Milk bottles© OJO Images/REX

Tesco’s review of its dairy supply group has sparked speculation about the future of premium supermarket contracts.

Retailers running the schemes, which cover their suppliers’ average cost of production, are investing millions to pay above the market rate for milk.

AHDB Dairy research shows the average price paid by Tesco, Sainsbury’s, Waitrose and Marks & Spencer in the past year was 33.1p/litre.

This compares with a UK average of 29.5p/litre – so those firms have paid £89m extra for milk between them.

See also: Tesco launches full review of dairy farmer supply group

Tesco’s letter to 650 direct suppliers said this year’s dairy upheaval had prompted a rethink.

It said the pricing mechanism would still be transparent and would reward farmers who pushed performance and standards.

Widening price gap

Clive Black, director and head of research at Shore Capital, said he was not surprised by the review, given the widening price gap and the state of the grocery market.

He said the cost-of-production deals did not encourage farmers to boost efficiency, so there could be a market-related element added into the price.

“Fair play to them with sticking to the terms to date,” Mr Black said.

“Tesco are not leading the market downward in terms of liquid milk prices.”

“But if [the scheme] remains in its present form then category profitability is taking a hit.

“At the moment there is a disconnect between what they are paying for milk and where the market is.”

At last week’s Livestock Event, the NFU praised those supermarkets running cost-of-production schemes and urged Asda, Lidl, Aldi and Morrisons to pay a transparent, sustainable price.

Sainsbury’s has said it has no plans to review its cost-of-production scheme, run along similar lines to Tesco.

M&S is using the Great Yorkshire Show to trumpet its “Milk Pledge”, a promise made in 2000 to pay dairy farmers fair, cost-covering price.

Market average

Principal consultant at The Dairy Group Nick Holt-Martyn said any review should not be on dragging down top prices but pulling up the market average.

“The real issue with these contracts is they are divisive,” he said.

“It is a two-tier dairy industry: those who are on aligned contracts and those who are not.”

The cost-of-production discussion has also caused a heated debate on Twitter.

Tesco’s move was picked out by some farmers.

Others debated the value of cost of production deals for the wider industry.

And the higher standards supermarket suppliers work to were in focus as well.