Session 2010-12
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UNCORRECTED TRANSCRIPT OF ORAL EVIDENCE
To be published as HC 952-i

House of COMMONS

Oral EVIDENCE

TAKEN BEFORE the

Environment, Food and Rural Affairs Committee

EU Proposals for the Dairy Industry

Wednesday 27 April 2011

Tom Hind

Jim Begg, Peter Dawson, Mark Taylor and Rex Ward

Evidence heard in Public Questions 1 - 98

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Oral Evidence

Taken before the Environment, Food and Rural Affairs Committee

on Wednesday 27 April 2011

Members present:

Miss Anne McIntosh (Chair)

Tom Blenkinsop

Thomas Docherty

Richard Drax

George Eustice

Barry Gardiner

Mrs Mary Glindon

Neil Parish

Amber Rudd

________________

Examination of Witness

Witness: Tom Hind, Director of Corporate Affairs, National Farmers Union, gave evidence.

Q1 Chair: Good afternoon Tom. Thank you very much indeed for joining us and participating in an inquiry into the dairy industry. For the record, would you just like to give your name and position?

Tom Hind: Sure, my name is Tom Hind and I am Director of Corporate Affairs at the National Farmers Union.

Q2 Chair: Thank you. Would you just like to outline for us what you believe the main problems are for the UK dairy industry, as of today?

Tom Hind: I think it is a very big subject, particularly recognising that we are here essentially to look at the Commission’s dairy package and the UK Government’s response to it. But I guess I will start by giving a contrast between some of the good news and the bad news, and it is clear there is some good news in the industry. For a start, we are starting to see a modest recovery in milk production in the course of the last year after quite a considerable decline in the course of the last five. We are seeing milk prices rise in the industry, with some of the highest milk prices ever paid to dairy farmers being paid currently, and we have seen some positive development in the way that dairy supply chains work, particularly the development of dedicated supply chains and more direct relationships between farmers and grocery retailers, at least in the liquid milk sector.

However, on the downside, dairy farmers-wherever they are in the industry-are facing considerable pressures in terms of production costs. Those costs are borne as a result of quite significant rises in the price of straight and compound feeds, in terms of rises in energy prices, fuel prices, fertiliser, to the extent that costs of production are equally at record levels, and probably the highest cost of production that we have experienced for quite some considerable time. We estimate they are in excess of 29 pence per litre. On top of that, the industry continues to consolidate at the rate of 10 dairy farmers leaving the industry every week. That may bring about a more consolidated industry, but there are big questions as to whether we are losing critical mass, at least in terms of the long-term capability of British dairying to respond to some of the opportunities that might lie in the future.

The dairy market is continuing to fail producers: whilst we are seeing rising milk prices, the UK milk price continues to languish towards the bottom of EU milk prices league. We are currently round about 23rd out of 27 Member States, despite the fact that market indicators would indicate a milk price way in excess of current averages, and despite the fact that we are less than selfsufficient in milk and dairy products, and despite the fact that for a number of years-at least three years-we have had a significant exchange rate advantage, which gives a significant competitive advantage to UK milk processors.

Q3 Chair: Are you able to give an indication of how many dairy producers there were in the UK 10 to 15 years ago compared with today?

Tom Hind: I can, but it is probably better that I provide some supplementary written evidence that provides those details rather than give a rough answer here.

Q4 Chair: If you could, that would be most helpful. Would you say that the problems with the UK dairy industry are the same for the rest of Europe and the rest of the world?

Tom Hind: There are some challenges that dairy farmers across the world face in common, not least of which are the integrity of the product, the pressures and the challenges that are posed by climate change, the volatility of commodity markets, rising input costs and the consolidation of their customer base, by which I mean the major grocery retailers. Some of those problems are shared, but nevertheless there are some problems that are specific to the UK, and in particular the British dairy industry. Some of those problems relate to the structure of our market; some of those problems are a legacy, frankly, of the old milk marketing boards.

Q5 Chair: Is there an EU-wide answer, do you believe, to the current problems of the dairy industry?

Tom Hind: I do not think there is a single answer, either at a European level or at a national level, and I do not think those answers can be primarily provided by Governments or by the European Union. But in relation to the Commission’s dairy package, we see some opportunities to overcome some of the problems that are associated with the weak bargaining power of dairy farmers and the exploitation that exists because of the nature of the way UK milk contracts operate.

Q6 Chair: I know we will come on to this in more depth in a moment, but how much of the current problems relate to farm gate prices, and especially what the consumers are prepared to pay for the milk at the supermarket compared with bottled water?

Tom Hind: I think we should leave the question of retail pricing to one side and focus very much on the question of producer pricing. In relation to producer pricing, what is evident is that in relation to the broad commodity markets-like butter and skimmed milk powder, like cheddar cheese and so on-the price that dairy farmers are currently receiving and perceiving is significantly less than market indicators would dictate, and that suggests that there are some systemic problems in the way that the UK dairy supply chain operates.

Q7 Amber Rudd: Hello Mr Hind. Last year the president of the NFU said that the UK dairy industry risked becoming unsustainable. Do you think implementation of the European Commission’s milk package helps reduce that risk?

Tom Hind: I think it plays a contributory part in providing some answers to the problems faced by British dairy farmers, in particular by overcoming the significant problems that are experienced with milk contracts. Milk contracts are the single most significant document that dairy farmers sign: they determine the terms of trade, the conditions of trade that exist between farmers and first-hand buyers or manufacturers. The fact is that milk contracts within the UK are fairly uniform in the way that they work, and they all exploit the fundamental weakness of dairy farmers, which is the requirement to sell a perishable product on a daily or at least every-other-day basis. If you think about it as a dairy farmer, you are obliged to sign a contract of a similar type that locks you into supply to one customer and one customer alone for a minimum 12-month period, with absolutely no certainty as to what price you are going to receive, with the exception of two contracts, broadly speaking: one is to supply Tesco and the other is to supply Marks & Spencer, which is for a privileged few dairy farmers. You would not sign those sorts of contracts in any other walk of life.

Q8 Neil Parish: Good afternoon, Tom. The European Commission want to see four elements in the contract, which is price, volume, seasonality of delivery and contract length. Quite a lot of contracts certainly have seasonality in there, but I imagine it is the contract length that you are particularly interested in. What is your view of a contract length, because in a falling market you are probably better off in a long-term contract if the price is reasonably high; if the market is going up then you are probably better off in a short-term contract because you can negotiate a better price. But how do you get the best of all worlds?

Tom Hind: Actually, the key element for us is the price determination. Contract duration is less of an issue. I think most dairy farmers are comfortable with the fact that we operate on rolling contracts in the UK with a notice period. There may well be some interest in the future from the point of view of some dairy farmers to looking at hedging a proportion of their volume on a fixed-term basis, and I know that certainly in France, for example, there is a desire to look at durational contacts rather than rolling contracts.

The issue in relation to price is to overcome this lack of certainty and transparency about the way that prices will be determined from month to month, from week to week. At the moment, as I say, milk producers sign contracts with some indication about how seasonality will operate, about how constituents will be remunerated for the milk that they are supplying, but with no certainty as to the base price, which can be adjusted according to generally quite vague variables, often at the insistence of the milk purchaser. That is not universally the case, but certainly is quite often the case. Under the Commission’s package, where Member States choose to put in place compulsory contracts, those contracts must either specify the price that a farmer will receive, or the means by which that price will be adjusted, and that will give much greater certainty, clarity and transparency for dairy farmers and thereby build more confidence in the future.

Q9 Neil Parish: And are there contracts at the moment with some of the companies that actually take that into consideration in this country?

Tom Hind: There are some contracts that take that into consideration. It is difficult to set out a vision for a perfect paradigm of milk contracts. I think we believe that there has to be some degree of flexibility, but there are a couple of examples where companies have made some advances. I cited earlier the example of the Tesco contract or the supplementary contracts that farmers sign through Arla and Robert Wiseman Dairies to supply Tesco, which set out some clearer criteria as to how prices will be determined on a six-monthly basis. There have been some advances by Milk Link-one of our major co-operatives-and by Dairy Crest as well. I have to be careful about not necessarily excluding companies, given that I am not a first-hand adviser on dairy issues. Certainly there have been some issues that have been positive, but they have generally been on the margins.

Q10 Neil Parish: One of the internationally traded and recognised prices is milk powder price, and what seems to be interesting about the depressed price of milk at the moment is that milk powder prices are trading at a very high level worldwide. Why is this not being recognised in the price that farmers are being paid for their milk?

Tom Hind: I think it is a question of the structure of the market and the structure of our processing sector, which is heavily dependent on a relatively limited number of customers for its custom: essentially grocery market retailers who exploit the fact that individual processors are competing for volume to supply them with an essentially generic product, which is commodity cheddar. The ability to be able to extract higher margins and prices on the stock market from wider commodities like butter and skimmed milk powder depends very much on your ability to place products onto those markets, which is limited given the processing capacity that we have-albeit we have the facility in Westbury Dairies-and is also limited by both a tactical and strategic view about where you want to place milk for the long term. Do you want to hedge your bets on the commodity market and potentially forgo long-term retail custom, or do you want to try and stick with the retailers because they are a long-term customer base? I can appreciate for a processing company that it is not easy to say all of a sudden, "Sod it; I am going to try and find another customer for my milk on the commodity market and forgo the retailers," but nevertheless we are not seeing that translation through because we are so fixated on that retail market in this country.

Q11 Neil Parish: One quarter of milk producers say they only have one option for a milk buyer. Another quarter of them-so 50% in total-say they only have the choice of two. Is this one of the problems with getting a better price for dairy producers and dairy farmers?

Tom Hind: The fact that in some parts of the country farmers do not necessarily have access to alternative milk buyers reduces the extent to which there can be competition for demand for raw milk. Nevertheless, that is a fact of life in terms of the consolidation of the industry that we have seen and probably will continue to see in the future. So I do not think we should overstate that as a particular issue for farmers, but certainly if you find yourself in, say, the south west of Cornwall there is effectively only one buyer; it happens to be a co-operative, which brings some advantages for its members who supply that company, but it does mean that you are limited as to the choice of whom you can supply your milk to.

Q12 Neil Parish: You have argued that a failure to implement a compulsory contract would "undermine the desire to see a harmonised approach across the EU". What would be the impact of Member States having a different approach to compulsory contracts? As you know, the Government is not keen on that idea.

Tom Hind: At this moment in time of course we are looking at Commission proposals rather than implementation, and Member States may well be relatively circumspect at this stage about what implementation choices they will make, obviously bearing in mind that the package that the Commission has proposed could be subject to further amendment as it goes through the decision-making process. Different Member States, because of the structure of their industries, different traditions and so on, will take different approaches. But there is a risk, for example, if a Member State like France were to put in place a requirement for compulsory contracts, that farmers could have much greater protection and certainty about the way that prices will adjust in future, yet dairy farmers here in the UK will be denied that opportunity.

Q13 Neil Parish: Is there a chance that big co-operatives-I won’t necessarily name one-that trade across Europe would also be putting different contracts in place in different countries?

Tom Hind: That is inevitable, given that contract law remains very much a national preserve, and indeed some Member States have to overcome the first hurdle, which is putting in place written contracts. Again, France is a very good example where dairy farmers do not possess written documents in terms of their supply agreements with dairy companies. That is the first stage to overcome. I think one of the important questions that we need to look at in terms of the future of the European Union in terms of milk is the fact that the ending of milk quotas will place much greater reliance on the milk contract to determine volume, and at the moment the milk quota is an individual producer right, so it is the producer’s right to decide if he holds quota, if he acquires more quota, and therefore it is his decision to decide whether to produce milk and how much milk to produce. When quotas go, the contract becomes the sole determinant of volume, and that lies in the hands of the first-hand buyer, not the dairy farmer, and it therefore means that the right to decide who produces what milk, where and when lies in the hands of processors, and that to us represents a further transfer of power.

Q14 Neil Parish: Of course milk quota is implemented differently across Member States anyway: France has got it linked much more to the land, hasn’t it?

Tom Hind: I do not think that really makes much of a difference in this instance. The quota is still an individual producer right, and that is the fundamental thing to be mindful of.

Q15 Chair: You referred to co-operatives, and obviously in certain Member States, particularly Denmark, there is a much greater reliance on co-operatives. Does that give them an advantage?

Tom Hind: It gives them a significant advantage in terms of their ability to compete in the market, and by virtue of the fact that Denmark has to export because it is more than selfsufficient, the development of a major co-operative-over a number of years, I have to say-has given them an ability to exploit market opportunities, both within the European Union and in third-country markets. I do not think we should lament what has happened in other Member States: fair play to them, providing they compete within accordance with competition laws across the European Union within the single market. I think that is good on them. The issue here in the UK is that we do not have those businesses. Part of the reason we do not have those business is that we lived under the legacy of the milk marketing boards for several years, and therefore were starting from some considerable distance in terms of the organic development of these quite significant and important consolidated farmerowned businesses at a European level.

Q16 George Eustice: Dairy UK obviously take a very different view on contracts and argue that the regulation of contracts is fundamentally at odds with the dynamism and innovation that has been shown in the UK dairy industry. Do you think that having these compulsory contracts would provide enough flexibility-for example, on volumes-to encourage competition and innovation in the industry?

Tom Hind: I do not see why they should discourage flexibility, and I do not see why they should discourage innovation in contracts. All the Commission proposals do is provide for some rather basic terms and conditions that all contracts should meet. What those contracts then say is of course up to the individual supply chains in question. Of course, if I were a milk processor and I had full licence to decide how much I was going to pay dairy farmers and therefore could use that as a form of variable adjustment in terms of the commercial negotiations that I was having with my customers, then I would want to protect that flexibility to adjust milk prices on a whim.

Q17 George Eustice: They maintain that farmers gain from this by having a premium payment as the quid pro quo for that. Is that something you would recognise, or is that something you disagree with?

Tom Hind: I think that is something that you would perhaps need to elaborate with Dairy UK afterwards. It is fair to say that there have been some developments in contracts that have been positive, but I do not understand how the dairy package that the Commission has proposed would inhibit the development of those contracts in the UK.

Q18 George Eustice: Freedom of contact is quite a big deal in British law, so as soon as you start doing that and introducing it, it is a problem. What is it at the moment that stops farmers and producers demanding those contracts? Is it just that it is too fragmented and they take what they are given?

Tom Hind: I think it is two things. First, it is a combination of the fact that farming is very fragmented. We are dealing with about 10,000 individual businesses, who are organised in different groups but do not find it easy to collectively negotiate, and perhaps we will come on to issues around producer organisations and collective bargaining later-there are some issues there. I think it is also the fact that the contracts that they are offered are almost universally-leaving aside one or two exceptions-of a similar type. Therefore your ability to demand those terms is relatively limited by the fact there is not the competition in the marketplace to offer a diversity of contracts that might offer a little bit more certainty in terms of price determination.

Just to pick up this point about contract law and freedom to contract, the fact may be that, in terms of business-to-business relationships, we do see freedom to establish contractual terms between two parties, but in relation to consumer law we have at least seen developments to ensure that the position of consumers is protected from contractual abuse in business-to-consumer contracts, and I think there is some scope for looking at how some of the principles we have applied in terms of consumer contracts might be applied in terms of businesstobusiness relationships as well.

Q19 George Eustice: Just building on this point, I can understand why they are not offered the contract, but could the NFU publish what a standard contract should look like and get your members to say that, from 2012, this is a contract that you should use? Is that at all possible?

Tom Hind: I laugh not because of the question, which I think is a very good one, but at some of the challenges that we face. We did produce a standard template contract in 2007 as a means of driving forward the debate on contracts, and it has generated some debate, and we have relaunched that contract, and yesterday we launched a further campaign trying to push the debate on contracts and the Commission’s dairy package further forward. The challenge for us as a trade association is that we are bound by competition law not to bring individual undertakings-i.e. individual farming businesses-together to do something of that kind of nature. I think it would be a serious breach of UK and EU competition law for us to do that.

Q20 George Eustice: Just coming back, if you support the Commission’s proposals and they talk about having if not a set price determined in a contract then a means of determining what the price should be, what might that means be if it is not a fixed price for a fixed period?

Tom Hind: Again, as I said, I think there needs to be some flexibility. The important thing is that the terms and conditions by which prices should be varied are set out in advance in the contract; at the moment, there is a base price that can be varied by just one side. At least having clarity is important.

Last week our counterparts north of the border in NFU Scotland come out with some interesting proposals that suggested that there might be some kind of base formula that could be included in contracts. We are having some discussions with them about their ideas, and we are examining them closely. I think in reality because different supply chains are operating in different markets, the reality is that the terms and conditions on price variation are bound to vary from farmer to farmer, from market to market, and that should be encouraged, but at least having some clarity and certainty about what variables make up the price should be included in a contract.

Q21 George Eustice: What types of things might it be, though, just tangibly? Are you talking about the world market price?

Tom Hind: As NFU Scotland suggested, it could be tangibles, like you operate in a formula that includes known commodity market indicators, like the milk-for-cheese value equivalent, or the actual milk price equivalent. It could be based on other indicators, such as indicators of production costs: the retail prices index. It could be based on the agricultural price index that is published by DEFRA. There is a range of different indicators out there. It is not for us to recommend a one-size-fits-all approach. Again, the principle should be that the terms and conditions by which prices are varied are known and understood by the farmers before they sign the contracts.

Q22 George Eustice: And finally, what do you think a fair notice period would be? That is something else you say should be stipulated.

Tom Hind: Again, this is not for us to determine, but the level of notice should be commensurate with the level of risk that the farmer is bearing. So if the farmer is bearing a considerable amount of risk in terms of the ability of the price that he gets paid for the product that he supplies to be varied quite radically, then clearly notice periods should be relatively short; whereas, if there is certainty and predictability about the price that he should receive, there is a clear case for the notice period to be longer.

Q23 Tom Blenkinsop: Hello, Mr Hind. Under current UK competition law, producer organisations can take up to 25% of national production, and yet the largest UK co-operative accounts for just 11% of production. What factors are discouraging greater consolidation in the industry?

Tom Hind: First of all, just to establish one point in terms of UK competition law, as far as I am aware the definition of relevant markets remains one for the UK competition authorities, i.e. the Office of Fair Trading, to decide. So whilst there might be some indications out there that suggest that up to a certain level you can have a degree of collective bargaining, nowhere are they set out in absolute, clear terms. The Commission is proposing, within its package, an ability for farmers, through producer organisations, to collectively negotiate contracts up to 33% of either the national market or combined national markets across a number of different Member States, which is one approach that you could take. We have to bear in mind that the Office of Fair Trading operates some fairly arbitrary distinctions about what is and what is not a relevant market.

What prevents farmers from consolidating? First of all I think we should recognise that there has been some consolidation. Over the course of the last 10 years we have seen farmers come together into groups, either the co-operatives that fell out of the enforced collapse of Milk Mark in 1999/2000, which has now lead to the two vertically integrated co-operatives operating in England, Wales and Scotland, or the development of direct selling groups amongst the private dairies, where farmers have collaborated and co-operated in groups, where there is at least some discussion taking place about the relationships they have with retailers. However, those groups, by virtue of both the contracts that they sign-which are individual to the farmer and the company, not with the group-have rather weak bargaining power, in the sense that they do not collectively negotiate, because again, the contracts are individually held with the individual dairy farmer.

Q24 Tom Blenkinsop: Dairy UK argue that the exemption to competition law would reduce investment and create inefficiency. How would you respond to that?

Tom Hind: I would be interested to know what their arguments are, because I am not sure how that would inhibit investment and create inefficiency. The only inefficiency it might create from their point of view is, again, an inability to adjust milk prices downwards and protect margin.

Q25 Richard Drax: Would there be a material difference in bargaining power or competitiveness between a 25% and 33% producer organisation?

Tom Hind: I think it is very difficult to say. There is not a massive amount of clarity within the draft regulation in respect of how bargaining power or co-operation in terms of collective negotiations could operate, and whether it is 25% or 33% may to some extent seem a peripheral debate, especially when the draft regulation inserts a derogation that allows national competition authorities to set lower thresholds on an individual basis, or to intervene to prevent a collective negotiation from taking place below that 33% threshold. I think in general terms the regulation that has been drafted by the Commission prohibits against hard-line, red-line prohibitions of EU competition law, and therefore I see no reason why the 33% threshold should not be supported.

Q26 Richard Drax: Would the creation of producer organisations have an impact on small-scale dairy producers?

Tom Hind: I think the question really is whether the creation of producer organisations as a legally constructed entity would bring advantages to British dairy farmers, and given that we do not have a massive amount of certainty on the detail of the package, it is difficult to say. The concept of producer organisations exists in other industries: they are legally recognised in the fruit and veg sector, in the wine industry, in tobacco, which of course we do not grow here in the UK, and part of the reason that they are established is to draw down community funds to finance operational programmes, which are about improving the marketing position of collective groups of farmers, at least in the fruit and vegetable sector.

In relation to the dairy package, the hook, if you like, is different: it is not to draw down funds; it is to be able to collectively negotiate-to at least have a degree of legal certainty at a community level that, as a group of farmers, you can collectively negotiate contracts with a customer. This is particularly an issue for, say, farmers in Germany, where you have a number of very small producer groups, say in Bavaria, who are concerned that their ability to collectively negotiate with their customer is undermined by national competition law, which is not clear on this point. So it gives a degree of legal certainty and legal clarity. To that extent it could help and encourage our own producer groups who are working quite closely with their own private dairies to become much more cohesive, much more united, and perhaps more professional in the way that they conduct negotiations. Now, that is a general statement based on the very limited amount of detail that we have at this stage, but it is certainly something that we are looking into, and something that we are discussing with producer groups actively as well.

Q27 Neil Parish: I just want to take you back to First Milk and Milk Link, who I think have about 10%, 11% each. Certainly when we talked to the Minister, he was not against the idea of those two farmer-owned co-operatives combining or co-operating, because at the moment do they not create competition with each other, rather than necessarily help get the price up for producers?

Tom Hind: My personal view is that they do: they are competing in similar markets; they are both commodity-cheese manufacturers; they operate in slightly different geographical locations, but essentially within the same market, and that creates more competition within that market. We do need to see consolidation in dairy processing, particularly in the cheese sector, and I think it is really up to the individual companies to answer the questions as to why they did not merge. We certainly encouraged that merger at the time. There may well have been specific commercial reasons that inhibited that merger from taking place. The important thing is that we do need to see that consolidation to ensure that we have a much more efficient and competitive milk-manufacturing sector in future.

If you look at the decisions that were taken at the time, the important thing is that not only, as you say, has the Minister given an indication that is something he would encourage but at the time the merger was proposed the Office of Fair Trading also gave its assent at the first stage for that merger to take place. That serves to exemplify that, where we are involved as an industry in more European-wide commodity markets, like cheese, there is an opportunity for the industry to consolidate commercially where it chooses to do so, but it is the commercial decision that matters here, and not necessarily the position of competition authorities.

Q28 Chair: Can I just press you on what NFU members would prefer: would you rather have a price stipulated by market indicators than one that would be free to negotiate with one buyer?

Tom Hind: They are potentially one and the same thing, in the sense that if you had an exclusive contract you could still have a contract that specified the price determinants. I think all of our members want a degree of clarity, certainty and predictability about the factors that will influence their milk price for the duration of the contracts that they sign.

Q29 Barry Gardiner: I want to ask you about quotas in a minute, but before I do could I just ask you: in the rest of Europe, would it be fair to say that dairy farmers play a more active role in the value-added end of milk production, in terms of producing localised cheeses, in looking at that part of the market where they can actually get some of that value-added for themselves?

Tom Hind: I am not sure I would agree entirely. I think we have seen quite a considerable degree of diversification at farm level, to the extent that the British Cheese Board lauds the fact that we have more varieties of cheese here in the UK, which in large part is due to innovation at farm level, and looking at the demand and desire from our customers for food of provenance. I think the farming industry has been able to exploit that to the extent that it can, but we have to recognise that we produce in excess of 13 billion litres of milk in this country. Not all of that can be supplied into niche markets; it has to go into some pretty big commodities, of which fresh liquid milk is one, and that is a largely commoditised market. The other part is generic cheese, which some of our dairy companies have tried to add value to, but frankly, essentially is a commodity product and is priced as a commodity product.

I think the bigger challenge is at the company level, the manufacturing level. Yes, we have seen some fantastic innovation by dairy companies to develop new products and put those products onto market, but again, we do not have the historical legacy of investment at a commercial level by companies like Arla Foods, like Friesland Campina, like Lactalis and so on, and right the way across the European Union, into a wide spectrum of added-value products on a range of different markets. We are starting from some way behind, and I think the real problem is in our ability to diversify the product portfolio at the manufacturing level. This is not to criticise the companies, because I think they have done some really good work, but their ability to compete has been impeded to some extent by historical legacy.

Q30 Barry Gardiner: That is very interesting. How could the Committee help you-or how could Government help you-to get more investment into that industry to see that diversification?

Tom Hind: In relation to manufacturers, it is really a question that is best posed to the manufacturers themselves. I hope that you will ask the same question of Dairy UK. I think it would be unfair of me, as a representative of producers, to comment on the needs of manufacturers. All I can see, at this very aggregate industry level, is that we have a massive exchange rate advantage, we have relatively efficient, well-invested producers operating on quite low milk prices, and yet we are still importing in excess of 70,000 tonnes of cheddar cheese from Ireland every year. So there are some big questions about the structure of our industry. That suggests to me that we are not as competitive as we perhaps could be.

I think in terms of what Government could do from a farming point of view, we have always accepted that most of the solutions for the industry are commercial; they are not for Government. But Government can play a facilitative role in terms of setting the rules of the game; helping farmers to invest; ensuring that the fiscal incentives are there for farmers to invest in infrastructure in their businesses; and ensuring that we have a rural development package that encourages farmers to diversify, to acquire new skills, to collaborate and to consolidate. Here we have a package of measures that has been outlined by the European Commission that may not be perfect but at least offers some opportunities. Rather than dismiss those proposals, the approach of the UK Government should be to try to work with those proposals to refine them to help make sure that they deliver long-term advantages for British dairy farmers.

Q31 Barry Gardiner: Thanks very much. That has given us some good prep for our next engagement, but I will return to my homework for today on quotas. The Commission has talked about the process of soft landing in getting us down from the whole business of quotas. If and when quotas end across Europe, what would the effect be on milk prices in the UK, in your view?

Tom Hind: I think the experience of the last few years and the volatility in the market shows that anybody who tries to predict a trajectory for milk prices in line with changes in milk quota and production volumes is either very clever or very silly. I think one thing we can be certain of is that milk quotas will end on 31 March 2015. There is no dispute about that; there is no longer any disagreement across the European Union-that will happen.

What will happen as a consequence of that is a matter of some conjecture. We have not seen the European Union fill the additional quota that has been allocated to the European Union over the course of the last three or four years. Nevertheless, some individual Member States have been able to increase production and would like to increase production further. Some of those Member States happen to be our competitors: the Netherlands, Denmark, and in particular the Republic of Ireland. I think we need to watch what happens in Ireland very closely, because the Irish Government and the Irish food industry has a very ambitious export strategy, which includes increasing its scale of dairy export by, I think, between 50% and 100% over the course of the next two years. Whilst the Irish Republic has important third-country markets right the way around the world, by far and away its biggest export market is the United Kingdom, and, if we do not follow and anticipate trends in Ireland at a commercial level, then there is every risk that we will continue not only to see the importation of significant quantities of Irish butter and cheddar cheese every year but increased quantities. It is important that we have a competitive manufacturing industry to deal with that.

Q32 Barry Gardiner: What is your take on the Commission’s suggestion that there might be a compensation package for reducing by 1% or 2% when required? How would you see the effect of that continued subsidy?

Tom Hind: I do not believe that the Commission’s proposal is the most intelligent one. I think farmers across the European Union would benefit from certainty, in particular the certainty that would come from ensuring that milk quotas are increased in a progressive fashion and abolished 2015.

Q33 Barry Gardiner: DEFRA is sceptical; you say it is less than intelligent?

Tom Hind: Let’s say we would be sceptical about the merits of that measure as well.

Q34 Mrs Glindon: Can I ask you, how should the value of milk be distributed through the supply chain? Should a particular proportion of the retail price of milk or cheese go to the dairy farmer?

Tom Hind: We make no statement about how margins should be distributed, only that farmers should receive what we consider to be a fair price, a price that reflects the investment that dairy farmers make in building up their herds and investing in their businesses, in trying to achieve economies of scale, and to meet the production costs that farmers face. What happens thereafter is a subject of commercial negotiations. Clearly there has been some important illumination given on margin distribution in the supply chain, but 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. There are obviously two components to that. One is the relationship between farmers and the companies that they have business relationships with-and that brings us back to the issue of raw milk contracts-and the second is the relationships that those companies have with their customers, which of course is a matter for the Groceries Supply Code of Practice, and hopefully the grocery market adjudicator when that is introduced.

Q35 Mrs Glindon: Can I just ask you, will the Commission’s milk package proposals or the grocery code adjudicator help dairy farmers achieve a fairer proportion of retail price of milk?

Tom Hind: I believe that the Commission’s proposals could go some way to giving greater certainty, clarity and predictability. I do not necessarily believe that they would lead to a whole scale redistribution of margin, but they would certainly prevent the position of farmers from being eroded by offthecuff decisions that are taken by milk processors who have conducted a weak negotiation with a customer that has led to them cutting their prices for the product that they sell to their customers by quite a lot. That might sound like a longwinded description, but what I am saying is that they would inhibit some of the shorttermism that takes place in terms of milk pricing. They would not necessarily redistribute margins.

Again, as far as the grocery market adjudicator is concerned, and the GSCOP is concerned, what it is there to do is to eliminate the abuse of power, not to distribute margin. It is about ensuring that we eliminate some of the abuses that continue to take place that we do hear about that exist at the top of the supply chain. That might bring greater certainty and predictability for manufacturers in their dealings with retailers; it might reduce the extent to which they are forced-again on a whim-to provide large financial handouts to some of their customers that are not written into contracts, and thereby might provide a much more stable industry environment, but it would not of itself redistribute margin.

Q36 Mrs Glindon: You mentioned the customers at the end. Do you think consumers are sufficiently aware of the impact of retail prices on farmers?

Tom Hind: I think we have seen an increased awareness amongst consumers about some of the issues within the supply chain. The consequence of that has been that we have seen some development by grocery retailers to offer better terms and conditions to farmers through dedicated supply chains, and that has had a benefit for the minority-albeit a relatively large minority-of dairy farmers who have the ability to access those contracts.

But there is a much wider problem outside of those arrangements in the rest of the industry that I think to some extent does go unnoticed, and it is important for organisations like the NFU, Dairy UK and others to try to bring that to the public’s attention. At the end of the day we want a British public that values British products, that believes that British dairy farmers and manufacturers are producing high quality, innovative, exiting dairy products, in which all parts of the supply chain generate some added value and some benefit from. Ultimately, given that we are operating in a market economy, given that ultimately it is customers who make decisions about what we produce, how much, where and when, many of the solutions to the problems in the industry can only be found by the interaction we have with customers.

Q37 Mrs Glindon: It is getting people beyond just perhaps the cheapest prices.

Tom Hind: I think we have to be mindful of the fact that, in times of financial hardship, at least some consumers are very careful about expenditure, and that is why we do see at this moment in time much more discounting, more promotions being offered to try to maintain brand levels through supermarkets and elsewhere, and that does have, potentially, negative consequences in the short term.

But I think at least in the long term-provided we have a stable economic recovery and growth in the future-the prospects for the British dairy industry ought to be positive. We have a very good market here at home: over 60 million consumers who are relatively affluent. We have a well-structured, well-invested dairy farming industry, we have some cracking processing facilities, and we have a massive market that is growing on our doorstep that we could and should be exploiting much more than we are doing at the moment. So it is not all doom and gloom; there are some really positive spots out there, but it is important that we correct these systemic failures in the dairy market once and for all. Although again the Commission’s proposals do not provide anything near the totality of the answer, they at least provide a partial solution to one of the biggest problems, which is the way that raw milk contracts operate, which is fundamentally exploitative.

Q38 Mrs Glindon: Can I ask you finally: do you think that the introduction of dedicated supply chains has benefited dairy farming as a whole?

Tom Hind: Yes I do. I think the benefit has of course come to those individuals who have been able to benefit from those direct supply contracts, and that is not anywhere near universal. But I think the one thing it has done is moved us from a situation where every single dairy farmer is a "have not" to a situation to where we at least have some "haves". Okay, there are some big challenges in the wider industry, and some may argue that the creation of dedicated supply chains has exacerbated and increased the pressure that retailers exert in terms of the wider market; it is difficult for me to demonstrate or prove that, but compared with the situation that I experienced when I entered the dairy industry about seven or eight years ago, we at least have a degree of certainty, where the producers who are supplying a 365-day-level supply, high-quality product into the liquid market can at least benefit from some greater degree of certainty and predictability about the relationship they have with their customer.

Q39 Amber Rudd: Putting the Commission’s proposals aside, what else do you think the UK Government should be doing to support the dairy industry?

Tom Hind: Again, as I said before, the bulk of the problems, and indeed the bulk of the solutions for the industry, lie within the industry itself. They are only for the supply chain either collectively or individually within different companies to resolve: there is no single solution, and there is certainly no magic bullet that DEFRA can fire.

But there are a number of things that the UK Government can do. Clearly we have been encouraged by the fact that the Minister has sought to re-energise the Dairy Supply Chain Forum. That could be a useful vehicle for trying to resolve some of the rhetorical problems that the industry faces. We think that DEFRA could work more closely with the industry to draw up a code of contractual best practice that goes beyond the European Commission proposals that are at a very basic level to say, "What should a contract consist of? What should be the ideal terms and conditions?" That is something that Government could work on constructively with the industry.

We think that Government could look at how information on prices and margins in the supply chain is delivered. Clearly we have to be careful about infringing commercial confidentiality, but equally it is important that farmers understand the market environment they operate in. The fact that they receive a price that is here, yet commodity market indicators are here indicates that there is a lacuna in terms of the information that is provided on how markets are trading.

Finally, we think Government could look at the way that the Rural Development Programme works, and I think the opportunity to bring the delivery of the Rural Development Programme for England into DEFRA and away from the Regional Development Agencies, a much more centralised approach, provides some opportunities to look constructively in the next couple of years at how national measures can be packaged that might benefit dairy farmers in terms of helping with skills, knowledge transfer, and the professional capability of those people who negotiate on behalf of dairy farmers as well.

Q40 Amber Rudd: Thank you. Do you think that the introduction of Government buying standards might be helpful?

Tom Hind: I think it would be helpful in terms of addressing one of the persistent concerns that our members raise about the standards to which Government departments buy. We were expecting Government to come forward with a set of standards before the parliamentary recess. That has not happened. We are hoping that they are produced early within the next month or so, and we look forward to receiving those proposals when they come forward from Government.

Q41 Amber Rudd: And what about labelling? Do you think that we could do better on that?

Tom Hind: I think we could do better on labelling. There is a gap, certainly in processed products, in terms of determining the origin of labelling. A good example again is Irish cheddar, which can be imported by a company operating in the UK, cut and packaged here in the UK and labelled with a UK health mark. It does not need to be labelled as Irish cheddar. I think it is important that we do have a much more universal approach to origin labelling. I know the UK Government favours a voluntary code in terms of origin labelling; that takes us so far, but we think it is really important to get behind the package of measures that was agreed at second reading in the European Parliament a couple of weeks ago that extends mandatory origin labelling away from red meat into dairy products as well.

Q42 Amber Rudd: Thank you. The British Retail Consortium described the UK dairy sector as "well placed to meet increasing global demand". Do you think there is anything else that DEFRA could do to improve export potential in the dairy sector?

Tom Hind: Again, I think this is really a question that needs to be posed towards milk processors, since they are the ones who will primarily be interacting with export opportunities, rather than farmers. I think there is a discussion about the legacy of food from Britain and whether we have an aggregate proposition to make into our key export markets as a food and farming industry. These decisions predate my involvement in these issues. But I think there is a discussion to be had about the extent to which-through UK Trade & Investment for example-we could be looking at facilitating food markets overseas, as well as wider services, industrial goods, pharmaceuticals markets, which are the core focus of UKTI.

Q43 Chair: You mentioned Irish cheddar, but is it not the case that British lamb benefits by being finished in France and sold as French lamb?

Tom Hind: We have nothing to hide. We operate within a single European market. We have no problems with the idea that products that are exported from the UK are labelled as UK products.

Q44 Chair: Can I just ask: what help is there to dairy farmers especially who have left the industry moving into other sectors, and particularly those who have left the uplands?

Tom Hind: There is no financial assistance that is available; there is some kind of restructuring package if that is the angle that is being examined here. Many of the decisions that are taken to exit dairy and go into some other sector are based on the perception that the prospects of those sectors-either in terms of market returns, lifestyle, ease of work, labour and so on-are easier than they are in dairy, which is a relatively resource-hungry activity from a farming point of view.

Q45 Chair: The concerns about slurry, the liquid slurry that comes out, has that been an issue with farmers leaving the dairy sector?

Tom Hind: It is an issue. The extent to which we can quantify how many dairy farmers have ceased or are maybe looking to cease production because of restrictions in nitrate vulnerable zones is difficult to give with any clarity, but it certainly is an issue, because the cost of compliance, in particular to have the necessary storage capacity available to comply with the close periods under NVZ rules, is quite onerous and quite significant, and of course because of decisions taken by the previous Government to phase out agricultural buildings allowances, it is no longer tax efficient for farmers to make the investments in those kind of storage capacities. That is something again that Government could look at-making sure that we have the right kind of fiscal incentives to help farmers deal with the cost of compliance.

Q46 Neil Parish: That leads on quite neatly. One direction that UK dairy farming could take is to go forward with the super-dairy: thousands and thousands of cows on one farm. Should DEFRA take a more proactive role in engaging the public on issues of super-dairies, and what position does the NFU take on the matter?

Tom Hind: I think we all have a responsibility to communicate the facts and ensure that facts are not overridden by fiction in respect of larger scale dairy farming. I think we should be careful about generalising a single direction of travel for the industry. There are many smaller scale family dairy farming businesses up and down this country that are robust business units, and are likely to remain robust business units, and are likely to remain a key part of the dairy farming landscape. Equally, it will always be in the interests of a large proportion of the British dairy industry to take advantage of our natural and geographical benefits that come from rainfall-maybe not this month, but normally-in certain parts of the country to produce grass. So we are always going to have industries that capitalise on that, and larger dairy businesses do not lend themselves very well to that kind of full-scale grazing operation.

But the important thing for us is that we have an industry that invests, that is competitive, that is efficient and is fit for the long term. To be able to compete, we need to seek economies of scale, and that means that we do need to look at ensuring that we have the ability to consolidate and to grow much larger farming businesses. That, for us, is an important development, but it is not a universal development that we will see, and certainly, yes, we do play a role as an organisation in trying to communicate the facts about large-scale dairying activities and what we think the benefits might be, not just in increased economies of scale, in terms of increased competitiveness, but better animal welfare, better environmental management, ability to deal with carbon emissions and so on and so forth. It is important that we look more holistically at the benefits that could come from some of these units.

Q47 Neil Parish: Part of me agrees with you entirely on the competitive side, but the other side of it is aren’t they one way of putting more family farms out of business? When you are trying to promote cows grazing and happy cows like Kerrygold Butter and the like, when you are trying to market that, you are keeping the cows indoors all the time. I think there is a serious question here: if you are promoting a dairy industry to the public, is it the right image we necessarily want to push?

Tom Hind: I do not understand the arguments that are advanced by some that the development of larger dairy farming enterprises somehow puts smaller businesses out of operation. There is no evidence to substantiate that argument. Again, we have seen a significant contraction in the scale of milk production in this country, and the fact that we might have some, and a relatively small number, of businesses that are looking to increase scale ought to be seen as a means of helping us redress that systemic decline we have seen in UK dairy farming.

In terms of industry image, I think it is important that we portray the dairy-farming sector as a business that needs to operate in the marketplace. Yes, it needs to be environmentally sustainable; yes it needs to respond to consumer demands; yes it needs to ensure that it has the highest standards of animal welfare and husbandry, but they can come from larger dairy businesses as well. What matters to us is not what a farm looks like but how that farm operates, making sure that it is operating to the highest standards, and we can generalise right the way across the industry about what is good and what is bad in terms of standards, but it very much comes down to individual management within that unit, rather than scale of production.

Q48 Chair: Mr Hind, you have been very kind. We are about to be interrupted by a vote. Can I press you on two issues: should DEFRA take a more proactive role in engaging the public on issues such as super-dairies? You also referred to whether DEFRA should look at providing assistance to farmers preparing for the new criteria for NVZs. If I could press you on what you would like to see on those two points.

Tom Hind: Again, I think it is largely for the industry to ensure that it portrays itself to the outside world, but I think Government does play an important role in ensuring that the facts are presented, and ensuring that at least agencies of Government do not use media perception as a means of influencing decisions they take on future dairying businesses. I think it is certainly a question that you should ask Dairy UK, given the involvement that they have with the dairy councillors-the industry’s representative body in terms of its external image-later. But certainly we would think it important that the Government helps to establish facts and helps to ensure that prejudice is not used as a means of discriminating against businesses.

Q49 Chair: So your bottom line would be you would like certainty and greater transparency?

Tom Hind: And predictability.

Chair: Thank you very much indeed for being with us; you have been very generous with your time. If I could invite the witnesses to take their place, I will adjourn now because there is going to be a vote at four o’clock, and we will meet again at quarter past four. There is only one vote. Thank you very much indeed, Mr Hind.

Examination of Witnesses

Witnesses: Jim Begg, Director General, Dairy UK, Peter Dawson, Policy Director, Dairy UK, Mark Taylor, Group Milk Procurement Director, Dairy Crest, and Rex Ward, Chair, Dairy UK Farmers Forum, gave evidence.

Q50 Chair: Thank you very much for being so patient. Would you introduce yourselves from the left for the record, and could you please say which company you are from?

Mark Taylor: My name is Mark Taylor; I am from Dairy Crest and I am the Group Milk Procurement Director.

Rex Ward: My name is Rex Ward. I am a dairy farmer from Cornwall. I was also the Director of Milk Link Cooperative.

Jim Begg: My name is Jim Begg; I am the Dairy UK Director General.

Peter Dawson: And I am Peter Dawson, Policy Director for Dairy UK.

Q51 Chair: Thank you very much for being with us this afternoon and participating in our inquiry. Can I just ask at the outset, do you think there is a fair balance between the parties to a contract at the moment in the dairy sector? Mr Begg?

Jim Begg: Yes, I think we do. I think that one of the success stories of the British dairy industry over the last 10 years has been the development of the relationship between farmers and processors, and it has been down to supply groups. That has resulted in a much closer connection; it gives a much clearer understanding; it gives a greater awareness of what the supply chain is doing; and it gives farmers a clearer insight into the market. At a time when there is a clear demand for an increase in transparency and an increase in certainty, what we have to understand is that we are going into this situation at a time when the uncertainty is becoming even greater, because what we believe is the biggest issue going forward is the whole question of how we manage volatility, both volatility in the input costs of farms and also volatility in the market returns. So we are moving into a period, and in fact we are dealing with what you might consider to be a transition, where the volatility of the marketplace is even greater.

But what we have seen, as a result of the closer connections in farm groups, is the development of contracts. We would agree with much of what the NFU has already told you, but we would challenge the concept that the contracts that exist in the UK industry are inadequate in some way. In fact, we think that the contract evolution in the UK has been much greater than in any other Member State. It is important to remember, as we consider the dairy package, that we have got farm contracts: every farmer has got a contract. We think that is a very important point of principle. That does not happen in other Member States. But we have been able to evolve these contracts. We have a range of contracts; we have contracts that suit the business in particular and allow the relationship between farmers and processors to develop in a way that-as we said in our submission-allows the payments of market premiums. My colleagues can elaborate on the way in which that has been done.

Q52 Chair: We will go through that. Just at the outset, I find it a little strange, and I wondered if you shared that feeling, that perhaps the key terms of the contract are not known by the farmers at the beginning of the period of the contract. It would not happen in any other sector.

Jim Begg: That is very much in the nature of the market. It is not just a feature of the UK; it is a feature of effectively all dairy markets right around the world. We have looked at this very closely and we see a great degree of similarity in the pricing arrangements that prevail between processors and buyers.

Q53 Chair: It does not make it right, just because it happens everywhere else.

Jim Begg: As I say, we have advanced the cause, if you like, of trying to make contracts more understandable and more reasonable than pretty much anywhere else, and we would challenge the suggestion that the farmer may be in a vulnerable situation as a result of that, because the way milk prices are calculated, the way they are derived, it is very important to understand that milk prices are driven by the trend in commodity markets: commodity markets are determined by the supply and demand for milk globally, so there is only so much that any particular national country can do, but that is the way it has developed. That means that dairy companies, if they are to receive a supply of milk, have to pay a commercial milk price. So dairy companies are paying a commercial milk price. They are paying a price that is driven by the market, farmers have protection from that, and that is the way it effectively applies in the UK, and pretty much around the world.

Q54 Chair: And you do not agree that the level of risk is mostly on the farmer?

Jim Begg: The level of risk is spread fairly evenly across the supply chain. Of course one of the issues is the whole question of cost recovery, and the ability of the industry to recover costs. Sometimes the view is put forward that the market is not working because, say, the milk price does not cover the cost of production. That is no more true for farmers than it is for any other part of the supply chain. No one in the supply chain in a commercial open market can rely on cost recovery. So because that does not happen does not necessarily mean that the market is not working or is in some way dysfunctional. There is a degree of protection that is within the system and the way that milk prices are generated. What the contracts can do is develop from that and try to steer the relationship between the farmer and the processor in a better way to get the maximum welfare of the market.

I should also just say that we have very much the same interests as NFU. We are looking at this whole dairy package from the point of view of getting more wealth out of the market, and in fact how it addresses the various issues that we see are important going forward, and very much part of that is the fact that we have profitable farms-farmers who get a good return for their labour, and also have investment funds to go into the future. If farmers do not have investment funds for the future, we have no farmers and we have no industry, so there is nothing to gain from a processor driving prices down below the price that the market throws up, or in any way doing anything that would not encourage the development of the profitability of farm enterprises. It is absolutely at the core of our assessment of the dairy package.

Chair: We will explore this.

Q55 George Eustice: Would you agree with the Commission’s assertion in their memorandum to their proposal that the milk sector went through a deep crisis, and this shows some of the shortcomings in market orientation in the milk sector?

Jim Begg: Again, as I say, the way we have looked at the Commission’s package is that what we are heading towards in all of this is an open market and a free market, and we have been led into that situation. We have been encouraged to head forward to a free market, all the signals from the Commission have been to that intent, and we are supportive of that because we are moving away from the whole concept of regulation and we see our future very much in an open marketplace and operating on commercial principles of competition. The Commission’s package coming back and introducing the possibility of regulation naturally was something that we looked at with some degree of scepticism because, if you like, it takes us a step back, in our view, rather than a step forward.

Q56 George Eustice: But leaving aside what their proposal said, which I think we will come to later, do you recognise that the dairy industry has been through a period of deep crisis? You are very bullish about the dairy strategy, but the NFU and the Commission are not.

Jim Begg: We are not in denial that there are some very real problems in the sector in the short term. We are of the view that you have to take a long-term perspective on these things; you have to look at the situation in the long term. It is very easy to look at the current system that you are in, for example, look at the milk price and the return from the marketplace at one point of time, and deduce a forward policy-a wrong policy, in fact, because the position that you are in at any particular point in time is not the one prevailing in the long term.

What we have seen in the last three years, and what the dairy industry and the European Community have seen, is a huge, massive increase in the volatility of markets. Many people consider that the volatility of revenue and returns in the marketplace is the key thing. I think from a farmer’s point of view, the real big issue is the reason for the volatility in input costs. We have seen a huge variation in input cost, and that has undoubtedly created pressures on some farms-not all farms, but many farms. The crisis that we talk about in that sense refers to the crisis of the volatility of markets, and we are all engaged-all engaged: farmers, processors, industry bodies like ours-in assessing and managing that process. So it is a transitory arrangement coming out of what you might consider to be the relative stability of the markets that we had when the price was heavily subsidised, and when we had support schemes and community budgets and that kind of thing, so we had to make that transition.

So it is less a crisis-although I am not denying that there are some real problems-but more an evolution to a new set of circumstances, which, frankly, we think are going to continue in the future.

Q57 George Eustice: Is there anything that you think DEFRA should be doing within the current legislative framework that would help support the industry?

Jim Begg: In terms of the price?

Q58 George Eustice: Just in terms of dealing with the crisis in the dairy industry; is there anything more it should be doing?

Jim Begg: As I say, we see the future very much like the NFU: the industry has a responsibility to move through the situation, to move to the new scenario, which I should also say we see as very positive. If you take a longer term view and you look at things on a longer terms perspective, there are a lot of positives, which should see this industry develop, nurture and be prosperous in the future.

But in terms of the Government involvement, all we do ask from the Government is to ensure that there is no structure imposed in the industry that renders us uncompetitive in any way with the competition that we compete with in the marketplace, and that can cover things like the dairy package, because we believe that there are some aspects of the dairy package that that might do. All we ask from the Government in that sense is to recognise these and allow the industry to prosper-farmers and processors-to get the wealth. The big issue for the dairy industry is getting more wealth. The key driver is increasing the pie. The disappointing aspect for us of the dairy package is that it does not do that, and that is a major disadvantage from that point of view. As we understand it at the moment, it is still evolving.

Q59 George Eustice: In terms of the NFU, we were talking earlier about the potential to increase dairy exports. Do you think there is anything on that front DEFRA could be doing to encourage that?

Jim Begg: Again, the description of the situation of the British dairy industry as far as its exports are concerned was precisely explained by the NFU in the previous evidence. We are to some degree a victim of history. In the past our focus and Government focus was very much on providing milk for the domestic market, and the rest of the products were sourced from other parts of the world. That was the policy. We moved into the European Community and we hit the problem of quotas, which immediately ossified the production levels in the UK. If we are to move from that situation into one that is export-led then we need more milk in which to do that, effectively; by and large we need more milk to do that.

I would like to think that at some point, when we see the relaxation of the quota regime, we would be able to exploit that in a more export-oriented way. However, it has to make sense from an economic point of view. There are very large costs of capacity that we must incur in order to be competitive in the global export markets of the future. We are a very long way away. It is certainly true that when most of the British dairy companies look at this, they see the potential more in the terms of import substitution and more in moving as much product away from commodity markets into added-value markets. We see the future in terms of a greater production and penetration of added-value markets. Now, if these are export markets, so much the better, but it has to make economic sense for the dairy industry. If it made economic sense for the dairy industry now, we would be doing it.

Q60 George Eustice: Okay. I just wanted to ask Mr Taylor a question, which is: if Dairy Crest went along to a supermarket to negotiate a sale, and that supermarket said, "You are not allowed to sell to anyone else in the world except us. All of your products must come through this supermarket alone. We want you to commit for a long period of time. When it comes to price, well, we will see about that when the time comes", do you think your shareholders would be happy if you signed such a contract?

Mark Taylor: I can see the analogy that you are drawing. I guess that would be a commercial decision that we would make on the facts that were presented to us at the time. Certainly in respect of our farmers, I have about 2,000 individual farmers that supply me; I certainly have individual contracts with each farmer. Those contracts do vary, and there is quite a proliferation, a range of contracts, and certainly in the last two to three years that range of contracts has increase in order to recognise the individual differences that exist between some of those farms, and in order for us to be more flexible in meeting both our farmers’ needs as well as our own and our customers’. That flexibility is extended to the point where we have fixed the price on a contract for a long period of time.

A year ago we set up a contract that fixed the price for farmers for two years on the volume that they supplied to us. Of course, that did not work as well as it could have done, because as Mr Hind indicated at the outset of his evidence, not only have we seen volume increase in the last 12 months or so, but we have seen prices go up as well. Those farmers that had fixed their input costs at the same time that they fixed the price that I was going to pay them for two years would have been in a good position, and those farmers that went on to that contract wanted to do it because they wanted certainty; they wanted to invest in their businesses. Moreover, they wanted to be able to prove to the banks that were going to lend them the money to invest in their businesses that their income was going to be secure. Not only did they have a processor with whom they had a contract that was going to take all of the milk that they produced-as indeed we do for every single farmer that supplies us, and my competitors would be in the same position-but we were going to guarantee the price.

I guess that demonstrates that whilst fixing the price might appear to be attractive, there are a number of moving parts in this industry and in these markets, and it is not always the solution. What you need is flexibility, and what my shareholders would not thank me for is not providing our business with a sustainable supply of milk, and that is the key point here. If I had to sum my job up, it is to provide a sustainable supply of milk for a demand-led business. That is the key. There is no value in me, whatsoever, in taking advantage of farmers that supply me. Yes, I have to be competitive in a very competitive market, where consumers are under pressure, my customers are competing with each other and I am competing also to hold or grow my market share. But there is no value in my doing anything to damage that supply chain.

Q61 Tom Blenkinsop: In your written evidence you suggest that regulation in the form of compulsory contracts would increase instability. What was the basis for that assertion?

Rex Ward: I am a farmer, so I work from that side. One of the reasons that we help set up Milk Link 10 years ago was for stability and security of supply. Without a milk contract, I have cows with no milk to go. It is great when you have 10 people knocking at your day saying, "I will take your milk," and in fact that is what happened when deregulation came in when Milk Marketing Board finished in 1997. There was a proliferation in contracts, the milk price went up to about 26 pence a litre-this was 13, 14 years ago-it was very good because everybody was competing for your milk at that same time. If I wish to invest on the farm, which we have, we want to know that we have a security of supply and a long notice period.

Now, in a way, I have a milk contract with myself, because I own part of the processing business. Milk Link is a fully integrated processing coop, similar to the European style. Any benefit that comes back to that comes back to me as part owner of that business, in effect, as a dividend. We cannot call it a dividend because of the co-operative structure. If I have three months’ notice or a very short period, which is really what Tom and the NFU are almost advocating, that is great when there is a great demand around there. We have discussed this at our members’ meetings and things like that, and asked our people if they would like to do that. In fact, we have got a contract in the north of England, when we took on some other suppliers who are not actually members. That was on a three-month contract, and they have moved away from that, because they did not have the security, because the image is that you negotiate together-and we will come on to producer organisations no doubt-you have a volume, and you sit around the table, and you have a lot of people beating down to take your milk. I think it was said earlier on that in Cornwall you probably have two main buyers, which would be Dairy Crest and ourselves, and in some parts of the country we have people who want to join us but we have not got that demand.

The other thing is, as a dairy farmer I also sell cattle, I sell culled cows, I sell other things, going back to the Chairman’s question. None of those can be guaranteed ahead in any base structure. There are some things that work on formula: we have up to 28 different contracts within Milk Link with those people who are specialists or suppliers of different types. So there are a whole range of those, but the fundamental is-I have a son of 31 and I asked him this question, and we have considered this issue because I have been trying to get two new entrants into tenanted farms in Cornwall-if they have not got a milk supply contract, they have not got a business.

That is the point that I would really want to reiterate to your question, that you need that security. That is not to say that you cannot go back, sometimes, to renegotiate if you wish to, but certainly on the co-operative model, whereby we own our processing, we explain to our owners-the farmers-how their milk price is attained, the vagaries of the market and how it goes up and down, and if you are a producer of anything, I think we have been used to some up and down. What we are trying to do is get greater stability, so there is not those peaks and troughs which everybody is intimating with the commodity markets in the world.

Jim Begg: So dairy companies pay premiums for security of supply. If they are faced with mandatory contracts that link price and duration of the contract, you reduce the security of supply and you reduce the incentive for dairy companies to pay premiums. It is as simple as that.

Mark Taylor: The milk price to the farmer would go down to compensate for that risk.

Q62 Tom Blenkinsop: Your evidence also says that it is imperative that the content of contracts is established on a voluntary basis. Would you advise your members to resist including conditions in contracts based on the four elements referred to the Commission, like price, volume, seasonality and contract length?

Mark Taylor: There are a number of things that would appear in contracts at the moment, so term, the pricesetting mechanic is included in there as well. It depends on which contract you are looking at, because as I said earlier there is a big variety of those contracts, so that would vary from very simple mechanics to fixed prices at the moment. That evolution is already taking place quite quickly. Things like the microbiological standard of the milk, the constituent elements of the milk, how much butterfat is in it, how much protein is in it, seasonality, profile payments, there are quite a number of things included in those contracts already. All of those elements are discussed, negotiated with farmers and representative farmers.

I met over 900 of our farmers individually last year, and the unanimous feedback that I got from those farmers was, "We want more simplicity in the way our contracts work. We like the fact that we can sell all of our milk to you and you will come and collect it, no matter how much we produce," and my farmers produced 5% more milk last year than they did the year before that, a positive sign against a number of years of declining volume-across the industry, not within Dairy Crest. But simplicity is the overriding message that I get, so they are saying to me, "Yes, we want to engage with you and talk about these things," which they do; "We want to be able to influence them," which they do. We changed a range of factors in our contracts based on that feedback from those 900 farmers last year, and we will keep doing that. It is an iterative process.

What I would stress is that I believe that since we as an industry have had the signals coming from the EU, coming from Government about the desire to move to a free market-which we support-this industry has responded very rapidly and is continuing to respond. It does take time. Agriculture, as you know, is encumbered by long planning cycles, and that feeds through into the rest of the supply chain. So it does take time, but I believe that we are moving very fast and we will continue to evolve positively.

Jim Begg: Can I just take up another point about the transparency and the certainty, which was a fairly major point that was put to you previously. I think-and I hope my colleagues will back me up in this-that the degree of transparency and the degree of the provision of information about the way markets are likely to develop in the future between processors and farmers is greater now than it has ever been. It is regular, it is weekly, it is extensive, and it is all happening in the supply groups, which is where the trust is developed and the information is provided and the future is planned. Really, in a nutshell, we do not want to sacrifice that, because if we go down an alternative route-which may be mandatory contracts-we would move into a much more volatile situation at a time when the management of volatility is absolutely the crucial aspect, which all of these issues like dairy packages and management systems have to address. That is all we are saying.

Q63 Chair: If it was so bad before, is it the case that, because the Commission is threatening action, you have had to open up in terms of greater transparency?

Rex Ward: No, if I can just go back. Obviously, when the Government split Milk Mark up into three parts, I was the Chair of 22 that formed Milk Link, which is really the milk from south of the M4. In that time we have had a farmer-controlled business; we had a number of contracts that we took on from the Milk Mark that was there. We then evolved those because there were just one or two various things and one size fitted all: there was a liquid contract and a constituent one. We have brought in a range of those over the years, and they have been going for seven or eight years at least, but it does evolve the same as my colleague has said here, as things go forward. There is also a difference depending on the volume you produce.

The seasonality has changed, but again, we do not change that; we have given a requirement that we have discussed with our farmers, and we do not alter the seasonality with less than 12 months’ notice, because it is those types of things. You cannot change when your cows are going to calve. But again, I think-and I am very proud of this-that our farmers now, we process three-quarters of our milk into product. They now understand what is the requirement of the milk to go into those products, what affects it, what things they can do on farm-we have done separate testing for casing, those types of things-so that we are producing the right milk for the right product and the right market. They understand that in statutory milk marketing days you had a volume of milk, it was collected, it went off, and you just got paid. They had no interest or understanding beyond the end of the farmyard gate. I think that is where we are: we are far more market related than that. But there has been such volatility in the last couple of years in all sorts of inputs. I think the main thing is-certainly speaking as a farmer-we want to have a bigger proportion of the end price at the front end, because times have been a bit hard and have not got any easier at the moment.

Q64 Chair: Mr Begg, you said it all happens at the supply groups. How many farmers are involved in the supply groups, and what about those who are not part of the supply groups? What happens to them?

Jim Begg: Correct me if I am wrong, but I consider that pretty much all farmers are in a supply group. Secondly, all the farmers who are supplying the major dairy companies are in supply groups, and in the smaller dairy companies they have just as effective a means of communication. It is a transformation almost beyond my recognition from the way it was under the Milk Marketing Board and the complete absence of contact between farmers and processors. I have to say, processors were just as guilty for not cultivating and realising that farmers were an integral part of their prosperity in the future, but they woke up way, way before the dairy package came forward, and that has been the situation for the last five years.

It takes time to develop trust. We very often go two steps forward and one step back on that, but the greatest chance that we have of moving forward productively and getting product into added value and paid premiums is through the supply group arrangements and through voluntary contracts worked out collectively between the dairy companies and the farmers.

Q65 Neil Parish: Dairy UK represents a very wide, if I may say so, interest really. You represent the interests of dairy farmers, producers, co-operatives, manufacturers of dairy products and distributors of liquid milk. One could argue that they are competing aspects of that; certainly those that are not farmer-owned cooperatives have to make sure their shareholders are well provided for, and so therefore there must sometimes be a competing element between what you pay the farmer and what you pay your shareholder. My question quite clearly is, in this broad spectrum of interests you represent, what is Dairy UK’s position on the milk package proposal? You are painting a very rosy picture of everybody being entirely united on the whole thing, but there is obviously some difference between dairy producers represented by the NFU and perhaps you. What is the position?

Jim Begg: First of all, in terms of the structure of Dairy UK, don’t you agree that that is the right way to be going forward? In 97% of situations that come before the Dairy UK board there is no difference, conflict or variation in view about what is in the best interest of the industry in future.

On the issue of price, Diary UK does not cover price other than when it comes up under the umbrella of industry schemes like this. This would have a material effect on the whole industry, across the whole industry, so we would get involved in that. But the absolute determination of price, the prices that are negotiated between farmers and our members, is not the responsibility of Dairy UK. We do not get involved in that, and it is obviously for competition reasons that we do not get involved. We have a very high penetration of the industry in the UK so we do not get involved. That is left entirely to the individual companies, and each has its different approach.

But on the question of the dairy package, which is a collective issue and will affect the structure of the whole industry, we have developed our position very much in line with the farm, the farmers and the processors, and Rex, who is the Chairman of our Farmers Forum is there to make sure that he supports all of these views. We have a united view about the dairy package. We have an agreed position on contracts. We accept pretty much all of the Committee’s proposals going forward, and all we are saying is the better way to do it is not the compulsory way but the voluntary way. We have an agreed position on the impact of producer organisations-which I presume you will come on to-and we have no disharmony there at all.

Do not forget, we are working for the industry. Our objective is to increase the pie: when we increase the pie, everybody benefits. That is the problem with this: it does not increase the pie. You see?

Q66 Neil Parish: Talking of the pie, you have led me on to another question quite neatly: how you slice up that pie. Do you get involved in that, because you are representing dairy farmers, dairy processors and almost-not quite-the retailer? When you see, perhaps, nearly a third of the price, perhaps, taken up by the processing element, is that not too high? I just pose the question.

Mark Taylor: I will just address your concern about the conflict between shareholders and farm-gate price first, and answer that by saying of course there is no conflict. I would say that, wouldn’t I? But the point I would make to you is that my shareholders are generally long-term shareholders. They want me to ensure that my milk supply is sustainable, and they understand that I have to pay a fair milk price in order to ensure that it is, or their returns come under threat. 25% of my shareholders are farmers as well, and those are farmers who have taken a greater interest in the business in order to share some more of the value that currently exists within that supply chain. That is one way that, just as in a coop where farmers would potentially receive some form of dividend, they do that in the same way with a plc as well.

The other point I would make is the fact that I have to add around £80 million to £85 million of value to milk is not negative: that is a good thing. I have to add £85 million of value before I get out of bed in the morning and then pay a competitive milk price. In Dairy Crest’s case, that is the highest price for cheese in the UK and right up there for milk-second out of the biggest three liquid milk processors, I guess. I would argue there is no conflict there. That drives us to be really good at adding value.

To the point that Rex was touching on a moment ago, I can remember when we set up the first of the dedicated milk boards in 1999-which I would be supportive of as well, by the way-and that was with Waitrose, closely followed by Marks & Spencer. Now that is a much greater feature of this market, and it has been a positive development. Having more farmers aligned, as opposed to not aligned-the "haves" and the "havenots", I think, that Mr Hind referred to-has been a positive objective that organisations like coops and plcs alike have shared and driven towards. Only 30% of my milk supply is now not aligned.

Q67 Neil Parish: In fairness, you are not answering my question, are you? The question is, are you satisfied that the percentage of the milk price that you take as a processor is not excessive, and that enough is going back to the producer?

Rex Ward: I will come in to that as well; it is those two things. I can be naturally confrontational if I wish to, but just a little bit of history: when I first set up there was the federation of milk groups, which I belonged to, and then was the DIAL, Dairy Industry, so it was the processors and the farmers. We put those two businesses together as Dairy UK. I sit on the board of Dairy UK and I represent Farmers Forum. The constituents of Farmers Forum are representatives from all the main milk buyers, which you were referring to about supplier groups and that. So again, we have a hierarchy that we can refer to if we need to, because we as an industry-and it is funded by farmers, make no mistake, all of Dairy UK- need to come together.

It is not putting the processors against the farmers. Fundamentally, after at least the processor-and I must choose my words carefully here-there is too large a proportion of the final price that you might pay on the shelf, which is there. That is what we have to address, because if there is not enough at the front end there will not be any cows for me to milk, and there would be nothing all the way up through. The bit I just need to put across, and I think this is important: every cow that is walking around is £10,000 invested. I need a return on that, the same as the money, £65,000, I put into Milk Link, I need a return on that I get, because without investment you are not going to get anything. We are starting from very far behind the European co-operatives because they have 40 years advanced of us. There is a cost of everything: if you look at the returns and what we get out of everything we do as a processor in Milk Link, it gets a return back to the farmer.

Mark Taylor: I would like to see my share increase, if that answers the question more specifically.

Jim Begg: And another point maybe just again to elaborate further: where we also have a common view, and where it differs a little bit from the NFU is that we all agree that there is no systemic failure of the market.

Q68 Chair: Excuse me, could you just say that again? Because that is completely contradicting what the NFU said. The NFU said several times there was a systemic failure in the market.

Jim Begg: No, which is why I raise the point: there is no systemic failure of the market.

Q69 Chair: But you just said you agreed with them.

Jim Begg: No, where we disagree with the point that was put by the NFU was that we do not believe there is a systemic failure of the market. We believe we understand how the market works, and we agree on that. I think probably 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. That creates the base. Processors pay premium over the base to get security of supply of milk. That is how the market works.

Now, you might ask how the farmer gets more from that particular market, and to do that he has to engage in the second phase of the pricing cycle, which is the way the processor earns from his customer and so on. That is driven by different circumstances: processors will invest in things-like, say, for example, a branded promotional campaign, or a new form of packaging-all aimed at getting a higher return from the marketplace. Now, that return goes back to the processor, not down to the farmer. If the farmer wants to get a share of that, he invests in the processing side of the business, either by way of taking share, as in the case that Mark has explained, or, as Rex has said, through investing in a cooperative. He invests in the co-operative and he gets the return. That is how the pricing system works.

It is important to make the point that that is not just the way it works in the UK; it works right round the European Community and in the United States of America, in different countries, we analyse this all the time, and we would be happy to share this analysis with you, which demonstrates that this is the way the market works all round the world, and it is no different in the UK. So we reject the concept that there is a systemic failure: the market drives the milk price.

Q70 Neil Parish: You talk about world prices. The last time we had high milk powder prices in the world, that drove the price of milk up. This time we do not seem to be seeing that. Is that because the processing sector is so dedicated to cheese and you just cannot get the cheese market up? Why is it that the price to the farmer at the moment is not higher, because you talk about world commodity prices: they are much higher than what farmers are receiving for milk at the moment.

Mark Taylor: The price that I pay for cheese has gone up by about 3.5 pence in the last 12 months.

Chair: Could you just speak up a little?

Mark Taylor: The price that I have paid for milk for cheese has gone up by around 3.5 pence in the last 12 months. That is a significant increase.

Q71 Neil Parish: But it is probably still not the price potentially milk would be for milk powder.

Jim Begg: We will deal with this point directly: the fact is that you cannot take the market price at any one point of time and correlate it with the milk price. There are lags in the system: that is what causes the frustration for the farmers. They see market prices rising and they do not see the milk price rise. But the milk price rise does come eventually, and that works up and down; so the lags are equal in application. The lags are long. In fact, our assessment and analysis suggests that the lags are something between six and nine months. In our submission to you, you will see a graph for which we used data from DairyCo, and that shows that over time-and this is why I say you have to take a long-term view of these things-these things balance each other out, sometimes to the farmer’s advantage, sometimes not, but the long-term trend is clear.

Q72 Chair: If your scenario is right, why have so many farmers left the dairy sector in the last few years? That is irrefutable evidence.

Jim Begg: Yes, but what I have to say to you is that there is nothing exceptional about the exit rate of British dairy farmers. The exit rate of British dairy farmers is actually less than the average for the European Community. It is roughly the same as the exit rate around the whole world. There are no exceptional circumstances there. Farmers are exiting for a whole variety of reasons, some of which are due to economic reasons, others are not. But the essence of it is that we have seen a rationalisation. We have seen a rationalisation in processing businesses as well, and that will continue.

Depending on your approach to these things, that is either a sign of increased competitiveness or a sign of a lack of vision. But it is happening all around the world, there is nothing exceptional about us, and we can demonstrate that to you with clear facts. So that is a natural phenomenon that is taking place in the industry worldwide.

Q73 Chair: I am just slightly confused: you are saying that, for the farmer to get more out of the contract, they have to invest in the processing side.

Jim Begg: Yes.

Q74 Chair: If they are telling us they are not earning any money under the contract because the inputs are higher than the-

Jim Begg: Than the milk price.

Q75 Chair: Yes-then how are they going to be in a position to invest? I am at a complete loss.

Rex Ward: Can I just go back on that? One point, just to do the abridged version from where it is. Northern Ireland is dependent on commodities: skimmed milk, powdered milk. Last time when it was high-2008-milk price to farmers went up immediately on a monthly auction system to 32 pence. When it went down again in November 2009, it went down to 16 pence, farm price. Now it has gone up again to 32 pence. That is why we have invested processing over here to take out that volatility, because at certain times of the year you will know that Westbury’s large dryer is empty. At the moment, with all the nice sunshine outside there, it is full. If we can sell that powder now at a higher price, that will come back into the market. But again, some of that is sold on forward contract, some is sold on spot, but it is there.

How can farmers invest in that? We as Milk Link, when we first started, we started with £6 million. We had no factories, we had a lot of milk, a lot of farmers’ assets, and we did an innovative thing: in fact we mortgaged our own farms. We used a five pence per litre guarantee so we could go and start borrowing money. But we also had to have a deduction off a very low milk price at that time, and that has only now ceased after 10 years, and we on average put in about six pence a litre out of our milk price as we went on to invest in processing. So that is what we as farmers have done: 1,600 of us. We did not ask for Government aid, we went out and did it. If you want to get to the Promised Land, you have to pay for it. It is who is going to do it? What we are asking, which goes back to Neil’s point, is we need more of the front end of the division. It is not for you here, but it is one of those things there, because it is a very, very capital-intensive business. We could all give up dairy farming tomorrow and turn our land into more profitable things, but that would cause you a great shortage of milk.

Jim Begg: But the issue that we have to focus on is the management of the volatility of input costs, because that is the biggest issue, in my view and in our view, affecting the industry going forward-how we do that, and how we manage it going forward.

Q76 Thomas Docherty: Sorry, Mr Begg, you did not answer the Chairman’s question about how you invest if inputs are greater than the price.

Jim Begg: Look, just like the market catches up with the milk price, so do costs, and at any one point of time you will never get a true analysis, but if you look at the position over a period of time, then you will see that the profitability is there. The cost issue is a difficult one, and we also struggle to try to understand the profitability of dairy farming. We rely on information like that produced by DEFRA, and that shows a clear profitability of dairy farming in terms of the revenue less the cost. So the margin that is left for the domestic income of the farmer plus investment is there. Now, if you look at the evidence and you look at the DEFRA evidence, I quite openly say that the income includes things like the direct subsidy, the direct payment. Even allowing for that, there is still a margin in there. So over a period of time, farmers have to be profitable. If they were not profitable-and it is our objective that they are profitable-we would not have an industry. They would have gone and disappeared by now.

Mark Taylor: Sentiment and confidence amongst farmers is a very key element to their decisions to invest. The last time we saw rapid inflation in commodity markets was in 2007. There was a different economic background immediately preceding that period, but we saw very rapid inflation in farm-gate costs, and those costs also needed to be recovered from the market. They were recovered, farmers’ prices went up, the two issues squared off, farmers began to invest. They were going to invest in putting a lot more heifers into the system to produce more milk, new parlours, etc, etc. We are in this increasingly more rapid cycle of volatility, have gone through, I believe, a similar phase now, and prices have increased.

Chair: I think we are starting to repeat ourselves, thank you.

Q77 Richard Drax: Just about your quote from your written evidence-that is Dairy UK’s-where you say that unless producer organisations are subject to "the normal laws of competition", you anticipate "a significant reduction in forward investment by British dairy companies." Why should a producer organisation with 33% of national production be so much worse for the future of British dairy farming than one with 25% of production?

Jim Begg: The answer to that is that we are not particularly precious about the scale of a producer organisation. The scale is almost irrelevant as long as there are clear and sufficient competition rules in place so a processor has the knowledge that, if a large-scale operation takes an action that renders him uncompetitive, he has a recourse to redressing that under competition law. That is all we are saying.

We have no problem or objection to the establishment of producer organisations. We firmly believe that it is up to farmers and farmers’ organisations how they market their milk. So the creation of producer organisations is not a problem, but what we do say is that any organisation that is established has to come within existing competition policy, because if they do not then frankly I do not think the processors would take the risk of investing in an area where they had no recourse if there was a problem. I do not think they would do it, and I am pretty sure I am right with that circumstance. It is not the scale; it is not the 25% or the 33% that we considered important. It is the fact that national competition authorities have the right to intervene if there are reasons for investigating a potential abuse of competition in the same way as they do now.

At the moment we do not think that the Commission proposals say that. We think the Commission proposals present a stronger test of competition, and that is something of a concern to us, so we are still, if you like, lobbying in Brussels on that particular point. But the principle that anything goes as long as it is covered by competition policy gives confidence and an incentive to invest.

Q78 Chair: Mr Begg, you are being very helpful. I wonder if you could just make your answers a little bit shorter, as we want to get everybody in. Thank you.

Jim Begg: Yes, of course.

Q79 Richard Drax: Talking of Brussels, if the Commission’s proposed producer organisation thresholds are applied across the rest of the European dairy industry, what would be the effect of that consolidation on the UK industry and dairy market?

Jim Begg: We want to ensure that nothing that is implemented in the UK creates a position where our processors and our farmers cannot compete with the competition elsewhere. To the extent that it does we would oppose it; to the extent that it does not then I think it is okay. I do not think from that point of view at the moment it is a major concern to us. We are more concerned from the specific case of the UK that on a case-to-case basis the national competition authority has got a chance to intervene.

Q80 Richard Drax: Is there pressure for further consolidation within the UK of the UK dairy industry?

Jim Begg: Yes; well, when I say pressure there is a full and clear understanding that we will gain efficiency by rationalisation, and I think that is uppermost in everyone’s mind, and there is never a day goes by when people are not looking at the possibilities and all that kind of thing. It is a slow process, it takes a long time. However, I think that is the absolute objective, and that is the same everywhere.

Q81 Richard Drax: Would this consolidation benefit consumers?

Jim Begg: It would drive greater profitability into the supply chain if you can gain efficiencies of manufacture. Do not forget that profit is a function of revenue and cost, and it behoves us to reduce our cost at the same time as increasing our revenue. It would bring more profit into the supply chain, and at the very worst it would bring more profit in without affecting the consumer at all, if you gain the efficiencies. But frankly, we and the NFU both agree that the industry needs more.

Q82 Richard Drax: Slightly just off that particular topic, do you support producer organisations having independent facilitators to resolve contractual disputes between farmers and dairies?

Jim Begg: We will have a look at it. I am embarrassed to say that it is the first time I have heard that concept. I promise you we will look at that. On the face of it, it is not something that would immediately worry me.

Mark Taylor: Do you mean somebody to negotiate for them?

Q83 Richard Drax: Yes. It is a question that you have not come across?

Rex Ward: It depends how good you are at negotiating and what your fallback position is, doesn’t it?

Jim Begg: We will have a look at that one.

Chair : If you have any further thoughts on that, perhaps you would be good enough to write to us, and then we could incorporate it in the inquiry. Thank you.

Q84 Mrs Glindon: What would the effect of ending milk quotas across the EU be on the UK’s milk prices?

Peter Dawson: Perhaps I can answer that one. I think our analysis is very broadly similar to the NFU. I think the majority of EU Member States are already falling below quota, so the final abolition would not have any impact on those countries. There are a handful of countries where they are up against their quota limit, so you could expect to see a further expansion of milk production in those states, but I do not think we are expecting a major surge in output from those countries. That would have an impact on the supply/demand balance of the European Union. We have a few more years to go yet before the quota constraints are finally lifted and a few more quota increases, so I think the final act of abolition might be fairly muted in terms of its impact on the industry’s commercial environment.

Q85 Neil Parish: Just a supplementary on that one: at the moment the UK is not up to its quota anyway, is it? It does not produce up to quota, so I suppose the main impact will be how much more imports might come from the Netherlands or Denmark. What is your view on that?

Peter Dawson: I think both the Netherlands and Denmark are amongst that population of countries that are up against their quota limits, but at this particular point in the price cycle it is quite clear that there is a huge expansion in demand from economic growth in the far east, so it would seem that there is still plenty of opportunity elsewhere outside the UK market for additional volumes from the European Union to be absorbed elsewhere, so additional milk is not necessarily going to end up in the UK market. The return they get from the UK market would not be significantly different from the return they get from any other European Union market. I do not think we need to feel that we are going to be especially victimised by the sudden abolition of quotas.

Q86 Neil Parish: Right, okay, my question now is that in your written evidence you state that "farmers are suffering a major squeeze on margins. Regrettably, as prices are determined by commodity markets, there is no automatic recovery of input costs in dairy. We submit that this situation does not demonstrate a non-functioning market." So the question is, do you consider the current distribution of the value of milk through the supply chain to be sustainable in the long term? This deals with supermarkets, deals with the lot, as far as I can see.

Rex Ward: No, in a word.

Q87 Neil Parish: That is the answer I wanted, thank you very much. But seriously, how are we going to rectify that? Just now we were talking about the fact that dairy co-operatives up to 33% would be too big. We have one retailer in this country that has 30% to 32% of the whole retail market. I do not suppose you are suggesting splitting that up are you?

Mark Taylor: You were asking us question about farming organisations.

Q88 Neil Parish: No, it is a serious question. Basically Tesco has taken out the top end of the market, and fair play to them, but that does not drive the price up overall to the farmer. How do we get the price up not only to the farmer but the processors? You say as processors you are not taking too much out of the chain-you would say that. You were talking about world commodity prices: we see high commodity prices, yet we are not seeing high milk prices.

Jim Begg: It has got a lot to do with that. What I believe you cannot do is you cannot impose contractual terms, for example, that override the market, because that is just going to create a problem in another part of the forest. So you are looking very much at the development of world markets and the global prices, because that is the way the markets work. To be honest, when you look at all the different factors that contribute to the future, we think that we are on a rising price cycle. We are on a hugely volatile price cycle, but it is rising all the time, and that is going to deliver hopefully-without any guarantees, but hopefully-a greater return to the farmer on an ongoing basis. Beyond that, they have to get involved further up the chain, and they do: in coops, and in share values, and in their private investments.

Q89 Neil Parish: Sorry, we have done that one to death, if I may say so, and I do not disagree with you, but what I am saying to you quite clearly is that farmers can co-operate through and buy into processing, but in the end it is the price that the consumer pays, and then how much that consumer pays, then how much of that goes back down through the processor and back to the farmer, and I think that is absolutely key. So how do we get that sustainable market? You talk about markets should be increasing; well, we are in increasing markets now.

Chair: Short questions, short answers.

Peter Dawson: Perhaps if I can try and elaborate on this. In our view, the process of price formation in the dairy industry is fundamentally from the bottom up. It starts in the commodity markets, goes to the raw milk market, goes to the wholesale market and then is left up to the retailer to decide how they want to take a position in the marketplace with consumer. As such, what happens in the retail market is almost completely independent of what happens in the raw milk market and the income to the dairy farmer. So it is not a question of trying to appropriate additional margin from the retailer and distributing it back to the dairy farmer. In a properly functioning marketplace, that is simply not going to happen. The dynamic is in the other direction, and it is a problem of the industry addressing volatile commodity markets and the effect it has on farmers that we have to address, and there is not a ready-made solution to try to appropriate margin from the retailer. In terms of the functioning of the market, it is not there.

Q90 Neil Parish: The next question leads quite neatly into that: the Minister has said that it is indisputable that the retailer’s share of the retail price has risen, whereas the share taken by the producer has declined. Will the Commission’s milk package proposals or the grocery code adjudicator help dairy farmers achieve a fairer proportion of the retail price of milk?

Jim Begg: It is very difficult-and I apologise for repeating myself-for me to see how the Commission’s proposals will deliver that, because I cannot see how you can impose a contractual situation that overrides the market principle, which Peter has explained and I have explained; we have explained that three times now. That is a very difficult thing to see.

In terms of the grocery price adjudicator, we support that. The reason we support it is we think it will instil greater confidence that the supply chain is working. It will: if there are abuses it will come out. So that will help. I would be less than honest if I said to you that we thought it was going to fundamentally alter the distribution of the margin down the milk price, but it will help instil confidence in the system. But we support it.

Q91 Neil Parish: Final question: do milk processors receive a fair proportion of the retail price-turning my previous question on its head.

Mark Taylor: I think there was some analysis done recently that looked back over a number of years, and the proportion of the price that processors received had remained pretty much unchanged for 10 years or more. I think you asked the question earlier and I said, in summary, I would like my share to increase-of course I would. I am sure farmers would like their share to increase too, and I am sure retailers would be in the same place.

Q92 Neil Parish: But I think farmers would probably argue that the percentage of the retail price they receive has decreased to a greater extent than yours.

Mark Taylor: I think the analysis that I have seen would support that.

Q93 Chair: Could I just turn to a question that the NFU invited us to put to you? Your representative role, Dairy UK, on the Dairy Council. Would you like to comment on that?

Jim Begg: Yes, the Dairy Council is a wholly owned subsidiary of Dairy UK. It is fighting the case for the acceptance and for the promotion of British agricultural product, dairy products, with consumers. It is undertaking the science. As we become more exposed to an awareness of food by consumers, it is more and more important that we are able to provide scientific justification for the claims that we make about our products. Everybody knows that milk is good for you, that it is a healthy product, it is nutrient rich and that it is an essential part of our basic diet, but we have to continue to tell people that and we have to continue to provide the science that makes our case, and that is the function of the Dairy Council.

In terms of the image of the dairy industry, that is a function of everyone. You will notice that we all have Proud of Dairy badges on. It is a function of everyone, it is a function of all the players in the industry, and because we are short of time, we might have elaborated on the other point, which is sometimes we get into situations where consumer opinions about developments in the industry differ from the science. If you take the question of large-scale farms, that is an issue there, where the science differs from the consumer perception. Cloning is another issue. These are difficult issues for the dairy industry, but we all have a responsibility to work very hard and to educate consumers to prevent, as in fact the NFU said, unrealistic and unfair prejudgement of these issues being taken by consumers.

Q94 Chair: But can I just look at the Danish model, where they have Caroline the Cow-Karoline-ko-which they use very powerfully as a marketing tool. Could we not learn from that.

Jim Begg: Yes we do, we do. That is another expression of confidence; when you see the industry prepared to invest in generic marketing, then that is a positive sign, and we are investing in generic marketing at the moment. There are two campaigns within the Dairy Council, Make Mine Milk and another campaign linking milk with sport as the Olympics come forward. So we are involved in that. Have a look at the buses. You will see all our promotional things going forward, all funded by the industry.

Q95 Thomas Docherty: Mr Begg, when we last met several months ago we had quite a long conversation about super dairies. That was previous to the EA decision. Do you think, in light of Nocton and the lessons that will be coming out of that, is the long-term future of the UK dairy industry dependent upon super dairies?

Jim Begg: It is not dependent on super dairies because there is an economic value to every type of farm, and every type of farm, every size of farm, has got provenance that can be developed to gain market premiums. What is absolutely crucial is that we do not deny ourselves the opportunity of having the establishment of large-scale farms. Large-scale farms offer cost efficiencies. We must get cost efficiencies going forward. This is exactly what I mean: we lost that opportunity, there were clearly consumer concerns, clearly ethical concerns. We did not believe the science matched that, but ultimately, we have to respect what the consumer thinks. We are not a production-driven industry; we are a market-driven industry.

Q96 Thomas Docherty: Sorry Mr Begg, but forgive me if I am wrong, it was the regulator that torpedoed it. It was not the consumer; it was the regulator.

Jim Begg: It was a technical issue relating to the Environment Agency, but I think we would be kidding ourselves if we did not accept that there had been a fairly strong consumer reaction against that whole concept. Again, I make the point: where consumer perception and science differs we need to prevent that from affecting our progress, and I regret what happened at Nocton.

Q97 Thomas Docherty: Do you think that DEFRA, or the Government more generally, has a role in getting across those messages?

Jim Begg: Yes I do, to be honest, and I think it is the one area where we would look for Government support. There is another area in which we would look for Government support, which is all to with what you talked about earlier-labelling and things like that. We have to make sure that we are not prejudiced by legislation that comes forward. In the case of super-dairies, yes, we would have preferred a stronger independent voice.

Q98 Chair: Finally, you did say, in the context of the questions you have answered, that relations have improved in terms of negotiating. Bearing in mind that it is a perishable product that the farmers have to sell, and perhaps you are not covering every farmer in the membership of your organisation, are you prepared to go the extra mile to try to reach a compromise if you do not wish to see regulation at European level?

Jim Begg: Yes; it would be a very unwise processor who did not take the relationship with farmers very seriously, and they would find out very quickly, to their cost, that that was the wrong course of action. They are the future. We have no business without them. They have to be profitable, and it behoves them to work together to get the best they can out of the market, every single time.

Rex Ward: Could I just use one example that came to us a month ago: one producer supplied all his milk to a very small bottler. He did not have a contract. The bottler sold his business to someone else and he had 24 hours’ notice to find another milk supplier. We wish to have the security.

Chair: Well, thank you very much for being so generous with your time and participating in our inquiry. Thank you very much for being with us. We stand adjourned.