How First Milk plans to get itself out of a tight corner

First Milk has seen no shortage of turmoil over the past 18 months, and last week there was yet more: new CEO Mike Gallacher (parachuted into the troubled farmer co-operative to replace Kate Allum on 18 March) revealed a dramatic “turnaround plan” for the dairy processor, based on cost cutting, job losses and an overhaul in milk price formulas.

There’s no doubt First Milk is in need of a turnaround, and it was always clear a new CEO would mean significant changes for the business.

Although First Milk actually returned a profit during the 2013/14 financial year - helped by strong commodity markets - it was hit hard when dairy markets subsequently collapsed, contributing to cashflow problems in late 2014.

Gallacher himself has made clear how serious the situation is: he believes the changes he is proposing are vital to safeguard First Milk’s future.

But he faces an uphill struggle to convince the co-op’s long-suffering farmer members. Already, his proposals have been met with a mixture of concern, resignation and hostility from farmers who are still smarting from the co-op’s decision to delay payments in January, a fall in milk prices, and a rise in the amount of capital they are required to invest in the business.

So what exactly is Gallacher proposing and why is it proving controversial? And what will his new strategy mean for First Milk, its farmers and its customers?

“When the market recovers, other buyers will open their doors”

First Milk says its new plan is based on a recently completed strategic review, which highlighted “operational issues within the business that must be addressed”. Cost reductions are a central part of the new strategy, which includes the proposal to axe up to 70 - mainly head office - jobs. The co-op is also launching an independent review into the “governance and commercial learnings from the business’ recent disappointing performance” in the mould of The Co-operative Group’s recent review by Lord Myners.

But arguably the most radical element of Gallacher’s reforms is a new milk pricing structure based on regional market conditions, which will come into force in June.

This will see First Milk’s manufacturing and balancing milk pools split into seven milk fields - all of which will pay an ‘A’ volume linked to 80% of the commercial value of milk coming from a specific field, and a ‘B’ price based on returns from short-term trading.

First Milk says this new approach will allow it to link farmer milk prices to the commercial returns of a particular manufacturing site. The more profitable the manufacturing site, the higher the milk price.

Lower milk prices

In practice, however, the upshot for many First Milk farmers will be a reduction in milk prices.

Indeed, the new pricing structure - which will cost £3.3m to implement - means only farmers in the Haverfordwest milk pool will see prices rise in June, with some farmers - such as those located on the Isle of Bute - looking at swingeing cuts to their milk price.

It’s little surprise, then, that NFU dairy board chairman Rob Harrison says the proposals bring “little or no comfort to members who have supported them over the years”.

Some farmers have even gone as far as to denounce First Milk as a “co-op no more”, and one dairy insider warns that, even if the turnaround plan works, the processor could start losing members in the second half of the year. “When the market recovers other buyers will open their doors, perhaps as early as the autumn, and First Milk will lose them,” he says. “It has lost the confidence of its membership; even the die-hard members are ready to go now.”

Another industry expert argues First Milk has failed in a co-op’s basic aim - to protect farmers from surges in commodity prices - and agrees a loss of confidence among members could herald an exodus from the processor.

Losing milk volume through farmer defections would be a serious threat to First Milk’s viability, but not everyone believes farmers will judge Gallacher’s proposals as harshly as some have suggested.

The general industry consensus is that the co-op will make it through, though many commentators warn Gallacher and his team have just two years to “build a decent business before commodities fall again”.

Dairy industry consultant Ian Potter adds that as painful as the turnaround could be for First Milk, Gallacher “made the right move” by setting milk prices based on local markets. “He has inherited a basket of a situation where few, if any, of his member owners are happy,” he adds. “He needs results and needs them quickly.”

As for what Gallacher’s proposed changes will mean for First Milk customers, Potter says with cheese supplies ringfenced by the co-op’s deal with Adams Foods, it is unlikely the changes will have much effect, even if the business does lose some farmers.

“If I were Adams and others I would be less worried this month than I was two months ago,” he says. “The deal between Adams and First Milk is not the problem, and if it hadn’t been done things would look a lot bleaker than they already look for them.”

Others agree there is no shortage of cheese on the market, so retailers should not be concerned about the impact of First Milk’s new strategy on supply.

Within First Milk itself, of course, there is set to be significant fallout from Gallacher’s proposed reforms. A consultation has already begun with the staff whose roles are under threat, and the Myners-style inquiry - which is expected to raise some uncomfortable questions about the co-op’s governance - is due to report back to members by the summer.

When it does, further dramatic changes are likely to be on the cards for First Milk.