Examination of Witnesses (Questions 120-139)
1 MARCH 2004
MR DRUMMOND
HALL AMD
MR DAVID
LATTIMORE
Q120 Chairman: You heard my question
to Wiseman, this issue of trust and transparency; and I suppose
also, given the diversified nature of your business, there is
the one about efficiency. What has Dairy Crest done to deal with
those three issues?
Mr Lattimore: If I can pick up
the issue of efficiency to start with, one of the things that
we have done is that the best-paying contracts are contracts with
Waitrose and M&S, where all three parties work together on
the issues facing us, and the returns. One of the things we do
as part and parcel of that is actually benchmark costs between
individual producers, so that producers can see what opportunities
they have to improve their efficiency. That again is some work
that the Milk Development Council is doing in terms of efficiency.
If I can just talk you through the processes in terms of perhaps
setting prices with our direct producers in Dairy Crest, what
happens is that they initially will come to us with a view of
the marketplace, including producer needs, which we sit and discuss.
We take it away and then we come back and respond to them, and
then following negotiations the prices are set at the end of that
particular process. So we put a lot of effort into trying to make
sure that the producers have an equal amount of information as
we do, so that they do not feel the process is not working for
them. I think this may be a way for the whole industry to try
and make sure that there is more information there, and openness,
recognising that a lot of pricing information will be, by its
nature, commercially sensitive.
Mr Hall: Chairman, might I add
a supplementary, which may not be absolutely germane to your point.
We have a very strong belief that the future of the industry is
not just about efficiency, although that is very important in
terms both of on-farm efficiency and our own efficiency as manufacturers.
We believe one of the fundamentals is adding more value to the
market through investment in brands, through product innovation.
Yes, we have spent, as we put in our submission, a very large
amount of money on capital investment from the point of view of
efficiency. What we have also done is over a very long time now
invested in building very significant brands, which both command
a premium and provide us with some sustainability of business
going forward. I would just like to give you an example of that.
By way of example, we pay the producers—the farmers who
supply our Davidstow site, which produces our Cathedral City,
which is a brand of mature cheese—a significant premium
versus the average milk price, typically 1.5 pence per litre,
and that is really on the back of the returns that we are able
to make through that added value. We think that is absolutely
central to the future of the industry moving forward.
Q121 Chairman: I declare an interest,
as you know, because I see the investment from my bedroom window.
Mr Hall: You do, don't you?
Q122 Paddy Tipping: Can we talk about
profit margins on liquid milk. I know these are commercial matters,
but can you give us an indication of what profit you are making
on a litre?
Mr Hall: As Billy Keane has led
the way, I suppose we had better not be shy. If you look at our
profit margins on our liquid business, expressed in pence per
litre, we make about two pence a litre. The other big difference,
of course, with us compared to Wiseman, is we are a broadly-based
business, so we have leading positions in all sectors of the dairy
market, so we have a range of margins. The margin on our cheese
business, which would be the other big business, is pretty similar,
actually. If I take the half-year we reported on, it was 2.1 pence
per litre. An important point within that, however—and these
issues have been well publicised, for those who may not have read
our financial report and accounts—is that the cheese business
consists of a very large slug of commodity cheese—mild cheddar,
unbranded cheddar, which operate very much at the bottom end of
the market—and I have to say that the margins there are
extremely slim, and we make more margin on about the 30% of our
business which is in branded and added-value cheese. So within
that 2.1 pence, it ranges from almost nothing to four or five
pence. The other big chunk of our business is the ingredients
business for bulk skimmed commodity products. Essentially that
operates pretty much at break-even. It is a very small positive
margin.
Q123 Paddy Tipping: So it is the added-value
part of the business that is the best bit for you?
Mr Hall: Absolutely. We are very
clear on that. That is what we invest in, and that is what generates
our returns and our farmer's returns.
Q124 Paddy Tipping: There has been an
increase in milk prices, two pence per litre. What difference
has that made to your profit margins?
Mr Hall: In terms of our profit
margins over the last 12 months, nothing; it has been a straight
pass-back. That two pence per litre was designated to go to farmers
on liquid milk, and that has been passed back to those farmers.
Leading up to Christmas there was also a similar move after a
lot of tough negotiation and discussion on cheese, and we were
able to pass back two pence per litre on milk for cheese, but
again with support back from the marketplace, so that made no
difference to our margins.
Q125 Paddy Tipping: You are very involved
with the multiples, and there is a lot of criticism of price in
supermarkets. What is your take on this? What do you think they
are making per litre?
Mr Hall: If you go back to the
previous session—because we have access to the same report,
obviously—the KPMG view was that they were making 25 to
30% gross margin on milk. That of course translates, if you look
at their net margins, to 4 to 5%, so obviously some would say
that is not excessive. In terms of our relationships with the
major multiples, obviously the pricing in milk is set by a variety
of different factors—commodity pricing, stocks of cheese,
capacity of the industry, currency—and negotiation with
those multiples. Where you have a differentiated product or a
differentiated brand you are in a better position, and therefore
you are in a better position to both get a premium return and
support your farmer base on that premium return.
Q126 Paddy Tipping: Some people say that
these negotiations are not equal; that the supermarket has all
the clout, and that the producer has very little clout. You are
somewhere in the middle in this. How do you see this David and
Goliath contest?
Mr Hall: I guess it is fair to
say that we have pretty robust conversations with retailers.
Q127 Paddy Tipping: You should be a politician.
Mr Hall: We do. The retailers
do tend to get a lot of flak because they are pictured as the
ultimate baddie. I have to say we have built our business through
working closely with retailers, which is how Wiseman built his
business. We have pretty vigorous sessions with them, but we have
built a strong and growing business over time on the back of a
range of products. We provide the right quality of service and
we provide the products that the customer wants. At the end of
the day the end customer is not the retailer; the end customer
is you and me as consumers. So in terms of the balance of power,
perhaps David could talk about that.
Mr Lattimore: If you look at it,
there are probably, say, five major retailers and five major processors,
there are three major co-ops and perhaps five major direct selling
groups, so the balance of power is a bit more equal than if you
start saying there are 25,000 individual dairy farmers. One can
discuss the quality of the organisation as you go on down the
chain, but the balance is potentially relatively equal.
Q128 Mr Jack: Do you benchmark yourself
against any of the major continental dairy producers to see how
you are performing?
Mr Hall: I can take that one.
No, we do not. We run our business on a number of key ratios.
We work very hard at making sure we get the right productivity
out of our capital investment. We look to make a proper return
on our marketing investment, so we spend a lot of time on econometric
analysis of our advertising effectiveness—I am not sure
it tells us very much, but we spend a lot of time on it. The continental
dairy producers are in a different position from us. They are
either very large vertically-integrated cooperatives, in terms
of mass users of milk, or alternatively they are very big multi-nationals—Danone
or Nestle—who operate very much in the band of added-value.
So perhaps it is something we should look at, but it is not something
that we have historically looked at, no.
Q129 Mr Jack: Can I just ask you, clearly
because there is a spread of activities, in the branded sector
is it not a fact that it is more difficult to secure changes to
prices because retailers are very price-point conscious, and there
does come a point at which they say "Well, no, we are not
prepared to sell that item beyond that particular price point;
we will get customer resistance", and therefore you are left
in some difficulty in trying to meet the pressures of the supply
side against a barrier from the retail side to change key price-points?
Mr Hall: Your point is well made.
It is never easy to get price increases from retailers. Our view
would be that you have more ability to do so if you have a brand
than if you are entirely in an own-label business, because in
a sense the equity sits with you as a manufacturer. Again you
are right that with the move to everyday low pricing there is
increasing emphasis on that end price, and therefore it is more
difficult to move the price forward. I think that poses a couple
of challenges for us. One is we obviously need to become more
and more efficient in running our businesses. The second thing
we need to do is get more and more effective in our marketing
in terms of the kinds of products we introduce, and—if I
can be spared a small commercial—you know we have just spent
a lot of time on our Cathedral City brand. We have introduced
new easy-open packaging, reclosable packaging. We have extended
it into ready-sliced and dip products, and it is through those
sorts of initiatives over a period of time that we can start to
address all those cost issues.
Q130 Diana Organ: You said that you obviously
have a very close relationship with your suppliers, the Dairy
Crest members, and that you try to keep them informed, and you
work with them and so the information that you have, you pass
on to the suppliers, and so on. One of the messages we are wondering
whether farmers really do understand is that in order to become
really profitable they have to be efficient; in order to be efficient
they need to have larger dairy herds than maybe many of them have
got, but eventually that will mean fewer dairy farms, because
it is going to be more efficient, bigger herds. Do you think your
members really understand that?
Mr Hall: Ask David; he sees them
on a weekly basis.
Mr Lattimore: I think I would
agree with you, there is a challenge facing perhaps not only our
own members but the whole of the dairy industry, in making sure
that everybody is aware of the challenges facing them in the future.
I think one of the problems is there are a lot of producers out
there that would recognise what the situation is and what the
future holds for them, and we communicate with those people regularly.
However, there are still little groups of people that do not really
engage in the process properly, and it is up to us to make sure
that we try and get through to those. That is why we hold a regular
series of meetings with them; we have even had special sessions
dealing with CAP, et cetera, et cetera, to try to get them to
engage. They do say that the only bit of correspondence you will
ever guarantee that a farmer will read will be the milk cheque,
so we usually send these messages through there.
Q131 Mr Jack: What, on a cheque?
Mr Lattimore: I think one of the
things that we can do is to make sure that what we are asking
them to produce, we are quite clear about exactly the specification
of milk that we want from them. We have just launched two new
contracts, one for liquid, one for manufacturing, which is cheese,
and these contracts have been developed with producers. If I can
give you an idea of the one that we have produced for the Davidstow
cheese factory, we have come up there with what would be the ideal
litre to produce a ton of cheese out of that factory. With producers
we have come up with a matrix, and if the producers can hit that
matrix they will get a much, much better price than they would
by just sending milk on a random basis. That is not Dairy Crest
handing over money altruistically; that is money coming out of
better efficiencies out of the supply chain, and that is the sort
of thing that we need to do across the whole of the industry,
in our view.
Q132 Diana Organ: Having established
that obviously Dairy Crest, although it might be a good thing,
is not a totally altruistic organisation—it is in business
for profit, as many others are—why do you think it is, therefore,
that the proportion of the retail price made up by the farmgate
price has gone down consistently over the last three or four years?
In other words, you are taking your fair share as a processor,
and the retailers are, but the farmer, the producer, seems to
be losing out consistently.
Mr Hall: I think if we take it
over the last three years there has been a fall in the percentage
of the retail price of milk accounted for by the farmgate price.
I think the key reason for that is, remember, about 50% of milk
in the UK goes into what we call manufactured products, not just
liquid milk, so it goes into cheese and it goes into butter powder.
In the last three years we have seen an absolute slump in commodity
markets, so we have seen 10- or 12-year lows in world pricing,
and it has been particularly difficult in the cheese market, where
prices pretty much collapsed—which is not too dramatic a
word—three years ago now. So that has put a lot of pressure
into the farmgate price, and therefore by definition it has come
down relative to the liquid milk revenue coming in at the top.
I think the other thing is that retailers have increased their
margins on liquid milk, as Billy Keane was saying, over that period
of time, because they had moved from a position where perhaps
they had pretty limited profitability to the sort of 25, 30% that
we talked about earlier.
Q133 Diana Organ: You were talking in
answer to Paddy Tipping's questions about price and profitability
on a litre and everything. Do all of your farmers, your producers
selling to you, make a profit? You know them well. You must know
what you are paying them for their milk, and what their costs
are.
Mr Lattimore: We would say that
on average they will be. Whether every individual—
Q134 Diana Organ: At any time?
Mr Lattimore: —of the 1,400
are, it is difficult to tell. There are bound to be ones within
there that would not be making a profit, but on average currently,
yes, they are.
Q135 Diana Organ: What do you think,
on average, people that are supplying you are making at present
on sales of liquid milk per litre, profit?
Mr Lattimore: Certainly in excess
of a penny a litre at the moment. Our average-sized producer would
be larger than the national average. Our average-sized producer
is about a million litres. We do have specialist contracts with
Waitrose and Marks & Spencer, and those producers would get
an additional 1.6 pence per litre over and above that. They do
have to do some additional work for that, but it does not add
up to the premium that they are getting. Uniquely with these two
particular contracts, we seem to have been able to find almost
an ideal, insofar as the retailer seems to be getting a product
that works for them and works for their consumers; it delivers
a premium through to the producer, and it works for Dairy Crest
as well, because, I have to say, having happy customers and happy
suppliers does tend to make for a happier processor.
Q136 Diana Organ: Outbreaks of happiness
all around us again.
Mr Lattimore: Yes.
Q137 Diana Organ: I realise of course
that the previous people I spoke to, they quite correctly put
me right that they are not, of course, producing cheese, you are,
and many people will know you for cheese, and particularly cheddar,
which is obviously the main one; it is 62% of all cheese produced
in the UK. However, we know from the Federation of Milk Groups
that research indicates that actually farmers are losing on the
profitability of milk that they are giving for cheese. They are
saying it is a figure of about 2% of the retail price of cheddar
cheese that farmers are losing on the milk sold to processors
to make this cheese. Is that true in your case?
Mr Hall: In terms of our experience
that would not be the case. I think that probably partly reflects
our mix of business, where we have much more cheese in the premium
and added-value sector. If you take our best price of milk for
cheese which is published, and go through it, we would pay an
average of 20 pence per litre of milk going to cheese. If you
take the average cost of production it is probably about 18 pence,
so the farmers who are supplying us with milk for cheese are making
on average about two pence a litre. I should qualify that and
say that if you wind the clock back 12 months ago when conditions
in the cheese market were particularly difficult—
Q138 Diana Organ: Which is presumably
when this research was done?
Mr Hall: Which is presumably when
the research was done—they would have been at about break-even
on average.
Q139 Diana Organ: So you are saying the
situation might be a little ameliorated from when the research
figures were coming in?
Mr Hall: It has been, yes.
Chairman: Colin, do you want to say something?
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