Opinion: Dairy sector should have welcomed cost-plus contracts

Milk splash

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Few sectors have felt the effect of market volatility in the past 18 months more than dairy. It has seen prices tumble from record highs to 20-year lows on the back of relatively modest shifts in world supply and demand.

One of the less attractive side-effects has been the emotive debate around the emerging gulf between the fortunes of those on retailer-aligned “cost-plus” contracts and “the rest”.

David Alvis
David Alvis is managing director of Yorkshire Dairy Goats, based in the East Riding. He is a Nuffield Scholar and formerly co-managed the Technology Strategy Board’s sustainable agriculture and food innovation platform

Many commentators have suggested that the widening gap between the haves and have-nots of the dairy sector is both unsustainable and unhealthy.

On the face of it, a 10p/litre differential in farmgate prices, for ostensibly the same product, might seem a tad excessive.

However, it was little more than a year ago (when dairy commodity prices approached their zenith) that these same contracts, now widely regarded as totems of the iniquity, were being derided as regressive and exploitative by many of those same voices that today condemn them as divisive and elitist.

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Many commentators have, since their inception, questioned the wisdom of “open-book” costing contracts, seeing them as merely facilitating a race to the bottom; a tool for mendacious retailers to turn the screw on dairy farmers.

But the market was always going to do that anyway, and at least a cost-plus mechanism offered producers the opportunity to manage their risk exposure.

If anything, those retailers who took the initiative to secure supplies of fresh milk at a time of dwindling production missed a trick by failing to build anything other than token requirement for continuous efficiency gains into the contracts.

“Supermarkets, after all, are businesses with shareholders and hardly renowned for their acts of selfless charity” – David Alvis

For the impartial observer, such a quid pro quo would have been a perfectly reasonable exchange for effectively offering producers an open-ended hedge against rising costs.

But at the time, the PR risk of enforcing such measures was perhaps seen as too great a price to pay for retailers, who were coming under ever increasing scrutiny for their alleged heavy-handed treatment of suppliers.

Unfortunately, yet rather too predictably, these contracts would not appear to have yielded the supply chain-wide benefits that had been intended and which were always going to be fundamental to their sustainability.

Supermarkets, after all, have shareholders and are hardly renowned for their acts of selfless charity; their milk procurement arrangements were never meant to benefit farmers unilaterally.

While some of their more foresighted contracted suppliers have used the income stability these contracts provide to invest for the future and build stronger, more efficient businesses, others merely saw them as an opportunity to take their foot off the gas and cruise.

Worse still, some saw it as a chance to load costs into their businesses in the naive expectation that Tesco et al would happily underwrite these in perpetuity.

When one sets the current state of unrest in the UK retail sector against the backdrop of a global oversupply of milk, it should come as no surprise to anyone that Tesco has recently announced it is going to undertake a comprehensive review of its milk supply contract arrangements. And where Tesco leads…

Some might see this as a welcome levelling of the playing field, but it highlights the wider industry’s reluctance to acknowledge and safeguard what was perhaps the single most significant advance in farmer-supermarket relationships of recent times.

Never has the old adage “be careful what you wish for” been truer.