A Coles coup to defuse milk intolerance

A price premium built into Coles' new supply deal with dairy giant Murray Goulburn should have farmers laughing and regulators reassessing supermarket cynicism.

The so-called ‘’milk wars’’ have taken a rather dramatic twist with the announcement today that dairy giant Murray Goulburn is entering the pasteurised milk market through a partnership with Coles.

The co-operative, Australia’s largest dairy co-op, has signed a 10-year contract to supply Coles milk for its home brand and will also relaunch its Devondale milk brand, with an initial period of exclusivity, on Coles’ shelves. As part of the agreement Murray Goulburn’s Devondale cheese brand will be stocked by Coles for the first time in almost a decade.

Coles has also signed a similar but smaller and shorter-term deal with another co-op, Norco, which has a presence in NSW and Queensland. Murray Goulburn’s strength is in Victoria and southern NSW.

To support the contracts Murray Goulburn is going to invest $120 million in two new milk processing plants in Melbourne and Sydney, which it says is the biggest investment in dairy processing since the industry was deregulated in 2000.

Murray Goulburn has, for some obscure reason, never had a meaningful presence in the fresh milk market despite processing about a third of the country’s milk production – nearly three billion litres a year – focusing more on manufactured milk products. It is the biggest exporter of dairy products.

While its entry to the sector is bad news for National Foods, which is in any case reviewing its position within the milk processing sector, it is good news for the co-op’s farmers and reshapes the discussion about the milk wars that Coles ignited with its $1 a litre home brand offer.

That debate has been characterised as an attack by the two big supermarket groups, Coles and Woolworths, on vulnerable farmers even though both of the grocery chains have said they have absorbed the loss of margin themselves. Farm-gate milk prices are, however, ultimately set by the international market, translated through the value of the Australian dollar.

Under the arrangements with Coles, Murray Goulburn will supply about 200 million litres of milk a year with a pricing mechanism that locks in a premium to the farm-gate price that will be protected regardless of fluctuations in the price.

As a co-op, Murray Goulburn delivers returns to its farmer members primarily through the price it pays for their milk (although it also pays them dividends) so the processing margin it generates from the agreement will inevitably be returned in full to its farmers. Its willingness to strike the deals with Coles undermines the argument that the supermarket group’s home brand milk price initiatives are damaging farmers’ interests and income.

The construction of two brand new, state-of-the-art processing facilities appears to be premised on a view that the existing processors, National Foods and Parmalat, have under-invested in improving their efficiency because they have been more focused on investing in their brands.

As the most efficient player in the dairy industry, partly because of Victoria’s climate and partly because of its scale and existing operational expertise, Murray Goulburn’s entry into the fresh milk category may also have implications for dairy farmers generally – it will compete with the other processors for raw milk.

The agreements are, from Coles’ perspective, timely. Woolworths has been negotiating with a relatively small group of farmers to buy milk directly from them and then contract out the processing in its own attempt to defuse some of the tensions and suspicion generated by the milk wars.

The controversy over the $1 a litre milk has spread into a wider debate about the supermarkets’ relationships with suppliers and has raised the threat that a mandatory code of conduct will be imposed on them.

The Australian Competition and Consumer Commission has been investigating their behaviour, which is somewhat perverse given its charter is to protect and promote competition and consumer benefit, and that only a few years ago it was directed to investigate whether grocery prices were too high because of a lack of competition.

The deals with Murray Goulburn and Norco would tend to signal, in the most high profile of the products affected by the trend towards home brands, that some of the cynicism about the chains’ behaviour has been misguided while the Murray Goulburn investment could also be interpreted positively as a sign that the competition between the two big chains is creating pressure and opportunities for investment in a more efficient and productive supply chain.

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