Why do Australian milk farmers need to protest supermarkets' milk price?

Question

Sorry this might be borderline off-topic (and I am an economics layman at best), but I found this rather puzzling and would like to know why this is happening.

I just came across an article which documents another development in the quarrels between Australian milk farmers and big supermarket chains.

As I understand it, the farmers demand that supermarkets charge higher prices for milk and then pass on the additional revenue back to the farmers.

When I think of the free market, I would expect this to be unnecessary, as the farmers could charge more when they sell the milk to the supermarkets or, if that doesn't work (why wouldn't it?), some farmers would stop milk production leading to milk scarcity leading to higher prices or, more importantly, higher revenue for the farmers.

What am I missing?

Answer 1

I would like to contradict Kenny LJ explicitly on his claim that "the free market works".

It only works if the market is actually free, i.e. competition exists. Which, you can argue, is not the case in the milk market.

What you are looking at is a cartel.

(Excuse me for citing numbers for the German market, not Australia, as I am more familiar with that market and have numbers ready that I don't have for Australia. I am quite confident, however, that while the ratios might differ a bit, the overall structure will be the same.)

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There are about 100.000 milk farmers in Germany, producing about 28 million tons of milk per year. As Mick pointed out, however, they are in the farming / production business, not in the transportation / processing business, so they have to sell their milk to dairies. There are just over 100 dairies in Germany.

And most of them have a monopoly on their region, meaning they're the only dairy a farmer could sell to.

Those dairies sell the processed milk to supermarket chains and other retailers / business consumers. About 60% of all the milk produced is sold by less than a half-dozen major supermarket chains.

Milk is a highly regulated food product, meaning that one dairy's milk is effectively the same as any other. There is very little competition in quality. The dairies don't even have "a product", the milk ends up packaged in the supermarket brand:

Woolworths has bumped the cost of its own-brand milk by 10 cents a litre, but Coles has refused to follow suit because it might burden customers.

So the only competition is in the price. Whoever sells cheapest. Customers buy the milk where it's cheapest (supermarket), because they simply do not have any realistic option to go for a "premium" milk product that's provided by middle- or small-sized, or regional, producers at a sustainable price with a transparent premium for the producer as well. It's just not available. There are "bio" brands, but that label is only saying something about how the cattle is kept and fed -- the price dynamics still apply:

The supermarket buys where it's cheapest (dairy), and the dairy tells the milk farmers how much they are willing to pay, take it or leave it.

A farmer that is not willing to sell his milk at the price the dairy dictates (even if it's at a loss), will not get his milk to market at all, but still have running costs to pay. Which means he'll be out of business pretty quick, forced to sell his business, land, and lifestock to some bigger farmer that is able to use scaling effects to produce at a lower price.

You could claim that this is the result of an oversaturated market, that less milk on the market would drive the prices up. That is correct, in a way, but the market is oversaturated because producing large quantities of milk as cheap as possible is the only bargaining chip the producers have in a market where literally no-one is going to a farmer to buy produce. Rising prices would not equate to rising margins for the farmers, as they simply have no control over the supply chain.

Concentration of power at the retailer end, a lack of competition in quality, and the inability of the producer to cut out the middle man (dairies) or create a meaningful "premium" market means the retailer is dictating the price, to the point where producer's margins are minimized and the only way to be a profitable producer is by economics of scale -- large combines swallow medium and small-sized producers, and the retailers are able to push the price even lower, repeating the cycle.

This is beneficial to the customer insofar as that the product (milk in this case) is available at every supermarket and extremely cheap. But it comes at a high cost, destroying middle- and small-sized milk farms (and dairies!) in a race to the bottom. Which also includes a race for the most milk-efficient cattle, to the exclusion of all other considerations.

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Refuting Kenny LJ's wholesale dismissal of regulation:

Suppose instead that these farmers instead benefited from low grain prices and enjoyed profits of 20 cents per litre of milk sold. Should consumers then have stood outside supermarkets demanding that milk prices be lowered by 10 cents per litre?

The consumers wouldn't have had to, as the supermarket chain would already, preemptively, have realized the opportunity to lower prices (to stay competitive to the other supermarket chains who would have done the same).

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Addendum:

In answer to a comment by @horns, this is a matter of official record and investigation.

Rewe was sentenced to 20.8 million Euro antitrust fine in May 2013. Spar was sentenced to 3 million Euro antitrust fine in November 2014. (Just two I was able to duckduckgo ad-hoc.)

Quoting the German Antitrust Office:

Our investigations have shown that the contracts between milk producers and dairies in Germany have long periods of notice and duration. In addition, farmers in Germany are generally obliged to supply the milk they produce exclusively to their respective dairy. There is virtually no possibility for them to switch to another dairy. This is a problem for farmers and hinders possible newcomers on the dairy side or dairies wishing to extend their activities. Another widespread practice is that the price of raw milk is set only after delivery and is based on reference prices and market information systems.

Also from that article:

The Bundeskartellamt questioned 89 private and co-operative dairies, which in 2015 procured approx. 30.9 million tonnes of raw milk. This is equivalent to around 98 % of the total milk supply volume. The authority's investigations have shown that in 2015 97.8% of the volume of raw milk covered by the investigations was sold subject to exclusive supply obligations. In addition, contracts for more than half of the raw milk supply volume can only be terminated with at least two years' notice.

There is no effective competition.

Answer 2

Please also see the new Additional Addendum at the bottom written a few days after I first wrote this answer.

You are correct and not missing anything. Absent good reasons to the contrary (and none have been given here), we may presume that the free market works.

If the Queensland milk industry is being "squeezed", then this suggests that there are simply too many dairies and some should shut down.

"We've got 370 dairies in Queensland at the moment, that could get down to 150 in eight to 10 years' time, and there will be more imported milk," he [Farmer McInnes] added.

Farmer McInnes's alarmist scenario illustrates a commonly-held economic fallacy that probably arises from the common tendency to think about everything in binary terms.

To him, it's either:

• Queensland raises the price of milk by 10 cents a litre and thereby preserves its 370 dairies; OR
• Queensland does not raise the price of milk and thus sees a catastrophic fall in the number of dairies from 370 to 150.

Such binary or all-or-nothing thinking is a failure to recognise how to free market works. The free market is capable of making marginal adjustments.

If at present, the Queensland milk industry is being "squeezed", then this suggests that there are simply too many dairies relative to demand. What should naturally happen is:

1. The least profitable/productive dairies voluntarily shut down.
2. Supply will fall.
3. The price of milk will rise to the point at which the remaining dairies are happy with the prices they receive.

The end result is that the number of dairies will fall, but probably by only a handful and not catastrophically to 150 (I don't even know where he gets this number from).

But even if the number of Queensland dairies does fall to 150, then this is not necessarily a bad thing, so long as this fall is a result of natural market adjustments.

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Lengthy addendum. Producers seeking government/public protection have always made certain specious arguments. Here in this article, in addition to the main such argument refuted above, several other of such arguments were also made. They are well worth refuting:

the costs are enormous.

Drought has led to soaring grain prices, making it more expensive for farmers to feed their herds on top of costs like water and power. ...

10 cents is the difference between getting by and making a profit, but have invested too much to pull out.

Under the free market or capitalist system, individuals take risk and can then enjoy either rewards or losses.

Suppose instead that these farmers instead benefited from low grain prices and enjoyed profits of 20 cents per litre of milk sold. Should consumers then have stood outside supermarkets demanding that milk prices be lowered by 10 cents per litre?

This would, of course, have been absurd -- but it is also exactly what the present farmers are doing.

At play here is also some sort of strange morality, in which it is thought "fair" that consumers "should" help pay for producers' costs.

But suppose I spend 20 years of my life creating what I (and no one else) consider to be a magnificent work of art. Should I then protest when nobody out there is willing to pay me $1M for this work of art and all the years of hard work I put in? No. Consumers (be it of milk or my magnificent artwork) are free to pay whatever they like and need not be coerced into paying more than they'd like.

Mr McInnes runs ... a family farm that's been operating for 104 years

Here the age of the farm was simply included without comment. This is an emotive argument based on age/history/tradition that clearly has some appeal.

It is not altogether invalid. Some communities/countries may collectively decide that certain things (like farms or art performances) are worth promoting, preserving, and hence subsidising or being otherwise protected from market forces.

However, such subsidies should be made clear, transparent, and explicit. And ideally, they should arise through the democratic process, rather than through a few farmers' protest outside a supermarket.

[raising the price of milk by 10 cents per litre] would only cost consumers an extra \$8 a year.

This, by itself, is not an argument at all. Why should each milk consumer in Queensland have to pay \$8 more per year to milk producers? Should they also each pay \$8 more to Queensland's avocado producers, the King of Thailand, or Mel Gibson?

Just because a cost is perceived to be small (and I personally do not perceive paying an extra A$8 a year for milk to be small) doesn't mean we can ignore the cost. Instead, every cost must be weighed against the corresponding benefits. And here, no benefits whatsoever have been articulated, other than that of helping out a few dairy farmers. And no reason has been given for why dairy farmers are any worthier of special help than are avocado farmers, the King of Thailand, or Mel Gibson.

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Another addendum. My answer above has been correctly criticised for being overly theoretical. And so I have spent a little more time studying the specifics of the Australian dairy industry. One particularly important reference is the Australian Competition & Consumer Commission's (ACCC) Dairy Inquiry: Final report (April 2018).

It turns out that there are market failures in the Australian dairy industry.† However, these market failures are not what everyone here has assumed.

A little background: On January 26 2011 (Australia Day), the supermarket chain Coles began its milk price war by offering $1-a-litre milk. Soon after, two other chains, Woolworths and Aldi, followed suit (see e.g. this story).

Everyone has thus assumed that the "villain" in this story is the supermarkets (and especially Coles). However, it turns out that the "villain" (if there must be one) is instead the processors, which are another intermediary between the dairy farmers and the supermarkets.

According to the Dairy Inquiry (p. xii), the key market failures arise from:

the strong bargaining power imbalance and information asymmetry in farmer-processor relationships.

The Dairy Inquiry issues 8 recommendations (pp. xxv–xxvii). All 8 pertain to rectifying the power imbalance and information asymmetry between the farmers and the processors. All 8 are contractual and informational. All 8 pertain to increasing clarity, transparency, simplicity, and the ease with which farmers can switch between processors in the farmer-processor contracts.

Importantly, the ACCC does not recommend raising supermarket prices as a possible solution:

The ACCC did not obtain any evidence that supermarket pricing, including $1 per litre milk, has a direct impact on farmgate prices ... 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.

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A common lay reaction to many economic problems is to call for artificial price floors. (Indeed, the Australian Labor Party has proposed doing so with milk prices if it wins the federal elections -- this is thus evidently a popular "fix".)

However, economists know that artificial price (and quantity) restrictions are generally a bad idea and usually cause even more problems. If there are market failures, then we should try to address those market failures directly, instead of using artificial price restrictions.

For example, if there are externalities, then one possibility is to use the appropriate Pigovian taxes and subsidies.

And in this particular example, the market failure is that of uneven bargaining power and information asymmetries between farmers and processors. Therefore, the economist's preferred solution is not a milk price floor, but to tackle the market failure directly, namely by reducing the information asymmetries between farmers and producers.

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†I never claimed otherwise. In particular, I never claimed, as has been caricatured by some of my opponents, that the Australian dairy industry is a perfectly competitive and free market. I merely claimed that all of the arguments in the originally-cited article were invalid and failed to explain what, if any, the market failures or imperfections were.

All markets in the real world are imperfect. The onus is on one to explain and ideally quantify what the market failures are. That way we can better understand the problems and find a better solution, instead of simply screaming for a price floor whenever there is perceived "unfairness"/"injustice"/"exploitation".

I have also deliberately put "villain" in scare quotes. In economics, we are less interested in looking for the "villain" or someone to blame than in trying to find solutions for each problem. And there usually are solutions, once we set aside our moral outrage.

Answer 3

Getting milk from the dairy farm to the retailer is too expensive for individual farms to manage on their own, with transporting, processing and packaging. There are also a host of consumer and health regulations that prevent dairy farms selling direct to consumers without first processing the milk. They are dependent on distribution networks to buy and collect the milk. Thus they have little bargaining power when it comes to negotiating the price, it often comes down to accepting what is offered as a take-it-or-leave-it deal. Some would liken it to paying "protection" to racketeers, except this is legal.

Farmers are also generally not well educated in areas such as economics or marketing, and so the quotes and sound bites are emotive and often a simplistic view of what would solve the problem as they see it. In this case, Coles charging 10 cents per litre more and passing that 10 cents back to the farmers would approximately double what they earn from their milk.

The supermarkets sell their own brand milk for about \$1.00 per litre, other brands are more expensive. But regardless of the brand, farmers typically get \$0.08 - \$0.15 per litre.

Possibly the only alternative solution that would deliver more money back to the farmers is if they were to organise into a collective, which could bring significant bargaining power, and dictate for what price they will sell their milk. The two main obstacles to this, however, are that the farmers are mostly parties to a supply contract which they would either have to break, at the risk of being sued for breach of contract, or wait until it expires, and the risk of falling foul of the various laws designed to protect consumers from anti-competitive practices such as price-fixing.

Answer 4

Not sure about Australia, but in America it's quite common for a large retailer to simply dictate to the producers the price they will purchase the commodity from them for. If a farmer's primary customer can simply declare that they will be paying 5% less for a product, the farmer really does not have much recourse. Or, if for whatever reason the expenses increase, the farmer either eats that cost, or it gets passed on. Unfortunately, they are not a storefront that can make up for it by selling to more customers -- they have their major customers, and they sell it to them. So if that major customer simply refuses to pay it, the farmer has no recourse.

Answer 5

Other answers and comments have outlined the general economic principles at work here. Here are the details unique to Australia:

1. Two companies, Coles and Woolworths, control the majority of the supermarket sales in the country. Critics call them a "duopoly." There are other stores, but the big two dominate. Their control of the market allows them to effectively dictate prices to some of their suppliers.
2. From 2011 to 2018 they were competing aggressively on the price of basic store-brand milk (presumably at little or no direct profit to themselves or dairy farmers; the major supermarkets may have profited indirectly by attracting customers away from smaller chains, who then buy profitable non-milk items).
3. Coles is still selling milk cheaper in 2019 than it was in 2010.
4. Last year Woolworths sold a limited run of "drought relief" milk at an increased price, marketed as helping out struggling dairy farmers. A significant number of customers chose to pay 10% extra (for the same product with a different label). Woolworths have now raised the price of their basic store-brand milk and dairy farmers want Coles to do the same.
5. Dairy farmers feel that pegging the consumer price of milk to $1/L for 8+ years while the prices of every other consumer product went up at the normal rate is not the kind of market behaviour they want to see.

Answer 6

Farmers cannot operate as ideal model businesses that can just turn off and on without impact. Only large corporations can even approach that level of abstract capitalism.

More specifically farmers (1) have certain minimum expenses both for family and farm related (loan payments), (2) are not diversified to get income from other product lines, (3) have little/no work knowledge or capital to get into diversification (4) limited ability to instantly increase or decrease the milk cows in production especially without significant surge losses. Cows cannot be stored like machinery. In fact if whole industry kills cows beef sale price plummets and it takes 2-3 years to "manufacture" many replacement cows on milk price upturn.
(5) Can sell significant volumes of milk only to the major grocery wholesalers. Direct sales to end customers fell off rapidly during 1930s-1950s, and is not viable for the vast majority of farmers today.

So basically farmers are economically trapped and unable to respond to market faster than 2-3 year time frames. Economically and politically its pretty easy for grocery stores to out last any actions farmers take. Stopping production? Most the blame would go to farmers even if all the independents could stick together. The government might even just seize assets in the name of the public good.

Typically wise grocery store chains in highly urbanized areas worldwide use this to take over private farming. They simply pay farmers low because they control sales. Eventually the store can buy out bankrupt farmers for a few cents on the dollar then hire the farmers back at low fixed wages.

In the end its true the grocery businesses assume most the economic risks. But grocery corporations usually curtail any chance of decent living doing farming as well. Wages after takeover generally aren't the sort to support much of a family and definitely not sending kids to higher education.

So the issue is the coming end of a way of life. Whether that is really intrinsically bad is debatable. Certainly going to stir up emotions among the adherents. But as a society It might be best to treat them as just another cult that refused to fit with the modern world. Maybe even need to fund mandatory government deprogramming and reeducation.

...Because big money WILL find a way around any such protections put up to protect this lifestyle based on old agricultural tech. And probably ways to pervert such an effort to make things even worse.

I do note that farmers who just want to remain independent might be able survive by going high tech in some way -- especially ways that allow faster more economic ways to respond to the market and economics. Perhaps "synthetic" milk not produced by a cow but closer than a pure factory. "Udder in a vat" 2.0!!!!

Answer 7

Your economical assumptions are completely correct. There are too many farmers/dairies and the least profitable should shut down.

What you are missing is that the least profitable farmers are, well farmers. They know no other trade and have probably inherited it. They can't easily switch jobs and they probably do not want to give up 'the family business.'

So they are turning this into a political/moral issue. There are a few things that help tremendously:

1. Nations always subsidize farmers to stay independent. Farming is an inherently political issue.

2. All farmers benefit from higher selling prices or subsidies. So even the most profitable support the case.

3. Farmers enjoy a good public image, even when they're not profitable or their treatment of animals isn't professional.