Chapter 2

The supermarkets' recent price decisions

Announcements by Coles

2.1        On 26 January 2011, Coles announced as part of its 'Down Down' campaign that the price of Coles Brand fresh milk will be cut by as much as 33 per cent, to $2 for a two litre bottle. The Coles Brand low fat milk was also reduced to $2 for a two litre bottle, eliminating the slight premium that was previously charged. In its media release announcing the price changes, Coles stated:

Coles is not reducing the price it pays to its milk processors either so this move will not impact them or the dairy farmers who supply them. In fact both farm gate milk prices and contract prices with processors recently increased. Coles is fully absorbing the price cut, bringing great value to customers whilst supporting Australian dairy farmers.[1]

2.2        At the same time Coles announced it would phase out its Smart Buy range of milk, leaving one generic Coles brand sold in the milk market. Coles noted that customers that previously bought the Smart Buy branded milk would receive a slight discount under the new pricing structure:

As well as lowering prices on Coles Brand fresh milk, Coles is also phasing out its Smart Buy fresh milk in order to simplify the range for customers. Customers who currently choose Smart Buy milk will also save money** by switching to Coles Brand milk at the new low price of $2 for two litres—the lowest price in store for any fresh milk.

**Smart Buy 2 litre full cream fresh milk was priced at $2.09 in every State so customers switching from this product to 2 litre Coles Brand fresh milk (full cream or lite) at the new regular low price of $2 are saving 4%.[2]

2.3        On 3 January 2011, Coles announced reductions in the prices of Coles brand butter and cream, and various brands of olive oil.[3] The 'Down Down' campaign has since been extended to cover a number of other grocery items, such as breakfast cereals and tea. Other private label products, such as eggs, had also been heavily discounted before the milk price cuts.[4]

Responses of other supermarket chains

2.4        Woolworths followed Coles' price discounting immediately, with ALDI and Franklins following soon after. The Australian quoted an ALDI spokesperson as stating that their price cut was to maintain its 'lowest price position'.[5] The Courier Mail reported Woolworths spokesperson Claire Buchanan as stating 'this is certainly not a sustainable price level for milk and it will inevitably lead to pressure at the farm gate'.[6]

2.5        The Australian Dairy Industry Council (ADIC) submit that the milk price cuts led by Coles and followed by other supermarkets will remove over $70 million from supermarket margins each year, with Coles experiencing less than half of this decrease.[7] The ADIC suggest that, on an industry-wide basis, the impact on revenue and margins could 'easily extend to hundreds of millions of dollars per annum'.[8]

Table 2.1: Comparison of retail full cream milk prices by quantity
(a major supermarket in Canberra, cents per litre)

	26 January 2010		25 February 2011
	Branded milk	Generic milk	Branded milk	Generic milk
300 mL	320	-	327	-
600 mL	222	-	228	-
1 litre	197	137	199	125
2 litres	184	124	195	100
3 litres	176	122	187	100

Source: Secretariat.

Table 2.2: Comparison of prices at two different major supermarkets in Canberra
 (20 February 2011)

	One major supermarket	The other major supermarket
Milk
Private Label 1L	$1.25	$1.25
Private Label 2L	$2.00	$2.00
Private Label 3L	$3.00	$3.00
Canberra Milk 2L	$3.89	$3.89
Canberra Milk 3L	$5.62	$5.74
Butter
Private Label 250g	$1.39	$1.39
Private Label 500g	$2.49	$2.49
Western Star 250g	$2.63	$2.63
Western Star 500g	$4.39	$4.68
Cream
Private Label 300mL	$1.25	$1.25
Private Label 600mL	$2.25	$2.25
Branded Label 300mL	$2.24 (Bulla)	$1.99 (Dairy Farmers)
Branded Label 600mL	$3.73 (Bulla)	$3.08 (Pura)

Source: Secretariat.

Previous price cuts

2.6        As noted at the start of this chapter, Coles previously offered two private label milk products. The January 2011 price cuts means that the price of one of these products has been significantly reduced, however, the lowest-priced milk previously available at Coles was a private label brand at $2.09 for two litres. The January 2011 price cuts only represent a 4.5 per cent price cut from this level. However, it is important to note that those concerned about the impact of lower prices may be more concerned at the price cut that occurred before that—in December 2009 one of the major supermarkets reduced the retail price for two litres of private label milk by eight cents from $2.17 to $2.09.[9] Coupled with the more recent price cuts, this represents a total decrease of over 8 per cent in just over a year.

What does "staying down" mean?

2.7        Coles' current marketing campaign includes heavy use of the phrase "down down and staying down". What length of time "staying down" actually implies is a pertinent issue for the sustainability of the dairy industry. Coles' submission addressed this issue, noting the factors that may determine when prices will change and concerns that may arise about false advertising if the price cuts were not sustained for a sufficiently long period of time:

It is intended that our milk prices will stay down for at least six months, subject to cost increases by suppliers and, in the case of dairy products, commodity price increases impacting on farm gate prices.

We note that, if Coles did not honour its price representations made in respect of milk as part of our "Down Down" campaign, it may give rise to misleading and deceptive conduct under provisions in the Australian Consumer law intended to ensure representations are fully honoured.[10]

2.8        The issue was examined further during Coles' evidence to the committee:

Senator XENOPHON—...with ‘Down Down’, what does that mean? ‘Down and staying down’. What time frame is there for that? Is that an indefinite period of time, subject to price fluctuations? What do you mean by that? It is a question that we have asked the ACCC as well.

Mr McLeod—Internally we talk about at least six months, if not longer. That is what we would anticipate. We think that is a reasonable time that the consumer would accept—’Down Down, we’re staying down.’

Senator XENOPHON—Okay.

Mr McLeod—We have avoided using words like ‘permanent’ or ‘every day’, as some of our competitors have, because we believe that particular statement leads people to believe that the price would never go up. I think that would be an unrealistic position to assume.

Senator COLBECK—Doesn’t ‘staying down’ mean that? ‘Staying down’ means to me that it is not going up.

Mr McLeod—No. We have explained that to our team members as well for when people ask...The reason that we have had difficulty was that consumers in Australia are very used to short-term promotional high/low prices. We still have thousands of specials every week in Coles but we want to try and differentiate between the prices that we were lowering and endeavouring to keep down, to ensure that we move from inflation to deflation. We want to make sure we raise that and highlight it with consumers, and that is where ‘Down Down’ came from. We are sufficiently realistic to recognise that prices ultimately will rise, as you can see, in some instances, but we push very hard to make sure we absolutely limit those price increases going forward.[11]

2.9        Contrary to Mr McLeod's assertion that Coles is not using words like 'every day', the committee notes that various Coles catalogues have incorporated that statement as part of the down and staying down campaign, with direct reference to the milk price cuts.[12]

2.10      This is also likely to be a key issue when assessing concerns about possible misuse of market power or predatory pricing. The Australian Competition and Consumer Commission (ACCC) were asked about how these sorts of phrases would be viewed in terms of predatory pricing:

When looking at an issue of possible predatory pricing, if the alleged perpetrator of predatory pricing says, ‘I am going to keep pricing the way I am forever more’—or at least for a lengthy period of time—then clearly the timing issue is something we would take into consideration.[13]

2.11      The ACCC were also questioned more specifically on the six month period cited by Coles as the minimum length of time the price cuts in milk would be maintained for:

Senator COLBECK—Can we go back to the time thing. How do you determine it? You said that you look at it on an industry basis. What would you pick up that might allow you to determine this? I will put something specific on the record. I have already said that the background that I am getting is that this will go for about six months and then prices will return to normal, and that will be within a time frame that will not offend what is understood in the act. But we have evidence from one of the processors that this sort of activity considerably changed the market in the UK within three months. Would that be something that would direct your attention to what sort of time frame might impact on this sort of circumstance?

Mr Cassidy—We would look at the normal pricing behaviour within the relevant market. I would not accept the proposition that has been put to you that six months is necessarily not long enough, which is what I think you are saying. I do not know how someone would make that judgment. Certainly, we have not arrived at that sort of position. But as I say, it is something that you look at in the context of the particular market and the pricing practices in that market.[14]

Consumer demand for milk

2.12      How responsive consumers are to a change in the price of milk in their purchasing behaviour was discussed during both this inquiry and the committee's previous dairy inquiry.

2.13      National Foods considers that:

...the volume of milk is pretty inelastic. Consumers in Australia drink 102 litres per head per year or thereabouts.[15]

2.14      Coles disagreed with this view:

We do not fundamentally believe that milk is inelastic. We believe that there will be a higher demand for drinking milk, which we believe carries a higher premium to the farmer. We believe the growth in drinking milk plus the increases we have given to all of our processors should offset any changes that you see in mix.[16]

2.15      Coles claimed that, based on an 18 month trend, the volume of drinking milk has increased by nearly 2 per cent.[17]

2.16      Coles also provided the committee with a graph outlining the trend in the growth in sales volume of drinking milk to support this claim. This was compiled by comparing the sales of one quarter to the sales of that quarter in the previous year, except for the months of January 2011 and February 2011 which were compared to January 2010 and February 2010 respectively. This shows an increase in milk volume of approximately 1.8 per cent in February 2011 above the 18 month average.

Figure 2.2: Australian drinking milk volume growth (percentage change from same quarter/month in previous year)

Source: Coles, Additional information no. 6, appendix II (long term population growth figure from ABS Australian Demographic Statistics, June 2010).

2.17      When the figures are represented on a monthly basis rather than quarterly, however, the trend in volume appears much more volatile, and the increase in February 2011 less significant.

Figure 2.2: Australian drinking milk volume growth vs. LY (by month)

Source: Compiled by Secretariat based on national milk production statistics published by Dairy Australia, www.dairyaustralia.com.au/Our-Dairy-Industry/Industry-Statistics/Latest-Statistics.aspx (accessed 8 April 2011).

2.18      Furthermore, when the volume data are disaggregated, the overall growth in sales of 'full cream' and 'reduced fat' milk—the categories for which prices are down—was less than 1 per cent above trend. The larger increase was in UHT milk sales, which is unlikely to have been caused by price cuts in supermarket private label non-UHT milk.

2.19      Professor Stephen King noted that in the short run the demand for milk is 'relatively inelastic', over a six to 12 month period,[18] but outlined how he saw the consumption of milk changing as a result of the price cuts:

Coles is certainly not going to need less fresh milk; almost certainly it is going to need more fresh milk. We would expect milk sales from Coles supermarkets to go up. Unless milk is an extraordinarily unusual product—in other words, it is a product for which demand has not slowed down—milk sales generally will go up as prices go down. As other sellers of milk products are forced to lower their prices to match Coles to keep their customers, you would expect total milk sales to go up. Sales may not go up by very much in the short term; demand may be fairly insensitive in the short term. But you would expect over the longer term that there would be some, possibly small, increase in milk sales.[19]

2.20      Nevertheless, it is too early to draw meaningful conclusions on any possible sustained increases in drinking milk volume as a result of the supermarket price cuts. Some customers may be slow to respond. Other customers may have over-reacted, deciding to buy a larger sized bottle of milk and then finding it was more than they needed. The February 2011 increase may reflect seasonal influence, or other factors. The situation should be clearer by the time the committee presents its final report.

2.21      In its 2010 report Milking it for all it's worth, the committee noted a UK study which found that, once in a given store, the own–price elasticity of demand for milk is -0.6 (by comparison, the demand for other goods is around -1, suggesting milk has a relatively inelastic demand). As milk constitutes around 5 per cent of the value of the average British supermarket shopper's basket or trolley, the effect of milk prices on the choice of store is not large, but including this effect raises the total elasticity to ‑0.8.[20]

2.22      The UK study also concluded that supermarket prices for milk there were consistent with what estimated elasticities would imply would occur in a competitive market.[21] As noted in Milking it for all it's worth, it may be difficult to draw the same conclusion in Australia as, although competition issues have been raised in the UK grocery sector, the UK has many supermarket chains with a significant market share whereas Australia essentially has only two.

2.23      As the price cuts have only been in place since late January 2011, it is too early to consider the elasticity of demand for milk in Australia based on the supermarkets' price cuts. However, the effect of the price cuts on overall milk sales and production is a key issue, and something the committee will examine further as additional data becomes available.

Possible impacts in Australia

2.24      It was outlined in evidence to the inquiry that the current retail price competition in milk is saving consumers $1 million per week.[22] Lower prices are of benefit to consumers as this improves their economic welfare, allowing them to buy more of that product, or to spend their savings elsewhere.

2.25      The fact that consumers are saving over $1 million dollars a week on what is, for many, a basic staple is not a benefit that should be dismissed lightly, or be disregarded by those concerned with impacts upon producers.

2.26      In an era of food price inflation, sadly exacerbated by recent natural tragedies and disasters, this represents a significant saving to individuals and consumers across Australia. This is particularly true for those on lower incomes, who spend a higher proportion of their income on food.

2.27      There are, however, a number of possible and significant impacts which may be felt throughout the dairy industry supply chain. This section does not aim to give a comprehensive account of all the possible consequences of the supermarket retail price cuts that were raised during this inquiry. Instead it highlights some of the issues put forward—particularly those most relevant to the inquiry's terms of reference. A number of these issues will also be examined in more detail in the remaining chapters of this report.

Effect on dairy farmers

2.28      The immediate, likely and possible impacts on dairy farmers of the supermarkets' price cuts are at the heart of this inquiry and consequently are considered throughout this report. This section touches on some of the issues that were raised.

2.29      As the price cuts are driven by the decisions of the major supermarkets, their views on the likely consequences on the supply chain are noteworthy. Coles have firmly denied that the price cuts will leave farmers worse off:

As Coles has fully funded the retail milk price reduction and paid a higher contract price to milk processors, we believe there is no reason why it should result in lower farm gate prices.[23]

2.30      Woolworths offered a different view, considering the lower prices:

...set a new benchmark, and can be expected to flow back to processors and farmers as new supply and pricing agreements are negotiated over the coming months and years.[24]

2.31      Woolworths also raised wider concerns about the effect of the price cuts on the dairy industry at this point in time:

Of equal concern is the fact that this price cut has been introduced at a time when the Australian dairy industry is facing a number of key challenges and is particularly vulnerable. These challenges arise from the significant impact of the recent adverse weather events—Cyclone Yasi in Queensland, flooding in southern Queensland, northern NSW and Victoria, and drought in WA. These events are in addition to the ongoing longer term structural issues already facing the industry, such as lower yields in northern regions and limited access to export or manufacturing market alternatives.[25]

2.32      At their hearing, Woolworths were perhaps more candid. On the possible flow on effects through the supply chain they pointed out they 'will always negotiate vigorously',[26] although through their tender process they suggested that Woolworths were actually a price taker for private label milk.[27]

2.33      The Australian Dairy Farmers consider that the price cuts are unsustainable and will flow on to farmers in future contracts. They were also critical of Coles citing recent increases in Victorian farm gate prices and not noting regional effects:

...when they know full well that Victoria is chiefly a dairy export market. What Coles has repeatedly failed to mention is that milk prices to farmers in the key drinking milk production markets of New South Wales and Queensland have dropped more than 15 per cent in Queensland and 10 per cent in New South Wales in the last 12 months. This includes farmers who supply milk which goes into Coles supermarket branded bottles. Processors and dairy farmers who supply the drinking milk market rely on the margin from branded milk sales for their profitability.[28]

2.34      These contractual issues, including some of the immediate impacts caused by the transition of sales from branded milk to private label, are discussed in more detail in Chapter 4.

2.35      The increasing divergence between the value of branded milk and the supermarkets' private label milk over the past decade, and its effects on the dairy supply chain, was also discussed:

...if you go back to 2000, the differential between the two pools of milk, proprietary brands versus supermarket brands, was roughly 18c a litre. The differential across all sales through the supermarket was about $44 million. Ten years later at the end of last financial year, that difference has blown out by about 71c a litre or across the value chain about $414 million. That is a big chunk of money in terms of the domestic dairy industry value chain. That is money that is not going back into the value chain. This latest discount by Coles has actually pushed that differential out even further. That gives them an absolute price advantage in terms of growing their own brand market share and it puts greater pressure on the proprietary brands and that is going to put greater pressure back through the value chain on, obviously, the farm gate.[29]

2.36      Broader consequences on other businesses and communities dependent on dairy farming were also raised:

...there are opportunities for significant damage to regional communities if farmers leave the industry. The situation and outlook report created by Dairy Australia said that for every dollar that is created at the farm gate there is an additional $3 created in regional communities. This additional money is created across the community through shops, veterinarians, buying fertiliser or agricultural chemicals, and things like that.[30]

2.37      As discussed in Chapter 3, total milk production has decreased significantly in the last decade. Concerns about the impacts of these price cuts were also discussed with reference to the decision of farmers to remain in the industry, as well as the likelihood of the next generation entering the industry:

The current action instigated by Coles will further damage the confidence of the dairy industry and may have the added effect of reducing Australia's total milk production. Already, there are indications by some dairy farmers that they are not prepared to invest further funds in their farms and will exit the industry.[31]

Why buy, run or finance a dairy farm when the revenues look uncertain or prices suggest minimal returns other than through land speculation?[32]

Dairy Youth Australia Inc believe agriculture is alive and well and a great career choice. As farmers we are committed to providing safe, nutritious, high quality and affordable food for Australian consumers and another 40 million people around the world. We are highly concerned our future is being undermined by the aggressive milk price war instigated by Coles.[33]

If these discounts continue, we have no choice but to cut our wages and reduce our purchases in local businesses therefore, creating a flow on affect to all the businesses and their staff in this town. We will also need to diversify in another crop or industry, which takes time to learn and implement, just so that we can repay our debts. Selling our farm is not an option as no-one in their right mind would want to buy a dairy farm with the lack of confidence in the industry, would they?[34]

There are people out there making decisions. They look at what has been happening. They have been through drought and this is the final straw. They have decided that they are not going to put up with this and that they are out.[35]

At the present time we have lost farms already and we have probably got, off the top of my head, about 14 farms in the process of exiting. The morale of our industry had already taken a massive blow. As I said, 98 per cent of our industry’s farms are in disaster declared areas. After that announcement on Australia Day, I can tell you all our people phoned. We had people working around the clock on phones seven days a week. I can tell you it is the worst I have seen the morale since the worst of the drought, and we had a decade of drought. We have young farmers who took over their parents’ farm during that drought and they were positive. They pushed through that and stayed in the industry. Those same young people are now saying, ‘If this is what is going to go on in our domestic dairy industry, what is the future for us?’ I can give you a list of a dozen names off the top of my head of farmers that are in the process of selling up and exiting right now.[36]

Shift to long life milk

2.38      An issue frequently raised during this inquiry was whether a long-term result of continued price discounting would be, due to decreasing supply of drinking milk, a shift towards increased ultra‑high temperature (UHT) treated milk consumption or UHT milk being the only milk product available in some regions:

...If the public want fresh milk in the long term, this price war will end that availability...[37]

...Australians are very used to fresh milk. Over time, it will be a gradual change...If the supermarkets keep running down this track of cheap, cheap, cheap, cheap forever, Australian consumers could conceivably end up getting used to New Zealand UHT milk.[38]

Fresh milk may become a luxury item, but the one thing we need to be very mindful of is that I do not believe that Coles and Woolworths would lose any sleep if they substituted long-life UHT milk for fresh milk. Fresh milk is a nuisance to handle with its costs and refrigeration. If they did not sell fresh milk or they sold a whole lot less of it and moved consumers on to long-life UHT milk, I do not believe Coles and Woolworths would lose any sleep. In some countries in Europe that is what has happened—basically you only get long-life UHT milk.[39]

65% of milk in Australia is from Victoria, with lower cost dairy production. If the reduced pricing results in dairy farmers exiting in other states (e.g. Qld, NSW) then the lions share of Australian packaged milk supply would have to be sourced from Victoria. Because of the refrigerated supply chain issues, it is reasonable to assume a shift from fresh to UHT is possible which opens the door for New Zealand supply. The longer term implication therefore for other states and fresh milk supply, could be devastating.[40]

2.39      Australian Dairy Farmers commented that it is difficult to predict whether consumption will change in this way:

...the issue is that, if there is a permanent downward movement in retail milk prices in Australia, basically that takes the fresh milk market from a low margin to an almost no margin industry for producers in those regions that Adrian and Chris talked about. That is not a sustainable long-term future. If the pressure comes back onto the farm gate price, which is where industry expects it would—if you take money out of the value chain, ultimately the most vulnerable group will be those supplying the raw product into that chain. So that would mean less fresh milk production in those regions—regional adjustment in Queensland, northern New South Wales, Western Australia. How the market then adapts afterwards, whether it is through UHT or milk being shipped up from Victoria we are not here to decide today, but it would put significant pressure on the regional industries in those states.[41]

2.40      Treasury expressed similar difficulties in predicting future trends in consumption, but noted the importance of consumer preferences in influencing the behaviour of market participants:

It is difficult for me to predict where things might be in 10 years time. Certainly the supermarkets, on the face of it, appear in the context of the current debate to be making statements that they recognise that their customers demand and value the supply of fresh drinking milk. I do not know if that is right. I think that there is no reason to disbelieve that at the present time. That being the case, it would be an interesting strategy for a supermarket to attempt to steer things in a direction where they are not supplying that milk while others continue to do so. They could be taking themselves out of a market which continues to reflect customer demand.[42]

2.41      The contention that Australians would no longer be able to buy fresh milk in some areas was strongly disagreed with by some submitters:

If current processors are stupid enough to stop marketing fresh milk, new processors will emerge to fill the gap because market demand for fresh milk will not disappear, and when there is demand, entrepreneurial capitalists will meet it.[43]

2.42      These viewpoints however may not fit with evidence received about the levels of profitability for processors in the Australian dairy industry (see Chapter 4).

2.43      International examples of increasing UHT consumption, particularly the European experience, were also raised. The Australian Bureau of Agricultural and Resource Economics and Sciences (ABARES) advised the committee that in Europe the percentage consumption of UHT milk compared to fresh milk appears to vary widely—for example, it is estimated that 95 per cent of drinking milk consumed in France is UHT milk compared to less than 10 per cent in the UK. However:

There was a tendency for those markets with a high level of per capita consumption of milk to also have a very low consumption of UHT milk. Countries like Finland, Sweden, Ireland, the Netherlands, Norway and United Kingdom all have relatively high levels of per capita milk consumption and also very low levels—below 20 per cent—consumption of UHT milk.[44]

2.44      Coles gave evidence that claims about other countries substituting fresh milk for UHT milk are 'factually incorrect',[45] noting that this has not happened in the last decade and that customer preference is the driver of demand.[46] This is an area the committee would like to examine further in its final report, and invites further submissions on the issue.

Effect on smaller retailers and vendors

2.45      A significant issue is the ability of smaller competitors of Coles and Woolworths to compete in the both the short and long-term, especially as milk is commonly accepted to be a multiplier product—that is consumers usually purchase other products once inside the store.

2.46      Early shifts in sales from smaller stores to the major supermarkets were observed by some witnesses:

What we are seeing now, with such a difference in price, is that they are going out of their way to go to a supermarket to pick it up. The volume of smaller shops—newsagents, mum-and-dad corner stores—has been reduced by up to 20 or 30 per cent because people are not shopping there; they are shopping at Coles or Woolies.[47]

2.47      The limited ability of smaller retailers to purchase milk at a similar wholesale price as Coles and Woolworths is an important issue, with the ongoing viability of these businesses and the implications on competition being genuine concerns.[48] Interestingly, some independent retailers were able to obtain milk at a wholesale price that allowed them to compete with Coles and Woolworths, although they noted this was due to the unusual circumstances such as a processor in their region which does not supply the major supermarkets having no choice but to cut their prices to stay competitive:

We have that price of $3.50, being the published wholesale price. Prior to Coles dropping the price we were paying around $2.20 to $2.30 for two litres of milk. In Western Australia you have National Foods supplying Pura, Fonterra supplying Brownes, and Harvey Fresh supplying their own brand. They obviously could not sit by and see their market diminish. They can’t not sell branded milk. Harvey Fresh do not have a contract with Coles or Woolworths, so if they sat around they would sit and watch their business go broke. We are currently selling Harvey Fresh milk for $1.99— [for two litres]...We are paying less than $2.[49]

2.48      The effect of increased supermarket private label milk sales on distributors over the past decade was also highlighted:

Since we hit deregulation of the distribution sector in July 1998 we have seen membership of our association in New South Wales decrease from around 1,200 to 360-odd today. That has been a direct result of the pricing policies of the supermarket and the home brand. We are not competitive anymore and the price we pay in the market is substantially higher than what other outlets are paying.[50]

2.49      The more recent effects of the major supermarkets' price cuts were also examined:

We do not have access to the same amount of generic milk or the same pricing for that generic milk to compete against Coles. I have 90 customers and their frustrations are great. The lady in the bakery goes and buys her three-litre containers of milk at the Caltex down the road because I have to sell it to him at a contracted price, whereas she is one of my general wholesale customers and, in our trade, they are the ones we have to keep happy by packing their fridges and all those sorts of things, because she is paying top dollar for her milk compared to the Caltex down the road.[51]

2.50      An example was also put forward of a vendor losing 15 per cent of their business from major shopping centres because the small business owners and franchisees in the centre started to buy their milk from Coles and Woolworths.[52]

2.51      However, some submitters placed the blame on the processors:

I ran a small café for several years and always bought generic milk at the grocery store because Dairy Farmers wanted to charge me retail prices for their branded milk, regardless of the quantity I purchased. This made them seriously uncompetitive with generic milk, especially when a delivery charge was added as well. This is another example of why this inquiry needs to be much more sceptical of the milk processing industry and much less suspicious of the big supermarkets. Processors are the moneymaking, price-inflating middlemen between farmers and consumers, and they are squealing only (or getting the farmers to do it for them) because they are being pressured to be less greedy by the big supermarkets.[53]

2.52      These issues were also raised more broadly, with some witnesses noting significant differences between the wholesale prices for branded goods offered to the major supermarkets compared to smaller retailers for a number of products:

...for example, slabs of VB being available to the major chains at prices that are about six dollars cheaper than what is available to independent liquor wholesalers.[54]

2.53      It was suggested that the monitoring of wholesale prices offered to the major supermarket chains compared to smaller grocers across a range of goods could be undertaken.[55]

2.54      The committee notes that processors sell milk at a lower price to the major supermarket chains than to milk vendors. This may just be the normal discount for buying in bulk (i.e. reflecting differences in costs or other benefits arising from having a guaranteed medium- to long-term purchaser of a high volume of product) or it may partly reflect the market power of the large supermarkets.

Effect on innovation and development

2.55      The increasing shift from branded products to the supermarkets' private label milk was also thought by witnesses and submitters to result in negative consequences for consumer choice and future product development in the sector.

2.56      The Australian Food and Grocery Council suggested, in a broad sense:

...if the Australian food (and grocery) manufacturing base is eroded, so too is the capacity of companies to invest and innovate in such areas as new, healthier and more sustainably-produced goods.[56]

2.57      Treasury referred to a 2004 National Competition Council review of the Australian dairy industry since deregulation, which noted that deregulation had resulted in benefits for consumers in the form of:

...increased choice of product and increased access to innovative products which are aimed at various dietary and convenience needs, noting that deregulation created strong incentives for dairy companies to expand their income base by engaging in greater innovation in product development and marketing.[57]

2.58      The future ability for processors to develop modified products was questioned:

For processors it is difficult to differentiate regular white milk in the market place. Processors have moved more to the modified milk products with different fat and taste profiles, added nutrients and levels of functionality for consumers. Processors have been able to capture the benefits of this innovation with more sustainable margins for their branded product, which in turn has supported category development. However, the latest round of retailer price cuts have targeted at this modified milk market segment, and initially reports have presented that processor modified milk brands have lost a significant amount of market share to the heavily discounted supermarket ‘store brand’ modified milk.[58]

The outcome for the category could be similar to the UK milk market, where the dominance and periodic price cutting of the retailer private label branded product has stifled innovation and new product development.[59]

2.59      Other submissions, however, rejected arguments about the need for a diverse range of products in what is a staple good, and suggested that the future of branded milk will reflect consumer attitudes to it:

If customers don’t see the value in your product, they won’t buy it. Branded milk is still just milk, a basic commodity. The “innovations” that processors claim for their milk are mere marketing ploys to attract higher prices for essentially the same product. It is no different than charging high prices for different brands of water. In many cases, the added nutrients put into some branded milk are either not necessary or are mere replacements for nutrients lost through over-processing. Protecting high-cost branded milk distorts the market and favours processors over consumers.[60]

UK grocery market and "milk wars"

2.60      Developments in other countries whose grocery sectors are dominated by major supermarket chains provide useful insights for matters being considered in this inquiry. A key example is the UK where milk price wars have regularly been a feature of price contests between the major supermarket chains. As the price cuts in Australia are still relevantly recent, and therefore the full effects of them cannot yet be conclusively determined, the experience and current strength of the UK dairy industry particularly warrants attention.

2.61      An examination of the UK dairy industry and grocery sector may also be particularly relevant given the UK background of a number of current key executives at Coles.

The UK dairy industry

2.62      Low farm gate prices have been an aspect of the UK dairy market for a number of years. Average UK prices steadily dropped from being over £0.24 per litre in 1996 to about £0.17 in 2002.[61] Although there were increases in prices in 2007 and 2008 which returned prices to 1996 levels, a recent parliamentary research paper noted 'these improvements were not sustained, and the outlook was depressed at the end of 2010'.[62] In February 2011, the National Farmers Union released a report arguing that a gap of £330 million annually existed between farmers’ production costs and the price they received.[63]

2.63      About 11 billion litres of milk are produced annually in the UK. There appears to be a similar trend in the UK as that experienced in Australia of declining number of farms but increasing herd sizes and productivity.[64] The UK’s National Farmers Union was reported in 2008 as stating that the number of dairy farmers in England and Wales has halved to 14,000 in a decade.[65]

2.64      The grocery market in the UK is dominated by the "big four"—Tesco, Asda, Sainsbury’s and Morrisons. These chains account for about 76 per cent of grocery sales in the UK, with Tesco having the largest market share (30.7 per cent in November 2010).[66]

Milk discounting in the UK

2.65      The most recent discount milk promotions in the UK occurred from July 2010, with Asda selling four pint bottles for £1.25 (£0.55/L).[67] This price war brought the average price of one litre of milk down to 58p per litre in October 2010, compared with an average price of 66p per litre in July.[68] The price war was reported as finishing in late November with Tesco increasing its price by 24 per cent to £1.55, followed by other chains with the exception of Asda (which maintained its discounted prices).[69]

2.66      The success that commercial strategies based on significant cuts in private label milk can achieve were pointed out:

...when, in 2010, the big 4 retailers reduced the price of house brand milk. While the price reduction did not increase the demand for grocery fresh white milk, the big 4 retailers were able to increase their share of grocery fresh white milk (from 55% to 59%) in just 3 months.[70]

2.67      The pressure these cuts had on processors is evident. In September 2010 The Guardian reported that Robert Wiseman Dairies, Britain’s largest milk supplier, was receiving lower returns as a result of the supermarket pricing strategies:

Wiseman, which supplies a third of the nation’s milk, said fierce competition and aggressive supermarket pricing would cost it £23m in profits over the next 18 months. Its margins are being squeezed by the supermarkets it supplies – Tesco, Sainsbury’s and the Co-op. Analysts blamed a price review by Tesco for the shock profit warning. Asda began a milk price war recently when it started selling four-pint bottles for £1.25 (and 2 bottles for £2), prompting Tesco to slash the price of a four-pint poly bottle on Monday from £1.53 to £1.35.[71]

2.68      In August 2008 milk was also at the centre of pricing struggles between the major supermarket chains. During this month, Asda cut the price of a two-pint bottle of milk from 80p to 50p and a two litre bottle to 99p. Tesco introduced Fresh ’n’ Lo milk at £1.06 for two litres. At the time, Asda was reported as insisting it was investing £1 million into the milk promotion and that no farmer would be disadvantaged.[72]

2.69      An earlier example clearly demonstrated that supermarket price cuts were leading to price reductions being thrust onto dairy farmers:

In some instances there is evidence that there was a resulting price reduction passed back through to the farmers. In March 2006 retailers dropped the retail price of milk by 14%. Arla, one of the UK's major milk processing companies subsequently announced in June 2006 that it would be reducing farmgate prices paid to farmers.[73]

2.70      The growing dominance of the major supermarket chains over the UK dairy market, a market focused on domestic consumption, was also noted:

A 2010 study by DairyCo on dairy supply chain margins noted the absence of any decline in retail prices for milk at a time of falling commodity and farmgate prices, concluding that processors and farmers absorbed the full impact of the decline in the dairy market.[74]

Supermarkets' influence on farm gate prices

2.71      The direct contracting of farmers to certain supermarkets has been a recent development in the UK. In 2007 Tesco formed the Tesco Sustainable Dairy Group, a group of dedicated producers, to whom it would pay higher prices. At the same time, Tesco launched "localchoice" milk, which is sold at a premium price but sourced from local farms. It is estimated that now about 3,000 out of the UK's 13,500 dairy farmers have special supplier deals with the major supermarket chains, although even these farmers may not currently be covering their costs of production.[75]

2.72      These direct supplier arrangements were raised at a public hearing with a witness explaining that the major supermarkets:

...have taken the processor right out of it, so they have taken brands out of it. They contract the farmer to supply the milk. It goes to the processing plant contracted for Tesco. You go into Tesco supermarkets and they have Tesco milk.[76]

2.73      Other witnesses were highly critical of the arrangements:

I am certainly aware of them. I see them, to a certain degree, as a 'divide and conquer' type strategy by our supermarkets. There are extra costs that these contracts which they develop with the farmers cause. They have certain stipulations about what they want et cetera which add extra costs into the whole system. I am not even sure whether those extra costs are covered by the extra price they are paid. They have higher welfare standards and they have higher quality standards et cetera; but we have a wonderful system here in Australia of both welfare and quality. We do not need to have these extras because we are producing a very good food product.[77]

2.74      Dairy Australia elaborated:

Quite separate to the collective bargaining provision, the UK case study example where supermarkets went to direct supply with farmers put a lot of pressure on the processing industry is probably relevant there. The result of that exercise of supermarkets taking direct control of the supply chain in the dairy industry in the UK—as DairyCo, their dairy industry body, in its independent study basically found—has been lower prices for farmers and processors.[78]

2.75      The major supermarkets in the UK are now considered to determine the farm gate prices, with Tesco particularly influential:

Because of the sheer volume of milk purchased by Tesco, the farm gate price set by this retailer is seen by many as setting a benchmark for the industry.[79]

2.76      In addition to the overall domestically-focused nature of the UK industry, however, there are other important differences between the UK and Australian dairy industry. Australian Dairy Farmers notes:

...dairy farmers in the United Kingdom receive large farm subsidies. ADF understands that the average subsidy to dairy farmers in the United Kingdom is 30,000 pounds per annum, with farmers receiving a further bail out from the British Government during the Global Financial Crisis. Australian dairy farmers are among the most efficient in the world and operate without government support.[80]

2.77      Another difference that stands out is the number of processors—the processing sector may be viewed to be more competitive in the UK than in Australia, with six major processors operating (Arla Foods, Dairy Crest, First Milk, Milk Link, Robert Wiseman Dairies and United Dairy Farmers).

2.78      The committee is concerned that certain developments in the UK dairy industry and grocery sector may be experienced in Australia. Relevant responses by successive UK governments to some of these issues are discussed in other chapters of this report.

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