Fonterra operations and ingredients director Bruce Donnison made the announcement at the south-west factory this morning.

The company will supply fresh milk from its Victorian suppliers to the supermarket giant for its "own-brand" milk from next year.

It will spend $30 million on a state-of-the art milk processing plant at the former National Foods plant which adjoins the Cobden factory. The site closed in 2010 and was purchased by Fonterra in 2012 for "future expansion".

Both companies said they would continue to work together to finalise contractual arrangements to reach a binding supply agreement.

Woolworths managing director of supermarkets Tjeerd Jegen said the new contract was "a win" for farmers, Woolworths customers and Victoria.

“We want farmers and Fonterra to provide quality milk for our customers," Mr Jegen said. "Fonterra has told us that with the certainty of a long-term contract they and their farmers can invest and innovate."

“Changes like integrated seals for milk containers and new, state-of-the-art processing equipment would not be possible without the investment brought about by this certainty. It’s these innovations that will see better tasting, fresher milk available in Woolworths stores. We hope our customers will enjoy the difference.

“We don’t want to see milk shipped long distances which only adds cost and increases the time between the farm and the supermarket shelf. These new contracts mean local farmers will supply Victorian milk to Victorian families,” he said.

Fonterra Australia managing director Judith Swales said Fonterra was "excited" to partner with Woolworths.

The announcement comes 12 months after rival Murray Goulburn announced a 10-year deal to supply milk to Coles for its house-brand label