Milk price reflects costs, not need

OPINION

Fonterra’s reduction in the milk solid payout to dairy farmers comes hot on the heels on an announcement by the Commerce Commission that the company’s calculation behind the setting of the milk price is fair.

This has prompted the suggestion supermarkets should be investigated in terms of their profit margins.

Although one supermarket chain has announced the profit margin on milk is just over 5%, no comment on stock-turn was made. A 5% margin on a product that goes out every day is somewhat more lucrative than 10% on yearly turnover.

Standard & Poor’s, the credit rating agency, reports that return on invested capital for supermarkets in developed countries is 16%. This includes the loss leaders (special offers) supermarkets use to attract customers.

The overall concern in society is that “milk is too expensive”. There appears to be an increase in the feeling that “we produce it so it should be cheaper here”, overlooking the fact that milk is cheaper now than it has been for many years.

In 1999, two litres cost just under $4 in today’s money. It is currently possible to buy two of these for $5.20.

The evidence is also that few house vendors would sell their property to a neighbour at half the price they could achieve on the open market, yet this appears to be what is expected from farmers.

What it costs to produce

What has yet to be understood is what it costs to produce milk.

Data from Statistics New Zealand show that since 1992 the cost of food has increased approximately 45% but farmers’ expenses have risen more than 60%. Fuel, power, labour and fertilisers have been the major drivers.

A Rabobank report released this month shows that dairy farmer perception of their farm business viability has decreased from more than 60% confidence in December last year to approximately 50% in June 2012.

At that stage, Rabobank calculated that 20% of dairy farmers would be unviable. The latest decrease in payout will put more dairy farm businesses into the unviable category, and farmer confidence is already decreasing.

The problem for society is that the drop in price will not affect the domestic price of liquid milk but it might affect the ability of people to pay for it.

Each dollar increase in the milk solid payout means more money circulating in New Zealand.

The NZIER calculates this is worth $270 in the back pocket of each and every New Zealander, which is more than what is required to pay for the average annual milk consumption of 90 litres.

A decrease in payout means less money circulating.

Kiwis benefit when New Zealand food is in demand overseas and people are prepared to pay premium prices for it. The alternative is a third-world economy.

Jacqueline Rowarth is Professor of Agribusiness at the University of Waikato