Archive: Why do UK milk prices follow global markets?

Published 19 September 14

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It is often asked why prices paid to dairy farmers in UK are affected by global markets when the vast majority of the milk we produce is sold in the domestic market. An examination of the basic factors underlying how farmgate milk prices are set can shed some light on this link.

Buyers set milk prices in one of three main ways: 1.on the basis of costs of production, 2.using a formula which incorporates market prices and/or input costs or 3.on a discretionary basis. The most predominant method, as shown in the graph below, is buyers’ discretion.

As the domestic market buys most of the milk produced in the UK, and prices paid to farmers for this milk are predominately set at the discretion of the buyer, why do changes in global markets affect pricing in the UK?

 Why do UK milk prices follow global markets?

The answer lies in the simple fact of competition – the same that occurs with prices at petrol stations, where they all need to keep prices in line with competitors or buyers will fill up their tanks elsewhere.

In order to secure sales, manufacturers of dairy products must offer a price to retailers and food manufacturers which is in line with other sellers. With manufactured dairy products such as cheese, butter and powders, competing sellers operate on EU and global markets. It is this relationship which links domestic milk prices to events on global markets. If commodity prices for exports and imports fall on wider markets, the price of our domestically produced commodity (and hence the farmgate price for milk supplied to that commodity) must fall if our processors are to remain competitive and able to sell the product.

On the surface, this does not seem to apply to fresh milk which is sold exclusively in the domestic market and does not face competition from imports. However, those milk buyers who operate in this market will still face the competitive pressure to pay a milk price in line with other buyers. If they pay too much higher they would risk being undercut by other suppliers who bought cheaper milk that would otherwise go to the commodity market. The one exception to this is those markets where the end buyer has effectively guaranteed they won’t switch to a cheaper supplier and are paying on a cost of production contract (ie aligned retail contracts). As such, changes to farmgate milk prices tend to be instigated by milk buyers exposed to global markets, but are then followed by the remainder of the industry. The result is that milk prices tend to follow each other because all buyers are avoiding either being undercut or over paying.

It is of course more subtle than this article suggests, with time lags, premiums, previously negotiated contracts and other factors also influencing milk prices. Ultimately however, if others abroad will sell dairy products more cheaply, then that puts pressure on the companies active in the GB market to drop prices or have no one willing to buy the product.