Memorandum submitted by the Co-operative Group (DFoB 26)

1. The Co-operative Group is the UK's largest mutual retailer. It is a family of businesses, most of which are consumer-facing and range from food retailing to financial services, and from pharmacy to farms. By far the largest business is The Co-operative Food which, following the acquisition of Somerfield in March 2009, now operates around 3,000 stores throughout the UK with over 21 million customer visits each week.

2. The Co-operative Group fulfils a federal role for all other consumer-owned co-operative societies through the Co-operative Retail Trading Group (CRTG). CRTG manages the buying and promotional function on behalf of those societies.

3. The Co-operative Group welcomes the opportunity to provide evidence to the Environment, Food and Rural Affairs Committee as part of its inquiry into the implications of the collapse of Dairy Farmers of Britain.

4. The information below sets out, chronologically, key elements of the trading relationship between DFB and the Co-operative Group from 2004 to 2009.

Sale of ACC to DFB

5. The sale of the Co-operative Group's Associated Co-operative Creameries (ACC) milk processing business to Dairy Farmers of Britain (DFB) in the summer of 2004 was the culmination of an exhaustive nine month process following a strategic decision by the Board of the Co-operative Group to exit the dairy processing sector. A number of parties were invited to acquire the ACC business and the various bids were evaluated in considerable detail. All potential buyers were offered the opportunity to undertake due diligence. In its indicative offer DFB stated that it would undertake due diligence into the following areas before making an unconditional commitment to buy: commercial; financial; legal; property; environmental and regulatory; insurance; pensions and employees. This due diligence was indeed undertaken by DFB and its consultants and was professionally advised throughout the negotiations.

6. At the time, the Co-operative Group was reassured that another Co-operative business was to take ACC forward into what it hoped would be a prosperous future, as part of an ambitious and expanding DFB enterprise.

7. On the day that the sale was completed, DFB issued a brochure, entitled Building a better future, to a range of stakeholders including members, customers, employees and suppliers. A copy of the brochure, produced and distributed by DFB, is attached for information.

8. At the time of the sale of ACC to DFB, the Co-operative Group agreed a three-year contract (running to August 2007) with DFB for the supply of 44 million gallons of fresh milk per annum. The majority of this was delivered direct to store, as part of the contract, and equated to approximately 80% of CRTG's milk requirement. In addition it was agreed, by rolling contract, that DFB would supply annually 3 million litres of Co-op Fresh Cream.

Renewal of Contract in 2007

9. In August 2007, DFB tendered to renew supply of fresh milk to CRTG and was successful in all lots where they were the incumbent supplier, with the exception of supply of some 8 million gallons to stores within the South West. In this one area, the DFB quote for supply was considerably higher than the quote supplied by Robert Wiseman Dairies, and the contract for supply in the South West was therefore awarded to Wiseman. The new supply agreement with DFB was for two years and was due to expire in August 2009.

10. In early 2007, the Co-operative Group proposed a number of initiatives to DFB that were designed to widen the product range and add greater value, as well as to evaluate supply issues both from a logistics and farmer-member perspective. Each of these initiatives is detailed below:

Products

(a) DFB was asked to quote for supplying a range (4 lines) of Christmas Brandy Creams. In March 2007, DFB was awarded the contract to supply. However, in November 2007, DFB failed to produce two of the four agreed lines.

(b) DFB was asked to quote for supplying an own-brand flavoured milk product range. In April 2008, following a competitive tender process, the flavoured milk contract was awarded to Dairy Crest whose quote was significantly more competitive than that of DFB.

(c) It was agreed to assess whether it would be possible to move towards Freedom Food accreditation for liquid milk. In February 2008, following changes made by the RSPCA to the Freedom Food criteria, it was recognised by both DFB and the Co-operative Group that the move towards Freedom Food accreditation was not possible in the short term.

Supply Chain Issues

Also on the agenda for discussion during 2007 was The Co-operative Group's desire to explore with DFB the possibility of moving towards a new form of dedicated supply chain. Under this model, which has now been adopted by some other retailers, The Co-operative Group wished to explore whether some of DFB's farmer-members might wish to supply milk which had been produced in accordance with a range of specified criteria, in return for an additional premium above that negotiated by DFB direct with its members.

11. As a commitment to this The Co-operative Group set up a 2p per litre accrual with DFB in readiness to develop a farmer pool and Freedom Food accreditation.

12. In February 2008, DFB management stated verbally that it had an objection in principle to any notion of a 'farmer pool' because of its co-operative structure and its rejection of any differentiated contract structure that moved away from the same treatment of all DFB members. DFB management stated that a farmer pool model would require the ratification of the DFB Board and that this was unlikely to be forthcoming. DFB appears to have been the only large dairy processor that objected to the option of the 'farmer pool' model.

13. The issue of logistics - how a product gets from its point of production to the customer - is inevitably an important feature of the supply chain relationship. During late 2007 and early 2008 the logistics dimension of DFB's contractual arrangements with The Co-operative Group became a source of major discussion.

14. When the contract with DFB was renewed in 2007, two prices were agreed with DFB:

(a) A price for liquid milk delivered by DFB from its processing plants direct to the store of the Co-operative Group and other Co-operative Societies across the South East, South, Midlands, Wales and Eastern England.

(b) A different price for liquid milk delivered by DFB from its processing plants to various Regional Distribution Centres, operated by the Co-operative Group, in Blaydon, Osset, Eccleshall and Alfreton.

17. This dual pricing to reflect two different logistics and distribution networks and associated differences in the cost of supplying to stores is not uncommon between suppliers and retailers. It was agreed as part of the 2007 tender process that a differential would be paid to DFB of 15p per gallon more for the milk delivered direct to store.

18. During the course of 2007, DFB would have been aware that the Co-operative Group was developing a major regional distribution centre in Thurrock, servicing stores across the South East.

19. In May 2008, at a formal meeting with managers of the Co-operative Group, DFB issued an ultimatum regarding the future supply of milk within the South East. Two of the proposals set out by DFB would have resulted in a significant cost increase for the Co-operative Group, and were rejected. The third proposal offered by DFB was that the Group seek an alternative supplier from the start of October 2008.

20. This move prompted a tender process for supply to the South East on a direct to store basis, and Wiseman put forward a quote that represented a significant saving compared with the price being demanded by DFB. This move was confirmed to DFB in June 2008. A meeting was scheduled to agree an handover strategy and this was implemented from 28 September 2008 onwards.

The 2009 Tender Process

21. In 2009 the Co-operative Group initiated a tender process for the supply of milk to societies within the Co-operative Retail Trading Group. A clear process, transparent to all potential bidders, was established with tender documentation sent out to five dairy processing businesses, including DFB.

22. Four clear objectives were set out as part of the tender process and the Co-operative Group was clear that it would make an assessment against each. The supply contract was also broken down into a number of elements or 'lots' that covered different geographic areas within the UK and also a 'lot' for the supply of organic element. The four objectives in the tender documentation were:

o Price

o Security of supply

o Service level

o Farmgate price

23. DFB confirmed that they were interested in only two of the five available 'lots'; namely the supply of milk to the Co-operative's RDC network (circa 34% of total volume) and the supply of organic milk (circa 2%). DFB was the incumbent supplier in both these lots.

24. On the issue of service level, DFB was informed that they were held in high regard. However, security of supply was raised with DFB as a concern, following months of media speculation regarding its long term viability.

25. On the issue of price, DFB was aware that it had not placed a leading bid in either of the two lots being considered by the farmer-owned co-operative. For reasons of commercial confidentiality, the Co-operative Group does not wish to state the different prices being proposed by the leading bid compared with DFB. In both cases, the difference by percentage is less than single figures; however, the overall benefit to the Co-operative Group (and the other societies which form CRTG) of selecting a supplier other than DFB is approximately £2.9 million between 2009 and 2010.

26. Of particular concern to the Co-operative Group, during these negotiations was DFB's attitude to farmgate price. It was already public knowledge that DFB was offering the lowest farmgate price compared to other processors. When the issue of cost price was raised, DFB was both clear and categoric that any downward movement would automatically be funded by a reduction in farmgate price. It was further stated that this had been agreed by the farmer-members of DFB.

27. Two issues that emerged during the tender process of earlier this year were, therefore, paramount in the decision not to award a further contract to DFB. The first was the assertion that any price reductions would be met automatically by a lowering by DFB of its farmgate price to its farmer-members. The second was the final price being offered by DFB that was significantly higher than at least one rival bid.

28. In mid-March 2009, at a meeting held at the Co-operative Group's Manchester head offices, DFB was informed that they had not been successful in securing any contracts to supply fresh milk to CRTG from August 2009 onwards. Although disappointed that its bid had not been successful, the DFB account team commented on the professional manner in which the tender process had operated. It was agreed at that meeting to delay any public announcement indicating that DFB had not been successful in securing any of the milk supply contracts.

29. In mid-April at the request of DFB, Peter Marks, Group Chief Executive of the Co-operative Group, met with Lord Grantchester who chaired DFB. No explanation was given about why Andrew Cooksey, Chief Executive of DFB, was not at the meeting, despite curiosity about his absence. During the meeting Lord Grantchester accepted that the tender process had run its course and that DFB had been unsuccessful. Instead, the meeting focused on how the two businesses could work together to ensure that DFB was able to communicate effectively and in a timely fashion with its farmer-members and with the media. As part of this transition process, the Co-operative Group confirmed that it would engage with other processors to encourage as smooth a transfer as possible from DFB to rival processors.

30. On 23 April, a joint statement was issued on behalf of the Co-operative Group, DFB, Robert Wiseman Dairies and Yeo Valley, confirming that the Group had awarded contracts to supply fresh milk to its stores to Wiseman, Dairy Crest and Yeo Valley and that both the Group and DFB were working with the new suppliers to ensure that the migration of milk supply was managed with customers' and farmers' interests in mind.

General Observations

31. It is a matter of regret that the ambitions of DFB in 2004 have not been realised, and that increasingly it had become uncompetitive within its peer group of national milk processors.

32. The Co-operative Group is proud of its co-operative ownership, structure and identity. We believe passionately that co-operative enterprises are both a viable and credible alternative to the proprietary business model.

33. However, strong corporate governance within any co-operative business is essential with open and honest communication to stakeholders, including members, about the organisation's business plan delivery and market place position. Furthermore, in a market-economy such as exists in the UK, the same commercial disciplines apply to co-operatives as to any other type of business. The Co-operative Group cannot promote 'co-operation amongst co-operatives' at the expense of taking wholly uncommercial decisions; a decision to renew further DFB's contract in the summer of 2009 would have been just that: an uncommercial decision, potentially harmful to the interests of the Co-operative Group and its members, and indeed those of DFB's farmer-members.

Co-Operative Group

October 2009