65] NFU Scotland said "processors
big and small are offering unrealistically low prices just to
retain their market share, but at unrealistic margins".
Over the past ten years, the retail price of liquid milk has increased
by 60% while the farmgate price has increased by only 34% and
the wholesale selling price by 31%.
(Figure 4) As a result, the gross margin enjoyed by the retailer
has increased by 170% while that of the processor has remained
static. In cheddar, processor margins have declined in the past
decade while retailer margins have increased.
Figure 4: Liquid Milk Margins.
21. The Minister told us that these increases
in retailer margins were neither fair nor sustainable.
He said that "when the product is still pretty close to the
material that left the farm, as opposed to a quiche or something,
it is difficult to justify such a substantial increase in the
retail price without increasing the price to the producer".
Dairy UK were divided over the issue of retail margins. The farmer
representative of Dairy UK agreed with the Minister,
however, Jim Begg, the Director General of Dairy UK, denied that
the price paid in shops had much bearing on the farmgate price,
...the main misunderstanding comes with the belief
that when you determine the farm price you start with the retail
price and work down. In fact it works the other way completely.
You start at the bottom and you work up, and the farmer's milk
price is driven by completely different circumstances from the
retail price, or even the price that the processor gets for his
product. The farmer's price is driven by world commodity prices,
which is driven by the supply and demand.
The NFU adopted a sanguine attitude to margins, stating
that "what matters to us is not how margins are distributed,
it is ensuring that farmers get a fair price and ensuring that
farmers are able to trade in a market that is fair".
22. The Minister claimed that there was little
scope for Government to interfere in retail margins "...if
we exclude Government intervention in the market by dictating
margins, formulae or something like that".
In addition to the implications for compliance with EU common
market regulations, setting a minimum price could distort UK farmers'
ability to compete globally and is likely to increase the retail
cost of dairy products, for which consumer demand is relatively
23. The Minister stated that market forces would
generate a price increase if dairy production fell sufficiently
to create an imbalance between supply and demand for liquid milk.
Domestic supply and demand imbalances are only a serious concern
for the liquid milk sector as processed products can be sourced
internationally. Given that processors can vary production between
liquid and processed streams, a severe shortage would only arise
if liquid milk suppliers could not source sufficient raw milk
from either stream, that is, a 50% drop in production.
We do not think this is an acceptable solution as it would entail
a very substantial drop in the number of dairy producers, with
undesirable consequences for rural communities, landscapes and
tourism, and consumer choice.
Dedicated supply chains
24. A recent positive development has been the
establishment of dedicated supply chains producing liquid milk
for the major supermarkets. These benefit the farmers involved
through guaranteeing higher prices to them than those paid to
farmers outside the supply groups.
Dedicated supply chains provide additional benefits, such as security
and predictability for suppliers and retailers, increased focus
throughout the supply chain on the needs of the customer, and
in some cases, provision of extension services or investment to
help producers become more cost-efficient or sustainable.
25. Currently only a minority of dairy producers,
some 10% of the total,
benefit from being in a dedicated supply chain. This creates a
divided market between the 'haves' supplying liquid milk to the
supermarkets and the 'have-nots' that supply processed products
into commodity markets.
In June 2011, the highest farmgate price, over 29 ppl, was paid
to farmers in the Tesco's dedicated supply chain, followed by
farmers supplying Marks and Spencers and Sainsburys. 
The lowest milk prices, around 25 ppl, were paid to farmers in
the dairy co-operatives First Milk and Milk Link, which are supplying
commodity cheese production or supermarkets' balancing pools.
26. We questioned why the dedicated supply chain
model could not be extended to other sectors, such as own-brand
cheese, allowing more farmers to benefit.
Tesco told us that all their non specialist cheddar and the majority
of their butter was British.
However, they argued that "trying to set up a dedicated supply
chain in respect of the milk producers for production of cheese
in practical terms would be much more difficult".
We found the arguments that it would be too difficult to set up
a dedicated supply chain for processed dairy products unconvincing.
A more likely barrier is the cost incurred by paying above the
market price. Tesco estimated the additional cost of operating
their Sustainable Dairy Group as £35 million per year,
which would amount to £50,000 for every dairy producer in
the group. Moreover,
the incentive for retailers to set up dedicated supply chains
to ensure security of supply is less for processed products, which
can be sourced globally, than for liquid milk, which of necessity
is sourced domestically.
27. While retail prices do not directly determine
farmgate prices, it is in retailers' long-term interests for producers
to be paid a price that covers their production costs. We welcome
the efforts made by retailers to raise farmgate prices and provide
greater certainty and transparency of pricing through establishing
dedicated supply chains. However, only a minority of producers
benefit from these arrangementsthe real challenge for Defra
is to extend the principles of dedicated supply chains into processed
products such as cheese and butter.
28. We are confident that the
future prospects of the UK dairy sector are positive, but this
depends on Government and the dairy industry resolving certain
issues. Despite having one of the most efficient production systems
in the world, UK dairy farmers are unable to cover their costs
and dairy processors are outcompeted by imported products. Farmgate
prices have recently become decoupled from both commodity market
indicators and farmers' production costs, indicating that farmers
are not consistently able to recoup sufficient value from the
supply chain. We conclude that Government action is justified
as the substantial drop in the number of dairy producers that
would be required to increase farmgate prices through market forces
alone would have undesirable consequences for rural communities,
landscapes and tourism, and consumer choice. Consolidation in
the industry must be driven by confidence, innovation and investment.
29. We call on Government to
take action to resolve this situation through addressing the structural
imbalances that result in low farmgate prices; encouraging increased
investment in processing, particularly in value-added products;
and exerting influence on retailers to establish dedicated supply
chains for processed dairy products, such as butter and cheese.
We draw attention to our views on the
draft Groceries Code Adjudicator Bill.