Milk headlines

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Given the debate on low retail milk prices and dairy farmers I thought I would help out our main stream media colleagues with some headlines they might like to use:

Coles threatens farmers. “We’ll sell more milk”

Farmers plead: “Dont sell more of our product”

Increasing milk sales to hurt dairy farmers

They all sound a bit silly don’t they. But this is the other side of the Coles retail milk debate. Low retail prices will increase retail sales, both overall and from Coles. This will hurt Coles competitors, particularly the dairy companies who market branded milk in competition with Coles’ home-brand product. But low prices and increased retail sales will help producers who supply the inputs. For milk, the main producers are the dairy farmers. There will be more milk sold and that means retailers have to convince farmers to supply more milk. You cannot do that by harming the farmers.

Don’t believe me? Well, let’s take another example that is close to home. China is booming by selling a lot of manufactured goods cheaply. Those goods use inputs like iron ore and coal (through power and smelting). China’s ‘low price’ policy has been a huge boon to those input producers like BHPB and Rio. It has been a huge benefit to the countries that produce the inputs – like Australia. It has hurt China’s competitors but helped their suppliers.

Now Coles ain’t China. And maybe Coles will not be able to maintain the low price for the long term, particularly as the farm gate price of milk starts to move higher as the quantity of milk sold at the retail level increases. But if the low price is maintained, then our dairy farmers will benefit.

24 Responses to "Milk headlines"
  1. For some reason this was all over the news last night, and my first reaction wast the same as yours – if you reduce the price of milk you will sell more (maybe not a lot more, since the price elasticity is probably low).  

    The only ones getting squeezed will be Coles, the competition, and the middle men.  Although Coles might attract more traffic into their stores and grab a little market share and more impulse buys.

    Also, the other thing completely missing was that Aldi already sold milk for $2.07 for 2 litres, and that the dairy industry is much bigger than just bottled milk – cheese, cream, butter, wholesale markets etc.  It would be some interesting context to see just what proportion of milk from the Australian udders ends up in bottles in the fridge at the two big supermarkets.

  2. Basic economics really.  or is it?
    The discussion overlooks some basic cost elements (inputs) of production:
    labour (no one is discussing slave or low cost labour, even with the automated milking systems in use
    the cows:  they eat to produce, and and getting more has significant lead time (typically a year, even if they are bought someone has to grow them)
    interest costs – banks haven’t stated a lower interest rate for the money required to expand the supply
    transport – can only go higher as fuel prices increase
    so it seems that there’s a bottom line on production costs even at scale.  And if it can’t be produced at a profit for the price offered on scale, then lower prices at the retail level mean a cross subsidy somewhere, which is the point the farmers – the ones on the TV I watched – are making.  Driving some of them out of business by making it unprofitable at the production level will ultimately make the product so expensive it becomes a luxury.
    Some balance in the discussion on this issue seems warranted.
     
     

  3. Stephen,
    Have you really analysed the demand elasticity for milk? People do not overwhelmingly switch from drinking Coca-Cola to milk. There is local, recent research confirming that price decreases do NOT significantly increase overall consumption of milk. Before creating another post on the milk war, please have a look at studies such as this one:

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    Deakin University (Ulubasoglu et al, 2010, Food Demand Elasticities in Australia, p 13):
    “Own-price elasticity of milk is estimated to be -0.23. However, the estimate falls short of being statistically significant, implying that the milk demand is invariant to price changes observed in this sample.”
     

  4. Marian,
    I’m not sure that is the correct way to interpret the standard errors for own-price elasticities. It is not obvious that an elasticity of 0 (i.e. perfectly inelastic) is the correct null hypothesis to use. It seems to me that there isn’t really a null hypothesis here that everyone would agree on.
    A better way to interpet the result would be to use a confidence interval, which emphasises that the error could be in either direction. Ulubasoglu et al’s estimate is -.23, but it is equally likely that the true paramater is -.46 as it is to be 0.

  5. “There will be more milk sold and that means retailers have to convince farmers to supply more milk.”
     
    Why will milk consumption increase?  And Farmers are quite happy to produce more milk, if there is a market, but only if there is a profit for them.

  6. Davidk – You’re assuming what you’re setting out to prove (the correct meaning of the term “begging the question”).  Stephen’s whole point is that there is no reason Coles’ decision to cut their margins means they will cut their suppliers’ prices, especially given that they’ll need to buy more of the stuff (which, if anything, will force suppliers’ prices up).

    If they could squeeze their suppliers harder they already would have – the boost in demand will actually reduce their capacity to squeeze.

  7. Stephen,
    Your argument implicitly assumes that there is a unified wholesale market for raw milk with a single price.  But what if the market is separated horizontally, with some farms supplying brand milk and others supplying supermarket milk?
     
    If aggregate milk demand is price inelastic, higher supermarket sales must lead to lower brand sales, and hence lower sales and prices for farmers supplying the brand market.
     
    One would think that the affected farmers would then switch their output to the supermarkets, but perhaps there are logistical or commercial constraints on doing this.
     

  8. The examination of this, and the conclusion of the writer was carried out on an economics examination only.

    The reality is much more complex, and the end result will be that the farmers who should hold the whip hand, will get screwed because their organisations are archaic and ridden with conflicting vested interests.

    This might introduce a new world of reality to a group who are still reeling from the last taste of the new world.

  9. This specious argument ignores the fact that per capita milk consumption in Australia has been flat at 100 litres per person per annum for a decade or more, despite retail price fluctuations (e.g.  supermarket discounting and addition and removal of the 11c per litre levy to fund industry restructuring).
    For a more nuanced piece than Stephen’s simplistic analysis on this issue I would recommend the below article on Business Spectator today: http://www.businessspectator.com.au/bs.nsf/Article/WES-Coles-WOW-Woolworths-milk-war-pd20110310-EST8R?opendocument&src=rss

  10. For anyone wanting the more detailed and nuanced economic arguments, see the book “New empirical industrial organization and the food system” by Kaiser and Suzuki. Unfortunately it is quite high level, and I imagine it would be pretty hard to follow unless you have graduate level training in economics. For example, the answer to Dave’s query could be found in the book.
    SK’s simplified argument holds true if the elasticity of milk demand is non-zero. Jim, do you have evidence for your claim that per capita milk consumption has been flat for the past decade?
     
     

  11. Here’s what ABARE has to say on the subject of elasticity in the context of the current discounting:
    “While it is too early to conclude the effect of this price discounting on consumption of milk, it is reasonable to expect that consumption of home brand milk will increase because of an increase in the quantity demanded for milk overall (due to the lower price) and substitution away from branded milk and toward home brand milk. Given that the
    consumer demand for milk is relatively price insensitive, it is unlikely that total milk consumption will increase
    significantly in response to the decline in the price of home brand milk, especially in the short term. However, it
    would be expected that consumers will substitute, at least to some extent, home brand milk for branded milk, and
    that consumption of branded milk would consequently decline. The degree of substitution will depend on the level of
    differentiation consumers perceive between the products and the additional price they are willing to pay for the
    attributes of branded milk.”

  12. Statistics on drinking milk consumption can be found at Dairy Australia (www.dairyaustralia.com.au). Page 24 of their Dairy Industry in Focus report shows that per capita consumption in Australia is largely unchanged since 1987-88.
     

  13. Hi manchild,
    Dairy Australia has a quite good report on the status of the dairy industry, which includes a chart of Australia’s per capita milk consumption. See page 24 of http://www.dairyaustralia.com.au/~/media/Publications/Australian%20Dairy%20Industry%20in%20Focus/2010/Australian%20Dairy%20Industry%20In%20Focus%202010.ashx
    Dave does raise a very important point. In Australia’s largest milk producing state, Victoria, processors (and hence, farmers) do have the manufacturing capability to supply either the export market or the local market. In Queensland, for example, that’s not the case and they are pretty much locked into fresh milk because (as I understand it) there’s just not the supply volume to justify large-scale and diversified manufacturing. In Queensland’s case, more than 90 per cent of milk production becomes drinking milk.

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    As a very average Victorian dairy farmer (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 Murray Goulburn, the cooperative 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.

  14. That’s reasonably strong language by ABARE standards. I guess the consensus is that the elasticity is close to 0. I suppose SK’s argument could be weakened to claim that the price war won’t hurt farmers, although it won’t help them either.
    Processors may be squeezed though, and its hard to determine what that will do in the long run.

  15. The thing is, manchild, that although Coles has been quick to point the finger at processors, they’re not the villians.
    Australia’s biggest processor is Murray Goulburn, the 100% farmer owned co-op. They’re not greedy overseas-owned fat cats!
    MG gives us a conservative an opening price at the start of the season (June/July) and then, depending on how the market plays out over the year, offer backpay the industry calls “step-ups”. If they can sell their product at a higher than expected price, we get more step-ups to match. In this way, the profitability of the processor is directly tied to the profitability of the farmers.
    Year after year, MG sets the benchmark farmgate price and the other processors follow with marginally higher prices.
    Since industry deregulation, farmgate returns have fallen and farmers now produce 10% less than we did because the profits are so, so slim. As you’ll see from the Dairy Australia report referenced above, Australian and dairy farmers are the lowest paid in the world, even though we are also the world’s most efficient producers.
    I’m not sure what your business is but I’d like to offer you an insight into the way we see it by drawing an analogy: imagine you were offered an accountancy practice. The offices were lovely and you enjoyed the work but the vendor warned you that: you only had one service to offer and could service only one client who told you how much you would be paid. Oh, and if it didn’t rain for a while, you were bound to make a loss. Would you buy the accountancy firm? That’s exactly what a dairy farm business looks like.
    Farmers like me who earn less than supermarket checkout operators on an investment of millions don’t do it because it’s lucrative. It sounds corny but it’s true that we do it for the love of it. It’s starting to look like that love might not be enough.
     

  16. Thanks for the info. I wasn’t aware of the pricing structure that the co-ops use. I wholeheartedly agree that dairy farming is a tough business, particularly given that you are exposed to large fluctuations that are out of your control (weather, exchange rates, international prices).
    Unfortunately, the reason that Australian dairy farmers get the lowest prices in the world is precisely because they are the most efficient producers. When demand is inelastic, industry-wide productivity improvements are translated into price decreases.
    Thanks for teaching me something today, and best of luck with your farm.

  17. That’s a pleasure, manchild. I really appreciate you asking the questions. It’s such a shame when economists publish material based on economic theory without doing as you have and considering the realities.
    We farmers have to take some of the blame for all the misconceptions about our industry. We are so focused on getting the job done that we tend to overlook the importance of explaining our situation to those beyond the farm gates. We should (and must) do better.

  18. The arguments over competitive milk pricing and the impact on farmers’ businesses seems to be bogged down in circular discussion.

    These are the facts as I understand them:

    1. Milk demand is mostly inelastic (i.e. just because the price drops doesn’t mean demand increases – all a matter of he public’s drinking taste.) This a bad place to be in.

    2. Milk is fundamentally a commodity product. With a commodity product any small operater, i.e. dairy farmer, is subject to commodity trap pricing. You get squeezed on price because there is not much to differentiate between milk from any othert farm prior to manufacturing of specific milk products. Another fundamentally bad place to be in.

    3. Coops exist. I assume they possess bargaining power with respect to pricing milk. A better place to be in.

    4. Prices are basically set in line with international supply and demand.

    5. ROI for dairy farms is abyssmal.

    Based on those shortened summaries and trends, why aren’t more people quitting the industry? “Love of it” has been mentioned from a producer perspective. Consumers are not obligated to consider such “love”; however they will consider the brand, any specialized milk product (Omega-3, %fat) or the price, or a combination of all the above.

    Question I have follows from this: Is a dairy farm a business or lifestyle? (Had an interesting conversation with a milk farmer’s daughter in which the implication was that consumers should pay higher prices to save the lifestyle and livelihood of dairy farming communities – that ironically she and her family chose not to live in because of perceived urban lifestyle opportunities…

  19. You’ve hit a sore spot there, DP! Of course, every farmer will have a different reason for staying on the farm, so I can really only offer my own perspective.
    Like most dairy farmers, I have carried it on from my father and conditions were much better when I was younger. He built a new house and sent two children to private school without working the farm anywhere as intensively as we do today.
    Succession planning is a new, hot topic for farming communities these days. The younger generation is finding there is just not enough money to go around and many (like the farmer’s daughter you know) are opting for other lifestyles.
    There was no room for me on the family farm either and I went to university to pursue another much more highly-paid career. All the same, the call of the country remained strong and, when he died, I fought hard to keep the farm. My accountant thinks I’m crazy.
    I’ve drawn the same conclusions that you have summarised so well and don’t plan to remain a commodity price taker. Like a woman posessed, I am actively investigating value-adding on farm to create a niche product as well as diversification.
    It’s not easily achieved though. In terms of value adding, the hurdles are many. All dairy products must be pasteurised and there are lots of food safety hoops through which to jump. My costings show we need to find around $100K to make it happen, plus a lot of extra time and energy. Given that my husband and I are already working two jobs, this is a real consideration.
    As you say, a farmer’s love of the land is no concern of consumers but screwing the price “down, down, down” does threaten the sustainability of the industry. At the moment, consumers are in a wonderful position. They have the world’s lowest cost producers on their doorsteps delivering safe, high quality product on the smell of an oily rag without the massive taxpayer subsidies that underpin US and EU production.
    Australian farmers are also responsible for much higher animal welfare and environmental outcomes than many international producers. On top of this, dairy is a huge employer in regional areas.
    The bottom line is that the supermarkets risk killing the goose that laid the golden egg.

  20. Thanks for the interesting and informative comments. Let me add a few more!
    While demand for milk is inelastic it is unlikely to be zero (and definitely not positive). In a quick look at some studies the lowest number I found was -0.1 (statistically insignificant from zero) to -0.13 (a 10% drop in milk price raises milk sales by 13%). The previous senate inquiry refers to “A UK study found that, once in a given store, the own–price elasticity of milk is -0.6”. See http://www.aph.gov.au/senate/committee/economics_ctte/dairy_industry_09/report/c03.htm#anc1
    So let’s be conservative and say that the elasticity of demand is -0.1. This is very inelastic. Further let’s take Aldi as the previous milk price ($1.07 per litre) and Coles ($1 per litre) as the new price level, so about a 7% price drop. Then sales would increase by 0.7%. Now this is ‘rough as guts’ – but all I am trying to point out is that even on a very conservative basis, if the supermarkets follow Coles the overall effect is going to be a rise in milk sales of around 1%. This milk has to come from the dairy farmers.
    I agree entirely that dairy farmers are doing it tough. The marginal dairy farmer is holding on by their finger tips and if the wholesale price falls they will go bankrupt. But this means less milk is produced – not more. The only way to get more fresh drinking milk is to convince the farmers to invest and produce more. And that will only be feasible if the wholesale price rises.
    What about the processors? Aren’t they cooperatives who look after the farmers as Marian notes for MG? Yes, MG is a coop – but it is the only big coop left. Fonterra is a global producer from New Zealand. National Foods is owned by Kirin (via Lion Nathan Group).  WCB is the fourth largest and is an ASX listed company. Pauls is owned by Parmalat, an Italian food group (I thought they filed for bankruptcy but the company website appears up to date). So I am glad that MG looks after its owners (the farmers) but I suspect the others also look after their owners – who are usually not Australian dairy farmers.
    Marion argues MG is the price setter in Victoria – but as MG is a major exporter its farm gate price follows the international price. All this means is that Coles policy probably will not affect the farm gate price for Victorian farmers as their price is determined by exports (I note this in the earlier blog on ‘milkonomics’). But this still doesn’t mean Coles’ policy will LOWER the farm gate price.
    In brief, the media claim is that the Coles’ policy will harm farmers by lowering the farm gate price for fresh milk. I still cannot see how that can happen – and inelastic demand and export set prices do not change the argument. They simply imply that the price will not rise or will not rise by much. They don’t get us a lower price – which appears to be the media claim.

  21. A few points of clarification.
    It is not fair to take Aldi as the benchmark retail price.  They are really only are niche player, operating in some parts of three cities only and appealing to a specific type of consumer.
    SK’s analysis makes sense in Victoria, but not really for the smaller groups of farmers in NSW, WA and Qld who are consumer drinking milk only suppliers. They are totally exposed to retail price movements and will face further pressure to leave the industry. That’s fine, just as long as we recognise this is a structural adjustment away from dairy production outside of Victoria.
    MG is part of the problem. Because of their Co-operative model and the structure of the market in Victoria, they do set the benchmark farmgate price in Victoria. But as they have made a number of poor business decisions, have bad management (remember this is the organisation that last year revealed it had being paying the CEOs wife $300k per year for “at home” support) and many inefficiencies they have helped drag the price down.  This is largely the reason why eturns in Australia are currently much lower than NZ, where Fonterra is performing much better than MG.
     

  22. It’s great to see you’ve looked a little more closely into the likely change (or lack of) in demand for milk now, Stephen.
    I still think you’re missing the most important point though and that is the balance of power in the supply chain. Coles and Woollies have enormous power while the farmer has none. In this scenario, it is the powerless dairy farmer who will ultimately wear the cost.
    Your argument as I understand it is that surviving farmers will gain new-found power as those around them are thrust into bankruptcy. (I raised your argument at a dairy gathering yesterday, by the way, and one unfortunate fellow involuntarily sprayed the room with his coffee!)
    The reality is that the number of dairy farms has been declining for many, many years (see the DA web site for hard stats) but this relentless attrition has not won us the ability to command a price for milk that delivers a reasonable ROI (currently less than 1% according to Dairy Australia).
    Everyone has their own opinion of the efficiency or motives of the different processors but milk is more expensive to produce than soft drink or bottled water. And now it’s now cheaper on the retail shelf than both. There’s no denying that this fact is no fault of the processors.

  23. Common sense says that any study takes a period of time, and during that time, population increases. People start drinking milk as young as… I don’t know when but I know it’s very young. But I know you can’t say that a low price will increase per capita consumption of milk.
    People drink milk for reasons that are unique and to really study this economic topic, one might have to do some psychology studies. I drink milk because it goes with cereal, it’s provides certain nutrition, it’s a liquid, some cheese taste horrible, yogurt can’t be drunk and the list goes on. Thus it makes more sense, and is supported by the article http://www.businessspectator.com.au/bs.nsf/Article/WES-Coles-WOW-Woolworths-milk-war-pd20110310-EST8R?opendocument&src=rss, that rather than an increase in the aggregate sales of milk, it will be a shift from branded milk to home brand milk.
    While I think milk is certainly price elastic to a minute degree, there’ll always be some anomalies out there, you certainly shouldn’t use these exact words in your blog post “Low retail prices will increase retail sales” as it is misleading and doesn’t account for the simple factor, i.e. increases in population may have caused the increase in the sales of milk.

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