A “milk war” between supermarket chains Coles and Woolworths has left many consumers in a bind. Yes, they want to lap up the cheap milk on sale in the two retailing giants’ stores, but they do not want to support a short-term marketing campaign that comes at the expense of farmers and long-term competition in the market.
At the core of the debate is concern over the Coles-Woolworths supermarket duopoly and whether these two old rivals are simply trying to wipe out smaller convenience stores and apply the blowtorch to other leading brands such as ALDI, Franklins and Costco.
The battle started in January when Coles cut milk to A$1 a litre for some home-brand lines as part of its “down, down, prices are down” campaign. With competitors launching similar discounting programs, Coles and Woolworths have also moved to reduce the cost of other staples such as bread, tea and toilet paper.
Paul Patterson, head of Marketing at the Australian School of Business, labels the initial Coles strategy as a “short-term gimmick”. “It’s a tactic to drive people into Coles – particularly those who might typically shop at a competitor’s store – designed to grab market share,” he says.
Although Coles and Woolworths collectively control about 80% of the supermarket pie, the former had been seen as an underperformer when Wesfarmers acquired the group in 2007. The new management has been hell bent on turning that around. “Coles have got their act together in the last six months,” Patterson says. “Their market share has increased, they’ve dropped a lot of their prices, they’ve cleaned up a lot of their stores, and they’re giving better levels of service.”
As the big two slug it out, other market players have been trying to protect their businesses. Nervous farmers have been quick to voice their concerns about profit margins under the new pricing model, noting that even Woolworths admits the low milk prices, not seen since 1992, are unsustainable.
Australian Dairy Farmers claims farmers will become the fall guys as a result of lower prices for items such as milk, butter and cream. The industry body finds it an irony that Wesfarmers is now the industry’s enemy after having its origins as a cooperative built by farmers for farmers.
Vice-president Adrian Drury says while cheap milk will undoubtedly attract customers, there has been little consideration about the long-term impact on dairy farmers. “Milk has an emotional attachment for people,” he says. “Other retailers are extremely sensitive to somebody dropping the price of milk because they know that it gets traffic through the door. I think what incenses farmers is that the companies can use it as a loss leader without any thought about the repercussions for farms.”
While Drury concedes farmers have not yet felt the financial effects of the price war, he has no doubt it has created industry uncertainty. “We’re not in a position to say farmers are going out the back door,” he says. “None of this has flowed back to the farm gate just at the moment … The problem is around confidence and knowing that heavy discounting sooner or later is going to come back to (influence) the farm-gate price.”
The timing of the discounting campaign is especially unhelpful in the aftermath of recent floods in Queensland and Victoria, according to Drury. With many dairy farms having been hit in the disasters, he says they are now lacking confidence to reinvest in the sector.
Trusting RelationshipsThe battle of the retailers is clearly in the political frame. In mid-March, the federal Senate launched an investigation into dairy pricing and whether Australia's supermarket giants have engaged in anti-competitive practices.
In a submission to the inquiry, Coles has defended its actions, arguing that price cuts to milk and thousands of other lines in the past 12 months are part of a strategy to improve customer trust in the retailer. It claims the discounts are delivering “real food price deflation in its stores of about 2%”. Coles adds that in January it increased contract prices for milk processors and included “rise and fall” clauses ensuring it will increase payments to processors if the farm-gate milk price rises.
Christopher Zinn, a spokesperson for consumer advocacy group Choice, says such reassurances are small comfort to farmers. “In regards to Coles saying ‘don’t worry, it won’t affect the industry’, it already has affected the industry because people are already freaked out about it.” Zinn says the discounting of milk, in particular, causes discomfort for many Australian families: “Milk is something that is special and it’s what we’re given as kids. It’s what we need.”
For consumers, this close connection extends to farmers amid fears they will lose out to the interests of retailers and processors. “Dairy farmers are seen as people who are essentially Australian and all good,” Zinn says.
Even Woolworths, in its submission to the Senate inquiry, has expressed reservations about the dramatic price cuts, saying there has been a “re-basing” of the cost of milk and its value to consumers. “In effect, the consumer baseline for price is now at 1990s levels but with 2011 input costs for all parts of the supply chain,” the retailer comments.
Despite matching Coles’ cost cutting, Woolworths has concerns about the medium to long-term implications of the strategy. “These prices set a new benchmark, and can be expected to flow back to processors and farmers as new supply and pricing agreements are negotiated over the coming months and years.”
Killing the Competition?There are differing views about the discounting strategy. Metcash, a distribution company best known for supplying IGA supermarkets, has accused Coles of threatening the viability of Australia’s food manufacturing base. In a personal attack, the group’s chief executive Andrew Reitzer told Fairfax Media’s BusinessDay that British bosses brought in to turn Coles around could soon depart the country with healthy bonuses, leaving an embattled manufacturing sector in their wake. Dairy processing firm National Foods has also criticised the wave of discounting, saying the price cuts “will not benefit any part of the dairy industry”.
Other significant players have been more supportive, with the ALDI and Franklins supermarkets also moving to cut prices. ALDI has stated that dairy discounting “is not anti-competitive, and doesn’t need to hurt dairy suppliers”.
Jack Cadeaux, a retail expert and professor at the Australian School of Business, says milk is a perfect product for retailers to use in a discounting fight. “It’s that high-penetration, frequently purchased staple product, so it’s a good product to discount,” he says. “They wouldn’t do this for a category such as brown rice or something like that which few people purchase. It wouldn’t make any sense.”
Cadeaux claims Coles’ strategy is all about taking on Woolworths rather than pursuing any other agenda against the likes of ALDI or Franklins. “I don’t think the intention of the supermarkets is to drive the small people out of business,” he says. “It’s a direct head-to-head competition between Coles and Woolies, primarily.”
His colleague at the Australian School of Business, Paul Patterson, is not so sure. “This will further kill competition outside the duopoly,” he says.
One potential threat to Coles and Woolworths’ massive market share may come from Costco, the giant US supermarket retailer that positions itself as a membership warehouse club where customers buy off the pallet, suggests Patterson. He believes the milk war is partly a pre-emptive strategy to keep customers away from Costco, which recently began trading in New South Wales and Victoria, and other would-be market entrants.
“I think this is a defensive effort to put pressure on the ALDIs and Costcos and even the Franklins and IGAs, and it will further put the corner store out of business,” Patterson says. “And what happens then? Coles wins. They’re not going to grab market share from Woolworths simply because Woolies responds in kind within 24 hours to any discounting initiative by Coles. But they’re going to grab market share from these smaller players.”
Such marketing aggression stems from a demand for growth from Coles and Woolworths shareholders, Patterson believes. “The two big players have got to keep looking at how they continue to grow their business because financial markets are demanding that.” Despite such pressures, Patterson does not believe such dramatic discounting will be part of a long-term strategy for either Coles or Woolworths. “I don’t think this is sustainable,” he says.
Choice’s Zinn says the price war demonstrates the power big brands, such as Coles and Woolworths, have over consumers and suppliers. He suggests that ultimately a short-term low price for milk is not necessarily in the best interests of consumers. “Cheap prices, ironically, might not always be in (that interest),” he says.
One of the chief concerns, according to Zinn, is how Coles can afford to subsidise milk prices by about 30%. Will other grocery items become more expensive to compensate? he asks.
“It’s great to have low prices, but we always have the question: ‘how is it paid for?’ If it means Coles is edging up the prices of less well-known items, well, it’s a free country but that’s not really transparent.”
Zinn notes that Woolworths, ALDI and Franklins have moved quickly to ensure their prices are competitive with those of Coles. However, he believes there may be other ways supermarkets can compete with each other rather than resorting to a “knee-jerk reaction just to follow suit”. For example, having a more comprehensive or a better range of products may be a smarter way of differentiating between supermarket chains.
Increasing DemandWhile farmers have reacted negatively to the milk price war, Cadeaux theorises there may be a positive for them. If prices are lower, people may drink more milk and that will increase demand, he suggests. “The whole language about this as an attempt to drive down the dairy industry and drive them out of business, I find that unbelievable,” Cadeaux says. “People will drink more milk if the price is lower.”
With greater demand for milk, Cadeaux says farmers should be in a position to increase farm-gate prices. “In most categories, producers would like to see retailers cut their price to expand demand,” he says. “This rhetoric about ‘driving us out of business’ goes completely against basic economic theory and I find it completely bizarre.”
However, Cadeaux concedes that pressure from processors – who act as middle men between farms and supermarkets – may lead to lower prices for farmers. “The processors in Australia are quite powerful and they’re overseas-owned for the most part,” he says. “They would be concerned that lower private label milk prices would affect the market share of their branded milk products. That’s an important factor.”
Australian Dairy Farmers rejects the argument that increased demand for milk will allow farmers to push up their prices. Drury points to consumers’ emotional connection to drinking fresh milk and that consumption levels generally do not change, irrespective of price. “Over the years it’s actually proven that the consumption of milk is pretty inelastic,” he says. “Any claim that more exposure to low prices and potential to increase sales is probably quite tough.”
Drury is also concerned that if more customers buy home-brand supermarket milk there will be less room in the market for branded milk products that offer a better return for farmers.
“If you go down and buy Pauls milk or Dairy Farmers milk or Norco milk at a corner store, you’d tend to pay a bit of a premium for it, understanding that the corner store has a small volume and has to charge a bit more per litre to make a living themselves,” he says. But the price of branded products may also have to be cut so they can compete with the supermarket brands, which in turn will put additional pressure on farmers.
Drury says while many consumers are taking advantage of cheap milk, Australian Dairy Farmers has received a lot of customer support since the milk war began. “We’ve been getting calls to say we’re prepared to pay more for milk and we want to support the famers,” he says. “Dairy farmers have always had a good relationship with the general public and I really believe to a large degree that they’re our customers … and we deserve the goodwill because we give them that wholesome product.”