Agriculture, Economics

179 – Discounted milk prices

In January 2011, Coles supermarkets discounted the price of “home brand” milk to $1 per litre, prompting a storm of protests from farmers. Do the farmers have a case?

Selling milk at $1 per litre means that Coles loses money on each litre sold. Clearly they are attempting to use milk as a “loss leader”: a way of enticing people into their stores so that they can sell other goods at profitable prices. It’s a sales promotion or marketing strategy.

Predictably, the other main supermarket chains quickly matched Coles’ new pricing strategy, removing much of Coles’ potential benefit. So far, Coles (and the others) are sticking with the strategy.

The response from farming advocates was swift and strong, with condemnation for Coles and its parent company Wesfarmers (which, ironically, started out as a farmer cooperative). Politicians lined up to offer critiques. The opposition agriculture spokesman, John Cobb, was quoted in a newspaper as saying that Coles had “totally alarmed members of parliament and particularly alarmed the Australian dairy industry”. Independent senator Nick Xenophon said the move “could have a devastating impact on our country’s dairy industry”. Dairy farmers said things like, “we’re all in deep manure”. The Dairy Farmers Association lodged a complaint with the Australian Competition and Consumer Commission (ACCC) for “predatory pricing”.

Interestingly, this occurred despite Coles stating clearly that they would absorb the losses themselves, and would not reduce the prices they paid their suppliers. This didn’t seem to placate anybody, so what is going on?

The main concern seems to be that the lower price will have flow-on effects to producers who are not the suppliers of Coles home-brand milk. This is quite plausible. Coles’ strategy will likely result in lower demand for milk from other retailers who aren’t willing to match the strategy and absorb losses. This will put downward pressure on retail prices, which could flow through to dairy farmers to at least some extent. The degree of impact on farm-level prices is hard to predict, depending on the responsiveness to price changes of each link in the supply chain (the “elasticities” of supply and demand for producers, processors, and retailers) and also depending on existing contracts. Farmers seemingly think that much of the price decline will be passed on to them, which perhaps is conceivable, as they are many and processors are few.

The complaint to the ACCC suggests that there may be something illegal about Coles’ strategy. I’m no expert on the law in this area, so I’ll watch this space with interest, but the idea that it could be illegal seem odd to me. After all, it’s a common marketing strategy. Just look at the advertisements for mobile phone programs. Most come with a phone thrown in almost for free. It’s interesting that we don’t see mobile phone manufacturers complaining about the use of this strategy for their products. Perhaps they think they wouldn’t generate any public sympathy. Or perhaps they don’t mind it.

I can think of a few reasons why the impact on farmers might not be as catastrophic as some are claiming. One is brand loyalty. Home brand milk was already relatively cheap, but it’s not the only milk sold, even in Coles itself. Another is convenience. Small stores survive despite selling their milk at much higher costs than supermarkets, because it is not always convenient (or even possible) to shop at supermarkets. That will continue to be true. Finally, the strategy might not be in place for all that long. I suspect that Coles’ main competition is from other supermarkets, rather than from smaller stores. With its two main rivals having matched the discount, there probably is little to be gained by maintaining the discounts, which will reportedly cost Coles around $30 million per year. The counter to that could be that with Coles, Woolworths and Aldi all offering the discount, the first to break ranks could lose customers to the others.

A separate question is whether there is something immoral about the discounting, as some farm lobbyists seem to imply. Personally, I find it hard to see why it could be considered immoral. Why should a business in a competitive market be prevented from offering discounts if it gets some marketing benefits from doing so. It clearly benefits consumers (notwithstanding overblown claims about the end of the dairy industry). Who among us hasn’t benefited from buying a discounted product of some sort in the past? When you did so, did you feel like you were participating in something immoral?

David Pannell, The University of Western Australia