Around one-quarter of Australia’s total milk production is consumed as market milk (drinking milk), with just over half of the volume being sold through major supermarkets. Other milk outlets include independent grocers, fast food outlets, corner stores and service stations, reports ABARE.
Market milk processors are contracted by supermarkets to supply their generic branded milk (also known as ‘home brand’ milk), and contracts usually run for two to three years. Contracted processors’ own branded products (‘branded milk’) are also sold by supermarkets. Home brand milk and branded milk are not identical—with branded milk having a wider range of products that are differentiated on fat, protein and calcium content—but there is likely to be a high degree of substitution.
Sales of home brand milk have been increasing in recent years. In 2009–10, home brand milk accounted for around half of the supermarket milk sales and around 7 per cent of overall milk produced. Home brand milk is normally sold at a discount compared with branded milk but some consumers continue to purchase branded milk, which suggests that they recognise some level of difference for which they are willing to pay a premium.
Since late January 2011, the major supermarket chains have reduced the retail price for their home brand fresh milk to $1 a litre, well below prices for branded milk. For example, Coles Brand 2 litre milk (full cream) was reduced from $2.47 a container to $2. In comparison, the price of a particular branded milk (full cream) at a major supermarket is currently $3.89 for a 2 litre container. Despite the reduced price of the home brand milk, the major supermarkets have pledged not to reduce the contract price to the processors for this milk.
While it is too early to conclude the effect of this price discounting on consumption of milk, it is reasonable to expect that consumption of home brand milk will increase because of an increase in the quantity demanded for milk overall (due to the lower price) and substitution away from branded milk and toward home brand milk.
Given that the consumer demand for milk is relatively price insensitive, it is unlikely that total milk consumption will increase significantly in response to the decline in the price of home brand milk, especially in the short term. However, it would be expected that consumers will substitute, at least to some extent, home brand milk for branded milk, and that consumption of branded milk would consequently decline. The degree of substitution will depend on the level of differentiation consumers perceive between the products and the additional price they are willing to pay for the attributes of branded milk.
In response to increased competition caused by the lowering of prices of branded milk, there is a possibility that processors could reduce branded milk prices in supermarkets and other retail outlets in order to protect their market share. Whether this will occur will depend on the difference in processors’ profit margins on home brand milk and branded milk (under the assumption that the supermarkets will not reduce the contract price of home brand milk). There are three possibilities.
- If the processors’ profit margins are similar for these two categories of milk, the processors will simply increase the supplies of home brand milk and reduce branded milk supplies as long as the contract price for home brand milk is not reduced. Under this scenario, the prices for branded milk are unlikely to change, and little of the impact is expected to spill over to the price of milk at the farm gate.
- If the processors’ profit margins for branded milk are higher than for home brand milk, the reduction in sales of branded milk will lead to a decline in the processors’ overall profits. In response, the processors could maintain market share by lowering retail prices and seek to pass this on by reducing the milk price offered to farmers. This could also apply to processors not supplying home brand milk.
- If the processors’ profit margins for branded milk are lower than for home brand milk, the prices for branded milk are unlikely to change, profits may increase because of higher sales of branded milk (and assuming that supermarkets maintain contract prices to processors) and some of this increased profit may be passed back to farmers in higher prices. However, it is unlikely that processor profit margins are higher for home brand milk.
Uncertainty in the current situation also exists in terms of how long supermarkets will maintain the lower prices for home brand milk and, if they are maintained over a long period, whether the major supermarkets will maintain their commitment to the contract price for home brand milk. If the contract price falls, it can be expected that the processors will seek to pass on the lower price to dairy farmers.
Should the processors seek to offer a lower price to farmers for market milk, the extent of the price reduction could vary between regions. In south-eastern Australia (especially Victoria, southern New South Wales, Tasmania and South Australia), the milk price paid by manufacturers for the export of dairy products sets a floor to the extent to which market milk price at the farm gate can fall.
In Victoria and Tasmania, where around 90 per cent of milk is used in manufacturing dairy products, the price paid to farmers for market milk will be closely linked to the price received by farmers for selling milk to dairy product manufacturers. Market milk processors will not be able to pay dairy farmers less than the price being offered by major dairy product manufacturers. Around 60 per cent of manufactured milk is exported in the form of processed products and so the price is determined largely by developments in the world market, rather than domestically.
According to ABARES farm surveys, the farmgate milk price in Victoria is expected to average around 36 cents a litre in 2010–11.
In northern New South Wales and Queensland, a very high proportion of milk production is used in the market milk sector. The average farmgate milk price in these regions is generally higher than that received by dairy farmers in the regions of south-eastern Australia (estimated at around 46 cents a litre in 2010–11). To a large extent, the farmgate milk price differentials reflect different farm costs for milk production and the cost of transporting milk between regions. In particular, the highest differential payable would reflect the transport costs of buying lower priced milk from the south plus any premium that may be required to secure a contract with dairy farmers in those regions.
Should the processors attempt to lower milk prices to farmers in northern New South Wales and Queensland as a result of supermarket discounting, the lowest that the price could be reduced to, while still maintaining farmer viability in the short run, would be the cash costs of production— currently estimated to average around 40c a litre per farm in this region. Maintenance of farm production in the region in the long run would also need to cover farmers’ depreciation costs, family labour cost and profit margin. Adding the first two costs would increase the estimated average cost of production to around 50c a litre, leaving no margin for price reductions without affecting average farm viability in the long term.
In Western Australia, a high proportion of sales of milk to the domestic market (around 70 per cent in 2009–10) and higher farmgate milk prices compared with south eastern Australia would suggest a similar situation as that for northern New South Wales and Queensland.