The report refers to ...
significant imbalances in bargaining power at each level of the dairy supply chain. This begins with the relationships between retailers and dairy processors, and progresses down to the relationship between processors and farmers.
The ACCC has identified a range of market failures resulting from the strong bargaining power imbalance and information asymmetry in farmer-processor relationships. These features of the industry result in practices which ultimately cause inefficiencies in dairy production. Neither the existing provisions of the Competition and Consumer Act 2010 (CCA), nor a voluntary code of conduct, sufficiently address these market failures. Therefore, the ACCC makes eight recommendations for improved transparency and allocation of risk in the commercial relationship between Australian dairy processors and farmers. Most significantly, the ACCC recommends that a mandatory code of conduct be introduced to address the market failures we have identified.The report states
The typical Australian dairy farm is a family owned and operated enterprise which involves high fixed costs and requires year-round intensive work amid uncertain and sometimes damaging climate conditions. For most dairy farmers, profitability is uncertain and subject to many variables beyond their control.
Many farmers believe that the major supermarkets pricing their milk at $1 per litre devalues the work they, their families and staff do to consistently produce high quality milk. The ACCC acknowledges and respects these concerns. $1 per litre is an arbitrary price that has no direct relationship to the cost of production for the supply of milk by farmers and processors to the supermarkets.
Recognising these concerns, the ACCC conducted an in-depth examination of the effects of retail pricing along the dairy supply chain. This included the use of compulsory information gathering powers to obtain data and documents from supermarkets and processors from FY2010 to FY2016, and summonsing all relevant processing and retailing businesses to give evidence under oath in private hearings.
The ACCC did not obtain any evidence that supermarket pricing, including $1 per litre milk, has a direct impact on farmgate prices. Importantly, we found that contracts for the supply of private label milk allow processors to pass the farmgate price paid to farmers through to the wholesale prices they charge to retailers. This means that processors do not have an incentive to reduce farmgate prices as a result of the lower wholesale prices they receive for private label milk, as the farmgate prices are passed through to the supermarkets.
Further, farmers’ lack of bargaining power means that they are unlikely to benefit from an increase in the retail (or wholesale) prices of private label milk or other dairy products. Even if processors were to receive higher wholesale prices from sales to supermarkets, this does not mean the processors will pay farmers any more than they have to secure milk.
Farmers’ ability to capture their appropriate share of profits will, as in all industries, depend on their bargaining power. As noted above, most dairy farmers have little bargaining power and limited scope to reposition their businesses or switch to a different farm enterprise. Farmers are also disadvantaged by a significant imbalance in the amount of pricing, market and product information available to them compared with processors. Processors are also far better informed about the minimum price that farmers are likely to accept than farmers are about the maximum price that processors are willing to pay. These information asymmetries mean that farmers are more likely to settle for a good offer rather than a better offer that could be available if they were better informed.
We have found that the bargaining power imbalance and this information asymmetry result in practices that transfer disproportionate levels of risk to farmers and soften competition between processors. These include complex and poorly timed pricing information, and contract terms which deter switching. These features add to uncertainty of farm income and make it difficult for farmers to identify and act when it is in their interests to switch to a competitive offer from another processor.
An example of this risk transfer was the retrospective price step-downs in 2016, which demonstrated that contractual arrangements between processors and farmers are structured in a way that allows processors to lessen the impact of their poor commercial decisions by retrospectively reducing the price they pay for farmers’ milk, long after the milk has left the farm. ...
Two main concerns arise from the ACCC’s key findings. First, bargaining power imbalances deter productivity-enhancing investments by farmers if they are unable to capture a sufficient share of the returns to make their investment worthwhile. Second, restrictions on switching soften competition between processors and reinforce farmers’ poor bargaining position.
Following consultation with the industry on our interim findings and recommendations, the ACCC concludes that a mandatory code of conduct would improve the quality of information and price signals, enable fairer allocation of risk, and remove restrictions on farmers’ ability to switch processors. While the introduction of a mandatory code will not overcome farmers’ relative bargaining disadvantage, it will mitigate some of the significant negative consequences. The removal of barriers to switching will also enhance existing competition between processors for raw milk.
Most major dairy processors are now corporations and not farmer-based cooperatives. However, industry practices have not substantially changed to reflect that processor and farmer are interests are no longer closely aligned. A mandatory code will assist this transition, by clearly setting out the rights and obligations of farmers and processors.
A change to industry practices to the benefit of farmers will mean some loss of bargaining power for processors relative to farmers. As expected, therefore, most processors opposed this recommendation. However, having carefully considered the submissions opposed to this recommendation, we consider that a mandatory code of conduct can be designed in a manner that improves the efficiency of the industry without substantial regulatory burden on processors.It goes on to comment
Supermarkets have significant bargaining power in their dealings with processors in most circumstances. This is reflected in the low wholesale prices supermarkets are able to negotiate and the terms of supply agreements between supermarkets and processors. Due to their bargaining power, supermarkets also have significant control over the level of risk they choose to be exposed to and the risks they pass onto processors. The type and extent of the risks that processors are exposed to depends on the products they manufacture and the nature of their wholesale supply agreements with customers. These include, for instance, exports, long term private label contracts with supermarkets or short term domestic supply agreements. Processors that are able to diversify by producing a variety of products and supplying a mixture of international and domestic customers reduce their exposure to specific risks.
Processors that mainly supply fresh dairy products for domestic consumption generally have more certainty about wholesale prices. As a result they are more likely to offer farmers fixed price contracts, which results in more price certainty for farmers. However, these processors face some uncertainty over continuity of supply to supermarkets which can limit their appetite for offering multi-year supply contracts to farmers. In recognition of the significant imbalance in bargaining power between supermarkets and their suppliers, including processors, supermarkets’ dealings with processors are presently governed by the Food and Grocery Code of Conduct. This is a prescribed voluntary code under the Act. Processor discretion to vary prices allocates disproportionate risk to farmers
Processors have significant bargaining power over farmers. Dairy farm businesses are typically small operations supplying much larger and financially stronger processors. Further, as raw milk is an essentially generic product, processors’ options for acquiring milk far outweigh farmers’ options for selling it. This makes it easier for a processor to threaten to not purchase from farmers in negotiations. This is aggravated by the perishable nature of milk, which prevents farmers from withholding supply to negotiate better terms with processors. Consequently, farmers are rarely able to negotiate contracts or prices with processors.
The bargaining power imbalance is reflected in farmgate prices, milk supply contract terms that favour processors and the extent to which processors can pass on risk to farmers.
Supply contracts between processors and farmers vary significantly, ranging from multi-year fixed- price contracts to arrangements that are effectively day-by-day, relying on terms in the processor’s Supplier Handbook which can be varied by the processor at any time. Farmers can face significant uncertainty in both the price they receive for their milk and the costs they incur to produce milk. This uncertainty can make it difficult for farmers to plan and make investment decisions to increase their productivity.
Farmers in export-focused regions in particular face uncertainty about the milk price they receive from year to year and within a season. This uncertainty, and the associated risks, largely reflects the market uncertainty faced by processors.
Farmers in domestic-focused regions experience greater price certainty, but have greater cost uncertainty due to their stronger reliance on fodder inputs to produce year-round milk.
In general terms, processors that pass on uncertainty and risks to farmers do so by adopting any or all of the following practices: ƒƒoffering only indicative pricing for a contract period (in some cases changing farm gate prices mid- season) ƒƒincentivising flat milk supply (or, penalising seasonal milk supply) ƒƒoffering only short term supply contracts to farmers.
The events of 2016 demonstrate that within-season price step-downs can cause significant detriment to farmers and the industry more broadly. The 2016 step-downs also demonstrate that processors generally have significant discretion when deciding whether to vary farmgate milk prices. The ACCC’s view is that processors should be able to manage their risk exposure during a dairy season without needing to shift this risk to farmers through mid-season milk price adjustments. This might be achieved by processors offering fixed prices for most of the milk they acquire within a season, so that farmers can choose the level of milk price risk their business is exposed to. Partially fixed price contracts have the capacity to reduce price uncertainty for farmers, allowing them to make better planning and investment decisions.
Farmers have limited insight into how farmgate milk prices are set by individual processors. Pricing offers from processors are complicated and often difficult to interpret. Final pricing is determined by many variables. These can be difficult for processors to forecast accurately at the time they make their opening offers to farmers for consideration, meaning that prices received by farmers can vary significantly from both the announced headline farmgate price, and the income estimates provided by the processors. This uncertainty arises even in the absence of mid-season price adjustments such as step-downs.
Dairy farmers rely heavily on income estimates prepared by processors when budgeting for a dairy season. However, they may not be aware of the assumptions made to produce these estimates, and the consequences of these assumptions not being met. As such, some farmers receive payments that are significantly less than they projected. Initial price offers from processors are often made very close to the commencement of, or sometimes after a new contract period has commenced. When combined with the complexity of offers, this timing reduces farmers’ ability to make well-informed decisions about production and budgeting, and whether to switch to a better offer from another processor.
Practices associated with the timing of Opening Price announcements have the potential to soften competition between processors and lower farmgate prices, especially if processors simply follow the price leads of other processors to avoid price competition. However, the ACCC analysed the historical price leadership behaviour of Victorian processors over time, and did not find any clear pattern of price leadership. In particular, we did not find evidence to suggest that Murray Goulburn or any other processor has in the past consistently signalled an Opening Price which other processors have then followed. Announced prices often do not reflect actual prices paid to farmers Processors typically make uniform pricing offers by announcing a single farmgate price at the start of the season. However, the actual prices that individual farmers receive vary significantly from the announced price. Further, farmers each receive different prices from processors despite the opening offers generally being uniform. The extent to which farmers generally receive prices above or below a processor’s announced price varies from processor to processor and from year to year.
A range of factors influence the farmgate milk price paid to farmers. These include: ƒƒCompetition between processors for the acquisition of raw milk—the degree of competition for farmgate milk varies significantly between regions and at different times of the milk production cycle. ƒƒFarm size—the largest farms typically receive better farmgate milk prices than smaller farms. This occurs for a number of reasons, including pricing incentives in contracts being tailored to favour larger farms and in some cases, the largest farms negotiating their own supply contracts. ƒƒIncentives for year-round milk production—processors may set price offers to encourage farmers to adopt a less-seasonal milk supply profile (flat production). The extent to which processors encourage flat production varies between regions and processors. In some regions the ability of a farmer to respond to seasonal pricing has a significant impact on the overall farmgate milk price they receive. ƒƒThe quality of milk produced—quality factors significantly affect the farmgate milk price. .... Overly complex milk supply contracts and price offers, delayed loyalty payments, and price announcements which allow farmers insufficient time to compare alternative offers, also restrict farmers’ ability to compare and switch between processors soften competition at the farmgate. Exclusive supply clauses in milk supply agreements do not restrict farmer switching and can be efficient for both farmers and processors. However, these kinds of clauses can be anti-competitive if they have the purpose or effect of substantially lessening competition in a market.In discussing the 'supermarket milk wars' the report comments
From 2014 onwards, supermarkets have used their bargaining power to encourage increased competition between processors for the supply of private label milk. This has enabled supermarkets to negotiate lower wholesale milk supply costs and improve their profit margins. While margins earned by supermarkets on private label milk are lower than for many other products, including branded milk, supermarkets still generally sell private label milk at a gross profit, except at times in Tasmania and Queensland (once distribution costs are taken into account). Supermarkets choose to absorb lower and sometimes negative margins in higher cost regions while making higher margins in lower cost states and from more profitable products. This is not particular to their dairy products, and enables them to maintain a competitive and consistent national pricing policy designed to build trust among consumers. In some instances supermarkets stock locally-sourced produce to support farmers in the region. Processors’ gross margins on private label milk have generally fallen, with wholesale prices approaching average production costs. Despite this, processors have continued to compete strongly for private label $ per litre milk contracts because the volumes of milk involved provide economies of scale in production, adding to overall profitability. Processors generally earn significantly higher profits on most other dairy products. These margins vary significantly between products, states and processors, but range between 30 and 60 per cent. Evidence obtained by the ACCC indicates that processors appear to offset lower margins on private label contracts with the higher margins earned on branded products. Margins for most other dairy products have been stable or decreasing since 2011.The ACCC did not obtain evidence of wholesale prices falling below levels that would force efficient processors to exit the industry. Although processors’ gross margins are very small for private label milk, they are positive, and processors are generally profitable overall. ...
Deregulation, and the gradual removal of pricing support for farmers, has had a pronounced impact on milk production and farmer profitability in Australia. Farmgate prices in Queensland and WA fell significantly immediately following deregulation, as processors sought to reduce production volumes to the level required to meet domestic demand. Many higher cost farms exited at this time. The ACCC has found that: ƒƒproduction volumes have trended down in these higher cost regions since price support was removed; the price of private label milk does not appear to have altered this trend ƒƒfarm exit trends in the higher cost regions have not changed in response to the introduction of one dollar per litre milk ƒƒtotal farm numbers, output and profitability trends have not changed since the introduction of one dollar per litre milk.
Competition between processors facilitates the lowest possible wholesale prices. Therefore it is not in the interests of supermarkets to force wholesale prices down to a point which causes processors to be unprofitable and exit. Processors’ margins on private label milk are already small and it may be hard for processors to achieve further cost efficiencies. Private label milk prices also constrain the wholesale prices that processors can achieve with non-grocery customers. This is straining processor profitability in high cost regions where supermarkets sell private label milk at low or negative margins. Therefore, wholesale prices will likely have to rise at some point in the future to maintain processor profitability. In turn, this would require action by the supermarkets which could include: ƒƒincreasing the retail price of private label milk ƒƒabsorbing any losses at the retail level into their own margins ƒƒrestructuring their supply chain in such a way that reduces costs, but maintains incentives for farmers to produce required volumes of raw milk. Contracting practices Contract arrangements in the dairy industry between processors and farmers are favourable to processors and exacerbate most farmers’ weak bargaining power. There appear to be few differences between the contracting options and terms offered by corporate processors and farmer-owned co-operatives. Certain contract terms and the complexity of contracts have limited the ability of farmers to switch between processors, and resulted in a lack of milk price transparency, and the uneven allocation of risk between processors and farmers. Contracts for the supply of raw milk may also contain some terms that are potentially unfair. The Unfair Contract Terms (UCT) legislation introduced by the Australian Government in 2016 provides protections for small businesses contracting with large businesses, and is likely to apply to some of these contracts. The ACCC is presently considering potential issues under the UCT arising from milk supply contracts for the 2017–18 season. Contract termination notice periods and automatic contract rollover clauses are problematic in most circumstances. Notice periods that require farmers to make supply decisions with limited or no access to price and/or other contract information may impact their choices and could also raise concerns under the UCT laws. Automatic rollover clauses may also raise concerns under UCT laws where they can be extended by significant periods of time. Although many milk supply agreements currently contain dispute resolution clauses, these often do not specify the process that is to be utilised to resolve disputes and therefore are rarely satisfactory. Given the significant imbalance in bargaining power between processors and farmers, the ACCC considers that the industry should develop a dispute resolution process that allows for mediation, arbitration or expert determination, where disputes cannot be resolved through negotiation.
This inquiry has revealed that many farmers are not aware of the terms and conditions of their milk supply contracts or agreements with processors. While the ACCC has concerns with the transparency and fairness of terms, farmers should more actively analyse their supply agreements and obtain relevant legal or financial advice where appropriate, including from representative groups, given the large monetary value involved. That said, their limited bargaining power will ultimately reflect the terms they are offered.Referring to collective bargaining and boycotts the report states
Collective bargaining authorisation is a legal tool available to farmers seeking to act collectively to redress bargaining power imbalances. The ACCC considers that although collective bargaining has worked in some circumstances in the dairy industry, it is not a broad remedy to the issues arising from the bargaining power imbalances that exist in the dairy industry.
Processors mostly lack incentives to negotiate with, or enter into agreements with collective bargaining groups. They rarely achieve gains from engaging in collective negotiations and therefore commonly choose not to engage with CBGs.
Processors are often in a position to circumvent engagement with bargaining groups by offering standard form contracts for milk supply to farmers on a ‘take it or leave it’ basis. These contracts are generally favourable to processors. This is not to say that current collective bargaining groups are ineffective or that collective bargaining should be disregarded as an option in the future. The ACCC has examined the history of collective bargaining groups in the dairy sector and found examples that work well. However, some of these groups were formed in unique circumstances, and have features that typically do not apply to most groups. Collective boycott arrangements, if authorised by the ACCC, might improve the negotiating strength of collective bargaining groups and help overcome the shortcomings observed. However, due to the perishable nature of milk, the threat of a boycott may be less effective in bringing dairy processors to the negotiating table and reaching a negotiated outcome than is likely to be the case in other industries. The need for a mandatory code of conduct Market failure in the dairy industry results from the strong bargaining power imbalance between processors and dairy farmers, combined with the information asymmetry between them. These features result in contracting and industry practices that are weighted heavily in favour of processors and which make it difficult for farmers to make efficient investment decisions. Efficient investments are likely to be deterred if farmers do not have the certainty that they will be able to capture a sufficient share of the returns to make their investment profitable. In addition, the barriers to switching between processors that we have outlined above reduce the effectiveness of competition for raw milk, and suppress farmgate prices.
Australia’s competition and consumer laws are able to retrospectively address isolated instances of behaviour and conduct which harm competition and efficiency in the industry. These laws include the unfair contract terms laws and prohibitions on misleading and deceptive, and unconscionable, conduct. However, the problems we have identified in the dairy industry emanate from the broader and inherent bargaining power imbalance across the industry, particularly between processors and farmers. The resulting effects and risks to the industry are widespread, and cannot be effectively addressed through the particular provisions of the CCA. The recently developed Voluntary Dairy Code has led to some processors offering improved terms in milk supply contracts for the 2017–18 dairy season. However, the Voluntary Code is not enforceable and processors can choose not to participate or comply with the code at any time. The ACCC does not consider that the Voluntary Code will adequately address the structural bargaining power imbalance, and the associated contracting practices in the longer term. Further, a process for monitoring compliance with the Voluntary Code currently does not exist, and it is unlikely this code could be effectively enforced in the future.
The ACCC considers the issues identified and examined in this inquiry are of such magnitude as to warrant being addressed by a mandatory code of conduct for processors. It may be appropriate to exempt certain processors from the application of a mandatory code based on market share, revenue or other threshold to ensure that regulatory compliance costs are distributed appropriately relative to businesses’ capacity to manage these.The ACCC makes several recommendations for improving interactions through the supply chain and supporting market conditions that facilitate efficient production and supply of dairy products -
1. Processors and farmers should acknowledge in writing the terms and conditions for milk supply.
This recommendation seeks to increase the clarity and transparency of the arrangements between processors and dairy farmers by ensuring that farmers are aware of, and acknowledge, the terms and conditions of their supply. This recommendation does not require the creation of any new or additional documents. Acknowledgement may simply take the form of signing or initialling a page in a Supplier Handbook, or sending a processor an email confirming that the contract has been accepted. Most importantly, contract variations that occur during a season or the duration of a contract should not be implemented until a farmer has acknowledged the contract variation in writing. For the avoidance of doubt, this recommendation does not suggest that parties be required to enter into contracts of fixed duration.
2. Processors should simplify their contracts where possible, including by minimising the number of documents and clearly indicating which documents contain terms and conditions of milk supply.
For example, in some cases the terms of a Supplier Handbook and a Milk Supply Agreement could be incorporated into a single document. This will provide benefits to processors and farmers, as contracts will be more transparent and easily understood. Clearer price signals can increase certainty and transparency in contracting practices and can improve efficiency in the market. The Australian Dairy Industry Council (ADIC) is in a position to work with processors to identify how contracts can be simplified and ensure this recommendation is implemented.
3. Processors should provide all contractual documents simultaneously before the commencement of the dairy season or contract term.
Farmers should be provided with all the proposed terms and conditions of their contract—whether that be the Supplier Handbook, any Milk Supply Agreement and/or any other documents that contain terms and conditions—simultaneously and with a sufficient time to properly consider them before the season (or contract term) commences. This will increase transparency and ensure farmers have the necessary information to make supply decisions before they have committed to supply a particular processor. For clarity, this recommendation does not require Opening Price Letters to be provided at the same time as contract documents, but does require Opening Price Letters to be provided before the new contract is entered into and commences.
4. Milk supply contracts should not include terms which unreasonably restrict farmers from switching between processors.
Many milk supply agreements contain clauses which act as switching barriers. These include loyalty bonuses or other payments that are paid in respect of one dairy season but require ongoing supply into a new dairy season. This recommendation is currently reflected in the requirements of the Voluntary Code, but this code is not enforceable.
5. The industry should establish a process whereby an independent body can mediate and arbitrate in relation to contractual disputes between farmers and processors.
The ACCC recommends ADIC should be responsible for establishing the body, and as part of this process should consult closely with farmer representative groups to determine the scope and procedure of the dispute resolution process. The ACCC also recommends that processors include detailed dispute resolution clauses in farmer contracts that allow for binding determination or arbitration. For the avoidance of doubt, this dispute resolution process should govern disputes between farmers and processors, and between collective bargaining groups and processors.
6. Farmers should ensure they have properly considered the legal and financial implications of their contracts with processors.
The average value of a supply contract varies across farms and regions, but in 2015–16 was just under $700 000. The ACCC’s view is that contracts of such significant value should be carefully and actively considered by farmers before they are entered into. However, we understand that in general, many farmers do not seek professional legal or financial advice before entering into a contract, and many are not aware of the terms and conditions of their milk supply agreements that apply to them. Farmer representative groups are well placed to provide general guidance about how common contract terms operate and how these can impact farm income. Because of the significant impact contracts can have on farmers’ operations, farmer representative groups should prioritise facilitating farmers’ general understanding of the procedures and key aspects of supply contracts. This may involve procuring legal advice to assist with providing guidance to farmers at a generalised level. This may include assistance in interpreting contracts, identifying emerging contracting trends and directing farmers to specialist legal and financial advisers. Farmgate milk prices
7. Processors should publish information identifying how their pricing offers apply to individual farm production characteristics to enable better farm income forecasts.
Processors need to improve the transparency of their contract pricing terms. This could be achieved through an interactive online model which allows farmers to enter their own production characteristics and obtain a reliable estimate of the final income to be received. Processors should publish information identifying how their pricing offers apply to a standardised set of model farms, accounting for common differences in farm size, seasonality of production, whether production is growing or retracting and how penalties, such as those relating to quality requirements, impact on pricing offers. This will improve transparency of pricing, allow farmers to make better comparisons of processors’ milk supply terms and enhance competition. A mandatory industry code of conduct
8. A mandatory code of conduct within the act should be established for the dairy industry.
The ACCC recommends that a mandatory code of conduct to apply to processors be prescribed for the dairy industry. Our view is that the inherent bargaining power imbalance between processors and dairy farmers, combined with unequal availability of information between them (information asymmetry) results in market failure in the Australian dairy industry.
Contracting and industry practices are weighted heavily in favour of processors. This has led to inappropriate allocation of risk, increased potential for inefficient investment decisions by farmers and less effective competition between processors. A mandatory code should therefore be designed to improve transparency and certainty in contracts, set minimum standards of conduct and provide for dispute resolution processes. In particular, a mandatory code should contain obligations on processors to improve the timing and manner of processors’ communication of price and other key information, and increase farmers’ ability to switch in response to significant changes to their trading terms. We have reached this view having considered alternative remedies, including relying on the existing provisions and mechanisms of the CCA (including collective bargaining), and other types of industry codes of conduct, namely a voluntary code or prescribed voluntary code of conduct.
The ACCC notes it may be appropriate to exempt certain processors from the application of a mandatory code based on market share, revenues or another threshold to ensure that regulatory compliance costs are distributed appropriately relative to businesses’ capacity to manage these.
