Select Committee on Environment, Food and Rural Affairs Minutes of Evidence

Memorandum submitted by Safeway Stores plc (A 61)

1.   What determines farmers' incomes?

  1.1  In real terms, UK agricultural output prices are driven by:

    —  The sterling/euro exchange rate.

    —  Movements in farmers' input prices (eg animal feed).

    —  Competition between farmers' customers, ie food processors and retailers.

    —  Decisions made in Brussels on regulatory costs.

  1.2  Real prices have been falling over a long period of time, but particularly sharply since the mid-90's.

    —  Between 1995 and 2000, total income from farming fell from £5.3 billion to £1.5 billion. Over the same period, farmers' fixed costs increased slightly from £6.7 billion to £7.1 billion.

    —  The decline in incomes was due primarily to the sharp appreciation of sterling against the EU currency basket from 1995 onwards.

    —  Falling incomes have severely weakened farmers' confidence and caused a collapse in on-farm investment.

    —  As the likelihood of a sustained increase in food prices is remote, the only way in which farmers' incomes can be substantially improved is by reducing their costs. This in turn implies significant restructuring in order to achieve scale economies.

  1.3  On the demand side, UK consumption of many primary products is declining:

    —  Liquid milk consumption is down 10 per cent, 1990-2000 (or 40 per cent since the late 1960s).

    —  Carcase meat (beef, lamb and pork) sold through retail outlets for in-home consumption is down 22 per cent since 1990.

    —  Vegetable consumption is down 12 per cent since 1990 (fresh potatoes down 29 per cent).

  1.4  Consumer preferences for food are influenced by four factors:

    —  Convenience—Lifestyle changes have been affecting eating habits for the past 20 years. The results include a big and sustained growth in ready meals, snacking, take-aways and eating outside the home.

    —  Variety—the same lifestyle changes and rising incomes are increasing consumer demand for a wider range of (largely) processed food, which is partly driving the growth in UK imports.

    —  Fashion—in recent years we have seen significant growth in the demand for the niche market products, eg organic.

    —  Assurance—the impact of successive food scares (BSE, GM, FMD) has undermined the confidence of some consumers in the safety of conventional food, particularly red meat.

  1.5  Farmers have responded to these changes by increasing their efficiency, ie substituting machinery for labour, improving yields. In primary products, however, where demand is static or declining, this has simply added to the downward pressure on prices.

2.   Farming and CAP Reform

  2.1  The prospect of decoupling support from production raises some basic issues about the motivation to be a farmer and the future structure of the farming sector.

  2.2  The question which farmers need to ask themselves is why they are farming at all.

  2.3  There are three possible answers:

    —  For lifestyle (ie tradition, private amenity).

    —  For public amenity (subject to receiving adequate tax-funded support).

    —  For markets (ie as a business, selling raw materials for processing).

  2.4  Lifestyle farming will probably continue especially when supported by incomes drawn from non-farming sources.

  2.5  Public amenity farming will depend on the level of support arising from modulation and the perceived complexity of applying for subsidies at farm level. Given the UK's disproportionately low share of the EU's RDR budget and DEFRA's declared preference for a "CAP Repat" strategy, the likelihood that UK farmers will be supported at the same level as their counterparts in some other EU member states seems remote.

  2.6  Commercial farming will almost certainly become more concentrated on large-scale units which can operate profitably in commodity markets at low prices. This does not mean that big is always best. Efficiency depends on the optimum use of all inputs, which is not confined to large-scale farms. Management skills also play an important part. But if we assume that the farms most likely to be able to compete post CAP reform are the relatively large arable farmers in Eastern England, the combination of low market prices and withdrawal of production subsidies is likely to drive further restructuring in favour of scale economies.

3.   The Curry Commission's Strategy

  3.1  Curry recommended that farmers should respond to CAP reform by:

    —  Increasing efficiency/reducing costs.

    —  Adding Value.

    —  Diversifying.

  3.2  Efficiency

    —  As not every farmer can get bigger, the practical solution for many will be collaboration or some form of co-operative venture to spread costs, pool resources etc.

    —  Curry proposes a Collaboration Board to help the process along but the case is argued in general terms. It is not clear how the Board will make a difference or how it will operate.

    —  The proposed Food Chain Centre is potentially a good idea in so far as it will carry out some useful analysis of supply chain issues in difficult areas like livestock, horticulture, dairy etc. But its work will be valuable only if it leads to action.

  3.3  Adding Value

    —  Farmers can add value by moving into processing or small-scale manufacturing to gain additional margin.

—  In most sectors (eg dairy) this would only be practical on a co-operative/joint venture basis, which would in turn require an appropriate level of financial support, plus business advice and management skills. In one or two sectors, eg dairy, it might also run into regulatory problems. However, given the outlook for commodity prices, adding value by forward integration would be a logical move for some farmers.

    —  An alternative strategy for farmers is to move into niche markets, eg organic local food, where unit costs can be recouped by premium prices.

    —  Curry believes that local food will become "mainstream" over the next few years, but there are some uncertainties about the market potential and also the supply chain/logistics infrastructure required to deliver it on a significantly greater scale.

    —  Organic is a £1 billion market in the UK and growing, with substantial opportunities for import substitution. Premium prices are essential to attract farmers into organic, but may also be a constraint on long-term market growth if "health scare" motivation by consumers of organic food diminishes.

    —  In some markets (eg milk, lamb) organic premia have proved unsustainable, so caution and thorough market research are required before committing to conversion. Organic production is not a certain ticket to success.

  3.4  Diversification

    —  Over half of all farms in the UK are already "diversified" in the sense that they derive income from non-farm sources.

    —  In terms of moving into other crops (eg pigs to arable), the prospects are limited partly by local or regional topography/climate/soil and partly by the fact that the depression in farm incomes has been general across virtually all sectors of agriculture. Although some modest price recoveries are being forecast in arable crops like winter wheat and spring barley, the outlook for most livestock and dairy products is not good.

4.   Processing

  4.1  Curry did not devote much space to this critical area of the food supply chain, but its prospects post-CAP reform will obviously impact on agriculture. Those prospects, in general, are not encouraging.

  4.2  In 1999-2000, the IGD did some detailed comparative benchmarking on seven key performance indicators for our beef, pig, lamb, poultry and dairy sectors relative to those of France, Germany, the Netherlands, Denmark, Brazil, Spain and the USA. The key performance indicators used here:

    —  Farm economics.

    —  Processing economics.

    —  Domestic market as an aid to competitiveness.

    —  Management and people.

    —  Infrastructure.

    —  Government.

    —  Science and technology.

  Each indicator was assessed on 15-25 separate performance measures.

  4.3  The results were uniformly bad for the UK. We came bottom of the table on all seven performance indicators.

  4.4  The IGD survey did not attempt a full explanatory analysis of the reasons for this performance gap. Clearly, however, some of these are likely to be:

    —  Internal, for example, poor management, inadequate past investment, weak domestic demand.

    —  Structural, for example, lack of integration between producers and processors, lack of scale economies.

    —  Governmental, for example, a regulatory framework based on the assumption that markets end at Dover and that combinations comparable in size to those achieved in some other EU member states are contrary to the public interest.

  4.5  Whatever the causes, CAP reform is likely to intensify the pressure on UK processing. Some of it will go out of business (eg in dairy, where there is currently too much processing capacity relative to demand) and some will fall under foreign control, implying a transfer of profit outside the UK.

5.   What can retailers do to help?

  5.1  Contrary to popular belief, the major supermarkets do not control market prices. These are set by the interaction between supply and demand. We react to what is happening in the major commodity markets.

  5.2  But in some markets (eg meat) we pay premia above prevailing prices for products which achieve our quality specification.

  5.3  We also try to alleviate the ups and downs of the market place by negotiating long-term contracts with selected quality suppliers, which obviously helps to give farmers more confidence in the future of their business than they would otherwise have had.

  5.4  We are expanding our range of organic products and also of non-organic local/regional foods, although many of these will continue to be low volume, premium lines.

  5.5  Wherever possible we will continue to source as much as we can from UK farmers and growers. Contrary to popular belief, we do not scour the world for the cheapest products, to the detriment of the home team. The reality is:

    —  While price is clearly very important to most consumers the key driver is usually price relative to perceived quality (ie taste, appearance).

    —  Selling any old rubbish at low prices is not, in general, likely to enhance a retailer's brand name.

    —  Where the major retailers source a product from outside the UK, it is usually because they cannot source it from the UK. Supply constraints may be structural, eg as with beef at the present time, or seasonal eg certain types of produce, or climatic, as with bananas and other tropical products.

    —  The growth of low cost imports is more likely to be associated with the foodservice sector than with the major retailers.

  5.6  Clearly, as CAP reform approaches the UK farming and food industries face a challenging time. It is particularly important, therefore, that we develop a more constructive, co-operative relationship across the supply chain—without being accused of collusion—and also between ourselves and Government. The Curry Commission's Food Chain Centre could well be the stepping off point for this development.

Safeway Stores plc

February 2002

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