Examination of Witnesses (Questions 1-19)
MR JOHN DUNCAN AND MR ROBERT AUDAS
TUESDAY 4 DECEMBER 2001
Chairman
1. Good morning and welcome to the Committee this morning. Just for the record and for your information, which I am sure you are aware of, the Committee is following up some of the recommendations we made in its report in the Session 1997-98, called The Present Crisis in the Welsh Livestock Industry. Could you begin by introducing yourselves please?
(Mr Duncan) Chairman, ladies and gentlemen, good morning. My name is John Duncan, I am here I think in my capacity as Chairman of the Federation of Milk Groups but I am also Chairman of First Milk, which has members representing 36 per cent of Welsh dairy farmers; we market their milk in First Milk.
(Mr Audas) Good morning, Mr Chairman. My name is Robert Audas and I am the chief executive of the Milk Group. The Milk Group is a new organisation which started in 1994 after the break-up of the Milk Marketing Board and has built up to about 1,200 members in England and Wales, of which about 110 of our producers are in Wales.
Mrs Williams
2. Mr Audas has told us when they were established, Mr Duncan can you tell us when you were established and tell us a little more about how many producers you have, and what percentage is that of the total UK industry?
(Mr Duncan) Would it help if I explained first of all what the Federation of Milk Groups was about, because it is the organisation which all dairy farmers look to to represent their interests. You will be aware that the milk industry was de-regulated in 1994. At that time we had the English and Welsh Milk Marketing Board and we had three in Scotland. We deregulated in 1994, at that time dairy farmers for the first time had a choice to whom they were going to sell their milk. In the end, only 50 per cent decided to stay with the co-operative structure, the other 50 per cent took the option to supply their milk directly to processors, for example Dairy Crest, Express Dairies, Wisemans Dairies, Nestlé. Therefore the dairy farmers lost a united voice, they lost the one organisation which could speak in all of their interests. The Federation of Milk Groups came together about two years ago. It was set up, first of all, by those of us who had stayed under the co-operative structure, but we also felt we could not seek to speak for the whole industry unless we found a wider forum which allowed the democratically elected representatives of those who chose to sell their milk on direct supply contracts to join us. So effectively in the Federation now we have some 80 per cent of Great Britain's dairy farmers represented, so it effectively is the mouth piece for the dairy farmer as a trade organisation. I know the NFU speak for them on political matters. As far as First Milk is concerned, it was set up just earlier this year as a result of a merger between Scottish Milk—hence my tone—and Axis Milk. Axis Milk was one of the three successor organisations set up when Milk Marque was obliged after the competition investigation to sub-divide itself. Therefore any unity that dairy farmers who were co-operatively minded had was split up into three different organisations, one in the north of the country, Axis going through the middle belt, and Milk Link further in the south. They all sit with us in the Federation of Milk Groups. You posed me the question about First Milk. That merger now represents some 18 per cent of UK milk production with 4,400 members. Within that, we have 36 per cent, as I mentioned earlier, of Welsh dairy farmers selling the milk to ourselves. To say they sell their milk to us is maybe not putting it in the right context. We in fact market the milk of our members and pass back to them the best price we can get from the market place. In the main we are marketeers of milk, although First Milk has developed some processing and we process some 10 per cent of the volumes which we take from our members' farms.
(Mr Audas) Just to agree with John in what he has said so far but taking it on as far as the Milk Groups are concerned, we have about 1,200 farmers supplying nearly 8 per cent of the UK market, probably about 8 to 10 per cent of the Welsh market as well. We have also invested in processing and about 10 per cent of our milk is processed in our own dairies, one in Somerset and one in Peterborough. The focus of the group since it started has been to grow and take a greater proportion of milk into co-operative hands but also to invest in posts in marketing and brands which will be key in the future if we are to protect the income of the producers against the inevitable on-set of international markets and the reduction in CAP support in the future. So our focus, as indeed with other co-operatives, though we started from a zero base seven years ago in terms of assets, is to build up the business which is marketing milk to the value of about a couple of hundred million pounds a year, but also to build on to that processing and added value markets which will supplement the income back to all our farmers in terms of the milk price.
3. How are your groups funded?
(Mr Duncan) From our members. If I refer to what happened in Scotland, because at the time of deregulation that is where I was involved, when the decision was made that the Milk Marketing Boards were to be disbanded, we in the north, just as Milk Marque in the south, got the opportunity to buy the assets of the Milk Marketing Board whom we succeeded. A proper valuation was carried out at that time and our members had to fund the purchase of those assets from what became the residuary Milk Marketing Board. Of course the problem we had at that time was because the processors, and I can say this quite clearly because we have said it in front of them, in whose interest it was to see the co-operative structure weakened, continued to pay (and still continue to pay) a premium over the price we can return from the market place. So there is an added incentive, the more times become difficult in dairy farming, for farmers to take the option of supplying a direct supplier because there is a premium there. The more that happened over the period, our pyramid was turned upside down, we had a smaller and smaller membership trying to support the cost of funding a business.
(Mr Audas) Originally, the Milk Group started just by farmers agreeing to pay a certain amount of money into a pool and starting a business with zero assets. The total grants received to date have been £150,000 in terms of marketing grants in the first three years from MAFF to develop the business. Out of that, we have built a £220 million turnover business with processing as well, but the money has come from our members. As John says, one of the difficulties of creating strong co-operatives has been not only the fact dairies, as they do in other countries, will pay a little premium to try and make sure they have a degree of retention and control of the industry while the co-operatives effectively support the overall milk price structure in the industry, but also the fact, which we may refer to later, that it has been more difficult for co-ops to merge into strong structures because of the investigations of the OFT some three years ago now into the structure of the industry which tended to work against the formulation of strong co-operatives. Co-operatives is basically the common structure around Europe and most of the world, it does allow a degree of protection of farmer prices, so it removes some of the bumps of the international cycles, but it does ensure also that the interests of the farmers are developed into brands and in terms of consumer interest on the retail shelves, which is very difficult to do in this country from the starting point of a few years ago.
4. Apart from the money you had from MAFF, did you have any money from associated bodies?
(Mr Audas) No, that is all the assistance we have had.
5. Can I ask that question of Mr Duncan? Did you receive any Government assistance or from any other associated bodies?
(Mr Duncan) No. No co-operative grants, nothing to help the funding of the co-op. We have, in the building up of our processing sector, received some developing grants for investment for example in some of our creameries, but that is quite separate from supporting the co-operative structure.
6. Nothing to help in the setting up of the group?
(Mr Duncan) No.
Mr Caton
7. Mr Duncan, you have described the democratic voice role of the Federation, and both of you in describing your organisations have laid emphasis on them being membership organisations, co-operatives. What I am not clear about, although the ownership is clear, is how your members actually control the policies of your respective organisations. Apart from that, how does any individual member influence the direction you are going in?
(Mr Duncan) We have a democratic structure. I am a farmer and am responsible to a region of our membership representing some 300 members. First Milk, I mentioned, was set up as a merger of Scottish Milk and Axis Milk. In each we have effectively operated through a north and a south region with a Northern Regional Board and a Southern Regional Board. We are all elected by dairy farmers in the same way as I am, and then there are elections on each of the boards to put directors on to the main board. So the structure works by taking information and concerns from our members up to the top and then disseminating and cascading information and knowledge back down to them. We meet with our members twice or three times a year, report to them effectively and all major decisions are ratified at an annual general meeting. So we do have a fully accountable structure.
(Mr Audas) Although we are a co-operative structure in terms of form, in fact it is based on shares rather than as a true co-operative. Basically we have a similar structure to John's, whereby we have six regions, regional committees are elected by the farmers in those regions, they appoint regional directors, and on the board of the company the regional directors who are farmer directors are the largest proportion of the board and all the resolutions of the board are approved at the AGM every year. So it is a fully democratic structure which does rely on a great deal of participation by farmers at every level, both in terms of the policy of the company but also in terms of the detail of how the arrangements for sampling and haulage and so on are worked in each region.
Mr Williams
8. You have given us a short history of how your groups became established, perhaps you could tell us what was the structure of the industry before then and who were the main players in it?
(Mr Duncan) It was quite straightforward. All dairy farmers in England and Wales had to sell their milk to the Milk Marketing Board which prevailed at that time. In Scotland for some reason we had three different milk marketing boards. A dairy farmer had no choice. First of all, if he wanted to produce milk, he had to get a licence from the local authority, then apply for the Milk Marketing Board in whose region he fell to take his milk, and it was as straightforward as that. Downstream from that the structure of the industry was quite different from what it is now because the Milk Marketing Boards were channels to sell the milk for the best price, and the pricing structure at that time was quite interesting in that you had two different prices. Milk going to the liquid market was priority, the price for that was set through the joint committees, which were representatives of the retailers and the boards, they agreed a price for milk to the liquid market, milk which was going into cheese, powder and manufacture was set at a different, lower price. Dairy farmers were to an extent guaranteed a reasonable return for their milk. Since deregulation, it has been turned upside down, with the price going up fairly quickly whilst there was competition for their milk—particularly as the processors endeavoured to undermine the structure of the co-ops bid higher prices—the milk price went up for two years to a high in 1996 of 25p a litre on average. Very quickly, once the membership of the co-ops fell back to under 50 per cent, that price came down and we had 8 or 9 consecutive selling rounds (and selling rounds occur twice a year) when the price came down, down and down, until the summer of 2000 when across the UK the average price was 16p, back 30 per cent. That is a potted history of the movement.
9. Who were the main commercial players in that structure?
(Mr Duncan) Dairy Crest has 33 per cent of the processing, Express Dairies 24, Robert Wiseman, ARLA, ACC 10 per cent each. So within five or six you have got between 70 and 80 per cent of British processing, mainly all PLCs.
Chris Ruane
10. If the price went from 25p a litre in 1996 to 16p a litre in 2000, we know who the losers were, the farmers. Who were the main beneficiaries of that?
(Mr Duncan) It is quite difficult for us to track what happens in the supermarkets but there is no doubt the price did come down there as well. To understand how the industry works, you have to be aware that intervention still operates in the industry, whereby milk is converted into powder and then it can be offered for a tentative intervention source. The original intention was that intervention operated when the market was in a time of over-supply and it took the top off the market.
11. So milk became scarcer and the price went up?
(Mr Audas) Yes.
(Mr Duncan) There is no doubt that coincided with the pound strengthening against the euro. One of the disadvantages that British farmers have is, if I can say it in this forum, farmers would probably say they were protected over the last ten years from the policies of the Conservative Government which was free market, and ultimately this Government as well, by the membership of Europe, because the CAP operated in many cases to quite a different policy from the British Government. When the rest of Europe chose to become members of monetary union, British farmers lost that degree of protection, and our intervention prices have suffered quite significantly because of the relatively high value of the pound against the euro.
12. So in a nutshell, the people who lost were the farmers, the people who gained were—?
(Mr Duncan) If you look at the returns, we did say some 70 to 80 per cent of processing is held by PLCs. Not many of these PLCs appear to be making, on the face of it, very significant profits. If you look at one of them at this moment in time, the share price has dropped within a year from 70p to 14p, but the biggest of those whose name I mentioned, their share price has gone up quite significantly.
13. Who was that?
(Mr Duncan) Dairy Crest which, perversely, was owned by dairy farmers.
(Mr Audas) We have provided some extra papers here which, if it is okay, we would like to circulate. Although there are structural issues as to where the value goes in the supply chain, which is what you are looking at, this graph on the front page compares an analysis of the total retail prices in different markets for retail milk, and the percentage which is coming back to farmers from retail markets. What is clear is that in those countries where there is a high degree of developed co-operative structures involving processing, a much higher proportion comes back to farmers than those markets where it is highly deregulated. So, in other words, where the co-operative structures have been formed long ago, they have been able to supply a market effectively. You will get countries such as Sweden, for instance, which has the same retail price of milk as in the UK but Sweden has the highest farmer prices in Europe and in Britain we have the lowest farmer prices in Europe. That reflects the different structures in the different economies. So, without a doubt, if one wants to protect farm incomes one does require the involvement of co-operative producers in successful companies building brands which consumers want to buy. It is not just a matter of trying to say who is getting a fair proportion of the supply chain, one has to put the structures in place, the brands in place, the marketing in place, to make sure the consumer wants to pay more back to farmers for real high quality local products. At the moment, just as an example, if you look at the butter market in the UK, the top selling British brand has got 9 per cent of the market. Over 50 per cent of the market for butter in the UK is now controlled by ARLA/Fontera, which is Denmark, Sweden and New Zealand, and they have just been given the go-ahead by the Competition Commission, without an inquiry, to merge. They produce over 50 per cent of the market, the top selling British brand has got 9 per cent of the market. It is only really by, we believe, co-operatives being allowed greater licence to merge, given more encouragement to develop brands and marketing, which will allow structures to be put in place more common to other parts of Europe which will secure a higher return for dairy farmers. Perhaps I can pass these round. (Same handed) The graph at the top is quite constructive, I think[1].
Mr Caton
14. The undermining of the price which you described, Mr Duncan, as people moved away from co-ops, that was farmers voting with their feet, was it not?
(Mr Duncan) Voting with their wallet or their bank account maybe rather than their feet. As the industry came under pressure and their farm businesses were put under pressure, many were driven to look for a better return. As long as the PLC processors were able to do it, many farmers maybe saved their businesses by doing that, but reluctantly. To put that into context, when we got to the winter of 1999-2000 and the price was down at 16p a litre, there were meetings throughout the industry where dairy farmers who had taken up contracts to supply directly said, "It is not working. The only way we can redress the situation is get back behind co-ops." There was a huge movement over that winter period, from which Robert's company and our own did benefit, and had foot and mouth not struck the industry, as it did in February this year, that movement was gaining great momentum and we would have seen a very significant return of direct suppliers back to the co-op structure, but because of people movement restrictions it was not possible to continue the momentum that the industry was starting to see.
Mr Williams
15. So the incentive to join your groups really came from that price collapse and the determination of farmers to find a better return for their product?
(Mr Duncan) The incentive to rejoin rather than the incentive to join. The co-operative structure where we had come from was effectively a compulsory co-op, so farmers when they were given the choice said, "My business might do better doing this." I would agree with your analysis, when they saw the price drop back so significantly, to the extent that very few businesses would be making any margin at all, people started to look around and said, "We need a better structure to the industry." That movement is still continuing but not with the same urgency it was. I should say that since that time we have been able to move the milk price from effectively September 2000 when co-ops like ourselves took a more aggressive stance in the market, but that was supported by the various militant actions you may have read about in the newspapers where groups of farmers boycotted distribution depots and we did see a price movement of 2p a litre back in the winter of 1999 and a further increase in the spring of this year.
16. Could you quantify the amount your members have benefited from rejoining a co-operative structure?
(Mr Duncan) No, it is easier to quantify what the industry has benefited from it. It is quite difficult to show how co-op members have benefited in the short-term, whilst the rest of the industry has been receiving a premium from the processors. These premiums in the main are disappearing but I think probably every dairy farmer would now concede it was the actions of co-ops like our own in the autumn of 2000 which meant the price went back up by 4p a litre towards 20p. I think that would be widely agreed.
17. So you are saying that all the producers in the industry have benefited from your action?
(Mr Duncan) Yes.
(Mr Audas) Yes.
Chris Ruane
18. As I understand it, farmers' integration within the food chain is a good thing because they get higher returns?
(Mr Audas) Yes.
19. Where would you say farmers' integration in the food chain is now? Is it going up? Is it plateau-ing? Is it going down? Where do we stand in the UK compared to the rest of Europe?
(Mr Audas) At this point in time we start from a very low base in the sense we have a highly fragmented structure which is starting to consolidate. All of the co-operatives are studying best practice all over the world to form the right structures for the future and many of us are basing it on some sort of European model where we see co-operatives growing, co-operatives taking more control on the overall transport and supply of milk into the market place, and investing further in processing and in brands. This is a slow process when the co-operative structures start with very few assets and a situation where farmers' incomes are at a relatively low ebb, but nevertheless the growth we have had in the co-operatives of late shows very clearly that farmers are interested in marketing their own milk, building their own brands, vertical integration, and what we need is some encouragement to be able to do that. That comes in two forms. One, in terms of assistance in marketing and developing vertically integrated businesses. Secondly, some degree of acceptance that modern co-operative structures are working in farmers' interests and all the interests of the supply chain and delivering good quality and good prices to the consumer at the end of the day, as they do in other countries like Sweden, where clearly the market is working in favour of the consumer because they are offering good prices and good quality brands in an industry structure which does allow higher income back to the farmers.
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