THE DISTILLERY: Coles' hot milk

Coles has shaken up the ‘milk wars’ debate by signing up Murray Goulburn for a 10-year supply contract, starting in 2014. It’s part of a delicate balance of cutting the fat out of the supply chain and delivering cheap milk for longer, while also not getting on the wrong end of the consumer watchdog for its control of buying from farmers.

As The Australian Financial Review’s Michael Smith explains, Coles is selling this story hard as evidence that it can continue to deliver cheap milk while giving the farmer a competitive price for his produce.

“The real incentive for Coles and Woolworths is the Australian Competition and Consumer Commission’s review into milk pricing. Even though food prices are falling, the enormous power that Australia’s two supermarket giants have over their suppliers is also firmly in the ACCC’s sights.”

The Australian’s John Durie is similarly observant of how the rationalisation of the supply chain does provide efficiencies that benefit consumers, but also strengthens the supermarket giant’s hand on the market.

“A standard milk supply deal, by way of example, would see Coles pay about 90 cents a litre for milk, pay the processor 37 cents and the farmer could get 45 cents, leaving Coles with a profit of 8 cents a litre. The producer and processor profits obviously depend on their efficiency, but the supermarkets call the shots and in opening the New South Wales and Queensland private-label milk tenders the rider was a cut in processor profits or further efficiency demands. In this case, Murray Goulburn boss Gary Helou seized the opportunity to launch a new growth avenue in market milk, which is a game his co-op has avoided, preferring the safety of long-life and processed milk.”

The Australian Financial Review’s Matthew Stevens explains how co-ops outside Australia have used their position to leverage deals like this. There’s nothing revolutionary about this.

“The effect of the new arrangement is that Coles has delivered the nation’s biggest exporter of milk products, Murray Goulburn, with incentive enough to enter the mainstream processing business. This matters very much to the incumbents because Murray Goulburn, like the smaller Norco, is a co-operative that is owned by the farmers. Their mission in life is to deliver the best possible milk price to their owners while covering the cost of capital invested to buy, process and sell milk. Elsewhere in the world, this commercial advantage has been leveraged effectively by dairy farmer co-ops. But, at least in the white milk markets, our local co-ops have been slow to exercise the natural leverage that is theirs. That is about to change."

Business Spectator’s Stephen Bartholomeusz is similarly bemused as to why it’s taken this long for the co-ops to act.

“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.”

Fairfax’s Malcolm Maiden says the Coalition’s pledge not to disadvantage Telstra’s shareholders doesn’t just reflect the unfathomable pain that trying to push them on the terms of the current national broadband network agreement would be too great. It’s just a fact that Telstra will be a crucial player on the construction of the NBN, whether it’s Stephen Conroy occupying the communications portfolio or Malcolm Turnbull.

In other company news, The Australian Financial Review’s Chanticleer columnist Tony Boyd says the challenge for Bank of Queensland when it comes to Virgin Money Australia, which is paid $40 million, is to find a way to turn the lossmaking but rapidly expanding business into a profitable operator.

The Australian’s Asia-Pacific editor Rowan Callick offers a pretty strong verdict on the concluded meetings between forums between Australian and Chinese business figures. The agreement to start direct convertibility for the Australian dollar and the yuan and the annual top-level exchanges between political leaders is a pretty good return.

Speaking of politics, The Australian’s Troy Bramston reflects on the legacy of former prime minister Bob Hawke as a way forward for Australian prosperity. Hawke championed the resolution of conflict as something that should be the nation’s top priority, with union and business working together for a common end.

And finally, The Australian’s economics editor David Uren says the budget picture has changed remarkably since 2010, when it looked like surging commodity prices and corporate tax collections were going to carry the revenue. Notwithstanding surging cost of healthcare and major pending defence upgrades, spending needs to come down as a share of the economy, argues Uren.