Don’t let higher milk prices see the dust settle on milk contracts debate

Drafting a contract that works in familiar market conditions is relatively easy. What is more difficult is designing one that performs when market conditions fundamentally alter.

Historically, many milk producers have been passive in shaping contracts and few will have considered how their contract stands given the radically different market conditions of the past 12 months.

With milk output continuing to fall, producers on an island highly suited to its production should be riding the crest of a wave. Few are, and producers continue to struggle with low margins and ridiculously low returns on capital. After 10 years of being bludgeoned in an oversupplied market there has been no strong and collective reaction in the opposite direction.

Price, price, price

One word tops all others every time for importance and that is price. There are two types of contract based on price. The first is when the milk buyer sets the price and, ultimately, the dairy farmer has to like it or lump it. Clauses like “The purchaser can vary the Milk Price Schedule at any time by notice in writing” are typical of this contract.

The second model is where the parties attempt to agree a price set by a formula. Such formulae vary in complexity and workability to the point where some become so impenetrable that they cease to be legally enforceable and are worthless. Others are based on the average price paid by a selection of other milk buyers. But the common mistake here is lack of clarity about exactly how prices vary, once there is a deviation from the standard litre produced by the hypothetical “standard producer” used in some milk price league tables.

There are still “Price to be agreed and, in default of agreement, to be determined by an arbitration” contracts around. Whether an arbitrator has ever been appointed on such a contract is not known. If one has ever been appointed, what he decided and the basis of his decision would be intriguing. Worse still, one occasionally comes across the term “agreement to agree a revised price” – legally meaningless and unenforceable.

Can I leave, please?

In practice, acceptance of a price is ultimately linked to the producer’s ability to move contracts. If there is nobody else to buy the milk you have to accept the price you can get for it and in some parts of the country the choice of buyers has diminished significantly since 1994. Where there is a choice and a better offer is available, the question will be: How soon can the move take place? If it cannot be for a year or 18 months, the producer will weigh up the trouble and expense involved in moving and may choose to stay put.

While there are a few milk buyers who will accept producers who have failed to serve their notice period with another firm, most of the big buyers operate a rule that they will not enter into agreements with producers who have failed to honour the terms of their existing contracts by leaving on short notice. Why they operate this rule and whether it is a concerted practice is unknown, but its effect on reducing producer willingness to move is real.

Disloyalty penalties

A pet hate are those mean clauses that provide for a producer who has given notice to be paid a reduced milk price during their notice period. This acts as a large disincentive to producers to change milk buyers and in practice operates to reduce competition for raw milk radically.

In the early days of milk contracts, such provisions were called “loyalty payments”, which were withdrawn when a producer was “disloyal” by virtue of giving notice. Nowadays these provisions come in all shapes and sizes with varying degrees of camouflage, but all have the same effect.

Retailer contracts

Are the so-called supermarket contracts all they seem to be? Is it pos-sible that, unlike farmer organisations, the retailers spotted the trend of falling production and anticipated the risk of higher prices? What better way to protect themselves than to secure their own nominated suppliers on their own contracts?

Such a suggestion may provoke howls of protest and not all supermarket contracts are the same and nor do all supermarkets have the same motives. Care needs to be taken in any analysis, but anyone believing that the likes of Asda and Tesco want to see higher milk prices for consumers to fund producer prices is sadly mistaken. Low prices for consumers drive these businesses and it is these low prices which ultimately pay for processors and producers.

Recognising that market conditions have changed and then taking action is what differentiates a successful business from the rest.