Milkonomics

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Sam has already commented on the milk price debate here. As background, Coles started a price war on home-brand (or own label) milk. The argument is that this will hurt farmers. Sam refers to an AFR article that points out that it is the export market that sets the milk price at the farm gate as the ‘marginal’ milk in Australia is exported. I have noted this before. Milk in Australia is a (big) export industry.

But even without exports, a little bit of economics shows that the ‘farmers will be ruined’ story is complete nonsense. As Coles drops the price of home-brand milk, total retail sales of milk in Australia are very unlikely to drop. Indeed, sales will probably rise. So Coles (and the other outlets that have matched Coles’ price) need at least as much milk as before. Which means that they need to encourage dairy farmers to produce more milk. Over the longer term, this can only happen if the price of milk at the farm gate does not fall. At worst it will stay the same (a likely result as the price is set by exports) or it may rise. So selling more milk in Australia will not hurt (and will probably help) dairy farmers.

Who loses? Not the customer. They get cheaper milk. Not the farmer – as explained above.

The losers are the dairy processors. They face stronger competition against their branded milk. This is more profitable for the processors than the home-brand milk. But for those of you who buy branded milk, I hate to tell you, but it comes out of the same cow as the home-brand stuff.

What we are really seeing is another step in cheap home-brand milk driving out the branded milk. This happens in industries where there is little product differentiation so that ‘brands’ are more about perception than real added-value. Eggs provide another good example.

The effect of the Coles move will mean that the processors have to be more innovative in their branding and marketing – or give up the branded milk. So expect to see lots of innovation but lower processor profits. Of course, this may hurt dairy farmers through the back door. Some processors remain farmer cooperatives so the farmers may get more for their milk but less as their share of processor profits.

12 Responses to "Milkonomics"
  1. Thank you.  That’s exactly what I thought.  It is not at all about supermarket competition or duopoly.  It is about milk competition.  You said it better than I ever could.

  2. It’s similar with taxi-drivers attitude to taxi-market deregulation. It would drive down taxi fees and guess what would happen next? The demand for taxis would rise and then they’d have to go out and get more drivers.  But most taxi-drivers I talk to are very suspicious of deregulation.

  3. The one sentence that always springs to mind is “If the supermarkets can start paying farmers less for milk, why aren’t they already doing so?”

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    I thought it was interesting your proposition that farm gate prices would not decrease due to increased demand (supply/demand 101) and the fact that a large proportion of Australian milk product is exported. The assumption underlying this is that the Australian market consumption is restricted by price rather than demand.
    Firstly, consumption of milk product within Australia has actually declined to some extent since the 2006/07 financial year, from 103.4L per capita to 102.4L per capita currently. As the price of milk has actually declined over this period in a real dollar sense, does this suggest that the market is already saturated? I guess we will find out whether or not this is the case within the next 6 months.
    Secondly, your comments that the Australian milk market is primarily export oriented, hence driven by export demand rather than domestic demand is not backed-up by the stats. Over the past 3-years there has been a decline in the volume of milk being exported due to “reduced availability for export” (currently sitting at 45%). This is being primarily driven by lack of innovation within the milk industry with no significant increase in milking yields within the last five years. In this case you would expect an increase in price due to market demand; however, Australia only makes up 2% of world milk trade volumes and as such, plays a very little role in setting milk prices.
    Consequently, it would appear that only time will tell which way the price will move. However, with increasing numbers of people reaching a “middle-class” status within China, we can only expect demand to increase in the long term. Furthermore, the alternative, to regulate the price that supermarkets are able to sell milk at, is simply unpalatable.
    Regards,
    Nicholas Lonergan
    Executive Director
    EquityDissector.com

  5. I can only confirm what you say about there being no product differentiation in eggs.

    I worked in an egg factory in high school. We put the eggs in one end of the machine. At the other end we had branded and own-label cartons. We didn’t care where the eggs went and they sure as hell didn’t either. I couldn’t believe that the price difference of up to 60% was due to different packaging only.

  6. Stephen   Apologies for not referencing your May 22 post, which certainly spans my post.   I lived in New Hampshire from 1997 to 2004 during a time when dairy farmers New Hampshire and neighbouring Vermont came under competitive pressure from cheap milk produced in the Mid-West.  
    As retail milk prices fell with those “imports” from the Mid-West, there was great public sympathy for the farmers.  If anyone pointed out that the dairy farms were worth a lot more as rural retreats of rich New Yorkers then they were howled down.  If it was pointed out that milk is a staple food of (very) poor families, they were ignored — even in liberal Vermont.   
    It was actually a little like the situation with water buy-backs.  The dairy farmers could sell out to rich New Yorkers, but that didn’t help the local communities much.  Sam

  7. Stephen,

    I made a similar comment (about lower retail prices leading to higher farm-gate prices) on Sam’s post, so I am pleased to see my understanding of the economics confirmed.

    I wasn’t aware of the branding issue, though, which shows that I don’t go shopping much.

    Thanks for helping to clarify this issue for me.

  8. On another line of thought, can’t the price battle over milk prices be viewed as an attempt by the Supermarket duopoly to increase the pressure on corner shops and small businesses.
    Their sales will fall due to now relatively higher prices compared to the big supermarkets, and with milk being one of those goods that you ‘run down to the corner shop’ to get, the effect of this will be noticeable on their balance sheets.

    What can the govt do to rid us of this duopoly?

  9. This article as conflates two distinct parts of the industry – farmers who produce milk for the drinking milk market and those who are part of the commodity game.  They are very different propositions. To supply the drinking milk market a farmer needs to be geared up to produce milk all year around, meet higher quality standards and usually be located near a major urban centre. While a commodity supplier can produce milk seasonally (i.e. in spring and summer when it is cheapest to do so) and not meet specific production targets.
    Also while the price of milk at the farm gate is largely determined by commodity prices in Victoria, it is not so in regions where either very little is exported (such as NSW and WA) or none is exported (such as Queensland).
    For the drinking milk suppliers, especially those outside of Victoria, the supermarket behaviour is a major influence on farm gate returns. It is these farmers, not some generic ‘dairy farmer’ who will be impacted by the aggressive Coles promotional campaign.
    Also, the point about processors seems a bit niave. If the processor is being squeezed, won’t they try to cut costs? By far their biggest cost is milk acquisition, which is where they will start. This is where the cost impact to farmers comes from.
    Finally, yes – this supermarket strategy is all about pushing out competition from other retail outlets, e.g. milk bars, convenience stores, foodservice distributors, etc.  More retail consolidation by our favourite duopolists.

  10. Jim makes a very important point about the vulnerability of dairyfarmers in states like Queensland, where about 92% of milk produced is sold as daily pasteurised milk.
    There is another point though that needs to be considered.
    As a very average Victorian dairyfarmer (45% of whose milk stays in Australia), I suffered six-figure losses when the GFC forced a sudden collapse of the international milk price (which flowed on to a 40% fall in our farmgate price) but it could have been worse. Domestic sales buffered us to some degree.
    I was so grateful that the coop we supply had invested in its Devondale range of supermarket lines. Coles is not just discounting milk, it’s attacking all dairy products and even Victorian farmers will inevitably feel the impact. Given that the average dairy farmer gets an ROI of about 2-3%, we can’t afford to be hit from yet another direction.
    It’s laughable to think farmers will be somehow protected from the lower profitability of retail milk sales. We are the only people in the supply chain with no bargaining power. As the ultimate price takers, we will cop it.
    Finally, the idea that lower prices will grow milk sales is pretty laughable. I can’t imagine too many people swapping from Coke, wine, or beer for a glass of milk. It’s all about stealing market share and positioning Coles as the lowest cost retailer.

  11. Stephen,
     
    While you are correct that the basic ingredient for branded and non-branded milks is the same, the processing companies do process them differently: non-brand milk often has higher quantities of leftovers (“waste”, if you will) from the manufacturing of other dairy products (cheese, yoghurt, etc) mixed into it.
    There are of course milk standards that must be maintained, but branded and non-branded milks do differ. (Even among branded milks there can be differences in taste.) Whether the difference is worth paying for is, of course, a matter for the consumer.

  12. Stephen – you just haven’t “thunked it thru”

    Jim is right, sorry you are wrong. The reason the farm gate prices are unaltered is that milk is sold on forward contracts, once those contracts complete the dairy farmers will be left with just enough “skin” to get by on, if they are very efficient. Once again we will see dairy farmers lose their farms.

    It is all about bargaining power.

    At the top of the tree are the major retailers, then come the processors, then the distributors, and lastly the most poorly organised group of all, the dairy farmers.

    The only way to break this cycle is for farmers to become militant and withhold supply while they renegotiate, but with high debts and little or no capital in the farming community, that won’t happen.

    Re-examine your analysis.

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