Volatility, Uncertainty & Change: The UK Dairy Sector

The U.K. dairy sector is in flux, it was thrust into the world market last year after the milk quotas fully deregulated within the European Union, compounded by record global milk production and challenging markets in China and Russia. Keeping in mind the quota system within the UK was nothing that resembled the Canadian model, but rather a heavily fragmented system with many processors directly contracting milk with farmers and virtually minimal monetary value associated with quotas prior to deregulation.

Over the past week, I had the opportunity to investigate the U.K. dairy sector, where I learned first-hand the diversity of production systems, geographical challenges with access to processing capacity. I met ‘have’ and ‘have not’ farmers in terms of milk contracts and consequently the price paid for their milk.  The post quota market in the UK is a living experiment on the how industry reacts to change in a global marketplace.

Production systems in the UK ranged from those mimicking the Irish grassed based systems; spring calving herds utilizing Kiwi cross cattle averaging 5500 litres per year through to farmers maximizing production with 3 times per day milking systems that resembled a North American model.  Overall, farmers are adopting a systems approach to dairy production where by highest output per cow is not necessarily the ultimate goal.

Every farmer I met was able to describe their perceived competitive advantage in terms of cost cutting measures, including areas where they hoped to improve. Unfortunately, a common theme rang through the group, that of ‘luck’.  Many were unable to differentiate why their farm was fortunate to have a super market contracts or the luck of farm location to utilize well drained fertile soils with strong grass growing capacity.

The cost of production models on farm ranged significantly, however a common theme is that every farmer knew their break even cost on a per litre basis. The cost range of £0.16 to an estimated average of £0.22 up to £0.26 per litre in the most intensive herd.  However, the intensive herd also had the supermarket contract. Prices being paid were about £0.21 to £0.26 for most but the specialty markets, including super markets it was closer to £0.36/litre.  It was estimated that only 10% of the milk was linked to the richer supermarket contracts.

The farmers I visited had contracts in place, but the likes of Tesco are demanding to see the financial statements of its farmers to make sure they are not too profitable. The specialty jersey milk contract is at capacity and will not take any additional milk, let alone struggle with the bulges of seasonal production. Then there are the international processors that buy milk in other countries, whereby the UK gets the same European pricing, it’s COP’s are most likely higher than its European peers. The group I have not mentioned, nor met are the farmers without a contract, selling to milk brokers at prices resembling world market. These farmers have immense & immediate pressure; they are perhaps receiving less than £0.15per litre.  Keep in mind, some selling to milk brokers benefited from higher milk prices last year.

However, three of the farmers I met this week had expansion on their mind.  As with many businesses, the conscientious managers will survive, and remember, we are still in Europe and single farm payments will be paid as usual which could be in the range of £80.00 per acre.  One farm I met has opted out of the government subsidy on sheer principal, I suggested they take the money, reduce debt or invest to reduce costs. His response was interesting and similar to other comments I heard within the UK; subsidy determines how farmers invest in their business. His explanation was clear, policies encouraged farmers to be environmental stewards, not farmers, as such farm and agriculture infrastructure such as processing plants, supply companies and a competitive value chains were never efficiently developed. These farms are now competing with global milk prices in a region that is disadvantaged due to the side affects of subsidization.

When asked what was the one metric used as a guide for management purposes; cost of production was a clear indicator of short term break even performance, however long term goals are based on return on invested capital. This is an interesting measure because to be it says farmers have a focus on profit and are willing to adapt and change as needed.   It was suggested that on farm; we should be aiming for 5 to 10% return on capital with firms invested in value added should seek returns up to 30%.

The processing side of the UK dairy sector is one element of total confusion; fragmented by local firms, varying sizes of cooperatives and a host of multinational companies give me a sense of market chaos, in other words as with the ‘have’ and ‘have not’ farmers, the same applies to UK firms processing milk and having the necessary infrastructure and markets.

The future is UK dairy is uncertain, however a major challenge is the vast disparity between farmers and no clear national strategy. The UK dairy farmer looks across the English Channel to the lowest cost, export based, Irish dairy sector, and to the east is the intensive and efficient Dutch model.  Positively, the U.K. has a large population who supports British food and love their milk and cheese based products, but farmers are entirely reliant on their processor to meet the market and compete in a global stage. Remember, in the European Union, food knows no borders.

 

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