Coles’ milk deal gives supermarket suppliers a reason to be sour

Coles’ ten-year deal with farmers’ cooperative Murray Goulburn will have significant consequences for the dairy industry. Image from www.shutterstock.com

Earlier this month, Coles and Murray Goulburn announced a ten-year deal that is likely to have significant consequences for the dairy industry, as well as Australia’s grocery sector more broadly.

Starting next year, Murray Goulburn will supply Coles’ private label milk. At the same time, its Devondale brand will be reinvigorated, with its cheeses returning to Coles’ shelves and – at least initially – Coles becoming the exclusive supplier of Devondale fresh milk.

A deal of this length carries with it considerable risk for both parties. Should market dynamics develop unexpectedly over the next decade, Murray Goulburn or Coles may well suffer. Coles might be locked into buying at prices which are no longer competitive, leaving it exposed on an extremely important product; conversely, Murray Goulburn might have committed itself to cost structures that it can’t sustain long-term.

Of course, the contract is likely to include mechanisms for price adjustments to account for such uncertainties. But as many lawyers will tell you, such clauses can often have unexpected shortcomings when reviewed years later. Try to imagine the world in specific commercial detail from now until July 2024 – that’s what the parties and their respective advisors have had to do.

At least Coles and Murray Goulburn have accepted these risks with their eyes wide open. By far, the parties most exposed by this deal are the other major dairy producers, such as Lion and Parmalat. Close behind them is the already over-worked supermarkets team at the Australian Competition and Consumer Commission.

On April 19, the ACCC granted approval to New South Wales farmers to collectively negotiate with Woolworths. This again makes life hard for the likes of Lion which, until Murray Goulburn came along, was Coles’ supplier.

From the ACCC’s perspective, that might just be competition at work. Indeed, superficially, there’s nothing to suggest the Coles-Murray Goulburn deal would raise competition concerns. Right now, Murray Goulburn doesn’t supply fresh milk at all, so how could it?

But the deal’s duration means that potential competitors are locked out of a significant portion of the grocery market. Depending on what else they can do with their milk (obviously Murray Goulburn has managed just fine not supplying fresh milk), this may reduce competition in the dairy sector.

The co-operative structure of Murray Goulburn also provides an interesting twist. Arguably, it’s the absence of a profit-making middleman that provides the foundation for this win-win arrangement. It also means that more dairy farmers will inevitably join the Victorian-based co-operative, particularly given its announced foray into New South Wales.

But the move of dairy farmers to Murray Goulburn will also affect the other major producers. Not only is their access to customers restricted, but they may also have to pay more for their inputs as their supplier base decreases. Over time this may reduce their economies of scale, making them less effective competitors.

The deal may also have broader ramifications. A logical consequence of a duopoly is a reduction in competition in all “upstream” markets. That is, over time, we would expect to see fewer suppliers to the supermarkets. This can create a vicious circle: the more that related markets become concentrated, the harder it is for effective competition to emerge in supermarkets. Smaller players can’t access the large-scale efficient producers, who are locked up by the major chains, and there are fewer “left-over” suppliers to deal with.

The parties haven’t sought authorisation from the ACCC for the deal. As such, they are confident that it doesn’t give rise to a substantial lessening of competition. If it did, the ACCC could bring court action, seeking an end to the arrangement as well as substantial penalties.

If the ACCC is concerned, at least it has time to make its assessment. Technically, it’s got another 17 years or so. But the market will adjust to this deal and, as they say, it’s hard to unscramble an egg. If the ACCC is worried, it needs to act sooner rather than later.

Regardless of ACCC action, it’s hard to see the milk wars continuing. In announcing the deal, Murray Goulburn said that the shelf price of milk will not affect returns to its farmers. This suggests prices are locked in — if so, Coles is hardly likely to take a hit on milk for the next decade. While consumers loved the savings (estimated to be $70 million a day), $1 a litre was widely considered to be unsustainable. At least dairy farmers can breathe more easily now.

A couple of years ago, milk was at the vanguard of the relaunch of private labels by the major supermarket chains. Now, it might be surfing the wave of the next big change. First, we had fewer supermarkets; next, will we have fewer suppliers?