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Dairy contracts in European countries: research

Analysis on the current state of the dairy sector and supply chains within European countries and the application and impact of mandatory written contracts and their suitability and potential application in Scotland.

Executive Summary

  • This report presents the results of analysis on compulsory contracts or mandatory written contracts (MWCs) applied within the dairy sector of European countries, looking into their impact and how they currently operate. This evidence will allow stakehodlers to come to an informed view as to their likely suitability and application in Scotland.
  • The purpose of this study is threefold:
  1. to provide an overview of the current dairy landscape in Scotland. This part of the work comprises a quantitative overview of the Scottish dairy sector structure based on available data and;
  2. to provide an overview of how these contracts are structured and operate in selected representative countries in Europe. As part of this work, case studies for six countries were constructed for: France, Hungary, Italy, Poland, Romania and Spain;
  3. to compare the Scottish sector with that of countries where MWCs are in operation; to examine and assess how MWCs could be applied in Scotland and likely impact of doing so and recommend to both industry and the Scottish Government steps to maintain the industry's long-term future.

Overview of the current dairy landscape in Scotland

Structure of the industry in Scotland

  • Scotland produces about 1.5 million litres of milk (around 9% of the UK milk production) and about 43% is in the hands of cooperatives. The evolution of the Scottish and the Rest of UK production is similar.
  • The top 5 processors account for around 94% of the all milk collection – with the top 2 accounting for around 56%. Farmers’ production depends strongly on them due to the exclusivity of milk delivery.
  • Almost 80% of the milk collected in Scotland is used for drinking milk and cheese (most of which is Cheddar). Both markets are very competitive at the retail level, which is the main market destination.
  • Milk production is seasonal, increasing in spring and decreasing in autumn. Information by processor shows that not all of them see the seasonal variation in milk collection (e.g., maybe due to contracted milk explains a lower proportion of the processors’ need and the remaining is completed with milk purchase on the spot market).
  • Prices paid to farmers for different milk uses (except between 2015-16) have a very close evolution. This is due to the fact that milk does not have differentiate utilisation. The reflection of this is that milk is considered commodity and its price follow the international price of traded commodities such as SMP or cheese.
  • Milk uses by processor are in very competitive categories: drinking milk and cheese. The retail market is highly competitive, with private labels being an important category in both product category. Processors supply retailers with branded and private label product because the need to produce at full capacity to reduce their cost per unit of output.

Dairy contracts in Scotland

  • Contracts are usually open ended (“evergreen”) with processors generally committing to purchase all the milk produced on a farm (i.e. exclusivity) during the period of the contract.
  • Notice periods for pricing agreements are generally long, from a minimum of three months to up to 12 months required from the farmer to the processor, with sometimes longer notice periods required from the processor to the farmer.
  • Farmers’ participation on the negotiation of contracts depends on the type of organisation i.e., whether it is a co-operative, a private company negotiating with a producer organisation, formal representative framework set up for the purpose or through dialogue at ad-hoc meetings. Similarly happens with the resolution of conflicts.
  • Base prices in contracts are depend on commodity markets’ prices (e.g., skimmed milk powder, cheese, butter).
  • Prices paid to farmers tend to consider the following elements: valuation of the milk by constituent content (e.g., butterfat, protein), quality requirements, pricing adjustments for milk quality, volume collection, transport, farm management practices.
  • Because of the competitive environment faced by processors, price clauses in contracts between processors and suppliers have historically been built around flexibility, i.e., the use of what is termed ‘purchaser discretion’, which means that a processor (milk purchaser) has the right to vary the price paid to farmers as and when they see fit.

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