Outlook cloudy two years on in the milk wars

ON THE second anniversary of the price war between Coles and Woolworths the debate about the power of the retailers ratcheted up a notch when the British government appointed a farming executive to its new supermarket regulatory body.

ON THE second anniversary of the price war between Coles and Woolworths the debate about the power of the retailers ratcheted up a notch when the British government appointed a farming executive to its new supermarket regulatory body.

The timing wasn't lost on Nationals senator John Williams, who was doing the rounds of radio stations lambasting the supermarket giants as they mark the Australia Day milk war battle that erupted between the two in 2011.

For Williams, establishing a regulator with the power to fine the supermarkets if they are deemed to be treating their suppliers unfairly, was news enough. But the fact that the government had appointed a former farm industry executive, Christine Tacon, was music to his ears. "It is a tremendous move and it is similar to what we have been trying to do in Australia," he said.

The move had the opposite reaction from the supermarket chains and some industry bodies. Coles dismissed it as lacking merit and adding to red tape, without any commitment from retailers or suppliers to work together. Woolworths said it was "working constructively" with the other major retailers, food and grocery manufacturers on an "alternative path" to a new regulator. The Australian Grocery Food Council said it was committed to "seeing what can be achieved through an industry-based approach".

The relationship between retailers and suppliers is a touchy subject for retailers because it has caused them a lot of grief. They argue that they have a great relationship with most suppliers and it is only a few whingers who are causing all the noise.

Whatever the case, since the price war between Coles and Woolworths began in earnest two years ago with the milk war, bread war and eggs war, there has been a lot of scrutiny. There have been accusations of misuse of shop-a-dockets, petrol prices and private-label brands being used to sell cheap foreign produce.

There have also been stories of "cliffing", where suppliers are asked to stand at the edge of a cliff and agree to certain discounts, and if they don't, they are told to look over the cliff and see if they like that better. Cliffing is said to be a choice between quick suicide or death by a thousand cuts. Unfortunately, most of the stories exclude the names of the victims, which makes it harder to prove or refute.

But the price war waged on the milk industry has created the biggest political storm, triggering a Senate inquiry and generating a lot of community sympathy for the farmers who were no longer viable after being caught in the crossfire of $1-a-litre milk wars.

Given the sensitivities, the supermarkets have poured a lot of time into trying to explain their actions and the complicated dynamics of the milk industry. On Friday, Coles issued a news release titled "the milk facts". It includes statements - and statistics - that the numbers of farmers in the northern states have been declining for a decade, rather than as a result of the price wars. It also states that milk production in the northern states has declined due to lower processor demand, rather than anything it is doing.

And it argues that its activity doesn't have any impact on farmers because Coles has fully absorbed the retail price cut in a lower milk profit margin, that it deals directly with the processor rather than the farmer and the price of milk is largely set by a global market.

But this is one side of the story. Many farmers and milk processors see the world differently, particularly when it comes to negotiating milk contracts.

It is true that global prices are the primary influence in the low-cost-of-production states of Victoria and Tasmania, but not in New South Wales and Queensland where the global price is largely irrelevant. Price there is set by a combination of a need to retain a viable farmer base to encourage year round production, as well as the profit pool the processor has available to share with farmers.

And from the processor's perspective, margins would have to have been affected by the discounting as volume has moved from the higher margin brands to lower margin private-label milk within grocery stores and also from higher margin convenience stores to lower margin supermarkets.

Given the scale of the major retailers and with market-wide milk volumes relatively unresponsive to price discounts, this can only result in a smaller value pool across the category. It is hard to find another interpretation.

Coles improved its offer to processors before the price discounting began two years ago but the discounting largely reversed a benefit to an industry that was suffering from unsustainable margins. Indeed, one of the bigger processors, Lion, went on record in the Senate inquiry saying it wasn't making a brass razoo on white milk.

While many will argue that these major processors are big and ugly enough to look after themselves, there are implications for farmers if they begin to look up the chain to recoup some of the margin loss. Deliveries to some regional areas are already marginal and the major domestic manufacturers act like a utility in subsidising fresh white milk to some areas. It would certainly attract political attention if they started to scale back to profitable routes.

The brutal reality is white milk manufacturers don't have many cards to play. If they refuse to produce private label, they have capacity utilisation issues and someone else will likely step in. There is also a fear that their presence in branded milk products could slip in the major supermarkets if they don't supply private-label milk.

It is a debate that is complicated and controversial and the stakes are high.

In Britain, it took 10 years and two reviews by the competition watchdog before any real reform took place and the supermarket industry is far less concentrated there than in Australia.

But from a pricing perspective, it is worth bearing in mind that Britain's retailers heavily discounted private-label milk prices for two years to drive store traffic. They recently started lifting prices after sustained public pressure.

Whether this is how it will play out in Australia is anybody's guess, but it will be a fascinating and politically charged journey.

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