AN extensive examination of the Australian dairy sector has identified the power imbalance between small farmers and big processors as a ‘market failure’.
But that pitfall could be remedied if the government adopted a mandatory code of conduct where large corporations could be fined hundreds of thousands of dollars for breaching its rules.
A report from an 18-month inquiry into the Australian dairy market by the Australian Competition and Consumer Commission (ACCC) was handed down yesterday making eight recommendations.
The ACCC’s investigation was triggered by the 2016 industry crisis where two of the nation’s largest dairy processors caused “substantial detriment” to dairy farm businesses in the southern regions, the report said, by imposing late-season retrospective changes to the farmgate prices.
“These ‘step-downs’ caused severe and unforeseen reductions in the incomes of more than 2000 dairy farmers and significantly impacted the productivity of the industry,” the report said.
“Farmers exited the industry and the volume of milk produced fell substantially in the following season - the events of 2016 resulted in a crisis for the industry.
“For many years questions have persisted about the fairness of prices and other trading terms that Australian dairy farmers receive for the milk they produce.
“These intensified after Australia’s major supermarkets reduced the retail price of private label milk to $1 per litre in 2011 and arose again in 2016.”
But while the ACCC’s report essentially cleared Coles and Woolworths of any wrongdoing on $1 per litre milk, dairy processors are now in the firing line due to the power imbalance it identified and the impact on pricing.
“The dominant picture that has emerged is one of significant imbalances in bargaining power at each level of the dairy supply chain,” it said.
“This begins with the relationships between retailers and dairy processors and progresses down to the relationship between processors and farmers.
“The ACCC has identified a range of market failures resulting from the strong bargaining power imbalance and information asymmetry in farmer-processor relationships.
“These features of the industry result in practices which ultimately cause inefficiencies in dairy production.”
ACCC Agricultural Commissioner Mick Keogh said dairy processors were multinational companies that dealt with hundreds and sometimes thousands of farmers and therefore had “enormous resources” in terms of information and market power.
He said in sharp contrast the farmers that the processers dealt with didn’t have the same volume of information and often had little choice, or their options were sometimes restricted, due to the nature of their contracts with the multinationals.
Me Keogh said some of the contracts for example required long notice periods for the farmers to be able to switch processors or contained mechanisms that made it difficult to change over.
“When we looked at the whole dairy sector it struck us that the biggest weakness in the system in terms of competition is the relationship between the processors and the farmers,” he said.
“We looked at a number of ways to address that and the most robust conclusion we could came up with was that you need a mandatory code of conduct to govern those relations between dairy farmers and dairy processors.
“Some have equated that to re-regulating the dairy industry but of course it’s nothing of the sort – there’s no consideration of regulation in terms of pricing or quotas or those sorts of things.”
Mr Keogh said a mandatory code of conduct aimed to focus on aspects of the contract negotiations between dairy farmers and dairy processors and “make them a bit fairer”.
“It focuses on issues like removing what are called ‘delayed loyalty payments’ which means that if you supply a processor one year you need to stay a supplier of that processor well into the next season, often before you can collect a loyalty payment that’s part and parcel of the price offered,” he said.
“They’ve largely disappeared although we’ve seen some of them re-emerge in the last little while.
“The other one is the ‘extended notice period’ for farmers who are considering switching processors.
“Often the amount of notice they give long exceeds the period of time that they would be able to get a viable alternative quote, so in other words they have to give notice sometimes up to six months in advance but another processor would only offer them a quote, perhaps only a month in advance, to the end of the season.
“A number of those sorts of arrangements do limit the ability of farmers to switch between processors and therefore limit the degree of competition between processors and therefore in the long run the farm gate price will inevitably be lower.”
Mr Keogh said the dairy industry had implemented a voluntary code of conduct which the ACCC acknowledged had led to an improvement in the standard of arrangements between dairy farmers and processes, during its 12-months in operation.
But he said not all dairy processors had signed up to the voluntary code which had “a number of weaknesses” - in particular no mechanism for dispute resolution.
“If a dairy farmer thinks what a processor is doing is in breach of the voluntary code, there’s no mechanism to have that dispute decided and let alone there’s no penalty for the processor as a consequence of that,” he said.
“In fact, the easiest mechanism for a processor who wants to break the code is to simply withdraw from the code because there’s no penalty and no compulsion associated with the processors’ participation in that.
“When we considered that the voluntary code actually needs strengthening, to be really effective, we realised it would mean even less processors were likely to participate, so the weakness of relaying on a voluntary code to get the behavioural change that we think is needed becomes very obvious.
“Hence we made a recommendation that the industry needs to adopt a mandatory code of conduct to govern behaviour between processors and farmers.”
Mr Keogh said adopting a mandatory code was ultimately a decision for the government and the ACCC didn’t have any powers beyond making a recommendation in its report.
But he said if the government chose to implement a mandatory code of conduct it could implement civil penalties associated with its operations.
“If there was a dispute resolution process in place and if farmers could then seek a ruling on the behaviour of a processor they believed was in breach of the code, if that processer was found to be in breach there would be consequences for that processor as a result,” he said.
“That means the code is much more likely to be adhered to by industry participants.
“Different codes have different arrangements in place but some of them have fines starting in the region of $10,000 to $12,000 and going upwards from there depending on the scale of the organisation and the seriousness of the breach but they can be substantial (hundreds of thousands of dollars for corporations).”
Mandatory code would assist transition
The report said the introduction of a mandatory code wouldn’t overcome farmers’ relative bargaining disadvantage but it would mitigate some of the “significant negative consequences”.
It said the removal of barriers to switching contracts will also enhance existing competition between processors for raw milk.
“Most major dairy processors are now corporations and not farmer-based cooperatives,” it said.
“However, industry practices have not substantially changed to reflect that processor and farmer interests are no longer closely aligned.
“A mandatory code will assist this transition, by clearly setting out the rights and obligations of farmers and processors.
“A change to industry practices to the benefit of farmers will mean some loss of bargaining power for processors relative to farmers.
“As expected, therefore, most processors opposed this recommendation.
“However, having carefully considered the submissions opposed to this recommendation, we consider that a mandatory code of conduct can be designed in a manner that improves the efficiency of the industry without substantial regulatory burden on processors.”
The ACCC said contracting and industry practices were “weighted heavily in favour of processors” which had led to “inappropriate allocation of risk, increased potential for inefficient investment decisions by farmers and less effective competition between processors”.
“A mandatory code should therefore be designed to improve transparency and certainty in contracts, set minimum standards of conduct and provide for dispute resolution processes,” it recommended.
“In particular, a mandatory code should contain obligations on processors to improve the timing and manner of processors’ communication of price and other key information, and increase farmers’ ability to switch in response to significant changes to their trading terms.”
The report said many farmers believed that the major supermarkets pricing milk at $1 per litre devalued their work and that of their families and staff, to consistently produce high quality milk.
“The ACCC acknowledges and respects these concerns,” the report said.
But it said $1 per litre was an “arbitrary price” that had no direct relationship to the cost of production for the supply of milk by farmers and processors to the supermarkets.
“Recognising these concerns, the ACCC conducted an in-depth examination of the effects of retail pricing along the dairy supply chain,” it said.
“This included the use of compulsory information gathering powers to obtain data and documents from supermarkets and processors from FY2010 to FY2016, and summonsing all relevant processing and retailing businesses to give evidence under oath in private hearings.
“The ACCC did not obtain any evidence that supermarket pricing, including $1 per litre milk, has a direct impact on farmgate prices.
“Importantly, we found that contracts for the supply of private label milk allow processors to pass the farmgate price paid to farmers through to the wholesale prices they charge to retailers.
“This means that processors do not have an incentive to reduce farmgate prices as a result of the lower wholesale prices they receive for private label milk, as the farmgate prices are passed through to the supermarkets.
“Further, farmers’ lack of bargaining power means that they are unlikely to benefit from an increase in the retail (or wholesale) prices of private label milk or other dairy products.
“Even if processors were to receive higher wholesale prices from sales to supermarkets, this does not mean the processors will pay farmers any more than they have to secure milk.
“Farmers’ ability to capture their appropriate share of profits will, as in all industries, depend on their bargaining power.”
Mr Keogh said Coles and Woolworths negotiated arrangements separately, as did other retailers, with dairy processors and in looking at those negotiations, the ACCC observed two notable areas.
He said one was that major supermarket retailers are negotiating with major multinational corporations that had considerable resources and the “wherewithal to negotiate”.
Some dairy processors told the ACCC they’d been looking at contracts to supply Coles and Woolworths and decided not to meaning some, especially those with home branded products, had the capacity to walk away from those negotiations, he said.
Mr Keogh said secondly, negotiations between the retailers and the dairy processors were already covered by the Food and Grocery Code which was a prescribed voluntary code.
“Woolworths, Coles and Aldi have all signed up to that and a review of that is underway at the moment by (former ACCC Chair) Graeme Samuel so in other words, we felt processors were in a better position to negotiate on an even keel with supermarkets relative to growers,” he said.
“But secondly, the Food and Grocery Code already deals with that relationship and is under review at the moment so we felt it wasn’t an area we needed to go into, with our deliberations.”
$1 per litre milk not predatory pricing
Mr Keogh said even if the $1 per litre milk price changed, there was “absolutely no requirement and in fact no likelihood” - based on supply contracts - that dairy processors would pass through any extra profits through to dairy farmers.
“They don’t pay a cent more than they need to,” he said.
“Even if, and this is a very big if, there were a mechanism available to require the retailers to charge a higher price for the milk, there’s absolutely no mechanism available to make sure that price gets passed through to dairy farmers.
“In fact dairy farmers get paid the same price irrespective of whether their milk goes into home brand or branded products, on the retailers’ shelves.
“That’s further confirmation that tackling the $1 per litre milk issue really misses the point – the point is the weakness in the negotiating power between the dairy farmers and the processors.
“We just passed comment (in the report) that it’s an arbitrary figure and in fact it’s been a decline in real terms since it was introduced in 2011 and we don’t think it’s sustainable in the longer term but it’s really up to the retailers to decide that issue.”
Mr Keogh said the ACCC’s analysis and figures showed that in some regions at differing times, $1 per litre milk was a loss leader but that pricing practice wasn’t illegal.
He said competition law outlawed predatory pricing and the test on that was what the ACCC viewed to be selling well below what the product costs and doing so for the purposes of removing competition.
“Whether $1 per litre milk is sold well below cost or not is only marginal, based on the figures we‘ve seen,” he said.
“Ccertainly in some parts of Queensland, the NT and WA and occasionally in Tasmania, it is occasionally sold right on the cost of below production, but then the second issue is, is that specifically done with the purpose of removing competition and that’s certainly not the case from what we’re seeing.
“In fact a lot of the competition is selling milk for exactly the same price so that test under the ACCC Act isn’t really met for predatory pricing so it’s not illegal for them to adopt that policy and they do that for other products like cereals.
And $6 cheese is in fact 60c per litre milk so it’s a much more substantial discount than $1 per litre milk.”
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The story Dairy processors could face hefty fines if mandatory code adopted first appeared on Farm Online.