Dairy farmers are to be rewarded for maintaining healthy herds for the first time under a new payment method that offers bonuses for high standards of animal welfare.

The retailer Marks & Spencer will unveil the scheme next week, agreeing to pay a "fair price" to producers which reflects production costs as well as the retail price of milk, and provides incentives for improving animal living conditions.

The move could help stabilise the beleaguered dairy industry. Milk is one of the top-selling items of food and drink in the UK, with more than 180m pints consumed every week. But the industry has been hard hit, with profits squeezed by retailers which have paid them only a small premium. A supermarkets ombudsman demanded by the National Farmers' Union – delayed until after the election – could ease this situation.

The new scheme from M&S, called Milk Pledge Plus, offers a price based on a formula that takes into account the M&S retail milk price. In addition, the retailer will pay farmers agreed bonuses based on the objectives of a plan that aims to ensure high standards of animal welfare, health and sustainability.

To create a clear set of objectives for its farmers to achieve and be measured against, M&S has teamed up with the Bristol vet school (part of Bristol University), which will monitor the scheme to ensure that farmers make continuous improvements to animal health and welfare.

Paul Willgoss, M&S head of technology, said: "Our new milk scheme will not only continue to give farmers greater security, but it will also incentivise them to have the highest levels of animal health and welfare, so that our customers can enjoy our milk safe in the knowledge that it comes from farms with the highest standards."

Mark Taylor, group milk production director of Dairy Crest – a major supplier to M&S and which supplies 18% of total UK milk consumption – said: "This is genuinely groundbreaking. Farmers are being given the opportunity to maximise their profit, and if they hit all the targets they can achieve a better milk price."

He said that although M&S was not one of the major retailers of milk in the UK, its relatively small share of the market meant it had the scope to be innovative.

Jim Begg, director general of the national trade body Dairy UK, said: "This is a further evolution and deepening of co-operation across the supply chain between a leading retailer and its suppliers. It shows that collaboration between farmers, processors and retailers is one of the best routes to securing the industry's future."

The scheme was devised in close consultation with farmers, who welcomed the move. The Soil Association, which represents organic farmers, said it approved of "any kind of initiative which gives farmers a fairer price for their product and which encourages better animal welfare standards."

Richard Brook, an M&S dairy farmer in Chichester, West Sussex, said: "It is vitally important to the future of our business that we make sure our cows are healthy and reared to the highest welfare standards so that we can continue to produce quality milk. Having the reassurance that we will be rewarded for our investment in these areas is a huge step forwards and something we are very excited about."