How processors decide the opening price for our milk

Piggy Bank

With the anticipation of shoppers pressed against the doors of a Boxing Day sale, farmers look forward to the “opening price” for our milk every season. This year, the hype was bigger than ever.

Last season’s prices were high enough that many farmers have recovered from the year before, commentators continue to gush about the future of dairy and processors are on the hustings looking to poach supply. On the other hand, global dairy commodity prices are tumbling and the Australian dollar remains stubbornly high. Uncertain times.

The first of the major processors to announce its (edit: this post applies to the south eastern Australian states only) opening price was Fonterra, the giant NZ co-operative, at $5.80 per kilogram of milk solids, only to be trumped hours later by Australian co-op Murray Goulburn at $6.00. The two forecast closing prices were in the range of $6.10 or $6.15 to $6.30, making this year’s buffer between the start of season price and the forecast close one of the narrowest ever, suggesting an increased risk of a historically rare and confidence-busting mid-season price “step down”.

Opening prices are a little contentious, with United Dairyfarmers of Victoria president Tyran Jones, labelling them “misleading“. I invited the two big processors to answer some questions about how the opening prices are set. Thank you to Matthew Watt of Fonterra and Robert Poole of Murray Goulburn for their explanations.

 

Q1. How do you arrive at an opening price?

A: Matthew Watt, Fonterra:

We look at multiple information sources. The most important one of these is the market intelligence we get from the Fonterra Global insights team. I expect that others in the market take a lead from our and Fonterra NZ pricing to leverage this information as well. Other information sources include GDT futures, Fonterra Treasury (FX), Rabo Bank.

  • We extrapolate these information sources into a number of different commodity and currency scenarios (this season we ran in excess of 15 pricing futures through our model)
  • Model looks at weighted returns based on forecast milk flows.
  • Sensitivities are completed at different commodity prices and currency
  • Following this, we establish the most likely estimate of closing price – this becomes the forecast close range.
  • We then compare the forecast close to our lower price scenarios & calculate an opening price that is paying what we can to farmers but also ensure there is a level of protection from any market/forecast downside.

A: Robert Poole, MG:
At a high level:

Milk Price = Total Revenue less Total Non-milk Costs less Profit. As stated below the 2014/14 milk pool grew to $1.7 billion up from approximately $1.2billion in 2012/13.

An extensive budgeting process occurs across the business. We estimate milk intake volumes and composition, determine product mix, budget sales revenue (sales and other), budget company-wide costs, determine profit requirements (to manage balance sheet and funding needs, and dividends) which provides for a milk price. Throughout this process we make certain assumptions such as pricing, volumes, product mix, foreign exchange and sales channels for revenues and savings initiatives, efficiencies, wages and working capital for company costs.

Improvements in the budget position as the year progresses are usually passed through as step-ups.

 

Q2. How have the margins between opening price and forecast close changed since 2008?

A: Matthew Watt, Fonterra:
The traditional rule of thumb was that opening price was 85% of forecast closing although published forecast closing prices are a relatively recent addition. This year our forecast opening is 94% of midpoint of forecast close range. To actually track this is difficult because published forecast closing prices are a relatively recent introduction.

A: Robert Poole, MG:
Yes, these are slightly different each year. In determining the amount of buffer required, allowance is made for those areas where the co-operative is exposed to volatility; upwards, downward  and other adverse conditions or potential risks.  Generally MG has an opening price between 90 and 95% of its initial forecast.

 

Q3. Given the uncertainty of the exchange rate and falling commodity prices, is there an increased risk of a step down this year?

A: Matthew Watt, Fonterra:
As the variance between opening and forecast close narrows, there are an increased number of potential scenarios that provide a number that is on or lower than opening price.

  • Our current forecasts suggest that commodities will improve which is factored into our forecast close price. However, these are subject to global economic conditions and global production – both can move quickly and can impact commodity prices either way
  • The exchange rate has been anticipated to fall for some time but it remains high and a number of forecasts suggest that this could increase. As a rule of thumb, every 1 cent move in the exchange rate (across a full year) will have a 5 c/kg MS impact on milk price
  • At this stage of the season, we have limited volumed that is priced and sold. This means that, any moves in the commodities or exchange rate have a large impact on the actual, final milk price. As we move through the season, we get more priced and sold, meaning that movements that happen later in the season have a lower impact on the farmgate milk price.

A: Robert Poole, MG:
The difference between the opening milk price and the budgeted milk price allows for adverse variances to budget and a step down in price is historically very unlikely.

 

 Q4. What percentage of your Australian suppliers receive a price that is equal to or above the published opening price?
A: Matthew Watt, Fonterra:
All of our published pricing is based on best quality milk. The greater the level of penalty/incentive built into the pricing construct and the relative achievability of the premium quality standard will impact the difference between average quality and premium quality.

On our new, simpler pricing construct, between 25 & 50% of our farms will be at or above average quoted price, (assuming premium quality). Given we also have a transition payment in place from old pricing system to new, the number that will actually receive more than the published number will be over 50%.

60% of our suppliers are within +/- 0.15 cents per kg MS of average price, based on premium quality. Naturally, the poorer the individual farms actual quality that is delivered, the further they get from average price due to penalties incurred.

A: Robert Poole, MG:
Approximately 50% of milk supply is above the average and 50% below – hence the weighted average.  The majority of suppliers are within 2 cents per litre of the average.

[NOTE from MMM: I did follow up with Robert to clarify his answer in terms of the percentage of farms but the information was not available for the blog.]

 

Q5. Aside from the opening price, what do you think are the top three reasons farmers are attracted to supply your business?

A: Matthew Watt, Fonterra:

  • As a broader comment on price, I would like to think that farmers look past opening price as a reason for choosing a processer, particularly on opening average quoted numbers. On the price aspect, whilst opening is an important indicative number, what is really important is how that pricing construct suits an individual farm and, what the actual as opposed to projected or opening price performance is.
  • However, the three key reasons that we think farmers value are
    1. Leveraging our Global Leadership for Local Benefit – this means giving the best market information to our farmers to help better decision making on farm and, as a key extension to this, introducing fixed base milk price to enable farmers to better manage price risk. The other aspect of this is the multiple product streams, brands, domestic and global markets that we are active in. This provides access to the best and emerging opportunities in the market as well as a balanced group of customers and products which serves to reduce risk.
    2. Supporting Profitable Farmers – Profitability in farming is fundamental to industry success and our success if we are going to have long term, secure milk supply. We clearly don’t control all of the profitability factors. However, there are some that we do and some we can influence. These include simplifying our pricing structure. A critical aspect of this was ensuring we were aligning the value that we could extract from the value chain into  a clear construct, enabling suppliers to farm profitably to their set of circumstances and available resources. We be believe it is now better understood, reduces risk to farm business profitability and enables better decisions around optimising margin to be made by our farmers. It also includes our support crew work, where we assist where we can with specific opportunities within business to increase bottom lines – this year we have identified well over $1M of profit that has been generated by specific farmers through this program.
    3. Partners in Asset creation – this means getting to a stage of sustainable profitability and then leveraging that for future growth. Again, our fixed base milk price program plays an important role in helping to provide the certainty and confidence required for a farmer to make an investment decision to growth. We are also leveraging our support crew team to identify opportunities to support the growth of our farmers, where it makes sense for them. The support can come in many ways – technical, helping prepare information for banks, direct finance assistance and the like.

A: Robert Poole, MG:

Our suppliers are attracted to MG for a number of reasons. If I had to limit these to the top three they would be:

  • The strong understanding that whilst opening price is very important that having a Co-op that has the objective of growing the pool of money available to farmers. For example in 2013/14 we have grown the pool paid to farmers from $1.2 billion to approximately $1.7 billion.
  • A desire to supply the last Australian farm owned dairy Co-op, controlling the milk supply process from end to end and passing benefits to farmers.
  • Stability – MG has a proven performance, reliability and track record of successfully running a large and complex dairy company for 64 years and we have a clear strategy to improve business performance
  • Service and support

 

2 Comments

Filed under Farm

Trying to express the inexpressible

milkmaidmarian:

Thank god we don’t have to deal with this in Australia. I hope we never do.

Originally posted on Farmer David Barton:

Three days ago a slaughterman came to my farm to shoot Ernie, our stock bull, and three other cattle that had tested positive for bovine TB.

They had to be killed on farm because they’d been given worming medication which meant they couldn’t be taken to a slaughterhouse. I invited the NFU to come down and film what was one of the most distressing experiences of my farming life.

That night I started trying to put my thoughts into words for a blog post. This is as far as I got.

I woke up with a feeling of dread in my stomach again….

I don’t have facilities for slaughtering my own animals on the farm so an unbearable time was spent waiting for the first – a beautiful young heifer – to get into the correct position.

I can’t watch….the BANG, when it finally comes, is piercing and final. The…

View original 301 more words

Leave a comment

Filed under Farm

George the Farmer app brings Aussie farming to kids around the world

Before the sun was up this morning, 3-year-old Alex was gasping in horror as football-crazy “George the Farmer” missed a bleeping seed drill alarm.

“Oh no, there will be bare patches in the paddock,” the little fellow moaned.

"Oh no, there will be bare patches in the paddock!"

“Oh no, there will be bare patches in the paddock!”

George the Farmer is the brand new app that transported Alex and eight-year-old Zoe to the Australian wheat fields. It brings farmers and other Aussies together in such a charming way and I wanted to learn more, so contacted George the Farmer’s creators, Simone Kain and Ben Hood.

The pair are partners in regionally based creative agency, helloFriday (based in the south east of South Australia) and both Simone and Ben grew up on farms.

Simone hadn’t been able to find any Australian farming apps for her then two-year-old son, George. So, making use of their creative skills over a two-year period when business slowed, they wrote, illustrated, produced an animated children’s story book and game App, which we downloaded at iTunes.

GeorgeTheFarmer

Here’s Simone’s story:

Q: Tell me about this interesting farming character.

A: George the Farmer is everyone’s friend. With his trusty dog Jessie by his side, George tackles the day to day activities of Australian farming life with enthusiasm, a can-do attitude and most importantly a big smile. Unfortunately George’s obsession with sports often plays havoc with not being able to finish jobs off in their entirety! Lucky for George, his beautiful and talented wife Ruby is always there to lend a helping hand. The importance and power of team work shines through in George’s Australian farming adventures.

George’s personality was modeled off of a few local farming friends traits and the stories that form George’s adventures have generally been created from issues that have arisen on my husband Justin’s, family farm. Whenever Justin arrives home at night and tells me about a problem that he’d encountered on the farm that day, I quickly pen down a new story line! The challenges that face George and Ruby closely reflect and make fun of the daily tasks that make up farming life, which makes it amusing not only for the one to eight age group, but adults alike.

Q: Why a farming character?

A: Although I could find some farming Apps for my son George, they weren’t great and they were either very American or English using terms such as field, fall and barn, for example. There was definitely a gap in the market for a children’s story whose primary focus was on Australian farms. The more we researched the idea, the more it became apparent that both city and rural children could benefit in learning about farm practices and food and fibre production in a fun, yet simple way.

Q: What has the feedback been like so far?

A: It is only early, however the responses that we’re receiving back are amazing. People have started following George through social media (Facebook, Twitter and Instagram) right across Australia and into New Zealand, the UK, US and Canada with App purchases so far in Australia, the US and Canada. Although George’s stories are based in Australia, it really seems to have international appeal. A follower from Perth wrote, “Fantastic! I have four little farm kids and the only farming apps for kids we’ve found have been American, which as we all know, is a fair bit different to our Aussie farm life!”

Q: What can you do with the App?

A: The App comes with the first story called, ‘George and the Seeder’ which follows George as he plants a wheat crop and then accidentally runs out of seed unknowingly. The story has a read to me function for those children too young to read, which has been narrated by ABC 891 (South Australia and Broken Hill) presenter Peter Goers, OAM, who has a really, lively voice that I think typifies a country Australia. The story can also be read on it’s own while still containing the additional farming sounds effects.

Along with the story there is also a memory game, colouring in game and a sing-a-long feature where the kids can sing-a-long to the George the Farmer theme song.

Children are enjoying the interaction of the story, being able to watch a tractor move, make a dog bark and a magpie warble, while at the same time unconsciously learning about aspects of seeding a wheat crop and what foods are produced from wheat.

My twin boys Louis and Frank (20 months) are crazy about the tractor and Jessie the dog in the story. They know how to use the iPad and out of the 40 or so Apps I have on the device, it is the main one that they like to open by themselves and use.

Q: The App has been welcomed across the agricultural industry with national media coverage, what’s in George’s future?

A: Ben and I are already deep in to the next George story which will be available as an in-app purchase through the current App in November. As long as there is interest in the character, we will continue to create stories and build on this App as well as others. Our dream would be for George to become a household name like Bob the Builder and Fireman Sam, also helping to highlight farming as a worthwhile career choice.

NOTE: I have not been paid to write this post, I just loved the app and thought you might, too!

3 Comments

Filed under Community, Family and parenting, Farm

Bittersweet as Devondale milk reaches Coles shelves

Photo: The Weekly Times


Three men in suits – a prime minister, supermarket supremo and the MD of a dairy processor – stood drinking glasses of frothy cold milk on the steps of the first MG Co-op factory dedicated to supplying fresh Devondale-branded and private label milk to Coles. Beneath the froth, however, doubt among the very dairy farmers sponsoring the opening celebrations continues to simmer and bubble.

Ever since the Coles deal was announced, there have been skeptics. Plenty question whether it is possible to make money supplying milk that retails at a dollar a litre and the concept alone that milk could be priced cheaper than water offends many dairy farmers.

The speculation and anger reached new heights this week, however, after a scathing opinion piece in the Australian Financial Review that says MG managing director, “Helou ‘in a hurry’ has a reputation at MG, as he did at SunRice, for being hell bent on revenue over margins.”

The AFR also writes, “MG’s margins are non-existent and its deal has locked the whole industry into $1 milk for a whole, punishing decade, structurally squeezing the profit pool.”

All that gloom follows the journalist’s derisory comments about the Sydney factory being at least one month late, $30 million over budget and the trigger for contractual penalties that can only be imagined. And, yes, when the deal was announced, MG’s farmer shareholders were promised the factories would cost “just” $120 million. MG now puts that figure at $160 million, hinting at a cost blow-out of staggering proportions.

To top it all off, Coles ads pimping our cherished, premium Devondale-branded milk at just 75 cents per litre sent shockwaves through the Australian dairy community on Twitter yesterday.

This ad went viral on Twitter for all the wrong reasons

This ad went viral on Twitter for all the wrong reasons

So, I sent a list of questions off to MG’s executive general manager shareholder relations, Robert Poole, who to his great credit offered these explanations:

Q. What are the actual costs of the two factories?
A. Following our initial cost estimates for the two factories we decided to invest in additional capability and capacity to maximise efficiencies through automation and layout. This brought the total investment in our Melbourne and Sydney facilities to approximately $160 million. This provided for future operational cost savings.

Q. Has MG been unable to supply milk to Coles on time?
A. We have had some shortfalls, however contingency plans were promptly enacted . Laverton is ramping up towards its full capacity and at the moment is servicing Coles requirements in Victoria plus the Devondale Brand both in Victoria and NSW. Our NSW plant remains scheduled to commence production in early August, at which time MG expects to be able to be supplying all of Coles requirements in Victoria and NSW

Q. If so, what are the penalties?
A. This is a contractual matter between MG and Coles.

Q. Does MG have adequate raw milk supply for the Sydney factory now?
A. In New South Wales, we have already sourced more than 180 million litres of milk. This is more than enough to cover our initial requirements of approximately 100 million litres per annum in this market and allows for future growth.

Q. When do you expect the Sydney facility to be supplying milk Coles with its full requirement of milk?
A. The site is being commissioned through July with production scheduled to commence early August, reaching full capacity by the end of August.

Q. When will the investment break even?
A. Both sites are forecast to add positively to MG’s farmgate price from year 1.

If the Murray Goulburn deal with Coles can withstand a 33% cost-overrun and Coles’ penalties while adding to the milk price from year one, this must be an extraordinarily lucrative contract indeed. Who would have thought the Down, Down, Down folks could be so generous?

While you’re chewing that over, take a minute to look at the new Devondale ads via my fellow dairy blogger Lynne Strong, who tells me her post discussing the commercials has gone viral attracting around 1500 views in 24 hours. MG cannot be accused of being boring!

11 Comments

Filed under Farm, Murray Goulburn, supermarket war and $1 milk

“Bring on the cows” demands a new routine

“Bring on the cows” trumpets The Australian, headlining a story about MG Co-op managing director, Gary Helou. In response to rumours that the co-op might purchase a large Tasmanian dairy farm, Mr Helou reportedly says:

“We are not farmers; MG is a global dairy food processing and milk company, and we will not be buying farms directly; that is not our business,” Helou says adamantly.

“The only way to get extra cows and milk is to up the farm gate price enough that farmers will want to invest (in more cows) themselves. So that’s what I have set out to do, maximise the farm gate price and reduce the cost of processing and the supply chain and then efficient production will follow.”

Here’s the problem: MG is not a global dairy food processing and milk company. It is a co-operative of Australian dairy farmers who are members because they expect MG to, first and foremost, maximise their profitability. Not by investing in a processor (they could just buy ASX shares if that was what it was all about) but by looking after farmers directly.

They don’t just supply MG, it’s not just their MG, farmers ARE MG.

Am I being hopelessly idealistic? I don’t think so. This focus on being a processor has flowed through to the co-operative’s milk price system.

The final milk price only tells half the story. The quoted “average weighted” milk price is skewed to favour farms with flat production curves (mirroring those of the processor) at the cost of farms whose milk supply matches the natural ebb and flow of cow and pasture. For the vast majority of Australian dairy farmers, the way our co-operative pays us is at odds with efficient milk production.

MG must remember what being a cooperative really means before its farmers will be ready to “bring on the cows”.

8 Comments

Filed under Farm

Frugal farm fun

The green knight comes to a milk maid's rescue

The green knight comes to a milk maid’s rescue

Zoe: “I love it when we get bogged. It’s fun.”

Silence

Zoe: “I love it when we get bogged. It’s great!”
Alex: “It’s not great for Mama, Za Za.”
Zoe: (Dancing on the spot) “I LOVE IT!”
Alex: “But Mama doesn’t, don’t you Mama?”
Me: “No, Little Man.”

He was right: I wasn’t pleased to be stuck in the sticky sulphuric sludge of the gully but wind the clock back 35 years and it would have been a different matter.

I remember the delight of being bogged amidst the despair of my father. Every bogging was an adventurous departure from the daily grind, complete with desperate stuffing of the wheel tracks with bark and anything else that came to hand before spinning wheels sprayed mud from here to kingdom come as the fishtailing ute wrestled its way free.

I was reminded of all that as the three of us trudged (or skipped) across the paddocks back to the dairy at dusk and again this morning reading The Conversation’s article about the cost of raising children. It turns out parents are really no less wealthy than childless couples. One of the reasons offered by the Curtin University scholars rings true:

“When children are present, nights at home with the family, a simple visit to the park, or watching your child play sport may provide enjoyment that would otherwise be gained through income-intensive pursuits, such as holidays and going to restaurants. This is more than a direct substitution effect – parents’ own utility may increase at a lower level of financial outlay.”

The best things in life are indeed free.

2 Comments

Filed under Family and parenting

Watch a calf being born

Although we keep an eagle eye over cows as they approach calving time, most give birth perfectly naturally without any help from us just like this lovely lady. Her calf was up and walking within the hour and running by the afternoon. These little animals are amazing sprinters! Just ask eight-year-old Zoe, who tried and failed miserably to outrun a three-day-old calf this morning!

7 Comments

Filed under Animal Health and Welfare, Farm