Government response
Introduction
The Government welcomes this report. It has raised
awareness of the need to improve relationships within the dairy
supply chain. The Committee's report has also highlighted the
need for the industry to work together to solve the problems caused
by low farmgate prices and the current uncertainties in the dairy
sector. The Committee has rightly noted the complexities of the
milk pricing system, the poor transparency, and the challenges
which face the industry, not least through the reform of the Common
Agricultural Policy. The Committee has also raised some interesting
issues with regard to the power of supermarkets relative to their
suppliers.
The Office of Fair Trading have responsibility for
competition law and the supermarket code of practice. This response
has been agreed with them and also with the Devolved Administrations.
Recommendations 1-3 and 5-7
We accept Defra's evidence that, although retail
prices for liquid milk rose by 2 ppl between October 2002 and
October 2003, the average farmgate price in fact rose by 1.46
ppl, as against the 0.6 ppl that might be expected. We therefore
conclude that the July and September 2003 retail price increases
were transmitted to farmers. (Paragraph 40)
However, we are concerned about the way in which
the price increases were achieved: despite the indicators in the
dairy market in 2003 suggesting that farmgate prices should increase,
the major supermarkets appear to have increased their prices only
when political pressure was applied by farmers. We are also concerned
about the way in which the price increases were transmitted. The
transmission was uneven: some farmers have benefited more than
others. The transmission was also delayed: it took some time for
increases in the retail price to reach farmers. It remains to
be seen how long this price increase will remain sustainable.
(Paragraph 41)
The events of 2003 suggest that market-based information
which particularly reflected known changes in the cost of production
and currency movements had little influence on the pricing decisions
of the major milk buyers. If the milk market is to work efficiently,
signals on factors affecting price must be responded to without
the need for application of external political pressure. (Paragraph
43)
We urge the dairy companies to examine the means
by which they communicate with their producers and, where they
feel that there is a legitimate reason for delaying transmission
of price increases on to farmers, to ensure that this is communicated
effectively to farmers. Constructive dialogue between dairy companies
and producers is obviously to be preferred to direct action. (Paragraph
47)
Given that we know that dairy companies are making
no more than about 3 ppl profit, the evidence we have received
suggests that about 18 ppl of the retail price of a litre of liquid
milk is being taken up by the dairy companies' costs. The dairy
companies will of course need to use some or all of that 18 ppl
in collecting and transporting raw milk and then processing it
into liquid milk. We believe that the dairy companies should provide
dairy farmers with a detailed justification of why it is that
they appear to need to take such a significant chunk of the retail
price of liquid milk to cover their costs. (Paragraph 56)
When added to the complex structure of the dairy
sector, the lack of transparency in the dairy supply chain means
that farmers have been unable to identify conclusively what proportion
of the 2003 retail price increases has passed back to them by
way of increased farmgate prices. (Paragraph 58)
The Government welcomes the Committee's conclusion
that the retail price increases were transmitted to farmers. The
Government shares the Committee's concern about the way the retail
price increases appear to have been achieved. Whilst the frustration
felt by many is understandable, we do not support farmer protests.
The Government agrees dialogue is preferable to direct action.
The Government recognises the thrust of the Committee's
conclusions about the way prices increases were transmitted and
how the expectation of farmers that they would receive the retail
price increases in full was not fulfilled. However, given that
milk sold by farmers can be used in a number of different end
products with different returns on each, it is unrealistic to
expect that all farmers would get the full amount, unless their
raw milk was sold to a supplier that only supplied the major retail
outlets with liquid milk. It is therefore not unexpected that
farmers will get different proportions of the retail price increases
precisely because their supplier may be involved in the production
of different commodities or the supply of different outlets and
therefore exposed to different markets whose performances differ.
The Government does not believe there is sufficient
evidence to support the Committee's conclusion that about 18 pence
per litre of the retail price of milk is taken up by dairy companies'
costs. However, this uncertainty over costs does serve to illustrate
the lack of transparency in the dairy supply chain.
The Government does not consider that price transparency
in itself, will improve farmgate prices. However, more openness
along the supply chain could help foster trust and thereby promote
collaborative action that helps address some of the underlying
causes of low prices (improving co-operation is of course part
of the rationale underpinning the Dairy Supply Chain Forum). The
Government would therefore welcome any moves by dairy processors
and others in the supply chain to improve the way they communicate
with producers. The work of the Food Chain Centre on value chain
analysis in the dairy sector, which is being supported by a grant
of £0.5m from Defra, could be more helpful. It should not
only help participants understand the costs of others in the supply
chain, but also help them work together to eliminate cost and
improve margins for mutual benefit.
Recommendation 4
We recommend that the Milk Development Council
commission research into the reasons why farmers are pulling out
of the dairy industry. In particular, it should ascertain whether
farmers who sell their milk through the farmer-owned co-ops, rather
than directly to the dairy companies, are over-represented in
the group of farmers pulling out of the industry. We consider
such information vital in tracking the development of the dairy
industry. (Paragraph 46)
Decisions on what research are to undertake are for
the Milk Development Council (MDC) itself, within the limits of
its statutory remit. The MDC has already conducted a useful survey
into farmer intentions, which will be repeated later this year.
Defra will also be funding survey work for next spring (2005)
to follow up the report by Professors Colman et al on the economics
of dairy production in 2002/03.
Recommendations 8-10 and 14
From the evidence we have heard in
the course of our present inquiry, we are extremely concerned
by the poor state of relations in the dairy industry. We have
seen evidence of suspicion and mistrust, preoccupied self-interest
and a lack of constructive dialogue. Some of the answers we received
to our questions were at best opaque, if not disingenuous, making
this a difficult enquiry to undertake and to conclude. We can
only agree with Dairy Crest's description of the dairy sector
as characterised by an "engrained adversarialism and blame
culture". Sadly, there has been no evidence of an improvement
since the Agriculture Committee inquiry. (Paragraph 59)
We commend the Government for the initiative it
has shown in setting up the Dairy Supply Chain Forum. (Paragraph
61)
We have serious doubts about the wisdom of the
Government's intention to withdraw from its role as facilitator
of the Dairy Supply Chain Forum. We are not confident that relations
within the dairy industry are sufficiently advanced as to be capable
of constructive dialogue and action without the facilitation of
the Government. We recommend that, rather than withdrawing from
the forum, the Government should instead continue to chair the
forum in order to demonstrate the importance that it places on
the dairy sector and the need for further change within the sector.
We recommend that the Government use the forum as a means to:
- take immediate action to establish what proportion
of the retail price of liquid milk and other dairy products is
retained by each of the participants in the relevant supply chain
in order to improve transparency in the dairy supply chain
- improve the information about the dairy market
that is available and communicate that information to dairy farmers
by way of regular, formal communication; such information should
explain how retail price increases are transmitted down the dairy
supply chain and provide case-specific data in respect of recent
retail price increases
- address, in an open and constructive way,
the engrained adversarialism and blame culture that continues
to characterise the dairy industry. (Paragraph 63)
We have been struck by the divergent
views within the dairy industry about what factors do, in fact,
determine the price of milk. We recommend that the Dairy Supply
Chain Forum take the lead in seeking to build a consensus within
the industry about the factors that are determinative in this
matter. (Paragraph 78)
The Government agrees that relationships within the
dairy supply chain can be difficult and that there is sometimes
mistrust between the different parts of the chain, particularly
with regard to prices. Nevertheless, there is good evidence that
the industry can and does work together to address issues of mutual
interest. Recent examples include the shared use of transport
between producer groups and processors to reduce costs and the
work on seasonality, which has seen producer groups and processors
talking openly about costs, and together coming up with guidelines
for the industry. Through the Dairy Supply Chain Forum, there
have been encouraging signs of more openness and a greater collective
will to cooperate in order to increase efficiency, address the
challenges facing the industry and develop collaborative solutions.
The Government is grateful to the Committee for its
comments on the setting up of the Dairy Supply Chain Forum.
The Government's intention has always been to chair
the Forum until an apposite point when ownership would be transferred
to the sector itself since success must ultimately lie in the
industry taking charge of its own future. Nevertheless, we recognise
that the transition to industry ownership of the Forum can only
occur when the industry is in a position to collaborate effectively
to take on its work. The Government therefore intends to continue
to chair the Forum for as long as the industry finds it of benefit,
and additional Government resources have been allocated to the
Forum and its sub-groups in this financial year to develop its
work. Even when the point is reached when a non-Government chair
can be found for the Forum, Defra officials will still be willing
to take part in the Forum's activities if the industry feels this
would have value.
At its meeting on 21 July, the Dairy Supply Chain
Forum discussed the Committee's main recommendations. The Forum
acknowledged that discussions about price are the most likely
to become adversarial. Price is inevitably the subject of negotiation,
rather than collaboration, and therefore is not and has never
been an area which the Forum could usefully (or indeed should)
consider directly. Nevertheless, members of the Forum did agree
that greater transparency about costs and prices would be useful
to build trust and reduce tensions. Increased transparency would
not in itself increase the farmgate price of milk, but further
improving trust could in turn help with collaborative approaches
to address some of the causes of low farmgate prices. Ongoing
work by the MDC (for example, their planned Annual Report on dairy
supply chain margins following up last year's KPMG report on milk
pricing) and work by the Dairy Industry Association Ltd in response
to the Committee's report, may be of some use in addressing the
issues about transparency. On issues other than prices, the Forum
noted that there is constructive engagement between the different
parts of the supply chain.
Recommendation 11
We see no compelling evidence in favour
of setting up a regulatory body to oversee the dairy industry
supply at this stage. (Paragraph 64)
The Government supports this conclusion. It is difficult
to see how a regulator could determine a fair price other than
by reference to a market price. A price regulator would almost
certainly be incompatible with EU competition law, or with the
common organisation of the market in milk and milk products.
Recommendation 12
Experience to date suggests that the
UK dairy sector is yet to exploit fully the benefits that could
arise from greater horizontal and vertical integration. (Paragraph
71)
The Government agrees that the industry has not yet
exploited the benefits of greater integration. However, achieving
greater vertical integration is the clear aim of the major dairy
farmers' co-operatives and there have been some positive developments
in some areas of vertical integration and also in moves toward
added value products.
Recommendations 13, 15 and 16
The disparity between the major supermarkets and
the primary producers results in an uneven distribution of power
along the dairy supply chain, with the balance of power being
weighted towards retailers. This uneven distribution of power
may account for the dairy market being slow to react to upward
pressure on retail prices, as it was in 2003, when prices increased
only following direct action by farmers. (Paragraph 75)
We welcome the decisions of the supermarkets to
increase the retail prices of liquid milk and cheese last year
while specifying that the price increases must be passed along
to farmers. However, on the basis of the evidence we have received
in this inquiry and the findings of the Office of Fair Trading's
review of the code, we agree with the Office of Fair Trading and
the Competition Commission that there remains a fundamental imbalance
of negotiating strength between supermarkets and most of their
suppliers. The code appears to have been ineffective in redressing
this imbalance, at least in respect of the dairy supply chain.
Supermarkets should carefully examine the way in which they exploit
their buying strength and establish whether this is compatible
with their oft-stated aim of supporting British agriculture via
supply chain partnerships. (Paragraph 83)
We urge the supermarkets to place more weight
upon their social responsibility to ensure, at the least, a sustainable
farmgate price for British dairy farmers. If supermarkets are
genuinely concerned about the farmgate prices received by all
farmers, we suggest that they aim to establish a balanced spread
of suppliers by increasing the proportion of products such as
liquid milk that they buy from farmer-owned co-ops. (Paragraph
85)
The disparity in size between dairy farmers on the
one hand, and the major processors and supermarkets on the other,
is not in itself necessarily a cause for concern. However the
Government accepts that a combination of factors has led to a
situation where there is an imbalance in negotiating strength
within the dairy supply chain. Were this to be exploited in a
way that harms competition, this would be a matter for the competition
authorities. But while the existence of buyer power may put one
party in a negotiation at a disadvantage, it does not inevitably
lead to competition problems.
UK dairy farmers appear to be disadvantaged in terms
of bargaining power in comparison with their counterparts in other
prominent EU dairy farming countries, in part by the weak presence
or involvement of UK producers (including through co-operatives)
in processing. The Government believes that the further development
of farmer-owned co-operatives has the potential to help dairy
farmers improve their position. We are seeking to facilitate this
through, for example, our support of English Farming and Food
Partnerships. We also believe that the work of bodies such as
the Food Chain Centre (which the Government also supports) and
the Dairy Supply Chain Forum can contribute to the creation of
an environment which fosters co-operation and collaboration between
farmers, and between farmers and the rest of the food chain.
Whilst we can support the Committee's call for supermarkets
to consider the impact of their purchasing policies on the sustainability
of a viable dairy farming industry in Britain, the Government
believes that it would be wrong for it to seek to dictate that
supermarkets should purchase products from one type of business
in preference to another.
Recommendation 17
We are particularly concerned about
the impact on dairy farmers of their financial support being reduced
under the CAP reforms while milk quotas remain in place until
at least 2015. Necessary restructuring within the industry is
likely to be hampered by the inflexibility of quotas. We consider
that eliminating milk quotas would be economically worthwhile
for the UK and for the EU as a whole and we encourage the Government
to continue its pursuit of this policy aim. It is most disappointing
that some other EU member states have opposed the initiative to
phase out EU milk quotas. (Paragraph 93)
The Government supports the Committee's assessment
of the impact of milk quotas and will continue to press within
Europe for their abolition. Within the constraints of the current
system, the Government has acted to reduce the burden as far as
possible. For example, we have taken steps to make transfers of
quota without land simpler to help restructuring. Nevertheless,
milk quotas still add considerable costs for those wishing to
enter the industry or expand their current business. For milk
quotas to be abolished, support prices will need to be reduced
down to the levels of world prices to remove the artificial incentive
to overproduce.
Recommendation 18
If dairy farmers were to join together,
in order to make the process of raw milk retailing both more unified
and more dynamic, it could well go some way towards redressing
the uneven distribution of power in the supply chain. We would
hope that CAP reforms will spur farmers to greater co-operation
and to further development of value-added products. (Paragraph
94)
The Government as part of its Strategy for Sustainable
Farming and Food, is supporting, through English Farming and
Food Partnerships, the development of farming co-operatives to
improve the bargaining power of farmers and help them access a
greater proportion of the value added to their produce. However,
the Government believes that individual farmers should determine
the type of relationship they want based on what they decide is
best for the long term development of their business.
The Government believes that in the long term the
decoupling of subsidies from production under the reforms of the
Common Agricultural Policy agreed at Luxembourg will bring considerable
benefits to all UK farmers, including dairy farmers, by encouraging
them to produce for profitable markets, rather than subsidy. Nevertheless,
due to the impact of support price cuts, the dairy sector will
need to address the challenge of a lower price environment. Through
the Dairy Supply Chain Forum, participants from all parts of the
supply chain have been working together to identify how the sector
might adjust to meet this and the other challenges it faces, and
thereby allow individual businesses to make informed decisions
on their future development.
The Government strongly supports the Committee's
recommendation on value-added products. The Government supported
the conclusions in last year's KPMG report the Prices and profitability
of the British dairy chain, that one of the reasons for milk
prices in the UK being consistently well below the EU average
was because of a lack of product innovation, an over-reliance
on the production of bulk commodities and an insufficient emphasis
on added value products.
Recommendations 19-21
We urge the Government to ensure that greater
emphasis is placed on communicating directly to the dairy industry,
especially to farmers, information about what forms of vertical
integration can be carried out under current competition law.
The Government must take steps to foster an environment that is
conducive to greater vertical integration. In its capacity as
chair of the Dairy Supply Chain Forum, the Government should work
towards achieving a balance in the dairy industry so that the
interests of UK domestic consumers are not protected to such an
extent that UK dairy producers are detrimentally affected. (Paragraph
102)
We encourage the Office of Fair Trading and the
Competition Commission to take all possible steps to ensure that
the dairy sector knows that the competition authorities are not
opposed to vertical integration in principle and are open to approaches
from within the dairy industry. The Office of Fair Trading and
the Competition Commission should be sending clear signals on
this point. (Paragraph 103)
We urge those dairy farmers who are not members
of farmer-owned co-operatives to consider carefully their decision
to remain outside the co-op framework. Although co-op membership
may be a less financially attractive option for farmers in the
short term, it is the most effective long-term option available
for farmers to gain greater control over when, to whom and at
what price they sell their milk. If farmgate prices are to increase,
farmers must act to redress the uneven distribution of power currently
in the dairy supply chain. (Paragraph 106)
The Committee's report refers to the steps that the
Office of Fair Trading (OFT) has already taken to inform farmers
and others in the food chain about competition law. These include
meeting with farming interests, the publication on its website
of answers to frequently asked questions on competition matters,
and the provision of confidential advice to those considering
mergers or joint ventures, including those involving vertical
integration. Defra will consider with the Dairy Supply Chain Forum
what more might be done and whether the Forum might be used as
a means of reinforcing the OFT's advice and disseminating it throughout
the chain.
To repeat the points made earlier about co-operatives,
the Government is supporting the development of farming co-operatives
to improve the bargaining power of farmers and help them access
a greater proportion of the value added to their produce. However,
the Government believes that individual farmers should determine
the type of relationship they want based on what they decide is
best for the long term development of their business. This could
include a range of partnership models with down-stream elements
of the supply chain.
Department for Environment, Food and Rural Affairs
26 July 2004
Office of Fair Trading response
You will recall that I gave evidence to the Committee
with Colin Farthing of the Competition Commission on 31 March.
I was grateful for this opportunity to set out the OFT's role
generally and in relation to the particular competition issues
that arise in the milk sector. I attach a note setting out the
OFT's response to the Committee's recommendations.
1. The Committee recommended that the OFT should
take all possible steps to ensure that the dairy industry knows
that it is not opposed to vertical integration in principle and
is open to approaches from within the industry. We are happy to
accept this recommendation. Vertical integration does not usually
cause competition problems unless one or other of the merging
businesses has market power. There is no reason why the dairy
co-operatives should not establish or extend their processing
activities. The competition aspects of qualifying mergers would,
of course, be assessed under the merger provisions of the Enterprise
Act 2002. Several mergers of this type have been cleared recently
by the OFT. The OFT is ready to give confidential advice to parties
considering a merger or an agreement.
2. The OFT will publish guidance on its website
at the end of July in the form of Frequently Asked Questions (FAQ)
on agricultural co-operation and competition law. There was a
need for this guidance in the context of the Curry Commission's
recommendation that collaborative ventures in agriculture should
be promoted. The FAQ address a wide range of questions about what
sort of competition issues might arise from co-operation among
farm businesses. Most forms of co-operation do not cause competition
concerns and our aim has been to give the agricultural community
a clear steer on what is permissible and what might cause problems,
so that they know how they stand in relation to the law.
3. The OFT would be happy to consider other lines
of communication with the agricultural sector. Defra will consider
with the Dairy Forum whether the Forum might be used to disseminate
the OFT's advice. While the OFT has a responsibility for enforcing
the law it also has an important role in raising awareness throughout
the business community.
4. More generally, the OFT notes the Committee's
view that the dairy industry in the UK is being damaged by poor
relations between different parts of the supply chain. To the
extent that better relations between different parts of the supply
chain will improve the efficiency of the supply of dairy products
to the benefit of all participants, including consumers, the OFT
would welcome them. However, we would be concerned if, in the
interests of improving their relationships, producers, at any
level of the supply chain, were to enter anti-competitive agreements
which had the effect of forcing consumers to pay higher prices
than would otherwise be the case.
5. In a similar vein, any increase in communication
between participants in the dairy supply chain, including greater
transparency of cost information, as recommended by the Committee,
will need to be implemented with caution. While a greater flow
of information may in some circumstances help markets to perform
better, it can also assist or encourage collusion between suppliers
at the expense of consumers. The OFT would be concerned if this
were the outcome of an increase in communication and transparency
in the dairy sector.
6. The OFT agrees with the Committee that there
is no compelling evidence for setting up a regulatory body to
oversee the dairy industry at this stage. Generally, competition
is likely to produce greater benefits than regulation unless there
is some failure of markets that cannot be rectified by other means.
7. On the supermarket code, the OFT notes the
Committee's view that the code has been ineffective in redressing
the imbalance in negotiating strength between supermarkets and
suppliers, at least in respect of the dairy supply chain. The
aim of the current audit of supermarkets' dealings with suppliers
is to establish the facts about supermarkets' compliance with
the code, as a basis to determine what future action, if any,
may be appropriate.
Penny Boys, Executive Director
Office of Fair Trading
29 July 2004
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