issues in the market place, we have doubt about it they would have been because the general negotiations about milk price. All of those liquid milk premium would have been there and it things are trust building over the years. would have been pretty substantial at various stages over the last 10 years and would have protected their incomes but that was not the Q172 Mr Jack: How many farmers do you have on thinking behind deregulation at the time. Are we your books? going to re-create the Milk Marketing Scheme? I Mr Walker: From April ’04 we will have in the cannot see how a regulator as such, which is what order of just over 1,200 or 1,300. this is supposed to be, is going to work eVectively.
Q173 Mr Jack: You have 1,300 and they are involved in this dialogue, what kind of issues do Q176 Mr Jack: We heard mention about the they raise or have they raised with you at the most Supply Chain Forum, is that the kind of body diYcult times? Did they blame any one particular which can genuinely try on a pan industry basis to individual/institution/system or whatever for the resolve some of the conceptions which do exist problems of the milk price or did they accept with about who may well be taking an unfair share of a shrug of the shoulders and said, that is the way the price of milk. that it is, currency, flaw in the market we will carry Mr Davidson: Fair share is an interesting concept on producing. Who did they blame? in free economics. Each leg of the chain ought to Mr Davidson: I think blame is the wrong word. be determined by supply and demand. Is an What we have done over a 10 year period is talk industry body such as that forum sensible? Yes, I through the issues that aVect the price of milk and think it is, for one reason it brings Defra closer to we have been able to be pretty open and honest the processors and to the farmer and to the with them and that has held us in good stead in retailers, and I think it helps from that point of terms of the relationship. Perhaps it is worth view. We have entered into arrangements with the deviating slightly, last year they decided to set up CAP which are just not in our farmers’ interests or their own capital raising structure, which obviously at least work against our farmers because they are has nothing to do with us, and as we understand exposed to currency. I am not sure that Defra it they have now started to buy shares in the understood that many years ago when we went into company as a result of that capital raising structure the latest leg of the CAP. to become more integrated in the objectives of the organisation. Q177 Mr Jack: One final question, the retailers because of their sheer size are very powerful players Q174 Mr Jack: Can you develop that? What are in the market, retailers talk the language of they going to use this capital for? partnership and understanding of relationships 9484161009 Page Type [E] 28-05-04 23:58:55 Pag Table: COENEW PPSysB Unit: PAG1
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1 March 2004 Mr Neil Davidson and Mr Peter Walker with the supply chain, do you really think that they magic wand and you were coming at this from the truly in their heart of hearts mean what they say in position of the farmer which would have been more that context? important, to keep the Milk Marketing Board or Mr Davidson: I do not think you can generalise to avoid the currency fluctuation? about that because there is a lot of variation Mr Davidson: I think if they had a choice then between what is meant by partnership and there are sensibly they would have held on to the Milk better retailers than others. Marketing Scheme because that certainly gave a lot of protection against currency swings. I think that Q178 Mr Jack: Without naming names— is unrealistic and therefore protection against the Mr Davidson: Which I am not going to do. currency swing has got to be the priority. This is an apolitical statement, joining the euro at the right Q179 Mr Jack:—do you see a genuine appreciation rate—and it has to be at the right rate otherwise from the supermarket side of the type of pressures they are under pressure forever if we joined at the which the industry has been under and a wrong rate—is probably the most pragmatic recognition that they do have a responsibility and solution to underpin milk prices in this country. I a role as principle buyers to take into account the stress that our farmers are uniquely exposed to kind of issues that make farmers concerned when currency risk, which is not the intent of the CAP, determining the price or is it, well, yes, we hear all the CAP is to protect farmers’ incomes and it does that but sorry the market place is keen. not work in the United Kingdom. Mr Davidson: No. The evidence is clearly in the two Mr Walker: It is a hard one to call because at the pence a litre plus price which we have seen over the extreme currency has moved the milk price at just last few years, those have been retailer initiatives over eight pence per litre and that has been a and they should be credited for that. real stress. Chairman: Okay. Gentlemen, you have heard what Q180 Chairman: Can I ask you one final question I said before so if there is any supplementary which is about what you said about the Milk evidence you wish to send to us you are free to Marketing Board, given the floating situation we do so. What you said is on the record and will have of the pound and what implication that has appear as such and help us in our deliberations on for the intervention of milk pricing if had you a the report.
Memorandum submitted by The British Retail Consortium (L20)
The British Retail Consortium (BRC) represents the whole range of retailers including large multiples, department stores and independent shops, selling a wide selection of products through centre of town, out of town, rural and virtual stores. In June 2003, the retail sector employed some 2.7 million people (11% of the workforce) and retail sales were £230 billion in 2002. Grocery retailing is significant in macro economic terms and was valued in 2002 at £111.3 billion.
1. The British Retail Consortium (BRC) welcomes the Environment Food and Rural AVairs Select Committee inquiry into milk pricing, which we understand will examine the market price and farm-gate price of milk and investigate why recent rises in the former have not led to increases in the latter.
2. This paper outlines the commitment of BRC’s members to British milk production, their strategic aspirations in the dairy industry, the issue of supply and demand and the role of retail price initiatives in the dairy food chain.
3. Food retailers believe milk is a valuable product and want to see a sustainable British dairy industry from which they are able to source supplies of the highest quality British milk from the most eYcient processing operations. The sector is keen to increase consumption of milk and milk products through increasing availability and encouraging innovation in the sector.
4. We believe the supply and demand, which continue to be out of balance remain at the heart of the issues facing the UK dairy chain, and that policy makers need to focus on the measures that can be adopted to facilitate change in the industry given that CAP reform will be of great significance.
5 We believe that the challenges facing dairy farmers need to be considered by the whole chain. Data published by the Milk Development Council (MDC) shows that supermarkets sell approximately 56% of milk that is consumed in liquid form in the UK, 17% is doorstep delivery, 5% is sold by convenience stores, garages, etc, and 22% passes through the catering and institutional sectors. According to MDC data, supermarket own-brand cheese accounts for 40% (138,000 tonnes) of total UK cheese consumption, sales of branded cheese accounts for 14% of consumption, leaving 56% of cheese going through other outlets, including catering and institutions. 9484161010 Page Type [O] 28-05-04 23:58:55 Pag Table: COENEW PPSysB Unit: PAG1
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Supply Issues 6. Many commentators have argued that the dairy industry is still struggling to adjust to the abolition of the Milk Marketing Board in 1994. The MMB national pooling system had eVectively cross-subsidised the price of milk used in cheese production from the liquid market. In addition, the emphasis on the liquid market restricted the volume of milk available for dairy product production, which had a dampening eVect on innovation. The removal of institutionalised price determination and more competitive conditions in the liquid milk markets are judged to have been a major driver behind the reduction in the average farmgate price of milk from around 26p in 1995 to 16p in 2000. Some analysts have also argued that the Monopolies Commission’s decision to break up Milk Marque in 1999, which in a bid to increase competition, fragmented a large section of the supply chain into several farmer-controlled cooperatives, accounting for 50% of the supply of milk to the dairies. 7. Farm gate milk prices were also put under pressure by the sharp increase in the value of sterling against the euro from the mid-1990s to the end of the decade, which reduced the value of CAP support payments to dairy farmers. According to KPMG, the relatively low level of added value in the UK dairy industry, ineYciencies in the supply chain and the recent tendency for milk output to exceed consumer demand are other factors that dampen the farmgate price of milk. 8. A popular myth is that multiple retailers have used milk as a loss leader and that this has depressed the farmgate price of milk. The reality is somewhat diVerent, as confirmed by the Monopolies Commission, which analysed the relationship between farmgate prices and retail prices. The Commission found that while milk was an important “known value item” in the average shopping basket, there was little evidence of loss leading. In any event, the Commission’s analysis concluded that for every 1p change in the farmgate price, the retail price changed by 0.5p in the medium term. There was no significant relationship between the two price series in the short term ie less than three months. 9. As a result of consumers moving away from doorstep delivery, multiple retailers have increased their market importance. In 1995, multiple retailers accounted for 45% of retail sales, while in 2002 this had risen to 65%. 10. It would be useful for the Committee to consider that the current structure of the dairy industry has only been in place for the last four years and is still evolving: (a) The major dairies (Dairy Crest, Wisemans and Arla/Express) are responsible for supplying virtually all the major supermarkets liquid milk requirements. Wisemans, which focuses exclusively on liquid milk and has been particularly successful in winning and keeping major retail contracts. Dairy Crest and Arla/Express, by contrast, process other dairy products in addition to milk and therefore face diVerent operational issues. (b) The combined market share of the major retailers is continuing to increase due to the decline of doorstep milk delivery and its replacement by one-stop shopping in supermarkets. According to data from the Milk Development Council, in 2001 households purchased 69% of their liquid milk from supermarkets, 25% from roundsmen and 6% from convenience stores, garages, etc. (c) Following a Monopolies and Merger Commission (now the Competition Commission) ruling, Milk Marque, which operated as both a marketing and processing organisation, has been replaced by three marketing cooperatives or “milk groups”—Milk Link, First Milk and Dairy Farmers of Great Britain. All three either have equity stakes in smaller, specialist processing companies or directly engage in some limited processing activity themselves. More importantly, between them they now own the whole of the equity in United Milk, the most recent entrant into volume liquid milk processing, which has already been financially restructured twice in its two-year existence. Those farmers who do not supply the major dairies direct (ie the majority) send their milk to one of these cooperatives whose role is to sell it on to the dairies as a “top up” for the supply they get direct from farms. (d) The co-operatives role as milk consolidators and brokers is reflected in the lower average prices they pay the farmers who supply them compared with the price paid by the dairies to their direct suppliers for liquid milk. In recent years this diVerential has on average varied between 1p and 2p per litre. 11. Milk supplied for processing into cheese is typically sold to the dairies at a lower price than liquid milk. Cheese, in particular, takes anything from 6 months to one year to mature and obviously involves a substantial investment in stockholding. The co-operatives compete with each other to secure supply contracts from the dairies. They also compete to retain a reliable portfolio of producers, but this has done nothing to narrow the gap between the supply terms they oVer their farmers and those oVered by the dairies to their direct suppliers. There are, therefore, three distinct farmgate price levels for milk: — The top price is for the direct supply of liquid milk to the dairies. — The middle price is for the supply of milk for processing into cheese. — The lowest price is typically paid by the co-operatives, although pooled market prices do vary according to market conditions and intervention prices. 9484161010 Page Type [E] 28-05-04 23:58:55 Pag Table: COENEW PPSysB Unit: PAG1
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12. It is argued that the break up of Milk Marque in 1999, which was ordered to increase competition, artificially created an industry structure that does not reflect the realities of the market for milk and milk products. Rather, say its critics, the post Milk Marque supply chain structure has an inherent reliance on the short term, focussing on contract retention, which prevents companies from building long term strategies. This is inconsistent with a stable dairy industry. 13. For example, the major dairies compete with each other to win supply contracts with the leading retailers. This involves competitive under-cutting, but since profitable commodity processing requires full utilisation of plant maximum volume there is an economic rationale for highly competitive tactics by the processors. However, the replacement of ineYcient plant with fewer, larger units has led to over capacity to the tune of around 20% (KPMG report p 83). 14. A further supply-side issue is the recent tendency for farmers to over-produce. The 80/20 rule now prevails within the producer base with liquid milk production heavily concentrated in the hands of a relatively small number of large, eYcient farming units. These farmers tend to operate with the lowest production costs. This situation is magnified by the average milk yield per cow growing by 2 to 3% a year. The requirement for all non-producing quota holders to dispose of their holdings by the end of March 2004 is acting as an incentive to those farmers who are planning to stay in the industry to expand their output by buying more quota.
Demand Issues 15. Demand for dairy products in the UK is, with the exception of the yoghurt category, either static or declining: — Consumer demand for liquid milk has been gradually falling for at least 20 years. Since 1990 consumption by UK households has fallen by around 10%. Demand for milk is price inelastic so the conventional remedy of price-cutting to stimulate sales growth is ineVective. — The cheese market is largely commoditised (in the form of mild and medium cheddar) and UK per capita consumption is both low by EU standards (9.9kg vs an EU average of 18.8kg in 2001) and barely growing. — Yoghurt is the only dairy product showing reasonable growth but the market is dominated by German and French brands and relatively little liquid milk is used in the production process (c5% of total UK output). 16. As a result, the UK dairy industry is unique within the EU in being heavily dependent on liquid milk. Around 50% of the liquid milk produced in the UK is consumed as milk, compared with 24% in Germany, 14% in France and 9% in Denmark. This has left UK dairy farmers exceptionally vulnerable to commodity price fluctuations and currency movements. Although a few attempts have been made to lift milk out of the commodity market by branding (eg Cravendale, Bowland) none has yet had a significant impact in the marketplace.
Retail Price Initiatives 17. The current dispute over farmgate prices, which began in the summer of 2003, and carried on through the autumn, has its origins in the market conditions that developed in 2000 and the structural characteristics described above. While this particular dispute has been resolved by retail intervention, it is highly probable that further disputes of this kind will arise in the future given the structural conditions outlined previously. 18. In 2000, as the average farmgate price reached a low point of around 16p per litre, UK milk production fell below its EU quota for the first time since 1984. In response to a possible shortage of liquid milk, the major supermarkets increased their retail prices by 2p a litre on the understanding that the additional revenue would be passed back through the supply chain to all farmers. 19. It needs to be highlighted that this was not a collective or agreed action by the retailers as this would have been contrary to the 1998 Competition Act. Tesco took the initiative and the rest followed. The dairies generally passed on the increase more or less in full but the co-ops passed on a smaller proportion of the total. Nonetheless, a further retailer-led increase in April 2001 brought temporary stability back to the market and quota was achieved in 2001–02 (and again in 2002–03). 20. A question that has not yet been answered is why intervention does not appear to have worked. Farmers have not received the Intervention Milk Price Equivalent (IMPE). 21. However, the spring 2002 output (or “flush”) of milk was 10% above normal, a situation which appears to have been unforeseen by processors. While cheese and milk powder production took up some of the surplus, the spot price fell to only 8p a litre (cf IMPE). As a result, the dairies promptly reduced the price paid to their direct suppliers by 3 to 4p per litre with pro rata reductions by the cooperatives. The eVects of the earlier retail initiatives were reversed at a stroke. 22. By the autumn of 2002, the liquid milk surplus had been eliminated (although as a result there was a substantial glut of cheese) and market conditions were favourable to another 2 pence per litre major retailer-led price increase. (We are unaware of any support from other sectors). 9484161010 Page Type [O] 28-05-04 23:58:55 Pag Table: COENEW PPSysB Unit: PAG1
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23. While milk output remained strong throughout the spring of 2002–03, the commissioning of United Milk’s new milk powder processing plant at Westbury, prevented the price falls seen a year earlier. However, in response to growing pressure from their members, who continued to face losses of up to £7 per acre compared with a surplus of £5 the previous year (Deloitte), farming organisations began to campaign for a further increase in farm prices. 24. As it became clear that the dairies themselves would take no action on their own account, Asda initiated a further round of price increases (2p a litre) in July 2003, which the other major retailers followed (but not other sectors). In each case, it was made clear to the dairies that the retailers expected these increases to be passed back to the farmers in full. The dairies assured the retailers that they would do so. 25. However, two problems quickly emerged, both of which were implicit in all the preceding retailer-led price adjustments and had generated considerable argument (and acrimony) between dairies and cooperatives. But in the autumn of 2003 they assumed major proportions. This reflected the pent-up frustration and increasing militancy among dairy farmers and their determination to achieve a farmgate price for milk which more than covered the average cost of production across the whole supply base (estimated at around 18p per litre). These problems were: — The growing discrepancy between the prices paid to farmers who supply the dairies directly and those who supply the cooperatives, with the latter group arguing that they had lost out through successive retailer initiatives and that the gap between them and the direct suppliers was now unacceptably wide. — The diVerential between the prices paid to farmers who supplied milk to be consumed as milk and those who supply milk for processing into cheese. The retailer price initiatives up to and including July 2003 were all framed primarily in terms of liquid milk. For predominantly liquid milk operations, like Wiseman’s, this was not a problem, but mixed dairy processors, like Dairy Crest, the issue remains complex. For example, up to July 2003 the proceeds of every retailer price initiative on liquid milk were spread across all of Dairy Crest’s direct suppliers, regardless of whether their product is consumed as milk, cheese or other dairy product. So whereas Wiseman’s direct suppliers received all or most of each of the 2p per litre increases implemented by the retailers, Dairy Crest’s received somewhat less, although exactly how much less is obscured by incentive bonus payments. The situation for Arla/Express, with its high reliance on liquid milk sales, lies somewhere between these two extremes. 26. The July 2003 price initiative crystallised these issues. Wiseman’s refused to pass on the 2p per litre in full because, they argued, they had paid all the previous 2p increase (October 2002) back to their farmers whereas their competitors had not done so. Dairy Crest, by contrast, said they would pass the full 2p on— but only to their suppliers of milk to be consumed as milk. This left their milk-for-cheese farmers feeling very aggrieved. As a result, the major retailers agreed to increase the prices they paid for cheese by £200 a ton. This would roughly equate to an increase of 2p per litre for Dairy Crest’s milk-for-cheese suppliers. 27. However, it emerged that Dairy Crest were proposing to pass on only 0.8p to their cheese suppliers and their failure to explain their reasons for doing this angered farming organisations. Eventually, after some aggressive picketing by farmers, Dairy Crest improved their proposal from 0.8p to 1.4p per litre. This was still not satisfactory to farmer bodies and secondary picketing of major supermarket distribution depots was started with a view to persuading the retailers to bring more pressure to bear on Dairy Crest. 28. In late November retailers agreed to increase the price they paid Dairy Crest for cheese by an additional £100 per ton (eVective 1 December) equivalent to 1.0p per litre, plus a possible further increase of 1p per litre on the price of liquid milk, eVective 1 January 2004. Dairy Crest promised to pass these increases back to the farmers in full. This means, in eVect, that all the farmers who supplied Dairy Crest with milk for cheese processing would, from 1 December, be paid 2p per litre more than they were on 30 September. However, we understand that these terms are also conditional on similar increases being agreed and implemented by Dairy Crest’s competitors. The situation remains inherently unstable. (Other cheese companies such as McClellands and Glanbia were also paid a total of £200 per tonne on the same basis).
Future Developments 29. The issue of supply and demand is clearly at the core of developing a sustainable dairy industry. Retailers want to see market forces determine the price changes throughout the dairy chain rather than on sector eVectively subsidising the rest of the market. As demand from consumers remains constant, retailers do not adapt to seasonal fluctuations, and oversupply, together with the seasonality of production are therefore key to the sector’s current problems. 30. Food retailers have tried to deliver fair returns for farmers via their processors but there is a limited amount that we can do. Around 12 billion litres of milk is consumed each year—only a small percentage is purchased via food retailers. There should be an understanding of other sectors in the chain and the market prices to these sectors to evaluate what they are doing to support price increases through the chain. This should include caterers, hospitals and schools and Government institutions. 9484161010 Page Type [E] 28-05-04 23:58:55 Pag Table: COENEW PPSysB Unit: PAG1
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31. On-farm eYciency increases will remain an important driver in developing market-driven solutions to the current problems facing the dairy sector, but eYciency gains are not just related to on-farm production. The Defra/IGD Food Chain Centre has recently begun to analyse eight supply chains within the industry and pinpoint areas for cost reduction and eYciency improvement. The study will also recommend ways of helping dairy farmers benefit from the “lean thinking” approach, which the FCC and MLC are currently applying to the red meat sector. The BRC is taking an active role in the dairy project. 32. We believe it is critically important that when the reform of the CAP dairy regime begins, the industry is much better placed to absorb and adapt to these changes than it is now. CAP reform may be expected to: — Reduce the farmgate price of milk, by anything between 3p and 6p a litre from current levels. — Encourage further mergers between the cooperatives, which EU law would certainly permit and which would help achieve a shorter, more integrated supply chain. The UK Fair Trading Act (1973), however, may obstruct further concentration unless the regulatory authorities decide otherwise. — Force farmers and processors alike to reduce their cost structures. This will oblige many farmers to leave the industry and encourage processors to close down any remaining, high cost plant, concentrating milk production in fewer, larger farm units. — The net eVect of these changes may well be a smaller, more compact and integrated industry but with a continuing tendency to produce more liquid milk than the market needs, given the likelihood of a continuing decline in consumption. This is particularly likely to happen once quotas are abolished from 2014 onwards. 33. Whatever the precise formula adopted in the UK, the impact of CAP reform will be painful and disruptive. It is essential therefore that the leaders of the industry should use the next 12 months to develop an agreed view of the likely impact of CAP reform, a broad strategy for dealing with it, and a plan for communicating the implications to all those farmers who will be on the receiving end. January 2004
Witnesses: Mr Kevin Hawkins, Director of Communications, Safeway Stores plc and Mr Richard Ali, Director of Food Policy, British Retail Consortium, examined.
Q181 Chairman: Welcome, gentlemen. I presume Q183 Mr Wiggin: Perhaps you can tell what you have not heard the previous sessions so I had prompted the major supermarkets to raise the price better say that we will be taking about half an hour’s of liquid milk and cheese? worth of evidence. We will give you every Mr Ali: This would be originally? opportunity to make your evidence as helpful to yourselves as well as ourselves and you can take as Q184 Mr Wiggin: Last year. read what has already been given to us not just by Mr Ali: I think it is probably useful to go back in yourselves but also by the other supermarkets. I history because there have been a number of price think it would useful if you quickly introduce increases. I think if we start in 2000 when it became yourselves and then we will crack on into the very apparent within the dairy sector that since the questions. mid 1990s there had been this inextricable Mr Hawkins: I am Kevin Hawkins, Director of strengthening of sterling and therefore an Communications for Safeway. I am a member of the inextricable weakening of the dairy support price BRC management board and also a member of the and actually of dairy farm gate prices as well. It Defra Dairy Industry Forum. became apparent in the 2000 the United Kingdom Mr Ali: I am Richard Ali, Director of Food Policy, was not going to get its quota and therefore there British Retail Consortium, we represent retailers was going to be a shortage potentially of liquid milk both food and non-food. in the market. The largest UK supermarket Tesco determined at that time to increase the price of liquid milk. It was going to pay processors on the understanding that processors would pass that Q182 Chairman: We are going to get straight into increase back down to the supply chain to eVectively price. I will make a quick observation and you may stimulate United Kingdom farm production. That care to respond, as you see from the three previous was the first time it happened. Obviously there were pieces of evidence the processors were tripping over a number of other events at the time, the fuel strike in themselves to give us evidence, orally as well as in October 2000, which also hit the headlines, but there written form, and we have our usual suspect Mr were a number of things which came together which Hawkins who is always willing to come and give actually meant that United Kingdom supermarkets evidence on behalf of Safeway’s but the other started to recognise that there was the possibility supermarkets did not seem to be so keen, is there a that the liquid milk they wanted in the market was reason? not going to be there. We can talk about Milk Mr Ali: I suspect because we have a common British Marque and the Competition Commission and OFT Retail Consortium position and I am paid to do it. at the same time. I think that is where it started from. Chairman: Good answer. Since then we have had a number of rises and retail 9484161011 Page Type [O] 28-05-04 23:58:55 Pag Table: COENEW PPSysB Unit: PAG1
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1 March 2004 Mr Kevin Hawkins and Mr Richard Ali price initiatives which have been placed in the Kingdom. We also have a European Union market market to try and basically give a temporary support which allows single trade in milk and milk products, mechanism to United Kingdom dairy farmers. Is the vast majority of that trade happens to be for the that likely to happen in the future? I do not know. United Kingdom in milk products and dairy We are where we are and I think it is very bold that products. Quite clearly there are price pressures and United Kingdom supermarkets have been forward equilibrium of supply and demand throughout the thinking enough to realise that they needed to inject single market. Of course there are global temporary liquidity into that market place to implications, especially for United Kingdom and stimulate production and keep the United Kingdom EU exports for whole milk powder and skimmed dairy structure going. milk powder in cheese. These market pressures are Mr Hawkins: It is worth adding that the increase basically supply and demand. I do not think that the that we implemented in October 2000 and again in dairy sector in the United Kingdom is any more April 2001, that was a two stage increase, that did divorced from market pressures than the French or lift dairy farmers’ prices back to something Danish market or even the Russian market. approaching a more reasonable level after four or five years of decline. What set us back was the events Q189 Mr Wiggin: I just wanted to touch on of the spring of 2002 when there was an unexpected something you said, what future changes in the price increase in the volume of liquid milk coming on to of milk and cheese do you think we might get? In the market, it was roughly 10% above where the your first answer you mentioned a temporary dairies expected it to be. There was no means support mechanism, what do you think farmers can available then of absorbing the surplus, the look forward to coming in? Westbury plant having not yet been opened. The Mr Hawkins: Clearly the big factor in the market response of the dairies was to cut prices, and quite now will be the impact of CAP reform. Both the dramatically by three pence or four pence between Dairy Industry Association and others outside the May and July of 2002. To some extent we have been industry like David Colman of Manchester trying to regain the momentum, the lost ground, if University and the report he has done for Defra are you like, since then. We implemented another indicating there will be a very significant fall in the increase in October 2002 which only partially farm gate price of milk for a number of reasons. compensated the farmers for the ground they lost in Clearly that is speculation and various outcomes the spring, I think it was two pence in October 2002, have been modelled and clearly the hybrid solution whereas the average loss was three pence to four proposed by Defra on the single farm payment and pence depending on whether you supplied a co-op or the impact that will have and how farmers will react a main dairy. To come finally to your question, the to it these are all variables and we cannot be precise July increase was, if you like, the final stage of an as to the outcome of it. Everyone seems to believe increase that started in October 2002 to take farmers that the farm gate price will fall by three pence or more or less back to where they were in the spring of four pence over the next few years, where it will end 2001, to repair the damage that was done in 2002. and the speed at which it will decline we could speculate about all day. Q185 Chairman: Can I come back in on that, are you V saying they did that o their own back, where did the Q190 Mr Wiggin: That is actually quite good from a market pressure come from? supermarket point view, you get cheaper milk, but Mr Hawkins: Both in 2002 and again in 2003 we do you think you will see an increase in the number were conscious of the pressure being applied to of demonstrations staged by farmers? dairies and of course to ourselves by action by the Mr Hawkins: Yes because the impact of CAP farmers, by groups of farmer. It was not nation- reform, leaving aside anything we might do, will be wide, it was sporadic. severe. There is no doubt it will hit the smaller farmers quite hard. Whether David Colman’s Q186 Chairman: That would push the price up, I am projections are right or not there are certain areas of talking about when the price was cut. the country, Wales and parts of the West Country Mr Ali: You mean the market? where a lot of farmers are quite small. The average herd size in Wales is 68 cows, the average for Q187 Chairman: Yes. Given that the final price to a England and Wales is getting on for 90 cows, there consumer is pretty low from all of the evidence we are many herds which are bigger than that. I think have seen, they are minor hikes. the pressure will be on the smaller producers to Mr Ali: Do you mean where does the market compete but with high cost base it is going to be very pressure come from? diYcult for them so I think there will be quite a backlash from some of those small farmers over the Q188 Chairman: Yes. How does that show itself? next few years and pressure on retailers to try and The dairies are doing things, they must get their put back in some way or another what the CAP measures from somewhere. process is taking away. Mr Ali: I presume a lot of the attention that this committee is looking at is the liquid milk price. What Q191 Mr Wiggin: Right. Just to clarify that, we are we have is a United Kingdom market supply and going to get a lower milk price and we are going to demand for milk and milk product, we are 80% self- see supermarkets putting some of that back in, is suYcient in our dairy production in the United that really what you are saying? 9484161011 Page Type [E] 28-05-04 23:58:55 Pag Table: COENEW PPSysB Unit: PAG1
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1 March 2004 Mr Kevin Hawkins and Mr Richard Ali
Mr Hawkins: That may well happen. I cannot Q196 Mr Jack: If that was the situation could you predict the future any more than anyone else can but tell me what happened to the demand for milk over that would be a possible outcome. this period? We have had a two pence increase at retail, followed by another year and then another two pence up. Q192 Mr Wiggin: You had a fairly good go at predicting demonstrations. How quickly do you Mr Hawkins: First of all the demand for milk is price think retail prices react in comparison to wholesale inelastic, it does not change very much at all. We price to changes in the strength of sterling or other have had a structural decline in consumer demand commodity prices? for milk now which has been going on for at least 20 Mr Hawkins: The last systematic work which was years which is not related to price, it is related to a done on this was by the Monopolies Commission on number of fundamental changes in diets, in eating its report on Milk Marque in 1999 which suggested habits, in lifestyles and so on. Liquid milk that retail prices followed changes in farm gate consumption seems to be declining between half and prices lagged by six months. I think for every penny 1% per annum and that has been sustained roughly per litre change in the farm gate price, either up or over the last 10 years. 50% of what is produced in this down, the retail price changed by 0.5 pence. I am not country by way of liquid milk is consumed as liquid aware of any more systematic work that has been milk, roughly 25% goes into cheese. The cheese done since then. market in terms of per capita consumption has been going nowhere in the United Kingdom, for the past 12 years it has been pretty static. Q193 Mr Jack: I want to follow that up, I would be grateful if somebody could supply us with a little bit of serious data on the average price of milk in Q197 Paddy Tipping: Will it go down? supermarkets. I notice that in paragraph 18 of your Mr Hawkins: There is no sign of it going down at all, evidence you point out to us that in 2000 it is slightly more price elastic than liquid milk supermarkets increased their retail price by two insofar as cheese does respond to price promotion to pence a litre on the understanding that the a limited degree. Roughly 70% of the cheese market additional revenue would be passed back to the in the United Kingdom is commoditised, it is supply chain. In paragraph 21 you go on to point out cheddar, it is either mild or medium cheddar. The that there was a change in the market place and you speciality market is relatively small, it is growing then point to the fact that dairies promptly reduced slightly but it is not the sort of attractive proposition the price paid to their direct suppliers by three pence for a farmer wanting to move out of liquid milk into to four pence a litre but you do not mention what cheese because the incentives are not there, the price might have happened to the retail price of milk is not there. For the last couple of years if anything under those circumstances, the first question is, did we have had a surplus of cheese in stock over anything happen given what is quite a dramatic demand because as a result of the over-supply of change in the price of milk? In paragraph 22 you go liquid milk in 2002 a lot of the dairies immediately on to say that you were favourable to another two put it into cheese. Of course the cheese is in stock and pence per litre and I am not clear from that whether somehow or other you have to sell it through. Cheese that was a retail price increase or not. We have up has not been a great story, there is only yogurt, four pence at retail and down four pence at producer fromage frais and diary desserts that have been level, just try and help me to move the fob, what was growing at all and they do not absorb a great deal of happening to the retail price of milk during this two liquid milk. year period? Mr Hawkins: The increase going back to April 2001 was the last occasion before the spring of 2002 when Q198 Mr Jack: Just to conclude, we asked our the retail price of milk was increased. I said earlier previous witnesses with reference to the farm gate that was second of the two stage increase that we put prices as a percentage of retail price if they could through October 2000 and April 2001. In April 2002 explain the falling trend, certainly from April ’02 to because of the unexpected surplus in output dairies September ’02 it is 40%, October ’02 to March ’03 it reduced the price they paid to the farmers by various is 41%, then we drop down April ’03 to September amounts over the following two to three months. ’03 to 39%. Nobody seems to be able to explain this phenomenon, can you? Q194 Mr Jack: Did that reflect the fact that the Mr Hawkins: What are these percentages? customer reduced their price? Q199 Mr Jack: The share back to the farmer. Mr Hawkins: We did not reduce any prices to our Mr Hawkins: This is presumably an average across customers from memory. all farm gates?
Q195 Mr Jack: None at all? Q200 Mr Jack: These are broad scale averages. Mr Hawkins: No. Of course the dairies gained Mr Hawkins: You have a two pence diVerential because their supply prices to us did not change, between the price the farmers get if they supply the what they changed was the price they were willing to dairies direct and the price they get if they supply to pay their suppliers who are the farmers. the Co-ops. 9484161011 Page Type [O] 28-05-04 23:58:55 Pag Table: COENEW PPSysB Unit: PAG1
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1 March 2004 Mr Kevin Hawkins and Mr Richard Ali
Q201 Mr Jack: If you go back to October ’02 to happens to the extra revenue after it is paid to the March ’01 from the data we have been supplied with dairies we lose control of. Does that answer your 49% of the retail price was the farm gate price, back question? down at the end of that series of data, April ’03 to September ’03 we are down to 39%. Q207 Mr Jack: It is an answer. Mr Ali: The retail price of liquid milk. We are Mr Hawkins: It is the only one can I give you, Mr comparing the retail liquid price with the farm gate Jack price. Chairman: We are more than happy to send you the figures. You can comment in a written response. It Q202 Mr Jack: What the farmers get back. would be useful to know what you make of that. Mr Ali: The two are not the same figures. I do not Although we are only able to take oral evidence the see how you can compare a retail liquid price with a body language behind was fascinating during that farm gate price for milk which may go into X particular exchange. Paddy Tipping is going to talk number of end uses. about margins.
Q208 Paddy Tipping: Clearly this is a sensitive area. Q203 Mr Jack: Let us say for the sake of the analysis I think from what you have told us it is going to get we are dealing with apples and apples, this is liquid even more sensitive, if I understand it liquid milk milk analysis, it is the proportion going back to the prices are going to go down. de facto we are going to farmer of what you sell it at and that series of data have more demonstrations outside dairies and indicates that that number, the percentage going outside our own stores, clearly you do not want that back to the farmer has been declining. from an image point of view. Mr Ali: I again come back to the point that I do not Mr Hawkins: Or an operational point of view. think those statistics prove very much because if you are basing your analysis and you are saying let us take the liquid milk price at retail and what you are Q209 Paddy Tipping: I thought image was comparing it with or you are trying to produce a everything. series of data is you are taking a farm gate price of Mr Hawkins: Operational issues are more than milk of which 50%— image.
Q210 Paddy Tipping: This is politicians talk against Q204 Mr Jack: I am not making that distinction, we managers. What is important, the only way of are talking about liquid and liquid. I do not think resolving this is to try and get some transparency you should confuse the matter by trying to muddy into the system. There are groups of producers who the waters by suggesting the composite farm gate say—and this is the point Mr Jack was making— price reflects other commodities, I am talking about hang on a minute, we are not getting a fair deal from liquid and liquid. the supermarkets. Can you just tell us how much Mr Hawkins: The obvious inference from what you profit say on a litre of liquid milk retailers are taking? are saying is either the retailers or the dairies or some Mr Hawkins: As I said to Mr Jack a moment ago combination of both increase their margins at the that question is very diYcult to answer on behalf of expense of the farmers. Yes? all of the big retailers because their supply terms diVer. Q205 Mr Jack: Yes. Mr Hawkins: As far as the retailers are concerned Q211 Paddy Tipping: Tell us about Safeway? every increase we have made in our retail prices has Mr Hawkins: It depends on the volume you do with been passed back in full to the dairies who supply us, a given diary as to what your supply terms are. Can there has been no increase in our gross margins. The I give you a kind of order of magnitude, at the problem that the farmers have had is what happens moment a supermarket of our size and with our between the dairies, the co-ops and them in terms of volumes might be paying the dairies who supply it 42 how much the increase in the additional revenue we pence, 43 pence, 44 pence, 45 pence a litre, it is that have raised from our customers that they at the end kind of range. The average retail price weighted of the day are getting. across all pack sizes and weighted by sales across all pack sizes, because that is the only way you can make sense of it, would be somewhere between 50 Q206 Mr Jack: Okay. pence and 52 pence. It gives you a feeling for the Mr Hawkins: Just to explain the mechanism when it magnitudes involved, that is gross. From that you has been agreed—I have to use the word agreed very obviously have to deduct wastage before you get to carefully—when one retailer has decided to put up the net, that is the sort of order of magnitude. prices and others decide that the market conditions are appropriate to follow we immediately tell our suppliers, the three big dairies, how much they can Q212 Paddy Tipping: Gross profit is about 10 pence invoice us for in terms of pence on the price because per litre. we all have diVerent supply terms with our dairies Mr Hawkins: Possibly less. depending on the volumes that we do with them. They immediately then invoice us at the enhanced Q213 Paddy Tipping: You have to take some price or they do so from an agreed date. What overheads out of that? 9484161011 Page Type [E] 28-05-04 23:58:55 Pag Table: COENEW PPSysB Unit: PAG1
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1 March 2004 Mr Kevin Hawkins and Mr Richard Ali
Mr Hawkins: Yes, indeed. That is gross but you have What game are you playing because as I said to the to deduct the on-going operational costs, and so on. processors there are those who are predicting a price of 14 pence a litre after the CAP reform takes eVect. Q214 Paddy Tipping: For an average company of That could be jolly bad news to you unless milk is your size what is the real profit per litre? not a very important market segment to you and Mr Hawkins: You have to make some judgments there are other ways you can make a lot more about what the net margin is going to be after the money. deductions and that is very diYcult to do because a Mr Hawkins: Milk and dairy together, we do not lot depends on the accounting conventions of the really distinguish between the two in terms of the particular company. When you get down to it if you way we look at the sector, we look at dairy as a take something between eight pence and 10 pence as whole, is a very important element in our total oVer the gross you have to deduct at least another three because it remains important to our customers, pence for overheads and net. That will vary from one whether they buy liquid milk in the same volume as retailer to the next to be honest. they did or not most of them do buy cheese, they do not buy enough of it or eat enough of it by Q215 Paddy Tipping: Let us just reinforce the point continental standards but they are all buying yogurt you made to us earlier on, there has been a two pence and dairy desserts. These products are a stable part rise and you have not kept any of that? of the typical shopping trolley and as long as that Mr Hawkins: Absolutely not. The whole basis of the remains the case it will remain an important part of deal is the whole thing goes back to the farmers. We our oVer. If you look at square footage it occupies in have that in writing from the dairies, yes, they would a typical supermarket that really tells you quite a lot pass it all back to the farmer. We insisted on that about where it stands in the pecking order. Can we last July. change the underlying decline in consumption of liquid milk? On balance that is unlikely, although Q216 Paddy Tipping: What evidence is there that there is one major consumer misconception which milk is being used as a loss leader to get people in I do not think is helping, and frankly the industry through the doors? itself has done nothing to change in recent years, that Mr Hawkins: None. is the perception that whole milk has a much higher fat content than in fact it has. In this day and Q217 Paddy Tipping: It used to be case, did it? age when everybody seems to be worried about Mr Ali: No. obesity and being overweight and all of the rest of it Mr Hawkins: No. it seems to me that a product which contains only 4% fat but which many consumers think is 30% to 40% Q218 Paddy Tipping: Never? fat really and truly there is a conception there in Mr Hawkins: I think the Competition Commission the market which the industry itself I think, with in its October 2000 Report said that it had found some help from retailers, should tackle. Leaving that some evidence of price cutting by Tesco and we aside I do not think we are going to be able to turn Safeway had also at one time back in 1999–2000 round the underlying trend in milk consumption V temporarily put milk on promotion as part of our because tea and co ee consumption, household promotional strategy. Both of us discontinued consumption of tea and coVee is declining and the whatever promotional activity we were pursuing national food survey has tracked that over a period because it did not generate any extra sales. Since of time. People are not drinking milk as a stand- then to my knowledge none of the big four or five or alone product as much as they did, it is not in schools six retailers has priced milk at a low cost or below like it used to be, there is a whole range of things. their supply cost and there would be no point in Cheese: I have already said we have half the level of doing it. consumption in continental Europe and again dietary reasons come into it yet again, low fat cheese V Q219 Chairman: If I can move aside to look at the has not really taken o in the market largely because relationship between the retailer sector and the dairy like non-alcoholic beer no-one has devised a product companies, you were not here for the previous that is worthy of consumption. I think we have a sessions obviously there was quite a stark diVerence problem there. The yogurt and the dairy deserts are between Wiseman’s, who are liquid milk producers, expanding. Because the United Kingdom industry, that is what they are, that is what they want to stay for whatever reason, was late into the game here, as as and they will intensify that part of the market I have no doubt one or two of the dairies will have segment, as against Dairy Crest which are intent on observed the dominant brands in the yogurt market adding value look at the other things to increase the are French and German. Although Dairy Crest are return. What can you do to give substance to some making valiant eVorts to try and catch up by of the weight both producers and processors want to building brands and winning consumer confidence see a more sustainable milk chain inasmuch that and building up that kind of consumer equity takes some of things you said earlier are pretty depressing a long time. I do not think there will be any major if you are a producer or a processor. We know milk change in the balance of market power between has declined in market demanded, we also know that foreign brands and United Kingdom brands in that it is quite diYcult to add value. You said cheese is part of dairy. However, as part of the Dairy Industry very much a stable market but not one where you are Forum, in addition to looking at things like CAP going to suddenly see a dramatic improvement. reform we have also set up a group to look at 9484161011 Page Type [O] 28-05-04 23:58:55 Pag Table: COENEW PPSysB Unit: PAG1
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1 March 2004 Mr Kevin Hawkins and Mr Richard Ali innovation and how we can accelerate the rate of is for two reasons, one is that the realities of the innovation. Product innovation is going to drive market place have not changed in the last two years, whatever growth there is left in the dairy industry it is still as competitive as ever and secondly it all going forward, not price so much but product depends what you expected from the code in the first innovation, making the range of products more place. I seem to recall the NFU for one and some of attractive and interesting to consumers. It is going to the other smaller suppliers and trade associations be a long, slow grind and it is going to require a lot saying right at the outset and being quoted in the of investment and a lot of confidence in the future. press back in March 2002 when the code was first Given the instability that CAP reform will cause for launched that the whole thing would be a waste of farmers and maybe processors and co-ops too, I time, it was toothless and it would not change think we have a problem. At the risk of possibly anything. The fact that two years on that is what repeating what one or two of the dairies may have they are saying does not surprise me. said they would see, or some of them, would see the future development of the liquid milk supply chain, and possibly other products too, in terms of more Q222 Mr Breed: That is not what the NFU are dedicated supply from farmers. A company like saying it is what the suppliers are saying and that is Dairy Crest now has 1,500 direct suppliers and it is far more important because they are your suppliers going forward, maybe the others have similar and the implication is, and was in fact expressed by numbers. Going forward they may well see a greater many of us at the time, the very reason they would proportion of their supplies coming from farmers not use the code was because of the whole aspect of who are dedicated to supplying them and nobody the fear of complaining. That I suspect is else. That may not be good news for the co-ops of demonstrated at least in part by the fact that no one whom there are three, there were six three years ago, has brought anything to the code yet 80% to 85% of there may not be three in another two to three years, your suppliers are still unhappy. In the light of that who knows. Certainly if you are looking at a and in respect of the OFT in their continuing contracting market the role of the co-ops is probably investigations how would you respond to a something that is going to come under pressure. suggestion that that code of practice should be given the force of law and that any breach would therefore constitute an oVence? Q220 Chairman: Can I ask you one factual question Mr Hawkins: For a start the code is already about the Forum, are caterers represented in the mandatory and has been for two years on the big Forum? I understand producers, processors and four supermarkets and we regard it as every bit as retailers are the other growing sector is the catering binding as if it were enshrined in an act of industry, do they feature in the Forum at all? Parliament. When the code came into eVect, just Mr Hawkins: I think there is a member representing before it went live we trained all of our buyers, we the food service sector generally. I think it is fair to revised all of our terms and conditions to bring them say they have not played a very prominent part in into line with the code and we said to our buyers you our discussions so far but we hope to get them must stick by the code. The issue, as you well know, involved because they are significant players in the is that the code as it was negotiated between market. They are represented on the Forum, yes. ourselves, the OFT and other parties did not emerge Chairman: If we can got on to the famous code of as a list of legally prescribed activities or practices. It practice, and I will ask Colin Breed to take that up. introduced the reasonableness test. When you have a reasonableness test there is clearly scope for men of Q221 Mr Breed: You will be aware we are in the first good will to disagree on what is reasonable two years—I think it is almost the anniversary—of behaviour in the circumstances. I think the NFU is the code of practice and in fact the OFT are carrying now trying to make progress on this and look at out a review, so far although they are in the middle what would be a definition of reasonable behaviour of their review they are taking more evidence their sector by sector because quite clearly there are consultation with your suppliers and their trade diVerences both of commercial pressure, structure, associations say that 80% to 85% of the respondents time scales, and all of the rest of it, between diVerent claim the code has failed to bring about any change sectors of our supply base, commodities, versus in supermarkets’ behaviour. I know that is an initial branding and fresh versus frozen, and if they can thought, but 80% to 85% of your suppliers feel that make some progress on that that it will be very it has not made any diVerence. I wonder if you have helpful. There is one point which frequently comes any comment on that? up which you have not raised, and I will raise it now, Mr Hawkins: At one level, as you well know, and as that is the suppliers’ organisations say they would the OFT have commented in the Report they make use of it if it was anonymous, if their name produced last week, they find it diYcult to make any does not have to be disclosed. OFT dispose of that firm judgments when the other party to the code, by saying, almost like the principle of natural justice, namely the suppliers, will not actually make that if a complaint is made against you you should complaints under it and use the code to advance know what the complaint is and who is making it their own interests or register disagreements or and there should be an open session in open court. If whatever. It takes two to tango on these occasions you want to make it more legalistic and legally and if the other decides, for whatever reason, not to binding you would have to follow that procedure make any use of it it is a little diYcult. In terms of am and lawyers would have to be involved, and so on. I surprised we have this result, no I am not and that The people who want anonymity would not get it if 9484161011 Page Type [E] 28-05-04 23:58:55 Pag Table: COENEW PPSysB Unit: PAG1
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1 March 2004 Mr Kevin Hawkins and Mr Richard Ali it was legally binding formally in the sense that you Mr Ali: I hope in five years’ time as regards new want it to be. The other point is on a common sense product development the work of the Dairy Forum basis if a big retailer is suddenly faced or any retailer will have yielded results and the work of the food is faced with a complaint from a supplier and he does chain sector will look at a more eYcient dairy sector not know the name, he just gets a recital of the facts and the chain which responds to what customers are and it is probably not going to take long to work out buying will have improved, product innovation and who the supplier is because the facts themselves will markets will have improved and the links between suggest one sector rather than another, he can quiz farmers and processors and the link between his buyers and of course he will soon find out, so to processors and retailers will have improved. We also say there could be anonymity is nonsense. To my hope that the Common Agricultural Policy will knowledge Safeway has never de-listed a supplier for allow farmers in the dairy sector to produce what the having an argument or raising a grievance with us. market wants. The only reason we would de-list a supplier would be for continued poor performance, failure to deliver repeatedly over a period of time, failure to achieve Q228 Mr Jack: Let me ask you one final thing, both product specification and failure to achieve quality. of you have mentioned the Supply Chain Forum and It is those things that let the customer down that some of the other structures which have put in place really matter and which drive our relation with our following the Commission on food and farming, suppliers. given that the farmer is driving to pull himself up by proverbial boot straps do you sense that retailers are starting to recognise that and to support it or is it Q223 Mr Breed: On that basis you would not mind always going to be a question of, well good on you if it was then a force of law because, as you said, it for trying but we will make our choice based on best is mandatory anyway and that would not make any value, best product, and it does not matter where it diVerence. comes from? Mr Hawkins: If people believe that giving it the force Mr Hawkins: That is not the case. For a start one of law is going to encourage the people who will not thing that has not been covered is the work of the participate in making it work then fine but let us be Food Chain Sector. The Food Chain Sector is now under no illusions that in so doing they are going to looking very hard at the dairy industry supply chain preserve any kind of anonymity. to see what costs can be taken out. I know that focus on cost reduction to the exclusion of everything else Q224 Mr Breed: Accepting all of that nevertheless as can in fact be a recipe for profitable decline but that far as BRC are concerned— is not the business we are in. What both the Food Mr Hawkins: I am speaking on this issue for Chain Sector and the Dairy Industry Forum are Safeway. about, as I mentioned earlier, is how we can Mr Ali: We represent a range of large to small accelerate the process, of the product innovation retailers, including the big four, and they have and that must be in the interests of the producer. The decided not to come along in an individual capacity. problem is with dairy, as indeed with so much in British agriculture, that traditionally the farmers Q225 Mr Breed: Has the code of practice succeeded have stood apart from the processors who in turn or failed? stood apart from the retailers and the idea of a much Mr Hawkins: It has failed because it has failed to more closely integrated operation, as we have seen engage the people for whom it was designed to develop in some continental countries, for a number protect and in whose interests it was designed to of reasons has never really been taken on board. operate, and we said so very plainly to the OFT. The There are one or two exceptions to that, poultry and issue now is where do we go from here? to a lesser extent the pig sector. In great swathes of the industry there is still this arm’s length Q226 Chairman: Okay. Just to finish, looking ahead relationship. Just to add to what Richard said, in five years, what is likely to happen to the price of another few years under the pressure of CAP reform milk? What do you see from a retailer’s perspective, there is going to have to be a lot closer relationship not what you think will happen to yourself, because between the producer, processor and retailer, not a you will be able to survive come what may, give us a non-adversarial one, because there will be always be quick picture of what will happen to the processing an adversarial relationship over a short-term industry, the producers or the industry? contract with or without a code of practice with or Mr Ali: Dairy farmers will be fewer in number, dairy without the force of law or bringing in the regulator farms will be larger, the productivity of dairy herd or Ombudsman or whatever, nonetheless I think will increase and there will be fewer cows. As far as that a closer working relationship and more the process sector is concerned there will be bigger, transparency, however you define that, subject to more modern processing plants. commercial confidentiality is the way it will go. If Chairman: Okay. that helps to build confidence it will accelerate that drive to innovation which is the only thing that is Q227 Mr Jack: That is it, we are going to have bigger going to, as I said earlier, provide growth in the plants and less cows. What about product industry. development, do you feel optimistic there will be new Mr Ali: Just to add to that, Ben Gill from the lines developed to try and give something of a lift to National Farmers’ Union said before he stepped the dairy industry in the United Kingdom? down as President, he was very clear that with the 9484161011 Page Type [O] 28-05-04 23:58:55 Pag Table: COENEW PPSysB Unit: PAG1
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1 March 2004 Mr Kevin Hawkins and Mr Richard Ali introduction of CAP reform larger processors are Chairman: Okay. Gentlemen, thank you very much. going to have to get more involved in their supply We will send you the figures so you can comment on base because CAP will not be stimulating over- them. You have missed what I said earlier, I will production and if there is over-production you can repeat it, if there are things you said it is hard luck buy lazily. If you do not have over-production you cannot unsay them but there may be things you stimulated by bureaucrats then quite clearly as a wished to have said and you would like to probably buyer of primary products you have to be more respond to our figures then feel free to send them to involved in the supply base. I think certainly on us as quickly as possible so it can help us in our liquid milk large retailers are already looking at that. deliberations. Thank you for attending.
Supplementary memorandum submitted by the British Retail Consortium (L20a) As NFUS states in its evidence, 50% of all milk produced in the UK goes into the dairy product market. However, the farm gate price quoted is presumably the average price for all oV-farm sales. In addition, it appears that the price quoted does not include monthly retrospective bonuses. We are also concerned at the definition of “retail price” used and how this was collated, ie is this a typical price or an average price? Given these issues, we believe that the comparison between the average farm gate price and a “retail price” for liquid milk is not one that is statistically valid. It is probably useful to consider in this debate that the Competition Commission Report in 2000 indicated that supermarket margins on dairy products were in line with overall grocery margins. The KPMG report stated that there is no evidence of excess profits in retailing across the dairy chain. Indeed, the KPMG report also noted that the main driver in the relationship between farm gate and retail prices is the change of consumer purchasing from doorstep delivery to supply through supermarkets. 9 March 2004 9595841012 Page Type [SE] 29-05-04 00:48:10 Pag Table: COENEW PPSysB Unit: PAG1
Ev 70 Environment, Food and Rural Affairs Committee: Evidence
Monday 8 March 2004
Members present
Mr David Drew, in the Chair
Mr Colin Breed Diana Organ Mr Michael Jack Paddy Tipping Mr Ian Liddell-Grainger Mr Bill Wiggin
Memorandum submitted by the Federation of Milk Groups (UK) (L14)
1. Executive Summary 1.1 Currency movements have lifted the base price for raw milk by the equivalent of 2.9 pence per litre since September 2000. 1.2 Initiatives in the liquid sector have increased the consumer price in this sector (50% of the whole market) by 4.0 pence per litre over and above the increase in the base price. 1.3 Since September 2000, the movement in liquid and cheese retailer prices has increased on average by 4.4ppl. In reality farm-gate prices have increased on average by only 2.0 pence per litre over the same period. Farmers supplying direct to liquid dairies have gained more on average than those supplying direct to manufacturing markets or those supplying the co-operatives. 1.4 The balance of the increased revenue was lost to farmers in Spring 2002 when supply and demand were severely imbalanced. The aftermath of Food and Mouth Disease changed the seasonal production profile, resulting in increased supplies and lower farmgate prices. 1.5 The balance of the increased revenue has been retained by the retailers and processors in the form of increased margins and has been used by the processors to combat their own increased costs. 1.6 Retailers and processors now control the supply and demand balance very closely using “Price Initiatives” and factory closures. Farmers are looking to re-establish some level of control by managing their seasonal milk production and through vertical integration. 1.7 With retailer and processor margins increasing over recent years, additional costs resulting from Farm Assurance and increased transport costs have been passed down the supply chain to the farmer.
2. The Raw Milk Market 1.1 Raw milk sold in the UK has a variety of uses and similar manufactured products reach the end consumer in a variety of ways. The overall market sales are summarised below as a percentage of the whole market.
Liquid Milk Major Retailers* 35% Middle Ground** 6% Doorstep 9% Cheese Mature Cheddar 10% Mild Cheddar 6% Other Cheeses 7% Other Products*** 20% Butter/Skimmed Milk Powder 7%
*Comprising the majority of Supermarkets. **Comprising other smaller stores, discounters, convenience stores (such as garages) and catering outlets. ***Other products include yoghurt, chocolate crumb, cream and whole milk powders. Each of the sectors identified has had diVering pricing pressures placed upon it in the last 36–48 months. These pressures can be split into four main areas, these being: — Consumer price movements — Currency movements — Movements in the balance of supply and demand — Additional On-Farm Costs 9595841001 Page Type [O] 29-05-04 00:48:10 Pag Table: COENEW PPSysB Unit: PAG1
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These are discussed below.
3. Price Pressures and Movements
3.1 Currency Movements 3.1.1 The Euro versus Sterling exchange rate has an impact on the value of both imported and exported dairy products. The exchange rate also aVects the value of Intervention prices for both butter and skimmed milk powder. 3.1.2 This impact is therefore mainly on Cheddar cheese, butter and skimmed milk powder. As such these products are used as the base prices for raw milk values in the UK. 3.1.3 Since April 2000 the Euro has strengthened considerably against Sterling, from around £0.60 to £0.70. 3.1.4 This increase has boosted butter and skimmed milk powder prices for Intervention by around 2.9 pence per litre. The base September 2000 figure of 16.3 pence per litre with July 2003 reaching 19.2 pence per litre. 3.1.5 This increase should also have impacted on the cost of imported cheese from within the “eurozone” by the same 2.9 pence per litre or approximately £290 per tonne.
3.2 Consumer Price Movements
3.2.1 Liquid Milk Price Movements 3.1.5.1 “Price Initiatives”—Over recent years consumers have been asked to pay higher prices for liquid milk on the premise the increase would be returned to dairy farmers . The first such initiative was seen in October 2000. These initiatives have oVered short-term fixes but because dairy farmers sell to a range of end use outlets some have benefited by a greater or lesser amount than others. 3.1.5.2 Raw milk sales for liquid milk within the UK are no longer carried out as part of a negotiation between buyer and seller based on the value of that milk. Instead they are based on “how much more can be extracted from the consumer”. As such retailers have the power, through “Retail Initiatives” to control the value of milk, limiting other external market forces which could result in further increases for the farmer. 3.1.5.3 The market now appears to work from the top down. Increased prices generated from the consumer is passed from retailer to processor. The processor then has discretion as to how much is paid on to his supplying farmer or co-op. While there is clear evidence that middle ground and doorstep customers received letters from processors advising them that prices were being raised by 3ppl plus “because farmer prices needed to be increased” some processors have declined to return any price improvement from this sector of the market. There is evidence that some processors may be using this increased margin to fund growth in the percentage of milk they have on direct supply to the detriment of the volume they buy from co-ops, thus restricting co-op suppliers to lower value outlets. 3.1.5.4 If we measure the impact in purely financial terms these initiatives have resulted in diVering degrees of return depending on the sector from which the consumer buys their milk. In pence per litre terms the movements between September 2000 and July 2003 can be summarised as:
Major Retailers !8.0 pence per litre Middle Ground !5.8 pence per litre Doorstep !6.7 pence per litre
3.2.2 Cheddar Cheese Price Movements 3.1.5.5 In store retail prices for Cheddar, which covers mild, medium and mature have moved by an average of £420 per tonne in the major retailers between September 2000 and July 2003. This is equivalent to 4.50 pence per litre. 3.1.5.6 Imported cheese represents 45% of total cheese consumption in the UK, around a third of which is for Cheddar. 3.1.5.7 Sales price for bulk Cheddar is greatly influenced by these imports. Both retailers and processors alike can import Cheddar to influence the price they pay for UK manufactured Cheddar.
Total Milk Price Movement Taking the increase in retail prices to the consumer experienced since September 2000 for both liquid and cheese, an average increase of 4.4ppl is reached. In reality, farm-gate prices have risen by no more than 2ppl. This means that a minimum of 2.4ppl of the increase has not been passed back to the farmers. 9595841001 Page Type [E] 29-05-04 00:48:10 Pag Table: COENEW PPSysB Unit: PAG1
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3.2 Movements in the Balance of Supply and Demand 3.2.1 The outbreak of Foot and Mouth Disease (“FMD”) in 2001 combined to very low farmgate prices earlier in the same year led to a significant change in the seasonal pattern of milk production. Milk volumes produced during Spring 2002 were at their highest level for 10 years. 3.2.2 This supply level, combined with a lack of available processing capacity in the UK, allowed processors to force down the price of milk in all market sectors. As a consequence farmgate prices fell by around 3 pence per litre from the start of April 2002. 3.2.3 Consumer prices did not react to this fall.
3.3 Additional On-Farm Costs 3.2.1 As costs of production and processing have increased, the majority of these costs have been passed back down the supply chain to the farmer. 3.2.2 Through the processors, retailers have stipulated that all milk must conform to specific Farm Assured standards. In reaching the requirements of Farm Assurance, farmers have had to meet the full costs of achieving the standard. No premium has been paid by processors for Farm Assured milk. 3.2.3 With Farm Assured milk required across the industry product range, the question must be asked whether or not the imported dairy products, in particular cheese meet the high quality standards demanded of UK farmers.
4. Farm-Gate Prices 4.1 The table attached as Appendix 1 [Not Printed] shows how farm-gate prices have varied between September 2000 and July 2003. 4.2 This illustrates that the impact of price changes in diVerent market sectors in not spread uniformly across all farmers. — Those supplying directly to processors involved only in the liquid sector have had increases of between 2.1 and 3.0 pence per litre. — Those supplying to co-operatives who have a range of customers have had increases of between 1.5 and 1.9 pence per litre. — Those supplying direct to manufacturing businesses have had increases of between 0.8 and 1.8 pence per litre. 4.3 The price increase at the farm-gate is dependent on the balance of exposure to the various market sectors. 4.4 The movement of farm-gate and liquid milk price changes is illustrated below:
5. Processor and Retailer Margins 5.1 Detailed analysis of liquid milk processor margins is very diYcult because the price of milk passing from processor to retailer is not available. A simple analysis of the published profits of liquid only processors shows that Robert Wiseman Dairies have a net margin which is the equivalent of 2.2 pence per litre whilst the figure for Express Dairies (now Arla Foods UK is 1.2 pence per litre). 5.2 Appendix 2 [Not Printed] shows that, by tracking the average farm-gate price with the retail price for 4-pints of liquid milk, the farmer’s share of the revenue has fallen by 10% over the period from October 2000 to July 2003. 5.3 Analysis in the cheddar market is possible. The actual margin for cheese sold through retailers can be estimated using consumer price information from Taylor Nelson Sofres with bulk cheese prices quoted by the Provision Trade Federation. This analysis shows: — 67% of the consumer price for mature cheddar is to cover costs (cost of production on farm, processing and storage costs, retailer overheads and transport costs at various points in the supply chain). — 33% profit is split as follows: Farmer "2% Processor !7% Retailer !28% January 2004 9595841002 Page Type [O] 29-05-04 00:48:10 Pag Table: COENEW PPSysB Unit: PAG1
Environment, Food and Rural Affairs Committee: Evidence Ev 73
Supplementary Memorandum submitted by the Federation of Milk Groups (L14a)
ADDITIONAL POINTS OF RESPONSE / COMMENT TO THE COMMITTEE The attached paper has been generated in response to the arguments and positions forwarded by the various groups and organisations to the committee via the first oral evidence session, and addresses a number of key structural points and arguments that we (FMG) feel need to be considered. We would ask the committee to take into account these points, and to view them as additional arguments to those already outlined in our original submission.
Points of Response/Comment 1. UK retailers currently retain a significant and disproportionate margin on dairy products. Clearly, in order to drive such margins, the supply chain in its current structure, is geared to drive benefits away from the farm gate. While competition and profit maximisation are the fundamental building blocks of modern commerce, the major concern for FMG and its members, is that under the current supply chain structure, the operating environment prevents the market from working in a balanced, free-flowing commercial manner—leading to a situation that prevents the bulk of milk producers from securing returns and also one that increasingly fails to the cover average costs of production at the farm gate. It is the view of FMG, that a far greater and genuine sense of co-operation and structural transparency must be adopted within the supply chain, to deliver a fairer and more equitable distribution of margins and profits. 2. There is evidence that dairy imports continue to severely undermine the value of UK dairy produce. A central factor in this negative process is the inconsistency in the enforcement of farm assurance regulations. The UK dairy industry is, in our view, quite rightly subject to strict farm assurance regulations and quality guarantees. Retailers and the dairy industry, including ourselves, work extremely hard to ensure that the strict checks and balances with regards farm assurance are upheld and adhered to. Assurance comes at a price, and that price is obviously added and calculated into the unit costs of dairy production. It is our view, that with regards farm assurance and quality guarantees that the UK dairy industry is systematically and continually undermined, as retailers have failed to ensure and enforce equally strict farm assurance schemes on imported dairy products. We also would urge that assurance/legislation be adopted that would ensure all imports are of an equal standard, as determined by the British Farm Standard (Red Tractor) and that all UK farm produce be required to carry the Red Tractor logo. This has additional benefits of protecting both consumer and farmer. 3. Recent “retail pricing initiatives” have not delivered what they promised, with critics from within some sections of the “producer” community claiming that they have simply served to pass further control with regards milk pricing into the hands of retailers. While pricing initiatives have oVered some temporary relief to dairy farmers, this has not been evenly spread across all sections of UK dairying. In the UK, milk processors by choice pay higher prices to direct suppliers to the detriment of the bulk of milk producers (co-operative members). It is reasonable to suggest, that this pattern may lead to a market that operates exclusively for the benefit of a selected few, with the majority of milk producers being excluded access from the value added market (liquid milk) Suggestions have been made that this is leading to an unmanageable, two-tier, dual-price farming sector. The reality of the situation is that while those producers that deal with liquid processors directly, because of the location of their farms, can enjoy higher returns and the associated benefits, whereas those farmers that are unlikely to secure a direct supply contract with one of the main liquid processors, are in eVect restricted from maximising the profitability and development of their business. It is the view of the FMG, that in order to level this situation, structural change with regards ownership of key points within the supply chain must be allowed to evolve and take place during this critical period in UK dairying. This calls into questions current UK rules with regard competition law, and more specifically, competition rules concerned with vertical integration. It is the view of FMG that it is only right and fair, that UK competition law applies consistently throughout the supply chain, specifically from the bottom up (producers) as it currently does from the top down (retailers). 4. Finally, and looking in more detail at the above point: it is the view of FMG that current, strict, UK Competition law has made it extremely diYcult for milk co-operatives to vertically integrate. The high cost of pursuing potential vertical integration opportunities are persistently overshadowed with the fear that where opportunity exists to secure and build a more viable future for members/dairy farmers, that the potential opportunity will ultimately be blocked and rejected under current competition rules. 9595841002 Page Type [E] 29-05-04 00:48:10 Pag Table: COENEW PPSysB Unit: PAG1
Ev 74 Environment, Food and Rural Affairs Committee: Evidence
It is imperative at this crucial time for the UK dairy industry that farmer co-operatives be legitimately free to pursue reasonable and justifiable vertical integration opportunities in line with other co-ops and multi-national dairy businesses (eg Arla, Fronterra) operating in the major dairy markets, including Europe, Scandinavia, North America and the Southern Hemisphere. 3 March 2004
Witnesses: Mr John Duncan, Chairman, and Mr David Strang, Advisor, Federation of Milk Groups, examined.
Q229 Chairman: Good afternoon, everyone. If we Q231 Chairman: So do you think matters would be could make a start. This is the third evidence session helped if there was a regulatory body to arbitrate on that we are having and some you know the score these diVerentials in milk prices? I should have said very well, but I do not know whether either Mr in my initial remarks that, of course, it is the rate of Duncan or Mr Strang have been with us in previous increase rather than the actual milk price. Should sessions. The aim is to get through four diVerent there be a regulatory body in this industry that sessions of evidence as expeditiously as we possibly actually looks at why there is such discontent among can, but obviously to try and build on the evidence farmers and why retailers just say “that is the market we have had so far. Please accept that our questions price” and that is what we have to accept? are going to be somewhat brief and brusque; it is not Mr Duncan: The problem is that we have a market in any way meant to be insulting but it is in order to price but the market price can diVer depending on to get through everything as fast as we possibly can. We whom the dairy farmer is selling his milk. It can V have got a replacement witness so it would be useful, di er by three to four pence per litre, which in Mr Duncan, if you could say who you are and what percentage terms is very significant. Would a your organisation is and then Mr Strang could regulator assist? Clearly it would depend on the Y introduce himself. terms of reference. It is quite di cult to see how at this stage, given the evolution of the industry, Mr Duncan: Chairman, thank you for your particularly the processing and retail sectors, one introduction. My name is John Duncan and I am the would find a role or remit for a regulator. Chairman of the Federation of Milk Groups. You may know that the Federation of Milk Groups is an umbrella organisation representing milk sellers, Q232 Paddy Tipping: In your evidence you talk mainly the four GB Co-ops, GB and Northern about the possibility of a two-tier, dual-price dairy Ireland. I make apologies for my colleague, farming sector with one level of producers directly Malcolm Smith, who is unable to attend, but this is supplying dairies and the others maybe going a V David Strang. di erent route. What are the consequences for Mr Strang: I am David Strang. I am a solicitor and people who, in a sense, are at the bottom, the people partner with a law firm called Barlow Lyde & who are not getting as much price? Mr Duncan: The consequences are that in due course Gilbert. We are long-standing advisors to First they would find themselves being exposed purely to Milk. the returns from the commodity end of the market. As we move into CAP reform, which is going to Q230 Chairman: If we can get straight into this. deliver reduced intervention prices, reduced access Clearly you may have heard some previous sessions to intervention, then the greater pressure to exit the on this but can I just ask the most obvious question: industry would be felt by those producers. why do you think farmers are always alleging that the price of milk paid to them is that much lower Q233 Paddy Tipping: Are they going to survive? than the retail price of milk? If that is a given, why is What is your prognosis? that so? Mr Duncan: To whom are you addressing that, Mr Duncan: I think that is a question that has been ourselves? posed by dairy farmers for as long as I have been involved in the industry, some 20 years, and, indeed, Q234 Paddy Tipping: Those producers that you have before the deregulation of the Milk Marketing just been talking about supplying the commodity Boards. The dairy farmers at that point in time end because they face some pretty severe world believed that the milk price doubled within two days competition, do they not? of leaving the farms, and clearly from that point in Mr Duncan: I am suggesting that is a potential, it is time wanted to see their business involved in milk not a given at this point in time. Were we to see this processing. You will be aware at that point in time situation developing then, yes, I think we could see in the South that the Milk Marketing Board of a very significant exit from the industry. England and Wales owned a business which had become Dairy Crest and in Scotland the Q235 Paddy Tipping: One of the things you could corresponding board owned Scottish Pride. The do, to go back to your opening comments, would be problems all started with deregulation when there to vertically integrate again. Clearly you have got was an insistence that the continuing Co-op strong views on this. What discussions have you had, organisations divested themselves of the processing say, with Defra or the competition authorities arms. That is where the problem arose. around that prospect? Is it a runner? 9595841003 Page Type [O] 29-05-04 00:48:10 Pag Table: COENEW PPSysB Unit: PAG1
Environment, Food and Rural Affairs Committee: Evidence Ev 75
8 March 2004 Mr John Duncan and Mr David Strang
Mr Duncan: That is a fundamental objective of all of Q238 Mr Wiggin: What is it? the major Co-ops in the UK, to do that. I know you Mr Duncan: Figures from 2001–02 suggest the figure have heard evidence from Milk Link, who have is on the top side of 70. In Scotland it is over 100. achieved a degree of success going down that route. Ireland is 30, yet Irish dairy farmers appear to For others in the Co-op it is more challenging achieve higher milk prices. What is happening about because of the consolidation that we have seen in the eYciency is the latest Colman-Harvey report1 processing sector. At this moment in time looking into UK dairy farming costs over the course opportunities—I do not overstate it or understate of the end of last year showed that the average cost it—do not grow on trees, they are exceedingly of production across 400 England and Wales dairy limited. Of course, with the consolidation the value farms was about 18 to 18.5 pence per litre. Three of businesses becomes that much greater. What years ago, when they last did that analysis, the cost approaches have we made? We gave some of production was 21 pence. I think there is no supporting evidence to the Curry Commission in its denying the fact that UK dairy farmers have been early days. I have not gone to the Competition driven down the eYciency route. Commission but certainly individual farmers and other groups of farmers have gone to them and posed these very questions. The issue of the Q239 Mr Jack: Just to follow on from an earlier restriction by competition on the development of point you were making about where you saw prices Co-ops is one which does test us. I will pass that to going in the light of the reform of the CAP and the Mr Strang. figures you have just given, do you think that UK Mr Strang: I think it has been an issue which has dairy producers, farmers, can actually lower their vexed the dairy industry since the deregulation and costs to the levels required to stay in business, even prohibition of vertical integration then and since the the most eYcient ones, in the light of about 21 to 17 demise of Milk Marque. There is no simple answer. to 18? Down to 14 is a big change. How is that going There has been some limited discussion with the to be achieved? OYce of Fair Trading that a number of people have Mr Duncan: I think we should be careful and not had, rather than the Competition Commission I assume that because in a certain set of given would say. I think their attitude is that in theory they circumstances the support mechanisms may go are not uncomfortable with the idea of vertical down to 14 pence that that, in fact, would be the integration but it very much depends on the price that UK dairy farmers would need to survive. individual circumstances, so I suspect that in Certainly as a representative organisation we would diVerent parts of the country the answers will be be looking at avenues to ensure that prices were not diVerent because they have a diVerent experience of driven as low as that. What steps are we taking? To conditions of competition. come back to UK eYciencies, one of the elements Chairman: We will look at milk prices and that has come out of the Colman-Harvey report is eYciency next. that over that period in time the average herd size in the UK has increased significantly, so they are assuming a direct correlation between eYciency, ie a Q236 Mr Wiggin: I wonder if you could tell us a little lower cost of production, with the herd size starting bit about why New Zealand is able to make a profit to increase, but the backbone to the UK dairy where the farmgate prices are less than half of those farming sector would still appear to be the family in the EU. Can you also say a little bit about dairy unit, but a family dairy unit eVectively run— Y e ciency and what steps are being taken by your I say this with respect—on more business orientated Y members to improve e ciency in milk production? terms that in the future, family business units, Mr Duncan: It is an interesting comparison. I think averaging around 150 cows. one comfort that UK dairy farmers have is that New Zealand is 12,000 miles away. They have got a clear climatic advantage. They have got a huge Q240 Mr Jack: What I am intrigued to know is operational scale. If you look at the average size of where you think the further eYciencies are likely to New Zealand dairy farming units they are come from? somewhere above 300 cows. If you compare that Mr Duncan: I am not suggesting that there will be with Europe, I think the lowest average herd size in that many more eYciencies to be driven out of the Spain is 18. There are huge advantages of scale. UK average dairy farm. I can assure you that in Similarly, their production is very much grass- speaking to many dairy farmers, every time they based, given that grass grows close to nine months of hear talk of them becoming more eYcient it means the year, and they have huge investment in surviving at lower prices. That is the context in processing and, of course, the fundamental which that seems to be accepted. If we look at the advantage is that approximately 96% of New structure of the UK herd compared to our main Zealand milk is collected from farms, processed, competitors, UK competitors—Ireland, France, marketed and sold by one Co-op. Germany, Holland—we have a stronger farm structure that should ensure that we can survive, that is if we can see this proverbial level playing field. Q237 Mr Wiggin: What about eYciency in the UK? Mr Duncan: The UK, in European terms, and I 1 (Colman and Harvey) February 2004, The Future of UK think we have evidence to show this, is clearly the Dairy Farming, available at http://www.defra.gov.uk/ most eYcient. We have the largest herd size. foodrin/milk/colman-harveyreport.pdf 9595841003 Page Type [E] 29-05-04 00:48:10 Pag Table: COENEW PPSysB Unit: PAG1
Ev 76 Environment, Food and Rural Affairs Committee: Evidence
8 March 2004 Mr John Duncan and Mr David Strang
Q241 Mr Jack: Are we as productive as the major Mr Duncan: Clearly multiple retailers, European competitors because we seem to have an supermarkets, are making a significant margin. We abundance of natural advantage, particularly on the see from the evidence you have taken that processors western side of the United Kingdom? In fact, within are making between two and three pence a litre clear the Community the three most eYcient producers margin. If we refer back to the question that I was should be Northern France, the West of the United asked earlier about the average cost of production, Kingdom and Ireland, yet here we are saying can we UK dairy farmers’ production was 18 to 18.5 pence hang in there and we have got everything going for a litre but the average milk price over that period was us. That is the bit I find is a paradox. less than that, so dairy farmers were operating a Mr Duncan: I think what is interesting in looking negative return. back at the average prices that have been paid to British dairy farmers compared to Irish and the main European ones, which I mentioned, over the course Q247 Mr Liddell-Grainger: But that is one of the big of the last six years is in five out of these six years problems, is it not? If you look at France, Germany, British dairy farmers have had lower prices. Lower etc., where their co-operatives do tend to be bigger, prices than our Irish competitors who have a much more aggressive, set up with EU money, we have a smaller herd size where for every litre that is problem, we have got one arm behind our back at all consumed domestically seven litres is exported, so it times. The retailers control us, do they not? I say goes on to either the world market or back into the “us”, I mean dairy farmers. UK and yet they have been able to pay their Mr Duncan: I would agree, Chairman. producers a higher milk price than we have been able to achieve in the UK. What does that tell us? I think Q248 Mr Liddell-Grainger: What would you do it focuses on the structure of the industry. about it? Mr Duncan: From our perspective it is particularly Q242 Diana Organ: You hinted in response to diYcult. Since the deregulation of the Milk Michael Jack that the larger units have cottoned on Marketing Boards we have seen a huge evolution in to how to become more eYcient but that there is a the structure of the industry. Although we are seeing slight problem that the majority of, shall we say, an exit rate of dairy farmers of 8% a year, there are family dairy farms have not really got the message. still 25,000 dairy farmers in the UK selling their milk We are not talking about their survival here but the to two or three Co-ops under direct supply only way they can become profitable and have a contracts, but the majority of that milk is processed business that is worth hanging on to is for them to by five major processors and sold on through half a have a bigger unit and larger herds. Do you think dozen major retailers. You can see where the that message has got through to people involved imbalance lies. I know I have not given you any with small farms, tenant farmers, small family remedies that you might be looking for. farms? Mr Duncan: You would assume so, but I think that a unit of that size does not always focus on accounts Q249 Mr Liddell-Grainger: Let us just take yoghurt. at the end of the year and return on capital. Many We have a direct threat on yoghurt from Europe and of those farms survive by continuing to tighten their yet we are very confined. I have an organic yoghurt belts with members of the family working away from producer in my constituency called Yeo Valley, who home. It is a labour of love. I am sure you have heard of. They are finding it very diYcult because they have to buy organic milk which has got slight problems at the moment anyway and, Q243 Diana Organ: So, in other words, what you are therefore, they are buying it over and above what the saying is they are not so interested in what farm market is probably dictating because, in fact, the income is, it is what the farmer’s household income retailers are controlling it so tightly it is very diYcult is that keeps them in the structure? for them to move. If we go on like this the members Mr Duncan: I would not dispute that. you represent and others are not going to be there because they will find it harder and harder to operate Q244 Mr Liddell-Grainger: Following on from what because you can go to Ireland, France or Germany, Michael was saying, we are finding that retailers are wherever you want to go to buy milk. Do we not keeping a larger and larger slice of the action from have to come up with some way of resolving this? the milk producers, are they not? Are you finding Mr Duncan: I think we really do have to because we that? are seeing a huge downward pressure on dairy Mr Duncan: One of the other questions we looked at farmers’ returns. Certainly many members are was the transparency within the milk supply chain. becoming more and more disillusioned. To go back over one or two of the points we made earlier, dairy Q245 Mr Liddell-Grainger: I was going to come on farmers saw themselves investing up to 10 years ago to that. in Dairy Crest and Scottish Pride, but that has gone. Mr Duncan: I beg your pardon. They saw Milk Marque being obliged to break itself up on the expectation that the successor Q246 Mr Liddell-Grainger: I want to know very organisations would be able to vertically integrate much straight down the line on retailers themselves their business. Some have found opportunities to do the margins they are keeping, supermarkets, and that but with the consolidation of the processing should we be looking at that? sector that is increasingly becoming a challenge. 9595841003 Page Type [O] 29-05-04 00:48:10 Pag Table: COENEW PPSysB Unit: PAG1
Environment, Food and Rural Affairs Committee: Evidence Ev 77
8 March 2004 Mr John Duncan and Mr David Strang
Q250 Diana Organ: When in July 2003 the major best price and the milk producers, as long as there supermarkets raised the retail price of liquid milk by are enough of them, are not their problem. What is two pence per litre, did they ever admit to any of you your response to Mr Hawkins? lot that they were selling milk as a loss leader Mr Duncan: I would not say that value added is not anyway? a primary selling organisation’s problem. The Mr Duncan: It is very diYcult to say with any real fundamental objective of the Co-ops, who are accuracy, as we are not privy to that kind of members of Federation of Milk Groups, is to information. We do not know how much retailers vertically integrate the business. First of all to get a sell milk for and we do not know how much it is captive market for the milk and also, hopefully, to generally sold to the processors for. You could argue gain a share of the value added. True value added is that they may have been selling milk as a loss leader built on the back of brands and that takes a huge up until that period of four or five years ago but that investment to recognise that. Of course, a processor is certainly not the case now. Information that was that has value added or a brand buys milk for that, provided by one of our members showed that the he does not buy milk at a premium to put into, he has widening gap between the price that dairy farmers invested in the development of the brand and, I receive and the price the consumer pays over the would contend, is entitled to get a return on it. course of the last six years has increased by Q253 Chairman: If the supermarkets continue to something like 12 pence a litre. take the line that they are playing a diVerent ballgame, what authority do you and your members Q251 Diana Organ: If you just look at the way that have in trying to pull them to something where you supermarket layouts are, particularly in urban areas, can at least talk about the rules even if you cannot they deliberately are putting it out as a loss leader play the same game? V because they know that lots of people go in to pick Mr Duncan: Selling Co-ops have e ectively little up milk and, if the milk is a reasonable price and it trading relationships with multiple retailers. What we have seen over the course of the last two years is is cheaper than buying it from a doorstep delivery, Y that is where they will get it and while they are there major retailers are ultra-sensitive to the di culties they will also pick up readymade meals and that dairy farmers are facing, hence the reason that Farmers for Action, for example, get access into everything else that they are flogging. They are retailers at very high levels. The question is whether always going to do this because bread and milk are the industry can continue to negotiate milk price on things that people in urban areas will drop into a a picket line. I would like to think that all of us supermarket for but while they are there will working together can probably work on the Lord probably spend another 20 quid on other things. Whitty supply chain meeting where we had the They are always going to do that but they never opportunity to meet with processors and retailers admit that, do they? and hopefully find a better way forward for the Mr Duncan: You may be right but, from our industry, but I have to say I think we are going to understanding, multiple retailers are now taking need some help. quite useful margins out of the price they sell milk at. Q254 Chairman: On that positive note, can I thank you for your evidence. As I say to every evidence Q252 Chairman: In your written evidence you talk giver, what you have said cannot be unsaid but there about wanting, as others have, to move us on to the may be additional points that you wish to agenda of value added. Is not the problem that you supplement. Feel free to contact us if there is are trying to play cricket and the retailers want to anything that you felt you did not get across and you play rugby and this is not at all in any way a common feel would help us make our report, or more game? I was struck by what Mr Hawkins said last particularly anything you felt was mistaken in what week quite honestly in the evidence session, that he you said in this session. I thank you for your thought the value added notion was a nice one but evidence. really supermarkets are not very interested in that Mr Duncan: Can I thank you for seeing us at short because they will sell whatever they can sell at the notice.
Further supplementary memorandum submitted by the Federation of Milk Groups (L14b)
1. A detailed breakdown of average herd sizes across Europe.
2. A fuller explanation / examination of the potential implications on the UK dairy industry as a whole, if the process of a “dual market price” system based on those with direct supply contracts, versus those without, is free to continue unaltered in the future at a similar pace witnessed over the last two-to-three years.
3. A detailed discussion paper on competition law with regard perceived barriers to vertical integration within the UK dairy industry. 9595841004 Page Type [E] 29-05-04 00:48:10 Pag Table: COENEW PPSysB Unit: PAG1
Ev 78 Environment, Food and Rural Affairs Committee: Evidence
1. Supplementary Note to Question Q238 by Mr Wiggin What are the average herd sizes across Europe?
Herd Size 2001
United Kingdom 72.4 Denmark 57.2 Netherlands 47.0 Luxembourg 37.8 Irish Republic 34.3 Belgium 33.0 France 32.7 Sweden 32.0 Germany 31.2 Italy 22.2 Spain 17.5 Finland 14.9 Greece 12.7 Portugal 10.8 Austria 8.9 EU-15 28.2
Source: DF&F 2002
2. Dual Price Market As part of our written submission, and as touched on during our oral evidence session, a key theme that we ask the committee to consider is the growing trend of a “dual price market”, characterised on the one hand by dairy farmers contracted to processors via direct supply agreements, and on the other Co-Op members. Direct supply contracts, as outlined below, secure a consistently higher market price per litre of milk than the contracts available to non-direct suppliers, who, are almost exclusively Co-Op members. The number of direct suppliers / contracts has steadily grown since 1994, with a general market assumption that direct suppliers now make up approximately 50% of all UK milk contracts. However, a crucial point within this trend is that direct supply contracts are, on our understanding and experience, only oVered to those farms / farmers based in strategically important locations in relation to UK processing plants and major distribution depots. On this basis, and assuming processors continue in the main to base their liquid milk processing plants in or around their current locations, approximately 50% of UK dairy farmers (ie those based in non-processor strategic locations) are eVectively “zoned-out” from the higher value contracts. This trend has a major de-stabilising eVect within the industry, generating a sense of resentment and anger among those that by virtue of their farm location, are in eVect restricted to operate within the lower tier, lower value bracket of the “dual price market”. It is also reasonable to assume, that coupled with the projected downward pressure on milk prices as a result of CAP reform, this trend will increase over time. With around half of UK dairy farmers now on direct supply contracts, the burden of balancing supply against demand is increasingly being passed onto the Co-Op farmer. This burden means Co-Ops’ are required to use balancing facilities whose returns are exposed to commodity prices which, over recent years have been influenced greatly by intervention support prices. The cuts in these support prices through CAP reform are therefore expected to have a greater impact on Co-Op prices than they will on direct supply prices. Outlined below are projected returns based on the CAP reform support price cuts. The figures for 2002–03 and 2003–04 are actuals, with average direct liquid supply contracts calculated as a simple average of current Dairy Crest, Wiseman & Arla contracts—against actual average Co-Op supply contracts calculated as a simple average of current Dairy Farmers of Britain, First Milk & Milk Link contracts, using the British Dairying standard litre (excluding seasonality payments). The calculations outlined below are based on a number of variables and assumptions—they are not definitive, and are included to support our written argument of a dual price market and its implications. The projections assume the CAP reform support prices have a greater negative influence on Co-Op prices (circa at a rate of 70%) than they do on direct liquid supply prices (at an assumed rate of 50%). This assumption is based on the Co-Ops greater exposure to commodity markets compared with the liquid market. 9595841004 Page Type [O] 29-05-04 00:48:10 Pag Table: COENEW PPSysB Unit: PAG1
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ppl Intervention Prices Average Liquid Average Co-op Co-op versus (ppl) Directs (ppl) Prices (ppl) direct
2002–03 18.00 16.61 "1.39 2003–04 18.52 19.08 17.73 "1.36 2004–05 17.28 18.46 16.86 "1.60 2005–06 16.04 17.84 15.99 "1.85 2006–07 14.80 17.22 15.12 "2.10 2007–08 14.43 17.04 14.86 "2.17
In 2002–03 and 2003–04 Co-Op prices set against Direct Supply Contract prices were consistently lower, equating to a diVerence in the region of 1.4ppl. Moving forward, the projections show an increasing divide between liquid direct and Co-Op prices. The calculations highlight a realistic potential that Co-Op prices may fall below Coleman & Harvey’s critical 15ppl barrier as soon as 2007–08, where, it has been predicted, the UK would see a mass exodus from the industry, resulting in a UK milk shortage. Crucially, with liquid direct farmers relatively protected from the price cuts, the mass exodus would come, in the main, from the Co-Op ranks. This exodus would also not necessarily be made up of ineYcient farm businesses, but simply those structurally blocked from entering the higher value markets for the reasons already outlined. The loss of milk from the Co-Ops would also seriously threaten the supply versus demand balance, lead to an overall shortage of milk in the UK, and threaten the existence of many specialist small dairy companies who are unable to secure their own direct farms due to their scale. In addition, we are likely to see significant regional variations in terms of the eVects of downward financial pressure on dairy farmers, with certain rural areas in England such as Cumbria, disproportionately suVering from the financial pressures of CAP reform, coupled with the implications as already outlined in terms of their location in relation to existing UK processing and distribution plants. Likewise, dairy farmers in Wales are also likely to suVer disproportionately from downward financial pressure, due to their average herd size, location and their subsequent structural inability to maximise and capitalise on eYciencies.
3. UK Competition Law and Vertical Integration Question 235 touched on the issue of the application of UK Competition Law to vertical integration. As indicated in our original submissions and reiterated during our oral evidence session, this is an issue of considerable significance for the UK Co-Ops. There is considerable evidence from other countries that vertical integration can produce a beneficial outcome both for producers and consumers of milk and the sub-committee will be aware how prevalent this industry model is in countries as diverse as the Netherlands and New Zealand. This is hardly surprising given the eYciency gains that can result from vertical integration through the elimination of a whole stage in getting the product to market. The main concern that vertical integration raises is where it leads to problems for businesses competing with the merging parties. In other words, does the vertical integration lead to competing suppliers finding that they are facing a restricted number of customers or does the vertical integration prevent other customers from having access to adequate supplies of the product in question? Vertical integration in the milk market in Great Britain (Northern Ireland is generally accepted to be a separate market) has largely involved the acquisition by co-operatives of processed milk businesses (eg cheese or skimmed milk powder plants) leaving the greater part of the (higher margin) fresh milk market in the hands of non-integrated dairies, in particular, Dairy Crest, Arla/Express and Wiseman. As the sub- committee will appreciate, this split may have undesirable consequences in the longer term for the farming community as it increasingly finds itself excluded from the higher value end of the market. The question posed by many in the industry is why vertical integration has not so far included the fresh milk sector. While commercially, the milk co-operatives may have diYculty in raising necessary funds for an acquisition in that sector (a greenfield operation probably being too uncertain a venture for the co- operatives), it may also be the case that uncertainty over the likely competition law analysis has restrained potential deals of this nature. The uncertainty would seem to result more from the repeated interest of the competition authorities in the sector rather than from any direct evidence that there would necessarily be opposition on the part of the competition authorities to vertical integration in the sector. Looking at the potential problems of vertical integration that we refer to earlier in this paper, a few comments are in order. 9595841004 Page Type [E] 29-05-04 00:48:10 Pag Table: COENEW PPSysB Unit: PAG1
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First, as regards the possibility that a vertically integrated co-operative could use its market power to deny competing processors a supply of raw milk, this would only have some force if raw milk were sold on a regional basis. In such a case, a hypothetical co-operative with a large market share in that region could refuse supplies to the competing processor in order to benefit its own processing arm and the processor, on this hypothesis, would not have access to adequate alternative supplies. There is however no evidence that this is the case. If it were, prices across Great Britain might be expected to vary whereas in fact, there is no regional pricing for raw milk. Each of the co-operatives supplies milk across a broad geographic area, sometimes at a considerable distance from where the majority of its farmers are located and this is a major factor behind the creation of a national market for raw milk. In any event, processors in all parts of Great Britain have successfully secured year on year increasing numbers of direct suppliers and both elements suggest that there is no prospect of competing processors not having access to milk on a competitive basis, were they to be denied a supply by the vertically integrated business. Problems could also be envisaged if competing suppliers of raw milk were denied outlets as a result of a vertical integration deal between one of the major milk supplying co-operatives and a major processor. However, this would only be feasible if the purchaser held a very large market share. There is no single purchaser with such a share of the national market. Equally, the national nature of the raw milk market means that it is improbable that any vertical integration would lead to the market in any particular region being “cornered” by a particular purchaser. It is disappointing that despite the various investigations that have taken place in the dairy sector, clarity has not been achieved as to the extent of vertical integration that would be considered acceptable by the competition authorities. While the reluctance of the OFT to commit itself in public can be readily understood, it has resulted in uncertainty and may have prevented transactions from occurring which are economically desirable. It would be for the benefit of the industry as a whole if a clear framework could be laid out to guide future developments in the structure of the industry. 23 March 2004
Memorandum submitted by DIAL (L22) Executive Summary 1. DIAL’s primary activity is to support the economic sustainability of its members and by implication the sustainability of the entire milk supply chain. 2. An essential element of this is that dairy processors and producers are profitable so they can invest in their businesses for the future. 3. Dairy farm profitability is a function of the eYciency of milk production and the revenue available from the market place. 4. The market for milk and dairy products operates fairly so that dairy farmers fully benefit from any growth in industry revenue. 5. There is clear empirical evidence that milk prices over time move in line with market movements. This view is substantiated by independent reports on the operation of the dairy market. 6. The rate of price transmission is aVected by the complexity of the dairy product supply chain and the multiplicity of factors that aVect the determination of raw milk prices. 7. In the future enhanced profitability for the dairy sector will stem from: (a) continued investment by dairy processors to improve processing eYciency; (b) focus by processors on value added markets and product innovation; (c) investment by dairy farmers to lower their costs of production particularly through the achievement of scale. 8. The role of government should be to assist the industry to implement these strategies which will ensure the economic sustainability of the dairy industry.
DIAL 9. This document is the response by the Dairy Industry Association to the inquiry by the Environment, Food and Rural AVairs Committee of the House of Commons into the market price and farm-gate price of milk. 10. DIAL is the trade association representing processors and distributors of liquid milk and manufacturers of dairy products in England and Wales. DIAL members account for approximately 90% of the milk processed in England and Wales. 11. DIAL’s primary activity is to support the economic sustainability of its members and by implication the sustainability of the entire milk supply chain. 9595841005 Page Type [O] 29-05-04 00:48:10 Pag Table: COENEW PPSysB Unit: PAG1
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Terms of Reference 12. The terms of reference unfairly prejudice an assessment of whether price transmission is occurring between market prices and farm-gate prices. 13. The terms of reference for the inquiry are: “The Committee will examine the market price and farm-gate price of milk, and will investigate why recent rises in the former have not led to increases in the latter”. 14. There is an assumption in the terms of reference that the market is not working fairly. We submit that the competitive forces along the dairy supply chain ensures that the benefits of any market growth are being enjoyed by producers. We believe that the market for raw milk functions fairly and that that neither producers nor processors are in a position to be predominant. 15. The perception that market price increases not have been passed back to producers may have been the result of: — Inadequate information on the complexity of dairy markets. — Misconceptions over the way the raw milk market functions.
Complexity of Dairy Markets 16. Price transmission in the dairy industry is a complex process. 17. A common misconception concerning price transmission is that increases in the retail price of liquid milk can be translated into an equivalent increase in the price of all raw milk. For example during the summer of 2003 some organisations have claimed that a 2ppl increase in the retail price of liquid milk sold through multiple retailers should have equated to a 2ppl increase in raw milk prices. This could never have been the case. 18. Dairies sell a range of products into a wide variety of markets. Sales of liquid milk in supermarkets only equate to around 25% of all the raw milk produced in the UK. This means that an extra 2ppl on the price of liquid milk in supermarkets only equates to a raw milk price increase of 0.5ppl. 19. The remaining 75% of domestic milk production is utilised in the production of a variety of products which are marketed through a number of diVerent marketing channels.
Utilisation of Milk 20. Raw milk is utilised for a large variety of products beyond just liquid milk. 21. By way of indication of the range of products made by the industry, whole milk can be processed and sold as: — liquid milk; — condensed and evaporated milk; — whole milk powder; — cheese, (the by-product of which is whey, which can be processed further into powder and a range of liquid uses); and — separated into skimmed milk and cream, usually with a fat content of 40%. 22. Cream can be processed and sold as: — potted cream; — bulk cream for further processing; — butter (the by-product of which is buttermilk); and — butteroil. 23. Skimmed milk can be processed and sold as: — skimmed milk powder; — casein; and — blended with whole milk to produce semi skimmed milk. 24. The majority of yogurt is made from skimmed milk or skimmed concentrate. 25. Skim and cream have diVerent values. Based on the aid provided by the EU for intervention buying of butter and skimmed milk powder, the skim fraction of milk currently has 58% of the value of whole milk and cream the remainder. 9595841005 Page Type [E] 29-05-04 00:48:10 Pag Table: COENEW PPSysB Unit: PAG1
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Marketing Channels 26. Liquid milk and dairy products are marketed through a variety of channels. 27. Any of the variety of dairy products produced by the industry can pass through a number of marketing channels. The industry’s primary customers are the major supermarkets. 28. However the other marketing channels include: — The doorstep delivery service. — Other multiple retailers. — Other retailers such as corner shops, tobacconists, newsagents etc. — Restaurants and other catering outlets. — Schools, hospitals and other institutional users. — Food processing companies that use dairy products as an ingredient. — Wholesalers and distributors selling dairy products on to retail and catering outlets. — Traders. — Foreign customers, both EU and non-EU. — Common Agricultural Policy support schemes. 29. As a result of the complexity of the market for dairy products each market segment will have a diVerent impact on raw milk prices (see table below).
% Of Producer Income Accounted for By:
Liquid Doorstep 7.3 Top six multiples 22.6 Other multiples 5.5 Independents 2.2 Non-household 7.7 Butter 6.8 Cheese Retail Cheddar Mild 2.8 Medium 1.1 Mature 5.8 Other Hard 2.3 Blue vein 0.6 Soft and other 1.7 Food services ! manufacture 8.4
Full Cream Powder 5.8 Skimmed Milk Powder 5.5 Condensed Milk 3.1 Cream 6.2 Yogurt 2.2 Other Products 2.3 TOTAL 100.0
Source: DIAL estimates.
Pass Back to Producers 30. Any price increase in any one market cannot be expected to have a uniform eVect on the prices paid to all dairy producers. 31. The eVect on the price paid to producers of any price change in any product market will be diVerent for individual producers. The benefit to any individual producer will be determined by: — how the producer sells milk in the raw milk market, whether direct to a dairy company or through a producer co-op; and — the proportion of milk individual companies or individual co-ops sell into any particular market. 9595841006 Page Type [O] 29-05-04 00:48:10 Pag Table: COENEW PPSysB Unit: PAG1
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32. By way of example, if prices for liquid milk rise the eVect on the payments that can be made by a dairy company to its suppliers will depend on the volume of milk they sell into the liquid market. Many dairy companies do not sell into the liquid market at all. 33. The dairy company will then have to decide whether to pass on that increase exclusively to its direct suppliers or to all its suppliers. It may wish to restrict any increase to direct suppliers in order to encourage the supply profile that it requires for the liquid market. 34. If the increase is passed on to all suppliers, then the extent to which any individual co-operative member will benefit will depend on the proportion of the co-operative’s sales accounted for by that dairy company. 35. It will also be aVected by the payment policies of the producer co-ops who may wish to retain funds for a variety of reasons including raising capital. Producer co-ops account for over 40% of milk and therefore play a very significant role in aVecting price transmission in the industry to producers.
Price Determination and the Role of Commodity Products 36. The returns from commodity markets play a key role in determining the long-term trend in raw milk prices and therefore determine the extent to which producer expectations can be fulfilled. 37. The fundamental factor aVecting the prices that can be paid to producers is that raw milk for any one product market cannot be priced independently of the raw milk used for any other market. The institutional framework provided by the Milk Marketing Board that allowed milk to be priced separately for diVerent products was removed in 1994. 38. The price of milk is now determined by the competitive interaction of market forces. Co-ops have the ability to switch milk between dairy companies to achieve the best returns and processors can switch milk between products. Likewise customers can switch supplies between processors. The outcome of this interaction is that prices will be strongly influenced by returns from commodity markets. By way of example, if the return from the sale of raw milk for liquid milk was 20ppl and that for commodities 18ppl, then the organisation selling milk for a return of 18ppl would have a strong incentive to oVer milk to processors of liquid milk. To achieve a sale, this milk would have to be oVered at a competitive price below 20ppl. Individual processors of liquid milk could not ignore this opportunity, otherwise their commercial position could be undermined by their competitors taking it up instead. This process could be accelerated if retailers seek to maximise their competitive position with consumers by being able to oVer cheaper milk. Similarly the market operates in reverse. If returns to liquid milk are lower than those to the commodity markets, then returns would have to be increased for the liquid market to maintain priority of supply over commodity markets given the need to supply liquid milk on a daily basis. 39. This analysis shows that over time all milk prices through competitive forces move in line with movements in commodity markets. 40. It is therefore important to understand the nature of the market for these products. Commodity markets are international markets. This means that for these markets the industry is unable to aVect the prevailing price and is in the position of being a price taker. This in turn means that the amounts that can be paid to producers for milk supplied for these products have to be adjusted in line with market returns. More than 40% of UK milk is utilised for commodity markets. The UK’s exposure to imports means that the UK industry cannot disengage itself from trends in commodity markets. Imports account for over 40% of UK cheese consumption and over 50% of UK butter consumption. A further consequence of this exposure is that prices are heavily influenced by movements in exchange rates. 41. Overall, the operation of the raw milk market has two consequences: (i) The mechanics of the market mean that price initiatives in the liquid or cheese markets cannot endure unless they are underpinned by movements in commodity markets. (ii) There will be times when the returns from commodity markets may not cover the production costs of producers. There is no means of ensuring that commodity markets will operate at a level that will ensure that all producers are rendered profitable.
Role of Intervention 42. The EU only provides a partial floor to commodity markets by intervention purchasing. 43. The European Union acts as buyer of last resort for commodity products through intervention purchasing of skimmed milk powder and butter at fixed prices. This provides a partial floor to the commodity market when prices fall to these levels. 44. The raw milk price equivalent from the sale of butter and SMP to intervention is called the Intervention Milk Price Equivalent (IMPE). Intervention prices are set in euros so the value of intervention is directly aVected by movements in exchange rates. 9595841006 Page Type [E] 29-05-04 00:48:10 Pag Table: COENEW PPSysB Unit: PAG1
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45. Commodity prices can however fall below the intervention level because the support provided is not comprehensive. Intervention is not available all year round and the Commission also has the option of introducing tendering procedures which reduce intervention prices if the volume oVered to intervention during a year exceeds a certain level.
Mechanics of Price Adjustments 46. The process by which price adjustments are actually achieved is long and complex and diVers depending on the product being sold. Whilst this may result in a lag in price transmission ultimately price changes are communicated through the supply chain.
Market Power and Price Transmission 47. The relative market power of the multiple retailers inevitably means that price adjustments are usually quicker downwards than in the opposite direction. The existence of large volumes of milk contracted on a short-term basis by the producer co-ops means that these price adjustments can be communicated relatively quickly.
Milk Production 48. Whilst milk production is reasonably predictable overall, marginal changes in peak or trough production levels can have a major impact on capacity utilisation for commodity products. This can have a significant impact on marginal prices.
Currency 49. Currency fluctuations directly aVect the returns from commodity markets which, because of their tradeability, are extremely sensitive to currency movements. This is demonstrated in the graph below which shows a strong correlation between currency movements and trends in the returns from butter and skimmed milk powder markets.
Index of Currency and Commodity Markets; Jan 94 = 100
130
120
110
100
90
80
70 J J J J J J J J J J 94 95 96 97 98 99 00 01 02 03
MILK PRICE EQUIVALENT OF BUTTER/SMP STERLING/EURO EXCHANGE RATE
Stocks 50. Stock levels also aVect the overall price environment for commodity markets. This is particularly important for the cheese market. During 2003 one of the reasons why the cheese market did not move forward in response to the change in sterling was because of the stock situation in the UK.
Sales from stock 51. Dairies buy milk before they know the return from the market. This is particularly true of milk for cheese which, because of long maturation periods, may be sold in a diVerent market environment from the one that determined the price paid for the milk used to make it. Consequently, in subsequent periods the price a dairy can oVer producers will be aVected by the gains and losses that may have been incurred from the sale of cheese from stock. 9595841006 Page Type [O] 29-05-04 00:48:10 Pag Table: COENEW PPSysB Unit: PAG1
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Frequency of contract re-negotiation 52. Currently, contract re-negotiation between dairies and producers is often focused on the six month periods starting April and October. Whilst some contracts are directly indexed to market returns, many may be fixed for six month intervals. This aVects the speed of price transmission. 53. Cumulatively, the eVect of all these factors is that prices to producers can lag behind movements in the market place both when prices are falling and rising. Consequently producers cannot expect an automatic adjustment in farm-gate prices when there is a change in commodity market price trends. This is one reason why the misperception has grown that recent market price changes have not been fully reflected in producer prices. 54. However in the longer run the market does function to transmit price change through the supply chain and to secure appropriate returns to producers. The graph below shows that there is a clear correlation between producer prices and trends in commodity markets.
INDEX OF MILK PRICES VERSUS COMMODITY MARKETS: ROLLING ANNUAL AVERAGE JAN 1996 = 100
MILK PRICE EQUIVALENT OF COMMODITY MARKETS UK RAW MILK PRICE 110
100
90
80
70
60 J J J J J J J J 96 97 98 99 00 01 02 03
55. This conclusion on price transmission through the supply chain is substantially shared by the report “Prices and Profitability in the British Dairy Chain” which was compiled by KPMG on behalf of the producer funded Milk Development Council. The analysis undertaken on behalf of KPMG by London Economics, found that (page 42 of report): — “in the UK, the retail price and the farm-gate price are more closely connected than in other European countries”. — “the level of price transmission on liquid milk in the UK is relatively high in both directions . . .”
Price Environment 56. The overall price level paid to producers is also aVected by a number of structural factors that are unique to the UK.
Import penetration 57. The UK is surrounded by countries that have a structural surplus of milk compared to the domestic consumption of those countries. They are therefore able to trade in our market at marginal cost. The UK’s lack of self-suYciency in milk production means that product has to be imported into the UK market to meet domestic demand. The role of imports is particularly relevant in to the market for cheddar cheese which is subject to significant import penetration, especially from Ireland.
EVect of the Fresh Product Market 58. The higher share of UK milk production which is used for fresh liquid milk generates higher service costs. This aVects the industry in two ways: (a) Higher transport costs are incurred both for milk collection and chilled distribution. Most European co-ops collect and manufacture on a local basis. 9595841006 Page Type [E] 29-05-04 00:48:10 Pag Table: COENEW PPSysB Unit: PAG1
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(b) The demand profile for liquid milk combined with the seasonality of milk production inevitably results in a low capacity utilisation for butter and milk powder factories. This eVect operates both at the annual and weekly level. The priority of supply given to liquid milk along with its flat demand profile results in an exaggerated supply profile to other product sectors. In addition the processing of liquid milk fluctuates over the week in response to consumer purchasing patterns. This results in weekly peaks and troughs for plant utilisation for commodity products. Overall the reduced plant utilisation and higher costs aVects the returns from commodity markets.
Role of Producer Co-ops 59. The majority of processors are not producer co-ops. Only around 10% of milk is processed by producer co-ops. Consequently the distribution of profits from processing are passed back through dividends to shareholders rather than milk prices as is the case in many other European countries. This distorts price comparisons between the UK and the EU. 60. Collectively these diVerences mean that UK dairy industry is in a unique environment and the problems and challenges that it creates can only be addressed within the actual commercial context of the industry and not through reference to the experience of other EU countries.
Processor Strategies 61. Dairies are pursuing a range of strategies to improve revenue to the industry and minimise the impact of commodity products on milk pricing. 62. Dairies are improving their technical eYciency by investment in new processing facilities and closing old and surplus capacity. This allows them to remove cost from the industry. UK liquid milk processors now operate some of the most modern capacity in the world. 63. Dairies are investing heavily in branded value added products. The creation of brands requires significant and sustained investment. 64. Dairies are seeking to improve their market position by increasing their scale of operation. This is being achieved by a process of mergers and acquisitions which recently culminated in the merger between Arla and Express. 65. These strategies are of immediate commercial benefit to processors. They also benefit producers because: — lower processing costs increases the amount of market revenue that can be passed back to producers; — investment in brands and value added products reduces the impact of commodity markets on raw milk prices as value added products are less exposed to price competition from substitutes. This reduces the impact of downward price adjustments; and — increasing the scale of operation improves the negotiating position of dairies which reduces reduces price volatility. It also provides them with the resources required to invest in new eYcient capacity and in the development of branded value added products.
CAP Reform 66. The reform of the CAP will put producer prices under downward pressure. 67. The EU commodity market is strongly influenced by the CAP market management tools utilised by the European Commission. Under CAP reform the support provided by the EU for dairy products will fall. The stated objective of these cuts is to bring EU domestic market prices into closer alignment with the world market. In particular the price provided by the EU for intervention product is scheduled to be reduced by 22% over four years. This will reduce the floor price available to the dairy industry. This will have an aVect on commodity market prices. Both producers and processors will have to adapt to the lower price environment that will result. 68. It is clear that an increase in size is central to producers maintaining their profitability. As part of the work of the CAP Reform Sub-Group of the Lord Whitty Dairy Industry Supply Forum, research was jointly commissioned by DIAL, Defra and the MDC from Professor Colman on the future of UK dairy farming. 69. The report states that: “The unequivocal conclusion to be drawn is that size is the key to eYciency with herd size increases critical to further costs reductions.” 70. Defra has a key role in assisting producers to achieve this objective, principally through the decision to be taken on the method to distribute direct payments to dairy producers. 9595841007 Page Type [O] 29-05-04 00:48:10 Pag Table: COENEW PPSysB Unit: PAG1
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71. The report by Professor Colman states that; “. . . any attempt to determine the payment on the basis of grassland and standard yields, rather than on the basis of eVective quota held, will penalise the most eYcient dairy farms and damage the future prospects of the industry.” 72. The agreement by both DIAL, FMG and the NFU to a joint statement calling for direct payments to be calculated according to quota shows that the view of Professor Colman is shared by the entire industry.
Fairness of the Raw Milk Market 73. The market for raw milk is functioning fairly. 74. The OFT has examined the dairy industry on several occasions, ie; Arla/Express merger, various complaints against the marketing practices of processors, the new arrangements for Westbury. It has not acted on these issues so it must be assumed that UK competition authorities are satisfied that markets are functioning fairly. 75. UK dairies are not making excess profits at the expense of producers. The KPMG report examined the profitability of UK dairy companies compared to their European counterparts and concluded that: “Overall, the net profit margins of UK processors have not increased over the period since 1997 and are in line with the performance of similar organisations in Europe”. January 2004
Witnesses: Mr Alan Hinton, President, Mr Jim Begg, Director-General, and Mr Peter Dawson, Policy Director, Dairy Industry Association (DIAL), examined.
Q255 Chairman: Can I welcome you to the second Mr Hinton: No, it has all gone back to farmers. session. Some of you are well known to some of us this side, so we will not need too many long Q258 Diana Organ: You are saying hand on heart it introductions. If you would introduce yourself and has all gone back to the farmers and you have had the other two people, that would be helpful, and then none of it? we will get straight into the session. Mr Hinton: Our members have already submitted to Mr Begg: Chairman, my name is Jim Begg. I am the the Committee that all of the monies through the Director-General of DIAL and I am also a member initiatives have gone back to farmers. Of course of the Dairy Supply Chain Forum. This is Alan there is an occurrence where there could be a timing Hinton, who is the Managing Director of ACC Co- lapse between the move and when it went back to operative Group, and on his left is Peter Dawson, farmers, mainly due to the diVerent types of who is DIAL’s Policy Director. contracts or who was selling milk and where it was Chairman: You well know the way in which we sold to. Our members have indicated to the approach this because you have managed to sit Committee that all of these monies have gone back through all the sessions so far and will probably sit to farmers. through the remainder of this. Mr Begg: You will appreciate that DIAL is a central organisation and we do not get involved with the purchase or sale of milk. We cannot say hand on Q256 Diana Organ: You are adamant in your heart that every one of our members did that, we do evidence to us that “UK dairies are not making not have the accounts. excess profits at the expense of producers”. I wonder if you could let me know a little bit about what Q259 Diana Organ: But you do know what is proportion of the recent increases in retail prices of happening along the chain. liquid milk and cheese has actually been passed back Mr Begg: Yes. What we can say is that in the to the farmers. What proportion has been kept by evidence submitted to the Committee on that you? What have you gained? The supermarkets put occasion, all of that was passed back. If you need the price up, I suspect from pressure from the further information and specifics from individual consumer that the poor old producer was really members, where these details apply to individual being ground down by it. I want to know what has members, I am sure they will be happy to make that really happened. Who got what out of the deal and information available to you. did they do well out of it? Mr Hinton: The evidence already given to the Committee by our members, the major dairy Q260 Diana Organ: I think that would be most companies, has indicated quite clearly that all of the useful. When you made that statement there were a monies from the initiatives have gone back to few wry smiles behind you. You could not see them, farmers. but I could. There were some slightly cynical looks. My second question is because maybe there is a feeling that that is not what happened across the Q257 Diana Organ: You mean you have had none board, what do you think can be done to make the of it? dairy supply chain more transparent so that farmers 9595841008 Page Type [E] 29-05-04 00:48:10 Pag Table: COENEW PPSysB Unit: PAG1
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8 March 2004 Mr Alan Hinton, Mr Jim Begg and Mr Peter Dawson and others at the beginning of the chain can readily Mr Begg: We can observe and look at the reports identify the relationship between what the customer which appear in publications and all the rest of it, is paying for milk oV the supermarket shelf or at the just as anybody else outside can see. doorstep and the farmgate price, so we all know who gets what out of the deal? Q264 Mr Jack: You do nothing yourself to see what Mr Begg: We do understand the demand for margins retailers are on. The reason I am asking this transparency but I think what we really need here is is because it is clear that some dairy farmers are dialogue and a bit more trust building up in the getting more of the price increases back to them, for supply chain. It is true that there are not published example, the lucky few, the chosen few, who supply margins or profit statements or anything like that, I directly to the processors and others are less do not think you would expect to get these in a free fortunate in terms of the food chain. Unless you can market, but what you have been hearing about is the have some idea of the relative shares that are taken new relationship between farmers and processors; by the diVerent players then it is diYcult to establish where the dairy companies engage the farmers in whether, in fact, each is taking an appropriate, terms of explanation as to why price movements are adequate, fair, whatever word you choose, part of taking place; where market information is shared; the price of the dairy product. I am just trying to find where farmers and producers have the opportunities out from your point of view what you know about to explain their needs and their requirements. What this. we have got here is a dialogue building up and much Mr Begg: I think the main point really, and what more information about what is going on in the people need to understand about the milk market, is marketplace. I do not believe you are going to get the that it does operate fairly. By “fairly” I mean it publication of margins, it is just not something that operates in a way where the price would be generated happens in a free market for commercial in the way that you would expect from a normally confidentiality reasons, but you have got rising functioning market. It is very diYcult to define what dialogue and much, much more information fair is but that is how we would see it. From time to generally being made available to milk producers time there are various people who analyse this trend; about what is going on in markets. The work of the is it fair? KPMG, for example, analysed that and Milk Development Council, for example, has been came to the conclusion that the UK market was a superb in communicating market movements to fair market, that there was reasonable price farmers, milk producers, and this all helps to build transmission, that no-one was making any excess trust and dialogue which will see us going forward profits, that the processors’ profits over a period of positively in the future. time had not increased, for example. By any reasonable basis of independent analysis they have Q261 Mr Jack: Can we just follow on from that. come to the conclusion that the market is fair. In the You monitor what the price of milk is going into the case of the individual farmer, the price that the system and you also must monitor what people are individual farmer receives in response to any selling product at. Is the question of the retail margin movement in the market will, of course, vary a uniform number across the major supermarkets or because it is a complicated market, it operates to does it vary from your analysis? very basic principles, but obviously the price that an Mr Begg: You will understand that we do not individual farmer gets will depend on who he sells his routinely monitor that kind of thing. As I say, we are milk to, the particular markets that they are in, the not engaged directly in buying and selling milk. In degree of speed of transmission of that market, so no terms of the retail situation, retailers are operating in two farmers are ever going to be in the same the same free market that everybody else is and you situation unless they are supplying a Co-op. That is cannot really criticise them for operating in what how the market works. It is a complicated market they see as their direct interests. but it works fairly, and that is the crucial thing.
Q262 Mr Jack: You are involved in the Supply Q265 Mr Jack: I hear what you say but it is quite Chain Forum and people who supply retailers by clear that some dairy producers who are the chosen and large like to know what they are doing. I cannot ones, who can supply direct to processors, are believe that you do not collectively keep some record getting a better share of price increases than others. of what retail margins are, even on the lowest to the Trading with Co-ops does not exactly seem like the highest, a range. best bet. What is that going to do to the structure in Mr Begg: We are constrained to a certain degree by the milk supply industry? competition rules and restrictions. In a fully Mr Hinton: In theory, Chairman, it is the choice of deregulated market the relationship between a the farmer who he supplies to. A number of farmers supplier and the supermarket is a confidential choose to supply Co-ops because of the advantages matter. It is a matter for these companies of being a part-owner of the end product. In theory, individually. as the Co-operatives move into the food chain direct or directly involved in products, although their prices at the beginning of the cycle may well be Q263 Mr Jack: So as an association you are saying lower, at the end it should come back to the same that you have not got a clue what the retail margins sort of price on average. There are some advantages are on either liquid milk or dairy products, you have to being in Co-ops. There are more people directly not got an ounce of an idea. supplying dairy companies than supplying Co-ops. 9595841008 Page Type [O] 29-05-04 00:48:10 Pag Table: COENEW PPSysB Unit: PAG1
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It is the choice of the farmer to a greater or lesser relationships and understanding—understanding— extent. As I say, as they diversify into the food chain about why a price moves when the market moves, or direct their margins or extra profits should come why it does not. We have been very much part of back a diVerent way, ie the selling of the products that process. direct to the consumer. Q269 Mr Wiggin: You go to all this trouble to Q266 Mr Jack: Just to return to the previous line of describe how a price moves, how a market grows, enquiry, just to be absolutely clear: you do not how you build up trust, and yet you have no clue monitor at all retail margins on any dairy product? what the actual retail margin is. Mr Hinton: We would not know that. We can pick Mr Begg: We do not. We do not routinely gather up a price structure from a retailing store and we can retail margins because that information is read what is published of the farmers’ prices, but it confidential to the business between our members is not our remit at all to investigate, and nor would and their customers. we want to get involved with our members’ direct business activities with the retailers, be it a hospital, Q270 Mr Wiggin: Do you not think that is what school or a multiple. That is not our remit at all. We people want to know? know the price at one end because we read it in the Mr Hinton: In all fairness, Chairman, our members press and we know the price at the other end, but in- know what their margins are. Bear in mind we are an between it is not our role as an association to work association of many diVerent types and our job is not out margins. to work out what their margins are, it is up to them to buy raw milk at whatever price and to make their Q267 Mr Jack: So you are quite happy, therefore, contracts or their agreements with their end without knowledge of the relative shares being taken customers. That is what their role is and our role is in the end pricing of dairy products to say that the to advise on greater things than the margins they market operates fairly? might make. Mr Begg: We have no formal role in price negotiation. We are prevented from having a formal Q271 Chairman: We are going to look at CAP now. role in price negotiation, which is why I have tried to Obviously one of the predictions in terms of the CAP explain to you that what we must do is have recourse is because of the surplus that remains in tact in this to defer to independent analysis of this situation. industry that the price to be paid to the producer The independent analysis leads us to submit to you could fall dramatically to as low as 14p. What is your that we are operating in essentially a fair market. We prediction and what would be the implications if are operating in a fair market in the UK. That does that was the case? not mean that the market will always cover Mr Dawson: As part of the Dairy Supply Chain everyone’s expectations, or even to some degree that Forum we commissioned research work through it will cover everyone’s costs, but what is important Professor Colman to look into this area as to what is that there is price transmission and there is a impact the price reductions under CAP reform may reasonable balance of power down the chain. have. He reviewed his previous work and came to a forecast that, say, on an ongoing price of about 16 Q268 Mr Wiggin: As the trade association for dairy pence a litre you might see a significant reduction in productions, what action have you taken since 2000 producer numbers to around about 16,000 by the to try to address what our predecessor, the MAFF year 2010. There would be a significant impact on Select Committee, described as “institutionalised producer numbers but the study also indicated that antagonism between the suppliers and the dairies”? by and large milk production would probably Mr Begg: It has been a diYcult situation over the remain at or around quota. It is quite conceivable years. I think that has got a lot to do with the history that, depending on the magnitude of the price cut and the separation of the farming and processing under CAP reform, the current scale of the industry sides. History is very diYcult to shake oV, even would remain unchanged. Alternatively, if the prices nowadays. We have been working very hard to try as they transpired after the CAP reform were less to build up trust in the industry. We have a very close than that then, yes, there may be a production and extensive dialogue on a range of policy issues impact. with the farming organisations. We involve them in working groups on operational issues, for example, Q272 Mr Breed: I think the one thing that everyone trying to find ways of taking costs out of the system. is agreed on is that CAP reform will put pressure on Their staV come to our meetings at DIAL. The producer prices. I suppose the only diVerence is the whole objective is to try to build up trust in the estimate of what that impact, that downward industry. I think it is working because we do find that pressure, is going to be. We have learned from other other organisations in the supply chain, the farming people giving evidence, saying very similar things to organisations, are very keen to do the same. We are you, that we may well see the numbers of actual keen to put the history behind us and I do genuinely dairy farmers decline but, in fact, production will think it is working. I think the dialogue between the probably be relatively stable at quota. The obvious dairy companies and the producers at farm level, corollary, therefore, is that we are going to see bigger and indeed the increased situation that we have here farms, larger herd sizes, greater eYciency and such now of joint ventures between dairy companies and like. Do you think we will actually get to a situation farming organisations, all helps to develop with the way the Single Payment is going to be made 9595841008 Page Type [E] 29-05-04 00:48:10 Pag Table: COENEW PPSysB Unit: PAG1
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8 March 2004 Mr Alan Hinton, Mr Jim Begg and Mr Peter Dawson available that some people, maybe quite a lot of Q273 Mr Breed: In your written evidence to us you people, will actually say “I am going to get out of quote from the Colman-Harvey report that “The milk” and we are going to see quite an exodus and unequivocal conclusion to be drawn is that size is the that exodus may take everybody by surprise and we key to the eYciency and herd size increase is critical may get down to a situation where we may see only to further cost reductions”. I think we would all liquid milk sales here and almost everything else is agree with that. Then you go on to say, interestingly, going to be imported? Do you think it is going to be that “Defra has a key role in assisting producers to much more gradual, along the lines of David achieve this objective”. Colman and David Harvey’s report? They go into Mr Begg: Yes. 2015–16. As we cannot even see what is going to happen the year after next, to be talking about Q274 Mr Breed: In the light of the decision over the 2015–16 I think is just total pie in the sky. Single Farm Payment you may feel—or may not— Mr Begg: As far as the Single Farm Payment is that Defra is basically saying “that is it” and, concerned, we did not favour the decision by Defra therefore, the market will determine the attrition. to go down that route. We were very strong in our What I think you are suggesting is that Defra ought view that we should go the other way. One of the to intervene in order to assist that process to happen reasons why we wanted that was because it would in a more planned way. If that is the case, how do give farmers more opportunity to face what you suggest they could do that? potentially could be. We have not forecast the price Mr Begg: What we meant by that was that they at 15, it depends on so many things, but certainly we should go down the historic route for quota for were pretty clear that there was going to be pressure determining the Single Farm Payment. and farmers in the short to medium term would need every assistance with restructuring their businesses. Q275 Mr Breed: Yet now they have not. We were very keen on the idea of an historic route, Mr Begg: They have not. We have to get on with it. as was virtually everybody else in the industry. In We remain in dialogue with Defra. As I say, the terms of what is going to happen, this is clearly what package is not complete, there are a number of other the industry has got to discuss in terms of finding a aspects which still have to be determined, and there strategy to go forward. It is still a little early to get a are a number of other policy initiatives which Defra definitive understanding. You have heard very many are looking at at the moment as we go forward, the people tell you that pretty much farmers understand whole business of cross-compliance and what what is happening here and they understand the farmers will be required to do there. All we are implications of this. I would not necessarily concur saying is that when they take these policy decisions, with that. I think that they have been told lots of as a priority they have to have in mind the continued times but they need to be kept on being told what the economic viability of farming in the country, that is implications of this are. We are certainly trying to do a very, very important factor. One of the negative that and the farming organisations, the MDC and things about the decision of Defra in England to go NFU, are doing that as well. There is still a lot to be down the area route and the other devolved regions decided and the final package, so to speak, is not going down a diVerent route was the signal to say really there. The time has not been there for analysis. that the other devolved routes felt, “here is a In terms of where we will end up, in the sense of are government that has listened to its industry, who has we going to be down to the liquid milk market, I do said ‘we value the importance of food production in not think by any stretch of the imagination that we the countryside and we have come behind you and are going to get down to that level where milk gone down the route of the historic payment’ ”, production falls to the level where it only services whereas Defra missed that opportunity. Here was liquid milk. On the other hand, in terms of our future the perfect opportunity to say, “We support you as raw commodities, I think it is very much the focus of an industry in future, we support farmers in the the industry and the processing industry to move out countryside” and I think it was missed. There was a of commodity markets to the full extent that they psychological message there. As they go through the policy that they will adopt on cross-compliance and can. We have been criticised for many years for all the other decisions on sustainability and having an over-dependence on commodity markets environmental objectives, they have to have an eye and we must move out of that area and into added to economic sustainability as well as the other value and branded markets as quickly as we can. aspects. There is strong evidence which is coming across now from the activities of the dairy companies and the dairy processors, assisted by the farming Q276 Mr Breed: In a way what you are saying is— organisations and the MDC in particular, that we Mr Begg: We are not asking for intervention. are now doing that fairly successfully. We have seen the launch recently of a lot of brands and a lot of new Q277 Mr Breed: On the one hand you are saying it products. I have a list of innovations and marketing is inevitable we are going to get bigger farms and initiatives which have taken place in the last year bigger herds and everything else, and on the other that demonstrate this point. It is not a question of hand you are saying you want to try to protect the being forced out of commodity markets, it is a rural farming community which, particularly in specific policy and strategic objective of the dairy many parts of England, is based upon much smaller processing sector. units. 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Mr Begg: I do not think it is necessarily arguing both opportunities for smaller players, indeed farmers ways. What we are trying to say is that the CAP possibly, to come in on a localised basis with reform has a major impact, it would appear to be regional products and brands and start up. I think going to have a major impact, and that Defra, in the we are going to get to a point where there are going implementation of their policy as far as they can, to be only four or five large brands that will probably should support the economic viability of farming in come from the continent but that in itself will create the countryside. That is all we are saying really. If opportunity, an opportunity we need to grasp and that does lead us down an inconsistent route then we encourage in the industry, be it small processors, as will resolve that. I do not think we are at that point DIAL represents small members as well, or farmers at the moment but if there are dilemmas then we will who may well see this as an opportunity to move out answer those dilemmas. of the mass, if I can use that term, 650 cows or Mr Hinton: One thing I wish to add to that is that it whatever, and into an area or product which could is essential that all the farming communities be sold locally very successfully. understand how the CAP is going to change their way of life. Although the bodies of the NFU and other bodies will be doing their very best, I do not Q281 Mr Jack: Just give me some examples because think we can leave Defra out of the circle. They have on a national scale the question I asked in terms of decided to go this way and it is critical that farmers dairy products was what are our continental understand how it is going to aVect them and the competitors doing that we are not and you have just way it is going to aVect them so that we do not have put the proposal forward that there may be a mass exit and if farmers choose over a period of opportunities for a farmer, or a group of farmers time to leave the industry, it is organised over a locally, to do something distinctive. Just flesh that period of time. I am not quite sure that it is going to out a bit more. Clearly if there is more value to be be as far as over ten years. There is a responsibility, added in the types of products to which the question as my colleague said. Defra asked for our opinions refers then the ownership of the added value part of and we all gave them unanimously but they chose it is very important. If it is a big branded not to go that way so, therefore, there is a certain manufacturer then there is not the same amount of responsibility on them to ensure that the responsibility, if they are adding the value, to pass it communications to farmers and, indeed, the rest of back necessarily to the farmer, but if the farmer is the industry are very professionally looked at. doing it then has got control of the value chain up until the point of sale. Just help us to understand a Q278 Mr Breed: It is just my personal opinion that little bit more how these two scenarios work? so many of the smaller farmers are so tight up Mr Hinton: One of our colleagues who, against their bank facilities that, quite frankly, many unfortunately, got called away today is an ideal of the decisions have been taken out of their hands representative for that, a representative from and in that case we will see a massive exodus. It may Mu¨ller, which is now a British organisation which not be necessarily what the farmers want. spent a huge amount of money in building a very Mr Hinton: Nor the industry. successful brand. As he was very keen to point out, that is a British organisation. It may have roots Q279 Mr Breed: The economic reality will hit them elsewhere but the success depends totally on having and a decision will be taken by others, namely their the product and if you want to have that sort of bank managers. That is the fear that many of us brand the monies need to be spent. I am thinking have now. now of dairy deserts rather than cheeses and things Mr Begg: We agree with that. In terms of our like that and if you pick out the major ones it is a very dialogue with Defra, with their support we are high capital spend on branding initiatives and continuing to get further analysis of this done. We building a brand. I think that is our problem in this are going to commission another study which will country, we started very late in building brands due, try and throw more light on the full implications for unfortunately, to the Milk Marketing Scheme which the countryside of what Defra have now decided to stifled the growth of brands because there was a— do. There is going to be more of that coming forward in the next few months. Q282 Mr Jack: Just to be specific; am I right in Q280 Mr Jack: Just to go back to the point you were saying that the problem is not so much the catalogue talking about in relation to innovation. The but the ownership of the value added chain? In other perceived wisdom is that continental dairy words, you are saying that it is continental producers are better at value added products than companies like Mu¨ller who eVectively are producers in the United Kingdom. Is that correct? If repatriating money back to their centre and it is not it is correct, what are we not doing that we should necessarily available for UK-owned and UK-based be? companies. I am still trying to get to the bottom of Mr Hinton: There is a very good point that should be this because all of the evidence we have had says that made that we are ending up virtually with four major continental dairy producers are much better at brands in this country and the majority of them are innovative, novel products, making more money not British based. Having said that, from these big because they are adding more value and the poor old brands will grow opportunities. Once you have Brits are late to the game not having any access to created these big mass brands there will be this value chain. 9595841008 Page Type [E] 29-05-04 00:48:10 Pag Table: COENEW PPSysB Unit: PAG1
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Mr Begg: You put it in very stark terms. As Mr “We are in with something here; this is worth Hinton has said, we have a little bit of history there hanging in there”? There must be something we can in terms of our approach to the Milk Marketing do with milk. Scheme which we have spent some considerable time Mr Hinton: Certainly if there was a product out trying to move on from. The crucial thing now is that there that was ground breaking I would not tell we get as much of our product and as much milk as anybody else, I would be doing it myself. One of the possible utilised in the added value sector. Who gets things Jim touched on was we have a very basic the benefit of that is what I think you are asking. product called milk, which we do fantastic things about and we, as an organisation, start with the cow Q283 Mr Jack: No. Let us be very specific. I am and go right through to cheddar cheese and sorry to labour the point. I go back to the evidence everything in between. One of the things we have not we have received. The evidence is that continental been able to do is to brand things very well. If you companies are doing better in this field, so in other take cheddar cheese, there is about 300,000 tonnes a words they are extracting more value out of the milk year and only about 50,000 tonnes of that is they are processing. Brits are not in the game, branded, the rest is sold as “me too”. That is a great therefore we do not seem to have access to that better step forward if we can move away from the value chain that our continental counterparts do. commodity, even on the cheese, because as a Mu¨ller is a German company and they have put a commodity, and the Committee mentioned it earlier fantastic amount of money into their Shropshire on, we are inviting imports into the country to fulfil plant but, if you like, that is going back to the centre, a commodity product. Brands on old products are to Mu¨ller HQ, and not somewhere in Brit dairyland. important and the initiatives on new products are Mr Begg: Mu¨ller in the UK is a British dairy very important. I look at the two or three brands company using British milk and employing British coming out in cheese this year already and it is very people to produce British products but there are important to move away from the commodity side. many other examples in the industry where our New developments are not easy even on liquid milk. members are doing the same. There is new, you One of our members has just launched a diVerent might call it Johnny-come-lately stuV, a new focus, a type of milk to take a diVerent edge and spin on these real interest and a real desire to develop added value things. There is an awful lot of initiative out there products, branded products, in our marketplace as but as a nation we are quite conservative when it the way to the future. It is not a new thing in the comes to dairy products. I have seen some terrific sense that it has happened today, it has been products which have failed because the British happening for a couple of years now and we are consumer does not quite understand them at this moving forward positively in that sense. Ultimately, minute in time but they will keep coming back until and indeed currently, that will deliver better returns we have a mature market and that is exciting. There for milk producers and that must be the right way. is a lot of work going on in relation to branding and new products. People feel that is the real way of Q284 Chairman: Just to finish with that, give us a putting value back into the industry. notion of what sort of products we are talking Chairman: Gentlemen, thank you very much for about? I can understand about Mu¨ller and their giving evidence. Certainly as Mr Begg has heard me yoghurts, I can understand about Dairy Crest and say before, what is said cannot be unsaid but if there FRijj, but what is out there that nobody else has is additional material that you wish to give us to thought of? This is really putting you on the spot but supplement your evidence then feel free to do that. what is the sort of thing where Mr Farmer can think Thank you.
Memorandum submitted by the Milk Development Council (L9) 1. Executive Summary 1.1 The market for raw milk is a complex one due to the number of products produced from it. However, in general the market does operate in an economically rationale manner and the majority of prices rises have been passed back to farmers. The reasonably successful operation of the market does not detract from the large amount of distress among dairy farmers as market changes cause substantial restructuring among farmers through lower farmgate milk prices. The fact that farmer direct action seems to be needed in order to ensure that prices follow the market upwards as quickly as they do downwards suggests that the situation is unsustainable and many believe that farmers need to increase their representation and power within the supply chain. There are several ways that Government could assist the restructuring process that is currently taking place.
2. Dairy Market Operation 2.1 The first issue which needs to be examined is what has actually happened in the dairy market over the past year and how much of the changes at retail and wholesale level have been passed back to dairy farmers. The following tables lay out the most important changes over the 12 months in a comparison between October 2002 and October 2003. 9595841009 Page Type [O] 29-05-04 00:48:10 Pag Table: COENEW PPSysB Unit: PAG1
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£/T or ppl October 02 October 03 Equivalent Change
Multiple Retailer/ 46.3 48.5 !2.2 Middle Ground Milk Price Doorstep Milk Price 75.1 76.8 !1.7 Wholesale Cream 900 1030 !0.6 (from Liquid Milk) Mild Cheddar— 1,800 2,100 !3.0 Wholesale Mature cheddar— 2,100 2,100 0 Wholesale Butter/Powder(IMPE)1 17.0 19.2 !2.2PPL Weighted Average !2.3PPL Increase2 Actual Farmgate Price3 18.13 19.59 !1.46PPL
Due to the nature of this sort of data, these figures are representative but it must be recognised that there is a potential for a small margin of error in the weighted average increase, probably of the order of !/- 0.3ppl. 1 IMPE % Intervention milk price equivalent— he price a processor of commodity products for intervention can aVord to pay for milk 2 The weighted average increase is calculated by weighting the potential increase in the milk price for a particular product by the national utilisation of milk for the diVerent products to calculate what the potential overall increase in the milk price could have been. 3 The actual farmgate milk price is collected by Defra, and calculated on the basis of returns from all purchasers of milk each month. 2.2 If we examine the price changes over the past 12 months then we can see that indeed farmgate price rises have risen in response to retail and wholesale price rises, although probably not as much as they could have done. It is important to note that there is likely to be some lag in farmgate prices and indeed we know that farmgate prices in November increased again, suggesting that the average increase in the farmgate price will be closer to 1.7ppl. 2.3 Therefore it appears that the diVerential between what in theory could have been returned and what has been returned is in the order of 0.6ppl. These fractions of a ppl are very important as they make the diVerence between a good or bad profit margin for a company or farm business, but the diVerentials are not of the magnitude that some believe they are. 2.4 Not seeing a full pass back of retail price rises to suppliers does not necessarily indicate that there is any problem with the market. Many factors determine the retail price, not just the cost of the raw material. Issues such as competitors and profit margin expectations also play an important part, as they would in any market. 2.5 All of the above comments should not detract from two significant points. Firstly, the price rises that have occurred have been partly forced through by direct action from farmers—suggesting that market may not work eYciently. Secondly, the operation of the market does not detract from the large amount of distress among dairy farmers as the market forces restructuring on the dairy farming industry through lower prices. In light of this it is important to understand the history of the market place and how prices are set in order to understand the challenges currently being faced by dairy farmers.
3. Market History 3.1 Over the past ten years there has been a sequence of events which has led to increasing pressure on dairy farmers. These are: the abolition of the Milk Marketing Boards, which led to the end of end use pricing, adverse exchange rate movements in the late nineties, and CAP reform. 3.2 End use pricing helped to create artificial diVerentiation and significant premiums for raw milk for high value uses as compared to commodity products. The end of the milk marketing boards meant that raw milk, whatever its use, was the same product and therefore a commodity. 3.3 Economic theory tells us that the price of any commodity, with several uses, will always be set by the lowest value use, unless the use to which the commodity is put is legally constrained (as with end- use pricing). Of course prices can be higher than this base, if certain uses require higher service levels incurring additional costs over servicing the lowest value use (ie precise supply patterns for liquid milk usage, etc.), and a small premium (although significantly smaller than under end use pricing) to ensure that milk is allocated to higher value uses before lower value uses. 3.4 The removal of end use pricing obviously weakened the position of UK farmers, and made the price of raw milk dependent on its lowest value use—commodity products. 9595841009 Page Type [E] 29-05-04 00:48:10 Pag Table: COENEW PPSysB Unit: PAG1
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3.5 Obviously, the UK and EU market for commodities must always be looked at in the context of the world market situation, where commodity dairy products are traded across the world, and prices set by world supply and demand. There are varying degrees of protection and support for the dairy sector across the world leading to influences on world supply and demand, and hence world prices. In many years, there is a world surplus of milk and dairy products which can be manufactured in several regions of the world at low cost, and transported around the world in competition with locally produced product. 3.6 The price of commodity products is dependent on several factors including supply and demand for those products. Competitor costs of production have a significant impact on world dairy commodity prices, which are significantly lower than the prices for commodities within the EU. The price for commodity dairy products on the EU market are protected by the various CAP market support mechanisms such as intervention buying, Private Storage Aid, export refunds, import tariVs, and subsidised usage of dairy products. The fixed intervention price puts a base in the market as, if the price for commodity products falls to the intervention price level, then the EU will buy in product in order to stabilise the market at that price. These mechanisms insulate the EU from the world market.
3.7 In practice, the market price for commodities within the EU is usually around the intervention price (although this may change as a result of CAP reform), and as this is set in Euros, the sterling/euro exchange rate is very important in setting the commodity base price in the UK. The strengthening of sterling during the mid to late nineties has had a significantly adverse eVect on the intervention price in sterling terms and hence the farmgate price.
3.8 The graph below shows the relationship between supermarket retail liquid milk prices, farmgate raw milk prices, and IMPE/AMPE (a theoretical price of what can be paid for milk by processors of commodity products based on the value of either intervention product prices (IMPE) or actual product market prices (AMPE)—whichever is higher).
3.9 The graph indicates that the farmgate price follows the commodity base price, while the retail price is aVected by several factors other than raw milk costs such as inter multiple retailer competition which led to liquid milk retail prices falling whilst raw material costs increased in the early nineties.
3.10 In addition to retail and wholesale price levels, there are many other factors that play a part in setting milk prices such as supply and demand for raw milk on both a short and long term, leading to seasonal fluctuations in prices, as supply fluctuates on a seasonal basis. Farmer pressure through direct action has helped to move prices higher, particularly when the market fundamentals have suggested that there should be a price rise, but it has not been forthcoming from processors. Whether this is a sustainable way in which to operate a market is questionable?
Farmgate v Average Annual Supermarket Price
55 40
50 35
45 30
40 25 Retail Price ppl
35 20 Farmgate Price ppl
30 15
25 10 Oct-01 Oct-90 Oct-91 Oct-92 Oct-93 Oct-94 Oct-95 Oct-96 Oct-97 Oct-98 Oct-99 Oct-00 Oct-02 Oct-03 Oct-89 Apr-01 Apr-02 Apr-03 Apr-95 Apr-89 Apr-90 Apr-91 Apr-92 Apr-93 Apr-94 Apr-96 Apr-97 Apr-98 Apr-99 Apr-00
Retail Price DEFRA Farmgate Price ppl IMPE/AMPE ppl Poly. (Retail Price) Poly. (DEFRA Farmgate Price ppl ) 9595841009 Page Type [O] 29-05-04 00:48:10 Pag Table: COENEW PPSysB Unit: PAG1
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4. CAP Reform 4.1 The recently agreed CAP reform will have a significant impact on the UK dairy market and will probably make things more diYcult for UK dairy farmers over the next few years. 4.2 CAP reform will reduce the support for the commodity products through the cutting of intervention prices over the next four years by around the equivalent of 4ppl in total (assuming no exchange rate changes). This means that the current lowest value use for milk will fall by around 4ppl, potentially bringing all milk prices down by around 4ppl, to around 15ppl. 4.3 This reduction in support will be compensated for by a decoupled annual payment of around 2.6ppl (gross before deductions of 10–30%). The fact that the payment is decoupled suggests that farmers should base milk production decisions on the milk price alone. However, some commentators expect many farmers to include the decoupled payment in their decision whether or not to produce milk, due to a lack of alternatives or lifestyle choices. 4.4 Obviously, with many in the dairy farmer sector suggesting that current price levels are unsustainable, a further 4ppl drop (around 21% drop on current milk prices) would make the position of dairy farmers even more diYcult. A critical issue is what happens to both milk supply in the UK and to EU and world prices for commodities. 4.5 If the UK milk supply falls due to farmers leaving the industry by such a degree that commodities are no longer produced (25–30% reduction in milk supply) then the lowest value use would probably be liquid milk production, and processors would pay higher prices in order to secure suYcient supplies to service consumer needs. Under this scenario, the UK would import dairy commodities from other countries. At present the smallest 50% of dairy farmers account for 25% of milk production. 4.6 Work that has been commissioned by Defra, DIAL, MDC, and NFU from Professor Colman, University of Manchester, suggests that only under worse case scenarios will UK milk supply fall significantly below current production levels (which are of course restricted to a maximum by quotas). This study and other work carried out by Exeter University suggests that milk prices will have to fall below 15ppl before milk production will drop below current production levels. The new intervention prices will see prices fall to around that level, but of course dairy farmers will be receiving the decoupled payment on top of the milk price. 4.7 An alternative scenario is that as EU production falls and the EU exports less dairy products, the EU/ world commodity supply could fall by enough that commodity market prices rise above the new intervention prices on a consistent and long term basis. Most evidence and academic reports suggest that although it is likely that world commodity prices will rise, to around the new intervention prices levels on average, they are unlikely to go any higher (apart from on cyclical peaks from time to time). 4.8 All of this suggests that the milk supplied for use for commodity products will experience the majority of the 4ppl drop.
5. Industry Change
5.1 All of these points suggests that a large amount of restructuring is going to take place both at farm and processor level over the next few years as these price cuts take eVect. 5.2 These price pressures will be a significant problem and threat to individual dairy farmers, and may lead to continued militant action. It is likely that the market will eventually restructure and become sustainable, but there may be a significant period of diYculty before this point is reached. One of the MDC’s core aims is to enable farmers to cope with the change as eVectively as possible. As part of that process, the issues involved were analysed in the MDC report “Prices and Profitability in the British dairy chain” produced by KPMG and published in March 2003, the conclusion of which was that there were no excess profits in the dairy chain, although dairy farmers were not making any profit at all.
6. Moving the Industry Forward
6.1 According to the Prices and Profitability in the British dairy chain report there are four fundamental problems with the market: — Supermarket Power — Low Value in the Chain —IneYciency in the Processing and Farming Sector — Restrictions in the regulatory and business environment 9595841010 Page Type [E] 29-05-04 00:48:10 Pag Table: COENEW PPSysB Unit: PAG1
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Supermarket Power 6.2 According to KPMG, the increasingly large percentage of dairy products sold through multiple retailers means that the power of the retailers has increased, leading to a smaller proportion of the retail price being passed back to dairy farmers. In addition, the increase in retail power may have the eVect of increasing the speed of farmgate prices following the market down, but slow the process of farmgate prices following the market up. Nearly all the Farmers For Action stimulated retail price initiatives have been retail prices following the commodity market upwards. However, pressure from FFA has been required to move the price upwards, suggesting that without this form of direct action, the market is slower to react to upward pressure than downward pressure due to the distribution of power along the supply chain. 6.3 The report suggests that there are several ways of tackling this increase in power. Firstly there must be greater communication and co-operation throughout the chain, while at the same time industry restructuring and vertical integration must take place in order for farmers to play a greater part in the supply chain. This communication issue is partly being tackled through the Supply Chain Forum, currently chaired by Lord Whitty which is providing some useful ways forward for the industry. 6.4 KPMG did look at the benefits of a regulator for the industry but decided that it would probably not work eVectively, although an improvement in the eVectiveness of the OFT Supermarket Code of Conduct would be beneficial.
Lack of Value 6.5 The second theme that KPMG identified was the lack of value created by the UK industry. A dependence on commodity type products, a lack of innovation, and a lack of marketing activity have all created a market in which the uses to which a litre of UK milk are put generate a significantly lower return at retail/wholesale level than a litre of milk in other European countries. This is particularly apparent if you look at the example of Italy, where a large proportion of their milk goes into high added value cheeses, with no commodity production (commodities and some raw milk is imported). This means that Italian farmers have significantly better milk prices than in the UK. 6.6 KPMG recommended that much more production innovation and marketing was needed in the UK to help boost sales volumes of dairy products. In addition, a low amount of product branding makes it more diYcult for processors to negotiate a greater percentage of the retail price from retailers. The MDC is currently working with the rest of the industry to stimulate market development through a variety of projects, and on behalf of the supply chain forum has established an industry wide group to tackle the problem.
IneYciency 6.7 One of the main problems identified by the KPMG report is that the industry at both processing and milk producing levels is not as eYcient as it could be. KPMG believed that although the liquid milk sector was probably eYcient, other processing sectors were not as eYcient as some of our competitors in the rest of the EU or world. KPMG believe that these eYciencies need to be improved in order to provide the maximum possible milk price to farmers. 6.8 In addition, KPMG believe that there is a significant problem at farm level, with the gap in production eYciency between the best and worse dairy farmers being too great. This is borne out by the latest work conducted by Professor David Colman of Manchester University commissioned by DEFRA and due to be published in the New Year. This suggests that part of the problem in the dairy sector is as much about ineYciencies within the sector as much as about unsustainable price levels. The MDC is focusing much of its eVorts on assisting dairy farms to improve their eYciency through a variety of programmes , initiatives and research, and has established with the Welsh Development Agency and Scottish Executive a national benchmarking system for dairy farmers.
Business Environment 6.9 The final area that KPMG identified as a problem was the business and regulatory environment which can be broken down in to three main areas: CAP and quotas, competition law implementation, and currency. 6.10 KPMG believe that quotas have restricted and increased the cost of restructuring of the industry over recent years. KPMG believes that if support for dairy farmers is reduced (which it has been since the report was written), then the quota constraints should be liberalised as well in order to minimise the costs for the industry to restructure. CAP reform has not significantly done this, despite the significant reduction in support. 6.11 KPMG fears that although the EU and UK have aligned competition law, there are some concerns that it is not implemented in quite the same way. The report suggests that a large amount of restructuring needs to take place in the dairy industry, and that although any restructuring will need to be done in consultation with the competition authorities, it seems important that any such moves are treated sympathetically and consistently within an EU context by competition authorities wherever possible. 9595841010 Page Type [O] 29-05-04 00:48:10 Pag Table: COENEW PPSysB Unit: PAG1
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6.12 In addition, the volatility of the euro/sterling exchange rate has caused a significant diYculty to dairy farmers over the past few years, and although the decision will obviously not be made on the basis of the eVect on the dairy sector, entry into the euro could give a greater deal of security and reduce the volatility in prices that farmer face.
7. Conclusion 7.1 Partly due to direct action from farmers, the dairy market is largely operating in a manner in which an eVective market would be expected to operate. However, the fact that direct action is needed tells us that power along the supply chain is uneven. There are fundamental changes in the EU market support taking place that are going to lead to large scale restructuring of the industry and these will create a great deal of diYculties for dairy farmers over the next few years. There are ways of improving the position of dairy farmers within the supply chain, which should lead to the end of a need for direct action, and lead to the market operating eYciently with dairy farmers gaining back more of the fractions of a penny that are currently being denied them by the market. Although these activities such as restructuring and vertical integration are needed and beneficial to dairy farmers, they will not reverse the fundamental reduction in market support that is going to occur. The Government could help to assist the process of farmers gaining a greater stake in the supply chain through supporting and facilitating the recommendations that have been put forward by the “Prices and Profitability in the British Dairy Chain” report. January 2004
Witnesses: Mr Brian Peacock, Chairman, Mr Kevin Bellamy, Chief Executive, and Mr Ken Boyns, Market Analyst, Milk Development Council, examined.
Q285 Chairman: I think it would be useful if you that there is transmission across the chain but could introduce your team and we will get straight because of that change in balance of power when it into the evidence giving session. is in favour of the supermarkets the transmission is Mr Peacock: Thank you, Chairman. I am Brian very slow and has been encouraged by direct action Peacock, Chairman of the Milk Development and the fact that, as we have heard, supermarkets are Council. On my immediate left is Kevin Bellamy, the sensitive to the actions of people like Farmers for Chief Executive of the MDC, and Ken Boyns, the Action yet when it is in the other direction and in senior economist. favour of the supermarkets it tends to be very quick Chairman: Okay. It is likely we are going to be and that is a reflection of the supply chain power. I interrupted by a vote, that is the bad news. The good think the second issue leads on from that and it is a news is that we will come back and whatever time we lack of vertical integration. I think we are seeing now lose we will make up but we are obviously trying to get organisations, such as the larger Co-operatives, through to the Minister so we do not keep him waiting beginning to move into a vertically integrated for too long. Michael, would you like to start oV? strategy but clearly we need to be careful in doing so that we are not adding to the competition in the Q286 Mr Jack: I think during the inquiry we got the market place and simply putting further downward impression that the only way that the price of milk pressure on price. Now while those are important in recent times has moved is because farmers became issues, I think we have to be careful that we do not vociferous, demonstrated, barricaded supply chains over-estimate the eVect that they might have because and all the rest of it. Can you just give us your take we estimate that those are fractions of a penny which on that because somehow you do draw the we are talking about rather than two or three pence. conclusion that it was farmers’ action that caused Clearly we have to look deeper than just the current the price to change and, therefore, somehow the issues on price, the two other issues which we would market place for milk is not working as it should do? identify are over-dependence on commodity Mr Bellamy: I think in simple terms the reason for markets, and we identify the fact that a litre of milk the direct action has been because the price structure going down the various supply chains in the UK which has been received by farmers has been returns significantly less from the consumer than any insuYcient to sustain their business. I think we have of the other European states that we looked at. The to look deeper than that and look at structural UK is twelfth out of 12 in terms of the value derived matters which point towards diYculties. We carried from a litre of milk. Finally, the lack of market out a piece of research last year on the prices and information and the lack of understanding of both profitability across the chain and that highlighted the consumer market place and how the market four issues which perhaps I will just briefly touch on. operates is a significant factor, so I think there are a The first one is the issue of supply chain power and variety of structural issues which we need to look at I think we can all understand that the balance of but fundamentally the problem is getting a price that power across the supply chain over maybe the past is sustainable to the producer and if he cannot get ten years has changed significantly partly because of that then he is likely to take direct action. the decline in liquid milk sales, partly because of the decline in doorstep sales, significantly because of the Q287 Mr Jack: Let us just pick up on three points end of use pricing at the end of the Milk Marketing which come out of what you have said. First of all, Board. What we have shown in our submission is do you sense that there is any genuine awareness by 9595841011 Page Type [E] 29-05-04 00:48:10 Pag Table: COENEW PPSysB Unit: PAG1
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8 March 2004 Mr Brian Peacock, Mr Kevin Bellamy and Mr Ken Boyns the major purchasers, supermarkets, of the impact Mr Peacock: It is diYcult to judge from our that their pricing policies are having on farmers? position, we are not in direct contact with the You made the point that reaction can be quick when competition authorities or OFT. To put a position it favours the supermarket, and clearly some of the on that is somewhat diYcult. However, I think there structural changes which have occurred with IMPE is a much clearer understanding about the way that have favoured supermarkets, therefore they have things may well be judged within the various projects taken advantage, but in so doing it has clearly had that people may want to put forward for discussion. an impact on the structure of the dairy industry. Mr Bellamy: What you can say, Chairman, is that Supermarkets are quick to point out that they are certainly the focus of our OFT on structure rather strong on corporate social responsibility, strong on than eVect will deter people from getting involved in partnership with farmers and want a good future for the adventures which will move us forward and add British agriculture. Some of these phrases do not cost to that with the legal charges of having to ring too true, do they, when it comes to dairy? investigate these things beforehand. I think the Mr Bellamy: I think you could level that up as an emphasis will slow down the period of restructuring. accusation but I think equally in the normal terms of businesses supermarkets have been doing what businesses do, they have an opportunity to maximise Q291 Mr Jack: Finally, you mentioned that in their profitability and they are seeking to do so within certain of our supply chains in the UK the returns the market place. I totally agree with you that in their were lower than the continental counterparts, why? terms of social responsibility and their other moral Mr Bellamy: That is a factor of the product mix responsibilities then, yes, there are some failings. which comes out of the UK in that across Europe there is far less milk going into the liquid supply chain, far more milk going into cheese and higher Q288 Mr Jack: So it is okay for them to use value supply chains. It is the basket of products considerable power and leverage irrespective of the which comes out of a UK litre milk. impact? Chairman: Can we now move on to look at the Mr Bellamy: That depends on your definition of impact of the CAP reforms and I will ask Bill Wiggin “okay”. to put some questions.
Q289 Mr Jack: Okay. Well, let us move on and talk about some of the competition issues. Do we have Q292 Mr Wiggin: If the farmgate milk price drops to the right attitude, in your judgment, in terms of our 15 pence a litre, how many farmers do you think will competition policy as it aVects dairy to allow the pull out of the industry? developments of vertical integration which are now Mr Boyns: I think it is very diYcult to estimate being demonstrated by people like Milk Link to exactly what is going to happen. The best estimate genuinely prosper and in the long term address some we do have is the David Colman and David Harvey of the questions of the past down the value chain to work. We suggest that we will lose 35% of farmers, the primary producer? 8,500 out of 25,000. That is the most reasonable Mr Peacock: I think it is true to say that the estimate we have got so far but whether it is accurate Government have tried hard to make sure there is or not only time will tell. consistency in the application of the competition law and to make sure it fits in with European legislation. Q293 Mr Wiggin: Do you think that will create a However, I believe there has been quite a lot of shortage of raw milk in the UK? nervousness in the industry about the application of Mr Boyns: It depends on what you term a shortage. the activities of the OFT and a reluctance in some If you mean less than quota then Colman and cases and a misunderstanding of some of the views Harvey’s work suggests that 15 pence is a crucial of OFT. It has been an issue which has stifled level. If we go slightly below we will have less milk discussion within the industry. The report we had than quota; if we are slightly above then it suggests done by KPMG highlighted some of these things we will fill the quota. Again, it is a knife edge, no-one and the Committee, I think, has already had that knows exactly what is going to happen. particular document but one aspect that KPMG did pick up was that there did seem to be some diVerences in application of OFT activities or Q294 Mr Wiggin: What do you think has to happen regulatory activities between ourselves and Europe. for the quantity of milk to be so low that there is a For instance, in Denmark the competition significant increase in price? authorities there seem to be quite happy to look at Mr Boyns: We have two markets. We have 14 billion behavioural measures with regard to Arla but in this litres of milk quota in this country, of which you country it is somewhat diVerent in its application. can argue about the size of the markets, but There have been some diVerences in approach and approximately 10 billion litres is the domestic some misunderstandings across the period. market, protected to a certain extent by transport costs, liquid milk, other value products and we have Q290 Mr Jack: The question I actually asked was four billion litres in a commodity milk market which where we are now can the emerging vertically is cheddar cheese, butter, powder. We have to lose a integrated organisations prosper or are they fair proportion of that four billion litres to allow suddenly going to find themselves the subject of supply and demand to bring the price up for the rest. further investigation? How much of that it is very diYcult to estimate. 9595841011 Page Type [O] 29-05-04 00:48:10 Pag Table: COENEW PPSysB Unit: PAG1
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8 March 2004 Mr Brian Peacock, Mr Kevin Bellamy and Mr Ken Boyns
Q295 Paddy Tipping: It all depends on the Single Mr Boyns: To be honest with you, I would have to Farm Payment, does it not, and how that is put some thought into that question before I answer. implemented. The decision to go down that route I am quite happy to put an answer in writing if you has not been welcomed with acclaim by the sector, would like. has it? What are the consequences? Mr Boyns: Theoretically there should be no eVects Q299 Chairman: That would be very interesting. on the sector on how the Single Farm Payment is Without going into which is going to be the best, made because it is a decoupled payment. I think a which is going to be the worst for small farmers, it large part of the industry is concentrating on will be diVerent, as it is at the moment? encouraging farmers to treat it as decoupled to make Mr Boyns: There are some very big traditional commercial business decisions. In reality Professors farming diVerences. For instance, there is a strong Colman and Harvey said a lot of farmers will treat emphasis on part-time farming already in France the payment as coupled. If that is the case then you and Germany. Those part-time farmers may react have to look not only at what large producers diVerently to what we would term a small farm in theoretically lose under the hybrid system but also this country which is where it is a full-time the extra eYciency they have got because they are occupation. That is why personally I think I need bigger in the first place than smaller farmers. some more information. Colman and Harvey’s figures suggest maybe three pence a litre, large producers go under three pence a Q300 Chairman: If you would like to think about litre lower costs than a smaller producer. that, I think that would be quite interesting. Paddy Tipping: Can you just take me through that Mr Boyns: Yes. again. So the larger, more eYcient producers who Mr Peacock: We would be happy to come back with have got more quota per hectare are going to be in a a considered view on that if that is helpful. stronger position, is that what you are saying? Chairman: Diana, quotas?
Q301 Diana Organ: KPMG did a report for you Q296 Mr Jack: Can you just define large for the sake about what would happen vis a vis milk quotas and of answering the question? the cost of restructuring the industry. Mr Boyns: Large in terms of how Professors Colman Mr Peacock: Yes. and Harvey define it is greater than 150 cows. They have, according to their figures, around about three Q302 Diana Organ: We have a situation, as you pence a litre lower cost than herds of below 70 cows. know, where the forthcoming support is going to be Now not every large herd will have very high quota to less for dairy farmers but the quotas eVectively are hectare ratios nor every small herd will have very low going to stay more or less as they are and remain in quota to hectare ratios but the work that Colman and place until 2015. What eVect is going that going to Harvey have done suggests on average larger herds have, do you think, on dairy farmers, the two have higher quota to hectare ratios and will lose out, pressures coming together until 2015? therefore, in Single Farm Payment over time. Mr Boyns: I think the quota price is a factor of supply and demand from farmers, so farmer demand will set it. If a lot of farmers want to expand initially Q297 Paddy Tipping: Just help me with this, because in an attempt to reduce their costs of production previous witnesses have told us, Professor Colman may then potentially it could be a large amount of quota. understand this, you may understand this, Mr Boyns, If people pay a large amount for quotas there are but when is the penny going to drop on the small two diYculties. Firstly, capital leaves the industry producer? When will they understand the significance of from existing dairy farmers, ongoing dairy farmers the new payment system? When will they make to exiting dairy farmers and, secondly, it increases decisions, I suppose that is what I am asking you? the capital investment in the dairy farm and makes Mr Boyns: It will take time because farmers are it harder to get a decent return on capital. traditionally relatively conservative. There will be Chairman: Michael, supply and demand? some farmers who understand it better than I do now. There will be some farmers who will take some Q303 Mr Jack: I want to ask one question about time to decide. There will be consultants, bank quotas. Do you think the European Union has managers in particular, talking to farmers about it. missed a trick in not scrapping them? It will take some time. It is diYcult to estimate Mr Bellamy: In terms of restructuring the cost of exactly how long. Certainly we are talking months, quota to the industry it means that capital is maybe a year or two years. removed from the industry and therefore potentially delays the process of restructuring.
Q298 Chairman: Can I ask one thing on the back of Q304 Mr Jack: What do you sense the attitude of that. Is this going to be international in Western UK dairy farmers is to that? Some have quite Europe? Obviously we are looking at diVerent enjoyed the comfort zone of quotas. It is bankable, systems of farm payment but let us look ahead five you have got this, you just keep turning out the milk. years, where will we be in this country with regard to Okay, there are problems with price but at least there the balance between smaller and larger producers is certainty. If you scrap quotas you move into an compared with France and Germany, for example? uncertain world for some farmers. 9595841011 Page Type [E] 29-05-04 00:48:10 Pag Table: COENEW PPSysB Unit: PAG1
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8 March 2004 Mr Brian Peacock, Mr Kevin Bellamy and Mr Ken Boyns
Mr Bellamy: Exactly. I would not suggest I was area and that has had a significant eVect over the representing the views of dairy farmers in saying that years on the way milk has been consumed. I think capital— Kevin wants to pick something up here. Mr Bellamy: One of the things we have done as an Q305 Mr Jack: Coming back to the thesis as put industry is understand the consumer better. If you forward by the two Professors, I was surprised that look at the demographics in the market place then 150 was deemed to be large. If you talk to me about doorstep delivery is now becoming more confined to large I would be talking about 250/300 plus, in New the older age range who have been used to Zealand we are talking 1,200, I know it is a diVerent purchasing milk in that way. As we move into a new regime. Given the climatic advantages we have in the generation then there is far more competition, as United Kingdom, should we not have campaigned Brian said, in the retail sector and, therefore, our harder to get rid of quotas so we could really take in share of throat as a liquid product is going down. our advantages and push them to the limit? What we need to do is to understand consumer Mr Boyns: It is KPMG’s recommendation in their trends and understand what consumers are looking independent report that they should be removed, if for and react and build products and new markets price support is removed. based on consumer needs.
Q306 Diana Organ: What is your view then? That is Q311 Diana Organ: In my constituency I have got a KPMG stating that, they are not in the business, large bottling plant for GlaxoSmithKline who are they are just the consultants looking at it. What is making Ribena and Lucosade and all these other your view about that? health drinks. What they do is they are putting in to Mr Boyns: The MDC does not lobby, we try to act every leisure centre, every swimming pool and a within the policy framework that exists. large number of colleges and schools a refrigerated machine which sells this drink through the Q307 Diana Organ: You must have a view about compartments either in Tetrapaks or bottles. We this? were talking about this, how much have you looked Mr Peacock: I think in any answer it would be a into schools, colleges, leisure centres? They put it in personal view. free by the way, the machines? You stick in a machine and it is refrigerated flavoured or natural Q308 Diana Organ: Let us hear that. flavoured milk sold in a carton, in a Tetrapak. Mr Peacock: I have to say, whenever the MDC Mr Bellamy: We have carried out research this year Council discusses this issue we are completely split on vending as a process. Vending of milk because of down the middle. its more limited shelf life does pose some problems Mr Breed: Like the NFU. but we are looking into how we can solve those. Let Chairman: That is very helpful, Brian. me point you towards an initiative which we are carrying out across senior schools across the UK Q309 Mr Jack: As intervention prices get lower the together with First Milk, one of the Co-operatives, purpose of having quotas seems to be less relevant by we are putting in—hopefully by the end of this the day. Milk consumption is declining, what are year—1,000 school milk bars which will make milk you doing about it? Why is it happening? and flavoured milks available to school children. We Mr Bellamy: Part of that decline, Chairman, is if you have successfully reversed the trend and decline in are talking about liquid milk—which I presume you subsidised school milk going into primary and are—there has been a long term decline in liquid milk. nursery schools in this country. Since the year 2000 Recently that has been due to the change from we have been increasing the amount of milk going doorstep delivery to supermarket purchase which is down those channels. We are looking at diVerent accompanied normally by a decline in volume channels and we are seeking to understand how we purchased by the household. What are doing about it? can bring new products and innovation into the Mr Jack: Can I just stop you there. Is it simply the sector. I think you have to look back over the last ten lug home factor which deters people? years where we have seen an increasing concern Diana Organ: They lug home the lager. about market share of commodity liquid milk and Mr Jack: Yes. Here we have a sage observation to my commodity products and clearly dairy companies right. Equally wine bottles are quite heavy. We have got and Co-ops have focused on reducing cost of consumption of heavy bottles of wine going up and milk processing rather than on innovation. What we have going down, the two are not quite substitutable, either to do is reverse that trend. We have to understand lager or wine. Why is it dropping? the consumer better. We have to get that Mr Breed: Water. information out there and we have to encourage innovation, and that is what we are seeking to do. Q310 Mr Jack: Yes, water. Any more bids! Paddy Tipping: You have given us one example, milk Mr Peacock: We have this disgusting term of share bars, what are the other examples of innovation and a throat in the marketing jargon and liquid milk over market access? the years has sustained a huge attack from a lot of drinks: soft drinks, things like Sunny Delight, a whole raft of things. I should not mention water but Q312 Chairman: Why has it taken so long? Why is certainly there has been a huge attack on the drinks this industry so slow oV the mark? 9595841011 Page Type [O] 29-05-04 00:48:10 Pag Table: COENEW PPSysB Unit: PAG1
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8 March 2004 Mr Brian Peacock, Mr Kevin Bellamy and Mr Ken Boyns
Mr Bellamy: I think you have got to look at the that oVers opportunities and we are about to see market share argument. Clearly what dairy Wiseman’s—one of the major dairy companies— companies have needed to do, as they have seen their launching a product based around one per cent. one retail outlet in terms of doorstep delivery be Mr Peacock: The industry does a survey on a regular transferred to the major multiples, they have needed basis asking the consumer what is actually the fat to concentrate on winning market share from those content of milk and about 30% of the people who major multiples and that has squeezed out the reply to the survey say that whole milk or full fat milk, innovation process. What we now need to do is whichever term you use, has indeed got 30% fat. encourage a reversal of that trend so that we can build brands and encourage innovation. That is Q316 Mr Wiggin: The diYculty is not just the fat what we are seeking to do. You asked me for another content but when you balance that as to why milk is example. I think the flavoured milk area is a good for you, that equation perhaps also needs a bit marvellous example of what we ought to be doing in of pushing. this country. If you go to any other country in the Mr Bellamy: Yes, I totally agree. Through our work world and you will see a range of flavoured milks in with the Dairy Council where we are communicating their own category on supermarket shelves. If you go those messages in co-operation with DIAL to the into a supermarket in this country you will see consumer world our problem, as always, is that the flavoured milk on the top shelf of the milk fixture. consumer is even more interested in the nature of the What we are seeking to do is research into flavoured product rather than health aspects and health milks, into flavoured milk additives, and recently we aspects do not sell the product. have seen new products launched really on the back Q317 Chairman: Can I just say one thing and then of some research which we carried out last year. Our Diana can come in. But, given that health strategy is to understand the consumer, to carry out association with milk, again have you not missed a the research, to look at innovation and then to trick in terms of some of the ways in which other publish that as widely as possible so that companies products have had their comeuppance because of the and organisations across the industry will take that various food scares there have been? Milk, within up and carry it forward. reason, has never featured in that and milk has got Mr Peacock: Similar things have happened in the the benefit of being seen to be a healthy product and cheese area and in things like dairy deserts and the yet the consumer either forgets or is disinterested use of cream. There is plenty to go at and that is the in that. sort of thing we are attacking in a similar manner to Mr Bellamy: Chairman, we carry out a usage and the flavoured milk and the liquid milk. attitude survey every year on milk, as Brian said, and despite people’s belief about fat content, the metric on people’s attitude towards milk as a healthy product Q313 Mr Wiggin: Can I just ask a question on the fat which is good for them remains in the upper 90 content because one of the problems I think milk percentile. Despite the fat issue people believe that milk consumption has is that it has a percentage of fat is a natural healthy product and continue to do so. within it. That is something that people do not tend to want. How are you looking at that and dealing Q318 Diana Organ: I have just two points, really. V with that because actually the fat free stu is not One is why do you not market it at 96% fat free really very milky, shall we say? rather than four per cent with fat? Also there is a real Mr Bellamy: I think there is a lot of confusion about campaign I think that can be done because young the eVect of fat within the market place. Our belief is teenage girls are very sceptical at doing things which that fat is a deterrent to people purchasing milk and are good for them and actually it is crucial that girls milk products and that the consumer does not between nine and 13 do drink a fair bit of milk understand the fat content of milk. because otherwise later in life they will get Paddy Tipping: Can you just remind us what it is so osteoporosis. it is on the record? Mr Bellamy: Very quick answers. First of all we are marketing milk as 98% fat free but I have to point out that is against Food Standards Agency Q314 Mr Wiggin: It depends on the milk. guidelines because they believe it is confusing the Mr Bellamy: The fat content of milk will be market place. Secondly, we will be in an application somewhere around 3.6 to 4% depending on the cow to the EU for structural funds to help communicate and all sorts of things. the messages to teenage girls. Chairman: We have to rush oV so as not to keep the Q315 Diana Organ: For the record, can you tell us— Minister waiting. Any additional evidence please there is semi-skimmed and skimmed milk—what is send to us. Thank you for your evidence this session. the fat content of those? I am sorry we are even more pressed this time Mr Bellamy: Semi-skimmed will be at 2% and because we have to go and vote. skimmed milk will be less than 1% Clearly we need to The Committee suspended from 5.34pm to 5.46pm for get that out as a message to the consumer but again a division in the House 9595841012 Page Type [E] 29-05-04 00:48:10 Pag Table: COENEW PPSysB Unit: PAG1
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Memorandum submitted by the Department for Environment, Food and Rural AVairs (L6)
MARKET PRICE AND FARM-GATE PRICE OF MILK JANUARY 2003
Executive Summary 1. The available evidence suggests that increases in the retail price of milk are passed back to dairy farmers. Nevertheless, farmgate prices are low and are likely to fall further as a result of the reforms to the dairy CAP agreed at Luxembourg. The reasons for the low farmgate price over the last few years are complex and cannot be reduced to a single factor. Many of these are for the industry to address itself. However, the Government can and has taken action in line with its Strategy for Sustainable Farming and Food to facilitate industry action. In particular: — Lord Whitty has been chairing meetings of a Dairy Supply Chain Forum, which has been looking at collaborative solutions to improve supply chain eYciency, as well as other issues. — Under the auspices of the Forum, the Milk Development Council has initiated an innovations workshop to look at barriers to innovation in the sector and how to overcome them. — Defra is participating in a further two sub groups of the Forum, which aim to facilitate the long term sustainable development of the dairy supply chain and help it adjust to the new environment created by the reformed CAP; and — The Government has made a grant of nearly £0.5 million to the Food Chain Centre to examine how to improve dairy supply chain eYciency.
Introduction 2. There can be little doubt that farmgate milk prices have been low over the last few years compared to their historical levels and that this has been reflected in dairy farm incomes, which have been falling since 19961. Although it is diYcult to be precise about the eVect of the CAP reform agreed at Luxembourg on farmgate prices, it is safe to assume that prices will fall further as a result of the reforms. This is likely to accelerate the existing trend towards fewer, larger, dairy farms2 3. The farmgate price of milk is influenced by a number of factors. The sterling-euro exchange rate can play a key role when Community prices are at intervention levels and for products that are subject to significant trade between the UK and other Member States, such as butter and cheese. However, the UK participates in a significant trade in dairy products3 and supply and demand on world and Community markets are also important, as are the level of stocks of products. Community prices can therefore be significantly above intervention levels. 4. Even for products that are relatively isolated from Community and world prices, such as liquid milk and some branded products, the prices paid for raw milk to make them will be influenced by the price paid for milk to make other products. If returns from one outlet for raw milk are significantly higher than from other outlets, then sellers will compete for that premium. Since milk is a relatively homogenous product, the main point of competition will be price, which will tend to erode any premium. 5. However, allowing for exchange rates these factors are not suYcient to explain why UK farmgate prices are consistently below the EU average, whether returns from the markets are transmitted to producers or the allocation of returns from the market between producers, processors and retailers.
Price Transmission 6. London Economics provided a rigorous statistical analysis for the KPMG study of prices and profitability in the British dairy chain commissioned by the MDC4. London Economics examined the UK milk market for the period from January 1995 to December 2001. It found evidence that adjustments to retail prices for liquid milk were fully passed back to the farm-gate price, though there was a lag of five months before the retail price change was fully reflected in the farmgate price. There were no diVerences in the impact of retail price increases and decreases on farm-gate prices, both were fully transmitted. In contrast a 1 pence increase in the farmgate price resulted in only a 0.6 pence increase in the retail price of liquid milk whereas a 1 pence decrease in farm-gate price reduced the retail price by 0.7pence. Since farmgate prices have generally been falling over most of 1995–2001, the diVerential in price transmission, depending on whether the direction is from retail to farm-gate prices or from farm-gate to retail prices, has been reflected in an increase in retailers’ gross margin. KPMG suggested that the reason why changes in farmgate prices are reflected less in retail prices than changes in retail prices are reflected in farmgate prices may be due to the relative lack of market power of producers.
1 See para 12 of annex. 2 See paras 23–25 of annex. 3 See para 8 of annex. 4 “Prices and Profitability in the British Dairy Chain: Report to the Milk Development Council”, KPMG, 2003. 9595841012 Page Type [O] 29-05-04 00:48:10 Pag Table: COENEW PPSysB Unit: PAG1
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7. Although London Economics found that retail price increases for liquid milk are fully transmitted to producers, there is a widespread feeling amongst dairy farmers that they have not received the full benefit of the recent retail price initiatives established by the supermarkets. However, it should be recognised that 1 pence per litre increase in the supermarket price for liquid milk will not produce an 1 pence per litre increase in the farmgate price, unless there has been a corresponding increase in the value of other dairy products. Only around half of the raw milk produced in the UK is used to produce liquid milk and only 65% of liquid milk is sold retail (rather than through food service outlets). 1 pence per litre increase in the supermarkets price would only therefore produce an increase in the average farmgate price of around 0.3 pence per litre. During the period between October 2002 and October 2003 we have seen retail prices for liquid milk rise by 2 pence per litre, whilst over the same period the farmgate price has risen by 1.46 pence per litre, with further increases due from December as a result of recent deals over the price paid for milk for cheese. This increase in the farmgate price is larger than would be produced just by the retail price increases and represents strengthening dairy commodity prices over this period. It is therefore diYcult to conclude that events in this more recent period undermine the conclusion reached by London Economics that retail price increases for liquid milk are fully transmitted to farmers.
Market Power 8. As noted above, KPMG concluded that the fact that changes in farmgate price are not fully transmitted may be the result of relative lack of market power of producers compared to others in the supply chain. They therefore examined the margins and levels of profitability of processors and retailers. Overall, they came to the conclusion that levels of profitability of processors and retailers in the UK were comparable to those in other Member States. On margins they found that retail margins where probably higher than in other Member States and that processor margins were not large (and for cheese were sometimes non- existent). 9. It has been suggested that the attitude of the competition authorities has hindered the development of large co-operatives that can negotiate on more equal terms with the larger retailers and processors. This view appears to stem from the break-up of Milk Marque that followed an investigation and adverse finding by the then Monopolies and Mergers Commission. However, the issue here was not the size of Milk Marque, though that clearly had a bearing on the case, but the fact that the company was found to have abused its monopoly position by establishing anti-competitive selling practices. 10. Since the break up of Milk Marque there have been a number of successful mergers in the dairy sector, some of which have involved its successors. Despite this, the perception persists in some quarters that the way that competition law is applied in the UK prevents the establishment of large dairy co-operatives. Following the publication of the report of the Policy Commission on the Future of Farming and Food5, which flagged up this issue, the OYce of Fair Trading met with farming interests to explain how competition machinery relates to their sector. It is also planning to post answers to frequently-asked questions on this subject on its web site. More generally, it has re-iterated its willingness to provide informal and confidential guidance to parties considering specific mergers or joint ventures so that any potential competition problems can be identified at an early stage. 11. The apparent discrepancy between farmgate and retail prices was one of the issues that prompted the investigation by the Competition Commission into supermarkets. In its report6, the Commission concluded that, taking all matters into consideration, it was satisfied that that the industry was broadly competitive and that overall excessive prices were not being charged nor excessive profits earned. However, it identified a number of practices engaged in by the larger supermarkets that, because of their buyer power, adversely aVected the competitiveness of some of their suppliers. It recommended that a Code of Practice should be established to regulated the practices that it had identified, and that it be binding on those supermarkets with 8% or more of the market. 12. The Secretary of State for Trade and Industry, who leads on competition matters, accepted this recommendation and asked the OFT to draw up a Code. This was done and the Code of Practice entered in force on 17 March 2002. The operation of the Code was reviewed by the OFT during 2003. As part of the review the OFT invited the views of trade bodies, including those representing suppliers of milk and dairy products. The OFT hope to publish the report and conclusions of its review early in this year.
The Comparative Level of UK Farmgate Prices 13. KPMG also examined the reasons why UK farmgate prices for liquid milk are consistently below the EU average. They highlighted a number of factors that might explain this. These included: — the structure of the UK industry; — the low value of the product mix; and
5 Farming and Food: A Sustainable Future, Policy Commission on the Future of Farming and Food, January 2002. 6 Supermarkets: a report on the supply of groceries from multiple stores in the United Kingdom, Competition Commission, October 2000. 9595841012 Page Type [E] 29-05-04 00:48:10 Pag Table: COENEW PPSysB Unit: PAG1
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— the low level of product innovation within the UK compared with some Member States. Their report also identified a number of areas where eYciency might be improved, through rationalisation or benchmarking and suggested that improved supply chain eYciency could contiribute towards improved farmgate prices. These findings on the dairy sector very much support the conclusions reached by the Policy Commission on the Furture of Farming and Food for all agricultural sectors. Many of these issues are for the sector to address itself. However, the Government can play a role in facilitating industry action and is doing so through the Dairy Supply Chain Forum, which is currently chaired by Lord Whitty.
Government Action on Farmgate Prices 14. Most of the causes of low farmgate prices for liquid milk in the UK are for the sector to address itself. As long as the rules of competition law are respected, negotiations between producers and purchasers or processors and retailers are private commercial matters in which the Government cannot and should not get involved. Similarly, adapting to the lower price environment likely to result from the reform of the dairy CAP will very much be a matter for individual businesses. Nevertheless the Government can and has taken action in line with its Strategy for Sustainable Farming and Food7 to facilitate the development of the sector to meet these challenges. 15. Lord Whitty has been chairing regular meetings of a Dairy Supply Chain Forum, involving participants from all parts of the dairy supply chain, which aims to find collaborative solutions that will improve the eYciency of the dairy supply chain. This Forum has established a sub-group to examine the immediate impact of CAP reform and a further sub group to facilitate the long-term sustainable development of the dairy supply chain, considering as a starting point the findings of the CAP reform group. This group does not intend to create a blueprint for the sector, but rather to identify the challenges it faces and the possible approaches to them, which should allow individual businesses to make informed decisions on their future development. 16. In addition, we have taken action to help the sector address improve supply chain eYciency. A grant of almost £0.5 million has been made to the Food Chain Centre to undertake a value chain analysis of the dairy supply chain to establish areas where costs may be reduced. The Food Chain Centre intend to examine eight diVerent supply chains in the dairy sector and hope that the initial findings on the first chain selected might be available at Easter. 17. A sub-group of the Dairy Supply Chain Forum has also been established to examine how innovation can be encouraged in the dairy supply chain The objective of this group is to stimulate and co-ordinate innovation for the development of British dairy products by creating a forum for the exchange of market information and ideas that anticipate consumer needs. The group will also consider how barriers to innovation might be addressed. 18. Furthermore, the Agriculture Development Scheme (ADS) oVers grants for the various activities associated with the marketing of produce, including dairy products, and welcomes innovative applications. Support is also available under the England Rural Development Programme, which encourages the development of new products and markets through the Rural Enterprise Scheme and the Processing and Marketing Grant.
Conclusion 19. The available evidence suggests that increases in the retail price of milk are passed back to dairy farmers. Nevertheless, farmgate prices are low and are likely to fall as a result of the reforms to the dairy CAP agreed at Luxembourg. The reasons for the low farmgate price over the last few years are complex and cannot be reduced to a single factor. Many of these are for the industry to address itself. However, the Government can and has taken action in line with its Strategy for Sustainable Farming and Food to facilitate industry action. In particular: — Lord Whitty has been chairing meetings of a Dairy Supply Chain Forum, which has been looking at collaborative solutions to improve supply chain eYciency, as well as other issues. — Under the auspices of the Forum, the Milk Development Council has initiated an innovations workshop to look at barriers to innovation in the sector and how to overcome them. — Defra is participating in a further two sub groups of the Forum, which aim to facilitate the long term sustainable development of the dairy supply chain and help it adjust to the new environment created by the reformed CAP; and — The Government has made a grant of nearly £0.5m to the Food Chain Centre to examine how to improve dairy supply chain eYciency. January 2004
7 Strategy for Sustainable Farming and Food, Defra, December 2002. 9595841013 Page Type [O] 29-05-04 00:48:10 Pag Table: COENEW PPSysB Unit: PAG1
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Annex 1
Background on the UK Dairy Sector
Structure of the UK Dairy Sector 1. The UK is the third largest producer of milk in the EU, after France and Germany, and the 7th largest producer in the world. Annual production tends to be around the UK milk quota of 14,186 billion litres. Whilst UK production was slightly under quota in the 2000–01, 2001–02 and 2002–03 quota years, the indications are that it might exceed quota in the 2003–04 quota year.
Quota Year Quota Allocation Amount Produced (million litres) (million litres) 1994–95 14,167 14,256 1995–96 14,167 14,324 1996–97 14,167 14,221 1997–98 14,167 14,294 1998–99 14,167 14,205 1999–2000 14,167 14,232 2000–01 14,179 13,885 2001–02 14,186 14,103 2002–03 14,186 14,064
2. In terms of value dairy farming accounts for around 20% of UK agricultural production and is the single largest agricultural sector. In the 2002 Farm Business Survey there were 25,548 holdings classified as primarily dairy farms. There are also around 40,000 people employed in the processing, manufacture and distribution of dairy products. 3. The average herd size in the UK is 75 cows per herd, which is significantly above the average for the EU15 of 28.2. Yield per cow, of 6,320 litres per annum, is also above the EU average of 5,812 litres per annum, but is lower than in the Netherlands, Sweden, Finland and Denmark. There has been a trend for several decades towards fewer, larger farms, with higher yielding cows. For example, since 1985 the number of dairy farms has declined by an average of 3.5% per annum. Similarly, the national herd has declined by an average of 1.7% per annum since 1992. However, this has been oVset by a comparable annual increase in average yield per cow. 4. A similar trend can be seen in the processing sector. The four largest processors in the UK are estimated to process around 60% of UK milk production. This level of concentration is comparable to that in other EU Member States. It should be recognised that there are also a large number of successful smaller processors. For example, it is estimated that there may be as many as 350 specialist cheesemakers making around 400 diVerent cheeses. 5. Around half of the raw milk sold in the UK is handled by farmers’ co-operatives, with the rest being sold direct to processors. This is comparable to France and Germany, although in Denmark and the Netherlands most raw milk is handled by farmers’ co-operatives. However, UK co-operatives are still predominantly brokers, rather than processors, and only around 5% of UK processing capacity is owned by co-operatives, compared to around 60% in France and Germany and 90% in the Netherlands and Denmark. However, some UK farmers co-operatives have made significant investments in processing and others have put arrangements in place, through a processing levy and/or members’ guarantees, to enable them to follow suit. 6. The structure of the UK industry where farmer’s co-operatives are predominately brokers, rather than vertically integrated processors is unique in the EU, although it is replicated to some extent in the US, where Dairy Farmers of America, for example, the world’s largest dairy co-op, process only about 20% of their milk. It has been suggested that this structure is one of the causes of low farmgate prices. KPMG suggested8, for example, that the cost to co-op members of this additional layer in the supply chain could be as much as 2 pence per litre. To reduce this they suggested that the co-operatives would need either to expand to achieve scale eYciencies or vertically integrate. 7. Although it is diYcult to give precise figures, it is generally agreed that there is a degree of overcapacity in the UK processing sector for some products and that, despite significant investments in new processing plant, some of this capacity is ineYcient9. Thus, in addition, to the existing trends towards fewer larger processors and increased vertical integration, we should also expect to see further rationalisation and modernisation of processing plant.
8 Prices and Profitablity in the British Dairy Chain: Report to the Milk Development Council, KPMG, 2003. 9 See, for example The End of the Road: Consolidation of the UK Dairy Industry, West LB Panmure, 2000. 9595841013 Page Type [E] 29-05-04 00:48:10 Pag Table: COENEW PPSysB Unit: PAG1
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Dairy Herd Production 14,285 Total Cows Milk Fed to Stock/ Production Waste on Farm 14,292b 283b Beef Herd Production 7 14,073
Raw Milk Available for Raw Milk Imports Human Consumption Exports 64 14,073c 414
7,120 Delivered to Co-ops 7,120 6,277 5190 Direct Sales Consumed on Delivered to 210 Farms Dairies 51c 11,467
51 5,798
d
Consumed as 113 6,628 830 Liquid 6,813c
5,538 Used in 77 6,638 1,100 Manufacture 6,715
a: Figure are provisional Dairy Wastage & b: Excluding any suckled milk Stock Change c: Includes 7 million litres of milk produced by the beef herd d: The split between processor and co-op production are estimates based on industry sources 132
The UK Market for Dairy Products 8. Around half of the raw milk produced in the UK is used to produce liquid milk, with cheese production being the next largest use, accounting for 25% of milk utilisation. This is rather diVerent from many other EU Member States. For example, in the Netherlands and France only around 15% of milk is used for liquid milk and in the Netherlands, France and Denmark over half of the raw milk produced is used for cheese production. 9. With the exception of liquid milk, the UK participates in a significant trade in most dairy products. As a consequence, prices for these products will be heavily influenced by the prices prevailing in EU and world markets. The value of UK exports of milk products is significantly lower than the value of imports and in 2002 the UK had a Negative trade balance of £536 million in dairy products. 9595841014 Page Type [O] 29-05-04 00:48:10 Pag Table: COENEW PPSysB Unit: PAG1
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This data shows UK production and supplies of milk products manufactured by both dairy companies and on farm. The data is quoted in thousand tonnes and is not directly comparable with the data shown in table 5.17 which is quoted in million litres.
Calendar years
Thousand tonnes (unless otherwise specified) 1999 2000 2001 2002 (provisional)
Butter (a) (b) Production (c) 141 132 126 141 Imports from: the EU 67 80 76 62 the rest of the world 47 38 39 39 Exports to: the EU (d) 50 39 36 33 the rest of the world 6 6 5 4 Total new supply (d) 199 204 201 204 Change in stocks (e) 11 –5 1 8 Total domestic uses (d) (e) 187 209 200 196 Production as % of total new supply for use in UK 71% 64% 63% 69% Closing stocks (e) 22 17 18 26 Cheese Production (c) 368 340 395 396 Imports from: the EU 236 225 246 241 the rest of the world 41 30 29 26 Exports to: the EU 49 48 57 57 the rest of the world 13 10 11 20 Total new supply 584 536 601 586 Change in stocks 1 — 5 2 Total domestic uses 583 536 596 584 Production as % of total new supply for use in UK 63% 63% 66% 68% Closing stocks (f) 10 10 15 17 Cream—fresh, frozen, sterilized Production (b) (c) 275 270 263 257 Imports from: the EU 8 10 18 12 the rest of the world — — — — Exports to: the EU 95 81 83 95 the rest of the world 1 1 1 — Total new supply 188 198 197 174 Change in stocks ...... Total domestic uses 188 198 197 174 Production as % of total new supply for use in UK 146% 137% 134% 148% Closing stocks ...... Condensed milk (g) Production 177 162 161 149 Imports from: the EU 14 15 14 11 the rest of the world — — — — Exports to: the EU 38 28 20 28 the rest of the world 13 3 2 2 Total new supply 139 145 153 131 Change in stocks 1 –1 3 -1 Total domestic uses 138 146 150 131 Production as % of total new supply for use in UK 127% 111% 105% 114% Closing stocks 8 7 10 9 Milk powder—full cream Production 102 105 83 105 Imports from: the EU 10 11 8 10 the rest of the world — — — — Exports to: the EU 28 28 29 53 the rest of the world 64 74 57 60 Total new supply 20 14 5 1 Change in stocks — –1 3 –2 Total domestic uses 20 15 2 3 Closing stocks 3 2 5 3 9595841014 Page Type [E] 29-05-04 00:48:10 Pag Table: COENEW PPSysB Unit: PAG1
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Calendar years
Thousand tonnes (unless otherwise specified) 1999 2000 2001 2002 (provisional)
Skimmed milk powder Production 102 83 71 71 Imports from: the EU 14 13 23 14 the rest of the world — — — — Exports to: the EU (d) 30 77 26 17 the rest of the world 30 35 4 6 Total new supply (d) 57 –16 63 61 Change in stocks –11 –66 7 16 Total domestic uses (d) 68 50 56 45 Production as % of total new supply for use in UK 180% –527% 111% 117% Closing stocks 71 5 12 29
Source: Defra Statistics (a) Includes butterfat and oil, dehydrated butter and ghee. (b) Includes production from the residual fat of low fat milk products. (c) Includes farmhouse manufacture. (d) These figures include the use of these products for animal feed. (e) In addition to stocks in public cold stores surveyed by Defra, closing stocks include all intervention stocks in private cold stores. Total domestic uses does not equate exactly with consumption since changes in unrecorded stocks are not included in the calculation. (f) Cheese stocks held in public cold stores. Public coldstores make their storage space available to the public or to the Rural Payments Agency, formerly the Intervention Board. The ownership of the store whether public or private is irrelevant. (g) Includes condensed milk used in the production of chocolate crumb and in the production of sweetened and unsweetened machine skimmed milk. Million litres (unless otherwise specified) Calendar years 1999 2000 2001 2002 (a) (provisional) Population and Yield Dairy herd (annual average, ‘000 head) (b) 2,445 2,354 2,251 2,219 Average yield per dairy cow (litres per annum) 5,964 5,977 6,347 6,531 Production Production of milk from the dairy herd (c) 14,581 14,071 14,285 14,488 Production of milk from the beef herd (c) 7 7 7 7 less on farm waste and milk fed to stock 285 277 283 282 Volume for human consumption 14,303 13,801 14,009 14,213 Value of production (£ million) 2,653 2,393 2,822 2,489 of which: milk (d) 2,586 2,300 2,658 2,397 milk products (e) 76 86 85 92 agrimonetary compensation . . 22 79 . . less levies (f) 9 15 . . . . Prices (pence per litre) (g) Farmgate price of milk excluding bonus payments 18.30 16.91 19.14 17.04 Farmgate price of milk including bonus payments 18.35 16.93 19.26 17.13 Supply and Use (h) Production 14,588 14,078 14,292 14,523 Imports 111 105 64 74 Exports 465 445 414 427 Total domestic use 14,234 13,737 13,942 14,170 of which: for liquid consumption 6,853 6,768 6,761 6,829 for manufacture 6,988 6,550 6,715 6,874 9595841014 Page Type [O] 29-05-04 00:48:10 Pag Table: COENEW PPSysB Unit: PAG1
Environment, Food and Rural Affairs Committee: Evidence Ev 109
Million litres (unless otherwise specified) Calendar years 1999 2000 2001 2002 (a) (provisional) of which: butter (i) 290 270 259 289 cheese 3,297 3,032 3,568 3,576 cream (i) 271 266 259 253 condensed milk (j) 603 522 536 504 milk powder—full cream 853 932 781 776 milk powder—skimmed 1,123 889 663 794 other 549 640 649 682 Dairy wastage and stock change 56 91 132 105 Other uses (k) 338 328 335 361
Source: Defra Statistics (a) 366 days.
(b) Dairy herd is defined as cows and heifers in milk plus cows in calf but not in milk, kept mainly for producing milk or rearing calves for the dairy herd.
(c) Excludes suckled milk.
(d) Value of milk sold for processing oV farm. Excludes milk processed on farm and sold direct to the consumer.
(e) Value of milk products manufactured on farm for sale direct to the consumer.
(f) Comprising milk co-responsibility levy from 1977 to 1993 and milk superlevy.
(g) The farmgate price is the average price received by milk producers, net of delivery charges. No deduction is made for superlevy. In the current year, estimated bonuses for April to December have been included.
(h) Aggregated data from surveys run by Defra, SEERAD and DARD, NI on the utilisation of milk by dairies.
(i) Includes the utilisation of the residual fat of low fat liquid milk production.
(j) Includes condensed milk used in the production of chocolate crumb and in the production of machine skimmed milk.
(k) Includes farmhouse consumption, milk fed to stock and on farm waste. Excludes suckled milk. 10. UK per capita consumption of liquid milk is about 20% above the EU average, although lower than in the Netherlands and Denmark. However, UK per capita consumption of cheese is about half of the EU average. Overall, consumption of liquid milk is declining at around 1–2% per annum, with consumption of other products remaining stable or increasing slightly. 11. Around 65% of household consumption of liquid milk is purchased through multiple retailers (Doorstep delivery has declined to around 20% of the market), with around 80% of household purchases of other milk products being made through multiple retailers. However, milk powders, butter, cream and cheese are all widely used in other processed products and the food service sector is increasing in importance. 9595841015 Page Type [E] 29-05-04 00:48:10 Pag Table: COENEW PPSysB Unit: PAG1
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The Consumption of Liquid Milk and Milk Products
8500 8000 7500 7000 6500 6000
Million Litres 5500 5000 4500 4000 1973 1975 1977 1979 1981 1983 1985 1987 1989 1991 1993 1995 1997 1999 2001
Liquid Milk Milk Products
12. Despite, or perhaps because of, the large part of UK milk production used for the liquid milk market, the overall value of UK of the products into which UK milk is processed is lower than in most other Member States. Research by London Economics for KPMG10found that in 2001 the value of a basket of dairy products produced by the UK was the lowest of the 12 Member States it studied. The average retail value of the products made from 1 litre of milk in the UK was only 43 pence, compared to an average for the 12 countries considered of 54 pence.
UK Milk Prices and Dairy Farm Incomes 13. There can be little doubt that farmgate milk prices have been low over the last few years compared to their historical levels and that this has been reflected in dairy farm incomes.
Dairy Farm Incomes in the United kingdom
100 Current prices Real terms at 01/02 prices 90 80 70 60 50 40 30 20 10 0 1994/95 1995/96 1996/97 1997/98 1998/99 1999/00 2000/01 2001/02 (provisional) 2002/03
10 Prices and Profitablity in the British Dairy Chain: Report to the Milk Development Council, KPMG, 2003. 9595841015 Page Type [O] 29-05-04 00:48:10 Pag Table: COENEW PPSysB Unit: PAG1
Environment, Food and Rural Affairs Committee: Evidence Ev 111
14. The farmgate price of milk is influenced by a number of factors. The sterling-euro exchange rate can play a key role when Community prices are at intervention levels and for products that are subject to significant trade between the UK and other Member States, such as butter and cheese. The eVect of exchange rates on the theoretical floor to farmgate prices provided by intervention can be represented by the Intervention Milk Price Equivalent (IMPE), which is a theoretical price that would be obtained if all milk were converted into the intervention products11, butter and skimmed milk powder (SMP). However, supply and demand on world and Community markets are also important, as are the level of stocks of products. Community prices can therefore be significantly above intervention levels and the theoretical returns to producers correspondingly higher. This can be represented by the Actual Milk Price Equivalent (AMPE), which is calculated using average market prices, rather than intervention prices.
IMPE v AMPE v Farmgate price
23.0 AMPE IMPE Farmgate price 22.0
21.0
21.0
20.0
19.0
18.0
17.0
16.0
15.0
14.0 Jul-02 Jul-03 Jul-00 Jul-01 Jan-02 Jan-03 Jan-01 Mar-02 Mar-03 Mar-01 Nov-01 Nov-02 Nov-03 Nov-00 Sep-02 Sep-03 Sep-00 Sep-01 May-02 May-03 May-01
Source: Defra and MDC Datum 15. The relationship between farmgate prices and commodity prices are illustrated in the table above, which shows farmgate price against IMPE and AMPE. Although only illustrative, rather than statistically demonstrable, it does suggest that allowing for seasonal variations, farmgate price follows AMPE, but with a lag of a few months. 16. Even for products that are relatively isolated from Community and world prices, such as liquid milk and some branded products, the prices paid for raw milk to make them will be influenced by the price paid for milk to make other products. If returns from one outlet for raw milk are significantly higher than from other outlets, then sellers will compete for that premium. Since milk is a relatively homogenous product, the main point of competition will be price, which will tend to erode any premium. 17. Neverthess, exchange rates and the evolution of EU and world commodity prices are not suYcient to explain why UK milk prices are constently lower than the EU average expressed in euros. This issue was also examined by KPMG They highlighted a number of factors that might explain this. These included: — the structure of the UK industry (see para 5 and 6 above); — the low value of the product mix (see para 12 above); — the low level of product innovation within the UK compared with some Member States.
Selling price of raw cows milk, 3.7% fat content: EU 15 (euros per kg)
1998 1999 2000 2001 Belgium 27.47 26.33 27.44 29.93 Denmark 30.8 30.26 30.86 32.34 Germany 29.52 28.47 30 32.82 Greece 32.72 33.69 33.47 35.62 Spain 27.99 27.33 27.05 30.33
11 In practice, it is a somewhat higher figure, since whilst the calculation takes into account processing costs it does not allow for the cost of collecting milk from farms. 9595841016 Page Type [E] 29-05-04 00:48:10 Pag Table: COENEW PPSysB Unit: PAG1
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1998 1999 2000 2001 France 28.52 28.11 28.81 29.99 Ireland 27.92 26.66 27.2 28.56 Italy 34.84 34.23 : : Luxembourg 31.45 30.65 30.53 32.73 Netherlands 30.59 28.62 29.15 31.27 Austria 27.64 27.76 27.83 31.76 Portugal 28.39 28.49 28.97 32.17 Finland 32.05 32.15 32.72 33.97 Sweden 32.71 33.11 34.74 31.22 United Kingdom 26.76 26.13 26.09 25.57 Source: Eurostat
The Dairy CAP 18. The primary mechanism of the Common Organisation of the Market in Milk and Milk Products is price support through intervention purchases of butter and skimmed milk powder (SMP). This provides a floor to Community markets and maintains prices for these products and, as a consequence, other milk products significantly above world levels. Community prices are typically 150% higher than world prices for butter and 35% for SMP. These artificially high prices have provided an incentive to produce more than the market demands and to restrain production by curtailing the build-up of intervention stocks, milk quotas were introduced in 1984. However, the level of milk quotas is still such that the Community has a structural surplus of milk products and various disposal measures are used to prevent this resulting in increased intervention stocks. 19. Subsidised usage schemes are available to encourage the use of butter and SMP. For example, the use of butter in pastry, ice-cream and making concentrated butter is subsidised, as is the use of SMP in animal feed. These schemes are designed to oVset the competitive disadvantage that these products would otherwise face due to their increased price relative to alternatives (ie vegetable oils for butter). Usage is subsidised either through selling intervention stocks at a reduced price or oVering an aid to use product on the open market. Usage of these schemes can be significant and as much as 25% of EU butter consumption is subsidised. 20. Another consequence of EU support prices is the need for high tariVs to prevent Community markets being flooded by products from third countries operating at world prices. The current EU bound-rates under the GATT are suYciently high to keep out imports other than those enjoying a preferential tariV rate (ie under GATT minimum or current access quotas, or through bi-lateral trade agreements). To allow EU exporters to compete on world markets and to keep the Community market in balance, export refunds are paid on exports of milk and milk products. Both the value and volume of subsidised exports are limited under the GATT, although normally these limits do not act as a major constraint. However, it is likely that any further agreement at the WTO would eventually lead to significantly lower tariVs for dairy products and much more restrictive limits on subsidised exports. 21. Total expenditure on the Dairy CAP in 2002 was around 2 billion euros of which around 300 million euros was spent in the UK. The total benefit to UK dairy farmers through improved farmgate prices was maybe in the order of 1 billion euro. The cost of the higher prices largely falls to UK consumers. Since intervention prices, aid rates for subsidised usage and export subsidies are denominated in euros, the sterling-euro exchange rate can play a significant role in determining UK prices when Community prices are at intervention levels.
Luxembourg Agreement 22. The main elements of the CAP reform package agreed at Luxembourg relating to the dairy sector are: — 15% price support cut for skimmed milk powder phased in over 3 years from 2004 (the same as agreed under Agenda 2000, but brought forward a year); — 25% price support cut for butter phased in over four years from 2004 (a 10% increase over Agenda 2000 and commencing 1 year earlier); — butter intervention limited to the period between 1 March and 31 August each year and an annual volume limit introduced after which automatic intervention is suspended or replaced by intervention by tender (both these elements already exist for skimmed milk powder intervention); — the introduction of direct payments for milk producers, in the form of the Dairy Premium and Additional Payment, phased in over 3 years from 2004 (introduction brought forward 1 year from Agenda 2000 and maxium aid rate increased); — dairy direct payments to be incorporated into the decoupled Single Payment Scheme from 2007, but Member States have the option to bring this forward to 2005 in certain circumstances; — extension of the milk quotas regime until 2014 from 2008; and 9595841016 Page Type [O] 29-05-04 00:48:10 Pag Table: COENEW PPSysB Unit: PAG1
Environment, Food and Rural Affairs Committee: Evidence Ev 113
— an overall 1.5% increase in milk quotas phased in between 2006 and 2008 (same level as Agenda 2000, but delayed 1 year). The areas in which Member States have discretion relate to the criteria on which to pay the addittional payment element of the dairy direct payments and date of their inclusion in the Single Payment Scheme, together with the criteria for allocating the additional milk quota to producers. Defra is currently undertaking a consultation on these options, which closes on 3 February 2004.12
Implications for Farmgate Prices and Dairy Farm Incomes of the Luxembourg Agreement on CAP Reform
23. The reforms of the dairy CAP agreed at Luxembourg will reduce support prices for butter by 25% (10% more than under Agenda 2000). We have estimated that the net eVect of these changes to the market support measures for the dairy sector will be to reduce total producer returns in the UK by 50 million euros and increase expenditure by UK taxpayers by 160 million euros. However, consumers should benefit from lower prices and when payments are decoupled, the dairy sector should benefit from the resulting eYciency gains, which we have estimated to be be worth 500 million to 1 billion euros across all agricultural sectors. 24. The projected fall in producer incomes results from the fact that the cuts in support prices are not fully compensated by the introduction of direct payments. When fully implemented the cuts agreed at Luxembourg will reduce the Intervention Milk Price Equivalent by 4.38 pence per litre (at an exchange rate of 70 pence to a euro). This represents a further reduction of 0.95 pence per litre over the cuts agreed under Agenda 2000. However, the level of compensating direct payments will now be higher, rising to 2.52 pence per litre (at an exchange rate of 70 pence to a euro), compared to 1.78 pence per litre under Agenda 2000. Although this represents compensation at a higher rate than agreed under Agenda 2000, it will not fully oVset the reduction in prices if they fall to the same extent as the price support cuts. 25.Furthermore, once dairy payments are decoupled the eVect on farm incomes will depend on the type of Single Payment Scheme instituted. Our initial analysis13 suggests that direct payments to the dairy sector as a whole would be about 10% lower under an area based single payment than under a historic entitlement approach. Within this overall figure, on average small and medium size dairy farms would gain, although large dairy farms would lose significantly under an area based approach. We are still considering which approach to adopt or whether to adopt a hybrid approach. 26. Whilst it is safe to assume that farmgate prices will fall as a a result of the reforms, it is less clear that they will fall to the full extent of the price support cuts, especially if the lower prices lead to a contraction of supply. Most analysts are expecting some contraction of dairy production in the short term, with recovery as more eYcient producers expand in the medium term. This is likely to accelerate the existing trend towards fewer, larger, dairy farms. The extent of any contraction and the speed of any subsequent restructuring is likely to depend on the extent to which producers treat their direct payements as decoupled, rather than use them to support dairy production. Under the umbrella of the Dairy Supply Chain Forum, Defra, together with the MDC and the Dairy Industry Association (DIAL) supported by the NFU have commissioned a short study to examine these issues. This should be available later this month and will be published on the Defra web site.
School Milk Subsidy Scheme
27. As part of the dairy CAP, Member States are required to make the EU school milk subsidy scheme available to primary and nursery schools wishing to participate; participation is entirely a matter for the school or LEA. The UK applies only the mandatory elements of the EU scheme, subsidising plain and flavoured whole and semi-skimmed milk and plain whole and semi-skimmed milk yoghurt. The maximum daily quantity per pupil on which aid can be granted is the equivalent of 0.25l of milk. In practice, most milk is supplied as whole milk in ´ of a pint servings. 28. The Government recognises the nutritional benefits of developing milk-drinking habits early in life and Defra, together with DfES and DH jointly fund a national top-up to the EU subsidy of up to £1.5 million a year in England. The taxpayer also bears the cost of some 70% of the EU subsidy. In 2001–02 the aid paid out in Great Britain amounted to over £9 million. We believe the dairy industry must also play a part in promoting the consumption of milk by school children and welcome the eVorts it is making in this area.
12 see http://www.defra.gov.uk/corporate/consult/dairy-capreform/index.htm, for further details. 13 CAP Reform Implementation: Distributional Impact of Area Based vs Historic Payment Schemes, which is available at http://www.defra.gov.uk/corporate/consult/capreformthree/econanalysis-031031.pdf 9595841016 Page Type [E] 29-05-04 00:48:10 Pag Table: COENEW PPSysB Unit: PAG1
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Reform of the Welfare Food Scheme 29. Under the Welfare Food Scheme operated by the Department of Health beneficiaries are issued with tokens which may be exchanged for seven pints of liquid milk a week and free milk is provided to children aged under five in certain day care facilities (complementing the school milk subsidy scheme). The DH has consulted on proposals to reform the WFS whereby fixed face value vouchers would be issued to cover a range of foods still including milk. The provision of nursery milk would be replaced by the provision of milk or fruit. It is likely that these measures would reduce the consumption of milk but it must be recognised that the new scheme aims to improve public health, not to support the dairy industry. DH does, however, recognise the industry’s concerns and has held discussions on options for doorstep deliverers to diversify into the supply of foods other than milk. January 2004
Witnesses: Lord Whitty, a Member of the House of Lords, Minister for Food, Farming and Sustainable Energy, and Mr Andrew Slade, Head of Livestock Products Division, Department for Environment, Food and Rural AVairs, examined.
Q319 Chairman: Minister, welcome. We are sorry Lord Whitty: It was also quite an achievement. I to keep you waiting. It is the exigencies of this think we have set in place a number of diVerent bits place, as you know. If you could perhaps just of work which probably are not really reflected on introduce Andrew that would be helpful. the full Forum agenda but are by the various sub- Lord Whitty: Yes. I have with me Andrew Slade groups of the Forum which would not have been who is the Head of our Livestock Products established without it. The main one being on the Division. CAP reform which has more or less completed its work but the most important one is probably the development of the industry forum which is Q320 Chairman: You know what we have been actually more or less driven by the industry and doing, you know what you are going to get asked would not have been set up, probably, had we not about. This is the final session of a number of established the Forum itself. There is another sub- sessions. Can I ask you a fairly straight forward group which relates to innovation within the question, which I know I have broached with you industry which as you will know the KPMG study informally before. How much importance do you found was one of the problems with this sector. give to the Dairy Supply Chain Forum and, given that the only people that everyone seems to want Q322 Mr Jack: I am just intrigued, this was more to talk to is you, what is the future of this or less put forward by the industry. Going back to particular Forum? the Chairman’s comments in terms of what has it Lord Whitty: I think one of the things which achieved, just refresh my memory, what is its became pretty clear to me after I got this job was objective? that the dairy sector was one of the sectors which Lord Whitty: I am not sure of the precise terms of V was su ering from what the Curry Commission reference but the objective is to address the issues identified as problems throughout the food chain, coming out of the Curry Commission and the the relationships and trust within the food chain. problems with the dairy sector and see how the Partly because of the economics of the sectors, dairy chain could operate more eVectively. which is the focus of your inquiry, and partly because of the inheritance, the relationships within Q323 Mr Jack: How are you addressing this the dairy sector were presumably worse than within agenda deficit then? How are you constructing the some of the other sectors, or at least significantly agenda for the Forum? Is this talks about talks? more acute. It was therefore necessary to bring Lord Whitty: To some extent, yes, because talking together the various elements within the sector to proper turkey must be between the various see whether we could talk through some of the elements of the industry itself, not by the problems. The Government’s role essentially is a Government. We have usefully commissioned a facilitating one there. Obviously we give it some number of studies and usefully discussed others. support. It is really to ensure that all parts of the dairy chain talk to each other constructively and Q324 Mr Jack: What studies have you look for creative solutions to their problems. I have commissioned? always said to the industry at some point it should Lord Whitty: The study by Professor Colman was be industry led rather than expecting the quite useful in guiding the industry to both the Government to run it but we have not yet reached current economics and the eVects of CAP reform. that point so we will continue to chair it and to help The KPMG study, although not commissioned by out, but I think at some point industry has to take us, was usefully discussed as well. responsibility for their own future structure. Q325 Mr Jack: Let us just say that this is an area Q321 Chairman: What has it achieved so far which has been trawled over an awful lot and one besides the fact that you can actually sit around a of the things which has quite clearly come out of table, which seems to be a way forward? the studies that you have mentioned is the challenge 9595841017 Page Type [O] 29-05-04 00:48:10 Pag Table: COENEW PPSysB Unit: PAG1
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8 March 2004 Lord Whitty and Mr Andrew Slade as to how the UK industry can live possibly with and have defined more or less the level of the reform of the CAP with milk prices as low as production and the level of ambition of the 14 pence a litre. Are you or will you be setting a industry. Personally I think this is unhealthy and work programme to address that type of issue? has inhibited the industry’s ability to adapt to Lord Whitty: The discussion on the CAP both at market changes and think beyond quotas. There the Forum and at the sub-group was addressing were some parts of the industry which were in exactly those kinds of issues and the ongoing work favour of the quotas at least being phased out but by the development sub-group was also discussing there were quite a lot which said “No, that is our what organisational, structural, contractual life line to have a quota and we have tradeable changes would be needed to ensure that the assets here and what will you do if you get rid of industry does meet these challenges and the them?” challenges of changing markets as well. It is not isolated to that particular issue although that is one Q332 Mr Jack: One of the arguments was that issue which clearly needs to be addressed if that when intervention was, if you like, the commercial were definitely to be the case. The question of the alternative to selling it to the market place, you had milk price is obviously the centre of your focus but a quota arrangement which helped to control the the real issue is can we have a viable industry and, amount of expenditure in terms of intervention but if so, what does it look like. as the price of intervention goods drops then the need to control the market, in other words the Q326 Mr Jack: I do not want to unnecessarily go market place, should determine what dairy and spend a long time forensically picking through products are produced. Why is it that the what this embryo body does but I wonder if Commission are not persuaded of the argument through you, Chairman, we might ask the Minister that the need for intervention and therefore a quota to provide us with a note to lay out in a little more regime, those days are gone? Why do they hang on detail what precisely the Forum’s agenda is, how it to the old structure? is operating, frequency of meetings, membership, Lord Whitty: I do not know that it would be so that we can get some idea of whether it is just necessarily fair to say that the Commission starting a very cosy way of chatting over a pint of milk from first principles would hold on to the old about the problems of the industry or whether it is structure, I think it is just that the sequence of going to contribute anything in terms of events in the dairy sector as compared with most benchmarking and taking forward the industry at of the livestock sectors, say, is a number of years a time of considerable pressure. On that, let us just behind. We are therefore going through a reform talk about milk quotas. They have survived in the which the beef sector and the sheep sector went round of CAP negotiations but, just for the record, through at earlier stages. I think the Commission did the United Kingdom start out in the probably recognise the inability of some Member negotiations to want to get rid of milk quotas? States certainly to think too much out of the box Lord Whitty: Beyond the end of the current when they are reforming these regimes, but you regime, yes. have to go through the same stages. Some of that, of course, is now slightly overtaken by the post Q327 Mr Jack: You did. When did you envisage MTR reforms but clearly a continuation of quota that the end should come? was part of the cushioning of the reduction of the Lord Whitty: As soon as possible after 2008. intervention price.
Q328 Mr Jack: Which countries were your allies Q333 Mr Jack: Let me just ask this. What analysis and which implacably opposed? have you done in terms of sustaining or, if you like, Lord Whitty: Very few, I think. underpinning the line you have taken, to the extent that my vision in a quota free world is that the Q329 Mr Jack: Just for the record, who was for United Kingdom dairy industry, which says it is and who was against? amongst if not the most eYcient in Western Lord Whitty: The Swedes and the Danes were in Europe, would be that given the opportunity to favour, the Italians were episodically in favour. produce what the market required and the quantities we required we should start showing Q330 Mr Jack: There really was not much some serious commercial advantage? Is that opportunity for you to win under those argument sustained by an analysis that Defra has circumstances? done? Would it be the antidote to the types of price Lord Whitty: Not a QMV at the moment, no. structure which are said to be the prospect for the industry in the immediate future in the light of the changes to the CAP? Q331 Mr Jack: That is disappointing in a way. Lord Whitty: A number of studies, including one When you went to say that you should get rid of by Professor Colman1, indicate that UK them, did you feel that you had the wholehearted competitiveness would lead to a benefit for the UK support of the UK industry behind you? whereas for several other milk producing countries V Lord Whitty: No. I think there are di erent views 1 Colman (Ed.), Phasing out of Milk Quotas in the EU,April within the UK industry and I think quotas have 2002 available at http://statistics.defra.gov.uk/esg/reports/ become a way of life since they have been instituted milkquota/default.asp 9595841017 Page Type [E] 29-05-04 00:48:10 Pag Table: COENEW PPSysB Unit: PAG1
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8 March 2004 Lord Whitty and Mr Andrew Slade it would not. I think that reflects both the Lord Whitty: As I say, we have told them, and I comparative advantage that we have in dairy have to say that my initial impression is that they production and the relative eYciency of large parts were right and that there was a problem with the of the industry. Our expectation would be benefit OFT. We talked, therefore, to the OFT ourselves to the sector from the removal of quotas. That and we talked to the DTI and we have talked to would not mean, of course, that the sector looked the industry in the light of that saying that they like it does now, we still envisage some serious should talk to the OFT if any proposition for restructuring of the sector, but in total terms the vertical or horizontal integration might meet up UK would benefit. with some OFT inquiry, or if it did have an inquiry Chairman: If we could now look at one of the other might reach the negative, they should talk to them inhibitors which is the lack of vertical integration at a very early stage. Many of them have in fact because of competition law. I will ask Diana to lead done that. I would hope that any future proposals oV on this. for integration and collaboration down the chain were discussed with the OFT at an early stage. I think the message about the desirability of greater Q334 Diana Organ: Can we start with the first one: integration could not have been clearer following does UK competition law limit vertical integration the Curry Commission and the Government’s in the dairy sector? acceptance of the Curry Commission’s overall Lord Whitty: I think the industry feels that it does. approach here. There is a whole history here of the abolition of the Milk Marketing Board and the dismantling of Milk Marque in the wake of the competition authorities’ Q338 Diana Organ: Okay. What about the decision and the feeling that the competition diVerence between UK competition law and EU authorities are very harsh on their definition of competition law and the way that EU competition competition or anti-competitive practices. It is not law might be implemented diVerently from UK my view that the OFT are unduly negative towards competition law? In what ways is it possible that vertical integration, indeed we have a number of could be a brake on the development of vertical recent examples, including now the various integration? acquisitions of Milk Link, the latest one being into Lord Whitty: I do not think the basic law is any Glanbia Food and, of course, the Co-op’s joint diVerent between Member States. The competition acquisition of Westbury, which have all been authorities are required to look at the market. The cleared with the OFT which indicates they are not issue in the UK, of course, is that it is pretty much, opposed to vertical integration. as far as liquid milk is concerned anyway, a closed market, more or less, whereas with certain Q335 Chairman: That is very small beer, is it not? continental European countries there is a trans- border trade, and quite substantial trans-border Lord Whitty: That is not very small beer really. trade. Therefore, looking at the dominance in one country is not the whole of the issue. Now one can Q336 Chairman: This is at the margins. have some doubts or criticisms of the judgments Lord Whitty: Westbury is pretty much the biggest which individual competition authorities have facility that we have got in terms of processing so made across Europe but they are applying the it is not small beer. The issue is whether there is, same rules. as the industry sometimes allege, a built in OFT objection to vertical integration. I think it is fairly clear that there is not otherwise such examples Q339 Paddy Tipping: During the course of the would not have got through. After the Curry inquiry a number of bodies have talked to us about Commission we did encourage the industry to talk the notion of a regulatory body which is going to more if there were any potential integrations, oversee the dairy supply chain, surely this has been horizontal or vertical, to make sure they did not canvassed with you. What do you think people are transgress the OFT general approach on that. I asking for to begin with? What is the conceptual think a more open relationship with the OFT has model as you understand it? transpired as a result of that. The OFT’s ultimate Lord Whitty: They are basically looking for position is whatever the market share or the nature somebody to sort out what has been a poor of the structural change, it is a question of whether experience, particularly for the producers of the price of milk and looking at the Government that is likely to lead to anti-competitive practices V rather than domination of the market or closing oV intervening in e ect to set prices. That seems to me of market outlets. not consistent with the general Government’s approach to the industry, all elements of the industry getting closer to the markets and being Q337 Diana Organ: If you are arguing then that it able to sort out these problems themselves. Of is really a perception that the producers have got course a diVerent issue which relates more to the which is the block to greater vertical integration, area of the code of practice and so on will be maybe what is Defra doing to get rid of this myth and to a breakdown in relationships. I do not think it is promote more vertical integration and to tell feasible in today’s world for the Government to farmers “No, it is not like you think it is, it is as promote a regulator of this sector in the sense that it is”? they wanted, the producers in particular wanted, 9595841017 Page Type [O] 29-05-04 00:48:10 Pag Table: COENEW PPSysB Unit: PAG1
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8 March 2004 Lord Whitty and Mr Andrew Slade which is really to determine pretty much the market at all. The milk goes straight from the farm to the price. Whatever the desirability of that, those days processor and straight from the processor to the have gone. supermarket.
Q340 Paddy Tipping: What about the notion of Q344 Mr Jack: What do you mean, therefore, by putting more transparency into the supply chain? the word transparency? If it is a simple food chain How could we do that? You are not very keen on there ought to be simple answers to simple a regulatory body but there needs to be trust and questions. We are struggling. We just heard a shared vision of the way forward, and evidence earlier that those who represent the transparency is an important element of that. industry somehow magically never monitor what Lord Whitty: Yes, I think as with other parts of the retail margins are, it is not their territory, it is not food chain we can all do with a bit more their business to know if retailers are making too transparency both on the question of how prices much or too little, this is not where they operate. are set and what deals are done and on the stability Your image of transparency gives me some hope of arrangements. Some work has been done on that that perhaps the relative shares might be exposed, by the MDC, on pricing in particular. The Food or would they? Chain Centre now is also looking at those Lord Whitty: The across the board ones would be, relationships, it has just started on their look at the yes. There would be some, if you like, relationships within the dairy sector. I accept that benchmarking of what happens in particular parts some help in looking at issues of transparency of the chain. would be desirable, that is a diVerent issue from regulation. Q345 Mr Jack: If I go to the Food Chain Centre and say “what are you doing to make this more transparent”, what are they going to be doing? Q341 Paddy Tipping: I accept that. How would we Lord Whitty: They are analysing the value of the do that then? How would we persuade people to product at the diVerent stages in the chain both work in a more transparent and co-operative way? from the liquid milk side and on the product side. You have got your Forum, which you told us They are at a relatively early stage of their earlier on, in a sense, was not your bag, it should activities. be the industry taking this forward. Lord Whitty: The Forum has played its role in flushing out some of the information both in Q346 Mr Jack: They are going to analyse the value V commissioning studies and in the work of the at di erent stages in the chain. What is the purpose various sub-groups looking at the relationships of this analysis? which exist. As I say, there has been ongoing work Lord Whitty: The purpose is that the industry could on the same area by the MDC and what I think is operate on a more rational basis. As Andrew has very successful work on the food chain conducted just reminded me, the KPMG report also covers by the Food Chain Centre in relation to red meat broad stabs at this area in the supply chain is now being looked at in terms of the value development detail. analysis and relationships within that sector. That is part financed by the Government and also part Q347 Mr Jack: You are a key stakeholder, to quote financed by the industry and one of the several post modern parlance, in the food chain sector. The Curry institutions, as I call them, is hopefully Government have put money into it and you say helping to facilitate the industry to put its own you hope as a result of their work the industry will house in better shape. operate in a more rational way. Perhaps you could explain to us where you see the rationality. What do you mean by that? Q342 Mr Jack: Can I just explore what you mean Lord Whitty: There are a number of diVerent by this word transparency. One of the things that aspects to this really. We have an industry which dairy farmers would like to have sight of is who has operated on a very variable price at the farm gets what in the value chain? Do you mean that by gate, has largely because of the quota system transparency? produced roughly the same amount of milk Lord Whitty: Partly, yes. whatever the state of the market—somebody once said to me, “If the price of milk goes up they Q343 Mr Jack: So you would like to see a proper produce more, if the price of milk goes down they understanding and disclosure by all the parties up produce more”—and the self-interest of all the chain of what their respective shares were, to elements must be a greater degree of stability in answer the question which has permeated through, that chain. Certainly it is in the interests of the particularly from the farming standpoint, the producers, I am pretty certain it is in the interests perception that they are not getting their fair share of the processors. It is an industry which in a sense of the value chain? has some over-capacity—somebody referred to the Lord Whitty: I am not suggesting that we could quotas as being a constraint on production, easily establish what every litre of milk had taken actually they tend to be a motivation for from it. This is actually a relatively simply food production and there is certainly over-capacity in chain compared with red meat. There are only the sense of getting a profitable return on it. There relatively few people who are taking any part of it is some significant instability in the market, both 9595841017 Page Type [E] 29-05-04 00:48:10 Pag Table: COENEW PPSysB Unit: PAG1
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8 March 2004 Lord Whitty and Mr Andrew Slade short-term instability, which the Forum has done sector, and the likelihood is that people have not a little bit about in relation to seasonality, and also complained about the supermarket practices longer term instability because there is no long- because they are afraid of being delisted or other term, or very few, long-term, firm contracts at price sanctions brought against them. I therefore think and quantity in the liquid milk side; there are more the code in its post-OFT inquiry into the big four stable relationships in some of the product side. But is not viable and the OFT’s further work on again if you had more clarity on the flows both of auditing will throw up some examples as to why it the milk and of the price at which milk was being is not operating as it should. The question then is exchanged I think the market could react more what you do about it. Do you have a diVerent sort sensibly to develop longer-term stability. of code which would probably be subject to the same problems? Even if you widened it to include Q348 Mr Jack: Do you think as a result of these the other large supermarkets and possibly even the discussions, bearing in mind that both the large processors, the problem would still remain as processing side and the supermarkets are always to whether an individual small supplier would be going to be the big players relative to the smaller prepared to take advantage of that code if he feared scale supply side, that there will be a real there could be significant sanctions. So I think the development of a mutual understanding about the supermarkets are probably the part of the food need to try to sustain a dairy industry? The chain which is most susceptible to public opinion Committee has learnt about the continual and most sensitive to public opinion and therefore haemorrhaging of numbers and inevitably there are need to recognise their obligations to the supply implications for the well-being of the rural chain in a more corporate responsibility sense economy if you have this continual reduction in the maybe backed up by a code, but nevertheless the number of dairy farms. Obviously some may code is not going to deliver the totality of what is amalgamate with others but there is bound to be needed in terms of trust and stability of the chain. an impact and sustaining a dairy industry would certainly from the industry stand-point be a key Q350 Paddy Tipping: You meet the supermarkets objective. Do you think there would be more fairly regularly, what are you saying to them? What mutual understanding and recognition of the eVect are you putting to them? which large players have on small players in this Lord Whitty: I say all sorts of things to them. market place as a result of the measures you have described? Q351 Paddy Tipping: Well? Lord Whitty: I am not sure if it is entirely as a result Lord Whitty: Of course they will say, “The bulk of of the measures I have described, but clearly part the value added in this chain is not us. We operate of establishing trust and mutual acknowledgement on fairly tight margins, we operate in a highly and understanding of what the position really is competitive sector, a big part of the diVerence does depend on having figures and information between what we charge on the shelves and the 18p, which are largely agreed, and it is probably a sine whatever it is, the 19p-and-a-bit now, that the qua non rather than what delivers a more stable farmers are getting is not down to us.” outcome. It is unlikely that the outcome would be an industry which had the same number of Q352 Paddy Tipping: But this is a strange world, is operators in it as it currently does. I do not think it not? We have an OFT code which many of the we are talking about reversing or even freezing the producers are saying is ineVective and are exit from the industry of a number of producers, frightened of putting into operation; you, the but what has happened until recently has been that Minister, have just agreed it does not work; you the total number of cattle has not gone down very have suggested the OFT knows it does not work, much, the production has more or less stayed so what next? What is the logical next step? constant, and it has been largely amalgamations of Lord Whitty: The next step the OFT are engaged herds and amalgamation also of the processing as in is doing an independent audit themselves which well. The net result is that neither is in a would require people to put their head above the particularly economic position. parapet. I think that will show up maybe not a wide Chairman: The missing element so far is the role range but some serious problems. I am not of the supermarkets and whether they themselves particularly talking about this sector but am talking should be much more subject to a firm form of about their relationships with suppliers in general. accountability. I will ask Paddy to ask some Personally, I think there is scope for a voluntary questions on that. code which the supermarkets, rather than being diVerentially subjected to in terms of the top four, Q349 Paddy Tipping: They are the big powerful could be persuaded to sign up to. That would player, there is a code of practice but how do you change the atmosphere, it would still require people rate the current practice? Is it working? Is it to identify themselves if they had problems about eVective? the non-operation of the code. Taken together with Lord Whitty: No. The OFT study itself shows that, other aspects of greater transparency within the although you can read it both ways. The code of chain, this could with reasonable goodwill—and practice, whilst it might be said it is by and large part of the Forum’s activity is to establish that being followed, has not actually given any security reasonable goodwill in the dairy sector—lead to to the suppliers of all sorts including the dairy more stable relationships, more longer term 9595841017 Page Type [O] 29-05-04 00:48:10 Pag Table: COENEW PPSysB Unit: PAG1
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8 March 2004 Lord Whitty and Mr Andrew Slade relationships and more confidence therefore in the solution. A long-term solution does require sitting long-term future for those who remain in the down at a table with them and that is why whatever industry. the short-term tactics of Farmers for Action and others have been, in the long-term you do have to Q353 Paddy Tipping: But there are some in the discuss this, and that is one of the things the Forum industry who say, “This code of practice ought to is attempting to facilitate. be given the force of law and therefore if the supermarkets do not stick to it—and there is an Q357 Paddy Tipping: What are you saying, as one issue about enforceability there which I accept— of the more respectable members of the they should be liable to some kind of oVence.” agricultural sector? What do you make of that suggestion? Lord Whitty: I am not respectable at all, I am a Lord Whitty: Of course the current code on the top politician. four does have the force of law and a proven transgression would be subject to further Q358 Paddy Tipping: I was going to remind you of Competition Authority intervention. The problem your history as a trade union leader. What would is, we have never got to the stage of proven your advice be to the farmers who feel they are transgression. being ripped oV? What should they be doing? Lord Whitty: As trade unions you can have the odd Q354 Chairman: Why is that? Given that demonstration and strike and whatever but at the everybody complains about everybody in this end of the day you do have to negotiate, and you industry, why have we never had a situation usually have to negotiate with somebody who is where— more powerful than you. You need to get Lord Whitty: They complain about everybody else yourselves together rather more eVectively in terms to me and you and in the pubs and clubs of the of how you negotiate, which in a sense is one of the agricultural community, but will they say, “You Curry messages, that the industry does not get itself diddled me on that contract” when they want to together suYciently and even the big co-ops within sign another contract next week? The answer to the sector do not always agree with each other and that is not very often. That is not just a criticism there is a lack of cohesion between the producers of the industry, it is understandable that if you and the processors when they are dealing with the want to remain in business you do not risk supermarkets and the catering companies. delisting. I think the supermarkets are not prepared Chairman: Whatever the situation at the moment, to be quite as harsh in that regard as people fear, there are those who will predict it will get that much but the fear is a very real one. worse as prices fall after the Single Farm Payment. I will ask Bill Wiggin if he can tease out from you Q355 Chairman: People go from being a member what you think is going to happen. of a co-op to being a direct supplier to going oV on their own, producers do take all manner of risks, Q359 Mr Wiggin: Let’s start with the decision to yet you are telling us that the big bad threat of the adopt a flat rate payment. Do you not think this supermarket prevents them from really actually may penalise the most eYcient dairy farmers, that saying what they think, so their only recourse is to is those who hold the most quota per hectare? picket. That is a pretty sad indictment of this Lord Whitty: There will be some redistribution, industry. both away from dairy and within dairy, but that is Lord Whitty: I do not think their only recourse is the nature of the total reform. It does have a to picket in fact. The relationships with the slightly diVerential impact on dairy, partly for the processors and the retailers are best discussed reasons we were discussing earlier, namely that the around a table rather than in the carpark of a earlier stages of reform for dairy are later than regional distribution centre from my point of view. those for other sectors. So there would inevitably There are times when shock tactics have an eVect be a distributional eVect if you moved from what but actually that is rather short-term and in the is a production-related subsidy to an area-related long-term they have to sit down and discuss. At the subsidy. Within dairy you could argue that the end of the day the supermarkets are still going to distribution was in favour of small and medium be there never mind how many pickets David producers. Some aspects of social and Handley and his friends manage to mount. environmental policy would be, yes, you do need to support them, but that is not the objective of the Q356 Chairman: They certainly moved a lot policy, the objective of the policy is to provide over quicker last time when they had the pickets on; the a pretty long lead-in period a situation where there 2p went on. There is an argument about whether is no diVerential in terms of support to farming it went— except one which reflects the public good which Lord Whitty: The more respectable elements in the farming delivers to the rural community and to the farming industry will say it was because of a lot of landscape, and that farmers’ decisions are therefore very solid work which the former president of the based on what the market is. That applies to dairy NFU was doing. I am not saying that the picketing as much as it does to anybody else. If you are a has no eVect, clearly if you are picketing you farmer with so many hectares, you would then have immediately start thinking a little more sharply to decide in the light of the fact all payments are about what you are doing, but it is not a long-term now decoupled, or will be at the end of the process, 9595841017 Page Type [E] 29-05-04 00:48:10 Pag Table: COENEW PPSysB Unit: PAG1
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8 March 2004 Lord Whitty and Mr Andrew Slade what is your best future market. Yes, as compared Lord Whitty: All parts of the United Kingdom will with under the old system to the end of the new be decoupled. system, dairy will in aggregate lose out and some of the more intensive, larger dairies would lose out within that. Q364 Mr Wiggin: I know that. Lord Whitty: So that means there is no additional subsidy for any additional pint of milk or Q360 Mr Wiggin: So you agree it actually penalises additional number of sheep. So in one sense they the most eYcient? are all equal. In marketing decisions or whether Lord Whitty: “Penalise” is not the word I would they will increase or decrease production, that is the use. The most eYcient will be the most competitive relevant thing. I appreciate that psychologically if and the most able to face up to the new challenges. you are getting a closer amount to your historic If you are looking at a static position and see a payment one side of the border as against another, farmer with so many cows per hectare, with so you may feel better oV, but actually the decision much production per hectare now, with so much facing you is based on the fact you are now in a subsidy particularly as the direct payments come decoupled world, and there should therefore not be through, if he remains absolutely static at the end any market advantage to being on diVerent sides of of that will he do less well than somebody slightly the border. Obviously, I would have preferred if all smaller or somebody in a diVerent sector? Of parts of the United Kingdom had taken roughly course, the whole point of the reform is to get speaking the same decision, but that is one of the everybody more market orientated, so they are consequences of devolution and people take engaged in a process of restructuring the industry decisions accordingly. There are parts of the likely which will end up with a more competitive sector, so there is no point taking somebody in 2003 and Welsh position which will be less welcome to the then somebody in 2013 in a totally static position— Welsh side of the border; they may well be using if they have any nous, and many of these farmers national envelopes, for example, which we have have quite a lot of nous in terms of the more decided not to. progressive elements in dairy farming, they will put themselves in a position to benefit from the market Q365 Mr Wiggin: There is a real problem though orientation. with severely disadvantaged areas which in my constituency are classed as such because of their Q361 Mr Wiggin: So we all want market altitude, they are not moorlands, they are just one orientation, we all want to bring diVerent parts of side of what is the other side a Welsh mountain, the dairy sector together to talk to one another, yet and yet those farmers are going to receive a third the way the Government sends out that message, of the flat rate payment which their neighbours on and it is diVerent in Wales and it is diVerent in the other side and probably their neighbours Scotland, is to say, “If you are the most further down the hill get. You have created with competitive, you have to face the toughest time”. this scheme some extremely peculiar situations for It is an interesting way of delivering your farmers going forward. Do you think it needs to be ambitions, is it not? looked at again? Lord Whitty: What we are delivering is a continued Lord Whitty: When we proposed, suggested or and definite level of support for farming and an hinted pretty broadly was that we were likely to ability for farmers themselves to adapt to the favour a system which moved towards an area market. If you were talking to entrepreneurs in any payment rather than an historic payment. There other sector, they would say, “That is exactly what were a lot of grumblings from some parts of the we want.” industry and a lot of support from other parts of the industry taken across the board, but one thing Q362 Mr Wiggin: I am not sure they would. they were united on was that if we do that we would Lord Whitty: Well, I think they would actually. I have to do two things. One was to ensure it is think most entrepreneurs in most parts of the phased in over a reasonable amount of time and industry would say, “What we want is certainty the other is that you avoid the most substantial about what Government is going to do and redistribution. The first was met by having what freedom to meet the market for our products on was probably the longest transitional period we our own decisions.” could conceive of which was eight years, the second was by dividing England between two areas so Q363 Mr Wiggin: I am sure they would agree with eVectively there was not a huge movement of the that part, I am not sure they would agree with money, if you like, up the hill. In order to comply the—well let’s talk about the diVerence with with Brussels rules you have to have an area which Scotland and Wales. Certainly in my constituency has some legal certainty about it, you cannot on the Welsh borders there are real diYculties simply define it by current structures of ownership with competitiveness now. To what extent do you or terrain, and the SDA border is one recognised think English dairy farmers are going to be in European and British law, English law, and disadvantaged in comparison with their neighbours which was the most obvious way of stopping the across the border because of the way the Assembly most drastic of the redistributive eVects. It still has chosen a diVerent type from you in terms of means the money within the SDA area will be the the Single Farm Payment scheme? same in total as it ever has been. The distribution 9595841017 Page Type [O] 29-05-04 00:48:10 Pag Table: COENEW PPSysB Unit: PAG1
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8 March 2004 Lord Whitty and Mr Andrew Slade within the SDA area, as for distribution in the non- Lord Whitty: I have already received, and would SDA area, will of course change but the total anticipate further, representations from the dairy amount of money in the SDA area will be the same. sector in the South West. I would not be too This does have some anomalous eVects. I know the disparaging if I say I rather expected that whatever beef sector in particular is very concerned about the proposition we have put out. Just to be clear on the diVerentiation of those who happen to be classified nature of the redistribution, we are talking about as SDA farms in part or in whole and those pretty a period where at worst the large dairy farms would much adjacent. We have received representations have over eight years of reduction of up to 17% in from particularly the beef farmers and other local their support, whereas the smaller and medium groups of farmers who are involved in that and sized farms would actually have an increase, the clearly before we finalise these regulations we will smaller ones a significant increase. When we talk have to take those representations into account, but about the South West in particular, bearing in mind wherever you draw the line there will inevitably be they do tend to be on the vociferous side, there are some anomalies. The bigger issue was if we had actually more small to medium sized farms there gone for a single area for England the than in many other parts of the country who might redistribution which you and the dairy sector are actually have a better case to complain about the complaining about would have been significantly redistributive eVect. greater. Q370 Mr Jack: Could you explain to me, because Q366 Mr Wiggin: Let me start by saying I am I really do not understand, how it is that the SDA grateful for the fact you are still considering. Can areas have such a low level of support? Up to now, I also say there is another worry which is, if you when if you like we had domestic control over are in of these severely disadvantaged areas you will payment for disadvantaged areas, we did it the have to increase your production to maintain your other way round, we looked at the special income, and therefore you may not have moved the characteristics and we made some additional money up the hill but you may have moved the payments to compensate for the problems of cows up the hill. farming in the least able areas to sustain Lord Whitty: That is one of the issues we need to agriculture. But looking at the Farming Today assess as to how important that might in practice interview, which I am sure you must have heard on be, because that could have in some circumstances 2 March, we have the complete reverse. Could you just explain to me how does SDA end up with at least some environmental downside as well as V rather distorting the pattern of production. e ectively the lowest level of support when there Mr Slade: In certain parts too few cattle is a are still tremendous structural problems in those problem environmentally, just as much as in other parts of the country? areas within the SDA too many is a problem. Lord Whitty: The current payment, the historic payment, in the SDA area is entirely based on the production SDA areas, and the number of sheep Q367 Chairman: The grazing implications. per hectare in some of those upland areas can Mr Slade: Yes. probably be counted on the fingers of a single hand. If you are basing it on the historic payments then it is sparsity which is the answer as compared to Q368 Paddy Tipping: The real issue in upland areas lowland areas. Of course that calculation does not has been over-grazing and I am pleased to hear the take into account the HFA which is unaVected by Minister say, “We think there may be some all these calculations. environmental consequences of this and we are mindful of this and need to look at it.” Part of this could be looked at as a result of the hierarchy of Q371 Mr Jack: Just for the record could you refresh our memory about HFAs? agri-environmental payments. Lord Whitty: The Hill Farm Allowance, which is Lord Whitty: That is one way of dealing with it, made on an area basis in most of the SDA areas, certainly both the entry level scheme and higher is unaVected by any of these calculations. So that, level schemes could perhaps provide some help to if you like, national pillar two finance part of the farmers in those situations. equation, remains the same. It is a diminishing absolute figure but it is not altered by these Q369 Chairman: Just before I bring in Mr Jack, changes. you have obviously been lobbied by the beef industry, unless I am misunderstanding this you are Q372 Mr Jack: Looking at the Farming Today going to be heavily lobbied by the dairy industry interview it may be a partial position in terms of on the way in which the English Single Farm the total amount of support which could be made Payments are going to be made. This was the part available, and I would very much like a note to try of the industry, certainly in the South West, which and make certain I have a proper view of what is was adamant it had to be historic, it could not be going on. The discussions centred on Mr Robert area based. Okay, we have a historic compromise, Gosling who had 320 dairy cows—which going I could say, in that it is moving from one to the back to some evidence earlier is actually a large other, but that industry is going to be very herd, so here we have somebody who is twice the unhappy. level which we are told is large and therefore 9595841017 Page Type [E] 29-05-04 00:48:10 Pag Table: COENEW PPSysB Unit: PAG1
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1 eYcient—produced 22 million litres of milk every be the same amount of money but distributed at year, 7,000 litres a day, which all sounds very good the end of this period by how much land you have news, but then you turn over in the transcript and got, provided you are in cross-compliance. That this particular farmer is going to be some £24,000 therefore is bound to mean somebody who has a year worse oV than a comparator in a non-SDA relatively small amounts of land and relatively large area. I was not certain what the basis of those numbers of beasts will have less of a share of that, numbers was but it does not seem to be quite the but the total amount in the SDA area as a whole picture of trying to assist farming. The diVerence is will remain the same. that the Single Farm Payment is about £20 per Mr Wiggin: But are the SDA flat rate payments the acre, £60 per acre less than the £80 attracted in the same? Sorry. non-SDA land. That just seemed to be the wrong way round and I do not understand how those numbers had come out, and why the SDA seemed Q375 Mr Jack: One of the things which Herr to get the worst deal. Fischler said he did not want to see under the Lord Whitty: The total amount of money within proposals put forward by Member States was the SDA does not alter as a result of this. substantial redistributions of monies, he was Mr Wiggin: What do you mean by that? concerned about that. Clearly you have won the argument in global terms about what you want to do in the United Kingdom, but in the SDA—and Q373 Mr Jack: If it does not alter, if it is a diVerent I follow the logic of the argument you have put label on giving some of it back to the farmer, just forward in relation beasts to land—are we not explain it in money terms. Here we have, according to the numbers we have been given falling out of going to see some structural changes occurring? In this Farming Today interview, a £60 deficit per acre the case of this particular dairy farmer it may well if you are in a severely disadvantaged area. Is that be—if the numbers are correct according to the order of magnitude diVerence right or wrong? radio interview, he says here and I quote, “The V Lord Whitty: I do not know about that individual di erence between myself at A and the farm down farm clearly, but as with the rest of England if you the road which is non-SDA and the same acreage move away from a production subsidy to a land will be something like £24,000 a year, so that is subsidy over an eight year period then the more quite a major impact on our business.” I would intensive the producers operating on a smaller agree with him, to try and take £2,000 a month out acreage will lose out compared with the less of the costs of his business—and he is already in a intensive producers. In a sense, put crudely in diYcult area anyway but he has 325 cows and probably that case, the subsidy will have moved seems to be doing all right—to find £2,000 per away from cattle towards sheep in that area if that month savings is by any stretch of the imagination is the kind of farming which operates in the an awful lot of money to take out of his business. uplands. If you do not want to see a structural change in terms of farming in areas like that, how are you Q374 Mr Jack: Let us focus on this particular going to address that kind of issue? farmer. I am still not clear, and I will put my hands Lord Whitty: I have never said I do not want to see up and say it may well be my lack of any structural change, I think the structural change understanding, and it probably is, but that is why should be determined by what farming in each of I am just probing this. Here we have a farmer in a these areas could produce for the market. If that severely disadvantaged area, in this case in particular enterprise is in the long-run not Derbyshire, looking after over 300 cows, so it is the sustainable at the level of support we continue to kind of unit we might want to encourage because give, then clearly there will be some structural it is large and we hope it will be eYcient. The net change there as elsewhere. As I said earlier, one of result is a severe reversal in terms of the support, the ways in which you avoid huge redistribution is the decoupled payment which the farmer is going by saying the upland areas, broadly speaking, will to get. Bearing in mind the importance which I be treated separately from the lowland areas, guess this farmer has to the rural environment in because otherwise there would be, given the vast which he operates, one might be inclined to say, acres of moorland you might otherwise have to “We would want to find ways of sustaining this enter into the equation, a very significant shift, farmer given the implications to his piece of rural much greater than the 10 or so % out of dairy we Derbyshire if he were not to carry on what he is are talking about here, away from the lowland doing at the moment.” With 320-odd cows it ought probably more intensive producers to the uplands. to be quite a viable business. I do not understand So that would be a very serious— how these numbers have fallen out and why you then go on to say that the total amount of money in the SDA remains the same. I do not understand Q376 Mr Jack: Let me ask you another question. how that works. Please explain it to me. What modelling have you done to assess the Lord Whitty: I thought I was explaining it to you. impact? You have said to us that perhaps you The amount of money in the SDA area at the would not shed a tear if this particular farmer moment and who gets that money, is determined moved away from dairy to— by how many cows you have got, how many sheep Lord Whitty: I did not comment on this particular you have got. The amount of money in future will farmer, I said there will be some structural change. 9595841017 Page Type [O] 29-05-04 00:48:10 Pag Table: COENEW PPSysB Unit: PAG1
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8 March 2004 Lord Whitty and Mr Andrew Slade
Q377 Mr Jack: You have talked about structural Q382 Mr Jack: It sounds to me as if you have been change. You have said, “We will produce what the giving a little thought to these less distorting and market will require”, but if I have understood you alternative methods, perhaps you would like to correctly livestock producers in general in the SDA share your thinking with the Committee on this? are all going to face the same problem and, bluntly, Lord Whitty: I would not at the moment. The issue in the SDA areas there is not a lot else you can do is, if you are going to use any diVerentiation it has but graze things either to produce meat for the to be one which is established legally to the table or, in this case, milk for the bottle. So if your satisfaction of the Commission. The most obvious range of alternatives is not that great, one will see such diVerentiation is the SDA, there is not a very potentially farmers saying, “Enough is enough”, obvious alternative. That is a dilemma we have. and then you will have the diYcult problem of what Wherever you draw the boundary, there will be is going to happen to the rural environs, the anomalies either side of the boundary. I regret this landscape, et cetera, et cetera. So what modelling particular farmer would appear to be particularly has Defra done to try to work out what the likely suVering from that because he has an immediate economic impacts and commercial decision-making comparable operation down the hill, but there will there is going to be by farmers in this area? undoubtedly be—and we are talking about a period Lord Whitty: If you are saying what will be the of eights years’ adaptation—changes in structure of sectoral impact area by area— ownership to adapt to the new situation. But there will be some downsides. Some of those downsides, as I said to Mr Tipping earlier, could be addressed Q378 Mr Jack: No, I asked a specific question, by the introduction of environmental schemes what modelling have you done to try and work out which would benefit people who were still grazing the impact on these areas of the policy mix which cattle or sheep. you have now decided on? Lord Whitty: Modelling of what? Modelling of Q383 Mr Jack: You are actively looking at all of which sector gets the money or of where the total these options? support is going? Lord Whitty: Yes. Chairman: I think we are looking at the diVerences within the SDA area but also between the SDA Q384 Mr Jack: When do you think you might be areas and the non-SDA areas. Non-SDA areas able to come to some conclusions? seem to be doing better. Lord Whitty: There are a lot of aspects of this policy on which we need further consideration: the nature of cross-compliance, for example, on which Q379 Mr Jack: Here is the Colman and Harvey we will be consulting. There are others on which Report which talks about the future of UK dairy we have to wait for the final definition by the EU farming, it is a piece of economic modelling, have rules which we are not now expecting for another you got a similar document tucked away in Defra couple of months. That takes us to at least May which says, “The future of farming in the SDAs”? and probably June before we can finally indicate Lord Whitty: No, is the short answer to that. the total structure of this package.
Q380 Mr Jack: So you do not know what the Q385 Mr Jack: It sounds like what I call the impact is going to be of the policy you have “ministerial summer” when you might just be able adopted on SDAs? to say something further about this. Lord Whitty: We know what the overall eVects will Lord Whitty: Roughly that order of timescale. be but we do not know, and we have not got the modelling, what the eVect will be in individual Q386 Mr Jack: Finally in terms of the diVerentials, sectors. Indeed when I was referring earlier to the because the same radio interview compared and earlier modelling, the redistribution would have contrasted the Scotland, Wales, England situation, actually greatly benefited, disproportionately which Mr Wiggin addressed earlier, are you benefited, the SDA area. We have now moved away worried at all about quota migration from England from that to put the SDA area— to Scotland? Again some of the diVerentials, farm versus farm of similar size, are quite substantial, and Scottish farmers might be busy plundering our Q381 Mr Jack: Mr Wiggin expressed joy at the fact quota. Are you not worried about that? there was still a chance for you to consider these Lord Whitty: They can buy the quota if there is matters and decide what you were going to do. quota on the market, but I go back to my earlier How are you going to decide what you are going point, that in a decoupled system the Scottish to do when you do not know what the eVect is you farmer will be getting the money on the basis of his want to respond to? land. There is no particular point, unless he can Lord Whitty: There are two diVerent eVects. One make a profit out of it, acquiring additional quota. is the eVect of not having a diVerentiation, the If there is profit to be made out of it, then the other is, is there an alternative diVerentiation which English farmer will be faced with exactly that same would be less distorting. If there is an alternative situation and no doubt will not wish to sell him the diVerentiation, is that acceptable in terms of the quota, or at least sell it at a rather inflated price. rules which were agreed last June? So I do not think there will be a general migration 9595841017 Page Type [E] 29-05-04 00:48:10 Pag Table: COENEW PPSysB Unit: PAG1
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8 March 2004 Lord Whitty and Mr Andrew Slade of quota, but there is a situation where that Lord Whitty: The SDA includes all moorland. obviously could happen, and because of the psychology of the diVerent methods of payment it Q389 Mr Wiggin: It is moorland and highland, is is possible there will be some slight tendency in that it not? direction, but I do not think it is a very rational Lord Whitty: Yes, it includes lots of other areas economic one. which are not moorland. Mr Wiggin: That is the danger, that people tend to think of it as moorland and it is clearly not. Q387 Chairman: What we have been trying to tease Thank you. out is in a sense this industry is being driven towards greater eYciency and it is going to be Q390 Chairman: We have now finished our driven towards greater eYciency up the food chain questions. There were two bits of evidence which whether we like it or not, and there may be some we wished to have back in terms of supplementary written evidence. There were Mr Jack’s two points, things we will have to say in our report about that, firstly in terms of helping us to understand how the but at the same time that producer, potentially Forum operates and the terms of reference, even from what we are hearing, is possibly going to be V though there are no formal terms of reference it moving in a slightly di erent direction away from would be useful to know what the operating system Y greater e ciency if the numbers are to be believed. is. Then the second issue is where are we with I think the one thing which surprised me was the regard to some of the negotiations on the actual notion that there is a neutral eVect in terms of the figures. We could do with some dates but also some SDAs when in eVect we do not really know that understanding of what is likely to be happening yet because the numbers have not yet been over the next few months. Is that something you calculated. You may want to come back to us in could provide us with? terms of additional evidence to help us tease out Lord Whitty: I am not sure what you mean by what implication that is going to have, but I will “negotiations”. say no more. Chairman: People are coming to you asking you to Lord Whitty: I did not say there would be a neutral look again at some of the aspects of this. eVect in the SDA, what I said was the amount of “Negotiation” is maybe too strong a word, “discussion” perhaps, as to how that will take money which is currently within the SDA would V remain within the SDA, it would clearly be e ect. V redistributed in a somewhat di erent way. Q391 Mr Jack: If you could include what I call the Chairman: It is not going from the SDA into other mechanical working-out of the numbers to V areas, so I would take that to be a neutral e ect. illustrate the points you were making, so I can Within the SDAs there will be some redistribution personally properly understand, compare and but that obviously needs to be talked through quite contrast between SDA and non-SDA areas? carefully. Perhaps you could put a little model in for us which would certainly help me. Lord Whitty: I think we can do modelling to that Q388 Mr Wiggin: In your answer to Mr Jack you extent. talked about agriculture based on the support it Mr Jack: Thank you. can receive, what I am unhappy about is that in my first question I think I pointed out how you would Q392 Chairman: Thank you for your evidence. I drive farmers essentially to farm more intensively am sure you will read it. I do not need to say that in severely disadvantaged areas, and there is a you cannot undo what you have so far done but danger of course they will simply give up and then there may be additional points. we lose the environmental benefit, because if the Lord Whitty: Indeed. Thank you very much. SDAs are at such a disadvantage then their land value will also fall, so you will hit them twice, not Q393 Chairman: If I can ask everyone to leave because we are now going to try and make some only with a lower flat rate payment but also with sense of what form our report is going to take. a drop in their land value. I am very worried about Lord Whitty: Good luck! that. You also mentioned moorland, and my particular area and the area we were talking about Q394 Chairman: All I would say is we need every in Derbyshire are clearly not moorland, so the legal bit of good luck to make sense of it. If people definition of SDA which you were talking about would not mind having their discussions outside clearly does not apply in a uniform way, and because we will have to struggle on a bit longer. perhaps that is also worth having a look at. Lord Whitty: Thank you. 9595841018 Page Type [O] 29-05-04 00:48:10 Pag Table: COENEW PPSysB Unit: PAG1
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Supplementary memorandum submitted by the Department for Environment, Food and Rural AVairs (L6b)
THE DAIRY SUPPLY CHAIN FORUM (Dscf)
Composition and Terms of Reference The Forum was established by Defra in 2002 to help address in the dairy sector some of the issues raised by the Curry Commission in relation to encouraging supply chain co-operation, increasing eYciency and promoting the sustainable development of industry. It provides a framework within which all links in the dairy supply chain can come together to discuss the challenges facing the industry and develop collaborative solutions. The formal Objectives of the Forum are attached at Annex 1. Lord Whitty currently chairs the Forum, with the secretariat functions being provided by Defra. The Forum has representatives from all parts of the dairy supply chain: the farming, processing, retail, and food industry sectors as well as the Milk Development Council (MDC) and Government. It currently meets on a quarterly basis. A list of the organisations involved is attached at Annex 2. The role of Government in the Forum has been to facilitate industry action to address the challenges facing the sector, and it was always the intention to pass its ownership across to the sector itself at an apposite point. It is foreseen that during the course of this year the Forum will have shown suYcient progress that participants from across the supply chain will be willing to continue the Forum under industry leadership and, to this end, we will be increasing the resources devoted to supporting the Forum and its sub-groups.
Work of the Forum In the first instance, simply bringing the various parties in the chain together to talk yielded useful benefits. However, an early substantive success of the Forum was to identify and achieve consensus that the increasingly seasonal nature of milk production in GB and its eVect on price volatility was an issue that could be addressed collaboratively by the industry. As a result the Dairy Industry Association (DIAL) organised a seminar attended by the major milk purchasers, including co-operatives and processors, on the issue and subsequently many purchasers have altered their payment structures or taken other action to address the problem. Subsequently, the Forum has focussed its attention on addressing some of the issues raised by the KPMG report on Prices and Profitability in the GB Dairy Chain (which amongst other things recommended that an industry forum be used to address some of the supply chain issues) and on the implications of CAP reform for the dairy sector. However, the Forum formed the view that to make progress quickly in these areas, more focused groups were required and it therefore established a number of dedicated sub-groups, made up of appropriate experts from diVerent parts of the supply chain, to take forward discrete areas of work. The main Forum now operates in many ways as a steering group for these sub-groups: identifying potential areas of work; monitoring their progress and ensuring that their work is co-ordinated with each other and with other initiatives that impact on the dairy sector, such as the Food Chain Centre’s value chain analysis1 and the implementation of the Strategy for Sustainable Farming and Food.
The CAP Reform Sub-Group The Cap Reform Sub-Group is chaired by Andrew Slade, Head of Defra’s Livestock Products Division, with secretariat support from his team. It has been meeting every six to eight weeks since late last summer. Its membership is drawn from the farming, co-operative, processing, retail sectors and the MDC. Its aims are: — to consider the implications for the English dairy industry of CAP reform; — review options for implementation of reform, including possible early decoupling and to ensure decision were taken on the basis of a common understanding; and — assess the likely strengths and weaknesses of the national industry in meeting the challenges of reform, and advise on how the former might be maximised and the latter positively addressed.
1 The Food Chain Centre is also looking at ways in which the eYciency of the dairy supply chain can be improved. Working in partnership with the NFU, MDC, DIAL and the British Retail Consortium it is carrying out an analysis of a number of supply chains involving various products. The aim of this project is to identify areas where eYciencies can be made. Initial results from similar work carried out in the red meat sector by the Food Chain Centre in partnership with the Red Meat Industry Forum identified potential cost savings of up to 10%. The dairy sector project is being part funded by a £500,000 Agriculture Development Scheme Defra grant from Defra. The Food Chain Centre is engaged in other activities which have the potential to benefit the dairy sector. These include the promotion of benchmarking and work on information sharing. These activities are also being part funded by the Government. More generally, through Defra’s support of English Farming and Food Partnerships, we are seeking to promote and support co-operation and collaboration between farmers, and between farmer and the food chain. 9595841018 Page Type [E] 29-05-04 00:48:10 Pag Table: COENEW PPSysB Unit: PAG1
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The desired outcome from the Sub-Group is an industry that is “ahead of the game” in Europe in successfully tackling the issues posed by CAP reform. The report into the Future of UK Dairy Farming by Professors David Colman and David Harvey was commissioned by the Sub-Group. It was initially expected that the CAP Reform Sub-Group would have a relatively short life. However, at the last meeting, it was agreed that, in pursuing its first and third objectives, the Sub-Group could usefully carry out further work on the wider implications for the dairy sector of the recently announced model of the single payments and to this end the group intends to commission further analysis from Professors Colman and Harvey. This should form the basis of a wider analysis that can feed into the work of the Industry Development Sub Group
The Industry Development Sub-Group The Industry Development Sub-Group is chaired by Peter Walker of Arla Foods, with the secretariat being provided by the NFU. It met for the first time in December, and has met twice since then. Its members represent at senior level all parts of the dairy supply chain, as well as including an expert from the banking sector. The aim of this Sub-Group is to facilitate the long term sustainable development of the dairy supply chain. The desired outcomes are: — To have identified and analysed challenges facing the dairy sector and to have identified how the it might develop to meet them. — To thereby enable individual business to make informed decisions on how to address these challenges, rather than providing a prescriptive “blueprint” for the sector. The Sub-Group is already using some of the early outputs from the Cap Reform and Innovations Sub- Groups. It has agreed to begin by looking into: — The international, EU and national policy frameworks within which the dairy industry will need to develop over the next 5–10 years. —EYciency (particularly strategies at farm level). — Demand. — Supply (also looking at the dynamic in neighbouring Member States that might impact on UK supply, such as the Republic of Ireland). —EVects of CAP reform (to be taken forward by the CAP reform group). — Investment (levels and barriers). — Regulation (regulatory barriers). — Image of milk. — Skills and training (on a vertical, cross chain basis, building on work by the Sector Skills Councils). The Sub-Group has split into a number of teams to take forward each workstream. First outputs for wider consumption are expected by the summer.
The Innovations Sub-Group The Innovations Sub-Group is chaired by Brian Peacock, Chairman of the MDC. The MDC also provides secretariat support. The sub-group’s membership is drawn from all parts of the supply chain as well as colleges, training organisations, consultancies and the food industry. Unlike the other groups it has sought to gain a wide number of participants through organising workshops to examine various themes on product and market development and innovation. To date two workshops have been organised. If issues emerge that require further analysis then smaller groups may be established to address these. The objective of the Innovations Sub-Group (or “Workshop”) is to stimulate and co-ordinate innovation for the development of British dairy products by creating a forum for the exchange of market information and ideas that anticipate consumer needs. It’s principle terms of references are: — To stimulate innovation in process technology, new product development, packaging and marketing of new dairy products in Britain. — To anticipate and meet market opportunities for British dairy products at home and abroad. — To highlight developments in consumer preferences for dairy products and monitor market trends. — To monitor, study and interpret the worldwide introduction of new and innovative dairy products. — To identify barriers to innovation and to liaise with governments, funding and regulatory bodies to overcome such constraints. 9595841018 Page Type [O] 29-05-04 00:48:10 Pag Table: COENEW PPSysB Unit: PAG1
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Work is presently progressing in the following areas: — Consumer Preference (looking in particular at lifestyle changes, the need for diVerentiation and segmentation of the dairy market). — Monitoring the worldwide introduction of new and innovative dairy products (looking at “health” and “wellbeing” dairy foods; health claims; the gathering and dissemination of information about worldwide dairy product innovation and new technology). Future work is likely to focus initially on: — Barriers to market development (including studies of purchasing practices and Regulations covering the sector to gauge whether they provide unnecessary barriers to innovation). — A study of health aspects of dairy products. — Facilities and services for innovation. 29 March 2004
Annex 1
DAIRY SUPPLY CHAIN FORUM: OBJECTIVES
Strategic Objective To increase the eYciency and promote the sustainable development of the dairy supply chain. Desired Outcome Improved collaboration across the dairy supply chain leading to eVective and innovative approaches to the challenges facing the sector that increase the eYciency and promote the sustainable development of the chain as a whole. Outputs To identify challenges facing the dairy sector that can be appropriately addressed through collaboration between some or all of the participants in the dairy supply chain. To establish sub-groups, containing appropriate experts from diVerent parts of the sector, to consider and agree eVective approaches to the challenges identified that will increase eYciency and promote sustainable development. To monitor, guide and evaluate the progress of the sub-groups.
Inputs Chairmanship and Secretariat for the Forum from Defra, at least until mid-2004 and thereafter a continued Defra involvement, but with Industry taking the lead. If appropriate, Defra involvement in, but not necessarily Secretariat support for, any sub-groups addressing particular issues. Willingness of other participants to devote time to the quarterly meetings and for organisations to devote time and resources to any sub-groups addressing particular issues. Success Criteria That during 2004, the Forum has shown suYcient progress, in promoting through collaboration eVective and innovative approaches to the challenges facing the sector that increase eYciency and promote sustainability, that participants from across the supply chain are willing to continue the Forum under industry leadership. May 2003
Annex 2
ORGANISATIONS REPRESENTED ON THE DAIRY SUPPLY CHAIN FORUM Arla Foods UK British Retail Consortium Country Land and Business AssociationDairy Crest Ltd Dairy Farmers of Britain 9595841018 Page Type [E] 29-05-04 00:48:10 Pag Table: COENEW PPSysB Unit: PAG1
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Dairy Industry Association Ltd (DIAL). Defra Federation of Milk Groups First Milk Milk Development Council Milk Link National Farmers’ Union Provision Trade Federation Robert Wiseman Royal Association of British Dairy Farmers Safeway Tenant Farmers Association
ORGANISATIONS REPRESENTED IN THE DAIRY SUPPLY CHAIN FORUM SUB-GROUPS CAP Reform Sub Group British Retail Consortium Dairy Farmers of Britain Dairy Industry Association Limited Defra First Milk Milk Development Council Milk Link National Farmers Union Industry Development Sub Group Arla Foods (Chair) Dairy Crest Ltd Dairy Farmers of Britain Dairy Industry Association Limited Defra First Milk Ltd HSBC Milk Development Council Milk Link Ltd National Farmers Union Nestle[acute] Robert Wiseman Dairies Royal Association of British Dairy Farmers Tesco Innovations Workshop Alvis Brothers Limited Associated Creameries Co-operative British Cheese Board Cricketer Farms Dairy Crest Dairy Industry Association Limited Defra Dragon Brands Express Dairies Food From Britain Highgrove Foods Imperial College London Lynher Dairies Midlands Co-Op Milk Development Council Milk Link Royal Association of British Dairy Farmers 9595841018 Page Type [O] 29-05-04 00:48:10 Pag Table: COENEW PPSysB Unit: PAG1
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Safeway Stores plc J Sainsbury plc The Fifield Organisation The Society of Dairy Technology Waitrose Welsh Development Agency 29 March 2004 937740PAG1 Page Type [SE] 29-05-04 00:08:52 Pag Table: COENEW PPSysB Unit: PAG1
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Wednesday 31 March 2004
Members present
Mr David Drew, in the Chair
Mr Colin Breed Diana Organ Mr Michael Jack Paddy Tipping
Witnesses: Ms Penny Boys, Executive Director, Mr Alan Williams, Branch Director of Competition Enforcement Division, Mr Bob Gaddes, Principal Case OYcer, OYce of Fair Trading, and Mr Colin Farthing, Inquiry Director, Competition Commission, examined.
Q395 Chairman: Good afternoon, everyone. Firstly, Commission. One recent example of a clearance in could I apologise for keeping you waiting. the dairy sector is a merger between three milk Unfortunately, in this place there are occasionally cooperatives and their acquisition of a processing things which get in the way of a Select Committee plant in Westbury, which we cleared because there inquiry. I think you are very aware of what we are were no competition problems that we foresaw. doing and I hope you are aware of the reason for Apart from our mergers work, we enforce calling you in, because it seemed as though you were competition law, which is European competition rather like Banquo’s ghost where all the time law applying throughout Europe, not especially to everybody kept referring to you in not always the UK. Competition law prohibits anti-competitive flattering descriptions but you were there. So we agreements (most obviously price-fixing) and also it thought it was very important to extend our inquiry prohibits the abuse of a dominant position. For and to take evidence from yourselves. Just to help us those parts of the law we make decisions in on our way, I think it would be very useful if you accordance with European law and those decisions could each introduce yourselves and just say which are subject to appeal and challenge through a area within that OFT or Competition Commission separate body, the Competition Appeal Tribunal, you tend to reside within. and the court system, not the Competition Ms Boys: Thank you very much and thank you for Commission. I do agree with you there does seem to the opportunity to dispel misconceptions. I am be a perception amongst farmers that we are Penny Boys, the executive director of the OYce of somehow anti vertical deals or expansion by Fair Trading. cooperatives or eVorts by farmers to secure better Mr Williams: I am Alan Williams. I am the director value down the supply chain for their produce, but of the Competition Enforcement branch which has nothing could be further from the truth so far as we responsibility for agricultural industries. are concerned. Most forms of vertical collaboration Mr Gaddes: I am Bob Gaddes. I am a deputy bring benefits and they very rarely cause competition director within the Mergers Branch of the OYce of problems unless the people concerned have Fair Trading. significant market power. There are other forms of Mr Farthing: I am Colin Farthing, representing the collaboration between farmers which do not Competition Commission. I am an inquiry director. necessarily involve anti-competitive features in agreements or where special arrangements can be Q396 Chairman: I know it is three to one, but you made. We have also got to bear in mind, of course, will chip in, I am sure, as needed. Could I just start the objectives of the Common Agricultural Policy with a very obvious question. Because we are when we make our competition assessment. There represented by two organisations I think it would be have not been any decisions by us that particular very useful to get just an overview of what you have agreements between farmers oVend the done in recent times with regard to milk price prohibitions, nor have we had an abuse of inquiries and also the relationship between dominance case. We have investigated allegations of yourselves because sometimes the OFT is used in cartels and an abuse of dominance amongst dairy evidence when we are talking about the Competition companies (not farmers) and at least two of those Commission and visa versa. cases are presently before the Competition Appeal Ms Boys: Shall I start oV with a brief outline of our Tribunal. Another of our roles where we do have a role in relation to the dairy sector and then leave closer relation with the Competition Commission is Colin to speak for the Competition Commission? In in enforcing and negotiating remedies which come the OFT our role centres on markets and eVective out of Competition Commission reports into the competition, so we do not hold a brief for any market as a whole. An example of that, which I am particular part of the economy. What we are sure you will probably want to hear more about, is concentrating on is the competitive process and the supermarkets code That results from a report the aiming at it delivering best value to consumers. On Competition Commission did in the year 2000 and mergers we are the frontline authority, so we clear our role has been in negotiating the code and then the great majority of mergers but if we see that there most recently in reviewing it and deciding that it was might be a problem involving the substantial an open question whether it was eVective or not and lessening of competition, which is now the test for that the best thing to do in those circumstances was mergers, we refer those mergers to the Competition to commission a compliance audit. We will be 9377401000 Page Type [O] 29-05-04 00:08:52 Pag Table: COENEW PPSysB Unit: PAG1
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31 March 2004 Ms Penny Boys, Mr Alan Williams, Mr Bob Gaddes and Mr Colin Farthing reporting further on that in the autumn. There is a been exploiting this monopoly position in the way it lot more I could say but I suspect it will come out in price discriminated and in the way it sought to questions. control the supply of milk being made available to the market. So in that case vertical integration per se was not an issue. I think this becomes clear if you Q397 Chairman: It would be useful to hear from Mr then go on to read the remedy in the report, which Farthing. was that Milk Marque should be divided into a Mr Farthing: The Competition Commission is an number of independent quota-holding bodies with independent body which was established under the an approximately equal share of the old Milk Competition Act in 1998 and superseded the old Marque supply of milk. The report then goes on to Monopolies and Mergers Commission in 1999. It is explain that the smaller bodies, the successor bodies, made up of about 50 members, who are part-timers. should be allowed to engage in their own processing They serve eight year periods and they are headed by as in the absence of market power this should not a chairman and two deputies. Our role is simply to prove to be a threat to competition. The report also carry out inquiries and produce reports. We work in makes it clear that the MMC in those days shared three areas, one is mergers, another is what is now Milk Marque’s view that vertically integrated called market inquiries (formerly monopoly structures in the milk industry may be desirable if inquiries) and the third is economic (including price) they facilitate the passing on of CAP subsidies to regulation inquiries for some of the regulated farmers. It also added that vertical integration set industry sectors. Over the last few years, since 1992, within a competitive framework may have potential we have looked at five cases which have involved to align the interests of producers and processors, milk. Three of them have related to proposed provide incentive to innovation and win shares in the mergers and the other two have been monopoly final product market and that this should be likely to inquiries. I think it is important to stress that we encourage a more commercial approach that have no powers to conduct inquiries on our own respected consumer’s needs. So I think it is clear initiative. Everything we do, every inquiry we from what we said in that report that we have no undertake is a response to a reference made to us by predisposition against vertical structures in the dairy Y somebody else. This is normally the O ce of Fair industry. We have also produced some general Trading but under certain circumstances the guidelines which indicate our attitude to vertical Secretary of State for Trade and Industry or other integration across the piece, not just in the dairy ministers, or industry regulators can make sector, and again I think that makes it clear that references to us, but we cannot do anything on our generally vertical integration will only raise own initiative. We have had a number of changes in competition issue where the firms involved are able our role and powers as a result of the Enterprise Act, to exercise a substantial level of market power in one V which came into e ect in June of last year. One of or more markets along the supply chain. So I think these is that we are now determinative in mergers in our general approach too it would be diYcult to and market investigations which are referred to us identify any kind of predisposition against vertical by the OFT and ministers who used to have this role structures. have now relinquished it except in a few public interest cases. We have also had a change in the test that we have to apply in carrying out our inquiries. Q398 Chairman: Thank you for that. I think it would We used to look at whether or not something was help the Sub-Committee if you were to both send us against the public interest. We now have two just a list of the number of inquiries in relation to the separate tests, one for mergers, where we have to milk industry you have been involved in over the last decide whether the thing before us is likely to result, decade. I was given information before this session, or can be expected to result, in a substantial for example, that OFT is involved in an inquiry lessening of competition, and if it is a market case we looking into the British Friesian Association. I do have to judge whether any features or combination not quite know what that implies but it would be of features in a UK market prevent, restrict or useful to know the degree to which you have had distort competition. The final thing is that we have that number of inquiries. now been given responsibility, as I think Penny said, Ms Boys: Certainly. for negotiating and implementing our own remedies in future. This is something the OFT did in the past. Q399 Chairman: Could I just add one quick follow So ministers will no longer be responsible for taking up, which fascinates me. You have done an awful lot decisions about remedies on the basis of our of work on milk. To what degree is milk fixed within recommendations and the OFT will no longer have a normal industry situation where you have a small to implement or negotiate them, although the OFT number of relatively large performers? Is that the will retain a monitoring role. As for the issue of norm of other industries or is milk very much an vertical integration in the dairy industry, which I industry which sits in its own isolated situation? know you are interested in, the only one of our Ms Boys: There are very distinctive features that one reports to have addressed this issue in any direct way does see in the milk market. There are 25,000 is one which we produced in 1999, a milk inquiry. In farmers, a much smaller number of large processors, this we decided that Milk Marque, which was the of course not exclusively so but three large main body in England and Wales at the time, was a processors. Then so many sales have switched to scale monopolist by virtue of its size. It had 49.6% of supermarkets and the supermarkets’ reliance almost the supply of milk. We also identified that it had exclusively on the three dairy companies for buying 9377401000 Page Type [E] 29-05-04 00:08:52 Pag Table: COENEW PPSysB Unit: PAG1
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31 March 2004 Ms Penny Boys, Mr Alan Williams, Mr Bob Gaddes and Mr Colin Farthing in their milk supplies. Of course that is not a and features of a market in the context in which it is description which is intended to eliminate other presented to us for analysis. For example, when we things, but those are the main features. Whether one looked at that merger which I referred to recently, of can think of other situations where production is as course that was all about really the sale of the fragmented is a diYcult question. There are certainly perishable, time-sensitive part of milk to some many other suppliers and producers selling through producers who then wanted to vertically integrate. supermarkets who think they have problems, as was Our clearance decision noted that certainly so far as evinced in the Competition Commission’s the processed market was concerned, the cream, the supermarkets report and which led to the decision to cheese, whatever, we were dealing at the very least have a supermarkets code. Alan, would you like to with the European market, possibly wider. So we add anything from your perception? were agreeing there with exactly that description Mr Williams: Yes. Milk market certainly has which you yourself have put forward and saying in distinctive features. I would doubt whether it is that context there is so much choice for consumers unique, though, and probably other agricultural that competition concerns have not arisen. In the markets have some similar features as well. There more sensitive, the raw milk part of that market, the may be others in other sectors, though oVhand I producers concerned did not have a particularly could not say which. It is not the norm but I doubt large share of the market. When we look to define whether it is the only industry with that kind of the market what we have to look at is where these structure. people are, how much they have got to sell, what is actually defining the market for them, and typically in milk it will be something like how far do you have Q400 Mr Jack: I want to explore with you in a little to transport the milk to the nearest processing detail, if I may—and I apologise to colleagues if I plants, within what time is it feasible to do that and tread on toes in respect of other questions we have what choices are open to people in terms of to whom got coming up—but I am trying to understand in the they sell their milk or from whom they purchase context of our inquiry in milk first of all how you their milk. approach competition issues where there is a very Mr Farthing: I think in terms of Competition distinct split in terms where milk is 50% a liquid and Commission inquiries we take a very similar fresh market and 50% a processed market and approach. One of the key stages in all of our therefore the characteristics of buying and selling V inquiries, whether it is milk or anything else, is to fresh, highly perishable products di er from those define the market we are looking at and part of this is which have a longer, I will not say infinite but to identify who are the people who are in the market, certainly a storable life. The second point is that the whether they are all domestic, whether they are liquid market is very much one which is UK based European or international and we also look at the but the processed market can at times be a world likelihood of other people coming in and out of the based market. The third dimension I would be market. As you say, in certain dairy products it is a grateful if you would comment on as to how you European or an international market. Cheese and take these factors into account is that unlike a lot of butter can be sold all around the world. In other markets the base price for the raw material, whether things, like liquid milk, it is a much more domestic it be liquid or processed, is determined by somebody market and the inquiries we have done recently, the else, in this case the Common Agricultural Policy’s ones I have mentioned, have all focused on liquid intervention system which has its milk price milk and by and large we have been looking at the equivalent, and that puts the floor in the market UK domestic market. place. So that determines, if you like, the basis from which all of these matters occur and one of the concerns which has been expressed to us is this Q401 Mr Jack: So given the structure that we have question of how much you can disaggregate the in the UK milk market, certainly from the point of United Kingdom’s position from a European view of the three co-ops, in the sense that if co-ops market place for dairy products and a world market themselves got bigger either by amalgamation or place for some dairy products in which we operate. seduction of supply from processor end use at the So how much of, if you like, the world picture and present time, I presume that if it became an issue to the European picture and then the distinction look at, if the increase in litreage from an enhanced between liquid and processed do you take into size co-op were directed to the process market, that account in adjudicating on competition issues where would have a diVerent perspective than if it was the buyer (in this case the majority buyer) is a person simply to get a stronger market position in the liquid with a dominant market position, namely a milk fresh market? That would be part of the criteria collective of supermarkets, compared with relatively you would look at to determine, for example, if two weak sellers, particularly in the liquid milk market? out of the existing three decided they wanted to be I am sorry if that is a complicated question but it one, if it was to fuel a big expansion in processing seems to get to the heart of what switches you on and and you are saying that you are looking at a oV in looking at competition issues. European or world dimension for competition on Ms Boys: It is a very clear question. Thank you. that those are factors you would weigh in deciding When we have a competition question to assess we whether somebody could increase eVectively their have to bear in mind all of those features which you share of the liquid milk market going through their have just so articulately described. So, for example, business if the end use was for this competitive what we have got to look at are the particular facts processed area? 9377401000 Page Type [O] 29-05-04 00:08:52 Pag Table: COENEW PPSysB Unit: PAG1
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Ms Boys: Yes. We have to look at the facts as Ms Boys: In that context, yes. Buyer power is a very presented to us, we have to check them out and, as important part of competition analysis. So the more Colin says, we have to look at other features of buyer power there is, the more relaxed one might be competition analysis such as are there any barriers to about more concentration from the people from entry, how easy would it be for alternative supplies whom the milk is being bought. It is a factor in that to come in. But in a market definition sense, I think it sense. I do not think I necessarily recognise the is the facts which dictate the conclusions one draws. pricing policy that you have hypothesised on milk. You could be right and it would be quite misleading and wrong for me to say you are not, but I do not Q402 Mr Jack: My final question is in terms of what think that was the fact as observed on the last triggers your activity. You mentioned the power of occasion on which supermarkets were fully the supermarkets. Because of the competitive examined by the Competition Commission, but environment in which retail operates it is seldom perhaps Colin would like to say something on that. that any one retailer is not very aware of what others Mr Farthing: Yes. This was one of the things looked are doing and you could argue that with a at in the supermarkets report and I think they commodity based product you are dealing with identified something like 34 diVerent categories of almost a monopoly purchasing situation because products which supermarkets sold and they looked they all look, they all react and within days nobody in detail at some of them and milk was one of the is going to be very far away from the other when it ones they looked at. This was a few years ago. The comes to the price of the commodity milk. Therefore period they were looking at was between early 1997 you have got not just one or two very dominant and August 1999 and what they saw there, I think, players but in actual fact a sort of theoretical was that there had been a suggestion that there had monopoly purchaser against relatively weak players been some kind of quite strong price competition in terms of our existing milk co-ops. Do you see either at the very beginning of this period or in the retail competition in those terms in the context of the years immediately before 1997. But in the period milk market or not? they then looked at, which as I say was from 1997 Ms Boys: To be honest, I think the way we look at through to August 1999, it looked as if most of the supermarkets is that milk is one product line multiples were seeking to restore their margins a amongst thousands of product lines that little to compensate for the reduction in margins supermarkets are oVering to consumers and the which had taken place in the earlier years. So to the business judgement which each supermarket has to extent that there were movements in both farm make is what price to oVer to consumers across the prices and retail prices for milk over that period you full range. So you will see forms of price competition saw those margins expanding a little over those years between supermarkets on particular lines, between and you did see diVerent attitudes being taken by particular products and you will see convergence in diVerent supermarkets. So it was not a homogenised other areas and it will vary over time. It is very approach, as it were. They were not all doing the diYcult, I think, to draw a conclusion simply in same thing. There were broad similarities but they relation to one product when it forms just one part, were by no means identical. and certainly not the most major or significant part, Mr Jack: Thank you. of everything that a supermarket is selling. Q404 Diana Organ: You are called the OYce of Fair Q403 Mr Jack: I think my only concern about that Trading and there is a campaign, which I am sure is that you talked at the beginning, in your you are aware of, which is called Fair Trade, where introduction, about the need to, if you like, start we are looking at us as consumers paying a decent from the point of view of the consumer, getting good price for chocolate, coVee and tea from developing value for the consumer. But where in the case of world producers, but you said to begin with that you liquid milk—and I think it has come out very clearly are interested in finding it fair for the consumer. To in this inquiry—you are dealing almost with a what extent do you think it is incompatible in the homogenous commodity there is very little chance milk market to make it a fair trading situation for the for product diVerentiation and therefore similarity consumer and for the producer, processor and of pricing is taken as read and there is not this retailer? collective, almost monopoly view as one retailer Ms Boys: Well, I think we start from the basis that watches what the other is doing and then says, “I if there is an open and competitive market with cannot be any diVerent from the other.” In other competitive forces at work throughout the supply words, the normal intercourse between buyer and chain, that should over time deliver the best value for seller, if there is product diVerentiation, does not the consumer and it should allow prices to respond necessarily work in the context of the liquid milk to changes in the market. For example, if there is a market and therefore the forces which bear down on demand for more milk then you want to encourage the supply side are disproportionately strong in that more people in as new producers. Conversely, if the particular part of the catalogue of the supermarket. demand for milk is declining maybe it is not sensible My question is, do you recognise that collective to keep the price at a certain level. So we start from buying power in the context of a commodity product the hypothesis that it is competition and the like milk when you are adjudicating on what the competitive process which will be the optimum supply side may do to strengthen its position versus result for consumers and for producers able to earn the buying side? a return. 9377401000 Page Type [E] 29-05-04 00:08:52 Pag Table: COENEW PPSysB Unit: PAG1
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Q405 Diana Organ: Obviously you are aware of the would argue that they can only do that from a fact that when we have had others in front of us they position of strength, through cooperation, and their say, “Well, you are only really interested in the notion of cooperation is, “You either join us or you consumer. You actually don’t have any particular are not part of this industry.” Is that just cultural or interest in the producer.” In your reply to me you are is it that you interpret competition in very diVerent hoping, of course, that the market will have all the ways to the New Zealand industry? There is no influence and how much the producers respond to competition in New Zealand because no one would that will determine whether they remain in ever get into that market. What are your comments competition. Given that, do you think there is a on that? better chance for the milk market working to the Ms Boys: I have not studied New Zealand but there benefit of all if we have a vertically integrated system are various reasons which occur to me why they like in New Zealand and in France or the one we might hold that view and have organised themselves have got at the moment with an internal competitive diVerently. First, of course, there will be certain market with two or three co-operatives and a small features about the New Zealand dairy industry. I number of processors? Which would give us a better think they are very eYcient. They have got lots of competition edge internationally and which would economies of scale, they have got a diVerent be healthier for our internal competition? topography and so on. But perhaps it is that they Ms Boys: Well, I do not have any particular view are, as you put it, so insulated from world about what is the best structure. What we are trying competition. It is a long way away. You have not got to do within the framework of competition law is to the chance of so many products arriving on your ensure that free competition enables the structures doorstep and you are not as open to competition as that best suit the particular features of the UK I think inevitably the UK is. But that is my market or the European market or whatever it is that hypothesis and I can see Mr Jack disagrees with me. is relevant at the time to emerge and evolve. I can understand and sympathise. I think it is very diYcult Q409 Chairman: Well, Mr Jack can give us a lesson sometimes. Competition is a painful thing. It is not from the antipodes. the same as a managed market which guarantees Ms Boys: Could I just ask Alan whether there is certain returns to people who happen to be anything he wants to add about his perspective. producing at a given point in time. So of course there Mr Williams: Just to say that I am not particularly can be diYculties, pain and pressure which may be familiar with competition law in New Zealand but very unwelcome to producers and likewise you can we are required to apply European competition law have situations which are very diYcult for and the UK’s equivalent here, so even if certain New consumers too, but over time I would not want and Zealand features were felt to be desirable by farmers’ we would not want to say we have got all the answers organisations we would not necessarily just replicate for what a structure might be. We can certainly see them here. We have to abide by EC competition law at the moment that those who are producers and the UK equivalent. themselves, and the processors, seem to be observing that their interests will be better enhanced and that Q410 Mr Jack: Could I just pick up on the we will still have competitive markets by more Chairman’s point. The reason I shook my head was vertical integration and we can see many situations that I was partly basing my line of initial questioning in which that would not cause any competition on thinking about New Zealand and if you had said, problems, so it is what should naturally emerge. But “Well, New Zealand has only 3% of its dairy output that would be rather diVerent from us, as it were, which goes to its domestic market and 97% has got seeking to manage or orchestrate a particular to go somewhere else,” that is a very fair point to outcome. start, but the type of products which New Zealand makes, because they are a long way from anywhere, Q406 Diana Organ: Not for you to manage the are in the transportable, storable, more durable end outcome but what do you think would make us more of the commodity market. competitive globally for the milk market? Ms Boys: Back to your point that it is the world Ms Boys: Oh, I have no doubt there; by having market there. competition. Q411 Mr Jack: But they are a very, very powerful Q407 Diana Organ: Internal competition rather player because they have got just about all of New than total integration? Zealand’s milk coming through an enterprise which Ms Boys: Internal competition, yes, and I think it is is owned by the farmers for their mutual benefit so quite risky in fact to build export industries on a that when it comes to the UK industry on a world basis that you can somehow insulate your domestic basis on things like milk powder, cheese and butter market from competition because so often you find and the associated sub-products we are fighting you cannot. against very, very powerful players in those market Diana Organ: Thank you. places, whereas clearly our liquid market is very much a domestic market by definition of the product Q408 Chairman: Just to pick you up on that point, and it is how competition policy deals with the we as a Select Committee went to New Zealand and competing demands which are made in the UK from there is no one as competitive in international an embryo vertically integrated series of co-ops who markets as the New Zealand dairy industry, but they are trying to play in the big world pool and at that 9377401000 Page Type [O] 29-05-04 00:08:52 Pag Table: COENEW PPSysB Unit: PAG1
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31 March 2004 Ms Penny Boys, Mr Alan Williams, Mr Bob Gaddes and Mr Colin Farthing same time sustain a competitive business in the Q416 Mr Breed: Have you had a number of domestic liquid milk market where a diVerent view approaches from parties prior to any consideration of competitive pressures or a diVerent reality of of such vertical integration? competitive pressures actually operates and it is how Ms Boys: We are open to people for informal advice do you combine a strong business with two very and yes, I understand we have had some approaches. distinctly diVerent regimes, which I think is part of the conundrum we are trying to understand. Q417 Mr Breed: Recently or a long time ago? Ms Boys: I suppose it does go back to your point of Ms Boys: Well, consistently over time, including how large is the liquid milk market, and it is still some recently. pretty large here. So I think it would be very diYcult, possibly impossible to manage some price or impose Q418 Mr Breed: I think you have partially answered or let evolve some structure and eliminate this, but do you think it is right that the OFT should competition in that liquid milk area simply to enable take some sort of proactive approach in trying to world trade to be maximised in the processed Y address some of the false perceptions there might be products. I think that would be very di cult for in terms of farmers’ perceptions, and indeed others, consumers. It would be quite a disadvantage to the that competition law is a real barrier to the market UK consumers. place at the present time? Ms Boys: Yes. I think it is extremely important that Q412 Mr Jack: You could have an interrelationship we do that. We try anyway to be as open as we can between the two because if you had a strong UK to explain competition law and to put it in context. based enterprise which was capable of taking its We publish a complete set of guidance on place on the world market and doing battle with competition law and in fact an updated version of these other big players it might by definition have that reflecting the changes which are coming into certain economies of scale and an ability to operate force on 1 May as a result of the EC decentralisation competitively in both market places. But it is the decisions will all be coming out next week. On question of how you adjudicate, if you like, mergers we have two guidelines, one covering our particularly during the growing pains bit where it procedures and the other our substantive guidelines gets big enough to play eVectively in both types of setting out how we go about competition analysis market, which obviously has an influence on the type and the factors we take into account. Especially for of stratagems which may be being considered in the the dairy sector we are also at the moment working UK dairy industry as to what is best for our industry on a list of frequently asked questions, to which because, bluntly, you need to be big and strong to there will be the answers, and we will have that ready play in those bits which are the world market but in May. I hope that will help. your definition says something smaller and competitive is what we favour for the domestic Q419 Mr Breed: Do you think, bearing in mind the market and the two may not be compatible. spread of the current production, processing and Ms Boys: I think that is right. I do not think they such within the UK, that in fact it is more likely that would necessarily be compatible. What I think you vertical integration will be possible in some parts of are postulating is a model where in the interests of a the country rather than others? significant UK presence in world competition for the Ms Boys: I think that must probably be so, processed part of the market you say, “We will pay depending on the location of processing plants to the price of no competition or very substantially particular farmers. I think that must be so because reduced competition for liquid milk.” that would be a factor in our market definition. I just Mr Jack: Not necessarily, but we might come back want to turn to Bob to see if there is anything he to that when we debate the supermarkets. wants to add to that. Chairman: I am sure we will. Mr Gaddes: Just to say that clearly what you have seen in the market on the liquid milk side is the move Q413 Mr Breed: Could I just ask a basic question towards bigger dairies and fewer of them, which first. Do you believe that there is today an open, leaves large parts of the country with very little local dynamic, competitive market in milk in the UK? market for their milk. So the suggestion will be that Ms Boys: Not necessarily. yes, there is some scope for increasing vertical Chairman: A good political answer! integration at a local level.
Q420 Mr Breed: Perhaps lastly on this section, one Q414 Mr Breed: If greater vertical integration is of the other perceptions, and it often happens in possible under this current competition law and may other aspects of policy as well, is that we here in the well be desirable, why have we not seen it take place? UK take a more robust, perhaps some would even Ms Boys: Well, I think you will have to ask the call it an extreme approach to European legislation players that. in certain areas, in this case in competition law. Do you feel that you interpret EU competition law in Q415 Mr Breed: Why do you think we have not seen precisely the same way as other countries in the EU? it take place? Ms Boys: I think it would be an overstatement to say Ms Boys: Attitudes, diVerent business plans, the that we do so precisely in the same way but it is very restrictions of the CAP, diYculties in getting hold of important and in fact it is written into the Acts under quota, lots of things. which we are operating that we must be consistent 9377401000 Page Type [E] 29-05-04 00:08:52 Pag Table: COENEW PPSysB Unit: PAG1
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31 March 2004 Ms Penny Boys, Mr Alan Williams, Mr Bob Gaddes and Mr Colin Farthing with European law and the change to which I briefly Q423 Mr Breed: But you will be aware of what the referred just now from 1 May when the European current figures are? Commission decentralise to national competition Mr Farthing: I do not know what the current figures authorities some of their responsibilities for are. As I say, we just do individual inquiries, but at approving, exempting or challenging agreements. the time when we looked at it that was the position. There is a network of national competition Mr Breed: If you take oV about 7 or 8 pence and you authorities in place which aims to ensure consistency might be close to it. Okay. We can draw our own of approach. We have also always to have regard to conclusions for that. European court cases and the way European law is being interpreted throughout the community and Q424 Mr Jack: What is the definition of “excessive”? you will find that reflected in our competition Mr Farthing: Well, disproportionate. decisions. Where we have got relevant precedents in European law we normally cite them. Q425 Mr Jack: Could you just give me some Mr Williams: Looking at the two European law numbers? competition prohibitions against anti-competitive Mr Farthing: Well, as I say, the gross margin which agreements and abuses of dominance, I have not was being earned at the time was 26.2% and that was seen any evidence to suggest that we are interpreting deemed not to be excessive. these any diVerently from anyone else. Mr Breed: It is even less excessive now.
Q421 Mr Breed: Finally on the abuse of dominance, Q426 Mr Jack: I just want to know what you would which I think was probably the aspect around which have thought was an excessive margin. the original investigation into the supermarkets Mr Farthing: We do not work that way. We look at centred, do you find there is no abuse of dominance the evidence in front of us— in terms of the purchasing policies of current supermarkets in terms of milk? Mr Williams: Just on a technical point, the Q427 Mr Jack: But you must have a definition if you supermarkets inquiry was under the Fair Trading are defining 26.2% as not excessive. Act and done by the Competition Commission; it Mr Farthing: We take a view on the industry in front was not done under the Competition Act or under of us, the sector, the relevant factors, the rate of EC law. Secondly, to be dominant a company has to competition and in the light of all those factors the have a fairly substantial market share. Not less than view taken was that the levels were not excessive in 40% is a sort of rough guide and none of the the supermarket industry at that time. supermarkets do come close to that, so they are not really dominant in terms of European law. Q428 Mr Jack: In that case what was excessive? You must be able to give me a numerical answer as to what is excessive. Q422 Mr Breed: No, but in respect of the Mr Farthing: Well, as I say, we do not work that way Competition Commission report it actually found round. Our job is— there was a complex monopoly, which actually meant that in terms of the 25% rule that did not necessarily apply. Therefore, in terms of the abuse of Q429 Mr Jack: So you can say that 26.2% is not the dominance of the supermarkets as a whole, in excessive but you cannot give me a number to say terms of the complex monopoly to which they are what is excessive? party do you find that they have abused such Mr Farthing: I am not saying that 26.2 as a number dominance? is not excessive, I am saying that when the group Ms Boys: Well, we must let Colin answer for the looked at this particular sector at that particular Competition Commission, I think. Alan is correctly time they took the view that the rate was not saying that in so far as we have applied the abuse of excessive. You asked me what the number was in dominance European law I do not think we have had that case and I told you, but it does not mean that we a case involving the supermarkets. always regard 26.2 as not being excessive. Mr Williams: I am not aware of any. Mr Farthing: The supermarkets report discussed all Q430 Mr Jack: But the reason why the Committee the evidence we received but the conclusion we is interested in that is that the data we have received reached was that taking all of this evidence into so far shows a falling farm gate price and a rising consideration we are satisfied that the industry is return to retailers, which is why we are a bit sceptical broadly competitive and that overall excessive prices about what you have just said and really how up to are not being charged nor excessive profits being date the information is because we are trying to earned. So that was the view that we came to on the understand why it is the farmer seems to be getting supermarkets as a whole. As I think I mentioned less and people at the other end of the chain seem to earlier, we carried out a review of the various be getting more. Have you got any thoughts on that? categories of products that the supermarkets sold Mr Farthing: As I say, I am not pretending that this and one of those categories was dairy products and is up to date information. All that I can tell you we found that overall (these are 1998/99 figures) the about it is the inquiries that we have carried out and rate of return across the whole piece that the the last one we carried out into this area used data supermarkets were making, their gross margin, was for 1998/1999 but yes, I agree it is four or five years 26.2% and in the dairy sector it was 25.7%. out of date. 9377401000 Page Type [O] 29-05-04 00:08:52 Pag Table: COENEW PPSysB Unit: PAG1
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Q431 Chairman: Outside of an inquiry where clearly Mr Farthing: There was an argument in relation to these are controversial areas, do you continue to do the Milk Marque inquiry, the one we did in 1999, any ongoing research? where Milk Marque and others claimed that there Mr Farthing: No. were special considerations to do with the Common Agricultural Policy which made it inappropriate to apply elements of competition law. So the group Q432 Chairman: So once an inquiry is finished, that carrying out the inquiry went to both the is it? competition directorate and the agricultural Mr Farthing: That is right. directorate in Brussels, DG4 and DG6, and put this argument to them. The answer we got back was that Q433 Chairman: So the fact that someone may the way in which the competition authorities were think—it is a bit like replaying a football match— operating in the UK was entirely consistent with that they have got the wrong result, they can decide European law. They indicated areas where there it in the next game. But there is no next game. would be diYculties but said that none of the things Mr Farthing: Well, there may well be a next game. If that we did in relation to this inquiry caused any new concerns arise and the OFT decides they want diYculty. I think after we had finished there was a to refer them to us to look again then we will look subsequent court appeal which again went to the again. There are sectors where that has happened. European Courts of Justice, where again our view But we do not initiate any work ourselves. We do not was upheld. So where this has actually been tested either keep a sort of roving eye over areas we have the answer has been that we are not doing anything looked at in the past or decide ourselves that we need which is incompatible with European law. to look at them again, but there is a mechanism which is through the OFT for deciding that if Q435 Paddy Tipping: Has anybody looked at Arla concerns revive or if new issues arise then there is and the way that the competition authorities in always the option of making another reference. Denmark looked at Arla and is your approach compatible with that? Ms Boys: The only occasion on which I think we Q434 Paddy Tipping: We were talking a moment or have specifically looked at Arla was in the recent two ago about European competition law and you takeover by Arla of Express. That was something were reminding us that it is closely aligned across the which fell to be considered first by the European country and I think Alan Williams said (I Commission under the European merger law but paraphrase and I may not have got this quite right) was then repatriated (as the phrase is) back to the that there was no evidence that it was interpreted UK authorities because of the significance of that for diVerently in the UK than elsewhere. You have seen the UK market. We did think that there was the the KPMG report. There is a suggestion in the potential for possible serious competition concerns KPMG report that we are stricter and more severe there and we made the reference to the Competition in the UK than elsewhere. What is your response Commission, who reported in September last year. to that? Mr Williams: The KPMG report specifically identified one factor in the UK which was not Q436 Paddy Tipping: What about the situation with present in other European countries and that was the Arla in Denmark then? Have you had a look at that? monopoly provisions of the Fair Trading Act and Ms Boys: No, not specifically. I imagine you are that was really the only diVerence it identified. There getting at the fact again that Arla, rather like New are a couple of points to be made there. First of all, Zealand, has a very large position within Denmark. the Fair Trading Act is in eVect no more: it has been I think again one would need to look more carefully replaced by the Enterprise Act, and the public at the facts than we have so far done, but I would interest test which the KPMG report was a bit imagine there would be features about the Danish exercised about in the Fair Trading Act has been market, the amount of trade there is in liquid milk replaced by a straight competition test which Colin there, whether the national boundary has any told you about earlier, ie whether there are market relevance at all to the economic market which might features which prevent, restrict or distort have shaped what has happened in Denmark. competition. So there is that change. The other Mr Williams: I do not know how they got to their change which has come about is one which Penny current position but it is very diVerent from ours. has referred to, which is that as from 1 May we will Essentially milk prices are regulated in Denmark. be directly enforcing Articles 81 and 82, the competition law provisions of the Treaty, and that Q437 Paddy Tipping: So this is competition law change will require us not to prohibit agreements aligned across Europe then, is it? If it is diVerent in which are permissible under EC law. So that will Denmark and it is the same company, it does not further limit any scope for divergence between the sound as though competition law is as closely UK and other parts of Europe. My reference to the aligned as we have been led to believe? fact that I do not believe we are enforcing the Mr Williams: No, that is a false inference. The law is European law, that is to say the Competition Act, the same. There may not have been any agreement to any more harshly than anywhere else—I did actually prohibit if Arla was that large at the time Denmark mean the equivalent UK law, that is to say the entered the European Community. There would not Competition Act. There are other bits of the law, or have been any agreement or any concentration to there were. prohibit; it would have already been there. 9377401000 Page Type [E] 29-05-04 00:08:52 Pag Table: COENEW PPSysB Unit: PAG1
Ev 138 Environment, Food and Rural Affairs Committee: Evidence
31 March 2004 Ms Penny Boys, Mr Alan Williams, Mr Bob Gaddes and Mr Colin Farthing
Ms Boys: There would definitely be, of course, reported profit levels we note that there does not diVerent situations across Europe. We see that appear to be any evidence to suggest that processors wherever we go in Europe there are things that are earned excessive profits from fresh processed milk diVerent. But the law and the application of the law which they supplied to the national multiples. is as uniform as we can get it to diVerent situations. Q441 Mr Breed: Through evidence we have received Q438 Paddy Tipping: I think we may want to so far we have been able to identify reasonably examine this a little further because it does seem to accurately the margins which have been available to be the case from the Arla example and other the producers and to the processors. It is somewhat examples that there seems to be more vertical more diYcult in terms of the retailers. Do you think integration in parts of the EU than there is here. that the retailers in a sense ought to be more Penny, you were trying to explain to me why that transparent in respect of the figures they can supply was the case. Give me another explanation. Try for the margins they are getting? again because I am finding this a bit hard. Mr Farthing: Well, as I said, the last time we looked Ms Boys: I do not think I can realistically give you a at that these figures were relating to 1997 to 1999 and good explanation of why, but what I can say and during that period we saw a certain amount of an what I am here for is to say that if there is a diagnosis improvement in margins and the explanation we or a presumption on anyone’s part that it is were given was that there had been more European competition law which is inhibiting that, competition either in the early part of that period that is not so. That is the most that I can or— legitimately say. Q442 Mr Breed: When you say “improvement in Q439 Paddy Tipping: Let me say something margins” do you mean margins of the supermarkets legitimately as well, that you accept that there is were increasing? greater vertical integration in other parts of the EU? Mr Farthing: The supermarkets were increasing Ms Boys: Absolutely, yes. their margins, yes. Chairman: We have already touched on the supermarkets and we are going to look at the famous or infamous code of practice, but just to lead into it Q443 Mr Breed: So they were increasing their I think it would be useful for Colin to set the scene margins in 1999? on where we are in regard to producers and Mr Farthing: In the period between 1997 and 1999, supermarkets. yes.
Q440 Mr Breed: We accepted earlier on there has Q444 Mr Breed: So do you think that then, and been a significant shift in the market for liquid milk, perhaps even more so now, the supermarkets were in particular from the doorstep deliveries, to the using liquid milk as a so-called loss leader or as a supermarkets through one stop shopping and such. known value item (as I think they like to call it)? Is there any evidence which you can point to where Mr Farthing: As I say, we do not have any evidence you think the major supermarkets may be using that of what has happened since then so I cannot increased market share, which they have actually got comment on that. In terms of a known value item, I over quite a relatively short period of time, to think the answer is yes. During the supermarkets improve their margins on liquid milk by applying inquiry this was one of the issues they looked at and pressure to their suppliers in order to decrease the although there is no oYcial, agreed definition of prices they are paying for milk? what a known value item is, almost all of the Ms Boys: I do not think we have got any evidence supermarkets would put milk in that category. So I that that is so. I do not know if there was anything think the answer is, yes. which came out of your more recent examination of milk or supermarkets. Q445 Mr Breed: Remarkably enough they are all Mr Farthing: One of the things the people who virtually the same? carried out the inquiry into Arla and Express looked Mr Farthing: Yes. Well, it varies over time, I think. at was the relationship between the cost of the milk There are periods when they are very similar and when it left the processors, Arla and Express, and the there are periods when one will open up a gap one evidence they received from the two companies, way or the other and then it will close again. So it is both for Express and for Arla UK (the operation in a dynamic market. this country), was that the average selling price of fresh milk to the national multiples (the supermarkets) has been fairly stable over the last five Q446 Mr Breed: Just on the code, when the years. Also, for each of them the diVerence between Competition Commission finished its rather lengthy the average selling price of milk to the national report, rather expensive report as well, the end bit multiples and the average variable cost incurred in came to not particularly substantive conclusions and producing this milk has also been quite stable. So the only basic recommendation was the introduction there is no evidence of much of a change. Although of the voluntary code, which many of us thought was this is based very much on what they were told by the a total and utter waste of time. Here we are two years two companies, the summary they reached is that later and you are carrying out your own review into although it is diYcult to form firm conclusions from that, the initial findings of which seem to endorse 9377401000 Page Type [O] 29-05-04 00:08:52 Pag Table: COENEW PPSysB Unit: PAG1
Environment, Food and Rural Affairs Committee: Evidence Ev 139
31 March 2004 Ms Penny Boys, Mr Alan Williams, Mr Bob Gaddes and Mr Colin Farthing more of what we thought two years ago than working. I suppose we could have just signed oV and perhaps what you thought two years ago. Would said, “Well, it must be fine,” but of course we knew you like to comment upon the initial findings? there was very great unhappiness amongst suppliers Mr Farthing: The only comment I will make is that and people were saying, “Well, you know, the code it is not a voluntary code, it is a statutory one. But is there but we don’t like to complain. We’re the person who has been looking at it is Penny rather frightened. Can we please make anonymous than me. complaints?” Obviously we have got the anonymous Ms Boys: We did the review of the supermarket complaints. They will be guiding what we decide to code. do next because it was a dilemma. We could have said, “Well, the code is working okay,” or we could Q447 Mr Breed: It is not a statutory code? have said, “Well, everybody’s unhappy so it’s quite Ms Boys: Yes, because it derives from the clear the code hasn’t worked. Let’s scrap it and start Competition Commission’s findings so it has the all over again,” or do as we decided, which was to force of law. commission a compliance audit where a firm to be appointed by us will go in and examine a sample of Q448 Mr Breed: That is quite interesting because we transactions and look at the paper chain for those were asking the people who came before us about transactions, explore with the parties involved whether they felt it ought to be statutory or not and whether the code was complied with in reality or not. they said, “Yes. It isn’t at the moment but we We have been able to use the anonymous complaints wouldn’t mind it being statutory.” So the British as a sort of rough guide of the areas to look at in the Retail Consortium, who were here on behalf of all of compliance audit because obviously you cannot the supermarkets, were certainly not under the look at absolutely everything. impression that it was statutory. Ms Boys: Well, that is a misunderstanding on their Q452 Mr Jack: How many former supermarket part. It is not statutory in that there is not a buyers have you got on your staV? Supermarkets Code Act but it derives from findings Ms Boys: What a good idea. To my knowledge we made by the Competition Commission, which have have got a very talented and diverse staV but I do not been put into eVect through an order. think we have got any supermarket buyers.
Q449 Mr Breed: But for supermarkets it was Q453 Mr Jack: When you look into this area who do voluntary as to whether they participated or not? you get your information from? What level of Ms Boys: No, it is mandatory for those management in Sainsbury’s or Tesco supplies the supermarkets who were the subject of the adverse answers to the questions you ask about how this area findings in the Competition Commission’s report, operates? which was the big four at the time. Ms Boys: Well, we have gone first to the suppliers and to their trade association bodies to say, “This Q450 Mr Breed: So the voluntary aspect was more code was put in for your benefit. How has it to do with the supply? operated?” Then when we asked the supermarkets, Ms Boys: No, the voluntary aspect, I interpret that yes, I guess it is their procurement side which has view (and I have heard it said) as all the furnished the replies – supermarkets, not just the big four (Waitrose, the co-ops and so on) should be covered by that code and not just those against whom the Competition Q454 Mr Jack: I do not want you to guess, I want Commission reached their adverse finding. you to tell me who, at what management level—I do not necessarily want names and addresses but at what level do you actually get this information about Q451 Mr Breed: So how eVective do you consider what really goes on? the code is in regulating the actions of the Ms Boys: I will have to provide you with a note of supermarkets and in terms of the imbalance of the specifics on that. power in the whole dairy supply chain? Do you think it is now better or worse since the introduction of the code? Q455 Mr Jack: I say that as somebody who a very Ms Boys: It is an open question. We have had the long time ago was both a supplier to supermarkets review. We did it after a year, as asked. If something and also in charge of procurement. I have seen both has been operating for a year you generally expect to sides on this. But when I look at the prices and have some hard evidence. You expect to say, “My payments section in this I think that whoever drew God, X, Y and Z breached the code. Look at this.” this up it is like dealing with the horse after it has There is an arbitration mechanism to resolve bolted because everything talks about what you disputes. You expect to see that mechanism used. must not do once prices have been agreed. But Now, we conducted the widest possible consultation coming back to this inquiry, the absolutely essential on how people had experienced the code in issue is the process by which the price is agreed. operation. We talked to individuals, we encouraged Ms Boys: Ah! Well, in that case you are quite right, them to let us know, we talked to trade associations, the code applies to trading practices; it does not we talked to farming bodies and no one came apply to price setting. We could not make up a code forward with any evidence that we could take up and which did that because there was not an adverse pursue in an enforcement sense to show it was not finding— 9377401000 Page Type [E] 29-05-04 00:08:52 Pag Table: COENEW PPSysB Unit: PAG1
Ev 140 Environment, Food and Rural Affairs Committee: Evidence
31 March 2004 Ms Penny Boys, Mr Alan Williams, Mr Bob Gaddes and Mr Colin Farthing
Mr Jack: But if you want to understand, as I am sure that at all. I think the set of issues of what process, you do, the interplay of the forces of supply and if any, we can put in place, we can only in the code demand and relative strengths then you really ought go back to the Competition Commission’s report to sit in on what goes on when prices are negotiated and its findings and the code was put in place very because to be quite frank, as somebody who used to specifically to address those findings. I take your do this for a living—I will not insult you by saying it point. I take away from today in our compliance is a joke but the key thing is how you actually set the audit we must ensure that on the supermarkets side price, what is the interplay, how are the forces of big we are getting a realistic picture of what is happening versus small in the supply chain actually exercised. but I think for us to imagine that the code would One of the points which I understand the govern eVectively a negotiating process between Competition Commission found in their report on people with market power and people without the various bits for Safeway, and I will quote the market power in thousands, if not millions of pricing information that we have in our notes on this, “that transactions, I doubt whether any regulation could there remained a fundamental imbalance of be eVective. negotiating strength between supermarkets and most of their suppliers and that the balance of Q457 Mr Jack: No, and I would concur with that. responses to its surveys indicated that suppliers’ But the point is if you have got better equivalents negotiating strength across all sectors had weakened between the strength of the supply side and the since the 2000 [Competition Commission’s] strength of the buying side, if they are much more on monopoly report. In its surveys of suppliers 79% to a point of parity then you can have a proper 94% reported that the code had not changed their interplay of competitive forces. We have talked dealings with the supermarkets and 6% to 15% said about vertical integration and we have talked about matters had worsened.” I would put it to you that potential increase and if I look, for example, at the that reflects the point at which the commercial structure of the co-ops, First Milk 2.5 billion litres, decisions are made and what does not seem to be Dairy Farmers of Great Britain 2 billion litres, Milk weighed in terms of either the way the code of Link 1.4 billion litres. That is just about 6 billion practice operates or your view of competition is the litres, roughly speaking half of the UK milk market. operation of this collective buying power of the Now, hypothetically if they decided to join forces we supermarkets. I can assure you that if you are at the are talking about a group who are controlling half of end of the telephone and you are speaking to Mr the liquid market in the United Kingdom and when Tesco or Mr Sainsbury, (a) you will be deeply you look at the power of the supermarkets they are respectful, (b) you will be very mindful in a buyers of eVectively more than that by definition. perishable commodity that you do not have an awful Supermarkets respect strength, not necessarily lot of bargaining power but the big buyer has an weakness. Weakness can be taken advantage of. I do awful lot of clout if he decides to de-list you or not get the sense that in terms of what the dairy decides that this week he is not going to buy from industry may do to strengthen its position the power you. You are very respectful and it is hardly of the buyer is weighed with suYcient weight in your surprising people do not complain too loudly when deliberations in determining what this sector may or the entire survival of their business can depend on may not do to strengthen its position in negotiation that weekly telephone call which determines the with the supermarkets. Maybe I am wrong and I prices that are going to be paid. As Mr Breed look to you to put me right. indicated, all of this is conducted in a less than Ms Boys: Well, I can only point you again to the transparent set of arrangements and the impression clearance decision we made on the First Milk and we have gained from talking both to individual three co-operatives acquisition of Westbury where farmers and their representatives, and indeed the indeed the existence of buyer power at the retail level trade associations, is that the idea that this collective was one of the factors we took into account which group of suppliers has any leverage on the led us to the conclusion that there were no supermarkets is for the birds. Yet I do not hear that competition problems there. There is another point being reflected in the way you are looking at the I think I should make too for clarity and that is that situation. Do you not think you ought to, if you like, actually of course when the supermarkets are get real and get to understand how this process purchasing milk they are not purchasing from the works so that when you adjudicate on this it can be 25,000 dairy producers, 98% of their milk is from the position of talking to people with purchased from three dairy producers. knowledge who actually do it, as opposed to the purveyors of information from supermarkets who will give you whatever view they want to give you? Q458 Mr Breed: On all the other sectors you look at there are similar situations where relatively small suppliers actually supply to very large plc Q456 Chairman: To summarise Mr Jack, what he is international companies, whether it is aerospace or saying is that you eVectively set the Queensbury car, whatever it is. The thing which actually stops the rules and you are dealing with people who are bare- abuse very often is what is called a contract. Did it knuckle prize-fighters out there and it is not being ever occur to you that in this particular area of reflected. course the understanding of a contract does not Ms Boys: It would certainly be common ground, as exist. Virtually nobody has a contract with the we have said at various points this afternoon, the supermarkets. It is done in an informal sense and supermarkets have market power. I would not deny therefore has all the weaknesses and everything else. 9377401000 Page Type [O] 29-05-04 00:08:52 Pag Table: COENEW PPSysB Unit: PAG1
Environment, Food and Rural Affairs Committee: Evidence Ev 141
31 March 2004 Ms Penny Boys, Mr Alan Williams, Mr Bob Gaddes and Mr Colin Farthing
That must have actually struck you as being bodies who do not have that size individually and somewhat strange that we have in all the other who do not engage in those anti-competitive industries, all the other things that we investigate, all practices. the other sectors and such the piece of paper which regulates and assists in the balance of the relationship is an enforceable legal contract which Q460 Chairman: In a sense Milk Marque in its own the supermarkets steadfastly refuse to enter into. In way, where we started the story with the Milk that sense before you even start to look at it the bells Marketing Board, was inevitably trying to move would ring, with respect? from a situation which was supply dominated, with deficiency payments and all that and for the Ms Boys: It is a question I would ask the dairy producer a much safer environment to one which companies first before the supermarkets. was what you would call half competition. But in Mr Breed: But that is only a response to the major actually moving through from half competition to so side. I think once someone has got away with it called full competition I think what we are saying all everyone is going to because if you do not actually the time is you have moved from not producer have to operate in a contractual relationship then control but producer confidence that they had some obviously it is going to be very beneficial for those influence over what was happening to a complete who are the more dominant. Whether they abuse lack of confidence, which is why so many dairy that dominance, which is the bit I accept you have to farmers continue and will continue to drop out of the prove—it cannot be a guess, it cannot be a feeling, it market. Is there any view that that should be cannot be a perception, it has to be evidential—but something you should have a view on, or is it many of us would say that if we looked hard enough competition come what may and if the supply chain and searched long enough there ought to be clear is incapable of getting its act together and the evidence of the abuse of dominance in the sector. producer base is eroding all the time that is not your problem? Q459 Chairman: Could I just pick up one point Mr Farthing: Speaking for the Competition because where we come into this, and I accept this is Commission—Penny can speak for the OFT—we do not at the start of the story, but in the way, not have views, as it were, in that sense. We look at inadequate as it was, that Milk Marque set the specific problems which are put to us and the price—not the total price but in a sense the minimum problem put to us at that time was the position of price—there was a mechanism there. There was a Milk Marque, did it have too much market power, mechanism whereby buyers and suppliers pitched in was it abusing that power, and we looked at that on the basis of what they thought was a realistic question and we answered that question. As I say, if expectation on both sides and eventually some other people wish to put other questions to us in the market equilibrium arose. When eVectively you bust future we will look at them, but we do not have a that up you have now got lots more suppliers continuing policy stance, as it were. We are not that incapable of accessing the market in any organised sort of organisation. way because even though they work through co-ops Ms Boys: I want to say something which sounds very those co-ops, from all the evidence we have seen, are unsympathetic and hard. Of course it is ghastly for very weak. So in a sense by trying to push towards people who find their businesses under pressure and this goal of competition in a sense we have ended up decide to exit the market. I do not want to say that Y in a much more dysfunctional, much more is not a di cult and unpleasant thing but I find it Y disorganised and much more unfair market. How di cult from my perspective to have any view about how much would be absolutely right for the UK or would you respond? I think both of you need to V respond because you were both involved implicitly di erent parts of the UK. That is a managed market or explicitly with the demise of Milk Marque. How and I think we do start from the perspective that would you respond to that? whatever the volume of milk production it makes economic sense for this country to have where a Mr Farthing: Well, the decision we took, as I good profit can be earned and where competitive explained, about Milk Marque was really on the prices are reaching consumers, that is where we want basis of two elements. One was that the share it had to be. Now, that will change over time but I do not in the market was very large, as I say almost 50%, start from a presumption that there is a sort of magic and the other was that it was conducting practices number for the existing dairy farmers, for whom which abused that share. So it had both a very strong pricing and competition arrangements should be put market position and it was abusing that position. into some managed form. If that were to be The decision that we took was that no remedy which anybody’s wish that would be most certainly left Milk Marque untouched would actually deal something for the UK Government and not for a with those concerns and therefore the only way in competition authority. which the competitive problems that we identified at the time could be addressed was by splitting up Milk Marque into smaller entities. As I said earlier on, we Q461 Paddy Tipping: We talked about anonymity were very relaxed about whether those smaller earlier on. Just tell me how you respond to people entities were vertically integrated or not. That was who come to you and say—I know you pick up all not the issue. The issue was Milk Marque’s size and the stories, do you not?—“Something’s going wrong the anti-competitive practices it was engaging in. So here. We’re frightened to complain.” Do you look at what we have moved to is a range now of successor that? What do you do with that information? 9377401000 Page Type [E] 29-05-04 00:08:52 Pag Table: COENEW PPSysB Unit: PAG1
Ev 142 Environment, Food and Rural Affairs Committee: Evidence
31 March 2004 Ms Penny Boys, Mr Alan Williams, Mr Bob Gaddes and Mr Colin Farthing
Ms Boys: Well, we wanted to capture the most and we must put that right,” or of course we could information that we could. So when someone wants say, “Well, contrary to everybody’s expectations it to come along and say, “Things aren’t working here does actually seem that things are working very but please, you know, I want to remain smoothly.” It is an open question at the moment. anonymous,” we still want to hear that. What we cannot do then without breaching that Q465 Paddy Tipping: So we might see some action in confidentiality understanding with them is actually the autumn, but I am just asking you more directly take it up with the supermarket. There have been whether people ought to be able to complain to you occasions when we have said to people, “Well, okay. on an anonymous basis and you should pursue that? Look, there have been other people making Ms Boys: People already are and our doors are complaints in this area who want to remain always open. We will take information of any type. anonymous. We might take this up with X All I am saying is that it is the people themselves who supermarket to explore what’s going on.” “Please are then restricting the use that we can make of that don’t, because the mere fact that you are looking at information. It is not us saying, “Oh, I’m sorry, we these particular transactions will blow our cover, as can’t act on that.” They are saying, “Please don’t it were. They will know who it is who has made the raise this with the supermarkets because . . .” complaint to you and we don’t want to take the Paddy Tipping: It sounds like the Whip’s OYce! risk”—as Mr Jack was outlining—“of the Chairman: We need a super action hero, the Milky relationship and the supply relationship being at Bar kid, but we will not get into that! risk.” Mr Jack: We need a milked confession!
Q462 Paddy Tipping: So how do we sort this out? Q466 Chairman: Could we just sweep up a couple of People are coming to you and saying, “This is a other things. We have had the call, which no doubt David and Goliath situation. We’re frightened of you heard, for the idea of a regulatory body for milk. losing our business.” You listen to them and there Have you a view on this? OV-milk is an expression may or may not be some substance in this. People do Mr Jack reminds us but we will try to pass on that. not want to take it forward. Should we change the Have you looked into this? Have you a view on this? code so that people can do that? It is outwith your direct responsibility. Ms Boys: Well, I think this is the important question Ms Boys: Yes. It would not be for us, of course. I we have got to address next. The next step for us is think there would be some questions that one would to have the compliance audit and to have, as it were, ask before reaching a firm view on that. What is the the trail of – objective? What would such a body actually be trying to achieve and how would it do it? What Q463 Chairman: Could you just say what the would the costs of doing that be? What would be the timescale of the compliance audit is. other disbenefits? My guess is that the disbenefits Ms Boys: We will be appointing a firm of auditors and the costs would outweigh any advantage, but next month and we expect to be reporting on that is just a passing view. conclusions from the compliance audit, plus our views on the “Okay. So what? Where next?” in the Q467 Mr Breed: Could I just come in on that. You autumn. could be right on an individual sector but in terms of the fact that we get a Competition Commission Q464 Paddy Tipping: So it is a possibility that people report into a particular sector abut once every ten or can complain anonymously and if you change the fifteen years or something and, as we have clearly code you will pursue it? seen, things have moved on significantly in three Ms Boys: It is not the change in the code, of course, years, would not the post of a regulator for the retail that would permit anonymous complaints. There is industry as a whole, bearing in mind that retailing is nothing to do with the code that is preventing that. ever more becoming concentrated in fewer and fewer It is the inhibition from the sort of imbalance in the hands, not just dairy, not just fresh produce but a lot supply relationship which is making people very of others so that indeed we have regulators, as you reluctant to do that. So I think the question for us at are obviously aware, in electricity, water, all the sort the end of the compliance audit is, is this code doing of basics of life in that sense where there is now a anything eVective? Perhaps not. What do we then commercial function where they did not use to be do? On the basis of the other evidence that we have and indeed where in the sort of ideal world that you should we make another reference to the might have thought of 50 years ago when we were a Competition Commission on supply generally or on nation of shopkeepers and where now we are a milk? Should we ask them to have another look at nation, if we are not careful, of a shopkeeper, is there this? Have we got evidence of abuse of dominance not at least some merit in having a regulator for the and anti-competitive agreements? I do not think we retail industry as a whole as the supermarkets seek will be in this position, but if we were then most to gobble up almost every other sector as well, certainly Alan and his team would be pursuing those whether it is pharmaceuticals, cosmetics, birthday under the Competition Act. Have we got examples cards, flowers, newspapers, magazines, insurance, of particular supermarkets breaching the code? In banking, I could go on? Are we not into a situation which case there would be enforcement action we where in fact the power of the general supermarket could take to say, “Well, the code seems to be requires the consideration of a regulator in general, working but here is somebody who has breached it of which Milk Marque would be one investigation? 9377401000 Page Type [O] 29-05-04 00:08:52 Pag Table: COENEW PPSysB Unit: PAG1
Environment, Food and Rural Affairs Committee: Evidence Ev 143
31 March 2004 Ms Penny Boys, Mr Alan Williams, Mr Bob Gaddes and Mr Colin Farthing
Ms Boys: I think I would just ask the same question, Ms Boys: I guess that would depend on the specifics. what would you hope to achieve? You mean some sort of agency, a collaborative arrangement. It is possible that could be judged within European law. Q468 Mr Breed: I suppose fair trading, which seems Mr Williams: It would depend on what we are to be the principle of the OYce of Fair Trading. intending it to do or what it might do. An agency Ms Boys: I wonder if actually what you were saying which was there to assist dairy producers and milk you would want to achieve would be a managed producers more eVectively market their product but market. left them with the ultimate pricing decision probably would not be much of a problem. But if you have in mind an agency which eVectively took most of the Q469 Mr Breed: By whom? milk around from most of the farmers and then set Ms Boys: Presumably by the regulator. the price for it you would be eVectively creating a monopoly supplier and that would certainly run into severe competition law problems. Q470 Mr Breed: Up to a point you could be correct, but if you have allowed the situation where we have Q472 Chairman: Mr Farthing, do you want to add only four major retailers and where we could end up anything? with even less perhaps that is, I am afraid, the Mr Farthing: I would agree with that. The last time corollary of it. If we have allowed competition to be I was directly involved in this was when we did the so diminished that we now even have to think about Scottish milk inquiry in 2000. That was at the time these things then perhaps that is, I am afraid the that “the white stuV”’, milk promotion, was taking natural progression of what we have allowed to place and that was conducted by the milk producers happen. collectively. As Alan has said, if it is simply Ms Boys: One would want to look at how coordinating an advertising promotion campaign competition was working within that particular then I do not have any problem with that, but if it structure. The last time it was looked at each of the goes into more worrisome areas then there could be supermarkets, significant market power though they diYculties. had, was judged to be competing eVectively. We had not lost competition, it was taking a diVerent form. Q473 Chairman: Okay. Could I thank you very The market had evolved a certain way into a certain much for the evidence you have given. I know we have asked for some written evidence, certainly in structure. So I go back to what I said originally. We terms of telling us what you have been inquiring into do not have a fixed view of what competitive so we have it on the record in the appendix, if structures are. We want to observe the competitive nothing else, of the diVerent inquiries you have process within whatever structures evolve and it is engaged with and clearly if there is anything else you up to us to enforce competition law against any would like to say to us which either has not arisen allegation of an abuse of a dominant position. The which you think may clarify our inquiry or that you holding of a dominant position is not against particularly wish to further expand on what you European law. have said. But, unfortunately, what you have said is on the record and will remain so, so we cannot do anything about that, but thank you very much for Q471 Chairman: Before we conclude, just a couple of coming. other things. There is also this idea of a supply side Ms Boys: Could I just ask by when you need the milk agency to try and get the marketing of milk note? brought forward in a more coherent manner. Would Chairman: As always, as soon as possible, but we are either of you comment on whether that would be not aiming to write over the Easter, unless Fiona something that would be allowed within your knows something diVerent to ourselves. Thank you particular interpretation of competition? very much. 937740PAG2 Page Type [SE] 29-05-04 00:56:37 Pag Table: COENEW PPSysB Unit: PAG2
Ev 144 Environment, Food and Rural Affairs Committee: Evidence Written evidence
Memorandum submitted by Robert Millar (L1)
As a milk producer in the Southern Isles Ring Fence, a very remote area of Scotland, I would like to contribute to your enquiry. 1. Virtually all the milk is processed into cheese which is all niche marketed by McLelland’s 2. The three creameries are owned by Scottish Milk Products Ltd, a subsidiary of First Milk. The fresh milk in the area is supplied by Claymore and Wiseman Dairies. There are only two producer retailers. Others stopped because they could not compete in the liquid market. 3. Milk producers and the creameries contribute approximately £25 million to the rural economy in South Argyll. 4. It is imperative that the Southern Isles Ring Fence continues. 5. The farmgate price for milk is threatening the whole rural infrastructure in this already fragile area. 6. It was a political decision which handed total control of the dairy industry to the few but large processors and retailers. 7. The vivid example is Arla, a farmer controlled co-op which handles 90% of the milk produced in Denmark and Sweden. 8. The UK competition commission rules are obviously incompatible with EU competition rules. 9. The UK is the only country in Europe to use IMPE as the base price for all milk contracts. 10. The MTR proposals are to reduce IMPE by 4ppl but with only 2.5ppl of direct compensation will complete the demise of dairying in the remote areas unless an equitable share of the consumer price for milk and dairy products can be returned to the producers. 11. The recent increase in the price of liquid milk was achieved by collusion of the supermarkets. The producers’ share from this initiative was derisory. It only contributed to increased profits for processors and retailers which were not achieved by eYciencies. 12. The processors can easily manipulate the market by always having a milk surplus regardless of supply, ie by closing Chard, thus continuously depressing the price. 13. The producer co-ops are being left with high cost peripheral areas where no other buyer exists and in these areas dairy farming is the biggest contributor to the rural economy. 14. A regulator may be too cumbersome, but some transparency must be introduced where the total consumer spend on dairy products is divided proportionately. 15. In 1933 the government created the Milk Marketing Boards to create a balance in the dairy industry. I realise this is not an option, but today’s producers are in the same predicament as they were in 1933. 16. Since it was a political decision to swing control of the dairy market to the retailing and processing sector, it will take a political decision to create a balanced market. 21 December 2003
Memorandum submitted by Pippa Woods, Chairman, The Family Farmers’ Association (L2)
The Family Farmers’ Association no longer has many dairy farming members. We are very concerned about the fact that dairy farming is no longer the mainstay of the small and family farm, as it once was. It is now so technical and capital intensive, and also so unprofitable, that fewer and fewer farmers are producing milk. As I have, personally, lived by, with and from milk production for 49 years, I hope my experience and opinions may be acceptable as evidence. I trust that you will have the actual statistics provided by economists, and/or the NFU who have professionals to study them. No doubt they will show you how, over the years, the proportion of the end price for milk—ie what the consumer pays—has been getting lower and lower in relation to what the farmer receives I have noticed that figures given for the farm gate price of milk tend to vary somewhat, so it may be useful to quote here what I have actually been receiving over the years. The figures are pence per litre and are derived by taking the total sum I receive for milk each year and dividing that by the number of litres I have sold. Thus the figure is after paying any transport costs and various other smallish items the dairy deducts for. I receive most of the bonuses available for hygiene, welfare, etc. but not all those for low somatic cell count as I keep my cows well into their old age, by which time they tend to have higher cell counts. 1995–23p; 1996–2zUl4p; 1997–25,35p (increases in line with inflation); 1998–2l.58p (what happened?); 1999–l9.96p; 2000–18.21; 2001–7.36; 2002–20.23 (shortage caused by F&M?) 2003–l’7.90p. Have you statistics for retail prices in those years? 9377401002 Page Type [O] 29-05-04 00:56:37 Pag Table: COENEW PPSysB Unit: PAG2
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I sell direct to Dairy Crest, as their bottling plant is only 15 miles away. Apart from the price they now pay, they are very kind and helpful to do business with. They do pay consistently a penny or so more than the co-ops, which is just about my profit margin. I only have just over 60 cows, as this farm is not topographically suited (too hilly) to keeping a larger herd. It is commonly stated that the minimum number of cows for survival is 100, but, in fact, I believe the average herd is still a little below this. The statisticians will tell you how it is increasing rapidly. A few years ago 60 was the average size. Do not be misled by articles on dairying referring to “The average dairy herd of 100 cows”. That is not yet true. Anecdotally, a recently established enterprise of 500 cows in Cornwall has just sold up, reputedly because of labour problems. But I have been reading an article about a farmer who is expanding to 800. How do the dairies fix the price? I think it is quite simple. They now pay just enough to attract the quantity of milk they wish to process. The Dairy Crest annual reports show that they are making a very satisfactory profit. It increases by a satisfactory percentage each year. (No doubt you will study some dairy companies’ annual reports,) They do have meetings with producers when they chat us up and tell us what good milk we produce and how well they are marketing it. Also, of course, why they cannot pay us a better price, as they would like to. I have asked them if they will be happy if so many of us give up that they only have enough milk for the liquid market, and none for manufacturing and the reply is certainly not. My personal belief is that they will continue to pay just enough to maintain their supply. Another complication is the Monopolies Commission/OYce of Fair Trading. The milk marketing Board was forced to disband as it was a monopoly. Later the same thing happened to its successor, Milk Marque. But I believe the government has used the same argument to prevent supermarkets from agreeing that they would all raise their milk prices, in fairness to farmers, alleging that would be monopolistic action. The simple answer to the question you are investigating is, therefore, there is nothing to prevent every member of the milk chain from making as much profit as he can. But we are not allowed to join together in a monopoly in order to secure a better price. You will also be aware that all the milk processors belong to an organisation now known as DIAL. It is very hard to believe that they do not employ some informal methods of co-operating. Likewise, there is no reason to suppose that every milk retailer is not well aware of what the others are charging. All are at liberty to charge the same low price, provided they do not advertise that they are acting in unison. 31 December 2003
Memorandum submitted by Richard Pool (L3)
1. Summary 1.1 Milk production in the UK is in gross excess. Surplus is disposed of by Community dumping on world markets, at taxpayer cost and to farmer, national and Community shame. 1.2 Production must be limited by the normal market mechanism of price. 1.3 Two issues currently militate against normal market forces: (i) old ex-MMB ideas of “co-operative” marketing, derived from the use of monopoly powers, to use the [captive] liquid market to fund other uses and to fund farmer-owned dairies. Such funding is both deeply abusive of consumers, and illegal. Supermarkets, caught in these attempts, are damned whatever they do. The old concept of equal farm gate prices for all producers is still deeply ingrained. (ii) Quotas. Besides acting to encourage production, albeit at a loss, fulfilled quotas are seen as the inevitable basis for decoupled Single Farm Payments in the dairy sector. This is a major factor in supporting illogical, loss-making and irresponsible milk production and a massive barrier to any rational reduction of milk production.
2. Background 2.1 Others will no doubt have pointed out the mechanism of price formation in the milk market and the chronic over-supply of this market both at Community and at national level; not least the over-supply of the national liquid milk market, the only market able to distort prices by commanding a premium over present CAP support levels for butter and smp. (and, by necessary implication, for bulk cheeses). The present Pricing Inquiry is itself a consequence of this over-supply. 2.2 This note looks at three responses being urged to “remedy” this over supply and its normal market consequences: (i) demands to restore, in some form or other, the old cross-subsidy from the liquid market to other uses, both by capital transfers and by milk price transfers. Both are bitterly abusive of consumers, and illegal; 9377401003 Page Type [E] 29-05-04 00:56:37 Pag Table: COENEW PPSysB Unit: PAG2
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(ii) the malignant eVect of the near universal assumptions that milk production must always be maintained to fill quotas and that future entitlement to a de-coupled Single Farm Payment will be based, not on a uniform land rate, but on historic “entitlement”; and (iii) continued disregard of dairy farmers selling direct to consumers.
3. Notes 3.1 Liquid demand. The Waterhouse Committee (a committee under the old Agricultural Marketing Act, chaired by the then Mr later Sir Ronald, Waterhouse) considered the size of “buVer” needed to support the MMB liquid milk market to be 15%. This suggests UK national milk production should drop to about 55%–60% of UK national quota. 3.2 Milk producers do not contest their dependence on dumping. When, recently, Westbury Dairies took over the running of the dairy, a spokeswoman is reported as saying “We are delighted to confirm that Westbury will stay in farmer control. The deal marks a milestone for the UK dairy industry, with the three leading co-operatives, Dairy Farmers of Britain, First Milk and Milk Link, working together in a unique joint venture to secure vital access to intervention markets”. (Ignoring the obvious errors in the above quotation, the obscenity of the producer thinking behind it is remarkable). 3.3 Farmers For Action, on the BBC recently, attacked Wiseman Dairies for making profits rather than paying farmers. When asked to note that Wiseman paid a high milk price, the reply was that, since they were selling more in the liquid market than others, they should pay more. Westbury (noted above, but in various of its recent manifestations) has made various calls for support for plant etc. Producers have contributed very large sums to co-operative and other dairies, both in low-or no-payment for milk and in dishonoured shareholder funds, bonds etc. Dairy Crest has repeatedly shown disregard for the interests of its farmer funders, first, under MMB control, by building dairy plant funded (illegally) by abuse of MMB compulsory powers, later by withdrawing plant so funded from the milk market to reduce the price it (and others) had to pay for milk on end of the MMBs, more recently by evading farmer shareholder control by RMMB handling of, amongst other funds, its old “Roiling Fund”. The list is long, and repeated in Scotland. 3.4 Major dairies and supermarkets seek, properly, to put milk and dairy products on their shelves at the lowest price, to the extent that they speak for their consumers, it would be wrong for them to do otherwise. Only when they can not restock their shelves can they be said to have taken their duty too far. 3.5 One long term and stable development, expected when the monopolies ended, has not occurred. Individual producers, or small groups, have not contracted with specific supermarkets to supply (and the buyer to take) milk; the supermarket taking responsibility for arranging the contract packaging of this milk by whatever dairy it wishes. The opportunities for developing quality farm standards, regional loyalties and public association of identified farms with specific supermarkets have not—yet?—been explored. 3.6 One small group of farmers do provide useful competition to supermarkets, on price, and also on quality and on service—those who sell the milk of essentially their own production direct to consumers, as retail “bottled” milk or as cheese, yogurt, cream etc. Such direct farm sales, getting closer to consumers, farmers markets etc., have been greatly encouraged recently for most farm produce, but not for milk. A wide divergence of support for, or opposition to, these milk producers has been shown by many organisations; RMMB treated them most improperly; Milk Marque and its successors were positively helpful to them; some local authorities hate, some love them; many in the Intervention Board, dealing with quotas, looked on them as rogues, a view reciprocated by many direct sellers, but now calming down; and many standards, appropriate to large organisations, may be very damaging when imposed on these often single family organisations.
4. Conclusions 4. This Committee should urge government: 4.1 to reject all calls, however disguised, for any cross-subsidy by the liquid market to the benefit of milk producers supplying other uses, as deeply abusive of consumers; as against the national interest; and as probably illegal under current national and Community legislation. 4.2 to support a distribution of the de-coupled Single Farm Payment, for milk at least, on an area average basis, and not on an historic entitlement basis. (Alternatively, to make clear now that supplies after March 2003 will play no part in these calculations). 4.3 to encourage and to protect from incidental damage, those dairy farmers who market direct to consumers the milk of their own production. January 2004 9377401004 Page Type [O] 29-05-04 00:56:38 Pag Table: COENEW PPSysB Unit: PAG2
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Memorandum submitted by Iorwerth Rowlands (L4)
My son and I have farmed this holding since 1948 and have recently been joined by my grandson who is keenly interested in farming in general and dairy farming in particular. We have 170 dairy cows. During the last three years our overdraft situation has deteriorated until we have reached a stage where it is impossible to continue without a substantial and fair increase in the milk price we receive. — It is outrageous that the supermarkets are still allowed to treat milk as a “loss-leader” and that we, the dairy farmers are forced to contend with a 365 day working year and be subjected to the tyrannical treatment from the processors and the supermarkets, who have built into the price they pay us, an adjustment to cope with their management losses. If they have no losses, then they have extra profit and win, if they have losses, we pay and again they win. — The UK milk industry is essential to the health of the nation, both children and adults benefit greatly from the safe standards rightly set out in the demands placed on us by regulation and we do not quarrel with this. It is however required that we are paid a sustainable milk price to enable us to re-invest in order to maintain these high standards set by the authorities. — The damage being done to the rural economy will result in devastation unless an element of control is supported by all governments of this country. It cannot be right that a system is allowed to operate where the transportation of milk is allowed uneconomically due to the direct buying by the processors and the overlapping of the collection service. Again, it is the dairy farmer, the basic producer who has to carry these extra costs. — The situation cannot be allowed to continue as it is and I implore the committee to consider carefully the current financial problems within the industry and remedy the injustices being imposed on the dairy farmers of Britain by both the processors and the supermarkets. 7 January 2004
Memorandum submitted by Messrs FW and JM Hart (L5)
The price of milk on this holding from 1996 to present, for milk of above average butterfat: 1. 1996 —24.8 pence per litre 2. 2000–01 —17 pence per litre 3. 2001–02 —19 pence per litre (rise due to publicity) 4. 2002–03 —17.05 pence per litre 5. During this period, products were controlled by the Milk Quotas, so there was no surplus to depress the farm-gate price. In fact, in the last two years farm production has been below the National Quota. With lower producer prices, a constant increase in consumer prices, over the same period, of almost 5 pence, the Trade supermarket are increasing their margins using their strength to exploit the weak, fragmented producers. 8 January 2004
Memorandum submitted by John Tuck, Dairy Farmer (L7)
Previous inquiries into milk marketing by both the Monopolies and Mergers Commission and the Agriculture Committee of the House of Commons have not recognised the intrinsic weakness of trading position of dairy farmers wholesaling milk. The Government of the day in 1933 did, and set up a statutory Milk Marketing Board to protect the supply of this component of a healthy diet. While this did restrict competition to some degree, its benefits were not only to the farmer. Complacency among milk processors and retailers as a result of wartime price controls, which lasted decades after hostilities had ceased, had more to do with the lack of competition in the dairy industry than the existence of the MMB. Currently low prices for milk are encouraging husbandry methods that are deleterious to the welfare of dairy cows, the environment, and the social structure of the countryside. The current high price of milk quota is I believe, an aberration that many will regret. The dairy processors oVer neither realistic premiums for level deliveries throughout the year nor invest in plant to take advantage of cheap seasonal milk but they were instrumental in the financial collapse of the United Milk plant at Westbury. 1. Milk production is a specialised process requiring high levels of capital and labour input, and also a long-term strategy and commitment, but the output is necessarily continuous, sometimes variable, but above all perishable. These are the facts that make milk marketing uniquely diYcult. The Milk Marketing Board, a statutory monopoly, was formed in 1933 to protect the financial well being of the producer from the predatory dairy industry, and to ensure a continuing supply of nutritious milk to safeguard public health. Despite being a monopoly the Milk Marketing Board served both producer and consumer well, particularly through the Second World War, and evidence of benefits to the consumer in lower prices since it’s demise is hard to find. 9377401011 Page Type [E] 29-05-04 00:56:38 Pag Table: COENEW PPSysB Unit: PAG2
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2. Of concern to everyone should be the intensification of dairy farms. Increasingly high yielding Holstein dairy cattle, bred for conditions that prevail in places like California and Israel, are being fed rations that largely consist of intensively grown arable crops, particularly maize and other cereals. Cattle are herbivores adapted to convert large quantities of forage, particularly grass either fresh or conserved, into milk and the consequences for the environment and for animal welfare of this intensification should not be underestimated, nor should the social consequences of the demise of dairy farming in areas not suited to growing arable crops. 3. The fact that this consideration of milk marketing by the Environment, Food and Rural AVairs Committee of the House of Commons follows reports by both The Monopolies and Mergers Commission and the Agriculture committee of the House of Commons since the break up of the Milk Marketing Board, indicates that an equitable solution to the problems that beset the milk producer and the supply chain to the eventual consumer has not been found. In fact before The Monopolies and Mergers Commission published their report on Milk Marque in July 1999, the wholesale price of milk was already falling, disproving the conclusions they had reached, and the report of the findings of the Agriculture Committee of the House of Commons published in 2000, which broadly supported the findings of the MMC can only be described as perverse. The history of milk marketing since vesting day only makes sense if it is viewed as a continual application of a “divide and rule” strategy by the major milk processors, augmented by a policy of reduction in processing capacity in order to maintain the fiction of surplus output in order to justify reductions in prices paid to farmers. The statutory powers of the Milk Marketing Board were removed because it was considered to be in the consumer’s interest to do so. Consequent reductions in the retail price of milk are hard to find. Excuses for failing to reduce, or even raising the price are a legion. 4. Contradicting the otherwise gloomy outlook for dairy farmers is the current buoyant market for milk quota. This is due in my opinion to a combination of desperation, wild optimism, and clever salesmanship by quota traders. The desperation stems from farmers who have expanded their output in the hope of trading their way out of diYculties, thinking that nationally our quota would not be fulfilled and that their overproduction would not be penalised. Now that production figures indicate that national quota probably will be fulfilled in the current year they need to acquire quota simply to receive payment for milk they have already delivered or will deliver before the end of the quota year. Wildly optimistic are those farmers who foresee large handouts as a result of the Mid Term Review of the CAP based on the amount of quota held by individual farmers, and those who believe that trading conditions are likely to improve in the near future. Clever salesmanship is persuading potential customers that what I have described as wild optimism, is good commercial sense. 5. The rise in the farm gate price of milk which followed the deregulation of the market in 1994 had very little to do with Milk Marque’s commercial strength but was almost entirely caused by processors oVering what amounted to bribes to tempt farmers away from the co-operative. At that point Milk Marque had no processing plant of it’s own, nor did it have, or any prospect of having, control of the output of milk. Without these, the commercial muscle of Milk Marque, allegedly feared by the Dairy Trade Federation was almost entirely illusory. 6. Milk processors complain with some justification that the Milk Marketing Board insulated dairy farmers from the realities of the market place, but they do not admit that for around half of the life of the Milk Marketing Board that they were even better insulated than the farmer by Government Price Controls instituted in the Second World War, and the last such controls to be removed decades after the war was over. In successive price reviews through the 1950’s and 60’s the price of milk to the farmer was reduced in real terms, by eVectively penalising him for increasing his eYciency, while the retail price was steadily increased to give the dairy trade “cost plus” improvements to their margin, guaranteeing their returns without the need on their part for enterprise, innovation or their attendant risks. However the dairy processors have been very successful in passing the blame for this back to the farmer as is witnessed by the introduction to the Second Report of the Agriculture Committee of the House of Commons, published in January 2000, which states that historically “few farmers saw any need for a commitment to marketing”; a ridiculous statement to make about the people who created Dairy Crest. 7. Milk producers are criticised for failing to react to the demands of the market place. I would argue that they have. First and foremost processors buying milk demand that it is cheap. The cheapest milk to produce is that from cows that calve as the grass begins to grow in the spring. The processors then complain that they do not have, and are unwilling to invest in, the processing capacity to deal with the “spring flush” of cheap milk. The New Zealand dairy industry, which is held up as an example of high eYciency, has a manufacturing sector geared to take advantage of cheap seasonal milk. They have suYcient manufacturing capacity, almost entirely farmer owned, to deal with a massive spring flush after which production gradually tapers oV through the year, until most plants are idle for a month or two in the winter. There is a premium (despite my best eVorts I am as yet unable to quantify this. I will forward the information as soon as I have it) paid to some farmers in New Zealand who provide “town milk” ie milk for liquid consumption, which necessarily needs a level production profile all the year round. The British dairy processors at present wants cheap milk and a level production profile. This simply cannot be done. They must make up their mind, and will either need to invest in the plant to deal with a spring flush, or they will need to pay a realistic premium 9377401011 Page Type [O] 29-05-04 00:56:38 Pag Table: COENEW PPSysB Unit: PAG2
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for level production. The alternative is that British dairying must contract so that it only fulfils the liquid market, at which point the processors will have no option but to pay a decent price for level deliveries unless they are prepared to see the industry disappear entirely. 8. The story of the processing plant installed by the United Milk co-operative at Westbury in Wiltshire has been an unhappy one. It was not the best conceived plan, but it was a brave attempt to give farmers a plant of their own. Of all the problems that beset it, the one that was insurmountable was failure run it at full capacity. There were a proportion of the farmers who contributed capital to the scheme who failed to supply milk. Milk producers who invested capital and were direct suppliers to processors, when they announced their intention to resign their existing contracts, were oVered extra money by their current buyers to continue to supply, thus denying the new plant vital throughput, eVectively and cynically making certain the eventual demise of the scheme. Note that the only people who had the strength and commitment to rescue the plant, to the benefit of all milk producers, were those condemned by the processors to receive the lowest prices; namely those committed to co-operation in bodies, now enlarged, but formed at the break up of Milk Marque. 9. This is a 200 acre dairy farm that has been worked by my family for at least 6 generations and over 200 years. I am now 61 and my wife and I are working as hard and long as we ever have in our lives. Much of the extra work is connected to another enterprise, pressing apple juice and making preserves to sell at farmers markets. It is this enterprise that keeps us afloat and we keep our milking herd as a hobby. Our son Stephen is in charge of the herd. He is 27, has a degree in agriculture, experience of dairy farming in New Zealand, and despite the present diYculties wants to make a future in dairy farming. An article he wrote in 1996, that won the David Shead Award for young journalists, oVered by The Dairy Farmer magazine, financed Stephen’s trip to New Zealand. The subject of the article was Dairy Farming in 2006, and he predicted that by then, after years of low prices farmers would be agitating for a new Milk Marketing Board. I think he was right in everything but timescale. What dairy industry will this country have in 2006? January 2004
Memorandum submitted by Malcolm Ronald, Milk Producer (L8)
As a milk producer in the Southern Isles Ring Fence area I would like to make the following points to your enquiry: 1. The plight find themselves in is a direct result of the abolition of the Milk Marketing Boards, by the previous government (Conservative). Milk processors and supermarkets now control milk supplies and the result is an ever diminishing share of the value of milk and dairy products to the milk producer. 2. As a result of demonstrations by farmers during the last year, supermarkets increased the price of liquid milk and cheese “supposedly” to enable the farmer to receive a price increase. Unfortunately very little reached the farmer. This cynical profiteering should be stopped and a way found to ensure dairy farmers receive a fair share of the value of what they produce. 3. One of the present government slogans is “A Fairer Britain”, but how can it be fair that farming families have to work longer and harder, meeting ever more stagnant farm assurance standards, yet receiving hardly any award, whilst processors and supermarkets eg Dairycrest, Robert Wisemans, Graham’s Dairys and Tescos, all announce record increases in profit? January 2004
Memorandum submitted by Glanbia Foods Limited (L11)
1. As Glanbia’s main UK activity is cheese production we will confine our comments to the relationship between market prices for cheese and farm-gate milk prices. 2. Cheese accounts for c. 25% of milk utilisation in the UK and, in the medium/long term, movements in the published Defra farm-gate milk prices are reflective of movements of both direct and Co-op milk prices paid by UK cheese manufacturers. 3. The table below shows annual average mid-point bulk cheddar prices collected in the PTF (Provision Trade Federation) bi-monthly market survey, for the mild and mature sectors. This is the most representative indicator of trends in the UK market. Assuming a 70%:30% weighting between the two sectors, an average has been derived.
1998 1999 2000 2001 2002 2003 Mild, £/Tonne 2,277 2,107 2,112 2,336 1,881 2,056 Mature, £/Tonne 3,132, 2,952 2,998 3,045 2,544 2,411 Average, £/Tonne 2,534 2,361 2,378 2,549 2,080 2,163
4. Market prices for cheese collapsed catastrophically between 2001 and the spring of 2002, as a result of the following factors: 9377401016 Page Type [E] 29-05-04 00:56:38 Pag Table: COENEW PPSysB Unit: PAG2
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— A collapse in world butter/SMP prices diverted milk into cheese in the UK and in Europe, leading to rises in both domestic production and imports. — The closure of UK butter/SMP capacity exacerbated the above problem. — The UK dairy industry overestimated the impact of FMD on milk production, leading to marketing Co-ops oZoading surplus milk at low prices at the back end of the 2001–02 milk year, much of it going into cheese. — Excessive competition leading to disorder in the UK milk selling Co-op sector aggravated the above problem. — By spring 2002 UK cheese stocks were up by 15K tonnes year on year. 5. The mid-price bulk mild cheddar reported by PTF fell by £600/tonne from £2,350/tonne to £1,750/ tonne, equivalent to 6ppl, between May 2001 and May 2002. The fall in mature cheddar prices over the same period was very similar. The Defra farm-gate milk price, however, fell by only 3ppl over the same 12 month period, leaving cheddar margins severely depressed. 6. Mild cheddar prices have slowly recovered since the 2002 low, aided by stable/rising butter/SMP markets, weaker sterling and the opening of new butter/SMP processing capacity at Westbury. 7. The level of price increase, however, has not been as great as expected at the beginning of 2003, as a record (since deregulation) level of milk production over April–December has channelled additional milk into cheese, slowing the rate of decline in stock levels. It was not until September that UK cheese stock levels fell back to the “normal” levels of 2001. 8. By October 2003 the mid-price for bulk mild cheddar reported by PTF was up by £400/tonne to £2,150/ tonne, but mature prices declined further, then remained flat until November 2003, so in October 2003 were actually £100/tonne below the level of May 2002. Therefore, assuming a 30% market share for mature, the average improvement in cheddar returns between May 2002 and October 2003 was only £250/tonne, or 2.5ppl. The Defra farm-gate milk price rose by 2.6ppl over the same period. 9. Defra returns for November 2003 onwards are not yet available, but Glanbia has increased its direct prices by a further total 0.75ppl by December. However, the mid-price for bulk mild cheddar reported by PTF had not increased by the beginning of January 2004. 10. With regard to the “retail initiative” paid by the multiples from November 2002 onwards, Glanbia has passed the additional revenue back to farmers on a pound for pound basis, by means of a price supplement calculated each month. The initiative was £200 per tonne, or c. 2ppl, but as only a proportion of Glanbia sales are through these outlets (the balance going into Foodservice and Ingredients), the actual rate passed back to farmers has varied between 0.905ppl and 1.532ppl, averaging 1.09ppl. 11. With regard to increases agreed by retailers in the autumn of 2003, Glanbia received virtually no additional revenue until November, but increased its milk prices by 0.75ppl from October, in anticipation of the rises, and recognising the severe economic situation faced by dairy farmers. 12. In summary, milk price reductions between 2001 and the spring of 2002 did not fully compensate for falls in the cheddar market, severely reducing profitability. Subsequent rises in the cheese market, however, have been matched by equivalent milk price increases. As a result, over all categories of cheddar, margins are estimated to have fallen by almost 2ppl compared to the average of 1998–2001. This represents a loss of c. £40 million per annum to the UK cheese sector. In no sense can it be claimed, in the cheese sector at least, that farm-gate prices of milk have not kept pace with improvements in market returns. January 2004
Memorandum submitted by Nick Holt-Martyn, Operations Director, ADAS Dairy Group (L13)
I provide consultancy to Defra Milk Policy Division. Due to my continual analysis of the market milk pricing is an issue I feel qualified to speak about. From our analysis there are a number of factors that have become clear over the last 4 years. 1. Since 2000 farmgate prices have been market driven although the market is distorted by the major retailers in the liquid and cheese sectors. 2. There is a distinct time lag between market movements and farmgate movements of around 6 months. 3. Since the 1uretail initiative in Oct 2000 the gap in wholesale equivalents has increased from 2.0 pp1 to 5.0 pp1 increasing the ability for milk buyers to end-use price. As the farmers co-ops hold the balancing volume they inevitably produce the lower prices. 4. Many farmers misunderstand the relevance of IIMIPE. It is an indication of the supported values for butter and SMP it is not a market minimum value. During the last year the wholesale cheese market has under-performed 1MPH due to high stock levels. The UK utilises around 18% of supply as SMIP, butter 9377401018 Page Type [O] 29-05-04 00:56:38 Pag Table: COENEW PPSysB Unit: PAG2
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and WMP compared to 72% as liquid and cheese. Therefore the influence of 1MPH is greatly exaggerated. It took 15 months for cheese stocks to fall through greater SMP production before the wholesale mature Cheddar cheese prices rose. 5 Farmgate prices by milk buyer reflect the sectors they are in. Liquid prices are more responsive due to direct retailer intervention. Dairy Crest’s recent price rise is due to several factors including expectations of cheese price rises, a mixed product portfolio and putting pressure on their cheese competitors such as Glambia. 6. There is no mechanism to equalise prices across the sectors as occurred under the MMB and early Milkmarque period. 7. Bi-annual price setting in April and October increases the time lag between markets and farmgate prices and reduces the transparency of pricing. 8. A further complication is the relationship between rolling milk production and farmgate prices, which can conspire to cause prices to fall rapidly at times of falling markets. 9. We expect production to be lower over the next 6 months due to quota pressure and milk prices to be stable through to the autumn 2004 with the gap between sectors narrowing. Thereafter CAP reform will aVect the “normal” market relationships outlined above but these aVects are not yet clear. 7 January 2004
Memorandum submitted by PWR and ARA Gantlett (L17)
1. Executive Summary The reason the farm gate price of milk is so low is simple, it is the nature of the product itself. Milk is a perishable product, produced daily under a system of production that takes years to establish and is unresponsive to market forces. Add to this the extremely competitive pressures exerted by the supply chain that delivers milk and its various processed products to the consumer. The result is an industry at war with its self and as ever it’s the little guy ( the farmer) who loses. We need an industry regulator, some one to oversee the whole milk supply chain, to bring transparency, co- operation and fairness, to deliver a supply chain rewards investment initiative and hard work, but most important delivers value to the consumer. OFFT MILK is not a joke , it’s a solution.
2. Background The above summery is very similar to an article I wrote in 2000 as Wiltshire county chairman of the NFU. In 2000 when farmers first started blockading supermarkets, I became involved in discussions between a leading supermarket, processor and farmers. It quickly became apparent how little each knew of each others business and the suspicion that existed of each other, but the biggest obstacle to progress was the threat, perceived or real of the competition commission. The process unfortunately came to nothing.
3. Alternatives Since 2000 there has also been a belief that the solution lay in the hands of farmers by creating better cooperatives and buying or building processing capacity. Three years of activity has failed to deliver any benefit to farm gate prices, it has however benefited a few accountants dealing in insolvency!
4. How Could it Work A regulator should not and could not set a farm gate price of milk, but it could establish what that price should be, and if the market can deliver it. We need a fairer distribution between farmers the current 4-5 pence diVerential is not sustainable and is divisive. A regulator could over see greater vertical cooperation in the supply chain the implementation of fairer contracts that can lead to more investment and greater eYciency. I see no reason to require legislation to in act this position, as the whole industry is sick of the current situation I am sure all sides would willingly cooperate. Funding could be from the MDC or similar small levy on producers. The regulator themselves should quickly establish if they required more rigorous powers and could seek them from appointing body Defra. January 2004 9377401025 Page Type [E] 29-05-04 00:56:38 Pag Table: COENEW PPSysB Unit: PAG2
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Memorandum submitted by NFU Scotland (L18)
Summary 1. NFU Scotland believes that, on the whole, milk producers are weak sellers of their product into a highly concentrated processing and retail market for milk and dairy products. We believe this dominance allows processors and retailers to capitalise from producers’ weakness in the market place. 2. This has been most evident in the past 12 to 24 months when significant weakening in the value of sterling against the Euro, and improvements in both world commodity markets and UK wholesale prices for milk and dairy products have not been fully reflected in the basic farmgate price paid to producers for their milk. 3. Farmgate milk prices received by farmers have been at or below the average cost of production for almost four years. This has led to a significant number of farmer demonstrations at both retail distribution and milk processing sites in the last two years. NFU Scotland, in its representations to both the retail and processing sector, has indicated its willingness to work with all parties on a long-term solution that will lead to all in the dairy supply chain receiving a fair share of the returns from milk and dairy products. This is necessary to ensure that production of the raw material, milk, can be returned to profitability at a farm level. Without commitment to such a process, farmer frustration over low milk prices will continue to lead to disruption and demonstration at key points in the chain.
In Detail 4. NFU Scotland welcomes the opportunity to submit written evidence to the Environment, Food and Rural AVairs Committee Inquiry into milk pricing where the terms of reference are: “The Committee will examine the market price and farmgate price of milk, and will investigate why recent rises in the former have not led to increases in the latter.” 5. Dairy farmers in the UK, and Scotland in particular, are amongst the most eYcient in Europe. Scotland, at 107 cows, already has the largest average herd size in Europe and significant improvements in eYciency have achieved in recent years. Despite the benefits of scale and eYciency, in an EU context, farmgate prices paid in the UK have been below the EU average for more than a decade and UK farmgate prices have been the lowest in Europe for the last three years. 6. The farmgate price received by UK farmers has been in decline since 1996 and has, since 1997, been at or below the estimated cost to a dairy farmer of producing milk. This ranges between 19p per litre (Scottish Agricultural College) and 21p per litre (Royal Association of British Dairy Farmers) according to cost analysis carried out by these organisations. Declining farmgate prices have resulted in unsustainably low returns to all dairy farmers over this period and restricted necessary investment and improvement on even the most eYcient premises. 7. Recent improvements in a number of key factors should have significantly reduced this downward trend in farmgate prices. Since April 2000, the Euro has strengthened considerably against the value of sterling from £0.60 to £0.70. This has led to an improvement in the intervention support prices paid for the commodity products of butter, skimmed milk powder (SMP) and whole milk powder (WMP). These intervention support prices traditionally set the base price for milk and dairy products. Since September 2000, the intervention prices for butter and skimmed milk powder have increased by around 2.9p per litre to 19.2p per litre. 8. The recent weakening of sterling also makes the UK more competitive on export markets for dairy products and less vulnerable to imports. This comes at a time when world prices for all the main dairy commodities have been rising. 9. Despite the improvement in these market fundamentals, farmer expectations that average farmgate prices would react more positively this year have not been realised. This created feelings of frustration and anger amongst grassroots dairy farmers and resulted in a significant number of farmer demonstrations at milk processing plants and retail distribution centres during September to December 2003. A similar situation occurred in 2000–01 when a combination of political pressure from producer organisations including NFU Scotland and farmer demonstrations resulted in a “retail price initiative” from major retailers which increased the price of liquid drinking milk and dairy products in supermarkets with the instruction given by retailers to processors to pass the price increase back to farmgate level. Although this resulted in higher farmgate prices, NFU Scotland believed that with retailers making margins of 30% on liquid milk and between 20 and 70% on cheese, there was suYcient money available within those margins to improve the farmgate price rather than ask the consumer to pay more. 10. Since the summer of 2003, NFU Scotland along with other producer organisations has been involved in a series of protracted negotiations with major retailers and key milk processors to secure a justified significant increase in the farmgate price of milk based on the improvements in the markets. This resulted in a small increase in the price paid for milk going into the liquid market in July. However, it took increased political pressure and further farmer demonstrations to secure further increases in the price paid for milk 9377401025 Page Type [O] 29-05-04 00:56:38 Pag Table: COENEW PPSysB Unit: PAG2
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used in cheese manufacture, finally agreed in December. As we enter 2004, it remains unclear whether these price commitments achieved from certain retailers and processors are sustainable and will actually deliver a justifiable increase of at least 2p per litre in the average farmgate price. 11. The following table, compiled by the Milk Development Council shows that even the gains already made across all commodities in the past 12 months have not been passed back in full to farmers and that retailers and/or processors have retained significant amounts from the price improvements. The table compares October 2003 with October last year and suggests that if all liquid milk retail price increases and other wholesale price rises had been passed back, then average farmgate prices could have risen by around 2.3ppl. However, prices have risen by only around 1.5ppl, suggesting that not all the possible extra revenue was passed back to farmers. Further increases were secured in November and December and it remains to be seen what proportion of these increases are returned to dairy farmers through the farmgate price.
£/t or p per litre October 2002 October 2003 Equivalent Change
Retail Milk PricE 46.3p 48.5p !2.2p Doorstep Milk Price 75.1p 76.8p !1.7p Cream (from Liquid Milk) £900 £1,030 !0.6p Mild Cheddar £1,800 £2,100 !3.0p Mature Cheddar £2,100 £2,100 0 Butter/Powder (IMPE) 17.0p 19.2p !2.2ppl Weighted average !2.3ppl DEFRA average Farmgate Price 18.13p 19.59p !1.46ppl
12. The influence of the major supermarkets (Tesco, Asda, Safeway, Sainsbury, Somerfield, Morrisons) and the key dairy processors (Dairy Crest, Wisemans, Arla/Express, Glanbia) on farmgate prices is significant. Supermarkets account for 65% of all retail sales of liquid milk and 72% of all cheese sales (including 80% of all retail cheddar sales). In reaction to the increased retail share being commanded by supermarkets, competition for retailer contracts between relatively small numbers of key dairy processors has been significant. 13. In the KPMG report into Prices and Profitability in the British Dairy Chain, completed in February 2003, it found that “Supermarket power has been reinforced by the net increase in liquid milk capacity by processors, as they have competed for this growing distribution channel. The result is that while prices to the consumer have remained fairly static, the spread between the retail and the farmgate milk price has increased significantly. Retailers have taken a higher share of the total liquid milk chain value and farmers have received less in the form of lower prices. The situation on cheese is less extreme, because there has not been the same change in the distribution pattern. However, because market prices have trended down over the period and both retailers and processors appear to have maintained their cash margins, the farmers’ share of the chain value has fallen.” NFU Scotland believes that the findings of this independent report accurately reflect the weak selling position of farmers and that this must be addressed. 14. To further highlight the importance of the supermarket sector, the following table supplied by the Dairy Industry Newsletter illustrates how the farmer’s share of the price paid by the consumer for fresh liquid milk has been eroded by 10% over a three-year period. Liquid milk accounts for 50% of all milk produced in the UK (with 35% of all the milk produced in the UK sold through major supermarkets as liquid milk).
Liquid Milk Price Analysis—October 2000 to July 2003
Retail Price Farm-gate Period p per litre p per litre % of retail price
October 2000–March 2001 37.0 18.2 49% April 2001–September 2001 40.9 19.7 48% October 2001–March 2002 40.9 19.1 47% April 2002–September 2002 40.9 16.4 40% October 2002–March 2003 43.1 17.7 41% April 2003–September 2003 45.3 17.8 39%
Almost a quarter of all milk produced in the UK is processed into cheese. The following work carried out by Taylor Nelson Sofres shows that, since April 1996, the overall consumer price for mature cheese has risen by the equivalent of 4ppl, while the price paid to dairy farmers has fallen by almost 8ppl. For mild cheddar, the price currently being paid by the consumer is very similar to its April 1996 level but the price paid to the farmer has fallen by more than 8p per litre in the same period. There has therefore been an increase in the margin of around 9ppl for mild cheddar and 12ppl for mature cheddar over the period of this analysis. While significant margins are available in the cheese market, it would appear that the bulk of the margin available has been and is still being retained by retailers and processors and not passed back down to farmers. 9377401025 Page Type [E] 29-05-04 00:56:38 Pag Table: COENEW PPSysB Unit: PAG2
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In Conclusion 15. The weak selling position of many farmers makes them price-takers in a dairy chain dominated by a small number of major retailers and processors. Even when market fundamentals indicate that a significant price increase is justified, the recent price negotiations have shown that farmers have limited ability to influence the price they receive. Public demonstrations leading to significant disruption of the dairy chain has proven to have a partial eVect in increasing prices. However, NFU Scotland feels that this is not a long- term option and would look for others in the dairy chain to work with them to establishing a pricing structure that ensures that all in the chain receive a fair return. Such an approach should be in the interests of the retailing and processing sector as it would assist in returning dairy farming to profitability, allow those farmers committed to milking cows to invest in their businesses and help guarantee future supplies of the necessary raw product, milk. 16. In line with the recommendations of the KPMG report into Prices and Profitability in the British Dairy Chain, NFU Scotland would support more eVective monitoring by the OYce of Fair Trading of the Supermarket Code of Conduct. This could be extended to include independent and confidential auditing of all price negotiations on milk and milk products between members of the chain to ensure that the market situation is properly reflected in prices paid. January 2004
Memorandum submitted by the Soil Association (L19)
The US still has a regulatory body which fixes prices in diVerent states monthly. The system works. Introduction 1. The Soil Association is the main organisation of the organic movement in the UK, and also the main Government-approved certifier for the UK organic sector. Our responsibility for organic farming and food is evident throughout the entire food chain, from consumers, retailers, processors and wholesalers, to producers, researchers and policy makers. Membership of the Soil Association charity (over 25,000) includes members from every link in the chain and we represent them all in working to develop the organic sector. The objectives of organic farming are the sustainable management of soil and the natural production of healthy crops with high nutrient levels, to produce healthy food for humans. This is achieved through good soil management focussing on the maintenance of soil organic matter levels and soil biological activity. Certified organic farming accounts for about 4% of UK farmland. The market for organic food is worth £1 billion, with UK organic farmland supplying about 45% of this and the rest supplied by imports. The Government’s target is for 70% of the organic market to be supplied by UK farmers by 2010. An increase in the area of organic farming is one of the Government’s “quality of life” indicators. The Defra action plan for organic farming, adopted in summer 2002, supports the development of the sector, and Defra have published a major paper setting out in detail the sustainability benefits of organic farming. The Food Standards Agency have said that consumers wishing to avoid pesticide residues in food or buy sustainable food can buy organic, and English Nature wants to see more organic farming because there is more wildlife on organic farms. The sustainability, biodiversity and animal welfare benefits of organic farming are accepted by the Government, and the Government’s policy on sustainable public procurement includes encouraging the purchase of organic food for those reasons.
General Comments 2. This evidence is given from a base of knowledge of the recent growth and development of the organic sector in the UK. In providing this evidence we have consulted with key players in the organic dairy sector — notably the Organic Milk Suppliers Co operative (OMSCo). 3. The Soil Association produces an annual market report, the Organic Food and Farming Report which documents organic market and consumer trends, produces quarterly market and pricing updates via our magazine “Organic Farming”, is in the process of completing a feasibility study assessing market intelligence and marketing support needs of the sector, produced a report in 2002 on behalf of the Milk Development Council looking at the potential for the organic milk market, and is contracted by Defra to run a proportion of the Organic Conversion Information Service (OCIS). We are therefore well placed to give evidence to this select committee on milk pricing issues relevant to the organic dairy sector. 4. There are around 450 organic dairy farmers in the UK producing 293.4 million litres of milk in 2002–03. Until 2001 there was a deficit in production ie retail and processing demand outstripped UK supply. Due to substantial increases in conversion resulting in more milk being produced in late and post 2001, even though the retail market continued to grow, supply outstripped demand to a level that only 62% of milk produced in 2002–03 found an organic outlet. 5. Trends over the last decade and more have led to the majority of raw milk being retailed by fewer and fewer multiple retailers and major rationalisation of milk processors at the expense of doorstep deliveries and independent sales (and wholesaling). This has resulted in milk being sold simply as a loss leader commodity leading to price pressures at the farm gate often to a level below the cost of production with a 9377401026 Page Type [O] 29-05-04 00:56:38 Pag Table: COENEW PPSysB Unit: PAG2
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devastating impact on the viability of UK dairy farms. The arguments of supply and demand cannot be used as a justification for this action. While the power of the buyers has become stronger and stronger, the position of the producer has become weaker and weaker. Retailers say they need to be competitive in the market place so the price cannot be put up but their shareholders demand more profits. The only option left for the hapless buyer is to squeeze the supplier. It must also be remembered that the buyer is rewarded financially on the margin achieved between buying the product and selling to the public. This practice means that whatever the retailer says publicly, their method of remunerating the buyers speaks otherwise. The break up of the Milk Marketing Board was immensely damaging to the dairy sector and there is a strong case for the re establishment of a central independent pricing body to ensure “fair play” throughout the dairy food chain.
The Effect of Milk Pricing on Organic Dairy Farmers 6. At first sight the organic dairy sector may be assumed to have been less aVected by general market price improvements not being passed back to the farmer. Healthy organic milk price premiums have been well documented and this fact has clearly contributed to the increase in organic dairy conversions. However, nothing is as straightforward as it seems, and there are several factors which mean that the organic sector has been negatively aVected: (a) Well publicised price premiums and promises for organic milk backed by widely reported volume contracts with a major multiple retailer, poor financial returns in the non organic sector, and an attractive Government organic conversion package all contributed to a sudden increase in organic milk production with expectations that the organic dairy sector oVered a more secure future. (b) Over the last two years 30–50% of all organic milk produced in the UK has had to be sold onto the non organic market at non organic prices. These prices are well below the cost of organic production, particularly when much of that milk has been sold at low price spot values. That improvements in general retail milk prices have not been passed back to the producer has been very damaging to the organic producer in this respect. (c) The supermarket chain who gave volume contracts at set prices to the main organic dairy cooperative reneged on this contract when other milk groups started to secure organic milk from their members and were prepared to undercut the organic market. The power of this retailer in the market place enabled them to walk away from this contract with no redress using the threat of continued business. This is totally unacceptable behaviour, and is provoked by other producer groups selling at below market price. 7. The result of all of these factors is that while the organic sector oVered great hope to many dairy farmers (many of which are medium sized family farms with recognised landscape, environmental, and social benefits), attracting a substantial number to start conversion in 1999–2000, these hopes are now being dashed. Unless something is done about the relationship between the major retailers, processors and milk buyers we risk an exodus of the farms converted at a time when the retail market for dairy products continues to grow. The only route left open then will be a return to import reliance at the expense of our own dairy sector.
Recommendations 8. A thriving dairy sector in the UK is desirable for food security, health, economic, social, landscape and biodiversity reasons. Within this, organic dairy production oVers the potential to maximise and lead these benefits. There are no long term advantages to the nation in allowing unnecessary price pressures (that have more to do with retailers competing for market share than any desire to oVer the customer a better deal) to damage the viability of a strand of agriculture that is so well suited to our climate, contributes so much, and has been such a central part of our agricultural activity. Our recommendations include: — Re establish a central Milk Marketing/Pricing Board. This would not need to take over the role of existing wholesalers, processors and co operatives. Rather, it would give them a fair framework within which to work. — New trading bodies should be considered that overcome diYculties with the Monopolies and Mergers Commission. These could be structured around formally constituted co operatives with transparent trading relationships. There should be no objection to one central marketing group or co operative handling 100% of an organic agricultural product providing that there is a wide enough group of stakeholders and that prices and trading is transparent. This may be the only way of redressing the balance of power between a few well organised multiple retailers and a large number of small and medium sized farm businesses. This is particularly relevant as we expect organic agriculture to not simply produce food, but deliver many wider benefits to rural and urban society. — Milk prices should be such that encouragement is given to farmers to add value to milk through milk quality, seasonality, processing and marketing as individual rather than commodity products (single estate milk, breed specific etc), and major processing suitability. Prices should allow the continuation of the small and medium sized herds that still exist, and encourage the establishment 9377401026 Page Type [E] 29-05-04 00:56:38 Pag Table: COENEW PPSysB Unit: PAG2
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of new small and medium sized dairy herds along with the use of a wider pool of genetic material (this will aid food security and improve animal welfare through avoidance of strain/breed specific problems). We should avoid the extreme rationalisation of the dairy sector that is currently being experienced. — The establishment of an organic ethical trade label for organic milk as being piloted by the Soil Association (November 2003). This initiative would ensure a fair deal for both consumers and producers, leaving a margin for the wholesaler and retailer. In addition it would start to increase public understanding and knowledge of organic farming issues. January 2004
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