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Costs of Doing Business in Australia: Dairy Product Manufacturing

Research report

This report was released on 10 October 2014 and assesses the cost structures of businesses operating in the Australian dairy product manufacturing industry, including costs relative to international competitors.

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  • Key points
  • Media release
  • Contents
  • Australian dairy product manufacturers face some cost pressures (such as energy and labour) relative to their competitors, but also some advantages, including highly competitive raw milk costs (the largest single input cost).
  • Some cost pressures may warrant government corrective action, but most costs are largely driven by market factors and the commercial decisions of businesses. Manufacturers and farmers will need to continue innovating and improving the efficiency of their operations in the face of a potential expansion in global supply (for example, once EU milk production quotas are removed in 2015).
  • Suggestions that Australian dairy manufacturing should emulate the so-called New Zealand model, with a 'national champion', are often based on an overly simplistic comparison of the export performance of the two countries' dairy industries; tend to gloss over the regulatory arrangements that underpin the New Zealand dairy industry (for example, domestic price regulation); and overemphasise the role of plant scale.
  • On-farm investment is crucial to increasing Australia's raw milk supply (and dairy product manufacturing output). Manufacturers may need to share more of the investment risks in order to increase raw milk production.
    • Farmgate price incentives to encourage 'new' milk, or reduce the seasonal variability of milk supply, are already in play where it is commercially desirable.
  • In 2012-13, Australian dairy product manufacturing generated a total industry value added of more than $2.4 billion (roughly 0.15 per cent of GDP) and employed over 17 500 people.
  • About 40 per cent of Australia's dairy output (in milk equivalent terms) is exported (predominantly as cheese and milk powder), with China and Japan the largest markets.
    • This level of integration of Australian dairy manufacturers into world markets means that domestic dairy product prices (and farmgate milk prices) are strongly influenced by international markets and prices.
  • Hourly labour costs in the Australian food, beverage and tobacco manufacturing sector in 2012 exceeded those in New Zealand, the United Kingdom and the United States of America (in common currency terms). In addition, Australia's measured productivity performance in the food, beverage and tobacco manufacturing sector between 2000 and 2011 has been relatively poor.
  • Wholesale prices of electricity and natural gas in Australia have risen sharply since 2006. For manufacturers of energy-intensive dairy products such as milk powder, this would have had a relatively substantial bearing on cost-competitiveness.
    • Energy cost increases in recent years are mainly due to spiralling network costs - partly driven by flaws in the regulatory frameworks governing electricity markets - and to a lesser extent, policies designed to reduce carbon emissions and promote renewable energy. While some reforms have occurred, further alterations to incentives in electricity network investment programs would be of value to the dairy and other industries.
  • Distortionary forms of drought assistance, biofuel subsidies and genetically modified crop regulations in some states and territories reduce adjustment and innovation, affecting the efficiency of the dairy industry and the rest of the economy.

Background information

Peter Garrick (Senior Research Economist) 03 9653 2240

Clare Sibly (Research Manager) 03 9653 2118

Retailing and dairy manufacturing input costs and policy implications

Please note: This is a joint media release with the Costs of Business: Retail Trade Industry case study.

The Productivity Commission released today two reports into input costs and their policy implications, they are: Relative Cost of Doing Business in Australia: Dairy Product Manufacturing; and Relative Costs of Doing Business in Australia: Retail Trade.

Dairy Product Manufacturing

In the case of dairy product manufacturing, the Commission found that costs in this industry are largely driven by market factors and the commercial decisions of business rather than government regulation or intervention, although there are some areas where corrective action by governments could be warranted. The functioning of electricity markets, for example, could be improved by reforms to pricing.

Following interest from a number of submitters, the Commission has also looked further at economies of scale in dairy manufacturing, and the Fonterra experience in New Zealand.

'The Fonterra experience in New Zealand does not readily translate to the present-day Australian dairy industry environment, and would not seem to justify regulatory intervention by governments,' Chairman Peter Harris said.

The report found that competitive pressure for export markets is fierce and poised to increase further once EU milk production quotas are lifted in 2015. However, there is considerable evidence that dairy manufacturers and farmers are responding effectively to these challenges.

Retail Trade

In the case of retail trade, the Commission found that regulatory restrictions, such as those on trading hours and planning and zoning, unnecessarily inflate retailers' cost of doing business.

Labour and occupancy costs comprise the majority of retailers' cost of doing business, although cost structures vary considerably across retail trade subsectors and between individual businesses. Despite larger increases in input prices than in output prices in recent years, cost structures and retail profit have remained relatively stable at a broad industry level. To some extent overall profitability has been protected by the lower cost of some goods reflecting both retailers' sourcing strategies and the appreciation of the Australian dollar. The rise in input costs has also been partly offset by productivity gains in the retail sector.

'While retailers' costs are largely market driven and require commercial responses, they are also inflated by red tape,' Commissioner Patricia Scott said.

'Restrictions on bricks and mortar retailers' trading hours are increasingly out of step with consumer expectations and the rapid growth of online retailing. While these restrictions aim to protect smaller retailers, removing trading hours restrictions does not appear to have a material impact of the structure of the retail sector. Retaining restrictions also ignores the potential for more than offsetting gains for retailers through lowering costs and increasing their ability to compete with online retailers, and greater choice and convenience for consumers.'

The Commission also found that planning and zoning regulations are complex, excessively prescriptive and often anticompetitive.

'With the exception of Victoria, progress by governments to address costly anticompetitive provisions has generally been slow and patchy,' said Commissioner Patricia Scott.

Background information

Clare Sibly (Research Manager) 03 9653 2118

Requests for comment / other

Leonora Nicol (Media and Publications) 02 6240 3239 / 0417 665 443

  • Preliminaries
    • Cover, Copyright and publication detail, Foreword, Terms of reference, Contents, Abbreviations and Glossary
  • Overview
  • Findings
  • Chapter 1 About the study
    • 1.1 The Commission's task
    • 1.2 The Commission's approach
  • Chapter 2 Australia's dairy product manufacturing industry
    • 2.1 Dairy product manufacturing
    • 2.2 Raw milk production
    • 2.3 Domestic and export markets
    • 2.4 Key dairy producing countries
  • Chapter 3 Costs of dairy product manufacturing
    • 3.1 Cost structure of dairy product manufacturing
    • 3.2 Factors underlying the cost structure of dairy product manufacturing
  • Chapter 4 Raw milk production in Australia: costs, volumes and seasonality
    • 4.1 Raw milk production costs
    • 4.2 Raw milk volumes and seasonal variability
  • Chapter 5 Opportunities and challenges for the dairy industry
    • 5.1 Achieving dairy manufacturing efficiencies
    • 5.2 Achieving ongoing productivity growth
    • 5.3 Getting more value from raw milk
  • Chapter 6 Potential policy refinements
    • 6.1 Good practice policy making
    • 6.2 Energy policy
    • 6.3 Trade access
    • 6.4 Urban and rural water supply
    • 6.5 Workforce issues
    • 6.6 Transport issues
  • Appendix A Conduct of the study
  • Appendix B Economics of dairy markets
  • References

Printed copies

Printed copies of this report can be purchased from Canprint Communications.

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