Some time ago I published a blog on the trend in Victorian milk production over the past decade ("The changing nature of Australian milk production - Part 1", Xcheque.com, 17th September 2010). The production decline and trend towards more off peak milk production was discussed in some detail. I had every intention of writing a second piece on the milk production trends in the rest of Australia. Time got away from me and now it is on the list with 27 other topics readers have asked me to write about. I am not going to redress that situation here but I can provide a glimpse of the issue and why it is relevant to the current bunfight on the Australian retail milk price.
For overseas readers with concerns of their own, the context of this discussion is the current spate of heavy discounting of milk price by Australian supermarkets. This was initiated by one of the major chains (Coles) as a strategy to reverse their declining share of the consumer dollar. Other supermarkets have followed and this has sparked a massive debate between farmers, processors, supermarkets, politicians, and plenty of other people with an opinion on the matter.
Since the issue blew up, there has been a regular stream of phone calls and e-mails asking this and that and generally trying to entice me into one side of the argument or other. It's a tough call, on the one hand Xcheque is normally farmer friendly but on the other we are not a fan of commercial vested interest - especially when it is at the expense of the rest of the supply chain and the community in general (local and global).
At the bottom of it all we stand for truth, justice and the dairy way and so I did respond to a question on an article published in the Weekly Times ("Milk price war truths", Peter Hunt, March 18 2011). The general sense is that Peter Hunt is unsympathetic to the cause of the dairy industry (farmers and processors).
I was asked to comment by a contributor to Udderly Fantastic, a private on-line forum for Australian farmers and dairy industry participants. What sparked my interest in this article, is that this history of supermarket pricing behaviour and milk production is described as facts about the past decade of the Australian dairy industry. Some of the information is fact but, as the header in that section of the paper suggests, a large part of the article is opinion ... and in my opinion, Peter Hunt has got it wrong.
After that long and torturous introduction, here is something of my reply on Udderly Fantastic.
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The first point that Peter Hunt makes is that the supermarket discounts are relatively modest compared to their recent price history and that the price differential to branded milk has been there for quite a while. In other words there is nothing new here, and it is not significant in historical terms, and everybody should have a cup of tea, a Bex, and a good lie down.
It is true that supermarkets have always used items like milk as loss leaders to attract customers. History tells us however that these periods of heavy discounting and market promotion create more momentum for a consumer product switch - and once they decide that $1 milk is OK to drink they are unlikely to go back to branded product. The most interesting fact for me is that Woolworths are providing 3 options for consumers - $1.00 red and black plain label milk, $1.20 "Dairy Fresh" milk (a prettier label but still Woolworths private label milk) and branded processor milk. This two pronged approach gives the consumer a choice of price and 'brand' - both of which are at a significant discount to processor branded milk. Is there any difference between the three? - the consumers will make the judgement in the end. Personally I have no doubt that there will be a significant and sustained change in the market share of private label milk - even after prices reset to more normal levels.
Peter's second point is that farmers, and their associated processors, have been their own worst enemies in NSW, Qld, and WA. Over the past decade they have exited ingredient and export markets in favour of a more lucrative domestic fresh retail market. Failure to diversify their customer base, and decline in overall milk production, has left them beholden to the controllers of the consumer dollar -ie. the all powerful supermarkets. The decline in milk production in these regions has been put down to "apathy" - an interesting if a little controversial view.
Peter makes the comment "National Foods and to a lesser extent Parmalat have been forced out of the manufactured dairy sector, especially in exports". The assumption is that the price of milk has stopped them from investing and competing in that area. It's my opinion if you like, but in the past decade neither company has demonstrated any interest in ingredient manufacture at almost any stage. It is not what they do. They have both had plenty of chance to take up the ingredient opportunity in SE Australia and have chosen not to do so. That market has been left to Murray Goulburn / Fonterra / Warrnambool / Bega / Tatura / Burra Foods and others. Furthermore, most of those businesses are now effectively private so it is not about the investment return expectations of co-ops vs private capital - it is about Strategy and Commitment to specific market sectors.
Is the production decline in NSW, Qld, and WA "apathy"? I would say definitely not. In my view it comes down to fundamental agricultural economics. Milk production in SE Australia (and New Zealand) is significantly more cost efficient than in most of north/central NSW, Qld and WA. Cows milk better in cooler weather and pasture based farming has a much lower variable cost (and therefore price resilience).
Before I start a stampede of cows to the south and east, there is definitely a future in the north and west of Australia for milk production for the domestic market. That requires a flat seasonal production profile and an associated higher cost. Farmers in those regions will continue to command a premium price for their milk (compared to Victoria). The transport cost of milk and milk products will determine what that premium will be. In the end farmers will make the decision whether that premium is sufficient but my guess is that it will be enough to maintain a relatively stable supply for some time to come.
I am much less convinced that there is an opportunity for large scale ingredient and export production in the north and west. As a global dairy industry investor, why would you go there when there is still plenty of lower cost production capacity in SE Australia (and in New Zealand for that matter). And when I mean cost, I mean both the cost of milk production on farm and the cost of processing and export.
So if the future of the dairy industry in the north and west is a domestic market, farmers, processors and supermarkets will have to learn to live together. My advice in this is to embrace economic gravity. Alternatively you could tap into some spiritual wealth and if you are very lucky you might just finish up on the winning side of one of those much more peculiar and illogical transactions.