Milk margins hit by retail price wars

Strong competition between retailers forced milk prices down in the shops and squeezed processor margins in the year to the end of March 2012.

DairyCo’s latest Dairy Supply Chain Margins report confirms the background leading to this summer’s recent and threatened milk price cuts.

Although it maintains that consumer demand for milk is relatively stable and insensitive to price changes, it also says that increases in retail price levels would not necessarily flow back to processors or farmers.

Consolidation in the processing sector means that this annual report is no longer able to calculate retailer margins on liquid milk. However the long term trend since April 1996 is for static or very slightly rising processor gross margins* of 17 to 18p/litre against retailer gross margins over the same timescale moving from about 2.5p to more than 22p/litre.

“In the past, increases in processor costs have been matched with rising retail prices,” said DairyCo/AHDB analyst Patty Clayton. “But a significant factor in the liquid milk market in 2011-12 has been the lack of such an increase. Price promotions on liquid milk and consumers tightening their belts meant retail prices did not rise.”

In the absence of any significant change in the structure of the liquid milk market which would change the balance of power, processor gross margins are expected to remain under pressure.

This pressure is driven by the need of a few players with large investments in processing capacity to operate near full capacity to ensure efficiency and compete to secure large retail contracts.

“Farmgate prices will continue to be driven by wholesale markets for dairy products, with demand for milk from the various product segments driven by their profitability,” said Mrs Clayton.

DairyCo supply chain margins: key findings

• Strong world dairy commodity markets increased competition for raw milk

• Average DEFRA UK farmgate price in 2011-12 – 28.1p/litre, 11.6% up on previous year

• Higher processor milk costs normally reflected in higher retail price – but not this year

• Seven year low for average retail liquid milk prices – 55.5p/litre

• Sharp retail price cuts of past three years reverse previous trend

• Unlikely that processor gross margins increased – high levels of competition in retail, pressure from retailers to keep wholesale prices down and increase in average farmgate prices

• Processor gross margins on liquid milk to remain under pressure

• Retail price movements in mild and mature Cheddar markets much more in-line with movements in wholesale markets

• Processor Cheddar margins fell while those of retailers were down slightly or the same

• Higher retail prices for Cheddar maintained retailer gross margins at 47% to 49%

• Processors gross margins fell from 15% to 10% for mild Cheddar and from 22% to 18% for mature Cheddar but this could be temporary

*Gross margins are calculated measuring unit selling price less unit cost price (in p/litre terms).