Whitehall Associates (Management Consultants)
Ormiston, Queensland 4160
Australian dairy industry went through a deregulation of its farmgate pricing
and supply arrangements in June 2000. This
process was brought about by a combination of factors, the most influential
of which was the commercial pressure brought by major farmer-owned dairy
product manufacturers and exporters.
companies claimed that the regulated milk pricing placed their farmers at a
disadvantage compared to their counterparts who were protected from the
commercial price of milk by what was known as market milk regulation.
The dairy farmers of Victoria agreed and the formal means by which
dairy regulation was challenged at law – a state national competition
policy review – resulted in a recommendation that the Victorian government
repeal the Dairy Industry Act 1992.
the period in which dairy regulation was under the spotlight in a number of
state and federal reviews, the merits of so-called controls over the pricing
and supply of milk were criticized by the rational economic fraternity for
creating an artificial environment which distorted milk production and led to
“undesirable economic outcomes”. Such
outcomes were said to result in an undue quantum of resources being attracted
to the dairy industry from alternate uses of farming land, water, capital and
effects of deregulation on the dairy industry have been well chronicled in
the media which has highlighted the effects of the loss of incomes of farmers
who were most significantly exposed to falls in milk prices.
paper however outlines some of the changes that have occurred in the dairy
industry value chain since the removal of regulation almost two years ago.
The changes that the move towards a totally commercial milk market
effects of supply and demand on the farmgate milk market;
impact of change on the business of the processor/manufacturer;
nature of the milk producers’ contract with the marketplace, and
and ongoing development of market information.
Change in context
within the industry has to be taken in context.
Any analysis of what has happened in the dairy industry in the two
short years since deregulation has to be read against a background of ongoing
change in world market dynamics and in the way that retailers and consumers
influence the marketing of products at home and in offshore markets.
specific terms, the dynamics that have affected the Australian industry
whilst changes occurred in farmgate markets have included:
in fortunes in world dairy markets;
deregulation of the pricing and wholesale distribution of packaged milk;
increasing use of generic brands in packaged dairy milk and a range of
increasing liberation and sophistication of major export markets –
requiring increased product and service differentiation and specialisation,
of major global dairy companies, the formation of a major single
manufacturer and exporter in the NZ industry in the form of Fonterra, and
that company’s investment in Australian manufacturing and export
has – in my view – given the dairy industry, at a national level, greater
ability to deal with these challenges. At
a regional level, the impact of deregulation on farmers and processors has
varied and in some areas has been extremely adverse.
Supply, demand and
the deregulation of the dairy industry has introduced new types of
competition into the industry which were previously unseen:
In the past
New forms of
competition now and in the future
Service level competition at wholesale levels for packaged milk
Price, service and quality competition for dairy products at wholesale
Price, service level and product quality competition in export markets
for dairy products
Strong price competition at wholesale levels for packaged milk
Supply competition between milk buyers (processors, manufacturers and
traders) for milk suppliers
the focus of the change in the dairy industry was placed on the formerly
regulated packaged liquid milk sector – which at a national level consumes
less than 20 percent of all milk produced by volume.
Yet because the level of milk used in packaged milk products in
certain states and regions was much higher than average the impact of this
change has varied.
Australian dairy industry now exports more than half its output in milk
equivalent terms. The “world price” for dairy products that are exported is
governed by several factors, including the prevailing export spot prices out
of Europe and the US (determined by prices net of subsidies), the Australian
dollar exchange rate, the demand for product from importing countries (which
is affected by the use of tariff protection).
As is the case with New Zealand (the major other “free market
exporter”), the majority of those exports by volume are dairy commodities
and ingredients – cheese, milk powders and butter – though there is an
increasing degree of specialisation and customisation in the product range
which offers some protection against spot market prices.
complete removal of regulated milk prices and supply management arrangements,
the total returns to the industry are now more directly driven by the level
of export returns available to major exporting manufacturers.
In basic terms, other uses of milk in the domestic market – over
time – are priced off the base level of returns set by the export market. The other direct influence of the world market on our
industry is the significant volume of cheese that is imported from New
Zealand, which to some extent keeps a cap on the returns that local
manufacturers can extract from the domestic retail cheese market.
In the past, the pooling of regulated market milk returns to farmers
offered some insulation from these effects.
second half of 2000, while deregulation was starting to adversely effect milk
prices across the liquid milk sector, export prices moved favorably for
Australia, resulting in a surge in export demand and in unit selling prices.
Poor seasonal conditions across the major production regions of
Victoria limited available milk to meet this strong demand for milk.
Within months of the change in industry arrangements, the industry
faced a situation where significant shortages of milk were creating strong
competition for supply between dairy manufacturers, driving up the price of
milk at the farmgate and in particular in the “spot” bulk milk market for
dairy components (milk protein and butterfat) between companies.
competition has taken two forms:
scurry for sufficient milk to fill (mostly export) market orders. This
occurred across south-east Australia driving up milk prices in the second
half of the 2000-1 season.
use of milk price to capture milk supply to damage competitors by limiting
throughput, weakening factory profits and the ability to respond to
market competition. This form occurred as Murray Goulburn and Nestle took
supply from Bonlac in 1998-2001. It is still occurring in South East
Queensland in 2001-2 between Pauls and Dairy Farmers.
form is specifically new since July 2000, but the emergence of the latter has
come about due to the weakening of companies who were and are exposed to milk
supply that depended upon regulated incomes.
Change to the business of
up to farmgate deregulation saw the introduction of new demands on the
business of certain processors. New
milk purchase contracts were released by companies that were previously able
to rely on regulated supply management arrangements to deliver milk to their
factory door. The prices offered at the time in such contracts had not
fully anticipated the sudden swing in world market fortunes.
onset of commercial farmgate prices (and given the transparency of those
prices), major retail chains stepped up to the plate and called for fresh
rounds of tenders, forcing strong price competition between processors for
the share of the supermarket segment of the packaged milk market (which is
approximately 50 percent of all packaged milk sales).
result of the fall in packaged milk margins as new lower prices swept the
supermarket shelves, the sharp fall in milk prices was passed onto farmers
with the most severe effects being felt in NSW and Queensland regions.
milk prices at farmgate quickly fell by as much as 8 cents a litre (depending
on the dairy company supplied and the farmer’s former access to market milk
returns). Over time, the effects of the supply response to falls in
returns took their toll on milk production volumes in these regions through
the exit of hundreds of producers.
respect, the effects of reduced supply has put significant pressure on the
profitability of commodity product manufacturing operations in areas north of
the Murray River, ironically at a time when export product prices were at
their highest for many years.
lower supply has not enabled recovery of fixed production overheads –
forcing consolidation and closure of many small regional operations.
The nature of the milk
absence of certain regulatory controls on the supply and pricing of milk, the
milk supply agreement is the major form of commercial regulation of milk
supply that operates in the industry today.
form of contract used in the industry prior to deregulation has been in the
form of a co-operative milk supply policy, where each of the farmer-owned
businesses sought to operate with a generic milk purchasing policy common to
all member-suppliers. The use of
these pricing policies is today largely unchanged.
advent of a range of sophisticated milk supply contracts, mostly by liquid
milk processors, has accompanied the deregulated farmgate market.
co-operatives have been forced to adopt more differentiation in their pricing
in order to produce a milk supply curve more suited to their business needs,
and/or to lay-off some pricing risk to the producer.
greater role for “the contract” as a tool provides the following contrast
between the past and future:
Management through a
states) the milk processor was able to rely on their milk needs being met
through directions being made by the regulator
states) individual farm production was influenced by limits as to the
quantity of milk output that would return the market milk price
supply agreements (usually for all milk produced by a farm)
limited number of contracts contain a stipulation that the producer be
required to supply an agreed minimum contract volume
input prices to milk processing – which varied by region
states) farmers incomes were supplemented by an allocated share of the
proceeds of packaged milk usage at regulated prices
states) farmers made business and production decisions based on their
chosen level of exposure / dependence on market milk incomes
cost of manufacturing products for the domestic market were higher due to
the DMSS payments
of the price risk
signals convey bonuses and penalties for:
Under or over-production (against a plan)
based on the end use of milk by the buyer
Production of milk with superior milk
component levels (butterfat and protein)
Conveying signals in milk
identified above, in the past two years, there has been some advancement in
the sophistication of the price signals conveyed by processors and
manufacturers to their suppliers. Chiefly,
signals are used to:
the overall quality of milk;
expansion of individual farm business enterprises;
milk flows to the market demand according to each company’s
market/product mix, and
the cost of unplanned milk production.
majority of milk purchased at farmgate in the industry is priced according to
standard terms and conditions that are offered by co-operatives and other
major exporting manufacturers. The
will to vary these policies is not strong; the major co-operatives still
treat as sacrosanct the obligation to take all the milk produced by their
suppliers at the times when it is cheapest to make milk, without
discriminating between suppliers on the basis of size and location.
Co-operatives lead in the structure of those policies; their
competitor exporters and milk buyers mimic those buying policies.
the broad trends towards the market for Australian dairy product requiring
more year-round product supply, the structure of these policies has not
changed significantly in the past few years.
Farmer-owned manufacturers remain committed to supporting seasonal
milk production as a low-cost strategy to their suppliers, whilst maintaining
investments in facilities sufficient to cope with the mounting peak supply
volume on the highest milk production day of the year.
Only timid use of pricing signals to encourage a flattening of the
production pattern, which would provide more efficient utilisation of factory
capacity, has been advocated. However, the desire of company managers to
achieve that outcome is strong.
time however, some greater use has been made of:
production incentives, which promote movement of production towards the
times of the year when milk is more difficult to produce;
and penalties for quality parameters;
payments rewarding larger producers, both through fixed cartage charges and
production volume incentives, and
incentives – rewarding increases in production over the prior season.
greatest use of signals in pricing has come from companies who have the
greatest at stake in ensuring their milk supply flows match their market
requirement (liquid milk leaders National Foods, Parmalat and Dairy Farmers)
across a range of dairy products. The
companies have adopted different strategies to deal with the trade-off to
their own respective businesses between security of milk supplies at
controlled prices versus investment in milk balancing and storage facilities.
the industry has seen the use of the concept of the production plans or
supply allocation by these groups in their contracts, coupled with the use of
penalty prices to combat unplanned volumes.
The use of these varies according to the overall supply and demand
situation. When an over-supply of milk was feared upon deregulation, the used
of tiered prices by several companies discouraged excess milk to plan. This
quickly swung when milk shortages were apparent such that production over
plan was actually rewarded in most cases.
advent of a commercial marketplace, the peak industry body for dairy farmers
has sought to remedy the position of the individual dairy farmer through
authorized collective bargaining under Trade Practice law.
Dairy companies have shown mixed interest in this concept. One company
has embodied the principles into its dealings. Co-operatives largely feel
this is redundant as collective bargaining is their main role. Other
companies have rejected collective negotiation.
The impact of the facility on the structure and dynamics of the
farmgate market is uncertain but likely to be limited.
view, the greatest tools that producers have in ensuring that bargaining is
broadly fair are:
existence of strong, viable integrated dairy co-operatives, and
of options they have for their milk and/or their enterprise.
to endorse intervention between farmer and processor the market will govern
all other outcomes.
transparency of farmgate milk prices has always been relatively high in the
dairy industry, although comparisons between company price offerings have
been made increasingly complicated in recent years as supply competition
between processors has intensified.
of pricing information in the hands of the wholesale and retail sector today
affects the dairy industry in two major ways:
allows the buyers to understand milk pricing and margin structures of
processors when calling for bids on milk supply tenders, and
landed world price for cheese effectively becomes the benchmark buying
price for cheese into this domestic market, more so now that the NZ dairy
industry has a major direct stake in the Australian industry at
changes give industry participants at farm and factory level less control
over price setting for their businesses. While the absolute level of prices
has become more transparent, the complexity of different pricing structures
has made the comparison between company offerings much more complex.
background, one of the greatest challenges faced by the total industry is to
communicate (in language that can lead to decision-making) the big picture
and the market dynamics that surround the industry in the context of the
world market. The future growth of the industry compels a clear view of the
demands and expectations of the available markets.
in 2000 has created a new Australian dairy market to which the industry is
still adjusting. The UK dairy industry deregulated in 1994 and is still
enduring the pain of transition through ongoing changes that are driven by
the industry’s inability to match supply with demand.
Our strength in this regard is far greater as a total industry, but we
are still very early into change for many participants.
time, we can expect to see more diversity in the devices that are used to
manage the milk volumes and its cost, despite increasing pressure to
consolidate our food sector for more effective global positioning.
The pressures brought on by new forms of competition will be some of
the drivers for ongoing change at corporate level.
impact of change in farm incomes in high-cost milk production areas will take
several years to have its full and lasting effect on the industry.
Future changes are not solely governed by the supply response of
farmers to changes in market access, but also (and largely) by the ability of
people to realise their available options, and to make and act on life
choices. The culture in these
affected regions has been shaped by a dependence on farming sustained by
certainty of prices at regulated levels.
dairy industry, that will see greater use of signals in the pricing of milk
to suit the business outcomes of processors, but also see the advent of risk
management tools to enable prices and input costs to be managed by
professional farmers and major processors.
future will also see the need for greater responsibility to be taken by dairy
farmers for the ethical standards of the product they supply in terms of
animal welfare, food safety, environmental impact and service reliability.
Today these elements are market differentiators. In future they will
be basic business requirements and their commercial enforcement through
business contracts is inevitable.
2001, The Australian Dairy Industry:
Impact of an Open Market in Fluid Milk Supply, ABARE Report to the
Federal Minister for Agriculture, Fisheries and Forestry, Canberra, January.
Rural and Regional affairs and Transport References Committee 1999, Deregulation
of the Australian Dairy Industry. The Parliament of the Commonwealth of
(United Kingdom) www.mdcdatum.org.uk