House of Commons - Administration - Appendices to the Minutes of Evidence

Select Committee on Administration Appendices to the Minutes of Evidence

APPENDIX 26

Memorandum submitted by Andrew and Nicola Morris (Q38)

INTRODUCTION

We are a husband and wife partnership farming a 65 acre County Council dairy farm in Worcestershire.

On leaving school we both worked on several different farms before attending agricultural college: Andrew gained an NCA at Walford and Nicola a BSc Agricultural Technology at Harper Adams. Andrew successfully applied for the tenancy at Eatons farm and began farming in his own right in 1991.

On leaving agricultural college Nicola worked as a dairy and business management consultant for Genus (now Axient) for six years, and began farming with Andrew in 1995.

It is our intention to remain in the dairy industry until we retire (2025), though we will struggle to continue if the milk price falls any further.

Our submission will hopefully provide some useful information on the marketing of milk from a dairy farmer's point of view.

THE MILK MARKET IN ENGLAND AND WALES

In 1991, we were legally obliged to sell all our milk to the Milk Marketing Board (MMB).

The MMB was formed in the 1930s to provide individual farmers with an effective way of marketing their milk. Prior to that farmers were at the mercy of the dairy companies and received an artificially low milk price.

With the advent of milk quotas in 1984 and changes in the market place (low fat milks) it was generally agreed within the industry that the milk market should be deregulated.

In 1994 the Scheme of Reorganisation was approved by Ministers. In November 1994 we were at liberty to sell our milk, in theory, to any processor. In reality at the time we had two choices:

We opted to sell our milk to Milk Marque because we believe that farmers will never receive a fair price for their milk unless they market collectively.

The five year period from deregulation to present day overwhelmingly supports this belief.

*Milk Marque is a farmer-owned co-operative marketing milk in England and Wales
**The Milk Group is a farmer-owned co-operative marketing milk in the Midlands

OUR MILK PRICE

Table 1 shows the changes in our milk price from 1990 to 1999 and the membership of Milk Marque (our co-op) 1994 to 1999.

Table 1: Our milk price pre-deregulation to present day


Year	Milk price ppl	Membership of Milk Marque nos*

1990-91	19.0
1991-92	21.5
1992-93	21.7
1993-94	21.4
1994-95#	21.8	20.3
1995-96	24.0	19.3
1996-97	24.3	17.4
1997-98	21.3	15.5
1998-99	18.3	13.1
1999-00	16.9**	12.1**

Notes
*Milk Marque Membership as at the end of each milk year (March)
**Budgeted figures
# Deregulation

The dramatic decline in our milk price may be due in part to the strength of the pound but it is mainly due to the demise of Milk Marque. In 1994-95 Milk Marque marketed about 60 per cent of the milk in the UK, today (October 1999) it is about 39 per cent.

The decline in milk price has had a dramatic effect on our farm profit. Table 2 shows the effect of the declining milk price from 1997 to 1999 on farm profitability.

Some of the decline in profit has been offset by cost reductions mainly:

We are now considerably more "efficient" than we were but it has been extracted at a high price: we now work a 60-70 hour week compared to a 50-60 hour week; we have not had a family holiday for two years; the farm is now farmed more intensively than it was, ie we have a similar number of animals on a smaller acreage.

Table 2: The effect of the milk price on the profitability of our farm 1997-1999


Year	Actual	Actual	6 months actual
	1997-98	1998-99	6 mths Budget
			1999-00

Total Income (%)	100	88	80
Total Costs (%)	100	92	82
Profit (%)	100	79	57
Milk price ppl	21.3	18.3	16.8

Despite the decline in milk price we remain committed members of Milk Marque as we still believe that farmers will never receive a fair price for their milk unless they market collectively.

OUR MEMBERSHIP OF MILK MARQUE

When we joined Milk Marque we knew that we would get a lower price for other milk than our neighbours who opted to sell direct or join smaller groups.

We believe the reasons for this are:

Milk supply versus processing requirements

In the UK we have a distinct seasonal pattern of milk production. On the whole most processors would prefer a level supply to enable their factories to run at optimum efficiency. Therefore, it is in the interest of the processors to source a percentage of their milk direct From the farm and to buy a varying percentage (depending on the time of year) of their milk from Milk Marque. That way they have a guaranteed minimum supply and Milk Marque has the sole responsibility of coping with the UK's seasonal pattern of production.

The buying behaviour of the processors means that at farm level the direct supplying farmer is offered a price incentive to supply direct whilst Milk Marque members have an artificially lower price because they carry the costs of finding a market for milk at times of the year when there is an over supply.

TRANSPORT CHARGES

The advent of deregulation inevitably lead to an increase in transport costs: within a five mile radius of our farm, milk is collected by three different tankers taking milk to three different destinations, pre deregulation there would have been one.

Milk Marque has a higher share of these transport charges: most processors will generally offer direct supplying contracts to the closest farms, leaving Milk Marque to collect milk from more outlying farms.

Milk Marque also has to bear the costs of transhipment: milk is normally delivered direct to nearby customers using the vehicles that collected it, however, a significant amount of Milk Marque's milk is transported over longer distances i.e. transhipped. This milk is taken to the depot and reloaded into larger multi-purpose tankers and delivered to its final destination.

As Milk Marque's membership has declined the proportion of milk transhipped has increased: in 1998 over 45 per cent of Milk Marque's milk was transhipped.

LIQUID MILK MARKET

The liquid milk market generates the highest returns to processors. The three main liquid processors, Express Dairies, Unigate and MD Foods, all source a significant percentage of their requirements direct ie approximately 40 per cent, 25 per cent and 50 per cent respectively (source UK milk report 1999).

Pre-deregulation, all dairy farmers had a share of the liquid milk premium, through the MMB's "pooled price policy". Post deregulation, as Milk Marque's membership has declined with an ever increasing number of farmers supplying direct, the remaining members have an ever declining share of the liquid milk premium and therefore, an ever declining overall milk price.

The UK seasonal pattern of production, transport charges and the liquid milk premium all have a negative effect on Milk Marque's milk price. Even with any economies of scale, Milk Marque is destined to be at or near the bottom of any milk price league table.

The milk price Milk Marque achieves determines the size of its membership. This is not a precise relationship, some farmers will leave if they are offered a better price, others will only leave once the Milk Marque milk price is close to their cost of production.

Thus, Milk Marque must be efficient, aggressive and innovative in the market place if it is to survive and prosper, and it could be argued that unless Milk Marque operates in this manner it is not acting in the best interests of its members.

One of the features which distinguishes a co-op from other organisations is that :

"It aims to optimise the returns to members for their produce, rather than to make a return on investment to shareholders."

It is Milk Marque's behaviour in the market place which ultimately lead to its referral to the Monopolies and Mergers Commission on 27 January 1998 under the monopoly provisions of the Fair Trading Act 1973.

The Monopolies and Mergers Commission (MMC) Report on the supply of raw milk in Great Britain

As members of Milk Marque, having read chapter 2 (conclusions) of the MMC report, we accept the findings that:

Milk Marque is a scale monopoly, even at its present size of 39 per cent (1999) and it has raised the average price of milk by virtue of its selling system

However, if it can been shown that the GB milk price is artificially lower than it should be, could this conclusion be reversed ie Milk Marque acted as an effective co-op and achieved an optimum price for its members?

MILK MARQUE'S INFLUENCE ON PRICE

The MMC put it to Milk Marque that, in principle, if prices had been set above the competitive level (level sufficient to cover costs with a normal level of profit) this might be attributable either to the exercise of market power on its part as by far the largest supplier of milk in GB or to the CAP price support system. The MMC measured the effects of CAP by calculating the coverage ratio (coverage ratio refers to the ratio of the producer's farm gate price to the target price) and found that the average coverage ratio for the period after deregulation, at 89 per cent, has been about five percentage points higher than the average coverage ratio prior to deregulation.

The MMC put it to Milk Marque that this increase in the coverage ratio broadly reflected the degree to which it was exercising its market power.

The Council of Ministers sets the target price, a key element of the coverage ratio, at levels that EC producers might realistically be expected to achieve. Therefore, if it can be shown that Great Britain (GB) has certain characteristics unique to its milk market, and that these characteristics have had a greater effect since deregulation, it could be concluded that changes in the coverage ratio do not necessarily indicate the degree to which Milk Marque was exercising its market power.

THE GREAT BRITAIN MILK MARKET

Features of the GB Milk Market which are unique:

1. THE BALANCE OF TRADE AND THE STRENGTH OF STERLING

Table 3 shows the UK balance of trade 1990 to 1997 and changes in the exchange rate over the same period

Table 3: UK balance of trade*


Year	Balance of Trade		ecu/sterling
	£m	tonnes	exchange rate
			Ecu/£

1997	320	-47,500	Jan	0.768
1996	408.8	-122,280	Jan	0.856
1995	249.0	-15,360	Jan	0.78
1994	na	-39,910	Jan	0.75
1993	na	-5,830	Jan	0.80
1992	na	-162,580	Jan	0.72
1991	na	-39,740	Jan
1990	na	-32,530	Jan

* exports from the UK minus imports into the UK

(source: Dairy facts and figures 1998; MMC report on the supply in GB of raw cows' milk of; UK milk report 1999)

MAIN POINTS

b) The pound was at its weakest in January 1996 and at its strongest in January 1992

c) When the pound is strong imports are cheaper and exports are more expensive. Therefore, when the pound is strong the balance of trade will be more negative; in respect of dairy products changes in the value of sterling do not appear to have a precise effect on the balance of trade:

For example when the £ was strong in January 1992 the balance of trade was -162,580 tonnes (the highest deficit) and when it was at its weakest in January 1996 the trade deficit was -122,280 tonnes.

2. GB HAS THE LARGEST LIQUID MILK MARKET EC

It could be argued that, because the returns from the liquid milk market are higher than for other products (Annex 1), GB should have one of the highest milk prices in the EU.

Pre deregulation, there was some restriction on how much milk was available for each dairy product; though the liquid milk market was given priority.

Post deregulation, the only restriction on how much milk is available for each product is price. Therefore, in theory if a processor was prepared to increase his share of the liquid milk market he could do so by securing a large proportion of his milk on market led contracts at a price. If several processors adopted this policy it would have a significant upward pressure on milk price.

Indeed in the two years immediately following deregulation demand for market led contracts was at its highest. (table 2.2 p43 MMC report 1999).

3. THERE IS VERY LITTLE VERTICAL INTEGRATION IN GB COMPARED TO OTHER EC COUNTRIES

Vertical integration is accepted to enhance the milk price of producers; lack of vertical integration is often cited as one of the reasons why the GB milk price is lower than most other EU countries (MMC report 1999 6.72).

Since deregulation the degree of vertical integration has increased (Annex 2), it is not unreasonable to assume that this would have an upward pressure on price.

4. MILK PRODUCER GROUPS MARKETING THEIR OWN MILK IN GB

There are currently 41 milk producer groups in GB (UK Milk Report 1999), varying in size from 10 members to over 13,000.

The majority of these groups are non quota holding: when they sign their contract with an individual processor, that processor is assigned the producer's individual quota.

These producers are effectively direct suppliers, though they can leave their chosen processor or processors, once they terminate their contract.

On the whole non quota holding producer groups tend to supply only one or possibly two different processors at the same time.

By assigning their quota to the individual processor, it is the processor's responsibility to deal with the quota administration (ie transfer of quota, balancing milk supply with quota available, calculation and collection of super levy).

This direct supply arrangement is most suitable for small groups as they avoid any of the administration costs associated with the marketing of milk and the management of quota.

Quota holding groups, of which there are eight in GB, are more costly to run than non-quota holding groups but quota holding groups are at liberty to sell their milk to any processor and they are never tied to just one processor.

It is very difficult to determine whether the number of groups, the type of group and the range in size have a positive or negative effect on price.

It could, however, be concluded, that because the producer group structure is markedly different than that in other EU countries, the market will operate differently and comparisons between EU price and GB price may be misleading.

Clearly, certain characteristics of the GB market are unique (ie the size of the liquid milk market, degree of vertical integration, and the milk producer group structure), and there is also evidence to suggest that changes in the strength of the pound do not affect the balance of trade in the conventional manner.

Is it possible that these two factors make comparisons between the GB farmgate price and the EU target price imprecise?

Is it possible that if Milk Marque had been able to supply some quantitative analysis (MMC report 1999 2.98 & 2.104) to show that the rise in milk price, immediately post deregulation, was in fact due to legitimate changes in the market rather than to an abuse of market power then milk producers would now be facing a more promising future?

THE FUTURE

Our initial reaction on hearing Milk Marque's proposals to split into three co-ops was disbelief that such a major change in policy was necessary.

Having read some of the evidence presented in the MMC report, it is clear that Milk Marque must either undergo structural change or the selling system must be reformed.

The proposed structural changes will not necessarily result in three strong co-ops because :

The new co-ops will have higher transport charges than existing groups, as members are spread over a wider geographical area.

The new co-ops will not have a fair share of the liquid milk premium whilst producers currently selling direct continue to sell direct.

The only advantage the new co-ops will have is that they will be able to expand their processing activities. Though, as with all new businesses the payback will not be immediate and will require significant investment. Thus, any additional processing capacity is unlikely to have an immediate effect on milk price

Reform of the selling system is an option, but for this option to succeed a certain amount of intervention from a third party would probably be required, and in addition the problem of Milk Marque's high transport costs would have to be addressed.

As milk producers we are not convinced that either the structural reforms or reform of the selling system will be in the best interests of producers.

A more radical approach is required and can only be achieved with Government intervention.

WHY SHOULD THE GOVERNMENT INTERVENE ON BEHALF OF MILK PRODUCERS?

In virtually all countries, whether high income and mature or developing, free market or centrally planned, the Government is in some way involved with its agricultural industry (Geoffrey Whitehead). If an individual Government does not intervene then foreign competitors will increase their market share at the expensive of that Government's own producers.

The GB dairy sector

Historically, the GB has always had one of the lowest milk prices in Europe (except for the two years immediately post deregulation).

The UK milk price is currently bottom of the EU milk price league table and is likely to remain there if Milk Marque is split into three co-ops: if Milk Marque has artificially raised the milk price by virtue of its position as a scale monopoly the disbanding of Milk Marque will result in a fall in milk price.

For a significant number of dairy producers any further decline in milk price will be unsustainable.

Trends in profitability, as discussed in the MMC report, indicated that farms in an ADAS survey were achieving a profit of 4.00 ppl in 1997-98, since then the milk price has declined by, on average, a further 2.75 ppl to March 1999 (UK Milk Report 1999). A further decline of 1-2 ppl is projected for the milk year ending March 2000.

A scheme must be devised which enables both milk producers and processors to achieve an acceptable profit, whilst delivering a fair price to consumers.

Milk marketing

In the UK we are in a unique position in so far as we have experienced a statutory milk marketing scheme (ie 1930s to 1994) and also a deregulated market from 1994 to 1999.

The statutory scheme was reasonably successful until the introduction of quotas and also the increase in demand for low fat milk, though it did stifle innovation and did not encourage efficiency in the processing sector.

The deregulated milk marketing scheme has also failed and will fail again if the only alteration to it is the disbanding of Milk Marque.

An alternative would be a scheme which:

Why should such a scheme be adopted?

The processing and retail sectors are now dominated by a handful of companies, primary producers can only derive a fair price for their product if they can compete on an equal basis.

In order to determine the optimum size and number of co-ops the Herfindahl-Hirschman Index could be used (2.387 MMC report 1999). British farmers are notoriously bad at co-operating and will not do so unless they are forced by statute, thus, if the proposed scheme is in the interests of the majority, membership of a co-op would have to be legally binding; the choice of co-op would be the farmers' decision.

If farmers continue to supply direct they will undermine any new co-ops, in the same way as Milk Marque has been undermined over the last five years.

The present transport system is inefficient and is taking money out of the industry which neither milk producers or processors can afford to lose.

The present transport system has environmental implications: there are more tankers on our roads and each tanker has to drive further to gain a full load.

If tankers were able to collect milk from farms on the basis of the destination of the milk rather than on the basis of which milk producer group had sold it, the industry as a whole would benefit.

Indeed in its submission to the MMC, Dairy Crest said that it wanted a transport system that was cost effective. Any transport costs should be quoted separately and processors and Milk Marque should work together to reduce costs for their mutual benefit.

The environmental benefits of a pooled transport system can not be underestimated.

IF THERE IS NO GOVERNMENT INTERVENTION WHAT WILL HAPPEN TO OUR DAIRY INDUSTRY ?

It is true that a lower milk price will, in theory, increase the efficiency of the Industry and should, therefore, benefit consumers.

However, there must be a point at which the milk price is high enough to allow a business to survive but insufficient to allow a proper re-investment programme to be implemented.

The rate at which producers are leaving the dairy industry is increasing. In 1996-97 6.2 per cent left, prior to that the average rate of decline over a 12 year period was about 3 per cent per year (MMC report 1999).

The loss of milk producers from the industry has implications on other sectors of agriculture: in the last 18 months four large herds (ie 100-250 cows) have been sold within a 15 mile radius of our farm, only one of those producers retired, the other three have become beef, sheep and/or arable farmers.

Farmers are an enigma to the general public: they complain a lot often when there is nothing to complain about. But when the "chips are really down" they can be eerily silent.

Looking at out own business we know the milk price is getting uncomfortably close to our costs of production and we by industry standards are in the top 10 per cent of farms in terms of efficiency.

How is everyone else coping and how long can they survive ?

CONCLUSION

There is definitely a need for structural and cultural changes in the UK milk market.

There is, however, only one proposal on the table; that is the disbanding of Milk Marque and the creation of three new co- ops. Our fear, as producers, is that unless the whole industry grasps the concept that co- operation is the key to surviving and prospering we all face a very bleak future.

4 October 1999



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