An Australian dairy co-operative strikes back

The latest round of ‘milk processor leap frog’ continued last week with dairy giant Murray Goulburn announcing a much awaited step up of $0.14 per kilogram butterfat and $0.35 per kilogram protein (about 1.7 cents per litre or $0.23 per kilogram milk solids).

This price increase is applied both retrospectively for all milk supplied to MG so far this financial year (since July 1, 2010) as well as all milk supplied for the remainder of the financial year (to June 30, 2011).

For a 2.0 million litre (150,000 kgMS) supplier, this latest MG step up equates to an immediate cash injection approximately $20,000-25,000, plus additional income between February and June of approximately $10,000-15,000 (depending on the shape of the supply curve). With MG being the accepted dairy industry benchmark, this latest step up will inevitably result in further price increases from most of the competing milk processors.

We note with interest the reiteration from CEO Stephen O'Rourke that MG believe their start of season price forecast remains on target. To quote directly from the supplier letter “With respect to the remainder of the season, we maintain our forecast for final weighted average milk price in the range $5.30kg MS - $5.50kg MS”.

This year has been the first time MG has provided a closing price estimate in their early communications on the 2010/11 milk price. This far into the season it is difficult to imagine what would have to go wrong for this forecast not to hold.

The other seemingly innocuous phrase that caught my attention was the term 'weighted average milk price'. In 2010/11 MG suppliers had for the first time a choice of three different milk payment systems:

• Traditional
• Seasonal
• Domestic

These alternatives represent a significant deviation from a long-held tradition of one milk payment model across their entire supply base. The change generated criticism from within MG and also outside their supply base (the latter being from some high profile industry commentators).

Those who know me, and have followed my comments, will know that I am not the leader of the MG cheer squad and have willingly voiced my criticisms of MG in the past. I should add though, that these criticisms relate to activities where MG has deviated from their core business of processing milk. I have in fact, rarely been critical on the milk price that they have paid. I believe MG is very transparent in its milk payments and a true reflection of the mix of both the local domestic and world markets that they operate in. If I was to level a criticism at MG, it would be that they were too slow in introducing alternative payment structures in the face of ongoing competition for milk. I say that fully accepting that I don’t know the MG business as well as they do themselves.

In my travels, the main criticism that I hear levelled at Murray Goulburn is “the higher milk price that they are paying under their domestic payment structure is cross subsidised by the lower price being paid to those who remained on the traditional or seasonal payments”. I would argue that this criticism is narrow in its focus and misses the mark.

Firstly, with one payment system across Victoria, southern New South Wales and south-eastern South Australia, Murray Goulburn have continually come under pressure from localised processors to hold their milk supply.

Secondly, annual Australian milk production has fallen by over 2 billion litres and our dairy industry is now much closer to being equally split between supplying domestic and export markets. Our understanding is that MG’s customer base has been similarly reshaped. They now require a less seasonal supply curve because a greater proportion of their milk services the domestic market. Dr Hauser also tells me that the nature of the export markets is changing as well, with higher valued export products requiring a more even supply of milk throughout the year. Australian export markets have evolved from years gone by where it was simply milk powder and butter into Asia.

The third reason why the criticism of the domestic payment system may be misplaced is that the encouragement of a flatter supply curve could be lifting the average milk price paid by Murray Goulburn. MG suppliers on the domestic payment system could in fact be subsidising those who choose to supply milk to the seasonal or traditional payment structures. How could this be you ask? Well a flatter supply curve means that MG has a more efficient use of milk processing capital. A flatter annual supply curve means that they can process more milk with less capital invested in milk factories by being able to operate closer to peak production for more days of the year. In addition, a flatter milk supply means lower stocks and working capital requirements. They are also better able to target high value markets that require fresh milk supply throughout the year.

It should also be noted that, under their previous ‘one size fits all’ milk payment system, there was already a considerable variation in the milk price that Murray Goulburn suppliers received. If we were to compare a seasonal 100% spring calving herd that produced no milk in July, with a split calving herd producing 45% plus of their milk in the second half of the year, the difference in milk price received was approximately $0.40 per kilogram milk solids in favour of the split calving herd. There is a valid argument that this price advantage is often overtaken by the additional costs required to produce milk on a year-round pattern (calving patterns are very much a farm by farm decision).

The other variation in milk price that is already imbedded in the traditional milk payment system is the difference between the largest and smallest suppliers – the milk production incentive. This could add up to $0.20 per kilogram milk solids difference. The merits of this is a discussion for another day, but industry insiders may recall that system also has foundations in competition for milk supply.

The impact of the introduction of the domestic payment model for Murray Goulburn suppliers is that, if we apply the same split calving supply curve to the domestic payment model, and the seasonal calving supply curve to the traditional and seasonal payment model, the differential is now as much as $0.60 per kilogram milk solids.

So in short by introducing two new payment models Murray Goulburn has;

1.  Reacted to competition at the milk supply level
2.  Reacted to the changing demands of their customers
3.  Quite possibly created a stronger business model by encouraging a milk supply curve that makes better use of their capital investment and allows them to target higher value markets
4.  Been a relatively small change to pre-existing seasonal and production milk price differentials.

So what is the Murray Goulburn ‘weighted average milk price’? Well, I'm only guessing because I'm not privy to the proportion of Murray Goulburn suppliers on each of their three payment schemes, or how much of the seasonal incentives those on the domestic payment system will actually capture. If however I was to look at the traditional payment model, the 2010/11 average annual MG milk price currently sits at approximately $5.00 per kilogram milk solids. Those with a flatter split calving type curve, who have chosen the domestic payment model, are receiving approximately $5.40 per kilogram milk solids.

Supply Curve	Monthly Peak:trough	Traditional	Seasonal	Domestic
Typical Industry Curve	3:1	$4.97	$4.95	$4.98
Seasonal(100% Spring Calving)	8:1	$4.84	$4.90	$4.80
Flat (Split Calving)	2:1	$5.09	$4.99	$5.38

Dr Hauser keeps reminding us that co-operatives have foundation in religion as well as economics. I must admit I never paid much attention in religious education classes at primary school. Apologies to Mrs Morley for my lack of attention and also for continuing to argue the case for Darwin's theory of evolution at, what I realise, now was the most inappropriate time. I do however recall the story of the man and his son travelling to town on their donkey. You know the one where everyone has an opinion on who should be riding the donkey.

I can't help feeling that everyone feels they know Murray Goulburn's business better than Murray Goulburn - and feels the need to tell them how to ride their own donkey. At the very least you would like to think those who are most vocal and most public in their criticism would at least take the time to air their frustrations with MG’s representatives and to hear the Murray Goulburn side of the story.