UNCORRECTED TRANSCRIPT OF ORAL EVIDENCE To be published as HC 971-ii

House of COMMONS

MINUTES OF EVIDENCE

TAKEN BEFORE

ENVIRONMENT, FOOD AND RURAL AFFAIRS COMMITTEE

DAIRY FARMERS OF BRITAIN

Wednesday 14 October 2009

MS HAYLEY CAMPBELL-GIBBONS and MR GWYN JONES

MR GORDON BROWN, MR PETER PEARSON and MR JOHN GREGORY

Evidence heard in Public Questions 89 - 189

USE OF THE TRANSCRIPT

Oral Evidence

Taken before the Environment, Food and Rural Affairs Committee

on Wednesday 14 October 2009

Members present

Mr Michael Jack, in the Chair

Mr Geoffrey Cox

Mr David Drew

Mr James Gray

Lynne Jones

Miss Anne McIntosh

David Taylor

Paddy Tipping

Mr Roger Williams

________________

Memoranda submitted by National Farmers' Union

Examination of Witnesses

Witnesses: Ms Hayley Campbell-Gibbons, Chief Dairy Adviser, and Mr Gwyn Jones, National Dairy Board Chairman, National Farmers' Union, gave evidence.

Q89 Chairman: Good afternoon, ladies and gentlemen. Can I welcome you to this further evidence session with reference to the Committee's inquiry into Dairy Farmers of Britain. Our first witnesses this afternoon come from the National Farmers' Union. Can I formally introduce Hayley Campbell-Gibbons, who is the Chief Dairy Adviser, and Mr Gwyn Jones, who is the National Dairy Board Chairman of the NFU. Can I thank you very much indeed for your written evidence to the inquiry. Our focus is very much in trying to track down what went wrong and, therefore, what lessons can we learn from the information which the Committee receives. One thing which struck me about the NFU's evidence, if I could start with this question, was almost a sense of reluctance to put on record why you thought DFB had gone wrong. Why was that?

Mr Jones: Chairman, I find that strange. I am not quite sure why you thought that. I think we submitted the evidence as we knew it and as we saw it taking evidence really from the Receiver's report.

Q90 Chairman: But you are an organisation which has a deep knowledge of the dairy industry. You have been involved in it for as long as I have ever known anything about the National Farmers' Union, you have a huge amount of expertise and you have what I call knowledge, both private and public. I was merely looking at the structure of the evidence in here, and it just struck me that there was not a little vignette in there to give the NFU's explanation as to why this business failed. You have dealt with all the consequences, you have got some things about lessons learned, you have got a commentary about the government response, you have got things about milk contracts, receivers, governance of co-operative businesses, but there is nothing to tell me why you thought it went bang. So why did it?

Mr Jones: I think it is fairly clear why it failed. I think the Receiver made it very clear that it was a combination of bad judgment, bad management and poor strategy. That is what he seemed to highlight.

Q91 Chairman: I know, because we have had the Receiver's evidence and we have had the Receiver's report. I am interested to know what the National Farmers' Union think. You have members who were members of this co-op. No doubt you talked to them and they said things to you. I can read the Receiver's report myself; I was just genuinely interested to know if the NFU had a view, or it might be that you agreed with everything that Stephen Oldfield wrote full stop. I just wondered, as experts in the field, whether you had an observation to make as to why you thought it went wrong. What, for example, were, in your judgment, the key business decisions that did not happen as they were supposed to? Was it destined for failure right from the beginning? That is a fairly provocative but, nonetheless, quite relevant question.

Mr Jones: Yes, it is a relevant question. I think it is right and proper for me to explain, first of all, that we represent farming members and, of course, we do get feedback from members. I do not think the NFU professes to have expertise in milk processing, but, of course, we have followed this all along and we do concur with the Receiver's report. We do concur with what he says. We do not have an independent view as such that is in any way different to that. It was very difficult, following this through, to know exactly what was going on. We had concerned members, we had some concerns of our own but, of course, all we can do (and we are in a very responsible position as the National Farmers' Union) is seek reassurances and invite executives in and talk to them and question them and if they give us reassurances then we have to take that at face value, because we have no evidence or any facts to suggest that things are any different from how they tell us. At the end, of course, again, the only evidence we have is in the Receiver's report, because he was the only person in possession of all the facts. That is the reality of it.

Q92 Chairman: I suppose I am a seeker after those bits of intelligence that come to an organisation like yours. You have got your ear very firmly to the ground; you have lots of people who are involved in the dairy industry. Here were two small co-ops that came together to form a big one. I would have thought that the NFU might have formed a view, even with the benefit of hindsight, as to whether this thing was going to fly and make it or whether you thought, "Oh, dear, I am not so sure about that. Unless they do X, Y or Z they are not going to make it." I just want to try and get some commentary. With great respect, we have talked to the Receiver; we know what he says. I am more interested in what you have got to tell us.

Mr Jones: The evidence we submitted, of course, we tried to base on factual information. If you are asking me what we heard and what we thought, of course I can elaborate on that.

Q93 Chairman: Please do.

Mr Jones: I think maybe to start with we ought to point out the difficult task all three co-ops had when they first started after the end of Milk Marque. We had three co-ops here that had an area of the country designated to them. They had no money, they were starting from scratch and they also had all the farmers that were assigned to them: they did not have the luxury of signing up the farmers they thought were well positioned geographically for haulage purposes or size, or any of those things. In fairness to them, I think we ought to state that before we start. So, all three co-ops were starting from a very difficult position. When DFB made the purchase and bought ACC, yes, of course, we had comments from the industry saying things such as, "There goes the rationalisation of the liquid industry for some years and farmers will end up paying for it." That is not in any way factual and that is not something we can act on, but those words were certainly around. Then, after a period of time, commentators (and we are not short of commentators in the dairy industry) were making all sorts of comments on a weekly basis, but, again, all we can do is seek assurances. If the NFU at any time comes out and says anything without being absolutely sure of its facts, we can have quite an effect. These comments were already having an effect on their customers and on our farmer members. If we said anything that was in any way detrimental, our members could leave and we could actually cause great harm to the organisation ourselves.

Q94 Chairman: You do not have to say anything detrimental, because this thing does not exist any more. The reason I am asking this is that this has had a further effect on the structure of the dairy industry in England. We have got two remaining farmer-owned co-ops, we have a number of quite well funded, in some cases very well funded, private processors and everybody is working within the national quota on milk, and one of the questions that I think people want to ask is, if we have some idea as to why dairy farmers did not make it, what implications does their failure have, if any, on particularly the remaining two farmer-owned co-ops? This is pretty profound to the structure of the dairy industry. Many farmers put their personal trust in dairy farmers - they felt it was the right way to go, they felt it gave them a share and an opportunity to influence the dairy business - but, sadly, that trust and hope was confounded by reality. We are interested to learn why their aspirations were, sadly, not realised, hence the line of questioning.

Mr Jones: Do you want to comment?

Ms Campbell-Gibbons: Yes, I can talk a little bit about the structure of the industry. I am not sure what the question was now, I am afraid.

Q95 Chairman: The question was really to clarify and help you to tell us, if you like, even with the benefit of hindsight, whether you felt, looking at this thing, it was ever going to make it. You have given part of an indication that perhaps it was not going to make it, and part of that might be that you want to say something about the capital structure of it. You were talking about ACC, for example. Looking at it from the point of view of professionals, was it the right kind of asset to buy in relation to the aspirations of the co-op?

Mr Jones: Again, I think, to be fair, you can only buy what you can afford and you can only buy what is for sale. If you take one of the other co-ops, Milk Link for example, they bought a large cheese company and they have turned it around, and that is the key. I do not think it is a matter of whether it is a co-op model or a plc model; it is all about the management in the end, is it not, and the investment made and then whether you can turn that round into a profitable enterprise. It is easy for us to say now, of course, with the benefit of hindsight, that ACC may not have been the best purchase, and at the time there were concerns aired to us but no evidence that anything was going to go wrong because they had actually bought quite a good customer within that deal. The question was how were they going to manage it and how would they turn it around? We kept getting reassurances that they would be able to do that. Looking at the evidence now, of course, there were many things we obviously did not know about. It seems that they attempted to merge and sell parts of the business many times over the years and we were unaware of quite a lot of that, certainly in terms of being sure. You do hear things, but you cannot ever be quite sure, and a lot of these things are confidential. I do not think the collapse of DFB in any way impinges on the other two co-ops in terms of the model or in terms of questioning their resistance because I think it is completely different. Companies fail too, do they not, on a daily basis almost. That does not mean the model is incorrect. It is, in the end, down to the management, but we have been saying since 2005 in our vision document, which we would be very happy to give you a copy of if you have not got a copy already, that we strongly suggested that the co-operatives had an independent evaluation to show whether they were being well managed, whether the investments were good and whether they had the right strategy. Unfortunately for us, we encountered huge opposition to that, not least from our own farmer members who believed in their co-ops and told us that this was seen as an anti co-op stance. I do regret the fact that that happened, but we have recently managed to persuade the levy body to do this for us.

Q96 Chairman: I am sorry, which body?

Mr Jones: DairyCo, the levy body, is now undertaking this work. It is a great shame that it was not done from 2005, because I have no doubt that if that had happened we would have had a better indicator, and our farmer members in particular, that things were not maybe going as well as they might.

Q97 Mr Cox: But there are some obvious constraints on the current co-operative model which other countries seem to have surmounted, particularly constraints on capitalisation. They cannot raise money on the Stock Market; they are subject to limitations on external investment; the amount a member can invest is 20,000. We are talking about major industry now. Twenty thousand pounds is wholly, I am sure you would agree, inadequate for the purposes of investment in what are major businesses. Do we not need to start looking at the model to see how we might assist co-operatives to flourish? In my constituency, which is a large rural constituency in Devonshire, I have had plenty of those commentators that you speak of talking to me and I do get the continuous theme throughout, which is that people are not easy with co-operatives. We had one fail in our area, a smaller one, the south-west. Do you not feel as a union that what we could do here, in Parliament, is look again at the structures for co-ops and try to do something about enabling them to flourish with a legal regime that would allow them to have better opportunities to raise capital, and so on?

Ms Campbell-Gibbons: I will answer that in part, I think. I think that certainly to be successful in the future we need to improve our competitiveness, and I think that UK co-ops have to be in a position to be able to grow. If you look at consolidation in the British dairy industry, I think that there are certain aspects, the cost of doing that and there can be quite a protracted process, that can put companies off. Often it comes down just to the commercial decisions for two different companies. I think certainly a competition framework might be something that is seen as a barrier for some companies, and that could be looked at. In terms of legal frameworks, we do have to look at the legal frameworks that the co-ops are situated in and the scrutiny that these companies are put under, which is often not as intense as the scrutiny that plcs are put under in terms of their financial performance.

Q98 Mr Cox: What about the actual model? Is it enough to put a restraint of 20,000 on a member's investment into the co-op?

Mr Jones: There is no restraint of £20,000. Many members would have vastly more than that invested. Some of the large farmers supplying Dairy Farmers of Britain, for example, may well have had in excess of £250,000 invested in that co-op.

Q99 Mr Cox: I am pleased to hear you say that, because we have been told otherwise, but that may be a point of fact on which we can be corrected. In any event, the situation of farmers when they want to exit, trying to get their capital out is often difficult and, again, puts a strain on the capital of the co-op. I am really asking the Union to propose improvements that might be made in the law that would allow these co-operatives to flourish better. Have you not got any positive constructive suggestions, or perhaps you might go away and think about it?

Mr Jones: No, I think I do. I think it is time to look at the rules, because there is no doubt that these rules were put together a very long time ago and no doubt it will do no harm to look again at the rules, for sure.

Q100 Mr Cox: Other countries do have a much more flourishing co-operative sector, do they not? For example, they give loan guarantees and they have all kinds of encouragements and incentives to co-operatives.

Mr Jones: Yes, I think we should remember that some of the European co-operatives are anything up to 100 years old and well invested, and some them are very good and very big, such as Campino or Arla, for example, but many co-ops have also failed and have not done particularly well in Europe either. So I think it is not so much the model on its own, though that may be part of it.

Q101 Mr Cox: Forgive me. I hear what you say about that, but we have had one of the main five go out of business and go bust; we hear that First Milk is making a loss of, what was it, seven-odd million; we hear stories of problem in others. I do not buy this story that somehow co-operatives are all fine and dandy, and what I am offering you is the opportunity to tell us how we should improve the prospects for these co-operatives to flourish.

Mr Jones: I certainly do not think that we should start getting too nervous about First Milk or Milk Link simply because DFB has failed. There are good reasons, and they have been explained, as to why First Milk incurred that loss. It is a very difficult time, the industry has gone through quite a recession, but I hear what you say and I agree with you that it would be a good idea to look at the rules and regulations.

Q102 Mr Cox: Take Milk Link. If you are a farmer who suddenly finds his price docked by a couple of pennies, as was happening a year or two back in Milk Link, because the cheese factory is not making sufficient margin, you are not terribly happy, are you?

Mr Jones: No, but the same goes for all milk buyers, whether they are co-operatives or plcs. They all have the ability (and this is why we make such a point of the contract) to deduct and adjust the milk price as they see fit, when they see fit, regardless of what farmers might say.

Q103 Mr Cox: I want to make plain, certainly speaking for myself, and I am sure others on the Committee, there is a tremendous friendliness towards co-operatives and we want to see them succeed, and that is why my question is targeted at perhaps what steps might the NFU think it would be worth taking to free up the co-operatives to allow them to capitalise more easily. Perhaps you would like to think about going away and putting something in writing on that.

Ms Campbell-Gibbons: We can certainly do that. More generally, if you are asking how do we believe that the structure around co-ops in general could be improved, I think independent evaluation of co-ops, and those reports would be confidential, made available to the shareholders, commenting on the executive performance of the company would be a very good start. I think you could have performance benchmarking. We are very pleased that DairyCo has recently contracted a company to investigate the UK milk processors, so co-operatives and plcs, on a range of indicators to look at their performance. I think that will be publicly available, and it is good for farmers to know that the company they are supplying is a strong company. I think also, as I mentioned, much more stringent financial accounting for co-operatives as well. I think those three things would be a very good start.

Q104 Mr Cox: They are always very good safeguards and guarantees. What I am looking for as well are steps that could be taken to assist co-operatives. I do not necessarily mean Government money, but in the framework would it be helpful to allow them to raise money more easily, the capital and so on? We need to understand what the Union's position is on what positive steps might be taken to assist the prosperity of these companies as well as the governance issues, which you very rightly referred to. I think there is a real problem over transparency and accountability and how the lines of accountability work in co-operatives and whether we have got the legal for a model right. You would agree with that.

Ms Campbell-Gibbons: Yes. We will submit a response to you on that.

Chairman: That is entirely consistent with paragraphs 16 and 17 of your written evidence. A brief supplementary from Anne and then we will move on to David Taylor.

Q105 Miss McIntosh: Do you think there is anything to be learnt from the way that co-operatives are formed and organised in other Member States? I am thinking particularly of Denmark and how efficient they are. They seem to be more marketing co-operatives. Is there something we can learn from the legal structure of co-ops in similar structures elsewhere in the European Union?

Mr Jones: I cannot claim to be an expert, obviously, on European co-ops. All I would say is that the co-op structure was set up here - take Milk Link for example - in close conjunction with Rabobank, who are our expert in co-ops in Europe, and I believe that the advice and the structures were taken on from both Rabobank and other co-operatives in Europe. I think there was some survey and intelligence brought into the start up of the co-ops, but I would agree if there are other things that we could learn, other things that would assist the co-ops, we should maybe look into that, and I will make a note of it. We can do that.

Ms Campbell-Gibbons: There was a report that was conducted for Defra by KPMG in 2007 that actually benchmarked or looked at certain indicators from UK dairy companies with global companies and other EU organisations, and they suggested that UK milk processors would be wise to invest more in the non-liquid sector, spend more on R&D, increase their capital expenditure, look to export more product and to vertically integrate as well. So I think there are a number of areas where we could certainly learn from what European co-ops are doing.

Chairman: One of the interesting things that follows on that very helpful answer and also when you were commenting with reference to Mr Cox's point is what are the barriers for UK co-ops in actually doing that? I think that is part of the problem that got DFB to where they are.

Q106 David Taylor: As the Chairman noted right at the very start, in your evidence you have in a sense regurgitated much of what the Receiver had to say, I guess, proving that we can infer from that that you endorse it, but one comment that you make which is separate from the Receiver's report is your paragraph 17, to which the Chairman referred a moment or two ago, where you say that an inaccurate and uninformed level of reporting surrounded DFB and you imply that was a factor in its rapid collapse. Is that how you see it? Are you talking about communications with the outside world, or with their members, or what type of communications? Are you saying one more spin doctor would have prevented them from collapsing?

Mr Jones: No, quite the reverse actually. There was certainly some damage done by outside commentators, who seemed to sometimes have remarkable inside knowledge as to what was going on. If a co-operative itself was not communicating effectively with its membership, they lost faith, they lost trust in the co-operative and many of them handed in their notice and a lot of them left. They were seeing a lot of members leaving and others handing their notice in, and the point we make is if you do not communicate effectively others will do it for you, and that is what happened. Of course, to have so much noise, if you like, in the media and on the Internet and everywhere else does not bode for good relationships with your customers either, because customers very often do not want to be related to companies where there is so much going on that it seems to be outside and there is all the worry, and there is no doubt at all that that did contribute to doing some damage both to the membership and customers.

Q107 David Taylor: What would have been different had there been better communications within the co-op from the board to its members? What might it have forestalled or headed off?

Mr Jones: I think it will be interesting to hear what the farmers answer if you ask them this question, but I would have thought if I was a farmer supplier of DFB I would have been much happier, however bad the news was, to have somebody be straight with me all the way through. I must commend DFB's council here, because they did repeatedly ask very good questions, poignant questions, and also kept confidence. Even at the end when things were very, very difficult for them, they were asked to make very, very difficult decisions, they did not leak that information. So the Council was actually doing a very good job and I felt that they were certainly let down in that they were not given the information, as they should have been, and they were not told exactly what the position was.

Q108 David Taylor: So not only was the information inadequate, was it inaccurate? Did it lead to irrational exuberance amongst the members of the DFB?

Mr Jones: Again, we were not there, but what I can say is that I am pretty sure the Council were reassured, as we were several times, that things were in good order, and I think there was a statement or two made that talked about "on the road to profitability" and "things are now going to be different", and that patently was not the case.

Q109 Chairman: Do you think that the Council should have had access to independent financial advice? You have just said they were not getting the information that they should have done. With no disrespect to the Council, were they necessarily framing the questions in such a way that it would elicit the important answers that they were seeking?

Mr Jones: In all honesty, there will be very few farmers in the country that would be capable of really holding a multi-million pound company to account, if one was being perfectly honest here. So, I think whether they are farmer directors, whether they are Council members or merely supplying members, this is exactly why we have suggested, or did suggest in 2005, that outside independent analysis was necessary, for precisely that reason.

Q110 David Taylor: You talk about financial advice, which would include independent evaluation of the performance of co-ops. In your vision for the dairy industry in 2005 you made the very point that you felt independent evaluation was necessary, but what sort of organisation would conduct the evaluation and how might it work in practice? Who would finance it, and so on?

Mr Jones: I would suspect that it would have been along the lines of what DairyCo, the levy body, are doing now. They have put it out to tender and they will award that contract to a qualified company, or individuals, to carry out this research; and it has to be, of course, in conjunction with and in confidence and have the co-operation of those co-operatives that are being looked at. We will see how it works, but they have now put it out to tender. We could send you a copy of the criteria, if you like. That might be helpful.

Q111 Chairman: Yes, that would be very helpful.

Mr Jones: And you will see what it is they have asked for in terms of expertise.

Q112 David Taylor: You quote, and presumably endorse, the Receiver's comment that there is no evidence of wrongdoing, but for a farmer director to transmit to members wildly optimistic predictions of revenue or profitability would be wrong, would it not, if it was knowingly done, or if it was recklessly done?

Mr Jones: Yes, if it was done knowingly or recklessly I would agree. I wonder whether that was the case. I think maybe here there was an element of believing in the dream, if you like, and taking it too far.

Q113 David Taylor: Who was feeding the dream? Who was feeding the farmer directors with the continuing information which until very late in the day they were unaware that the dream was turning into a nightmare?

Mr Jones: Again, I would probably suggest that maybe there was a lack of knowledge, a lack of expertise on their part, in that on their own they maybe did not have enough understanding of the position they were in or what they were doing. I honestly cannot answer that question.

Q114 David Taylor: You said a few minutes ago (and I paraphrase a little) that farmer directors are sometimes, maybe often, not the right people to be on the boards of large businesses.

Mr Jones: I think they have a role to play.

Q115 David Taylor: In what form?

Mr Jones: Looking after the membership and making sure that the decisions taken by the executive do not have necessarily huge impacts on a farm, for example, because the executive do not necessarily know enough about dairy farming to realise that some of the decisions they may make may have huge impacts on a farm, but what I do not think they are capable of doing in the main is holding the executive to account and knowing exactly what a multi-million pound business is doing.

Q116 David Taylor: The NFU talk about clear performance benchmarks for farmer controlled businesses, and you exclude some obvious ones: milk price leaks and company accounts, and so on. What on earth do you have in mind. What other benchmarks are you going to suggest to them and to us would be worthwhile, accurate, robust and relatively straightforward to collect? What suggestions do you have? You must have something in mind?

Ms Campbell-Gibbons: We do. I certainly would not exclude the milk price. I think you have to look at profitability, but that also includes what your raw material cost is, so I think that has to be included. Your technical performance based on the market you are actually operating in and then, as we have said, the criteria that DairyCo set out in its performance benchmarking goes into a lot more detail about the sorts of things that you can compare companies on, and we would endorse all of those. We will supply you with copy of that.

Q117 David Taylor: Did your vision for the dairy industry in 2005 incorporate in its recommendations any reference to benchmarks of this kind?

Ms Campbell-Gibbons: Yes, it did.

Q118 David Taylor: Why did you not, in the interests of your members, when you were aware that such benchmarks were not in use, urge them on Dairy Farmers of Britain?

Ms Campbell-Gibbons: We pursued this on a number of occasions actually and we recently published a survival plan to the British dairy industry, and that reinforced the need for this performance benchmarking. Initially we called on Dairy UK, the processors trade association, to set up this exact thing, and I think there was such resistance from the membership of that organisation that it did not really happen. There have been some developments, there have been master classes that have been run for processors, so I do not think it has been wholeheartedly ignored, but I certainly think that we need something much more robust, and DFB has highlighted that.

Q119 David Taylor: It is relatively easy for the Receiver in a sense conducting the inquest on the dead body of DFB to identify what caused the fatal collapse. What you are suggesting is that there are things which you were unhappy about which, if incorporated at a much earlier stage, would have led to a much healthier DFB with maybe a long-term future. Are you not partly culpable for not ensuring these things happened on behalf of your large membership of dairy farmers?

Ms Campbell-Gibbons: I think you would have to recognise the NFU's role. We are not a delivery body, we are not buying or selling milk, but we are in a position where we can lobby and we can influence, and certainly this has been a consistent lobbying message we have pushed at all levels in the dairy industry for the last four years.

Q120 David Taylor: As the Chairman said, the NFU is the largest single repository of experience and expertise about the dairy industry. Whatever you may feel is your narrow role, you had a wider role here in heading off the collapse of DFB.

Ms Campbell-Gibbons: I do not believe that is the case. We represent farmers and we champion British farming, but we do not have access to any of the information that would have enabled us as an organisation to benchmark the performance of these businesses.

Q121 David Taylor: Do you agree with that, Mr Jones?

Mr Jones: Yes, I do, although I would say that certainly in the vision document, and in all the lobbying we have done since, we have been pressing on these day in day out, just as we have been pressing for better contracts now for a long, long time, and very often, sad to say, it is our own members who are not the first to pick up on these things and do it for themselves. There is a job for us to do there and we are making progress, but it is not nearly as fast as I would like, I can assure you. It would be rather good if we were able to get our farmer members maybe to act more speedily and do things that they have not always done for themselves over the past few years.

Q122 Chairman: Can you recall when, even informally, the NFU as an organisation first picked up a sort of concern that all was not well at DFB?

Mr Jones: I think the first concern probably was raised at the purchase of ACC, if you are talking about people being worried. Was this the right thing to do? Was it worth that money? Certainly there was an awful lot of people in the industry questioning that, but, of course, once you have done that, what really matters is what you do next, is it not?

Q123 Chairman: True. Did it come up at the Dairy Board as an item for discussion or was that, if you like, the observation of an interested party who said, "I am not quite certain about that"? Did anything follow from that observation?

Mr Jones: No, not in that way, because the Dairy Board, obviously, is made up of farmers who supply different companies and different co-ops and we tend not to have discussions about anyone's organisation because one must remember that the co-operatives are owned by the members, they supply their co-operatives, and there has been quite a lot of history in the dairy industry since the break up of the Milk Marketing Board between those who supply co-ops and those who do not.

Chairman: I can understand the formal thing, but, like everything else, the best bits of a meeting are what happens in the margins.

Q124 Paddy Tipping: You talk to us, Mr Jones, quite a lot about contracts. One of the problems here was that the Co-op contract was reduced in price and then disappeared and the Tesco Local Choice contract did not produce the volumes that were talked about. If we were talking about mature contracts where both sides were recognised and comfortable, how would you describe it? What do you want from a contract?

Mr Jones: If I describe very briefly what the existing contracts look like. At the moment any dairy farmer, in nearly all cases, has to sell all his milk, all the milk he produces, to the one buyer and then that buyer decides, as he sees fit, depending on his performance, the marketplace and all sorts of other things, how much he is going to pay for that milk, and we have seen plenty of price reductions with little notice, no notice, some of them even retrospectively. Of course, now to almost any company you supply you have to serve a 12-month notice period, so during that 12-month notice period your milk price could go anywhere, and if the company is in trouble and you want to leave, you simply cannot. So there are lots of aspects of contract templates, and we will make sure you have got a copy and the guidance notes, but the one thing that we are saying is that if the farmer representatives that are negotiating milk price, whether it is a co-op or a plc, if agreement cannot be had, if they totally fail to agree, which would be very rare, but say they certainly could not agree, we believe that any supplier who wants to leave ought to be able to leave quite quickly, because we think it is totally wrong that a milk supplier has a 12-month notice period when a company could be in trouble or is involved in a serious competition within the marketplace and, therefore, lowering the milk price. In the way it operates any promotions, any undercutting of the marketplace, any building of the business can be done at the farmer's expense, to put it crudely. So we believe that had a contract like that been in place with the DFB, for example, much greater pressure could have been brought to bear very much earlier and, at the very least, then the executive would have had to be honest with the negotiators.

Q125 Paddy Tipping: So reducing the length of the notice would redress the power a bit?

Mr Jones: No, I must make that clear, because that is not what we are saying. We actually promote long notice periods because we do want to see farmers and buyers getting closer together.

Q126 Paddy Tipping: I mean the get-out clause for the producer.

Mr Jones: Yes. It is the buyer or the farmer. If the farmer is seeking a price increase that is far in excess of what is available, or if the buyer wants to reduce the price more than he should or the market allows him and the negotiation cannot be concluded, that is when we say there ought to be a get-out clause.

Q127 Paddy Tipping: I understand that, but what about the two other issues you raised with us: one that you are supplying totally to one distributor, one retailer and, secondly, the issue of prices going down without any notice? Surely that is inequitable, is it not?

Ms Campbell-Gibbons: What I can do is just briefly outline the main elements, the main point in this template or ideal milk contract that we have designed. Of course, milk prices have to move in line with the market, and farmers accept that prices have to go down as well as they go up, but the problem at the moment is that there is no stability and there is no transparency, bar a few exceptions, which we can talk about. So we have produced a flexible template that essentially looks to bring absolute clarity to milk contracts, because often they are very complicated and I think it is fair to say that a lot of farmers do not fully understand what they are signing. So they need to be much more understandable because it is the most important piece of paper that a dairy farmer ever signs. We have the options for rolling fixed-term contracts or standard evergreen contracts that we currently have in the industry. We suggest you might want to sell to more than one milk buyer. Currently most farmers are tied into an exclusive contract, and I think that is something that especially larger farmers might want to look at in the future. We specify that the milk price and the price determinations, whether that is a formula or other mechanism, must be written into the contract and that any variation to that price must be agreed by negotiation, and that is the fundamental driving point that Gwyn was referring to, because without that you really are at the helm of the buyer who can make unilateral price decisions and the farmer has no control at all really, and there are other technical elements that we believe can be improved.

Q128 Chairman: Can I say, for my greater understanding, in terms of the dealings that DFB had with is customers, they were involved in some form of tender process. Can you describe how these tenders operate?

Ms Campbell-Gibbons: I am not too familiar with that myself, I am afraid.

Mr Jones: With retailers?

Q129 Chairman: I gather that every so often they had to tender for the business. In other words, they had to tender for the Co-op contract, perhaps for Tesco. I just wanted to know how these tenders worked?

Mr Jones: We do not have detailed knowledge of those. We understand that they vary - there are Internet tenders, there are all sorts of different tenders, but, again, I think the processor's position in relation to major retailers is very similar to the farmer's position in relation to the processor very often, and I think that is another part of the problem. I think the solution to the dairy industry (and this is European as well as in this country) is certainly in the supply chain. There is enough money in the supply chain and there need to be some adjustments here to make sure that there is not abuse at the one end and the position is strengthened slightly.

Q130 Chairman: The reason I am asking this is that the fundamental cash flow of the business is going to be determined by who it sells to.

Mr Jones: Yes.

Chairman: I am not an expert on these tenders, and I was not certain how they worked and, once you had agreed them, over what period the agreed price then maintained and what were the mutual contractual obligations of the signing parties to a tender. If you cannot deal with it now, perhaps you might just do a bit of homework for us and let us have a note on tenders, because I noticed from members of the public that those who clearly do understand it were nodding when I mentioned the word "tenders", so there is somebody in the room that understands it. I understand that you may not, but it would be helpful for us to understand the process.

Q131 Paddy Tipping: You talked about the supply chain and there being enough money in the supply chain. Is not one way of resolving this for supermarkets, who sometimes get a lot of unfair criticism, to have a direct relationship with the producer?

Ms Campbell-Gibbons: I think for certain segments of the market, yes, that is absolutely essential. We have seen some excellent examples of retailers in the last few years getting much closer to farmers and to processors. I think retailers, processors and farmers all working together has been very successful and the retailers who have started these relationships are very pleased and talk very positively about what has been achieved. They all operate slightly differently. At the moment they are all exclusive to the liquid sector. So we probably have about 30 per cent of liquid milk being sold through retailers in these relationships and about 3,000 farmers in all. So, yes, I believe that they are a very good way of injecting more stability, much more transparency and, I think, profitability, ultimately, throughout the chain.

Q132 Paddy Tipping: Would you name some names?

Ms Campbell-Gibbons: Yes. Tesco, I think, stands out for us as the leading example. Tesco announced in April 2007 a dedicated supply pool with 850 core farmers and, crucially for us, that contract set out a minimum price guarantee which would be the cost of production, it has got a market tracker in there as well as part of that formula, it is fixed for six-months so you get the stability written in there and it is working very well. I think production in that pool is increasing at about three per cent a year, whereas national production is going down. So it shows that farmers have more confidence and they are investing. Other retailers, Sainsbury and Asda, for example, pay a premium over the base price that is set by the milk buyer. To our mind that is still good and there is still money going down the chain, but it does not necessarily stop the price from fluctuating, so they could perhaps be improved. I suppose the issue is that we do not have anything like that replicated in the cheese market, which has been under substantial pressure this year, and I do not think dedication is exclusive to the retail sector either. We have very large food service sector companies and other players that I think would benefit from securing their milk supply in this way.

Q133 Paddy Tipping: That is helpful. Can I switch the subject. DFB went into receivership in June, but there had been some talk earlier on in the year in March or April of it going into receivership during what is called the spring flush, presumably when there is more milk available. Suppose it had gone into receivership in March or April. What would have been the consequences for farmers then?

Mr Jones: It would have been far worse. In fact, in June normally things would not have been all that bad, but we are still dealing with the fallout of DFB to this day, and it has been in conjunction with increased importation of cheese into the country. So there has been liquid milk around in excess of what has been required and we have seen a lot of British milk, mostly, if not all, up to Red Tractor standard going into the drying plant when in fact it had been displaced by cheap imported cheese. So I think had it happened in the flush, it would have been an awful lot worse, there is no doubt about that.

Q134 Mr Cox: How could it have been worse, because these poor people did not get paid? They may have sold it, but they went two or three months without getting a milk cheque.

Mr Jones: They lost one month's milk cheque, which is bad enough - that is more than the profit for the year - and they have lost all their capital, of course. It is approaching 100 million in total, if you put everything in, and that is all farmers' money, but had it happened in the flush, in the spring time, then the effect on the marketplace would have been much worse because that is traditionally when there is more milk in the marketplace anyway, so that is what I meant by that. Again, I would commend the way the industry came together to pick up the farmers and do what they could. I thought that was very good indeed. We are concerned now about some of the very low prices, given that we are seeing a slight recovery in the industry and given that people have had time. Again, we are seeing contracts being offered to these people, but we still have some members on very low prices which seem unjustifiable at this moment.

Q135 Chairman: One of the aspects that the NFU did comment on in its evidence was allegations by farmers of them being taken advantage of once DFB had collapsed with very poor prices for milk. I wonder if you would care to make some observations about what went on, and whether in light of the fact that eventually, and actually quite quickly it seemed, the members or the farmers who wanted to carry on in dairy ultimately did get absorbed into other organisations and whether you have any thoughts as to how (and hopefully it will not happen again), if such a set of circumstances were to happen again, you might stop predatory pricing at a time of distress like this?

Ms Campbell-Gibbons: I can respond first on that. We were extremely concerned by reports that came in from our members very early on actually, particularly those that were not in the best location, they were very small volumes, and perhaps did not have many options. They were being approached by buyers and being offered very low prices: 14, 15, 16 pence per litre. At the time, I think, a lot of these farmers were just grateful that somebody was coming along to pick the milk up and not just ourselves but the Secretary of State also put a message out saying that farmers needed to be careful about what they sign. I would not say that farmers were under duress as such, but they were very vulnerable and perhaps were signing things that, in hindsight, they regretted and, of course, there is no cooling off period. A lot of those farmers are on contracts that have a three-month notice period, others have signed up to a 12-month notice period, so they are in this position again where if the market, as it has, starts to pick up, they cannot move around very quickly. I think one way to ensure that this is not as easy to happen would be to make sure that farmers that are on market-related contracts are able to move around the minute that a better price becomes available because without that there is no pressure or incentive on that buyer to increase that price. Again, it is all anecdotal, and we do not have any evidence because we do not know at what price buyers sell their milk on, and I think that raises another issue actually. As the industry becomes more structured and gets closer to its own customers, I would like to see more information (and it would have to be retrospective) about the price that the product is sold on to the end customer at because we all know what price the farmer gets but, of course, we do not know what price the processor sells the milk on, the cheese on to its own customer, and I think that would enable us to identify where any unscrupulous behaviour or margin stealing was going on.

Chairman: We are still searching for the mystery of the missing ten pence per litre. We did that four years ago, but we have not found it; so good luck to you in looking for the nirvana of transparency in the pricing of milk.

Q136 Mr Drew: On that point - it follows directly from what the Chairman has just said - is not this industry in dire need of a complete research turnover? There are so many secret gardens and so many poisonous relationships, would you not welcome another Competition Commission inquiry into this industry? It is clearly monopolistic, it clearly has all sorts of devious practices, is it not about time that someone came in and really did look into it on the back of DFB, for example, to see whether it is performing as a competitive market or whether, in fact, there are just so many Spanish practices that it is unacceptable certainly to producers and, dare I say, consumers?

Mr Jones: Again, we can send you a copy of the European report investigating the dairy industry there. We have been giving the same message to the Commission that the answers are in the supply chain. I would not go as far as you have just stated. I think, in fact, relations have improved over the years, to be honest.

Q137 Mr Drew: They would have to improve; they could not get much worse.

Mr Jones: That is true. We have been calling for an ombudsman, as you know. We do feel the worst excesses of retailers need to be curbed and we passionately believe that if farmers had a better contract which gave them some degree of influence over negotiations, then, of course, that would spur the processes to be more efficient, go out and sell a bit harder and would actually assist them. If they were under pressure from retailers, for example, to lower their price, they would be able to explain that they would have to go back and---

Q138 Chairman: Just to be clear, because you were singing the praises of retailers a moment ago with the closer relationship with producer supply groups, floors in the market in the case of Tesco, additional payments, and I think you referred to Sainsbury and one other. I almost thought you were going to tell me some of these excesses did not exist, but now they are back in the argument.

Mr Jones: Let me be clear. There are more than just four retailers in this country. There are four big ones, but there are many others. The problem is that, whenever processors go into a tendering round (and we will come back to you on the details of that, and I would like some specifics, if I may, because I want to come back with exactly what you want rather than tell you today what may not be factually correct), of course, if you know that you can deduct that from your farmers and protect your own margin, you are going to think differently from whether you then have to go back and conduct another round of negotiation, which may go against you if you were asking for too much. That is one point. The second point is that whilst we praise the major retailers on their liquid and what they are doing on liquid, we are extremely concerned at their attitude to cheese. You can have two farmers producing milk next-door to each other: one will be very well looked after and assisted in all sorts of ways, have confidence in investing for the future, and next-door a very similar farmer could be producing milk for cheese and he has to compete with the cheapest cheese that can be found anywhere in the world, it seems to me.

Q139 Paddy Tipping: We talked about this a bit before, but, very briefly, if the processor reduces the price of milk, as has happened, what should be the length of the contract period for the producer to come out? It is twelve months in some cases at the moment. Should it be immediately, or three months? What is your view?

Mr Jones: That is for discussion. Again, we have provided a template.

Q140 Paddy Tipping: No, what is your view?

Mr Jones: My own view would be a month if prices cannot be agreed, which would be very rare because the pressures would be immense on both sides, of course, with tremendous responsibilities on farmer representatives as well as the company, but if they totally fail I would say within a month. Otherwise, we would have people who handed notices in and within 12 months they are in a recession and the buyer is not there any longer. So there are all sorts of reasons to make sure that they can move quickly if things are not going as they should.

Ms Campbell-Gibbons: I just want to absolutely clarify though. We advocate long notice periods and partnerships between people in the supply chain, but with the current terms and conditions a long-term partnership arrangement is a concern to us. So you have that safety net to allow you to get out if things go wrong, but we do want to advocate long-term partnerships or relationships.

Q141 Paddy Tipping: You talked about a template that you have got. Are you going to let us have that?

Ms Campbell-Gibbons: Yes, we do have a template, which I will send you a copy of.

Mr Jones: We believe that a proper contract would be beneficial for both sides, without a shadow of a doubt. It would bring farmer and processor closer together. There is no doubt about that.

Q142 Chairman: The Government played an important role in helping to facilitate, if you like, the rescue package that was ticking the box. When we look in the wider context at the dairy industry - I forget its name - the sort of Dairy Board, the great and the good meeting and talking about things, I think Defra likes to look across the horizon and facilitate meetings and do all kinds of things, we have talked an awful lot about the structure of the dairy industry because, quite clearly, that does impinge or did impinge on the financial well-being of dairy farmers. If you had a free hand in defining what you think government could or should do to facilitate genuinely a healthy dairy industry, what advice would you give Hilary Benn?

Ms Campbell-Gibbons: I can talk about the Dairy Supply Chain Forum, which is what I think you were referring to earlier, that has been a useful forum. Certainly a few years ago, when there was very little dialogue between retailers and processors and farmers, that forum had a very important role to play. The industry has moved on now and relationships are a lot better, but I think that there are still some fundamental debates that we have to have as an industry that we are possibly not having out in the open, and looking at the reasons why milk production is falling and actually tackling some of the issues there, I think that government can have a role to play in facilitating that, looking at the role of milk contracts in the dairy industry. It is something that the Commissioner has picked up on as a tool for reducing volatility and introducing stability. So, again, knowing what Defra's position is on that and getting them to facilitate a debate rather than it always coming from the farming union angle I think would be very interesting. If you look at the more regulatory side of things, then of course we believe there are areas where Defra and government would generally take the cost and burden away from dairy farmers, and there are numerous examples that I could give you of that and I would be happy to submit them separately.

Q143 Chairman: Moving for a moment to the specifics, farmers who were affected by the collapse of Dairy Farmers I think made two requests, and these were underlined by the union. One was a request from HMRC with reference to their tax position, and the second was whether there could be some derogation or delay from the full implementation of the Nitrate Vulnerable Zone requirements. Have you had any kind of positive feedback from government on either of those points?

Ms Campbell-Gibbons: No, we have not. We have had a negative response from the minister regarding our request to extend the implementation period for NVZs. That has been turned down, unfortunately.

Chairman: Did he give a reason?

Q144 Mr Cox: I am sorry, could are you repeat that?

Ms Campbell-Gibbons: I think we sent a copy of the letter with our documents. We requested an extension to the implementation period for NVZs to four years - we have currently got three - because we believe that the industry had suffered a terrible blow and that this would be a good signal to the industry from Defra that they understood and had to be sensitive to the demands that it placed on it. We have been told that this is not possible within the regulations, so farmers will not be getting an additional year, which is very disappointing, and on the HMRC issue we have not had a response yet. I believe that that has not been resolved.

Chairman: Okay. Thank you very much indeed for the evidence that you have given orally this afternoon, thank you in advance for the further information you are going to kindly supply us in writing and, again, our appreciation for the written evidence that you sent before. Thank you very much indeed.

Memorandum submitted by Mr Gordon Brown

Examination of Witnesses

Witnesses: Mr Gordon Brown, former DFB member, Mr Peter Pearson, former DFB member and Mr John Gregory, Director of Rock Farm Dairy, County Durham, gave evidence.

Q145 Chairman: Could I formally welcome a different Gordon Brown and Mr Peter Pearson, who are former DFB members, and John Gregory, who is a Director of Rock Farm Dairy. May I thank you all for coming before us this afternoon, particularly Mr Brown, who very kindly sent some evidence which I have read and found a very useful and helpful commentary on some of the things that went wrong. We will come back to those in just a moment. If we could start, first of all, with Mr Brown and Mr Pearson, I think, Mr Brown, in your evidence, in fact, the second paragraph talks about the impact in the starkest possible terms on your business. You said that the losses that you and your family had incurred were in the order of £120,000 in terms of capital investment and bad debt. That is a pretty big hit on anybody's business. I am trying to put that into context about the size of your milk business because £120,000 is a big enough amount of money in any terms, but it is useful to know 120,000 as a proportion of what?

Mr Brown: The turnover for last year, the financial year 2008-2009, would be around about half a million pounds. The turnover this year, because of lower milk prices and lower milk volumes, will be a lot less. It will be somewhere between £350,000-400,000. One hundred and twenty thousand pounds is more than the net profit I would expect to have in any one year. Effectively, it means that looking at the bad debt I would have to work for two years for nothing.

Q146 Chairman: It must have been a very difficult period for you psychologically. There you were obviously realising that DFB was in difficulties. Particularly in the spring you were soldiering on, I suppose, more in hope than expectation, hoping that you would get paid and then, all of a sudden, the world falls in on you. Give us a feeling as to the whole problem, and perhaps, Mr Pearson, you might like to add your own thoughts. When did you first get wind that things were not right?

Mr Brown: I always knew that Dairy Farmers of Britain had taken on a tough task; I had no idea that it was that tough. This time last year, actually slightly earlier - we are in October now, are we not - in July, August last year the price that I was being paid by DFB was on a par with the non-aligned pools from Arla and Dairy Crest.

Q147 Chairman: Just for our benefit, when you say "the non-aligned", what does that mean?

Mr Brown: The three majors, Arla, Dairy Crest and Wiseman's, now have separate milk pools within their business. You have got the supermarket prices which pay a premium and then they have a non-aligned pool, which is everything else. That milk will be heading towards the sort of places that DFB's liquid milk would be heading to: the garage forecourts, the middle ground, the discounters and people like that. Their price was comparative to mine, a point two, point three difference, but not a great deal.

Q148 Chairman: Just tell me, Mr Brown, where is your farm?

Mr Brown: It is near Carlisle. It is six miles east of Carlisle just south of the Scottish border.

Q149 Chairman: Mr Pearson, where are you located?

Mr Pearson: The Staffordshire moorlands.

Mr Brown: That was the situation we were in. We had been promised for the first time real cash as a return on our member investment - 6.5 per cent I think the figure was - at a time when base rates were low and falling. It seemed like things were not great but the business was heading in the right direction. The crunch point was at the end of September when that cheque did not turn up and from that moment on it really was at descent, and psychologically it is the not knowing that kills you. When I was voted off the Council in 2008, but I was asked to go back on for a final few weeks, when the Receivers were actually called in, there was a sense of, "Thank God that is over". It was a sense of closure almost, that chapter was ending. Through May I did not know if I was going to get a milk cheque, and you set the vac pump off every morning to milk the cows not knowing if you are going to get paid for these cows. You have got all the costs coming in, everyone still wants paying - the staff, the electric, the feed, the fertiliser, all that is to pay - but I spent the spring not knowing if I would get paid. Psychologically that was the worst part. Then 3 June came round and you felt, "We are starting to build up again from now." I thought I had got rescued by First Milk, but that turned out to be a bit of a difficult situation when they cut my milk price back to 18 pence a litre. I visited Harper Adams, my old college, in September where they have just built a brand new dairy unit. They get 27.7 pence a litre for their milk from Robert Wiseman Dairies on a Tesco contract. At that time I was on eighteen. So there is that obvious impact. I could not compete, so I took the decision to start selling my cows.

Q150 Chairman: Mr Pearson, do you want to add your own testimony to that?

Mr Pearson: I am in a slightly different position from Gordon in that we took the decision to sell our cows, so we no longer milk cows. There were a number of reasons for that. I have been involved in milk politics for a number of years, so the build up, with the fact that DFB was not successful, I was quite concerned about where the future of the milk industry was going. We had a sale arranged for 18 June, and, of course, DFB went bust on 3 June. So there was quite a traumatic period leading up to our sale as to what effect it would have on the rest of the milk industry, but we also farm in a marginal area just outside The Potteries, 554 foot to 750 foot above sea level.

Q151 Chairman: Mr Gregory, where are you located?

Mr Gregory: We are located in Durham. We supply milk throughout the north-east of England from the borders of Yorkshire up into Northumberland. It is a family business. We were dairy farmers producing milk until round about 20 years ago when we had problems with some contaminated cattle feed, so I can understand the plight of these gentlemen as well. We had to make a decision then, where we were not financially sound enough to continue to replace the herd. We lost the herd and we were in a position where we had to make a step forward. Then we started to purchase our raw milk in and process it in the dairy and retail it on doorstep milk rounds, and that is basically where we have progressed through the family where we have started in milk production since 1987.

Q152 Chairman: Did you buy any milk from dairy farms?

Mr Gregory: We were a customer of what was, obviously, Milk Marque, Zenith, Dairy Farmers. We used to purchase all of our milk from Dairy Farmers for our production until around about six months after they actually purchased ACC. We found there was some politics going on where we were paying a hell of a premium on our price that we were purchasing the milk for and other independent dairies in the north-east were also facing the same problem, so we all elected to go out and purchase milk direct from the farms. We were pretty much outcast by Dairy Farmers, we were then treated as an enemy, but it actually took seven weeks from not purchasing any raw milk from Dairy Farmers before anybody actually realised to even make contact with us. So I think on the background of this, there were a lot of people not watching, as obviously previous people have commented, what was actually going on with the general running of the business from the actual collection from the farms.

Q153 Chairman: So you divorced buying from them, started buying from somebody else and nobody noticed.

Mr Gregory: Nobody noticed for seven weeks. We put our own milk tankers on the road. The farms were Dairy Farmers' farms. They put the notice in as per the contract stated to come with us - at the time we only actually took four farms on - and nobody actually noticed for seven weeks.

Chairman: Incredible.

Q154 Mr Drew: I would like to touch on a couple of points. Two of you have mentioned politics in the dairy industry, which is fascinating as an industry in itself. Mr Gregory, you were saying you were carrying on with your business almost oblivious to what the rest of the industry was thinking or doing. I am just interested in how information exchanges in this industry. I thought everybody knew everything about everybody else's business in dairy, but it almost implies that even if you were in the know, and you were on the Council, it was difficult to obtain pretty basic information about the future of this firm. What was it that made it so difficult, given that you are pretty tightly knit as a group of people, that apparently, until the very end, people did not realise how bad the situation was? Perhaps Mr Brown wants to respond to that.

Mr Brown: The dairy industry is a very political industry. I do not have great experience in any other industry to benchmark it, but I have always been frustrated by the level of politics. I am a straightforward businessperson and, with all due respect - I am sitting in front of politicians - there seems to be an absolutely unnecessary level of politics and personalisation in the dairy industry that has always frustrated me and I think it will be there for a long time to come. Why, I do not know. In terms of getting information, it was difficult to get at the information I really wanted to know. We had presentations from our executive and from the directors and I would not say it was fraudulent but certainly the overall impression that was given of the business was incorrect as events have proved. Within a year of the collapse Rob Knight, who was paid an awful lot of money by us, was continuing to insist, "Your business is in good heart". The chairman of a struggling company may well represent the business to the outside world in that manner but when you are up in front of the owners of the business, in effect your institutional shareholders if you are a plc, he was being less than honest.

Q155 Chairman: Mr Pearson, was that your impression?

Mr Pearson: Could I first make the point that I am not a farmer's son, I came into this industry from outside. I actually married a farmer's daughter, which eased the way into it, but I am not a farmer's son so I maybe have a slightly different viewpoint. I would agree with what Gordon said about the difficulty of getting correct information. We were told, "You can't allow this out into the public". As has already been mentioned by Gwyn, the industry commentators were very quick to pick up some of this information and to broadcast it on the Internet and they seemed to be better informed than the Council were. I came up through Milk Marque, Zenith and Dairy Farmers of Britain and I sat on the Dairy Farmers of Britain Council from the takeover through to about 2008, a similar time to Gordon. I am not particularly good at asking questions in an open forum, so I would ask questions of the chief executive, the directors and everybody else after the meeting and the answers we got appeared on the whole to be satisfactory taking into account the fact that on the league tables the cost prices were one or two pence lower than what they should have been and the fact that sometimes I do not think they really understood what the league tables were trying to say.

Mr Brown: As a Council member I always had to have a continuing dialogue with the directors on a telephone basis. If I had relied upon what had come from Council meetings, what had come through on the official channels, I would have had a completely erroneous view of the business. It certainly was not a perfect view I got of the business but you had to ring the directors up on a Sunday night and say, "Look, what's happening?" and even then you did not get the full story, as events have proved.

Mr Pearson: The milk industry is a very complicated industry. I have had the benefit of being a member of the European dairy farmers organisation and I have travelled and been involved not with the NFU but for my sins I sat on the COA Milk Policy Committee, which did not meet very often. One of the major points about the milk industry is there is a two-tier market: the liquid milk market which governments in the past and processors tend to protect and then there is the commodity market. Depending on who you supply, and as Gwyn pointed out the farmers can be next door to each other, I have a league table with me and there is eight to ten pence a litre difference and on a million litres that is 100,000 quid. You are talking about large amounts of money.

Q156 Paddy Tipping: You lived through this and you have been involved with it for a long time. If you were pointing the finger and saying, "This was what went wrong", what were the significant things that went wrong?

Mr Brown: There was one significant event and that was the purchase of ACC. When you make a big strategic move like that if you get it right you are a hero and if you get it wrong you end up where we did. At the time the questions were asked. I look back on it and I do not reproach myself because I asked all the right questions, as did many others members of the Council: "Have we paid too much? What's the state of this business? Aren't we just holding up rationalisation of the industry?" We were told at the time that if one director had dissented from the purchase of ACC it would not have happened.

Q157 Chairman: Can I just ask, and I am sorry if I am going to sound ignorant, is the ACC the old Co-op's dairy business? Is it one and the same?

Mr Brown: Associated Co-operative Creameries.

The Committee suspended from 4.20pm to 4.31pm for a division in the House.

Q158 Paddy Tipping: You were saying the difficulty was when ACC was acquired at a cost of, what, £81 million.

Mr Brown: It was of that order. When we acquired ACC we acquired liquid processing at Blaydon, Fole, Portsmouth and Cardiff, an ingredients plant at Llangadog and a cheese plant at Llandyrnog. I was speaking to a director at the Dairy Event and it seems that there was a cover-up going on with the vendors of the business and a very large cost was not apparent in due diligence and came to light at a later date.

Q159 Paddy Tipping: What do you mean by a "cover-up"?

Mr Brown: When you are selling something and you have got problems with what you are selling you might wish to cover it up.

Q160 Chairman: Who did the due diligence?

Mr Brown: You are speaking to the directors, are you not, in a week's time?

Q161 Chairman: I just wondered if you happened to know.

Mr Brown: The directors are responsible for it. Was it Smith & Williamson? I am not entirely certain.

Q162 Chairman: Okay.

Mr Pearson: Chairman, on the due diligence, one of the points that came up at the meeting that PwC had in Bolton was somebody asked about the due diligence, and I am just a farmer so I do not know common practice, and it is apparently common practice that due diligence is only carried out by one of the parties and the other parties accept it, but that is something you would have to get clarification on.

Q163 Chairman: We will. We will make a note of that. That is something we will probe the directors about.

Mr Pearson: I think if you asked Stephen Oldfield he would give you the same reply.

Mr Brown: Dairy Farmers of Britain had a subsequent difficulty in that the vendor was their largest customer once we had bought the business, so there was a difficulty in the relationship there, do you sue your largest customer.

Q164 Paddy Tipping: Was that part of the reason for the fall-out with the Co-op then?

Mr Brown: Yes. If we had just left well alone in 2004 ACC would have been bought by one of the majors and that business would have been rationalised into it. We knowingly held that process up because what we wanted to do was become one of the majors ourselves and that was, in effect, our ticket to the game. We would then use that as a foothold and do a deal with one of the majors. That was the strategy and it failed.

Q165 Paddy Tipping: Does that purchase reflect badly on the management of the company? If you are looking at why a company goes wrong often it is the management. How did you rate the management?

Mr Brown: Well, as farmers we contributed £60 million in capital to the business and in addition there were final milk cheques and it has all gone. I think that answers the question.

Mr Pearson: Chairman, if I can just come in on that. To be fair, if you looked at all the information available at that moment in time, and certainly we have got some recent information from August 2009, the margins that people were getting increased the closer you got to the consumer. One of the reasons that I stayed with DFB against all consultants' advice, and they turned out to be right, was that I believed the milk industry would get more competitive as technology improves production and globalisation encourages that production to move to areas that have low costs. The only way I could see that we could survive as a family was to increase the margin obtained back to the farm. The theory at the time was that you moved closer to the consumer and as you moved closer the margins went up. To my mind, and I know I am not alone, the purchase of ACC enabled us to go on that one step. You have to remember that IMELCA in our area failed because they had a modern factory but no marketplace; we had bought the marketplace. I think there were some things in that purchase that were kept from the producers. It turned out that some of the sites were only leased and I think you would have to clarify with the directors but I suspect that in the agreement those sites had to be put back in a certain order and paid for by the members. Looking forward, and you probed Gwyn on factors relating to the other co-ops, and certainly this gentleman asked how you could change the governance of the co-ops in order to drive the business forward, I am not sure I agree that there is any difference between a co-op structure and a plc but they both have to be profit orientated. One of the things that was lacking, and it may have been leftover from the Milk Marketing Board because you have to remember that a lot of staff moved from the MMB, which was a monopoly, through to Zenith and the other companies, was they had not got that drive that possibly an individual has. Certainly there was an ethos within the Co-op at Llandyrnog that DFB had difficulty with in getting rid of some of the staff and that took two and a half years. They appeared to us as the Council that all the time they were trying to rejuvenate this company and as Stephen Oldfield has pointed out £144 million was spent in capital costs, acquisitions and various other things to try and streamline that business. You also have to remember that some of the companies you are competing with have dedicated supplies which are more profitable than others, in other words the liquid milk market, and those companies also rely on the co-ops to supply what they are not getting direct off the farmer, so they only supply 80 per cent and the other 20 per cent comes from the co-op. There are all sorts of issues within the industry that are a disadvantage. The lady across here asked about Denmark and New Zealand, maybe it was in Stephen Oldfield's presentation, and 90 per cent of the producers in Denmark supply to Arla, so they are both virtual monopolies, although there is some problem in New Zealand where I think Fonterra is trying to get an equity stake because it has almost got too big. There are problems when co-ops get too big, but we are not at that stage in the UK I have to say.

Q166 Paddy Tipping: Mr Gregory, you are a bit detached from this. Why do you think DFB went down?

Mr Gregory: My opinion, and what Peter and Gordon were speaking about, is that it all stems from the purchase of ACC. We saw that as an independent outsider. We spoke to our area manager who was responsible for our raw milk purchasing and said that as a customer we were not very happy, we did not think it was a good idea and he said, "Yes, it's going to be a good thing, it's going to be good for the marketplace as well". "Hopefully it will be successful but we think you are buying a bad egg" was the comment. What has progressed from there is the fact that the management was kept on from ACC and you had a company which was not profitable, which was not making good margins, not necessarily run by the best of people and they had inherited this management but quite a few had been sidestepped, let go and gone and worked for competition taking confidential information on customers, pricing and stuff like that which should never have happened.

Q167 Paddy Tipping: Mr Pearson told us that the fact it was a co-operative structure did not matter, that was not a contributory factor. Do you all agree with that?

Mr Brown: I would agree with that. It was not the reason why DFB went bust. It was a bit of the problem, I do not want to disregard it completely. You mentioned with the NFU about 20,000 and it is true there was a £20,000 limit on capital but how DFB got round that, and how the other co-ops get round it, was by having loan notes instead. You can get money off of members, the bigger problem is in terms of getting outside capital into the business. I would suggest that DFB had a bigger problem in terms of getting outside capital into the business and the business model was bad.

Q168 Paddy Tipping: Both you and Mr Pearson were on the members board at ---

Mr Pearson: The Council, not on the board.

Q169 Paddy Tipping: You must have been pretty fed up that you were not getting the proper story.

Mr Brown: We were. As I say in my written evidence, I did not expect the purchase of ACC to suddenly make everything right. When you buy a business in any industry it takes time to sort it out. I thought three years would be about right but it later turned out, and this was kept from us, there was a £7 million a year margin erosion when the three years came to an end with CRTG, the Co-operative retail group, and we were not doing well but we had that £7 million buffer. Once that £7 million went, and that was in the summer of 2007, that was when DFB really got onto its death spiral because it coincided with a time of high commodity prices. From a point where we could be fairly safe and think, "We're always going to be better off than the people who are turning milk into cheese and powder" it came to a point where everyone could do better than us and that was when members started to leave. When you have got a rapid exodus of members from a co-operative it is just like hoisting a big red light above you and everyone can see it. No matter what the directors or the executive said, the business was in trouble.

Q170 Mr Cox: Do you not think that there is a fundamental problem about farmers co-operatives, and I am very strongly in favour of them, that there seems to be a problem potentially, not in all perhaps but in some and, Mr Pearson, you spoke about the culture, that because you have got a whole lot of shareholders essentially who are farmers, who are busy producing, what you do not have is what you would have with a plc. You do not have the kind of external scrutiny from shareholders from a wide range of walks of life who are interested in one thing, which is the bottom line. Farmers are busy milking and they do not have the time sometimes to devote to the kind of scrutiny that other shareholders might.

Mr Brown: I would have thought the people who ought to have been doing that were the farmer directors. They were paid £24,000 a year each, and in some cases more than that, to give up their time to keep tabs on things.

Q171 Mr Cox: Why just farmer directors, were there not other directors?

Mr Brown: There were and the non-executive directors were paid a good deal more. There is always a suspicion if you are non-executive directors that you are there for yourself. I would never have thought that of the farmer directors because they are from the farming community and collectively, if you speak to the five or six farmer directors, I would imagine they have lost possibly over half a million pounds between them because they are quite big milk producers. They have lost a lot of money and their reputations are finished over this matter. Those were the people who saw what was going on in the business, or should have seen what was going on, and yet they went ahead with the purchase.

Q172 Mr Cox: Is it not possibly because they are committed to this entity of the co-operative and there is a lot of sentiment involved in it in a hardnosed way that a company might not be?

Mr Brown: Some months ago between January and February of this year I asked one of the directors, "Do you think you were suffering from group thinking?" and I think they were. I did not realise that at the time. When you look back with a bit of hindsight, it is only in the last year or so that ---

Q173 Mr Cox: What do you think of the NFU's idea of independent evaluation?

Mr Brown: Who would they be and what would they do? It is difficult. To let someone in to know that amount of information, the DFB has gone, it is not going to affect the DFB.

Q174 Mr Cox: I mean for a model for the future.

Mr Brown: I am all for scrutiny of public companies as a potential investor in them. It looks like I am going to be press-ganged into joining First Milk with a retention of 0.3 pence per litre from 1 November and I do not want to see that go the same way as my half pence a litre went with DFB. I am all for scrutiny of what First Milk are doing.

Q175 Chairman: Can I just ask about the democratic processes within the Council/board of director relationship. Were there ever any matters put to a vote to the Council?

Mr Brown: Yes.

Q176 Chairman: ACC purchase being one?

Mr Brown: In the Articles of Association of DFB no purchase greater than £15 million could be undertaken without the consent of the farmer Council.

Q177 Chairman: Coming back to your point, how was the farmer Council advised of this? You were critical of the due diligence.

Mr Brown: Yes.

Q178 Chairman: Normally if some company is going to buy an asset you would have a very comprehensive assessment, financial accounting and everything else to say whether it is a good deal or a bad deal. How was that communicated to the Council?

Mr Brown: It came to us in June 2004. We had a Council meting and the board and executive asked us to lift the safety catch in effect. We said, "Why do you want to do this?" and they said, "We can't tell you". Philip Moody was giving a presentation. You are aware who Philip Moody is?

Q179 Chairman: You are going to tell us.

Mr Brown: Philip Moody was a non-executive director of DFB. He is an accountant, corporate finance specialist and partner in Smith & Williamson.

Q180 Chairman: They were the accountants of the company at one time, were they not?

Mr Brown: They were corporate advisers. I do not think they were accountants as such to the company.

Q181 Chairman: I know they got replaced by PwC in the endgame.

Mr Brown: They were the corporate advisers. Philip Moody was asked by someone, a farmer Council member, "Are we going to buy ACC?" and his response was, "If I knew anything I couldn't tell you and if I didn't know anything I'd have nothing to tell you". That was all we had to go on. We talked about it. I can only speak for myself here, I am not speaking for the Council of DFB. My view was we were a Council of 80 farmers and it was out of the question that we could undertake due diligence as ourselves. What we did was we appointed a board who had responsibility for the strategy of this business and it was for them to take the decision and if they got it wrong then by implication we had got it wrong as well by appointing those people. That was where the accountability - political and democratic accountability - lay with the business. I trusted them. As a Council member I have a share of responsibility in it all. The actual purchase was in the middle of August and the Sunday before it went through we had small meetings round and about, and we had one with Malcolm Smith, the then Chief Executive, in Clifton near Penrith, and Lord Grantchester was there and Michael Oakes, and they said, "This is what we are going to do". It was ambiguous at that point as to whether or not we could have stopped it. I thought we could not and they said we could. We had the discussion with them, they went through it and we asked the obvious questions: "Are we paying too much? What is the strategy? What is the competition going to do?" There was no sense that it might go wrong, they were super confident. A couple of days later we had the Council meeting and took a vote and it was as near as damn it unanimous by the Council to buy it on the strength of the recommendation that came from the board.

Q182 Chairman: Mr Gregory, as a keen outside observer of the scene, what is your take on all of this?

Mr Gregory: Obviously the build-up to it all was kept very hush-hush, it was not discussed and nobody seemed to be getting any outside information. We were a customer of Dairy Farmers at the time because we were purchasing our raw milk from them and we had done through Milk Marque and Zenith previously. We were getting little bits of rumours. We were speaking to our area rep, Stuart Richardson, and we said, "Do you not think it's a bad idea?" and you got the feedback, "The board is confident that it's going to work" and we never ever thought it would work.

Q183 Mr Cox: You run a business.

Mr Gregory: Yes. We have grown our business. We are a family business. In 1996 our business was doing 1,200 litres per day and we are currently doing 120,000 litres per day. That is all through growth, partly by the collapse of Dairy Farmers. We doubled our volume when Dairy Farmers collapsed in June. Prior to that the growth was being made by being able to give customers service, quality and produce and also pay farmers a very fair price. As part of our contract we are paying the farmers over two pence a litre greater than the middle ground price that Gordon had. That was our benchmark and still is. Desperate farmers who we took on when the receivers were appointed who had lost their month's pay check, lost the first three days of June also from the receivers being appointed, needed to know that somebody would collect the milk. Some of them were outlying, some of them had already put their notice in and were 11 months into their notice period to leave. These people went straight on to our standard contract which was giving them around about 24 pence per litre, which was way more than the 18 pence they had previously been receiving from Dairy Farmers. Some of the outlying farms that had not put a contract in, we put them in on 21 pence per litre. In November they will roll on to our standard contract so they will be receiving 24 pence plus a litre for their raw milk. That is the biggest key to making the farmers confident in the product. You have had previous conversations with the NFU about terms of contract and notice periods and stuff like that. I do strongly believe that as a dairy, and also as a farmer, the dairy and farmer needs confidence in at least a 12 months' notice period because we have got to purchase raw milk out of the contracts so if we have not got enough raw milk to supply our customers' needs we have got to go and look for that. If a farmer gives us a month's notice to leave where do we go and find that milk from? Have we got to pay a spot milk price which two months ago was low but today is 27 pence, 28 pence per litre?

Q184 Mr Cox: I do not think the NFU was suggesting notice periods should be reduced, it was only in a circumstance where the farmer could not agree a contract with which he was happy and which he considered to be fair.

Mr Gregory: The dairy needs the confidence that the farmer is not going to pull the plug on him in a month's time. On the question you asked earlier regarding the tendering processes, when you submit a tender you have got to enter into a minimum of a six to 12 month price guarantee for that tender so you have got to know six to 12 months in advance that you expect your costs to be roughly what they are when you enter into the contract period. If you have got to go out and purchase milk at a higher price because farmers have left it puts you in a bad predicament serving the needs of the contract.

Q185 Chairman: One of the things that intrigued me, bearing in mind the Co-op's central part as a major purchaser from DFB, was as I understand it they were not able to satisfy the Co-op in terms of the tender process and were beaten by Wiseman. Given that so much depended on keeping the customer base intact, how did they get it so wrong?

Mr Pearson: Chairman, as I understand it the Co-op is one of the five major retailers that does not have a farmer direct supply system. I would imagine what was going through the directors' minds, although you should never take anything for granted, was that two companies with the same ethos would get together and form a direct supply system. The Co-op is in competition as everybody else is in the retail marketplace.

Mr Brown: CWS have come out of this very well indeed. Not only did they offload the assets onto DFB at a good price, they have not got a dedicated supply pool, they are the largest purchaser of milk that does not have a dedicated supply pool. We all watch the adverts on the telly saying how wonderful they are, how ethical they are and how caring and sharing they are, but I have to say I do not see it as a UK farmer.

Q186 Chairman: Whilst that is a fair observation it still does not quite answer my question as to how it went wrong. In other words, was it the DFB's perception that everything would be all right because they were like for like in ethos or was it they just had not realised that the Co-op were going to be ruthlessly commercial?

Mr Brown: I was asking the same questions in 2004: "What are our customers going to do? What are all the other stakeholders that we are going to be dealing with going to do to us?" The board seemed assured that it would be fine, that we could just run the business. I am not sure what more I could have done. They had seen the due diligence and we, as a Council, placed our trust in them.

Mr Pearson: There was a lot of information floating around not only in the previous 12 months as to the future viability of DFB and as a purchaser of milk you might be quite concerned as to where your milk was coming from. I think in the receiver's report he said there were 320 people under notice, something like that.

Q187 Chairman: I think it was 322.

Mr Pearson: Of course, one of the reasons that we ceased milk production was because we would have had to have given 12 months' notice to leave and I could not see that our business could sustain that sort of loss so we pulled out of milk production. That was before the receivers allowed everybody to go to various other places. In fairness, some members have gone to an increased milk price. As I tried to point out earlier, there is a lot of money involved and you can soon swing either way. Gwyn pointed out one of the original factors was the splitting up of the co-ops in that Milk Link had the bottom section, First Milk had the middle and DFB had the top section.

Mr Brown: Geographically.

Mr Pearson: Thank you, Gordon. I always felt that we had the most marketable region for the reasons that environmentally we had the smaller farmers and we had those farmers in the Peak District and the Lake District that tended be smaller producers but had increased haulage costs because of the very nature of the business. I think you asked earlier what Defra should do and I think what people have to do is realise what they want out of the UK milk industry: are we Europeans or are we UK? A lot of the products can come from outside the UK but the liquid milk industry is sacrosanct to the UK. Certainly we seem to be getting a two-tier milk supply system at this moment in time in that the liquid milk men are moving on fast and the commodity men if they can produce at a lower cost are surviving but probably further away from the marketplace. That is the first thing I would say to you. Environmentally it is a big issue. I know people will argue that the environmental payments are paying them to maintain the environment, but as a farmer myself I would sooner be paid to keep livestock and work than I would to be a park keeper. I only have 36 years of agriculture, I have not got 400 years which some people have. There is definitely an environmental issue there. I would also say that DFB's members, as has already been pointed out, put 67 million in, and DFB's members have rationalised the liquid milk side of the UK milk industry and paid for that on their own. They have paid for it out of the retention. This leads me to more issues in terms of NVZ requirements. I know Hayley has already indicated that is beyond the remit of the EU, but another reason why we will continue milk production is because of satisfying the EU NVZ regulations coming in. There is also a matter which has escaped me, I am afraid.

Q188 Mr Cox: Could I possibly take advantage of the losing of your thread to ask one question of both of you. You said that you were going into another co-operative. Could you explain to me why would you want to go into another co-operative? Secondly, can you give me the practical advantages of belonging to a co-operative rather than supplying Dairy Crest or one of the other major milk producers?

Mr Brown: With respect to First Milk, it is beggars cannot be choosers.

Q189 Mr Cox: Name me a practical advantage that a farmer has ever got out of supplying Milk Link or one of the big co-operatives as opposed to Dairy Crest or one of the other businesses?

Mr Brown: There are not any. If had the choice I would not, but Harper Adams is 27.7 pence. I went to see them this September and they will not have me because of where I am geographically, so you are left with the pickings really.

Mr Pearson: Chairman, can I come back on that point. As a personal view, and it is not an ideological view, I have always believed in co-operation and not co-operatives. I have followed Glanbia in Ireland and the Kerry group and these are companies that started off as co-ops and developed into major companies. Also there is a purchasing group up in Staffordshire and if you had joined that purchasing group in 1972 and paid your five pounds, we are now paying our members who leave £1,700. From my point of view it was a business decision that I hoped other people would drive that company forward and that money would come back because if you multiply it up, I did say to the chairman one day I had £54,000 capital in plus I lost a milk cheque and if you just took the £54,000 it would have turned into 13 million. As a business decision if they had increased at the same rate, and do not forget that we were employing businessmen who had been directors of Mars, professional directors, they should have seen what was coming.

Mr Brown: As an addendum to what I said, in theory the co-operative model works. It can work the rest of the world over. As a primary producer to add value to your basic commodity makes sense, but for all sorts of practical reasons it has not worked in the UK dairy industry as yet.

Q190 Chairman: Mr Gregory, you are on the other side of the fence. As a postscript observation, what do we need to do to try and secure future success for our dairy industry?

Mr Gregory: I do not believe that the co-operative side of things does work. As a hands-on family business the size of DFB is not something that could be run and managed by a family structure, but to be able to pull things together where you know what is going on in the business, where you have got people who know and report to the right people to make sure the business works and the model works, making sure of your customer needs, making sure your members, your farmers are happy, this is what we have done and that is how our business has succeeded in giving people a better price for their milk and being able to give customers the service that they require at a reasonable cost. What is playing a big part in causing problems in the UK is outside competition and very aggressive canvassing by certain independent areas in the UK. They hit dairy farmers hard in April of this year, especially in the northeast, and I do not think that has helped the business either. As a footnote, it is as well not to have too many eggs in one basket, as Dairy Farmers did with the CWS contract. That was the biggest part of the problem. As Gordon said, once that was gone that was a recipe for the downfall of the business.

Chairman: Gentlemen, may I thank you on behalf of the Committee for your insightful and genuinely helpful observations. You have made this thing live a bit more than sometimes the cold, dry words on a piece of paper communicate. You have also given us some very important perspectives on the way that the business operated. I am most grateful to you all for coming and joining us this afternoon. Thank you very much indeed.