Australia’s federal government Productivity Commission has found that on-farm investment was “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, according to the Commission. The Productivity Commission said that more farmgate price incentives to encourage ‘new’ milk or to reduce the seasonal variability of milk supply were commercially desirable.

Competitive pressure for Australian dairy exporters is likely to increase and 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, according to a report from the Australian Government’s Productivity Commission.

The report, Relative Cost of Doing Business in Australia: Dairy Product Manufacturing, was released on 10 October 2014, and assessed the cost structures of businesses operating in the Australian dairy product manufacturing industry, including costs relative to international competitors.

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

Following interest from a number of submitters, the Commission 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 was considerable evidence that dairy manufacturers and farmers were responding effectively to these challenges.

Cost pressures on the dairy industry

The Commission found that Australian dairy product manufacturers faced 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, according to the Commission, but most costs were 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.

Fonterra model would not work in Australia

The Commission found that suggestions that Australian dairy manufacturing should emulate the so-called New Zealand model, with a ‘national champion’, were often based on “an overly simplistic comparison of the export performance of the two countries’ dairy industries”.

The Commission also found that these suggestions also tended to “gloss over” the regulatory arrangements that underpin the New Zealand dairy industry (for example, domestic price regulation), and overemphasised the role of plant scale.

Australia’s dairy export markets

The Commission found that about 40 per cent of Australia’s dairy output (in milk equivalent terms) was exported,predominantly as cheese and milk powder. China and Japan are the largest export markets for Australian dairy.

The Commission said this level of integration of Australian dairy manufacturers into world markets means that domestic dairy product prices and farmgate milk prices were strongly influenced by international markets and prices.

Employment in Australia’s dairy industry

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.

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.

Rising electricity and gas prices impact Australian dairy manufacturers

The Commission found that wholesale prices of electricity and natural gas in Australia have risen sharply since 2006, impacting on Australian dairy manufacturers.

For manufacturers of energy-intensive dairy products such as milk powder, this would have had a relatively substantial bearing on cost-competitiveness, according to the Commission.

The Commission said energy cost increases in recent years were mainly due to spiralling network costs — which it said were 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, according to the Commission.

The Commission said “distortionary” forms of drought assistance, biofuel subsidies and genetically modified crop regulations in some states and territories reduce adjustment and innovation, were affecting the efficiency of the dairy industry and the rest of the economy.