Why Murray Goulburn’s price step-down is unfair

Richard Lange, Director at Sustain: The Australian Food Network

For all dairy farmers, the 2016 crash in milk prices is far worse than a market correction. It strikes at the heart of dairy farming and undermines the basis of farmer co-operatives.

There is rhythm to milking cows twice a day. It needs predictability, consistency and routine to make this perishable food.

The two things that dairy farmers fear most are, first, the milk truck doesn’t pick up the milk, and secondly, the milk cheque doesn’t come as expected. A fail in one or both of these things and trust with the milk company is broken.

So when Murray Goulburn (MG) announced a step down in price without warning, and backdated it to July 2015, it was felt as a fundamental breach of the ‘trust contract’ by their 2,600 farmers.

As price takers in food markets dominated by large buyers, farmers form co-operatives to realise economies of scale, share the costs, increase their bargaining power vis-à-vis the supermarkets and other buyers, and, in sectors like dairy, share in the potential added value from manufacturing and marketing.

At the same time, milk and dairy products are a globally-traded commodity, which means the prices Australian farmers receive are to a significant extent determined by global markets. With recent increases in dairy production in many countries, there is now a global over-supply of milk.

While this means that there is no simple answer to the current predicament of Australia’s dairy producers, it’s also the case that fairness requires that we take action to support our dairy farmers.

Background to Murray Goulburn and dairy co-ops

MG was formed a farmer-owned co-operative by 14 dairy farms in 1950; and grew to become Australia’s largest milk processor, with more than 2000 employees as well as its 2600 farmer-owners and suppliers. As with all companies, these farmers depend on their elected Board to represent their interests.

Most dairy companies set the milk price at the start of the financial year and usually make two or three 3 step-ups in price, subject to the company’s market performance. These ‘step-ups’ include a retrospective payment for milk volumes already supplied to the company during the year. Typically, this opening price is around 85-90% of the final price at the season end.

As a farmer co-operative, Murray Goulburn has generally sought to maximise the return to farmers. MG ran a low margin/low cost business model and proudly declared that it paid the highest milk price possible. This was its mantra and it was used to aggressively build their supplier base.

MG was so good at this business model that most MG farmers were loyal suppliers, even in the market downturns, and renowned for supporting the MG view of the world. From recent events this has now changed.

The April 2016 price cut

To most dairy industry observers, the step down announced by Murray Goulburn at the end of April, without warning or any consultation with its farmers, is appalling for its suppliers and bad for the industry. It is also quite unlike Murray Goulburn.

Part of the problem can be traced back to June 2015, when MG listed a unit trust on the ASX to raise capital of $500m and projected a return for investors based on a milk price of 45 cents per litre. At the time, it appeared MG had solved a long standing issue of co-operatives hamstrung by a lack of capital for reinvestment and growth.

The ‘new’ MG business model pursued a strong value added strategy with investment in brands and capital. It entered uncharted territory by serving two masters, investors and farmers.

For financial year 2016, Murray Goulburn was forecasting a profit of $89m. By February 2016, this forecast had fallen to $63m and now has been downgraded to $39m-$42m.

At the start of this financial year, the unit trust listed at $2.10 a unit, it is now trading below $1.00.

For MG suppliers, the milk price dropped from 42 cents per litre to 35 cents per litre. As is the convention for step ups, the step down in milk prices meant it was back-dated for the start of the 2015/16 year, such that farmers have been ‘overpaid’ for 10 months.

On any measure this does not meet the fairness test.

The last time the industry had a step down in milk price was 1973 with the oil price shock and 2009 by Warrnambool Cheese and Butter (WCB).

MG’s attempt to defy ‘market’ gravity is remarkably similar to that 2009 situation experienced by WCB. Both suffered an adverse shift in the market when trying to deliver promised returns to investors.

The bigger picture: milk as a global commodity

During the 2015/16 season, MG, like other exporting dairy companies, faced a downturn in the world market price due to an oversupply of dairy products. An increase in European and US milk production, and subsequent increase in stocks, have depressed prices globally.

Whilst these market conditions were recognised by most players in the industry, the new MG business model made it difficult for analysts to assess its level of exposure to these market prices. This was made worst by exaggerated claims that its diversified portfolio, particularly from domestic branded sales, had mitigated the impact of the commodity market downturn.

The commodity market regularly fluctuates in price and one of core functions of the co-operate is to manage, absorb and protect farmers from this price fluctuation. This is why the step down in the farm gate price is not only uncommon but a failure of MG in its role as a co-operative.

But Murray Goulburn failed to manage farmers price expectations

The ‘new’ MG failed on something it would never have done in the past; it failed to manage its farmer’s expectations on milk price.

This failure to provide clear price setting expectations has massive impacts on dairy farmers.

These farmers have an annual plan and incur upfront costs based on their expectations of milk price and seasonal production conditions. This year was a tough season. Many Victorian dairy farmers incurred debt from high water and/or feed costs.

The lack of transparency by MG’s on their market performance is not fair.

When announcing the step down, MG also announced that low milk prices were likely to continue for three years to cover the estimated debt of $200 million. This debt incurred by MG management was shifted onto farmers as shareholders/owners. They are now faced with an average additional debt of more than $120,000 per farmer. This is not fair.

Wider industry impacts: the actions of Fonterra

For the industry, MG has been the major price setter upon which most other processors set their price. So its failure means not only the MG suppliers are affected, the industry is as well.

Fonterra Australia claim to have been advising their farmers of the tight market conditions. These farmers supply Fonterra, through the Bonlac Supply Company, and have their contracts tied to the farm gate price of MG. After one week, Fonterra dropped, then partially restored, their farm gate price for their milk suppliers. This also is not fair.

This was an opportunistic response by Fonterra Australia, made worst by Fonterra (NZ) CEO Theo Spiering’s comment that they would seek to maximise the returns for their NZ farmers implying it was at the expense of their Australian suppliers.

For MG, there is likely to be more changes to the MG board. There are also questions on how the co-operative will trade out of its significant debt position, assuming support from the banks.

Where to now?

In the end, there are no winners from this situation. The co-operative, that was set up more than 60 years ago by farmers to support farmers, has let them down. They are now fighting for survival – quite literally, in some cases.

Desperate farmers are now looking find alternative processors to take their milk, with limited success. Farmer groups like Farmer Power are calling for an immediate 50 cents a litre levy on milk to help farmers make it through the crisis.

There is an immediate need for farm management and welfare counselling services for farmers across the dairy regions of Victorian and Tasmania. Tragically, there have been unconfirmed reports of farmers suicides in some places.

Dairy farmer representative bodies such as UDV and Dairy Australia and its regional dairy programs will provide direct support services. All, including the federal government, are turning to the Australian Competition and Consumer Commission and Australian Securities and Investment Commission to intervene and question the transparency and fairness in what has happened. The ACCC has strong powers to act quickly, if required.

Consumers can support Australia’s dairy farmers by buying branded milk at the full price. There may be scope for an expansion in local sales of milk, cheese and dairy products through farmer’s markets, though that can only absorb a fraction of the milk being produced.

Longer term, there appears to be an ongoing structural issue for farmer owned co-operatives when seeking to raise capital.

Can dairy co-operatives serve two masters, farmers and investors? There are examples of such ownership structures, though they are not without challenges.

Australian dairy companies need to prioritise strong engagement and transparency with their suppliers through regular communication on market and business activities – this applies to the board and management team alike.

There will be many CEOs ensuring they are on top of their numbers, evaluating the impact of market demand and supply and prioritising their own farmer suppliers.

In this situation, fairness in the treatment of farmers as suppliers has gone off the rails.

Has there has ever been a stronger case to put farmers first? I doubt it!

Richard Lange is an agricultural economist and worked for almost 20 years in the dairy industry. He is currently contracting to various food businesses including Organic Dairy Farmers Co-operative in North Geelong.