Further supplementary memorandum submitted
by the Federation of Milk Groups (L14b)
1. A detailed breakdown of average herd
sizes across Europe.
2. A fuller explanation / examination of
the potential implications on the UK dairy industry as a whole,
if the process of a "dual market price" system based
on those with direct supply contracts, versus those without, is
free to continue unaltered in the future at a similar pace witnessed
over the last two-to-three years.
3. A detailed discussion paper on competition
law with regard perceived barriers to vertical integration
within the UK dairy industry.
1. SUPPLEMENTARY
NOTE TO
QUESTION Q238 BY
MR WIGGIN
What are the average herd sizes across Europe?
| Herd Size | 2001
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| United Kingdom | 72.4 |
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| Denmark | 57.2 |
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| Netherlands | 47.0 |
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| Luxembourg | 37.8 |
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| Irish Republic | 34.3 |
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| Belgium | 33.0 |
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| France | 32.7 |
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| Sweden | 32.0 |
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| Germany | 31.2 |
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| Italy | 22.2 |
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| Spain | 17.5 |
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| Finland | 14.9 |
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| Greece | 12.7 |
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| Portugal | 10.8 |
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| Austria | 8.9 |
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| EU-15 | 28.2 |
Source: DF&F 2002
2. DUAL PRICE
MARKET
As part of our written submission, and as touched on during
our oral evidence session, a key theme that we ask the committee
to consider is the growing trend of a "dual price market",
characterised on the one hand by dairy farmers contracted to processors
via direct supply agreements, and on the other Co-Op members.
Direct supply contracts, as outlined below, secure a consistently
higher market price per litre of milk than the contracts available
to non-direct suppliers, who, are almost exclusively Co-Op members.
The number of direct suppliers / contracts has steadily grown
since 1994, with a general market assumption that direct suppliers
now make up approximately 50% of all UK milk contracts.
However, a crucial point within this trend is that direct
supply contracts are, on our understanding and experience, only
offered to those farms / farmers based in strategically important
locations in relation to UK processing plants and major distribution
depots.
On this basis, and assuming processors continue in the main
to base their liquid milk processing plants in or around their
current locations, approximately 50% of UK dairy farmers (ie those
based in non-processor strategic locations) are effectively "zoned-out"
from the higher value contracts.
This trend has a major de-stabilising effect within the industry,
generating a sense of resentment and anger among those that by
virtue of their farm location, are in effect restricted to operate
within the lower tier, lower value bracket of the "dual price
market".
It is also reasonable to assume, that coupled with the projected
downward pressure on milk prices as a result of CAP reform, this
trend will increase over time.
With around half of UK dairy farmers now on direct supply
contracts, the burden of balancing supply against demand is increasingly
being passed onto the Co-Op farmer.
This burden means Co-Ops' are required to use balancing facilities
whose returns are exposed to commodity prices which, over recent
years have been influenced greatly by intervention support prices.
The cuts in these support prices through CAP reform are therefore
expected to have a greater impact on Co-Op prices than they will
on direct supply prices.
Outlined below are projected returns based on the CAP reform
support price cuts. The figures for 2002-03 and 2003-04 are actuals,
with average direct liquid supply contracts calculated as a simple
average of current Dairy Crest, Wiseman & Arla contracts—against
actual average Co-Op supply contracts calculated as a simple average
of current Dairy Farmers of Britain, First Milk & Milk Link
contracts, using the British Dairying standard litre (excluding
seasonality payments).
The calculations outlined below are based on a number of
variables and assumptions—they are not definitive, and are
included to support our written argument of a dual price market
and its implications.
The projections assume the CAP reform support prices have
a greater negative influence on Co-Op prices (circa at a rate
of 70%) than they do on direct liquid supply prices (at an assumed
rate of 50%). This assumption is based on the Co-Ops greater exposure
to commodity markets compared with the liquid market.
ppl | Intervention Prices (ppl)
| Average Liquid Directs (ppl) | Average Co-op
Prices (ppl)
| Co-op versus
direct |
2002-03 | |
18.00 | 16.61 | -1.39
|
| 2003-04 | 18.52 | 19.08
| 17.73 | -1.36 |
| 2004-05 | 17.28 | 18.46
| 16.86 | -1.60 |
| 2005-06 | 16.04 | 17.84
| 15.99 | -1.85 |
| 2006-07 | 14.80 | 17.22
| 15.12 | -2.10 |
| 2007-08 | 14.43 | 17.04
| 14.86 | -2.17 |
| |
| | |
In 2002-03 and 2003-04 Co-Op prices set against Direct Supply
Contract prices were consistently lower, equating to a difference
in the region of 1.4ppl.
Moving forward, the projections show an increasing divide
between liquid direct and Co-Op prices. The calculations highlight
a realistic potential that Co-Op prices may fall below Coleman
& Harvey's critical 15ppl barrier as soon as 2007-08, where,
it has been predicted, the UK would see a mass exodus from the
industry, resulting in a UK milk shortage.
Crucially, with liquid direct farmers relatively protected
from the price cuts, the mass exodus would come, in the main,
from the Co-Op ranks. This exodus would also not necessarily be
made up of inefficient farm businesses, but simply those structurally
blocked from entering the higher value markets for the reasons
already outlined.
The loss of milk from the Co-Ops would also seriously threaten
the supply versus demand balance, lead to an overall shortage
of milk in the UK, and threaten the existence of many specialist
small dairy companies who are unable to secure their own direct
farms due to their scale.
In addition, we are likely to see significant regional variations
in terms of the effects of downward financial pressure on dairy
farmers, with certain rural areas in England such as Cumbria,
disproportionately suffering from the financial pressures of CAP
reform, coupled with the implications as already outlined in terms
of their location in relation to existing UK processing and distribution
plants.
Likewise, dairy farmers in Wales are also likely to suffer
disproportionately from downward financial pressure, due to their
average herd size, location and their subsequent structural inability
to maximise and capitalise on efficiencies.
3. UK COMPETITION LAW
AND VERTICAL
INTEGRATION
Question 235 touched on the issue of the application of UK
Competition Law to vertical integration. As indicated in our original
submissions and reiterated during our oral evidence session, this
is an issue of considerable significance for the UK Co-Ops.
There is considerable evidence from other countries that
vertical integration can produce a beneficial outcome both for
producers and consumers of milk and the sub-committee will be
aware how prevalent this industry model is in countries as diverse
as the Netherlands and New Zealand. This is hardly surprising
given the efficiency gains that can result from vertical integration
through the elimination of a whole stage in getting the product
to market.
The main concern that vertical integration raises is where
it leads to problems for businesses competing with the merging
parties. In other words, does the vertical integration lead to
competing suppliers finding that they are facing a restricted
number of customers or does the vertical integration prevent other
customers from having access to adequate supplies of the product
in question?
Vertical integration in the milk market in Great Britain
(Northern Ireland is generally accepted to be a separate market)
has largely involved the acquisition by co-operatives of processed
milk businesses (eg cheese or skimmed milk powder plants) leaving
the greater part of the (higher margin) fresh milk market in the
hands of non-integrated dairies, in particular, Dairy Crest, Arla/Express
and Wiseman. As the sub-committee will appreciate, this split
may have undesirable consequences in the longer term for the farming
community as it increasingly finds itself excluded from the higher
value end of the market.
The question posed by many in the industry is why vertical
integration has not so far included the fresh milk sector. While
commercially, the milk co-operatives may have difficulty in raising
necessary funds for an acquisition in that sector (a greenfield
operation probably being too uncertain a venture for the co-operatives),
it may also be the case that uncertainty over the likely competition
law analysis has restrained potential deals of this nature.
The uncertainty would seem to result more from the repeated
interest of the competition authorities in the sector rather than
from any direct evidence that there would necessarily be opposition
on the part of the competition authorities to vertical integration
in the sector. Looking at the potential problems of vertical integration
that we refer to earlier in this paper, a few comments are in
order.
First, as regards the possibility that a vertically integrated
co-operative could use its market power to deny competing processors
a supply of raw milk, this would only have some force if raw milk
were sold on a regional basis. In such a case, a hypothetical
co-operative with a large market share in that region could refuse
supplies to the competing processor in order to benefit its own
processing arm and the processor, on this hypothesis, would not
have access to adequate alternative supplies.
There is however no evidence that this is the case. If it
were, prices across Great Britain might be expected to vary whereas
in fact, there is no regional pricing for raw milk. Each of the
co-operatives supplies milk across a broad geographic area, sometimes
at a considerable distance from where the majority of its farmers
are located and this is a major factor behind the creation of
a national market for raw milk. In any event, processors in all
parts of Great Britain have successfully secured year on year
increasing numbers of direct suppliers and both elements suggest
that there is no prospect of competing processors not having access
to milk on a competitive basis, were they to be denied a supply
by the vertically integrated business.
Problems could also be envisaged if competing suppliers of
raw milk were denied outlets as a result of a vertical integration
deal between one of the major milk supplying co-operatives and
a major processor. However, this would only be feasible if the
purchaser held a very large market share. There is no single purchaser
with such a share of the national market. Equally, the national
nature of the raw milk market means that it is improbable that
any vertical integration would lead to the market in any particular
region being "cornered" by a particular purchaser.
It is disappointing that despite the various investigations
that have taken place in the dairy sector, clarity has not been
achieved as to the extent of vertical integration that would be
considered acceptable by the competition authorities. While the
reluctance of the OFT to commit itself in public can be readily
understood, it has resulted in uncertainty and may have prevented
transactions from occurring which are economically desirable.
It would be for the benefit of the industry as a whole if a clear
framework could be laid out to guide future developments in the
structure of the industry.
23 March 2004
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