Dairy: The September price increase: Needed to cover production costs, or a market killer?

Sunday, October 5, 2008

That's the debate surrounding an unscheduled price increase of $1.45 a hectolitre, defended by Dairy Farmers of Canada, but opposed by the restaurateurs and some industry experts

by TREENA HEIN

Dairy Farmers of Canada (DFC) is coming under heavy fire after requesting, and receiving, an unscheduled milk price increase on Sept. 1.

Several prominent agri-food industry spokespersons say that there will be grave consequences for Canada's dairy industry. But Bruce Saunders, DFC's vice-president and Dairy Farmers of Ontario chair, plans to stay the course, saying: "We will cover our cost of production, and let that fall where it may."  

The cost of industrial milk (used to make products such as cheese, yogurt and ice cream) rose by two per cent ($1.45 a hectolitre) on Sept. 1. That's less than half the amount requested by DFC. This price hike follows the usual increase in February of the last few years, the increase equalling one per cent in 2008. 

Al Mussell, a senior research associate at the George Morris Centre agricultural think tank in Guelph, sees this emergency price increase as "reactionary, not strategic" for dairy producers. "Anybody who says that this is necessary for survival is shooting you a line," says Mussell. "The 'cost of production formula' still leaves a cushion for the farm. You're going to kill your market and that's not the way to survive."

But Saunders says survival isn't the issue. "For the dairy farmer to maintain his revenues to the operation at the same level, in order to have the same net revenue, this price increase was necessary to cover the increased costs." DFC cost of production data from October 2007 and indexed up to July 2008 show prices for feed up 19 per cent, fuel and oil up 42 per cent and fertilizer and herbicides up 46 per cent, these being three of the 13 components DFC uses to calculate cost of production.

But, says Ron Reaman, vice-president of federal issues at the Canadian Restaurant and Foodservices Association, everyone is facing increased costs. "Our sector and every sector is seeing them." The difference is, he says, that "we are in an open market environment. The supply managed guys, the producers, don't work in that environment. It's a huge disconnect."

Reaman considers the unscheduled milk price increase "short-sighted, unconscionable and unacceptable." He charges that, over the past 13 years, industrial milk prices in Canada have risen 55 per cent, while the cost of producing milk has grown only by about two per cent. Canadian Dairy Commission (CDC) numbers provided in August show that over the last six years, producer revenues for all milk has increased by $10.30/hl, more than double the increase in cost of production ($4.95 a hectolitre). Revenue from industrial milk over the same time period has increased by $8.21. CDC further says that data before that time period is not comparable because of changes in calculation formulas.

Adds Saunders: "The returns to the farmers haven't gone up as much as the industrial milk price increases have gone up over the last 10 years. When the CDC subsidy of $5.94 a hectolitre was removed in 1998, this shortfall to the farmers was made up by increases in market price over the following three years or so, but the producer income didn't change. It was just a change in where this money came from."

Next to retail, the Canadian restaurant and food service industry is the dairy producers' second largest customer, according to Reaman, and worth about $2 billion per year in sales. "We want to be able to sell more cheese and dairy to our customers," he warns, but "Canadian consumers can't afford to pay these prices." 

Response to threats
"We have some grave concerns about the long-term viability and sustainability of the Canadian dairy industry," says Reaman. "We think it's time for reform." Mussell agrees. "There are those who would say immediately that the system's been around for better than 40 years and it has stood the test of time, but there are threats." 

Mussell and colleague Ted Bilyea outlined those threats in a recent George Morris Centre Special Report, "At Odds With Stated Objectives: Increasing Industrial Milk Prices in Canada." They state that this unscheduled industrial milk price increase is "in direct violation of some of the key strategic objectives articulated by dairy industry leaders."
These objectives include market expansion, a smooth transition to new standards for cheese composition, preparedness for anticipated increased global competition and improved management of escalating milk quota values.

In fact, the opposite of dairy market expansion has been occurring for quite some time in Canada. According to Reaman, Statistics Canada numbers show that "there has been a decrease in consumption in the overall dairy product aggregate category of 8.4 per cent over the last 13 years." Mussell agrees. "[Dairy product] consumption is decreasing on a per capita basis in Canada. It's a good thing we have an increasing population."

Saunders says that market expansion is a goal of DFO, but "you shouldn't have to buy that expansion by taking lower revenues. In my view, as long as the price of milk to the consumer is no greater than the (rate of price increases) that the consumer is paying for food products in general, then it's fair for that increase to take place." 

About a year ago, new standards for cheese composition were announced, which limit the use of non-traditional dairy ingredients Compliance is required by Jan. 1, 2009. Mussell says that processors have been begrudgingly preparing to adjust to these standards, but, he believes, "this price hike could change that." Mussell and Bilyea suggest that processors may choose instead to use alternate ingredients and "simply stop referring to their products as cheese."

Will processors go down this road? "The George Morris Centre has identified the potential," says Don Jarvis, president and chief executive officer of the Dairy Processors Association of Canada, He points out that this has already happened with both ice cream and cream cheese. "When you look at what's available down the ice cream aisle, more and more the new products are 'frozen dessert,'" Jarvis says. "Will this happen with cheddar for example? I don't know."    Saunders' response? "It's a sad commentary about the food industry if their only goal is to save money by using the lowest cost ingredients. The demands for efficiency shouldn't be borne by the farmer alone. Let the processing industry take a lower margin."

Saunders acknowledges the trend of dairy products being edged out. "But, at the same time, I don't believe the consumer is being given a clear choice in terms of labelling. The discerning consumer will pay for the purer forms of cheese and other dairy products."
Mussell and Bilyea also argue that increasing industrial milk prices will not assist the Canadian dairy industry in adequately preparing for anticipated increased competition due to an impending World Trade Organization (WTO) agreement. Mussell expects to see "lots more products coming in at a lower price. Canadian dairy products are going to have to fight for market share. If we're going to compete, we have to price competitively." 

Commitment not shared
Mussell claims Bruce Saunders stated publicly last year that he felt a WTO agreement was an impending certainty which was going to hurt Canada's dairy industry. "He said something like 'We can ignore it and get walloped or we can recognize it's coming and take action.' He said 'We have an opportunity to shape our own destiny.' Apparently not all of his colleagues shared his commitment. His philosophy was only as strong as a 30 per cent increase in fertilizer and the price of diesel fuel."

Saunders defends his previous statement. "By 'action,' I was saying that producers should get their financial – houses in order – get out of debt as much as they can – in order to be able to respond to whatever the international rules are." He adds: "There will be a price cut when we have to do it.

If we do it now, we will have no Canadian dairy product market to safeguard."
Hiking the price of milk is going to do nothing but boost already escalated milk quota values, counters Mussell, when the industry has identified the opposite as a goal. "The primary driver of quota values is milk prices," he says. "The way to solve the quota value issue is to lower the milk price."

Mussell and Bilyea argue that dairy producers should "reject a support price increase, particularly in an environment in which consumers are challenged by steep inflation in other consumer goods. There are many ways to mitigate income shortfall of small dairy herd operators. However, these alternatives will never be given the thought deserved as long as the industry can simply raise price in the short term." Saunders says: "You can't say this shortfall will affect only the small operators. I will add that to get an income shortfall payment from government, good luck." 

When asked whether he thinks the supply management system in Canada is sustainable and will be able to withstand current and future threats, Saunders says:
 "We have a role to play in the market, in identifying market growth, in addressing concerns of the processors on labelling and issues like that. But the bottom line at (Dairy Farmers of Ontario) is that, any time there are cost increases, those costs must be covered." BF