Both dairy producers and processors must work harder to address and improve efficiency across the supply chain, says the NFU's 'Vision for the Dairy Industry'.
Producers need to "adopt a more business-like approach" says the report, adding that too many dairy producers have not embraced new systems, such as benchmarking, aimed at reducing costs.
Yet, the NFU says processing industry association Dairy UK must take the lead in addressing efficiency gaps in processing.
"We have some excellent processing in the UK, but there is a gap in understanding the true cost of milk processing, due in part to a lack of transparency, which the industry needs to get a grip of."
Part of this efficiency drive will be linked to greater industry consolidation, something the NFU sees as inevitable and necessary if Britain's dairy industry is to improve its competitive position.
The report says more investment is needed to profit from current product trends in cheese, yoghurt, probiotics and flavoured milks. Current investment levels are "short-sighted" and "too little of sufficient scale and clout to compete with overseas companies".
A new industry body that helps the industry to pool information on consumer trends and demand is needed, the NFU says. It added that it may even be more beneficial for manufacturers to pool some resources in a new 'school of excellence', aimed at adding value.
One obstacle to this is the widely held view among processors that the Office of Fair Trading may prevent collaboration or consolidation on competition grounds.
Industry analyst David Hallam, of William de Broe, recently told www.DairyReporter.com that some kind of future collaboration between Dairy Crest and Arla could not be ruled out. He said the two did not actually compete directly in one particular area.
The UK's larger dairy processors have begun to invest more on research and development in the last couple of years. Analysts say Dairy Crest has progressed a little better, particularly after launching its St Ivel Advance milk enriched with Omega-3. But, Arla UK is set to open a new state-of-the-art factory and Robert Wiseman is said to be developing its own milk brand.
Ken Boyns, industry analyst with the Milk Development Council, said the moves were positive but there is "probably a fair way to catch up" with other European industries.
The NFU says that a better contracting system could help to produce a greater R&D focus.
Those producers supplying materials for higher value products, such as cheese and yoghurt, should get more money, the report says, adding that production quotas should give way to contracts based on the market situation.
"As the industry develops more stable contractual relationships, it is anticipated that the transfer and extension of R&D can be driven through milk groups."
The UK dairy industry must be more adaptable and efficient because "fundamentally, the sector has the right ingredients for a prosperous future: a large and wealthy market place, strong domestic products and a skilled and efficient milk production base".