Unit 3 Micro: Oligopsony - Dairy Losses Drive Farmers from the Fields

Hats off to the herd! Milk production in the UK is expanding yet many dairy farmers have or are likely to leave the industry over the next five years unless raw milk production becomes more economically viable. Can the stakeholders in the sector reach fresh agreement on sustainable contracts for the near 40 million litres of milk produced every day?

Milk is just about the most regular purchase that we make in the shops and supermarkets. The nation consumes over 5 billion litres of milk every year, but few of us stop to check the price as our cartons drop straight into the basket. 53% of the milk that produce in the UK is sold as liquid milk. The other 47% goes into cheese, butter, yoghurts and a variety of other dairy products.

At the other end of the supply-chain, the price that dairy farmers get for their milk is absolutely crucial; indeed unless the return that milk producers receive improves in the near future many more farmers seem set to leave the industry unable to sustain mounting losses. According to this report in the Guardian/Observer “At least one dairy farmer has gone out of business in Britain every day for the past decade, as supermarkets have more than doubled their share of the price of a pint of milk”.

Those that remain will be unable to generate sufficient profit to finance re-investment in breeding stock, new buildings and farm machinery. Low levels of investment will hit productivity and may also affect animal welfare - healthy cows need good facilities and farmers need a profitable price.

The National Farmers Union (NFU) has estimated that dairy farmers in Britain are losing upwards of £300 million a year as supply costs increase and lag behind the farm-gate price paid to farmers by the major milk processing and distribution businesses such as Robert Wiseman, Arla Foods and Dairy Crest. These processors have oligopsony power in the market in other words; they have significant purchasing power when buying from producers at an earlier stage of the supply chain. The main alternative is either for farmers to join a cooperative - in the UK Milk Link and First Milk has roughly 10% to 11% of the market apiece - or to sell their milk direct to local and national supermarkets or direct to customers through farm shops.

Whilst it is vital for the dairies to establish and build strong supply relationships with dairy farmers, for many years there has been concern that the giant milk processors have used their buying power (economists call this a situation of monopsony) to keep farm gate prices lower than they might otherwise be. The NFU’s data finds that the average cost of milk production is currently 29.1 pence per litre (ppl). With an average British milk price of 25.94ppl, this result in a 3.16ppl gap between the cost of producing milk and the price the farmer receives.

Dairy producers have had to cope with a surge in their operating costs over the last few years. For example, average feed wheat prices are 66.7% higher than a year ago; the average price of fertiliser is 19.4% higher than at the same time last year and ammonia Nitrate bag prices are 34.2% higher than in May 2010. Feed wheat prices alone are said to contribute around 20% of the unit cost of each litre of milk supplied. Average income from dairy farms in 2009-10 was more than £24,000 before any income from EU farm support payments but for many that income is not enough to reap a profit.

Faced with persistent losses, many farmers have closed down and leave for pastures new. UK dairy cow numbers have declined by 10,000 in the last year alone, in the UK there are now 1.85 million dairy cows in the dairy herd and this has shrunk by seven per cent over the last five years.

Back in the supermarket aisles, Sainsbury’s, Waitrose and Tesco charged £1.49 for 4 pints in June 2011 with Asda charging £1.25 for 4 pints. 4 pints converts to 2.27 litres. A quick calculation tells us that farmers are getting an average of 59 pence for supplying 4 pints but the retail price in most supermarkets is 90 pence higher.

Many milk supply contracts require farmers based in Britain to sell all their milk to one of the major buyers for no less than 12 months and without any certainty of the base price they would receive. Milk processors then supply mainly to the supermarkets.

The Farmers’ Union is lobbying for a revised system of milk supply contracts what ensure milk supply deals bring greater fairness to relationships between milk producers and processors. This campaign has gathered momentum in the last two years partly because of steeply rising costs for many farmers (notably the soaring cost of livestock feed) and also because of the failure of Dairy Farmers of Britain, a milk producer cooperative which was responsible for 10% of UK milk production and which collapsed in 2009 leaving many farmers desperately searching for buyers of their produce.

Without a higher farm-gate (or wholesale) price the probability is that a growing number of farmers will opt to leave the sector. Some have attempted to diversify into higher value-added products such as yoghurts, ice-creams and cheese and there are some notable successes especially when niche brands that can sustain premium prices have emerged. Low profitability is also incentivising a longer term switch towards large-scale intensive milk production in mega-dairies which smaller-scale farmers giving way to huge complexes capable of supplying millions of litres every day.

Enlightened food retailers are also seeking to reach deeper agreements with farmers for example the ‘Milk Pledge Plus’ payment scheme set up by Marks and Spencer a milk payment scheme that adjusts for changing costs of supply and which also offers rewards for dairy farmers who meet high animal health and welfare standards. Show-casing local sourcing of milk which meets strict environmental standards is often a profitable marketing strategy for the supermarkets and provides greater certainty about revenue streams for the farmers themselves.

The vast bulk of milk produced in the UK will continue to flow through the processing industries to the supermarkets. In Britain we have not made enough progress in resolving the disputes between farmers, suppliers and supermarkets and a solution remains unlikely because of the imbalance in bargaining power between farmers and processors.

Put simply there remains a huge, structural price differential between what dairy farmers get at their gate and what the consumer pays at the supermarket. This monopsony power is a market failure that has cost many jobs, cut agricultural investment and made the UK more dependent on milk imports.

More reading:

BBC News (July 2011): Berkshire dairy farmer sells up because of milk prices see also this video: Berkshire dairy farmer’s cow herd auctioned

BBC news video: Milking 5,000 cows three times a day

BBC video: Row over super dairy cow scheme in Lincolnshire