Dairy contracts in European countries: research

3. Review of the evidence on dairy contracts in European countries

3.1 France

Key points

• Contracts were introduced to provide stability and transparency in the relationship between farmers and processors.
• The contracts specify the quantities to be delivered to processors and the pricing formula in the case of private companies. The latter is not a fixed indicator but a set of negotiated indicators used within a formula. Whilst the components are in general known, the weight to each one of them is confidential and only known to the negotiated parties.
• Cooperatives must also state the pricing elements within their contracts, but do not have the ability to restrict volumes, hence the widespread use of A/B style pricing.
• Currently France is implementing to requirement to include an indicator related to costs of production (production and processing) in the pricing of milk.
• There is some stability in the relationship between retailers and processors given by the use of negotiated annual contracts for branded products, which account for about 70% of the dairy products on the market.

3.1 Compulsory formal contracts and producers organisations were implemented in France in 2010 (Decree N° 2010-1753 of 30 December 2010). The decree, which came into force on the 1st of April of 2011, was reinforced by the adoption in 2012 of the Milk Package and the recognition in April 2012 of producers organisations (PO).

3.2 According to Dervillé and Allaire (2014) and Trouvé et al. (2016) MWCs were introduced as a result of several issues:

• The significant concentration of private companies on the French dairy sector.
• The progressive elimination of quotas.
• Competition issues around the role played by the French Dairy Interbranch Organization (CNIEL) in balancing the power relationships along the supply.
• The distress associated to the bankruptcy of several dairies in 2009.
• The limited collective bargaining of producers.

3.3 As specified in Article L631-24 of the Rural Code and Maritime Fisheries on contracting in the agricultural sector, the main objectives of MWCs are:

• To guarantee the relations between the individual producers and the processors.
• To stabilise prices in the face of increased volatility risk.
• To fight against the reduction of the price of milk from peripheral areas, specially mountain areas.

3.4 There are two types of MWC: (1) individual "simple" contracts (i.e., individual producers and a processor), which are now a minority; (2) individual contracts signed by the members of the PO, supplemented by a collective agreement developed between the company and the PO. The contracts comprise by law seven mandatory components: the duration of the contract, the quality of the product, the volume of milk, the collection of milk, the price, payment and termination.

3.5 Moreover, Article L631-24 aims also at strengthening the role of PO in the negotiation of contract terms, and to balance the relationship between the producers and the companies.

3.6 The French law distinguishes two types of Producer Organisations: i) the commercial PO that, as the owner, sells the production of its members (i.e., there is transfer of ownership from the members to the PO); ii) and the non-commercial PO which collectively negotiating sales contracts on behalf of its members, markets their production but with no transfer of ownership.

3.7 As of October 2015, 51 POs were recognised and represented 40% of volumes delivered to private dairies. Most POs are associations structured around dairy production sites. They are vertical POs with a regional dimension (i.e., formed by a pool of farmers selling to one processor) and note that larges processors dairies deal with multiple POs. Transversal POs are infrequent being France Milk Board the only case which encompasses three POs covering the entire French territory.

3.8 Co-operatives in France are required to provide the same terms as in private contracts in terms of price (Lambaré et al., 2018). The use of contracts does not affect the duration or nature of the co-operative commitment to its members but does mean the terms and conditions by which the milk price is determined, and volumes are assessed is made explicit to members in the same way as in contracts offered by private dairies.

3.9 Because of their status, co-operatives are compelled to take on all the milk of their members. As such, and unlike private processors, they cannot make use of volume clauses in a commercial contract to manage their milk supply. This createsan issue for them around managing upstream volumes and keeping a balance between processing capacity and negotiated markets. As such, rules need to be defined within the co-operative framework to deal with this issue (Trouvé et al. 2016).

3.10 For the case of France, the implementation of the Milk Package did not require the establishment of an interprofessional association because the French dairy interprofessional association CNIEL was first created the 21st March 1974. It was a joint initiative of the three federations representatives of the dairy milk professional assembly Fédération Nationale des Producteurs de Lait (FNPL), la Fédération Nationale des Coopératives Laitières (FNCL) and the Fédération Nationale de l’Industrie Laitière (FNIL). However, in January 2014, la Confédération Paysanne was incorporated as a new member. It is a private organisation with 40 million euros of annual budget. Funded by a mandatory fee paid dairy farmers (70%) and processors (30%), proportionate to the milk volume produced /processed.

3.11 Between 2010 and 2012, French Dairy Interbranch Organisation (CNIEL) positioned itself as a facilitator for contractual procedures. It elaborated a guide to good practices and created an Interprofessional Commission on Contractual Practices (CIPC), However, the CNIEL mission is weakened due to the lack of consensus between its parts.  All decisions must be taken by unanimity of all its members: farmers, dairy cooperatives and private groups.

Offer contract and duration

3.12 The contracts consist of written and compulsory commitments between milk producers and their buyers for a minimum five-years (seven years for new entrants). In the absence of a reference to the renewal conditions in the contract, these are considered as being evergreen contracts for a period equivalent for which it was initially signed but with the possibility of termination under 12-month notice.

3.13 Article L631-24 recommends to include in the contracts a restrictive list of reasons for termination by default. The contract would thus be considered as indefinite except in cases of force majuere for particular reasons under judicial control. In the case of non-renewal, the purchaser needs to notice the producer no less than three months in advance. The mandatory clauses of the contract also relate to the volumes and characteristics of the milk to be delivered and the methods of collection of milk. These elements are specified in the contracts through private negotiation.

Volume delivered

3.14 The volumes, after the elimination of the quota, were established based on the former quotas. Contracts specify the obligations, except in exceptional circumstances provided in the contract, to the seller and the purchaser. In particular the conditions of access to the milk, the frequency and the time-frame of collection, the conditions for the removal of the milk and the procedure established for sampling and measuring the quality and composition of the milk. At each removal of milk, the quantity collected shall be notified by the purchaser to the producer in the form of a delivery order.

3.15 On the interviews it was clear that contracts did not contain exclusivity clauses. This is due to the fact that a processor deals with several POs (e.g., Lactalis negotiates with 19 POs).

Milk price

3.16 All contracts must contain a milk price or a price formula to indicate the monthly price to be paid (ALTA, 2017). Contracts most often use the indicators provided by the CNIEL as a reference. This can at times be adapted by region to allow for variations in markets. For the case of co-operatives, a system of double (or triple) pricing linked to  volumes produced is often used. The contract always needs to specify the criteria and modalities taken into account for the determination of the basic price of milk. The indicators most often selected are those established by CNIEL such as:

• Index of industrial products of milk powder and butter
• An indicator related to export cheese prices for Gouda, Edam and Emmental
• An indicators of the level of consumption in France
• The difference between the average price of milk paid in France and Germany.

Dispute resolution

3.17 When there is a conflict or question related to the trade relations between producer and purchaser of cow milk, there is an institution named the Médiateur des Relations Commercials which is free of charge and has a preventive role. Mediations are carried out by an independent group made of one mediator and three delegates, and cover all agricultural sectors.

Market transparency – information disclosure

3.18 To facilitate contractual negotiations within the food sector, the Observatory of Price Formation of Food Prices and Margins was created in 2010. The aim of the organisation is to track prices at different stages of the industry and to determine the margin between the stages of the suply chain. This is done using public statistical data.  Note that the outputs are publically available as well so everybody can track the margins.

Processors and retailer relationships

3.19 In France, retailers have significant negotiation power. This is increased by the fact that they are allowed to jointly negotiate with processors. The main reason behind this is that the competition authority is keen to maintain low prices for consumers. This is also the reason why the Processors’ Association is not allowed to participate in contract’ negotiations.

3.20 Negotiations between processors and retailers are in two forms: (1) negotiation for national brands, which occurs annually from November to February and (2) negotiation for private labels. The margins are tighter in the second case due to the higher substitutability of products. Private label has a much smaller markets share, with only 35% of all the milk products sold at retail level.  Brands account for 65% of the market. In the case of UHT milk, however 70% is private label.

3.21 Branded products are sold to retailers on 1-year contract where price and volume is agreed. Private label products are be sold on indefinite contracts, in which case prices tend to remain fixed until one party to the contract asks for a renegotiation. This requires a 3 month notice period if a higher price is to be implemented.  However, if the retailer re-negotiates a lower price, this is often implemented immediately. The longer term contract between processors and retailers provides some stability downstream the chain.

Prospects

3.22 Farmers are relatively happy with the contracts. Although the strucutre of French contracts has limited their ability to expand (they cannot sell what they want), this was not a big change from the quota situation and most understand that volume management helps to support the price.

3.23 The main benefit to processors, excluding cooperatives, is they are no longer required buy all the milk delivered to them. This reduced their volume risk and helps with planning capacity.  Previously, they were obliged to buy all volumes delivered while still paying a price indexed to market movements.  Cooperatives have dealt with the volume issue by implementing differntial pricing.

3.24 The pricing mechanism in contracts is currently being modified to introduce cost of production for farmers and processors. It is thought this will ensure income stability for farmers, but also provide support to processors in their negotiation with retailers as they will be able to pass on any additional cost. Before this is applied it needs to be approved by the European Commission.

3.25 Diagram 2 presents a summary of the presents the structure of French dairy contracts along the dairy supply chain.

Figure 10: Diagram 2 - French dairy contracts

3.2 Hungary

Key points

• The introduction of contracts was not a dramatic change to the industry as they were already in wide-spread use before the Milk Package.
• Processors adapt pricing within contracts to their final markets and offer farmers a specific set of conditions (e.g., pricing alternatives) for their choice.
• Volumes expected to be delivered are declared in advance and tolerances are negotiated between the parties.
• POs play a role in balancing the negotiation power of farmers and purchasers and on mediation. Key on this is the competence of the head of the producer organisation.
• The IBO also plays a role as a place for discussion. It brings all the stakeholders. It is the only case in Europe where retailers are part of an IBO.

3.26 It has been suggested that a common feature of pre-socialist regimes in transition to liberal economic systems, has been the initial inability of their public institutions to properly enforce contracting agreements. This uncertain legal-business environment, resulted in producers and processors of milk, who may struggle to establish long-term relationships based on formal agreements, opting instead for oral agreements or using spot markets (Bakucs, et al., 2013).

3.27 The Milk Package was implemented in Hungary in December 2012, making mandatory the use of written contracts for the marketing of raw milk between producers and first purchasers of milk and establishing a minimum contract duration of six months (European Commission, 2016). A survey from members of the Hungarian Dairy Product Council (HDPC), which accounted for 75% of the Hungarian milk quota, found that approximately 72% of its members sold their milk under a written contract (Bakucs, et al., 2013).

Offer contract and duration

3.28 The contracts consist of written and compulsory commitments between milk producers and their buyers for a minimum of six months. However, information from interviews suggest contracts are often of longer terms, anywhere from 1-3 years or evergreen. Contracts can be ended with notice of between 90 to 150 days.

Volume delivered

3.29 Volumes are specified within contracts, with farmers providing information on volumes to be delivered within a set period (monthly, quarterly or annually). Depending on the processor, there are tolerances around these volumes of between 5% to 15%, which are often negotiated.  Deviations beyond the agreed limits generally incur a penalty.

3.30 Not all the contracts include exclusity clauses.  In some cases, farmers can sell milk elsewhere but only directly to consumers and only up to 25% of their production. They cannot sell to other processors.

Pricing

3.31 The pricing used is adapted by processors according to their businesses, i.e., there is plenty of discretion in the way that the pricing is set. One of the interviewed processors set prices two months ahead. They are conservative on their pricing and they do not reflect the peaks and troughs observed on the market price. Nevertheless, they follow the average market price. In addition of the base price, there are premia for fat, protein and bacteria content. Price is lagged to keep in line with market and to help smooth price for farmers.

3.32 Another processor provides farmers with a choice of pricing options, using Hungarian market prices, the EU28 average price (or prices in neighbouring states) and spot market pricing. These indicators will then be used for the length of the contract. They offer farmers a set of 5-10 indicators in different combinations and around 20 ‘pricing’ choices to the farmer. The models offered to farmers are managed to align with relevant product markets of the processor.

Dispute resolution

3.33 There a no centralised or formalised dispute resolution authority in Hungary. According to the interviewed producer organisation, the contracts contain the seeds of conflicts resolution. If the processor is not satisfied (e.g., due to a quality issue) then he would complain to the producer organisation. They would send the milk to an independent laboratory for check of quality. If the contract is not fulfilled then there would be a penalty. For amendments to the contracts the parties come first to the producer organisation.

Market transparency – information disclosure

3.34 It was considered by all the interviewees that contracts increased market transparency. Contracts remained confidential between parties and the interbranch organisation (as in France) does not participate in negotiations. However, it plays an important role in bringing producers, processors and retailers together to align the interests across the supply chain. The interbranch organisation membershop covers 80% of raw milk production, 70% of the retailers, and 95% of the processors.

3.35 In addition, the interbranch organisation plays a role in the collection of publicly available data (product balances for raw milk, wholesale and retailer) and also is involved with the generic promotion of Hungarian dairy products.

Process of introducing the mandatory written contracts

3.36 Due to the lack of the tradition of trading between producers and processors during the Communist period, contracts were widely ued pre-accession. Processors indicated that the introduction of mandatory contracts did not cause any dramatic changes.  Similar contracts were alreay in place before the Milk Package and there exists a good level of trust between farmers and buyers in the Hungarian dairy industry. The biggest change resulting from the legislation was the requirement to use formula pricing.

Processors and retailer relationships

3.37 Processors and retailers do not have annual contracts. Sales to retailers are genearlly done on a short term basis, typically for around 1-6 months. There are 6-8 big retailer operating in Hungary, most of which are multinationals such as Tesco and Auchan. These companies posses strong market power due to their size and their ability to import dairy products. Negotiations between processors and retailers are frequent and often influenced by spot market pricing. One of the processors indicated that some stability in pricing is obtained from providing a differentiated product; products such as UHT milk obtains only low margins. If the product is well known to consumers it increases processors barganing power.

The role of the POs on the contract negotiation

3.38 The interviewed PO’s head was a former officer of the ministry of agriculture and also former IBO manager (i.e., he has excellent knowledge of the legislation). The role of the PO is to negotiate better contracts for its members. It does not own the milk and the contracts are between each farmer and the processor.

3.39 The PO was formed because farmers came to him asking for help. The formation of the PO took some time as farmers needed to see the benefits. It occurred when farmers needed to deal with a crisis of low milk prices and wanted to improve the competition for milk. Its formation was helped by getting the Government to require membership in a PO to qualify for subsidies. Once farmers saw the benefits of ‘group negotiations’, more wanted to join.

3.40 According to him the main benefits of the PO are increased transparency and increased competition for milk supplies.

Prospects

3.41 The use of mandatory contracts, including the use of established pricing formulas and other pricing mechanisms seem to operate well and producers and processors do not have negative views as regards the contracts. The only disruptions that were observed were due to the behaviour of some retailers introducing imported dairy products at very low prices. In this situation, the IBO (helped by members) have been useful to solve the problem.

3.42 Diagram 3 below summarises the structure of the dairy contracts in Hungary.

Figure 11: Diagram 3 - Hungarian dairy contracts

3.3 Italy

Key points

• The structure of the Italian dairy sector is unique in the sense that a sizable proportion of the domestic milk production is dedicated to DPO cheeses, which provides regional differentiation of the milk.
• The introduction of contracts did not affect the performance of the sector because they were already using similar contract.
• Producer organisations negotiate the contract conditions on behalf of farmers, and market the milk to multiple buyers. Farmers receive a weighted average price obtained from all sales (the PO negotiates with and sells to several processors).
• Producer organisations play an important role not only on the negotiation but also on the milk logistics (e.g., some cheeses can only be produced by milk from a specific region.

3.43 The provisions of the Milk Package were implemented in Italy by the Ministry of Agricultural, Food and Forestry Policies (MIPAAF) through the Ministerial Decree (M.D.) N. 15164 on the 12 October 2012. This Decree regulated the organisations of producers, their associations and inter-branch organisations; the negotiation of contracts for raw milk delivery; and the regulation of the PDO and PGI cheese supply.

3.44 The aforementioned Decree established a criteria for the recognition of POs, requiring a minimum quantity of marketable production. This meant the POs must demonstrate they have a mandate from each member, lasting three years, for not less than 75% of the arithmetic mean of the quantities of milk delivered in the last two years by the single producer.It was also established that producer of milk could only join one PO.

3.45 For IBO in the milk and milk products sector to obtain recognition, in case of organisations at national level they must prove they account for 25% or more of the of the economic activities of the sector. For organisations operating in a single economic area, the threshold is 51% with respect to the area and 15% at national level. Currently, there is not an IBO for the dairy sector in Italy.

Offer contract and duration

3.46 The Italian law on contracts governs the marketing of raw milk between producers and processors at the national level. The development of this national legal context was the result of negotiation/consultation between the Italian Government and the main institutional representatives of processors (ASSOLATTE) and producers (CONFAGRICOLTURA, COLDERETTI, CIA).

3.47 With regard to the negotiation of contracts for the delivery of raw milk, recognised POs (or APOs) are entitled to negotiate and underwrite supply agreements on behalf of their members for all or part of the milk conferred.^[2]

3.48 Contracts for supply of raw milk with the first buyers in Italy must comply with all the elements required by the Milk Package (e.g., price to be paid on delivery, delivery volume and calendar, duration of the contract, resolution clauses). The minimum duration of contracts in Italy was extended in 2015 to one year.

3.49 With regard to PDO and PGI production, the Milk Package provides that, upon request of Producer Organisations, Interbranch Organisations or Consortia of protection, the State may establish binding rules for a limited period of time regulation of the supply of cheese benefiting from a designation of origin protected or a protected geographical indication. The possibility of establishing these rules presupposes the existence of an "agreement concluded between at least two thirds of the producers of milk or their representatives representing at least two thirds of raw milk used for the production of cheese and, where appropriate, at least two thirds of producers of such cheese which represents at least two thirds of the production of this cheese in the geographical area".

Volume delivered

3.50 Based on information from the interviewed PO, it was indicated that members must provide an estimate of their production volumes. This is because the PO operates as a pooling agent, finding markets for members’ milk Producers can exceed the volumes by 3% to 5%.

3.51 In terms of exclusivity, from the interviews it was pointed out that there are no specific clauses on the contracts saying that producers cannot sell to other processors; however, it was indicated that in practice this is not common practice.  This is partly a function of the high volumes of milk going through POs or APOs and into PDO/PGI cheeses.

Pricing

3.52 As pricing within contracts covers a period of a year fixed price options are not common.  Based on information from the interviewed PO, both fixed and index linked pricing are used. The most commonly used pricing system is to use an initial base price which varies through the year according to an index. The index is linked to market prices, with companies seting their own mechanism or indexes. Commonly used mechanisms are average German prices, the price for Parmigiano Reggiano (most common DPO cheese) or a combination of market indexes.

3.53 The contract with pricing based on indexes is more common for DPO products and fixed prices are more common for generic products which are then sold to retailers or merchants. The use of fixed pricing for the raw materials gives processors and merchant firmer grounds for negotiating with retailers and for achieving a price which provides them with a margin (e.g., often used for fresh milk/ soft cheeses).

3.54 White cheese (i.e., the balancing product for milk surplus) is mainly sold as a commodity product to wholesalers who package and re-sell it. These sales are often priced based on spot market prices (as they do not require regionally sourced milk) The spot prices are published weekly at a regional level by the Chamber of Commerce. The Chamber of Commerce sets prices through agreement of supply chain participants who submit, then agree, the price. There are sub-commissions for liquid milk, butter and non-DPO cheese.

3.55 Farmers are paid 30 days in arrears, at the end of each month. The price paid to the farmer is an average price (adjusted forbutterfat, protein and hygiene characteristics) achieved from all sales, weighted by volumes with a deduction of transport costs and administrative fee.

Dispute resolution

3.56 The role of the Government as mediator has been relatively poor. 2 or 3 years ago they set a meeting to solve issues between producers and processors but without success. There is no really mediation. However, the Government (i.e., Ministry of agriculture) asks producers about every two month whether they are happy with the contracts.

3.57 Information from the interviewed PO indicated that conflict resolution is written into the contract and there is no official body that checks the contracts – it is left to the industry. In addition, it was mentioned that there are in general good relationships between the parties.

3.58 Although there are no special mechanism for mediation between the producers and processors in case of conflicts, in case of abuse of power it is the Italian Competition Authority (i.e., Autorità Garante della Concorrenza e del Mercato AGCM) that intervenes. An example of this happened when the main agricultural unions (e.g., Coldiretti) sent AGCM a report complaining of poor correlation between the consumer price of dairy products, the processing prices and the producers’ price for raw milk. AGCM launched an investigation on 5 May 2015 consisting of a fact-finding survey on the dairy sector which closed on the 2 March 2016.

3.59 The AGCM analysed the sector, taking into account both the legislation that prohibits anti-competitive agreements and abuses of a dominant position, i.e., Article 62 of Decree Law no. 1/2012, bearing the "Discipline of commercial relations regarding the sale of agricultural and agri-food products", an as amended by Decree Law no. 51/2015.

Market transparency – information disclosure

3.60 It was considered by all the interviewees that contracts increased market transparency. Contracts remain confidential and the Processors’ Association do not participate in negotiations.

3.61 The consulting firm CLAL provides significant amount of information about the dairy sector in Italy and Europe. However, the specific indicators used for setting price within individual contracts are confidential to the parties to the contract.

Processors and retailer relationships

3.62 Processors sell primarily into retail channels; food service and exports account for a smaller share of sales. Retailers buy on medium to long term contracts (generally 12 months) which provide more security and stability to manufacturers. Nevertheless, retailers have substantive influence on prices paid to processors.

Process of introducing the mandatory written contracts

3.63 In the interviews it was stated that the introduction of mandatory contracts did not have an important impact on the sector due to the fact that they were already using contracts. The contracts were, however, shorter in terms of duration.

Prospects

3.64 A study carried out by AGCM (2016) on the dairy sector found that none of the sectors of the supply chain appear to be able to generate and permanently extract excessive profits to the detriment of milk producers. On the contrary, a high degree of competitiveness was found within retail markets.

3.65 AGCM then highlighted that in these markets, significant price pressure is exerted both by the strong countervailing power of the large-scale retail trade and by the considerable presence of foreign brands and national brands that use foreign raw materials.

3.66 In terms of relationships between processors and producers we were told that they are very good. The majority of farmers stay with the same buyers for long periods of time and generally have good relationships while prices are generally stable.

3.67 Diagram 4 presents a summary of the structure of the dairy contracts in Italy.

Figure 12: Diagram 4: Italian dairy contracts

3.4 Poland

Key points

• About 70% of the milk handled in Poland is done by cooperatives. Therefore, contracts only operate for the other 30%.
• The introduction of the contracts did not have a big effect on the industry because as in other countries they were already operating under contracts.
• In contrast with other countries, there is no minimum length of a contract. The contracts conditions are market determined.
• The structure of the contracts in Poland follow the CMO and they need to specify the price, quantity, quality, length, payment terms, force majeure, conditions for acceptance and delivery.
• The Agricultural Market Agency is in charge of verifying whether (1) the delivery of agricultural products is carried out based on a contract concluded in written, electronic or paper form; and (2) the contract fulfils the requirements specified by law.

3.68 The Polish Government considers agriculture to be one of the pillars of the country's economy, a source of jobs and wealth creation for rural areas. The country uses all the levers at its disposal (Stachowiak, 2014):

• Almost 25% of the aid of the 2nd pillar has been transferred to the first pillar to support ' active ' agriculture;
• 15% of direct payments are coupled aid, in particular towards livestock farming;
• Redistributive payments for the first 30 hectares (about €41/ha) and support for young farmers.

3.69 Compulsory contracts were introduced in Poland in October 2015. However, as stated by Trouvé et al. (2016) dairy contracts existed in Poland before the Milk Package reforms and were used by the Polish Government as a relatively effective way of protecting farmers from fluctuations in the price of milk and ensuring quantity and quality of milk deliveries to dairies.

3.70 Despite the introduction of contracts in 2015 the Polish Minister of Agriculture was very critical regarding the measures of the Milk Package. He stated that the measures were not adapted to the Polish dairy sector, where the cooperatives dominate.

3.71 Due to the aforementioned reasons the application of the Milk Package in Poland was made at a minimum level due to the opinion that Polish farmers would be very little motivated to join a PO due to the fact that they were not use to have freedom of choice and the predominance of cooperatives in the Milk collection.

Offer contract and duration

3.72 The contracts apply to all the stages and to all the buyers from the producers. In the case of milk only raw milk is covered by the contracts. The contracts apply to all the forms i.e., written and electronic. If an email has all the elements of a contract, it is a contract. Contracts in Poland do not have a minimum length. The contracts conditions are market determined. There is no minimum length of a contract. Contracts need to specify the price, quantity, quality, length, payment terms, force majeure, conditions for acceptance and delivery.

3.73 Each contracting party has the right to terminate the contract with a six-month notice period. However, the processor has the right to terminate the contract with immediate effect if the milk does not meet the quality conditions.

3.74 As regards milk testing the content of fat and protein are done at random, milk temperature as well as the total number of microorganisms, number of somatic cells, antibiotics / inhibitory substances, organoleptic assessment are done at each collection.

Volume delivered

3.75 Volume to be delivered is included on the contracts. The quantity is collected by processors. There is no obligation to sell all the milk to the processor (no exclusivity). Dairy cooperatives collect all the milk from their producers.

3.76 The contracts do not carry an exclusivity clause, but are, de facto, exclusive within the term of the contract. If it is disclosed that the producer gives the contracted milk to another purchaser during the term of the contract, the processor has the right to dissolve the contract from the date of disclosure of that fact. In addition, the producer for the contracting entity must pay a contractual penalty of 3 months gross value for milk delivered to the contracting producer calculated as an average over the last 6 months.

Pricing

3.77 The interviewes did not provide much information about how pricing is set up in the case of private processors except that it is market determined and they consider factors such as fat, protein and bacteria content. In addition, it includes additional payments for quality and deductions if the delivery of milk is lower than 200 litres.

3.78 In the case of cooperatives, the price of milk is set for each month by the Management Board of the cooperative, depending on the quality of milk delivered and the financial capacity of the cooperative. In addition, it also includes discretionary bonuses. The payments are made by the 20^th of the next month.

Dispute resolution

3.79 Most disputes arise due to the milk price. The Agricultural Market Agency is in charge of checking contracts in case there is a problem. They do not check all the contracts that are signed but those that are referred to them.

3.80 In terms of the monitoring of contracts, they do so when they are:

• based on a report,
• based on other reliable source of information about violations
• selected contracts based on a risk analysis.

3.81 The Agricultural Market Agency verifies whether:

• the delivery of agricultural products is carried out based on a contract concluded in written, electronic or paper form.
• the contract fulfils the requirements specified by the Community and Polish law.

Processors and retailer relationships

3.82 According to the interviewees retailers have high negotiation power when negotiating with processors. Although they indicated that there seem to be contracts between retailers and processors, but none were sure about the conditions. Note that all the big retailers operating in Poland are multinationals (3 French Leclerc, Auchan, Carrefour, Lidl, Biedronka (Portuguese), Tesco and Kaufland). There are also Polish small retailers.

Market transparency – information disclosure

3.83 It is important to note that about 70% of the milk in Poland is in the hands of cooperatives, therefore the contracts only operate on the remaining. There is no information disclosure unless there are issues with the contracts. The contracts are left to be negotiated by the parties. The Polish Government tried introduced a interbranch organisation but it did not progress.

Process of introducing the mandatory written contracts

3.84 In Poland, they already had contracts before the introduction of mandatory written contracts in 2015. According to them contracts did not change the situation of the market.

Prospects

3.85 None of the interviewed institutions indicated potential problems with the contracts. This may be due to the fact that contracts were already in operation before the Milk Package.

3.86 Diagram 5 presents a summary of the structure of the dairy contracts in Poland.

Figure 13: Diagram 5: Polish dairy contracts

3.5 Romania

Key points

• The Romanian dairy sector possesses a singular structure with only about a quarter of the milk production being sent to dairy processing plants.
• The regulation is applied to the relationships between producers and first buyers of milk.
• It was agreed the minimum content that any milk contract should cover is: price (variable prices, fluctuating with the market, price fixed and not negotiated), duration, (minimum 6 months), quantity, quality (minimum standards and bonuses and penalisations), and payment methods.
• POs and IBO failed in being established and given the disparities in negotiation power, it is not clear how conflicts are resolved.

3.87 Before the implementation of the Milk Package in 2014, milk was marketed under verbal agreements that in most of the cases were very informal, and frequently triggered complaints from the producers. It mainly referred to changes to the price previously agreed. This circumstance along with the fact of a decreasing producing sector, stimulated since 2010 an increasing dialogue between processors and the government to attend to producers’ demands as to more stable and clear negotiated condition. Thereby, the Romanian implementation of the Milk Package included the imposition of mandatory written contracts (MWCs) for the marketing of raw milk.

3.88 In addition, it is important to note that the Romanian dairy sector possesses a singular structure. Of a total production of 4.5 million metric tonnes only a bit less that 1 million tonnes are sent to dairy processing plants. The rest of the milk is either self-processed by producers and distributed through direct selling to consumers or self-consumed in farm. There is also in Romania a black market of milk that moves yearly around 800,000 tonnes of milk. The introduction of MWCs was used as an opportunity to reduce this black market. Using EU funds, a subsidy per declared tonne of milk was offered to producers, obtaining as a result a 50% increase in the amount of milk declared.

Offer contract and duration

3.89 The regulation is applied to the relationships between producers and first buyers of milk. It was agreed the minimum content that any milk contract should cover, namely: price (variable prices, fluctuating with the market, price fixed and not negotiated), duration, (minimum 6 months), quantity, quality (minimum standards and bonuses and penalisations), and payment methods.

Volume delivered

3.90 Expected volumes are included in the contracts; however, the interviewees did not not know the details.  Note that given the aforementioned structure of the sector, processors do not face with the need of a balancing product (i.e., they are in deficit).

Pricing

3.91 The common practice to establish the price currently in Romania, is to review the price for each natural production season (autumn and spring). That is reviewing the price or renegotiating the price twice a year irrespective of the duration of the contract (there are cases of 12 and even 24 months contracts). The Romanian average price roughly follows the EU price trend with a delay of two months, being situated a below the average EU price.

Dispute resolution

3.92 There is no mediation between farmers and processors. In practice, given the differences in scale between producers and processors if something happen it is not clear how the clauses of the contracts are enforced.

Producers organisations and Interbranch organisation

3.93 As regards producer organisations two were set up in Romania after the implementation of the Milk Package. However, they were not successful in terms of joint negotiation with processors and both evolved into co-ops.

3.94 The Romanian administration made several unsuccessful attempts to set up an interbranch organisation. They counted with the support of the APRIL, the processors’ association. The main issue is that producers organisation misunderstood the role of the IBO as one of setting prices.

Market transparency – information disclosure

3.95 It was indicated in the interviews that the Romanian government has access to significant amount of information on the dairy market. There exists a register of first buyers of milk. Quantities sourced, prices, milk constituents (fat, protein), and supplier have to be reported. However, it was mentioned that there is not an efficient utilisation of these data to inform the functioning of the market.

Processors and retailer relationships

3.96 At the interviews it was indicated that most of the retailers were multinationals with important power of negotiation but the interviewees did not have information about the contracts between processors and retailers.

Prospects

3.97 According to the interviews, given the structure of the Romanian dairy sector, contracts do not play a substantial role. Nevertheless, it is expected that they will continue operating as they add transparency to the relationships.

3.98 Diagram 6 presents a summary of the structure of the dairy contracts in Romania.

Figure 14: Diagram 6: Romanian dairy contracts

3.6 Spain

Key points

• All sales of milk in Spain must be covered by a contract which specifies the milk price, volumes and term of the contract. Volumes must also be specified in the contract as well as delivery tolerances to be specified in the contract.
• The price in the contracts can be either fixed, variable or a mixture of fixed and variable, but they are set for the duration of the contract. In the case of a variable price, the reference used to adjust prices must be specified in the contract and be verifiable from published data. Contracts offered by the largest processors are dominated by fixed price offers (around 70%).
• Contracts must be offered to farmers for a minimum duration of 12 months. However, farmers can refuse the initial offer and agree a different length.
• Variations to contracts within the contract term can be negotiated between parties but must be agreed in writing and notified to the Government Department responsible for monitoring the regulation.
• Milk buyers retain discretion over the price level, as this is set at the beginning of the contract.
• While initially met with resistance by milk buyers, both farmers and processors feel they have improved the situation in terms of improving price stability and transparency.

3.99 The Milk Package was implemented into the Spanish legislation in 2013 (Ley 12/2013, and RD 1363/2013). It made mandatory the use of written contracts between producers and first purchasers for the marketing of raw milk. As part of this process, the Spanish inter-branch organisation (Organización Interprofesional Láctea – INLAC) was designed to play the role of coordinating the process of implementating the mandatory contracts. The main features of the Spanish legislation on mandatory contracts are as follows (Gobierno de España, 2015):

Offer contract and duration

3.100 The milk purchaser must make a written offer to the producer at least two months before the beginning of milk delivering. The offer must include all the elements of the contract with a minimum duration of 12 months, although the producer could ask for a shorter duration. This offer is meant to serve as a base for further negotiation of contract terms. The negotiation should be freely negotiated between the parts in the contract.

3.101 Any contract may be agreed as renewable (i.e., rolling contracts or evergreen contracts) for similar length periods with a resignation period of two months. Whether the purchaser wanted to change the terms of the rolling contract, the new conditions should be sent in written to the producer at least two months before the end of the contract.

Pricing

3.102 The Spanish regulation establishes that the price agreed in the contract may be determined as either a fixed price, a variable price, that should be established through a price mechanism specified in the contract or a mixed one (part fixed and part variable).

3.103 INLAC commissioned the University of Santiago de Compostela (USC) a thorough analysis of the Spanish dairy market in order to move forward the implementation process of the Milk Package.

3.104 The USC experts concluded that the best way to protect supply chain stakeholders against market price volatility was the inclusion of non-linear price mechanisms within the contracts to establish the raw mil price. Classical economic theory assumes a linear relationship between changes in prices and quantities produced under the assumptions of perfect information and an efficient market structure that naturally tends to equilibrium between supply and demand. However, the Spanish raw milk market may behave quite differently and the reactions of the economic agents market signals may be not as efficient as predicted by the economic theory.

3.105 Several factors may explain the efficiency problems in Spanish milk market: (1) operational difficulties to adapt production on the short term, what normally results in a lagged response, (2) high production investments entails high fixed costs, this may prompt opposite effects in front of a decrease of milk prices, triggering an increase in production as long as these are higher than the variable costs (Santiso Blanco, et al., 2014). In this context, the inclusion of benchmarking or referencing mechanisms was expected to enable enough flexibility for market changes whilst providing producers and processors with enough certainty about the price. The USC designed up to six dairy cow milk indexes and they are permanently updated and freely accessible to the industry through the INLAC website (INLAC, 2019).

3.106 Even though competition law prevents INLAC from recommending that this should be the preferred option to apply, its support and following up of its implementation seems to suggest that it is the preferable option to them. This agreed price or price mechanism cannot be modified unilaterally during the length of the contract (no purchaser discretion). Only if both parts agreed to change it, they must finalise first through a written agreement the current contract and then to establish the new price or price mechanism in a new contract with a new duration.

Dispute resolution

3.107 Given the commercial sensitivity of contracts’ content, INLAC has been entrusted with supervisory duties over the matter. Thereby, all the contracts signed between producers and first purchasers of raw milk must be sent to INLAC, remaining in custody for at least two years. This access to the contracts enables INLAC to act as a mediator in case of disputes arisen from misinterpretation or breach of contract terms. If an agreement could not be achieved through this amicable procedure, the parts must determine in the contract if they prefer to refer the dispute to either the ordinary court system, or the Spanish Arbitration Court. In this last case the dispute will be solved in a single procedure.

Exclusivity

3.108 Each producer may subscribe as many contracts with as many purchasers of milk, as long as he/she only has a single contract with each of them to regulate their commercial relationships.

Market transparency – information disclosure

3.109 First purchasers of raw milk are enforced by law to monthly feed an electronic database with the milk volume that they have received from each producer. The total amount paid to each producer, including premiums and penalisations must also be declared.

3.110 A weighted average price is obtained by dividing the total amount paid between the litres delivered and published every month by Spanish region. This database is freely accessible (Gobierno de España, 2019).

Views about the contracts in Spain

3.111 As regards the functioning of contracts (Santiso, et al., 2018) provided the following opinions from stakeholders:

3.112 From the processors’ perspective - There exists an imbalance between a 12-month contract between producers and processors and shorter contracts that currently occur between processor and retailers, similar to the situation in the UK. The processors have stated that they face difficulty in setting long term prices within contracts without compromissing the flexibility required to remain competitive in the market. As a result, prices offered over a 12-month term are often viewed to be too low, and farmers prefer shorter term contract which offer higher prices.

3.113 As regards the indexation price mechanisms, processors fear that benchmarking the price of raw milk will remove competitiveness to their final product, in particular for products aimed to export markets. They feel it would be useful to have informaton on the implications of using such indexation tools, and indexes would need to be updated periodically to adjust for changing market dynamics.

3.114 From the perspective of the producer - Producers consider that the bargaining power imbalance between themselves and processors prevents effective negotiation. The buyer imposes the conditions on the contract, including the price and index.

3.115 Producers disagree with using the FEGA price as benchmarking index, because the index is not independent as it is affected by the previously established price set by the buyers. Moreover, it is their view that the increase of prices received in 2017 was lower to that in the European markets due to the extensive use of the FEGA index as the benchmark.

Prospects

3.116 Santiso and Sineiro (2016), who were involved in designing the Spanish price indexes, consider that the entire process of the CMO implementation in Spain has been affected by two factors namely: (1) the diffused distribution of the devolved powers between the central and the regional governments and (2) the pressure exerted by anti-trust governing bodies against the introduction of indexation tools. They concluded that the actions of the Spanish Comisión Nacional de la Competencia (CNC)^[3], regarding the implementation of the Milk Package may have been partially biased in favour of the retail sector due to their proximity to the final consumer. As a result, some initiatives aimed at improving the relationships in the raw milk supply chain were opposed by the CNC, and even some sanctions have been imposed to dairy processing industries for anticompetitive behaviour (price collusion) (Santiso and Sineiro, 2015).

3.117 Santiso and Sineiro also concluded that the imposition of mandatory contracts has not been followed by an actual process of negotiation between the involved parts (i.e., producers and processors), and has become a mere bureaucratic burden where normally the processor imposes the content to the producer in a take it or leave it offer.

3.118 The price volatility during 2014 and 2015 encouraged farmers to refuse in great numbers the established minimum contract duration of 12 months. According to the most recent data available only 4.3% of total raw milk deliveries in Spain were under a contract with a duration of 12 months or more by September 2018 (Gobierno de España, 2018). Despite the provided indexation tools, the majority of the farmers opted for fixing the price and reducing the duration of the contract. The elimination of the European dairy quotas in 2015 added pressure to the situation, resulting in an increase in milk production that was destined mainly to the spot market. In this environment, the renovation of a great deal of contracts coincided with an oversupplied market (Santiso and Sineiro, 2016a).

3.119 In spite of the usefulness of the indexation mechanisms to counterbalance price volatility, these still remain underused throughout the sector. By September 2018, 63.2% of milk deliveries were under a fixed price contract, 22.3% under a variable price contract, and 14.5% under a mixed price one (Gobierno de España, 2018). The USC as part of their mandate to follow up and improve the implementation of the indexation tools has surveyed the sector as to understand why this is resistant to use the indexes.

3.120 Diagram 7 presents a summary of the structure of the dairy contracts in Spain.

Figure 15: Diagram 7: Spanish dairy contracts