Reference no: EM13851259

Supermarket milk pricing

In early 2011, Coles supermarkets (owned by Wesfarmers Limited) introduced its new milk pricing strategy - lowering the price of its private label brand to $1 per litre. At the time, it was widely thought that the purpose of the strategy was to cause discomfort to its major competitor, Woolworths. As a result, Woolworths quickly followed suit with a decrease in price of its own private label milk brand to match that of Coles. The strategy was largely considered a controversial move, with investigations from the Australian Dairy Farmers Association and an inquiry into supermarket pricing decisions and their impact on the dairy industry by the Senate Economics Committee. Before 2000, state and federal governments set the price of milk in Australia. However, deregulation of the industry combined with a greater emphasis on private label branding by Australia's two large grocery chains (Woolworths and Coles) paved the way for the introduction of competitive pricing strategies in the milk market.

According to a 2011 report by PricewaterhouseCoopers, Australians consume on average 102 litres of milk per person each year. So, what effect did such a drastic price cut have on the Australian market? At the peak of the price war in 2011, more than 72 per cent of the milk sold in Coles supermarkets was at $1 per litre. Coles' returns on the investment saw 64 million litres of their branded milk sell between 2011 and 2012. Woolworths gained 10 million litres in extra sales of their branded milk only during their first year after implementing the strategy in 2011. Overall, the market saw a 100-million litre increase in milk sales. However, there is speculation that the increase in sales was purely a reflection of changes in population growth, rather than as a direct by-product of the adjustment in price.

Furthermore, despite a growth in sales volume of milk for Coles of 11 per cent, the value of sales declined by 2 per cent. Similarly, for Woolworths the growth in sales volume increased by 3.7 per cent, but the value of sales decreased by 2 per cent. This decrease in value was thought to occur due to the cost-based pricing approach adopted by the supermarkets. Profit margins were tight, ranging between 2 and 3 per cent. Currently, Woolworths is the overall market leader in milk sales, with 2012 seeing 498 million litres of fresh milk sales compared to Coles at 424 million. Despite volume share peaking at more than 72 per cent, Coles' private label share of the milk sales dollar peaked at just above 56 per cent in late 2011, and fell to 50.7 per cent in the three months to February 2013 - almost where it was before the milk wars began, although its volumes would have been much higher. Woolworths' private label share by value of sales barely increased from the 50.3 per cent it had before the price war, and the small volume gains meant it fell to 44.6 per cent in 2012.

The reduction adversely affected Australian dairy farmers, with many farmers having to cease operations due to an inability to keep up with the drastic cut in price. It is believed that in some circumstances a farmer receives as little as 5 per cent of what the consumer is charged at the check-out. The pricing strategy adopted by the leading supermarkets has been described as unsustainable over the longer term. However, not all farmers were adversely affected. In some cases, the price war increased demand for more expensive farmhouse milk. For example, Red Cow Dairies, based in Tasmania, has seen a dramatic increase in sales following the price cuts by major retailers. From 150 litres a week, they are now selling in excess of 2000 litres a week of milk. Similarly, A2 milk, with its clear, differentiated positioning in the market as assisting ‘digestive well-being' has seen an increase in its sales figures.

Based on market figures it seems as though the reduction in milk prices in Australia has had a generally negative impact, bar some exceptions, for the key players involved, including Australian dairy farmers and the major supermarket chains. Given its seemingly negative impact, why was Coles so keen to adopt the $1 per litre pricing strategy, and why did Woolworths follow suit? Part of the explanation revolves around using the lower priced milk as a bait to encourage consumers to visit supermarket stores more often. It was expected that these trips would result in the purchase of additional grocery items while in store. The strategy would also discourage consumers from purchasing milk at other locations, such as convenience stores. However, some believe that the key reason behind the strategy was a longer term vision of cutting out secondary milk suppliers and partnering directly with farmer-owned groups; for example, the Great Ocean Road brand of milk, Tamar Valley Dairy in Tasmania, and Norco in Western Australia. Given that over 70 per cent of all groceries purchased in Australia are obtained from either Coles or Woolworths, there is fear in the marketplace that this strategy of the leading supermarkets dealing directly with farmer-owned groups may allow them to re-adjust prices, and subsequently grow their profit margins.

Questions

1.Would you describe the demand for milk in Australia as elastic or inelastic? Why?

2.What pricing strategy would be used to best describe the reduction in the price of milk to $1 per litre?

3.What pricing adjustments do you foresee being carried out in the future by Coles and Woolworths?

4.Do you think that the strategy implemented by Coles has been successful? Why/why not?

5.What ethical concerns should be considered by marketers when setting a pricing strategy?