House of Commons - Environment, Food and Rural Affairs

Select Committee on Environment, Food and Rural Affairs Ninth Report

3 Were the retail price increases of 2003 transmitted to farmers?

28. In July 2003, the major supermarkets (Tesco, Sainsbury's, Safeway, Asda, Somerfield, and Kwik Save) raised their prices on liquid milk by 2 ppl. The supermarkets asked the dairy companies to pass the cash increase back to farmers in full.[29] In September 2003, the supermarkets again increased their prices: the price of cheese was increased by the equivalent of about £200 per tonne (roughly 2 ppl equivalent), with effect from 1 October 2003. Again, the supermarkets specified that the price increase was to be passed back to farmers in full.

29. The increase in the retail price of liquid milk was prompted by the financial difficulties being experienced by dairy farmers. As we have noted above, many farmers have struggled to break even, let alone to turn a profit, because the farmgate price of milk is insufficient to cover farmers' costs and has been for several years. Spurred on by these financial difficulties, some farmers applied pressure to the supermarkets to raise prices. Prior to retailers' decision to increase the price of liquid milk in July 2003, FFA had threatened to take direct action against retailers unless they agreed to raise milk prices by 2 ppl. FFA had previously protested against the retailer Lidl's plans to cut retail milk prices; in May, FFA's chairman, Mr David Handley, commented that retailers should learn a lesson from these protests, saying that they "had better withdraw their horns or they will see what Lidl saw."[30]

30. Following the July and September 2003 retail price increases, some farmers became frustrated because they believed that the dairy companies were holding on to the 2ppl increase and not passing it on to farmers. Consequently, between August and November 2003, FFA organised a number of blockades by farmers of the dairy companies' processing plants around Britain.

31. The evidence we have received indicates that there is still a general perception amongst farmers that they do not receive the full benefit of retail price increases. For example, FFA told us that:

Every time that there has been any form of increase, there seems to be a proportion which has failed to get back to the primary producer, although the retailer has indicated, at every stage of the negotiation, that they wish that money to come back in full but, because we have such a complicated system, that never appears to happen, and when any of the processing sector are asked the question why, all we ever get is a complicated answer which the majority of us find very difficult to understand.[31]

32. In seeking to establish whether the 2ppl increase in the price increases of July and September 2003 were transmitted back to farmers, in full or in part, it is important to note that any increase in the retail prices of milk or other dairy products sold by the major supermarkets will not result in an equivalent increase in the overall farmgate price of milk. For instance, a 2 ppl increase in the price of liquid milk sold in supermarkets will not result in an increase of 2 ppl in the price of raw milk bought from farmers, because liquid milk sold by supermarkets accounts for only about a quarter of the total UK market. Defra estimates that an increase of 1 ppl in the supermarket price for liquid milk would result in an increase of the average farmgate price of around 0.3 ppl;[32] an increase of 2ppl should therefore result in an increase of around 0.6 ppl.

33. We note that Defra's estimates do not correlate with those given by FFA which, in July 2003, estimated that the dairy companies should be paying the following price increases, on the basis of their percentage share of the retail market: Dairy Crest, 1.4ppl; Arla, 1.4ppl; Express Dairies, 1.5ppl; Robert Wiseman Dairies, 1.7ppl.[33]

Evidence that increases were transmitted

34. As regards the liquid milk market, Defra believed that retail price increases were fully transmitted to producers, although the department acknowledged the "widespread feeling amongst dairy farmers that they have not received the full benefit" of the recent retail price increases. Defra pointed particularly to the fact 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.[34]

35. Defra did not directly comment on whether the September 2003 increase in the retail price of cheese has been fully transmitted to farmers. However, it appears that the increase in retail price did result in an increase in the price paid for raw milk acquired for the purposes of cheese processing. On 5 December, for example, Dairy Crest increased payment by 2ppl, although it made retrospective payments of only 1 ppl more for October milk and 1.4 ppl more for November milk. Dairy Crest made this offer conditional on other cheese processors making corresponding increases in payments, which they appear, on the whole, to have done.

36. Similarly, the MDC's analysis was that the majority of price rises had been passed back to farmers.[35]

Evidence that increases were not transmitted

37. Farmers' groups do not accept that the 2003 retail price rises were fully transmitted to farmers. The NFU submitted that the increases in the retail price of liquid milk:

… resulted in some improvement in farmgate prices but farmgate price increases varied. Some producers received increases of over 0.5 ppl while other producers received no price increase at all. In the main, this difference can be attributed to the business mix of the purchaser of milk to whom the farmer sells. For example, direct suppliers to a liquid milk only processor did receive a price increase while direct suppliers to a cheese manufacturer did not. For suppliers of co-operatives the price increase would have depended on the amount of business they have with customers who supply into the liquid milk market.[36]

38. The Federation of Milk Groups (FMG), which represents all of the 30 or so milk groups in the UK, also submitted that the benefits of price increases have not been evenly distributed across all UK dairy farmers. The FMG told us that that farmers supplying directly to liquid dairies had, on average, gained more than those farmers who supply the co-ops or who supply directly to manufacturing markets.[37] The FMG cited the following data to illustrate the varying prices paid to farmers supplying different purchasers:[38]

Increases in farmgate prices: September 2000 to July 2003

Purchaser	Price increase (ppl)
Dairy companies (liquid milk)
Express Dairies (now Arla)	3.0
Arla Foods	3.0
Robert Wiseman Dairies	3.0
Dairy Crest	2.1
Dairy companies (cheese)
Glanbia	1.8
Dairy Crest	1.7
Dansco	1.0
Co-operatives
First Milk	1.9
Dairy Farmers of Britain	1.7
Milk Link	1.5

39. It can be seen from this that those producers supplying directly to processors involved only in the liquid sector have had increases of between 2.1 ppl and 3.0 ppl, whereas those supplying to co-ops who have a range of customers have had lesser increases, of between 1.5 ppl and 1.9 ppl. The FMG expressed concern about this gap, suggesting that it could lead to "an unmanageable, two-tier, dual-price farming sector" and a "very significant exit from the industry" by those farmers who currently supply co-ops.[39]

Some transmission of price increases

40. 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.

41. 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.

Dairy market not operating as it should

42. Both the MDC and the NFU submitted that the indicators in the dairy market in 2003, such as the weakening of sterling since the beginning of 2003 and the general improvements in commodity markets, were such that farmgate prices should have increased before the action of retailers in July and September.[40] The MDC suggested that the fact that retail prices increased only following direct action indicated that, without direct action, the market was slower to react to upward pressure than downward pressure.

43. It is not sustainable for price increases in the dairy market to occur only when prompted by political pressure, such as direct action. 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.

Uneven and delayed price transmission

44. We acknowledge the concerns of the FMG about the gap between the higher prices paid to farmers who supply processors directly and the lower prices paid to those who supply co-ops, and we note its suggestion that this may lead to "an unmanageable, two-tier, dual-price farming sector". The BRC reinforced this suggestion when it described farmgate prices as having three distinct levels:

a top price, for the direct supply of liquid milk to the dairies
a middle price, for the supply of milk for processing into cheese
a lowest price, typically paid by the co-operatives.[41]

45. From comments made by DIAL, it is clear that each individual dairy company decides whether to pass on any price increase either exclusively to those farmers supplying it directly or to all its suppliers—that it, the co-ops—and that a company may wish "to restrict any increase to direct suppliers in order to encourage the supply profile that it requires for the liquid market".[42] While this is a legitimate business decision, open to each dairy company to make, we are concerned that the effect of doing so may be to discourage farmers from joining the farmer-owned co-ops and selling their milk through them, or to drive out of business those farmers that do sell through co-ops. While we have heard evidence that some dairy farmers are pulling out of the industry, we have received no evidence about the profiles of these farmers. We note, however, that the proportion of farmers who are members of co-ops has declined in recent years. When the milk market was deregulated in 1994, over two-thirds of farmers joined co-ops whereas, in 2000, only about half of farmers sold their milk to co-ops.[43]

46. 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.

47. We understand why some dairy farmers became so frustrated with the delays of the dairy companies in transmitting the price increases to them that they turned to direct action. Supermarkets had specified that the price increases should be transmitted to farmers in full; farmers, understandably, expected to see fairly immediate benefits from these price increases. It is entirely unsatisfactory that the benefits of retail price increases should take so long to reach the producer. 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.

Why do farmers believe that retail price increases have not been transmitted?

48. Although we have concluded that there has been some transmission of the 2003 retail price increases, it is clear that farmers' perception is generally that price transmission has not occurred. This perception appears to be a consequence of the complex structure of the dairy sector. As discussed above, raw milk is purchased both directly by processors and also by co-ops, who may either process it themselves or sell it on to processors. It is then turned into a wide range of products which are sold for varying prices on both the domestic and international markets and offered for retail sale at prices determined by individual retailers. Prices are affected by currency movements, exchange rates and fluctuations in worldwide supply and demand. All this means that it is extremely difficult for farmers to track the path of retail price increases as they move down the dairy supply chain.

49. The difficulty in tracking retail price increases is exacerbated by the lack of clarity as to what proportion of the retail price of liquid milk and other dairy products is actually taken by each of the various players in the dairy supply chain. We received some evidence that farmers are receiving a progressively smaller proportion of the retail price of liquid milk: for example, the MDC stated that "the increasingly large percentage of dairy products sold through multiple retailers means that the power of the retailers has increased, leading to a smaller proportion of the retail price being passed back to dairy farmers."[44] With this in mind, we sought to establish the proportion of the retail price that is taken by each of the various players in the dairy supply chain. We focussed particularly on the example of liquid milk, as this should have been more clear cut than focussing on commodity products.

Who takes what share of the retail price of liquid milk?

Retailers' share

50. Retailers' costs and profits in respect of liquid milk (and other dairy products) do not appear to be readily available. The Royal Association of British Dairy Farmers (RABDF) criticised retailers for demonstrating "no level of transparency whatsoever" about their costs" in contrast with farmers' and processors' costs, which the RABDF considered to be either widely available or readily estimated.[45]

51. Consequently, we asked the BRC what the profit margins of the major retailers are in respect of milk and dairy products. Mr Hawkins responded on behalf of (what was then) Safeway as follows:

It depends on the volume you do with a given dairy as to what your supply terms are. Can I give you a kind of order of magnitude, at the moment a supermarket of our size and with our volumes might be paying the dairies who supply it 42 pence, 43 pence, 44 pence, 45 pence a litre, it is that kind of range. The average retail price weighted across all pack sizes and weighted by sales across all pack sizes, because that is the only way you can make sense of it, would be somewhere between 50 pence and 52 pence. It gives you a feeling for the magnitudes involved, that is gross. From that you obviously have to deduct wastage before you get to the net [profit]…[46]

Mr Hawkins estimated that "if you take something between eight pence and ten pence as the gross you have to deduct at least another three pence for overheads and net", although he said that this amount would vary between different retailers.[47]

Farmers' share

52. Since 2000, farmgate milk prices have varied between 16 ppl and 20 ppl. From March 2003 to February 2004, the average price was 18.27 ppl.[48]

Dairy processors' share

53. From the evidence we have received, the dairy companies' profit margins appear to vary from 1.5 ppl to 3 ppl. Robert Wiseman's told us that its operating profit over the last 6 and a half years has remained between 2.34 ppl and 3.13 ppl.[49] Dairy Crest stated that it made about 2 ppl on liquid milk and a similar margin on cheese.[50] Arla Foods estimated that it made between 1.5 ppl to 2 ppl on liquid milk.[51] We received no clear evidence about the costs to processors of producing a litre of liquid milk.

54. DIAL, which represents the majority of dairy processors and manufacturers, was keen to emphasise that UK dairies are not making profits at the expense of producers. It cited one of the conclusions of the KPMG report that "overall, the net profit margins of UK processors have not increased over the period since 1997 and are in line with the performance of similar organisations in Europe."[52]

Processors' costs appear improbably high

55. If we accept the evidence we have heard, we know the costs and profits taken from the retail price of a litre of liquid milk by retailers, the profits made on a litre of liquid milk by the dairy companies and the average farmgate prices received by farmers. If we assume the cheapest retail price per litre together with the highest estimates of proportion of profit, we can hypothesise that the following shares are taken from the retail price of a litre of liquid milk priced at 50 pence:

56. 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.

57. What is more, if it is unclear what proportion of the retail price of liquid milk is taken by each of the various players in the dairy supply chain, then the proportions will be even less clear in the case of dairy products, which are more complicated markets.

Transparency in the dairy supply chain

58. The fact that we have been unable to account for the entirety of shares taken of the retail price of liquid milk leads us to agree with the NFU that "the dairy supply chain [is] insufficiently transparent to enable producers to be certain that the price increase from retailers [is] finding its way back to them."[53] 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.

59. Transparency in the dairy supply chain is particularly important because of the fraught relations within the dairy industry. This is not a recent state of affairs: in February 2000, our predecessor committee, the Agriculture Committee, referred to the "institutionalised antagonism between the suppliers and the dairies".[54] 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".[55] Sadly, there has been no evidence of an improvement since the Agriculture Committee inquiry.

60. Relations within the industry will continue to be poor while there is uncertainty about the proportion of the retail price retained by retailers and processors. Farmers need to have the information to enable them to assess whether increases in the retail price have been fully transmitted; if such information is not made available, they will suspect that a proportion of the price increase has been siphoned off along the way. We are disappointed that the industry itself has not taken greater responsibility for monitoring the situation; for example, we were surprised to learn that DIAL feels able to maintain its belief that the market operates fairly while feeling no need to collect data on matters such as the retail margins on liquid milk and commodity products to support its belief.[56]

61. We acknowledge that that Government has attempted to show some leadership in this respect, by establishing the Dairy Supply Chain Forum in 2002. The forum is currently chaired by the Minister for Food and Farming and is made up of representatives from all parts of the dairy supply chain as well as the MDC and Government. It meets quarterly and is intended to encourage supply chain co-operation, increase efficiency and promote the sustainable development of the industry. The forum's primary function appears to be acting as a steering group for the three sub-groups which it has established. The sub-groups are:

the CAP Reform Sub-Group, which aims to assess the implications of CAP reform for the English dairy industry and reviews possible options
the Industry Development Sub-Group, which aims to facilitate the long-term sustainable development of the dairy supply chain
the Innovations Sub-Group, which aims to stimulate and co-ordinate innovation for the development of British dairy products.[57]

We commend the Government for the initiative it has shown in setting up the Dairy Supply Chain Forum.

62. However, we are concerned that, when we questioned the Minister for Food and Farming about the forum's terms of reference and agenda, his response was so vague as to convey the sense that the Government has no agenda for the forum other than bringing together representatives of the dairy supply chain.[58] What is more, the Government has subsequently told us that, during the course of this year, it foresees itself withdrawing from the forum as the forum will, by then, "have shown sufficient progress that participants from across the supply chain will be willing to continue the forum under industry leadership".[59]

63. 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.

64. In this context, we note that both FFA and the RABDF have asked that a regulatory body be set up to oversee the dairy industry supply chain, to bring greater transparency to the supply chain.[60] We understand the concerns that are prompting farmers' groups to call for such a body, but we believe that the recommendations we have set out above should go some way towards answering those concerns. We see no compelling evidence in favour of setting up a regulatory body to oversee the dairy industry supply at this stage.

29 "Unclear gain from milk price rise", Farmers' Weekly, 11 September 2002 Back

30 "More action over low milk prices?", Farmers' Weekly, 30 May 2003 Back

31 Q 47 [FFA] Back

32 Ev 103 [Defra] Back

33 www.farmersforaction.org Back

34 Ev 103 [Defra] Back

35 Ev 92 [MDC] Back

36 Ev 3 [NFU] Back

37 Ev 70 [FMG] Back

38 Appendix to memorandum from Federation of Milk Groups (not printed) Back

39 Q 234 [FMG] Back

40 Ev 96 [MDC]; Ev 3 [NFU] Back