COLES is facing a 20 per cent increase in the price it pays dairy processors for private label milk following a spike in global prices.
Coles has "rise and fall" clauses in private label milk contracts and has vowed to increase payments to dairy processors to reflect the higher farmgate prices they incur.
In the past two weeks Murray Goulburn, Fonterra Australia, United Dairy Power and Warrnambool Cheese and Butter have flagged an average 20 per cent increase in opening prices for the 2013-14 season, driven by the softer Australian dollar and global demand, The Australian Financial Review reports.
Queensland Dairyfarmers' Organisation president Brian Tessmann has called on Coles to stand by its promise to pay higher prices to processors which would in turn be passed on to farmers.
"If they are true to their word the price for Queensland dairy farmers supplying Coles with fresh milk should see their price rise by at least 24 per cent, which is the increase announced by Murray Goulburn," Mr Tessman said. Coles said processors will have to substantiate claims, and cost price rises are likely to vary between processors, depending on regional conditions.
"Coles will review any cost increases and decide whether it absorbs any cost increase in our margin or pass it on to consumers," a spokesman said.
The price rises will further dilute the thin margins the major supermarket chains make on $1 per litre milk.
Macquarie Equities estimates the major retailers are paying between 85 cents and 90 cents a litre for private label milk and selling it for $1 a litre, making a gross profit of 10 to 15 per cent.
After costs of doing business around 15 per cent and wastage of 2 per cent, the retailers may be making a small loss, the broker says.
Mr Tessman said Coles has previously claimed it will not sell fresh milk below its cost of goods sold. "We now question how they can maintain that claim, pay processors more and still sell fresh milk at the ridiculous price of $1 per litre," he said. "It just doesn't add up." However, Coles says it is confident it can absorb any cost increases in the short term through internal efficiency gains and maintain its $2 for two litre retail price strategy.
"Coles's new long-term contacts with Murray Goulburn and Norco will ensure higher farm gate prices for farmers and lower commercial costs so the retailer can sustain a low retail price," a spokesman said.
Coles is believed to have negotiated a 10 cents a litre price reduction, to 81 cents a litre, with Murray Goulburn, which plans to build two milk processing plants in Victoria and NSW this year.
Woolworths, which also has private label milk contracts with Lion and Parmalat, is less affected by the surge in milk prices because it does not have rise and fall clauses in its contracts.
"We are not altering our approach for contracting private label milk in this round," a Woolworths spokeswoman said. "We contract a processor to supply our milk, and they in turn set the farmgate price."
Woolworths is, however, pressing ahead with plans for a new brand of milk sourced directly from a small group of dairy farmers in the NSW Manning Valley. The move is part of a plan to bypass processors, deliver better returns to farmers and counter perceptions it exploits dairy producers.
Woolworths said it was on track to have the new brand, Farmers' Own, on shelf by the middle of this year. It is believed to be negotiating a toll processing agreement with Parmalat.
