Dairy producers must lower production costs to compete globally

The reduction of subsidies and abolition of milk quotas is throwing open the door to the global marketplace. If farmers want to become global traders they have to understand the ground rules for management and success.

Like many other agricultural commodities, the price paid is determined by supply and demand. When supply is in decline, the seller makes the price, and when the supply is in excess, the buyer will determine the price.

We have a confused milk processor, at times an uncaring retailer, and a dairy farmer who is trying to establish and run a good business.

Tony EvansTony Evans
Head of business consultancy
The Andersons Centre

Spring 2014 saw the peak price for milk in the UK and the likelihood is that 18 months later we are experiencing a trough that is as low as the price 10 years ago.

See also: Top milk producers concentrate on costs not milk price

However, if you consider the average over a two-year period, the price paid over 18-24 months will be about 26-27p/litre.

Fail to deliver top price

The problem for many processors was that due to their product mix, poor route to market and, in some cases, their operational inefficiencies (for example, transport, small manufacturing plant and excessive supplier management costs), they failed to deliver the top price paid.

They also failed to clearly indicate the ground rules of successful global trading – that you must learn to manage and trade within a volatile market.

Look, for example, at a grain farmer who in 2009 received £98/t for wheat, then £180/t in 2012 and is likely to receive about £120/t this year.

Despite price differences he still trades successfully. The key difference is the average cost of producing 1t of wheat is about £135/t – 75% of the peak price.

The average cost of producing a litre of milk is quoted at 29-30p/litre. This represents about 88% of the peak price.

Commercial goal

The key message, therefore, is if the UK dairy industry is going to trade successfully in a volatile market, it must lower its overall costs of production to benefit more at the peak price and to better withstand lower returns.

A reduction in cost of production to 25-26p/litre has to be the commercial goal, and for many businesses this is achievable.

For those milk production businesses that cannot reduce their costs of production due to weather conditions (mostly either very dry and therefore unable to grow grass, or very wet and cold and unable to grow or use grass) they either have to cease production, relocate their business, or get an aligned milk contract that assures them of a price that covers their costs.

In this case, however, the retailer needs to cherish this supply base and be consistent in its message rather than abuse its position and run the risk of losing its milk supply.

Be realistic

In return, the milk producer cannot expect the highest price when the product is in demand if he cannot live at the lower end.

So where to go from here? The UK can either go back to five years ago and cease being a global trader and just concentrate on the liquid market and high-value manufacturing.

This in turn could see up to 30% of the dairy industry cease trading, reduce new product development and create a stagnant, demotivating environment.

Alternatively, the UK can recognise that it has 66 million customers on its doorstep, and many millions more in mainland Europe, and a weather and industry environment to compete with some of the world’s lowest-cost producers (recent European costings show that the UK has the second lowest cost of milk production in Europe).

But to be a successful global trader we need the following:

  • Clear industry leadership with fewer competing milk buyers and producers
  • State-of-the-art manufacturing capacity close to the milk supplier (having 92% water – very expensive to haul round the country)
  • Two levels of producers recognised and respected by both retailers and processors – one for the liquid sector and one for the manufacturing sector
  • Milk producers who choose to trade in the global market and run their business accordingly
  • A milk production environment that is rewarding and based on business and profit; profit brings choices.