This report assesses the cost structures of businesses operating in the Australian dairy product manufacturing industry, including costs relative to international competitors.

Key points:

• 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.