Memorandum submitted by The British Retail
Consortium (L20)
The British Retail Consortium (BRC) represents
the whole range of retailers including large multiples, department
stores and independent shops, selling a wide selection of products
through centre of town, out of town, rural and virtual stores.
In June 2003, the retail sector employed some 2.7 million people
(11% of the workforce) and retail sales were £230 billion
in 2002. Grocery retailing is significant in macro economic terms
and was valued in 2002 at £111.3 billion.
1. The British Retail Consortium (BRC) welcomes
the Environment Food and Rural Affairs Select Committee inquiry
into milk pricing, which we understand will examine the market
price and farm-gate price of milk and investigate why recent rises
in the former have not led to increases in the latter.
2. This paper outlines the commitment of
BRC's members to British milk production, their strategic aspirations
in the dairy industry, the issue of supply and demand and the
role of retail price initiatives in the dairy food chain.
3. Food retailers believe milk is a valuable
product and want to see a sustainable British dairy industry from
which they are able to source supplies of the highest quality
British milk from the most efficient processing operations. The
sector is keen to increase consumption of milk and milk products
through increasing availability and encouraging innovation in
the sector.
4. We believe the supply and demand, which
continue to be out of balance remain at the heart of the issues
facing the UK dairy chain, and that policy makers need to focus
on the measures that can be adopted to facilitate change in the
industry given that CAP reform will be of great significance.
5 We believe that the challenges facing
dairy farmers need to be considered by the whole chain. Data published
by the Milk Development Council (MDC) shows that supermarkets
sell approximately 56% of milk that is consumed in liquid form
in the UK, 17% is doorstep delivery, 5% is sold by convenience
stores, garages, etc, and 22% passes through the catering and
institutional sectors. According to MDC data, supermarket own-brand
cheese accounts for 40% (138,000 tonnes) of total UK cheese consumption,
sales of branded cheese accounts for 14% of consumption, leaving
56% of cheese going through other outlets, including catering
and institutions.
SUPPLY ISSUES
6. Many commentators have argued that the
dairy industry is still struggling to adjust to the abolition
of the Milk Marketing Board in 1994. The MMB national pooling
system had effectively cross-subsidised the price of milk used
in cheese production from the liquid market. In addition, the
emphasis on the liquid market restricted the volume of milk available
for dairy product production, which had a dampening effect on
innovation. The removal of institutionalised price determination
and more competitive conditions in the liquid milk markets are
judged to have been a major driver behind the reduction in the
average farmgate price of milk from around 26p in 1995 to 16p
in 2000. Some analysts have also argued that the Monopolies Commission's
decision to break up Milk Marque in 1999, which in a bid to increase
competition, fragmented a large section of the supply chain into
several farmer-controlled cooperatives, accounting for 50% of
the supply of milk to the dairies.
7. Farm gate milk prices were also put under
pressure by the sharp increase in the value of sterling against
the euro from the mid-1990s to the end of the decade, which reduced
the value of CAP support payments to dairy farmers. According
to KPMG, the relatively low level of added value in the UK dairy
industry, inefficiencies in the supply chain and the recent tendency
for milk output to exceed consumer demand are other factors that
dampen the farmgate price of milk.
8. A popular myth is that multiple retailers
have used milk as a loss leader and that this has depressed the
farmgate price of milk. The reality is somewhat different, as
confirmed by the Monopolies Commission, which analysed the relationship
between farmgate prices and retail prices. The Commission found
that while milk was an important "known value item"
in the average shopping basket, there was little evidence of loss
leading. In any event, the Commission's analysis concluded that
for every 1p change in the farmgate price, the retail price changed
by 0.5p in the medium term. There was no significant relationship
between the two price series in the short term ie less than three
months.
9. As a result of consumers moving away
from doorstep delivery, multiple retailers have increased their
market importance. In 1995, multiple retailers accounted for 45%
of retail sales, while in 2002 this had risen to 65%.
10. It would be useful for the Committee
to consider that the current structure of the dairy industry has
only been in place for the last four years and is still evolving:
(a) The major dairies (Dairy Crest, Wisemans
and Arla/Express) are responsible for supplying virtually all
the major supermarkets liquid milk requirements. Wisemans, which
focuses exclusively on liquid milk and has been particularly successful
in winning and keeping major retail contracts. Dairy Crest and
Arla/Express, by contrast, process other dairy products in addition
to milk and therefore face different operational issues.
(b) The combined market share of the major
retailers is continuing to increase due to the decline of doorstep
milk delivery and its replacement by one-stop shopping in supermarkets.
According to data from the Milk Development Council, in 2001 households
purchased 69% of their liquid milk from supermarkets, 25% from
roundsmen and 6% from convenience stores, garages, etc.
(c) Following a Monopolies and Merger Commission
(now the Competition Commission) ruling, Milk Marque, which operated
as both a marketing and processing organisation, has been replaced
by three marketing cooperatives or "milk groups"—Milk
Link, First Milk and Dairy Farmers of Great Britain. All three
either have equity stakes in smaller, specialist processing companies
or directly engage in some limited processing activity themselves.
More importantly, between them they now own the whole of the equity
in United Milk, the most recent entrant into volume liquid milk
processing, which has already been financially restructured twice
in its two-year existence. Those farmers who do not supply the
major dairies direct (ie the majority) send their milk to one
of these cooperatives whose role is to sell it on to the dairies
as a "top up" for the supply they get direct from farms.
(d) The co-operatives role as milk consolidators
and brokers is reflected in the lower average prices they pay
the farmers who supply them compared with the price paid by the
dairies to their direct suppliers for liquid milk. In recent years
this differential has on average varied between 1p and 2p per
litre.
11. Milk supplied for processing into cheese
is typically sold to the dairies at a lower price than liquid
milk. Cheese, in particular, takes anything from 6 months to one
year to mature and obviously involves a substantial investment
in stockholding. The co-operatives compete with each other to
secure supply contracts from the dairies. They also compete to
retain a reliable portfolio of producers, but this has done nothing
to narrow the gap between the supply terms they offer their farmers
and those offered by the dairies to their direct suppliers. There
are, therefore, three distinct farmgate price levels for milk:
— The top price is for the direct supply
of liquid milk to the dairies.
— The middle price is for the supply
of milk for processing into cheese.
— The lowest price is typically paid
by the co-operatives, although pooled market prices do vary according
to market conditions and intervention prices.
12. It is argued that the break up of Milk
Marque in 1999, which was ordered to increase competition, artificially
created an industry structure that does not reflect the realities
of the market for milk and milk products. Rather, say its critics,
the post Milk Marque supply chain structure has an inherent reliance
on the short term, focussing on contract retention, which prevents
companies from building long term strategies. This is inconsistent
with a stable dairy industry.
13. For example, the major dairies compete
with each other to win supply contracts with the leading retailers.
This involves competitive under-cutting, but since profitable
commodity processing requires full utilisation of plant maximum
volume there is an economic rationale for highly competitive tactics
by the processors. However, the replacement of inefficient plant
with fewer, larger units has led to over capacity to the tune
of around 20% (KPMG report p 83).
14. A further supply-side issue is the recent
tendency for farmers to over-produce. The 80/20 rule now prevails
within the producer base with liquid milk production heavily concentrated
in the hands of a relatively small number of large, efficient
farming units. These farmers tend to operate with the lowest production
costs. This situation is magnified by the average milk yield per
cow growing by 2 to 3% a year. The requirement for all non-producing
quota holders to dispose of their holdings by the end of March
2004 is acting as an incentive to those farmers who are planning
to stay in the industry to expand their output by buying more
quota.
DEMAND ISSUES
15. Demand for dairy products in the UK
is, with the exception of the yoghurt category, either static
or declining:
— Consumer demand for liquid milk has
been gradually falling for at least 20 years. Since 1990 consumption
by UK households has fallen by around 10%. Demand for milk is
price inelastic so the conventional remedy of price-cutting to
stimulate sales growth is ineffective.
— The cheese market is largely commoditised
(in the form of mild and medium cheddar) and UK per capita consumption
is both low by EU standards (9.9kg vs an EU average of 18.8kg
in 2001) and barely growing.
— Yoghurt is the only dairy product
showing reasonable growth but the market is dominated by German
and French brands and relatively little liquid milk is used in
the production process (c5% of total UK output).
16. As a result, the UK dairy industry is
unique within the EU in being heavily dependent on liquid milk.
Around 50% of the liquid milk produced in the UK is consumed as
milk, compared with 24% in Germany, 14% in France and 9% in Denmark.
This has left UK dairy farmers exceptionally vulnerable to commodity
price fluctuations and currency movements. Although a few attempts
have been made to lift milk out of the commodity market by branding
(eg Cravendale, Bowland) none has yet had a significant impact
in the marketplace.
RETAIL PRICE
INITIATIVES
17. The current dispute over farmgate prices,
which began in the summer of 2003, and carried on through the
autumn, has its origins in the market conditions that developed
in 2000 and the structural characteristics described above. While
this particular dispute has been resolved by retail intervention,
it is highly probable that further disputes of this kind will
arise in the future given the structural conditions outlined previously.
18. In 2000, as the average farmgate price
reached a low point of around 16p per litre, UK milk production
fell below its EU quota for the first time since 1984. In response
to a possible shortage of liquid milk, the major supermarkets
increased their retail prices by 2p a litre on the understanding
that the additional revenue would be passed back through the supply
chain to all farmers.
19. It needs to be highlighted that this
was not a collective or agreed action by the retailers as this
would have been contrary to the 1998 Competition Act. Tesco took
the initiative and the rest followed. The dairies generally passed
on the increase more or less in full but the co-ops passed on
a smaller proportion of the total. Nonetheless, a further retailer-led
increase in April 2001 brought temporary stability back to the
market and quota was achieved in 2001-02 (and again in 2002-03).
20. A question that has not yet been answered
is why intervention does not appear to have worked. Farmers have
not received the Intervention Milk Price Equivalent (IMPE).
21. However, the spring 2002 output (or
"flush") of milk was 10% above normal, a situation which
appears to have been unforeseen by processors. While cheese and
milk powder production took up some of the surplus, the spot price
fell to only 8p a litre (cf IMPE). As a result, the dairies promptly
reduced the price paid to their direct suppliers by 3 to 4p per
litre with pro rata reductions by the cooperatives. The effects
of the earlier retail initiatives were reversed at a stroke.
22. By the autumn of 2002, the liquid milk
surplus had been eliminated (although as a result there was a
substantial glut of cheese) and market conditions were favourable
to another 2 pence per litre major retailer-led price increase.
(We are unaware of any support from other sectors).
23. While milk output remained strong throughout
the spring of 2002-03, the commissioning of United Milk's new
milk powder processing plant at Westbury, prevented the price
falls seen a year earlier. However, in response to growing pressure
from their members, who continued to face losses of up to £7
per acre compared with a surplus of £5 the previous year
(Deloitte), farming organisations began to campaign for a further
increase in farm prices.
24. As it became clear that the dairies
themselves would take no action on their own account, Asda initiated
a further round of price increases (2p a litre) in July 2003,
which the other major retailers followed (but not other sectors).
In each case, it was made clear to the dairies that the retailers
expected these increases to be passed back to the farmers in full.
The dairies assured the retailers that they would do so.
25. However, two problems quickly emerged,
both of which were implicit in all the preceding retailer-led
price adjustments and had generated considerable argument (and
acrimony) between dairies and cooperatives. But in the autumn
of 2003 they assumed major proportions. This reflected the pent-up
frustration and increasing militancy among dairy farmers and their
determination to achieve a farmgate price for milk which more
than covered the average cost of production across the whole supply
base (estimated at around 18p per litre). These problems were:
— The growing discrepancy between the
prices paid to farmers who supply the dairies directly and those
who supply the cooperatives, with the latter group arguing that
they had lost out through successive retailer initiatives and
that the gap between them and the direct suppliers was now unacceptably
wide.
— The differential between the prices
paid to farmers who supplied milk to be consumed as milk and those
who supply milk for processing into cheese. The retailer price
initiatives up to and including July 2003 were all framed primarily
in terms of liquid milk. For predominantly liquid milk operations,
like Wiseman's, this was not a problem, but mixed dairy processors,
like Dairy Crest, the issue remains complex. For example, up to
July 2003 the proceeds of every retailer price initiative on liquid
milk were spread across all of Dairy Crest's direct suppliers,
regardless of whether their product is consumed as milk, cheese
or other dairy product. So whereas Wiseman's direct suppliers
received all or most of each of the 2p per litre increases implemented
by the retailers, Dairy Crest's received somewhat less, although
exactly how much less is obscured by incentive bonus payments.
The situation for Arla/Express, with its high reliance on liquid
milk sales, lies somewhere between these two extremes.
26. The July 2003 price initiative crystallised
these issues. Wiseman's refused to pass on the 2p per litre in
full because, they argued, they had paid all the previous 2p increase
(October 2002) back to their farmers whereas their competitors
had not done so. Dairy Crest, by contrast, said they would
pass the full 2p on—but only to their suppliers of milk
to be consumed as milk. This left their milk-for-cheese farmers
feeling very aggrieved. As a result, the major retailers agreed
to increase the prices they paid for cheese by £200 a ton.
This would roughly equate to an increase of 2p per litre for Dairy
Crest's milk-for-cheese suppliers.
27. However, it emerged that Dairy Crest
were proposing to pass on only 0.8p to their cheese suppliers
and their failure to explain their reasons for doing this angered
farming organisations. Eventually, after some aggressive picketing
by farmers, Dairy Crest improved their proposal from 0.8p to 1.4p
per litre. This was still not satisfactory to farmer bodies and
secondary picketing of major supermarket distribution depots was
started with a view to persuading the retailers to bring more
pressure to bear on Dairy Crest.
28. In late November retailers agreed to
increase the price they paid Dairy Crest for cheese by an additional
£100 per ton (effective 1 December) equivalent to 1.0p
per litre, plus a possible further increase of 1p per litre
on the price of liquid milk, effective 1 January 2004. Dairy Crest
promised to pass these increases back to the farmers in full.
This means, in effect, that all the farmers who supplied Dairy
Crest with milk for cheese processing would, from 1 December,
be paid 2p per litre more than they were on 30 September. However,
we understand that these terms are also conditional on similar
increases being agreed and implemented by Dairy Crest's competitors.
The situation remains inherently unstable. (Other cheese companies
such as McClellands and Glanbia were also paid a total of £200
per tonne on the same basis).
FUTURE DEVELOPMENTS
29. The issue of supply and demand is clearly
at the core of developing a sustainable dairy industry. Retailers
want to see market forces determine the price changes throughout
the dairy chain rather than on sector effectively subsidising
the rest of the market. As demand from consumers remains constant,
retailers do not adapt to seasonal fluctuations, and oversupply,
together with the seasonality of production are therefore key
to the sector's current problems.
30. Food retailers have tried to deliver
fair returns for farmers via their processors but there is a limited
amount that we can do. Around 12 billion litres of milk is consumed
each year—only a small percentage is purchased via food
retailers. There should be an understanding of other sectors in
the chain and the market prices to these sectors to evaluate what
they are doing to support price increases through the chain. This
should include caterers, hospitals and schools and Government
institutions.
31. On-farm efficiency increases will remain
an important driver in developing market-driven solutions to the
current problems facing the dairy sector, but efficiency gains
are not just related to on-farm production. The Defra/IGD Food
Chain Centre has recently begun to analyse eight supply chains
within the industry and pinpoint areas for cost reduction and
efficiency improvement. The study will also recommend ways of
helping dairy farmers benefit from the "lean thinking"
approach, which the FCC and MLC are currently applying to the
red meat sector. The BRC is taking an active role in the dairy
project.
32. We believe it is critically important
that when the reform of the CAP dairy regime begins, the industry
is much better placed to absorb and adapt to these changes than
it is now. CAP reform may be expected to:
— Reduce the farmgate price of milk,
by anything between 3p and 6p a litre from current levels.
— Encourage further mergers between
the cooperatives, which EU law would certainly permit and which
would help achieve a shorter, more integrated supply chain. The
UK Fair Trading Act (1973), however, may obstruct further concentration
unless the regulatory authorities decide otherwise.
— Force farmers and processors alike
to reduce their cost structures. This will oblige many farmers
to leave the industry and encourage processors to close down any
remaining, high cost plant, concentrating milk production in fewer,
larger farm units.
— The net effect of these changes may
well be a smaller, more compact and integrated industry but with
a continuing tendency to produce more liquid milk than the market
needs, given the likelihood of a continuing decline in consumption.
This is particularly likely to happen once quotas are abolished
from 2014 onwards.
33. Whatever the precise formula adopted
in the UK, the impact of CAP reform will be painful and disruptive.
It is essential therefore that the leaders of the industry should
use the next 12 months to develop an agreed view of the likely
impact of CAP reform, a broad strategy for dealing with it, and
a plan for communicating the implications to all those farmers
who will be on the receiving end.
January 2004
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