Tuesday, May 17, 2011

When a bottle of milk is cheaper than a bottle of water

How does milk end up on the shelves at shops?

Each cow produces roughly 20 litres of milk daily. The milk is then sold to the Processors who buy from farmers, processes and packages the milk which is then sold to retailers. According to Ken Henrick, the chief executive of the National Association of Retail Grocers of Australia, the retailers share of the dairy industry's gross profit is around 80%. Farmers earn varying rates, from as little as 17 cents per litre to 35 cents per litre.

Many are just breaking even and treading water with inability to expand herd numbers or invest in plant and equipment, forced to defer their capital improvements.

If you live in Australia, you would be well aware of the battle between the dairy farmers versus our two supermarket monopolies, Woolworths and Coles. Our Australian dairy industry produces 9 billion litres of milk annually.

Unfortunately for our diary farmers, they have battled with rising supply costs(feed, diesel, transport, labour) whilst also battling with shrinking margins due to the major supermarkets cutting the sale price of their home branded milk to $1 per litre. Consumers now reach for the home brand milk that costs $1 per litre instead of buying the independent milk labels at $2.40 to $3 per litre. So you're probably thinking, "Who cares as long as I can buy cheap milk".

The problems associated with cheap milk

A 600ml bottle of water costs $1.30 but a 1L bottle of milk costs only $1. That's where the ridiculousness lies. It doesn't take a rocket scientist to figure out that the production costs of producing one litre of milk exceeds the production costs of producing one litre of bottled water.

As dairy farmers exit the industry, there will be decreasing numbers of dairy farms. Falling supply will push up prices. Secondly, as the independent milk suppliers, farms and processors shrink in numbers, their bargaining power against retailers will diminish and they will inevitably be price takers.

There is also the question of whether the major supermarkets will increase milk prices back to pre-discounting era prices and retain the profit margins for themselves without passing any profit increases to dairy farmers who have been rendered powerless.

Although I have shares in a major supermarket and possibly a conflict of interest as well due to my history with one of them, I would never want to see the destruction of our dairy farming industry. As a shareholder, an increasing dividend is good but not if it comes at the cost of other farmers and suppliers' misery. I'm happy to accept less dividend growth if it will prevent the implosion of our dairy farming industry.

The problem is, which bottle of milk will Australian shoppers reach for when they contemplate the shelves full of independently labelled milk and the cheaper, generic milk? One that is cheaper today, or one that is more likely to ensure the viability of our local dairy farmers for the future and therefore, cheaper prices in the long run?

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