Category crunch: Turbulent times in UK liquid milk
By Katy Askew | 30 May 2012
Dairy companies are struggling to turn a profit in liquid milk
The UK liquid milk sector is experiencing an ongoing decline in value sales. Despite gradually increasing volumes, the price being paid for milk is dropping. As a consequence, milk producers find themselves struggling to turn a profit in the category. In part one of our two-part Category Crunch, Katy Askew looks at the dynamics shaping the UK's liquid milk market.
Liquid milk in the UK is a sizeable category. In the year to 15 April, consumers purchased 5.13bn litres of milk, up 1.2% on the previous year, with an additional 60.9m litres of milk sold than a year earlier.
Per-capita consumption in the country is high as UK consumers view milk as a drink rather than an ingredient and population growth has resulted in swelling demand.
However, the dairy industry is struggling to generate profitable returns from liquid milk.
Last week, the country's largest dairy processor, Dairy Crest, said the performance of its dairies division had been "unsatisfactory" in the 12 months to the end of March. The company revealed that, in a "challenging environment", its dairies unit failed to achieve an "acceptable level of profitability".
Dairy Crest cited "downward pressure on pricing" in a "tough consumer environment" and an "extremely competitive" middle-ground market as two of the primary factors impacting its performance.
These sector-wide pressures mean that, although volume sales are edging up, value sales of fluid milk are in decline.
According to the latest data from research firm Kantar Worldpanel, fluid milk sales totalled GBP3.18bn (US$4.95bn) in the 52 weeks to 15 April. This represents a decline of 1.2% on the prior year.
The drop in value sales has been driven by a fall in average selling prices, which were down by 2p per litre - or 2.3% - during the year, the Kantar figures reveal. Pasteurised milk, which accounts for 85.3% of fluid milk sales volumes, witnessed the steepest decline in value, with the average price paid per litre down 3.4% year-on-year.
According to the assessment of the UK's largest milk processors, the downward pressure on pricing comes as retailers respond to the depressed consumer environment.
Pressure on household incomes - from rising unemployment, low wage increases and rising inflation - has resulted in the development of an ever-more value-conscious consumer.
UK buying patterns are evolving in response to the more austere consumer environment. Shoppers are increasingly taking a 'little and often' approach to milk purchases as they look to reduce waste, while sales through discount channels have risen and, in the major retail multiples, competition around price - particularly for staple food products - has stepped up.
"We are in an environment at the moment where our customers - the major retailers - are obviously under significant pressure. That is resulting in higher levels of promotional activity and this is having a significant impact on value sales," a spokesperson for Muller-owned UK milk supplier Robert Wiseman Dairies tells just-food.
Arthur Reeves, external affairs director at Dairy Crest, concurs. "The reason that value sales are falling is because supermarkets are pricing very competitively... retail milk prices are cheaper now than they were this time a year ago. I think the reason is consumers are finding it pretty tough going at the moment and retailers are competing between themselves."
Likewise, Neil Kennedy, the CEO of UK dairy co-operative Milk Link - which plans to merge its operations with Danish-Swedish dairy giant Arla Foods to leapfrog Dairy Crest and take the top spot in the UK dairy sector - tells just-food declining value sales are the product of "wider market conditions".
"The economy is in a difficult place. Consumers are watching what they spend and of course retailers respond to that by trying to offer competitive prices," he says. "The level of promotion has grown and the level of consumer participation in promotional activity has grown. This has taken some value out of the liquid milk market."
However, while the country's big retail multiples have cut the selling price of milk, dairy marketing expert Hamish Renton, managing director of Hamish Renton associates, says supplying the country's major retailers is the most lucrative part of the liquid milk market.
Many of the countries largest retailers have dedicated liquid milk supply chains where a premium is paid to secure volumes.
Initiatives include the Tesco Sustainable Dairy Group, which issues payments to farmers based on a cost model. In the five years that the TSDG has been in operation, Tesco says it has invested GBP145m in the group over and above the average UK producer milk price.
Sainsbury's recently implemented a similar scheme, while The Co-op and Morrisons pay a premium to farmers above the base rate they receive from dairy processors.
"All the major retailers have their own pools of liquid milk... If you are in that pool as a farmer you do get very well looked after, with all sorts of benefits, and you get a very fair price for your milk," Renton tells just-food.
Nevertheless, the country's three largest dairy processors are all vying for supermarket milk business, making it a highly competitive market as they jostle to maintain or grow sales volumes. Dairy Crest, Arla and Robert Wiseman all compete heavily on price and, when UK retailers put their contracts out to tender, processors must bid aggressively for business.
Dairy Crest's Reeves points out supermarkets do look beyond price when they enter milk supply contracts.
"Supermarkets like businesses that deliver on time and in full, that are efficient, that look after their farmers. We are doing all that. We like having supermarket milk business," Reeves says.
The most challenging part of the liquid milk market in which to operate is the middle ground, which is made up of a variety of different buyers including local authorities, schools, coffee shops, discount retailers and c-store operators and independent retailers.
"The middle ground is one of the toughest markets to operate in - it is populated by hundreds of processors, both large and small. It is a very, very competitive market. If you are to compete in that market it is literally shop by shop, street by street," Wiseman tells just-food.
The middle ground is a crowded space, with smaller-scale local and regional dairy processors selling into it alongside the large dairy groups. It is a 'buyers market' - with an over-abundance of supply - and many buyers form large procurement consortia to negotiate the lowest possible milk price.
According to Shore Capital analyst Clive Black, the imbalance between supply and demand is an issue that is endemic to the liquid milk sector as a whole. Rather than viewing pressure on milk prices as a short-term consequence of the wider economic environment, Black says it is the result of "over capacity" and "industry indiscipline".
"You have three large players slugging it out for the supermarket non-returnable trade and then those same three, plus a number of smaller regional players, seeking to fulfil the demand of the middle ground. Capacity imbalance is at the heart of why industry margins have contracted in recent years," Black says.
Black says supply will "inevitably decrease" as producers are forced out of the market.
"But it can take an awfully long time for what is inevitable to actually transpire. I would have thought it is going to be gradual consolidation and rationalisation in the industry," he tells just-food.
While we have seen recent evidence of a realignment of capacity to demand - including Dairy Crest's closure of two dairies - and consolidation in the sector - the recent takeover of Wiseman by Germany's Muller and the planned merger between Arla and Milk Link - there are still those in the industry who would disagree with Black's assessment.
Julie Macleod, senior analyst with industry group DairyCo, insists this conclusion is overly simplistic.
"It is not as clear cut as supply outstripping demand because there is always opportunity for milk to be diverted from the liquid milk market," she says. "If the cheese market has a better margin and there is more demand, processors do have some freedom to divert milk here."
With the causes of declining sales values are still up for debate, the impact these difficult conditions are having on the bottom line is clear. In part two of our Category Crunch, just-food looks at how the country's largest dairy processors are responding to current trading conditions.
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Category crunch: Turbulent times in UK liquid milk