Tuesday, 08 March 2011 13:40

Coles cuts reduces farmgate price

Written by 
Joanne Bills Joanne Bills

The recent move by Coles to slash private label milk prices to $1 per litre has caused a huge stir in dairy circles during the past month.

While Coles claims they are absorbing the cuts and seeking to protect both farmers and consumers. Most farmers would recognize this for what it is – a marketing strategy and part of a wider price war to gain share of the grocery dollar. But how do private label products affect the industry and how will these changes really impact your farmgate price?

Private label or homebrand products already have a significant foothold in the milk category. While private label products accounted for around 50% of supermarket sales in 2009/10 – they accounted for over 70% of the regular milk segment.

Private label products mean lower margins for both retailers and processors. However, private label products also offer retailers greater control of their supply chain and help reinforce customer loyalty to the supermarket rather than brands.

In recent years, major retailers have reduced the shelf space available to branded products, narrowing the range available to shoppers and pushing consumers toward private label products.

This in turn has increased competition between manufacturers for private label contracts, often driving down wholesale prices and manufacturer margins. This underpins strategies such as Coles’ “down, down prices are down” campaign.

While Coles have absorbed the costs associated with cutting their own private label prices on milk, additional costs will also be incurred by processors and other retailers – both supermarkets and smaller convenience stores – as consumers switch to cheaper products.

DA modelling suggests a 10% shift to private label reduces processor profitability by around one cent a litre. If processors are forced to discount branded products to protect market share the impact is even larger, with a 10% cut reducing processor margins by an estimated four cents a litre.

The consequence this reduced profitability could have on farmgate prices varies according to regions and markets.

For the majority of farmers in southern regions, prices are driven by the international market, and the outlook is positive. Victorian farmers supplying domestic processors will still have their price benchmarked against an export price in any forthcoming contract negotiations. Therefore the impact will be limited, while export returns remain strong.

Farmers who are much more dependent on the drinking milk market – in Queensland, northern New South Wales and Western Australia are potentially much more exposed.

Milk prices in these areas have become less connected to southern benchmark prices over the past few years, as the regional balance between fresh demand and supply has been the key driver.  However, the extent to which the price cut impact will be passed on to farmers is uncertain and will be monitored closely in the coming months.

Coles’ action and the devaluation of milk are certainly disappointing and unfortunately appear to target farmers who are also dealing with floods and drought.

Let’s hope this latest marketing strategy will be quickly reviewed and reversed over the coming months!

Joanne Bills is Dairy Australia’s Manager Strategy and Knowledge.

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