Hagar Cohen: Australia's giant retailers, Coles and Woolworths, are again under investigation. The big two have already been the subject of a number of past inquiries. And now the ACCC is examining new claims that the supermarkets are abusing their dominance. The duopoly controls 70% of the market.

Barry Fawcett: They were constantly putting forward requests for additional trading terms. They would find avenues to either squeeze more margins out of you or request more money to be spent on the product to keep it on the shelf.

Hagar Cohen: Food producers say the retail giants use their market power to control their suppliers.

Barry Clarke: The supermarkets, they take more and more of your product until you're producing most of your product out of your factory to go to them, and once that happens you've lost the rest of your market. Then they can tell you that they'll pay you whatever they like.

Hagar Cohen: Hello and welcome to Background Briefing, I'm Hagar Cohen.

The food industry is in crisis. Today many producers are operating with wafer-thin margins. Others have already collapsed. There are some high profile examples. Last year, the baking giant Goodman Fielders reported a net loss of $150 million. They've cut 541 jobs and announced plans to close a further 15 factories. This month, the cannery Windsor Farm Foods shut its doors for the last time. And the iconic Aussie brand of tomato sauce, Rosella, went into bankruptcy and laid off its 70 workers.

Bill O'Meara: What does it mean? It means that I'm broke.

Hagar Cohen: Amongst the casualties was Rosella forklift operator, Bill O'Meara.

Bill O'Meara: At 8.30 in the morning we were told that the company had gone into receivership. Not a very pleasant day. It was just sprung on us. People didn't have much of an idea about what was going on. There were some down faces that day, very down.

David McKinna: The food industry is in a historic low point. Most of the food companies are unprofitable. The reality is that we're going to lose a lot of companies, a lot of food companies have gone.

Hagar Cohen: David McKinna is a food industry consultant.

David McKinna: Rosella is a classic case where it's a 130-year-old brand that went into bankruptcy a few weeks ago. There are many more companies in the same sort of boat. So there has already been many of those companies gone into bankruptcy but there's going to be many more in the future.

Hagar Cohen: Four years ago Rosella was taken over by a private equity company. The group bought other established Aussie brands, including Aristocrat which makes pickled vegetables, chutneys, and sauces. Rosella's assets will be sold to pay creditors. The other brands like Aristocrat hang by a thread.

The founder and former managing director of Aristocrat is Barry Fawcett. He says most of the business was supplying Coles and Woolworths.

Barry Fawcett: Coles and Woolworths would represent over 62%, 63% overall. We increased capacity to running at over 200 jars a minute. To give you an idea what that meant, when we were packing pasta sauce for Woolworths or Coles we could fill five semitrailer loads a day.

Hagar Cohen: The manufacturer, he says, relied on the giant retailers for survival.

Barry Fawcett: If you lost those two customers it would be death, there would be no question at all. You'd have to reconsider whether or not you continued in business. The amount of money that you'd spent on machinery, you just had to make that machinery work. If it didn't work, you're in all sorts of trouble.

Barry grab If you lost those two customers it would be death, there would be no question at all. You'd have to reconsider whether or not you continued in business.

Hagar Cohen: In 2008, the consumer watchdog first looked into claims that the retail giants were abusing their power. In the end it didn't find against the supermarkets. Now the ACCC commissioner Rod Sims is at it again. He told Senate Estimate that 50 suppliers have come forward on the condition of confidentiality.

Rod Sims: We have identified some behaviour, which has come from the allegations from those we've spoken to confidentially, and we've said if that behaviour can be put to proof then that could be a breach of the Act, so the Act can come into play. Secondly, we've described how we are going to protect the confidentiality of those who have come forward. And thirdly, what we have said is that, from where we sit now, we think there is some merit in a code of conduct, is an appropriate place to…

Nick Xenophon:Sure. I'm going to cut you short because I've only got two or three minutes, sorry. In relation to the issue of suppliers coming forward, whether they are farmers or food processors, a common complaint I hear from people and some of my colleagues here is that they are terrified of it ever being known...is there sufficient protection in the Act…

Rod Sims: If there is retribution as a result…there's protection in the Act if there is retribution, that's quite clear in the Act, and the way we are dealing with this investigation is we've taken the information from the confidential discussions, we will now keep that confidential, and to progress the investigation we're going to use our compulsory information gathering powers, largely from people who haven't come forward.

Hagar Cohen: Some of the suppliers' allegations may amount to unconscionable conduct or misuse of market power by the supermarkets. That's according to a statement Rod Sims tabled to the Senate. It reads in part:

• Persistent demands for additional payments from suppliers, above and beyond that negotiated in their terms of trade.

• The imposition on suppliers of penalties that did not form part of any negotiated terms of trade.

• Threats to remove products from supermarket shelves or otherwise disadvantage suppliers if claims for extra payments or penalties are not paid.

• Failure to pay prices agreed with suppliers; and

• Conduct discriminating in favour of home-brand products.

The supermarkets in the past have disputed any suggestion of inappropriate behaviour. Background Briefing approached Woolworths for an interview, but they declined.

From Coles, the managing director, Ian McLeod:

Ian McLeod: I am absolutely confident that there is no systemic abuse of market power in Coles. Our buyers operate in a professional way.

Hagar Cohen: So you're saying you're confident there hasn't been a systematic abuse of power, but you're saying that there may be anecdotal?

Ian McLeod: You have to look at every individual case on its own individual merit. It's certainly not our position at all to abuse our position in the marketplace. We want good, strong, firm relationships with our suppliers, we want to see our suppliers grow, we want to see our Australian suppliers grow in particular, and actually we have grown our supply base in Australia more than we ever have previously in the last four or five years. That's as a direct result of working more cooperatively with our suppliers to bring better products, better quality, better value to the Australian consumer.

Hagar Cohen: The price war between Coles and Woolies—with milk sold for $1 and other products heavily discounted—is popular with consumers. But it's creating bad blood between the retailers and many of their suppliers. Suppliers have largely kept this quiet. It's because they've been frightened that if they speak out, their business would be on the line.

James Stacey: You hear anecdotal evidence of abuse of market power, but in terms of getting anyone to go on the record it is extremely difficult.

Hagar Cohen: James Stacey is the Nationals’ candidate for the Senate in South Australia. He's been talking food suppliers into revealing their stories to the ACCC.

James Stacey: I've probably had direct contact with 15 to 20 suppliers into the retail market, both of quite large scale and smaller scale suppliers

Hagar Cohen: How concerned have people been about approaching the ACCC? What are they telling you?

James Stacey: The ACCC is a government agency. Government agencies leak, and it's a very expensive leak to your business if that happens. But there has been some people that have got to a point where they've just had enough. Like one person I spoke to, they had been asked to contribute a significant amount of money for a national promotion of their product, and six months after spending $250,000 promoting their product it was pulled off the shelves. So you can see there are some fairly frustrated people out there.

Hagar Cohen: Background Briefing has spoken to a number of those food suppliers who approached the ACCC. All said they would lose their contracts with the supermarkets if they spoke to us. But such is the frustration, several suppliers did agree to speak, some openly, others on the condition of anonymity.

Danny, not his real name, is the CEO of a company that supplies both Coles and Woolworths. In this revoiced interview he describes why he decided to go to the ACCC.

Danny: Speaking to the ACCC, it puts these things out in the open. Companies understand that it's not isolated situations that they go through. We get to know that things we experience are happening with other companies.

Hagar Cohen: You feel you're not alone?

Danny: Yes, that we are not alone.

Hagar Cohen: He says some of the supermarket buyers have engaged in what he believes is blackmailing. He wouldn't say whether it was Coles or Woolies.

Danny: At some stage we started feeling…and this is what I hear from other companies as well, that their behaviour was really blackmailing.

Hagar Cohen: Blackmailing? Can you be more specific?

Danny: When the supermarket buyer tells you that if you don't do this or that then your product will be taken off the shelf.

Hagar Cohen: They say that explicitly?

Danny: Yes. You are put in a situation where if you don't give them…and in the end it's financial benefit…if you don't give them that financial benefit, then they'll take you off the shelf. So they use threats.

Hagar Cohen: What kind of threats?

Danny: A threat will be financial demands to stay on the supermarket shelves. The supermarkets expect a certain quantity of sales from your products and if that is not met they request a lump sum of money to be passed on to pay for that shortfall. Or another example is being asked to pay to be on the shelf in the first place, and that would mean a lump sum that has to be paid.

Danny grab You are put in a situation where if you don't give them…and in the end it's financial benefit…if you don't give them that financial benefit, then they'll take you off the shelf.

Hagar Cohen: Background Briefing put Danny's claims of blackmailing to Coles managing director, Ian McLeod.

Ian McLeod: Well, I can't talk about individual circumstances that I don't know the details of. If that particular supplier wants to write to me directly I will ensure that the position that he feels that he's been put into is thoroughly investigated. All I can say is that from a Coles policy perspective we want good, positive, constructive dialogue and good, positive, constructive results from the relationship that we have with our suppliers to bring the best possible prices and offers to our customers every day.

Hagar Cohen: So would you say the threats of deletion unless a supplier subscribes to a trading term, for example, is against Coles policies and guidelines?

Ian McLeod: Absolutely.

Hagar Cohen: But this is a growing concern.

The former CEO of Aristocrat Foods, Barry Fawcett, says they were constantly threatened with deletion. In other words, taken off the shelves.

Barry Fawcett: Yes, constantly. Constantly.

Hagar Cohen: And so they'd tell you that specifically 'you might be gone soon'?

Barry Fawcett: They would normally flag a product that was in question by moving your product from a specific place on the shelf down maybe one or two shelves down, and that was virtually the beginning of the end. If you know your product had dropped two shelves, you then had to do something about it.

Hagar Cohen: How much notice would you be getting before deletion?

Barry Fawcett: Not a great deal of time. You'd be brought in maybe three weeks, asked what you were going to do about it, and if you couldn't resolve it you'd be gone within that period.

Hagar Cohen: And that's both Coles and Woolworths?

Barry Fawcett: Yes, they had the same philosophy. If you didn't address the issue and do something about it and couldn't, in their terms, show a better return for Woolworths or Coles, they would delete you.

Hagar Cohen: Does that mean, in other words, 'give us a discount'?

Barry Fawcett: It could be interpreted that way, definitely.

Hagar Cohen: And how did you interpret it?

Barry Fawcett: Well, a lot depended on whether or not we had stock packed off, whether or not we were really conscious of retaining the product, and if we were we may give them, for instance, an additional rebate of 5% for three months.

Hagar Cohen: 'Rebates' are industry jargon for discounts. The retailers charge their suppliers a rebate, a fee for different things. Barry Fawcett says those fees were on the rise.

Barry Fawcett: If somebody in a higher position than a buyer, they thought up some new scheme that they could get half a percent out of their suppliers, you work out a half percent out of total sales Woolworths or Coles, it was an enormous amount of money. And they were constantly working on it.

Hagar Cohen: One of the rebates Barry Fawcett disagreed with involved the level of discounting of his products. Coles demanded a bigger price cut from him than they would offer the costumer in the store, therefore increasing their own profits.

Barry Fawcett: If your product was promoted in a supermarket and Aristocrat bread-and-butter cucumbers were on special for the week, they might say you would get the supermarket 10% and they might reduce it 7%. So they would be benefiting for that period the product was on promotion.

Hagar Cohen: Coles have always claimed that they absorb the cost of their discounting. But managing director Ian McLeod now says suppliers do share the burden of discounting, only because some of their profit margins are too high.

Ian McLeod: I think what we've done is negotiated firmly but fairly. If you are seeing suppliers who have got profit margins that are maybe four or five times the rate of your own profit margins, than if you're looking at the share of the investment in terms of bringing prices down, we felt as though the suppliers in some instances could contribute more.

Ian Grab I think what we've done is negotiated firmly but fairly. If you are seeing suppliers who have got profit margins that are maybe four or five times the rate of your own profit margins, than if you're looking at the share of the investment in terms of bringing prices down, we felt as though the suppliers in some instances could contribute more.

Hagar Cohen: Suppliers are already contributing a wide range of fees or rebates.

We've heard earlier from a supplier who wants to be known as Danny. He says he is being charged a regular fee for breakage. That's just in case supermarket customers drop and damage his products.

Danny: How often do you see someone in a supermarket drop a product? It's very rare. I would say if a customer drops a product of one company, it wouldn't happen more than at the most five times a year.

Hagar Cohen: Are suppliers charged for that all the time?

Danny: Yes there is a specific rebate for this, a certain percentage is taken.

Hagar Cohen: Which you have to pay regularly, regardless of whether someone dropped your products or not?

Danny: Yes.

Hagar Cohen: What's that percentage?

Danny: I don't want to say.

Hagar Cohen: To say might identify his company, says Danny, and that, he feels, could cost him his business.

Background Briefing asked the managing director of Coles Ian Mcleod if suppliers concerns about retaliation are justified.

Can you give your personal assurance to suppliers who speak out that they will not be penalised by Coles for speaking out?

Ian McLeod: If a supplier has got a concern and they believe that concern to be legitimate, then if they want to write to me I will personally investigate it, and I'll go back to them personally as well. I'm more than happy to do that. And I'm absolutely confident that there is no systemic abuse of our position within Coles.

Hagar Cohen: One other food supplier, Tony Lutfi, has agreed to speak openly.

Tony Lutfi: [laughs] We are hoping that the supermarkets will still talk to us after the interview.

Hagar Cohen: Tony Lutfi's company, Greenwheat Freekeh, produces a type of grain called freekah. It's popular amongst consumers from the Middle East. Past bad experiences with the big retailers led him to focus on export and leave the retailers. But he's now in discussions which may see Greenwheat Freekeh back on the shelves of Coles. Tony Lutfi is willing to speak out, even though he doesn't think suppliers can force supermarkets to change their ways.

Tony Lutfi: If all the other suppliers collectively got together and attacked the supermarkets they would be like 18,000 ants stomping on the foot of an elephant, and I don't think they're going to achieve anything other than the elephant stomping on top of them.

Hagar Cohen: Lutfi first sold his products to both supermarkets in the late '90s. But his company was new and he couldn't keep up with the demands to produce large quantities. He went back to Coles in 2004, and was shocked when they expected to buy his product at the same price as in the '90s.

Tony Lutfi: They said, well, we have terms with you and we have prices with you and we'll allow you to come back at those terms and those prices. I said to them at the time, look, these prices are too low, these prices were 1997 prices, it's now 2004, there is no way we can supply you at this, we will be at a loss. It was below our total cost. I chose to accept that with the understanding, they said, that we would be able to increase our price every three months by 5%.

Hagar Cohen: Lutfi says he started selling for a price that was 70% below the value on the wholesale market. With a 5% price increase every three months, he might start making a profit within a few years.

But after entering into a contract, Lutfi says, Coles changed the terms. All of a sudden he could only ask for a 5% price increase once a year, instead of every three months as they agreed.

Tony Lutfi: As a consequence, when we attempted to sell our product to other organisations, to grow our pie, if you like, and sell it to distributors, the distributors would go to Coles and say, look, but I can buy it from Coles cheaper than the price you are selling it to me.

Hagar Cohen: As well as selling at below cost, Tony Lutfi says Coles also expected him to pay a rebate, a fee, to use their computerised ordering system.

Tony Lutfi: They force you to become part of a technology process or system which means that without that process you will not be part of their ordering system. In my humble opinion that should be the cost of the supermarket. It is not fair to pass the cost of your business improving your efficiency in your business to me, because you are not improving my efficiency at the same time, you're only improving your efficiency. For me it doesn't matter whether your order comes through a computerised software package that you created yourself or whether you sell me a purchase order on the fax machine.

Hagar Cohen: At the end, Tony Lutfi decided he was better off without Coles. He terminated his contract.

Background Briefing spoke to another supplier who worked with Coles and Woolworths for many years. He's now left the business, and he didn't want to identify himself so we'll name him Joe.

Joe: The concerns are, even having left the industry, we don't want to be in a position where there can be any sort of impact back on anybody.

Hagar Cohen: Joe says that when he was still in the business one of his product lines was deleted as it was being delivered to the supermarket warehouse.

Joe: We had one product which was effectively removed from the shelf with no notification. Quite literally we found out when a delivery truck was rejected at the door, at the supermarket warehouse.

Hagar Cohen: So your product was already in the truck at the supermarket warehouse and it was then that it was rejected and you were told that your product will be deleted.

Joe: Yes, we were fulfilling an order. To our understanding we were meeting both internal and external benchmarks, so we never thought there were any concerns regarding it.

Hagar Cohen: Similar incidents followed. Joe says that one time in the lead up to Christmas, the promotion schedule for his product, which was planned months in advance, was suddenly cancelled. It was devastating for his business.

Joe: We had built up stocks in anticipation of larger sales and then a short period before the promotion was due to run we were advised that all of the promotions had been cancelled.

Hagar Cohen: What's a short period?

Joe: Within a couple of weeks.

Joe grab I'm aware across our category that yes there has been a quality issue. At the end of the day if suppliers are put under that much pressure to be able to supply a product to meet particular price points, then quality is something which is always going to be reviewed and adjusted.

Hagar Cohen: The supermarket's own label products, known as home-brand, were promoted and put on special instead.

Joe: What we then discovered subsequent was that there were a lot of promotions cancelled across the chain, and oddly enough a lot of home-brand product was then actually on price discount in the lead up to the Christmas period. The best explanation that we were given is that somebody had taken a business decision that during this period we would have very few branded promotions and we would focus on home-brand.

Hagar Cohen: Coles' managing director Ian McLeod acknowledges that the breach of an agreement was unacceptable.

Ian McLeod: If you commit to an agreement, an arrangement, then you're seen to follow that through, otherwise it undermines your credibility. So by agreeing to something and then moving away from it unilaterally is something that I wouldn't support or endorse.

Hagar Cohen: The ACCC is also looking at whether the retailers are discriminating against branded products in favour of their own home-brand.

Here's supplier Joe again:

Joe: There are sections of categories where we've seen whole ranges of product removed and replaced with home-brand. So you're always entering discussions or your thought process always have an overlay that, well, if we are unable to satisfy the requirements of the supermarkets, regardless of what their requirement may be, then we actually risk being removed. There is the expression which has been going around called cliffing, and that is to a large extent a reality.

Hagar Cohen: 'Cliffing' is industry jargon. It's when the retailers' demands can push suppliers over a cliff, in other words off the shelves.

Joe: In reality it's basically supermarkets, in this instance, continuing to make demands until you get to the point where you either concede or get withdrawn. The third option, which is to simply say no, doesn't exist.

Hagar Cohen: Why not?

Joe: Because the no essentially leads to a larger loss which is just deletion. And that's what I'm saying, you keep having this balloon over your head saying that a large portion of my business is going to be removed which will actually lead to the overall deletion.

Hagar Cohen: Joe says this kind of squeeze is having an effect on the quality of products.

Joe: I'm aware across our category that yes there has been a quality issue. At the end of the day if suppliers are put under that much pressure to be able to supply a product to meet particular price points, then quality is something which is always going to be reviewed and adjusted.

Hagar Cohen: Can you tell me about the specifics of that example that you know of?

Joe: It's basically where materials are sourced from or the integrity of packaging or the age of product. I really don't, for obvious reasons, want to go into specifics.

Hagar Cohen: At Colac, south west of Melbourne, the meat processor CRF employs 400 people. When it started just over a decade ago, it secured a ten-year contract with Coles. 98% of its lamb kill service was taken up by Coles.

A previous investor and board member at CRF, Simon Ramsay, is now a member of the upper house in Victoria. He says eight years into the contract, the relationship between CRF and Coles turned sour.

Simon Ramsay: I could say that the management of Coles and the management of CRF were coming further and further apart. They were particularly hard-nosed in relation to pricing. Coles certainly had a large control of CRF given it was the principal supplier of meat and consequently they used that power, I guess. Certainly in the meat division they wanted more control of CRF. We couldn't get any decision from Coles in relation to ongoing contracts. Consequently that left us fairly open in relation to how do we continue the business.

Simon grab Well, I felt that Coles were doing basically a typical dummy spit in that they said, well, if they can't have the company, no one else can.

Hagar Cohen: At one stage, some of the investors, including Simon Ramsay, wanted to sell the company. There were a few potential bidders, Coles was one of them. Ramsay says Coles tried to use its market muscle to get what it wanted.

Simon Ramsay: There is no doubt Coles indicated that if they weren't the successful bidder then any other potential bidders wouldn't have the Coles contract. And I guess that's where I became alarmed that here was a large corporation using its muscle to try and drive the price down from other potential bidders to take control of CRF.

Hagar Cohen: Why are you saying there's no doubt? Was it said so explicitly?

Simon Ramsay: There was enough innuendo, if I can use that word, or there was enough correspondence to say that Coles indicated that if they didn't get the preferred bid they would not be interested in having CRF continue service kill for their lamb.

Hagar Cohen: You said you became alarmed at that stage. What do you mean? What exactly did you feel about that situation?

Simon Ramsay: Well, I felt that Coles were doing basically a typical dummy spit in that they said, well, if they can't have the company, no one else can.

Hagar Cohen: Did you feel at the time that that kind of behaviour amounted to bullying?

Simon Ramsay: I believe that Coles used its influence and power to try and buy the company at a discount price. That's my personal view and no doubt Coles will take another view and as well some of the shareholders, but that is no doubt the price they were offering was significantly less than what we believe the market value of the company was.

Hagar Cohen: By what kind of percentage?

Simon Ramsay: The Coles offer was 60% or 70% less than the final offer the shareholders accepted.

Hagar Cohen: Investors rejected the Coles bid. Today CRF is doing well, despite losing its contract with Coles. Coles had previously denied that in this case they were acting with anything other than good faith.

It's not just suppliers who are feeling the squeeze of the price war between the big two. The independent shops are forced to participate in the discounting.

Fred Harrison is the CEO of Ritchies IGA, which has 70 stores across the eastern states.

Let's have a look at your specials. Have you got anything for Easter? You do.

Fred Harrison: Sure. One thing where the market is change now, it's all about coming out and saying half price. In my early years…in fact if I take you back three years ago, an excellent special would be 30% to 40% off. These days unless you're 50% off you're not getting a look in. Even Easter eggs, which is a line that traditionally has avoided heavy discounts, we're now discounting by 50%.

Hagar Cohen: Shall we have a look at the dairy section?

Fred Harrison: Sure.

Hagar Cohen: Fred Harrison has milk for $1 a litre, just like Coles and Woolworths, but he says he's not happy about it.

Fred Harrison: I must say we range $2 milk, $2 for two litres, We’ve got the three-litre for $3. It's not the feature of our milk case. As you can see, looking at our milk, it has minimal shelf space. We are actively trying to promote the branded product, but for the customer who says no, no, no, I want to buy $2 two-litre milk, there is the offer.

Hagar Cohen: Is it selling well?

Fred Harrison: Yes, it does, we are constantly filling it.

Hagar Cohen: So you don't like that system because you're saying it hurts the farmers, yet you do it.

Fred Harrison: That's right, we've got to compete against Woolworths, Coles and Aldi. If we took the attitude no, we're not going to do it, then all that is going to happen is 90% of our customers might applaud us, but 10% won't, so just we lose another 10% of our business. We cannot afford to alienate any percentage of our customer base. Bread is another. It's just gone to $1.10, but up until this week we were selling 650-gram bread at 99c. In 1990 we were selling 650-gram bread at about $1.29. So here we are, 23 years later, selling a key retail loaf of bread cheaper than we were 23 years ago.

Hagar Cohen: Later in his office, Fred Harrison concedes that by participating in the price war against his will, he plays into the hands of the retail giants.

Fred Harrison: Exactly right, it does play into the hands of Coles. Margins are being stretched, budgets are being stretched.

Hagar Cohen: Can you give me some numbers? How much are you stretched as a result of this?

Fred Harrison: Our EBIT—earnings before interest and tax—our profitability is today about 1.4 cents in the dollar. If I take you back four years ago it was probably 2.5 cents in the dollar. But that's pre-tax, so we've almost halved, our profitability has almost reduced by 50% over the past two or three years, and much of it is on the back of having to sell key volume lines virtually at zero profitability just to stay in the game.

Hagar Cohen: Isn't that fair enough in a free market society?

Fred Harrison: As you remove layers of competition, prices eventually go up. We've seen that well and truly before. At the moment you've got quite a vibrant independent sector, that's at around 20%, round figures. If that's to drop to 15% or 10% and decline, then the levels of true competition will evaporate. And then when there's a choice of two or three, the consumer is going to have to then pay a higher inflated price.

Hagar Cohen: Fred Harrison is the CEO of Ritchies IGA.

The crisis in the food industry goes right across the supply chain. Farmers, who are right at the bottom, are suffering the most. For example, the dairy industry in South Australia is in so much strife that for a whole year, farmers have been selling their milk at below their cost of production.

It's early in the morning at David Basham's dairy in the Adelaide Hills, and it's milking time for his 400 cows.

David Basham: We have what we call a herring-bone dairy which is 24 cows on each side of a long pit with a dairy farmer milking the cows in the middle, so one of my staff is milking the cows.

Hagar Cohen: David Basham is the president of the Dairy Farmers Federation of South Australia. In the past year his dairy has made a loss of $120,000. If things don't improve this year, he will join the mass exodus from the industry.

David Basham: You can't cope with another one at that level, it's just not something the business can continue to do. The issue is when you make a loss like that you either eat into the assets of the farm by running down fertiliser et cetera, which you have to pay back in the future, or you borrow money from the bank. And when you do those things there is always interest to be paid. We can't continue to eat into our capital to continue farming, it's not good business sense.

Hagar Cohen: South Australian dairy farmers this year have received 37c a litre from the milk processors. That's under their cost of production which is 42c.

David Basham: It's either 37c or zero. We can sit down and talk to the companies, but it's very difficult as an individual to shift the situation. Very easy for the milk processor to say, well, you are just a difficult client to have, we can get the milk from someone else for the same price, why would we pay you any more, why would we do anything different for you?

Hagar Cohen: The milk processors Parmalat and Lion say they've been hit hard by the supermarket price war. It all started when Coles announced it will sell home-brand milk for $1 a litre. Woolworths and the other retailers followed suit.

Coles said that it would absorb the cost of its $1 a litre campaign. But Background Briefing has seen a document from one of the main milk processors that shows in the past year Coles has dropped the price it's paying the processor for milk.

South Australian upper house member Robert Brokenshire, who's also a dairy farmer, says processors should toughen up in their negotiations with the retailers. He says their poor contract terms are having a massive impact on farmers.

Robert Brokenshire: In January this year, as an example, I received just over 30c a litre for quality wholesome Jersey milk. In real terms that is the worst price our family have received in about nearly 30 years. It's happened because the processors were too eager to get big tender contracts from the duopoly at any cost. Those processors that write to us as farmers and tell us that it's all Coles and Woolworths that are the problem, I say bunkum, I say you have done the wrong thing in selling the product so cheap to those retailers.

Hagar Cohen: Farm gate prices for milk are so low that one South Australian farmer decided he had to find another way. Today he runs a fully operational milk processor called the Fleurieu Milk Company.

Barry Clarke: So the bottles come down the conveyor onto the rotating table, and there's somebody down here taking the bottles off, putting them into the crates and onto a pallet, and then from there they get wheeled straight into the cold room.

Hagar Cohen: Is that milk for today?

Barry Clarke: Yes, that came out of our cows this morning in the dairy, and by late this afternoon that will be in the shops.

Hagar Cohen: Barry Clarke says when a Coles buyer approached him with a business proposal, he declined.

Barry Clarke: They were doing a local promotion. I asked what sort of money were they looking at paying per litre, did they have a price in mind. And he didn't seem to think that price was an issue at that point in time, it was whether we could supply enough product for him.

Hagar Cohen: So what did he say, just don't worry about the price?

Barry Clarke: Don't worry about the price at this point. If you can supply us with enough product, then we'll work out a price. And I found it easier to say we didn't have enough product.

Hagar Cohen: Barry Clarke resisted because he thought Coles would have tried to reduce his margins to the very minimum.

Barry Clarke: I don't doubt that for a moment, that yes, they would certainly try and get us to lower the price. But we've set ourselves a margin that we need to make on each litre of milk and we've been able to stick with that.

Hagar Cohen: What is that margin?

Barry Clarke: At the moment it's $2.60 a two-litre bottle is what we wholesale sell it for. There is a reasonable profit in that. I do know of other suppliers of fruit and vegetables, that food line, where the bigger the supermarkets, they take more and more of your product until you're producing most of your product out of your factory to go to them, and once that happens you've lost the rest of your market, and then they can tell you that they will pay you whatever they like, and that leaves you with nowhere else to go.

Hagar Cohen: Barry Clarke refuses to work with Coles or Woolworths. Now, on top of his profits from the processor, Barry Clarke, who's a dairy farmer himself, says he is paid 60c a litre for his milk. That's nearly double that of other dairy farmers in his state.

Dairy farmers are selling up across the country.

Lynne Strong: We've got 12 separate housing blocks on the farm, individual…

Hagar Cohen: From the Adelaide Hills to Jamberoo Valley south of Sydney, where Lynne Strong's family runs a dairy.

Lynne Strong: It's perfect for dairy farming, it's actually the birthplace of the Australian dairy industry…

Hagar Cohen: She says while the consumers get the benefit of cheap milk now, it's important the ACCC looks into the wider impact.

Lynne Strong: The ACCC's customer is the consumer. I'm a consumer too. I can go out and take advantages of the cheap prices in the supermarket, but as someone who has a strong knowledge of the dairy industry I know that we're going to have long-term implications for fresh milk. That's a no-win situation.

Hagar Cohen: Background Briefing's coordinating producer is Linda McGinness, research by Anna Whitfeld, technical production this week by Stephen Tilley, the executive producer is Chris Bullock, and I'm Hagar Cohen.