The dairy industry is one of the most important by sbi60117


									                         Current global trends in the dairy industry
                                                                  Dr Bill Pritchard
                                                  Lecturer in Economic Geography
                                                               University of Sydney

                                                         Prepared: 1 February 2001

The dairy industry is one of the most important components of the world food system,
and is undergoing dramatic change at the current time. Currently processes of change
are being driven by a wide range of forces including shifts to the regulatory
environment for dairy production and trade, technological changes to the production
of milk and milk-products, rapidly shifting consumption trends, and the restructuring
of transnational corporate strategies with regard to this sector. It is highly probable
that within ten years, the global dairy industry will be scarcely recognizable from its
current form.

Global production

In 1999 the world consumed at least 556 million tonnes of dairy products. (Dairy
output is usually measured in terms of tonnes of milk solids. One kilogram of milk
solids is the equivalent of 8.33 litres of milk.) Of this amount, approximately 90
million tonnes is accounted for by buffalo, goat and sheep milk (these products being
significant in some poorer nations, notably India and Pakistan). The estimate of
world total production however probably understates actual output, because of
difficulties in enumerating production levels outside of the market. In countries such
as India and those in Africa and the former Soviet Union, considerable quantities of
milk and dairy products are manufactured for individual, household or village
consumption, and hence are not recorded within market statistics. Hence, whereas it
was estimated that in 1999 India produced approximately 75 million tonnes of dairy
products, it is likely that actual production exceeded this figure.

Two key factors influence the geography of global dairy consumption. As expected,
affluent nations consumer larger per capita amounts of dairy products than do poorer
nations. However, there is also a strong dietary influence that shapes the consumption
of dairy products, meaning that nations with comparable per capita incomes may
exhibit dramatically different dairy consumption levels. Within the developed world,
European consumption levels greatly exceed those in North America or Australasia.
Higher levels of dairy consumption levels of Europeans compared to North
Americans and Australasians can be explained largely through the dietary significance
of cheeses, yogurts and other processed dairy products, particularly within central and
northern Europe.

In contrast, Japanese consumption of dairy products remains low. Although Japanese
per capita incomes are comparable with those of many nations in Europe, and are
higher than those in Australia and New Zealand, dairy consumption is extremely low.
The incidence of dairy consumption in Japan and East Asia generally is influenced
heavily by the traditional absence of dairy products within East Asian diets, and a
dietary intolerance by some Asian people to digest dairy foods.

The widely varying levels of dairy per capita consumption worldwide have key
implications for the industry. They mean that in developed nations, this is a mature
industry with generally modest prospects for growth. Typically, dairy consumption in
most developed world nations is increasing at about the same rate as population
growth. Also, demographic factors are important in shaping regional patterns of dairy
consumption, with young populations tending to consume larger per capita volumes
than older populations. This means that, with the ageing of populations in the West,
there are significant challenges for dairy producers to maintain consumption. One
response has been to promote new dairy-based commodities (‘fresh’ dairy products
such as fromage frais), so that the dairy industry increasingly competes with other
food sectors for consumers’ share of stomach.

On the other hand, it is held by many in the dairy industry that developing nations are
the key to future growth in the industry. For decades, dairy agencies such as the
Australian Dairy Corporation and the New Zealand Dairy Board have heavily
promoted the nutritional benefits of dairy products in markets such as Asia and
Africa. Increased per capita incomes, changing dietary preferences and urbanisation
in these nations hold the prospect of increased levels of dairy consumption in future
years although, as noted above, it is unlikely that per capita consumption rates in these
nations will ever match those in the West. The process of increased dairy
consumption in developing nations is assisted greatly by retail restructuring in these
markets, especially the growth of franchised convenience store outlets such as Seven-
Eleven, with refrigerator cabinets.

The changing dynamics of the economic geography of dairy production: changes
within nations

Traditionally there have been powerful forces encouraging the location of dairy farms
and processing facilities close to end-markets. There are strong constraints to the
trade of milk and dairy products, owing to their perishable nature and relative
bulkiness. This is particularly true for liquid milk. Hence, although some areas are
suited well to dairy production and traditionally have developed specialist dairy
processing expertise, the industry as a whole has remained relatively geographically
dispersed. The demands of satisfying urban needs for liquid milk have tended to
encourage a proliferation of dairy producers proximate to urban centres. This is seen
clearly in large nations such as the United States and Australia. In the U.S.,
manufacturing milk production has been concentrated traditionally in Wisconsin and
Minnesota, although in recent years industry growth has occurred strongest in
California. Nevertheless, liquid milk production remains highly dispersed: milk is
produced in every state of the union, bar Alaska. In Australia, these geographical
tendencies have meant that whereas the cooler climate states of Victoria and
Tasmania have traditionally been the mainstay of the dairy industry, contributing the
vast bulk of the nation’s processed dairy products such as skim milk powder and
cheeses, liquid milk production has been dispersed nationally. Production regions
such as the Hunter Valley north of Sydney or the Gold Coast hinterland south of
Brisbane are not viable dairy regions in terms of manufactured milk products, but
their proximity to major cities has allowed them to continue to play an important role
in the industry with regard to the supply of liquid milk.

Technological and market changes however are causing rapid shifts to these
geographical patterns. On the one hand, improved transportation has allowed urban
markets for liquid milk to be satisfied by more distant dairy regions. In Australia it
has become increasingly commonplace for Sydney’s liquid milk needs to be sourced
by Victorian milk, produced up to 900 kilometres away. These types of changes are
crucially dependent also on changing regulatory environments.               State-based
regulatory systems for liquid milk have often acted to protect local producers, thus
prohibiting or discouraging inter-state trade in liquid milk. Until 2000, inter-state
trade in liquid milk in Australia was effectively prohibited via State-based legislative
restrictions on the sale of liquid milk from ‘other than approved’ suppliers.
Deregulation of liquid milk markets on 1 July 2000 ended these prohibitions. In
Australia, deregulation involved a AUD1.8 billion restructuring program to
compensate the losers from the reforms (mainly smaller dairy farmers, especially
outside Victoria and Tasmania), funded from a consumer levy of 11 cents/litre on
liquid milk.

On the other hand, liquid milk markets in Western nations are fragmenting due to
increased consumption of Ultra-High Temperature (UHT) milk, the use of new
packaging technologies, and the replacement of full cream milk with specialist milk
types. The longlife shelf capacity of UHT milk facilitates greater distances between
sites of milk production, and places of milk consumption.1

Changes in agricultural practices associated with dairy production are also actively
reshaping the geography of the industry. In the U.S., the traditional mode of small-
herd dairying associated with Wisconsin and Minnesota is being replaced by high-
input so-called ‘industrialized’ dairying associated with California. This change
executes an increasingly scientific system of dairy cow feeding. It is also consistent
with the use of Bovine Somatrotopin (bST) as a growth hormone to optimize dairy
output. In a more general sense, the dairy industry in any case is being restructured
via breeding programs and improved feeding regimes that are producing higher yields
per cow. In just four years between 1995 and 1999, average yield per cow in
Australia rose by 7%, and average herd size by 19%. There are now approximately
12,000 dairy farms in Australia, down from more than 20,000 in 1983. However,
national output has almost doubled in this time.

These developments have the net effect of reducing the geographical dispersal of the
dairy industry. Dairy production increasingly will be located in regions with
amenable climate and access to environmental resources (water, feed). This may be
good news for dairy producers and dairy workers in those production regions (say,
Victoria in Australia; California in the U.S.), but bad news for dairy farmers and
workers in regions that traditionally have relied on proximity to urban markets as a
source of competitive advantage.

 In Australia at least, consumption of UHT milk has also been advanced because processing
companies have been able to use lower-priced manufacturing milk. This gives UHT milk a price
advantage over liquid milk.
The changing dynamics of the economic geography of dairy production: changes
between nations

In addition to the types of changes described above, it is likely that future years will
witness significant changes in the global distribution of dairy production. These
changes will be significant, but their size and importance are often over-stated in the
business and financial media. Some 93% of world dairy production is consumed in
the country of origin: exports comprise just 7% of world dairy industry output. More
liberalized global trading conditions brought about by the Uruguay Round Agreement
on Agriculture and other trade agreements will act generally to increase the volume of
dairy products traded internationally, but the pace of this growth will be gradual rather
than dramatic. This is an important point to remember, because in the Australian and
New Zealand financial media especially there is tendency to hyperbolize the possible
gains to Antipodean dairy producers from reduced agricultural support payments in
Northern Hemisphere nations.

In this context two general conclusions can be made. First, it is likely that the
majority of dairy demand in the key consumption areas of Europe and North America
will continue to be sourced from internal production. Obviously this is more true of
perishable products such as liquid milk and yogurt, than it is of cheese and skim milk
powder. Second, it is likely that total world trade in dairy products will increase
steadily in line with increased dairy consumption in non-traditional dairy nations.
Changing diets in Asia and Latin America encourage increased dairy consumption.
Cheese is a key commodity in these developments, because of its role in pizzas and
pasta-based cuisines. The global growth of franchised pizza outlets is a significant
contributor to demand for cheese in non-traditional dairy markets, such as the Asian
Newly Industrializing Economies and other so-called ‘emerging markets’. At the
current time, Asian imports of dairy products represent 50% of world trade in the
sector. Because of declining agricultural export support programs and generally high
production cost levels, EU producers will continue to meet local European demand,
but will be less able to capture these emergent export markets. Lower cost producers
in Australia and New Zealand, possibly as well as those in Argentina and India, are
better positioned to benefit from increased export demand. Between 1995 and 1999,
the share of world dairy exports contributed by Australia and New Zealand increased
from 33% to 45%.

The industrial structure of the dairy industry: dilemmas for cooperatives

Dairy farmers are highly dependent upon having a local processing facility to buy
their product, because milk rapidly deteriorates prior to processing. Traditionally this
has encouraged the development of cooperatives in the dairy sector. Cooperatives
emerged worldwide in this industry as a means to alleviate the vulnerability of dairy
farmers. By pooling their resources and operating their own collectively owned dairy
processing factory, dairy farmers are able to minimize their market risk. This is
known as the principle of countervailing power. Cooperative rules usually require the
compulsory purchase of all members’ product. Hence, by becoming members of a
local cooperative, dairy farmers have been able to ensure an outlet for their highly
perishable product.
The emergence of cooperatives in the dairy sector was associated also with local
control and local identity. In eras when transport was uncertain and costly, it became
imperative to locate cooperatively-owned dairy factories central within farming
communities. Changes to technologies and transport over time have challenged these
patterns, creating dilemmas for dairy cooperatives.

The Irish model

During the 1990s the Irish restructuring of dairy cooperatives was seen internationally
as a model worthy of closer inspection. The processes developed in Ireland over the
past two decades appear influential in recent restructuring programs unleashed in
Australia and New Zealand, at least. Hence, it is worthy to investigate the Irish
experience in some depth.2

The historical experience of the Irish dairy industry encapsulates these issues. Ireland
was a leading exporter of dairy products (mainly butter) in the nineteenth century. In
the 1880s the centrifugal separator was introduced to the industry (from Germany),
allowing the rapid and efficient separation of cream from milk. By 1900 there were
approximately 800 creameries in Ireland, of which approximately half were
cooperatively-owned. By the 1920s however, private-ownership of the creamery
sector was largely displaced by cooperatives. In general, cooperatives could more
flexibly adjust to lower and unpredictable profit levels. In this era a hierarchy of
creameries evolved, whereby ‘branch creameries’ servicing a radius of approximately
five kilometres (or about 50-100 farmers) would first separate the cream from milk,
then transport the cream to central creameries for conversion to butter. With the onset
of the Great Depression the Irish Government established a statutory authority (the
Dairy Disposal Company) with responsibilities to rationalize the industry, effectively
creating a cooperatively-owned national dairy sector. In subsequent decades
regionally-based cooperatives underwent ad hoc amalgamations, leading to increasing
centralization within the industry. This was accelerated in the 1960s by Government
proposals for amalgamations in the industry, aiming to generate efficiencies and to
reduce excess capacity. The number of creameries was reduced nationwide from 192
in 1966 to just 46 by 1978, and 35 by 1990. This process was often characterized by
conflict and tensions between creameries, but nonetheless led the way to an
increasingly efficient and modernized dairy industry. In 1990, the five largest
cooperatives (Kerry, Waterford, Avonmore, Dairygold and Golden Vale) accounted
for approximately 75% of Irish dairy production.

Thus, the Irish dairy sector entered the 1990s as an industry featured by significant
recent restructuring. This paved the way for the Irish dairy industry to begin a new
phase in which private capital and internationalization were to prove particularly
important. During the 1990s Irish dairy cooperatives - especially the Kerry Group –
entered into a series of high-profile international dairy acquisitions. These included
the 1994 acquisition of the US company DCA food ingredients for 250 million Irish
pounds, and the 1998 acquisition of the US Dalgety Food Ingredients for 335 million
Irish pounds. These acquisitions and others meant that by 1998, only 26% of Kerry’s
turnover originated in Ireland. Moreover, dairy products contributed less than 10% of

  This section is based extensively on: Breathnach, P. (2000) ‘The evolution of the spatial structure of
the Irish dairy processing industry’ Irish Geography, 33(2), pp 166-84.
Kerry’s turnover. Other corporate restructurings in this period included the 1997
amalgamation of the Avonmore and Waterford groups. Additionally, the Irish Dairy
Board has been restructured, so that it is now a cooperative owned by Irish dairy
cooperatives. The Irish Dairy Board has also engaged in a number of international
acquisitions over recent years.

At the same time as making these acquisitions, the Irish cooperatives were
restructuring their capital bases. This has involved the cooperatives establishing
holding companies to manage and own downstream processing operations. This
separation of milk supply from downstream processing has been associated with the
injection of private capital into the processing sides of the dairy industry, leading
ultimately to a dilution in farmer-ownership of these businesses. By 1997 farmer-
ownership in the Kerry Group had fallen to 39%. At one level the development of
these hybridized cooperative-private capital businesses responds to desires to raise
equity in a situation where farmers are unable or unwilling to provide capital. At
another level however it responds to a general bias in capital markets and in
management circles against cooperatives. As the Irish dairy expert Prionnsias
Breathnach comments:

     It is clear that the momentum behind privatization has emanated from the dairy
     groups’ professional management, at least partly because of their belief that a
     conventional corporate structure is necessary in an increasingly competitive
     international environment. Among the key consequences are that share price
     and profitability will replace milk price as the key performance indicator among
     the big dairy groups (Breathnach 2000: 182)

Restructuring in Australia and New Zealand

Cooperative structures have also been restructured significantly in Australia and New
Zealand over recent years. In Australia, these processed commenced with the Kerin
Plan to restructure and reduce export support arrangements in the mid-1980s. This
Plan reduced the level of cross subsidisation in the industry, intensifying the need for
dairy producers to generate competitive efficiencies. Within two years of the Plan
coming into effect, more than a dozen dairy cooperatives in the State of Victoria had
merged to form two cooperatives (Bonlac and Murray-Goulburn), which had in turn
privatisated their equity structures. In New South Wales, a number of regional-based
cooperatives merged to create Australian Cooperative Foods, which trades under the
name Dairy Farmers. Privately-owned dairy companies were also being restructured
in this period. The early 1990s saw the emergence of National Foods as the nation’s
leading liquid milk producer (it was the first dairy company to own liquid milk
processing facilities in all Eastern States), and the entry of transnational capital into
the industry for the first time with the Italian Parmalat group taking over the liquid
milk and ice cream manufacturer Pauls in 1998. The Pauls acquisition cost Parmalat
AUD436 million, which was considered by analysts an expensive price, justified only
through the prospect of increased profits arising from further restructuring in the

By the mid-1990s the key debate in the Australian dairy industry concerned the
abilities of cooperatives to raise equity. The 1997 Cooperatives Conference, for
example, was themed around the issue of finance. Australian Cooperatives Foods
(renamed in the mid-1990s as Dairy Farmers Cooperative), under the Chairmanship of
Ian Langdon, was a leader in stimulating debates about the appropriate equity
structures for the industry. Financial analysis carried out in 1995-96 proposed an
equity restructure of the cooperative, with the value-added parts of the business spun-
off into a listed company (i.e., the Irish Dairy model), but this was rejected by
cooperative members. Within a couple of years, however, these issues were revisited.
By 1999 Dairy Farmers faced intensified competitive threats arising from the
impending deregulation of liquid milk farm gate pricing, the entry of (cashed up)
Parmalat within the industry, and incursions by National Foods into the cooperative’s
key consumer market of Sydney. This led to Parmalat launching an unsuccessful
takeover bid for Dairy Farmers in 1999, followed in 2000 by merger discussions
between the cooperative and the listed company National Foods, which broke down in
December. National Foods offered AUD793 million for Dairy Farmers, but the
cooperatives’ members rejected this bid for fears that it would dilute their stake in
ownership and control. The failure of the Parmalat and National Foods bids for Dairy
Farmers highlights an important legal issue: under New South Wales cooperatives
legislation, any takeover must be agreed to by at least 75% of members.

These developments took place in the same context of a New Zealand entry into the
Australian dairy sector. During 2000 the New Zealand Dairy Board acquired 18.2%
of National Foods, and 25% of Bonlac. During 2000 Bonlac shifted its strategy away
from value-added products and towards dairy exports, in moves seen to provide
increased focus on the company’s areas of competitive strength. In 2000 it sold (for
AUD30 million) the Spring Valley and Wave beverage brands to Cadbury
Schweppes. (The decision to sell’ Wave’, a flavoured milk brand, is instructive.
Wave will continue to be manufactured by Bonlac, but ownership of the brands now
rests with Cabury Schweppes). By November, Bonlac had tentatively agreed to the
terms of an alliance with the NZDB, subject to the resolution of issues concerning the
rights over Bonlac’s key cheese brand, Bega.

These corporate restructurings took place in the context of developments also in New
Zealand, and emerging debate on trans-Tasman mergers. In late 2000 New Zealand
dairy leaders announced plans to merge the New Zealand Dairy Group and Kiwi
Cooperative Dairies, creating the world’s 14th largest dairy group, and effectively
reducing the New Zealand dairy sector to the control of one entity. The merger would
also include the NZDB. The proposed name of the merged entity is Global Dairy Co.

The public announcement of this proposed merger stimulated a new round of
discussions concerning trans-Tasman mergers and alliances. In the late 1990s Kiwi
Cooperative Dairies purchased a controlling interest in the West Australian dairy
company Peters & Brownes. As noted above, during 2000 the NZDB had acquired
stakes in Bonlac and National Foods. By January 2001, the financial press began to
report that the proposed Global Dairy Co. was close to securing mergers with the
Dairy Farmers Cooperative, and Bonlac. These mergers would be in addition to the
NZDB’s 18.2% stake in National Foods. At the time of writing these developments
are still in progress.

The key competitive advantage posed by the merger of New Zealand and Australian
dairy exporters relates to efficiencies in export arrangements, marketing, promotion
and representation. Effectively, trading Australian dairy exports through the already-
extensive New Zealand trading network achieves economies currently not present.

The changing dairy supply chain

The restructuring of dairy farming and processing sectors globally is being undertaken
in a context of dramatic changes to the control and management of the world’s food
system. Dairy products are being sold into channels that are becoming greatly more
concentrated and internationalized, with the result that dairy producers are being
forced to radically adjust their corporate strategies. These factors lie at the heart of
the kind of changes witnessed in recent years in Ireland, Australia and New Zealand,
amongst other nations.

Several key inter-related developments have encouraged changes in the distribution of
power within dairy supply chains. Concentration in the retail sector has evoked
significant changes to the purchase patterns of dairy products. In the case of liquid
milk, the relatively fragmented arrangements of local distribution that traditionally
have characterized the industry have given way to retail sales in supermarkets and
franchised convenience stores. Since the mid-1980s there has been considerable
market concentration in grocery retailing, creating a situation where a small number
of large, internationalized chains have substantial buying power. In combination with
the general expansion of generic and store-brand commodities over this period, this
has executed a shift in economic power away from food manufacturers, and towards
retailing capital. This process has been illustrated in Australia since the deregulation
of liquid milk pricing, where supermarkets have placed intense pressure on dairy
companies to lower their prices at the same time as maintaining retail price levels. In
the first six months of pricing deregulation in Australia (i.e., from June to December
2000), it is estimated that AUD750 million has been transferred from dairy farmers
and consumers to supermarkets because of the latter’s ability to exercise economic
power within the liquid milk supply chain.3 This has been translated into a reduction
in the asset value of dairy farms Australia-wide by AUD3.7 billion. Increasingly, the
viability of Australia’s liquid milk producers depends upon (i) the extent to which
they can capture supply contracts with supermarket chains, and (ii) the extent to
which they can own and exploit branded- higher profit milks. In 1998-99, value-
added modified milks such as high-calcium and low-fat varieties held 45% of sales.

The rise of a generally concentrated food service industry also impinges upon dairy
producers. The expansion of the food service industry is best seen through the
emergence of global fast food chains over the past two decades. Dairy products are
key ingredients to pizzas, in particular. Pizza Hut (global sales US$5 billion) and
Dominos Pizza (global sales US$3.2 billion) play a major role in encouraging
standardization of product (pizza cheeses) and through their buying power, place
downwards leverage on dairy producers’ pricing.

It is also the case that as the international food system becomes more complex, dairy
products increasingly are being used as food ingredients for further-processed
commodities. The growth of prepared meals, for example, relies heavily on the use of

 Data estimated by the Australian Milk Producers’ Association. See: Wright, S. (2000) ‘Farmers
vowing to become political force on deregulation’ AAP 5/12/2000.
dairy ingredients such as cheeses. Other industries making significant use of dairy
products as food ingredients, such as ice cream and confectionery, also have
witnessed considerable industrial concentration over recent years through the
transnational strategies of large corporations. Nestle and Unilever, in particular, have
engaged in aggressive merger and acquisition behaviour since 1990, with the net
result of dramatically rationalizing key components of the global food industry.
These developments pose major challenges to the dairy industry.

Global concentration in the dairy industry

The outcome of these economic pressures have been to encourage global
concentration in the dairy industry over the past decade. In 1992 the world’s top 20
dairy companies generated USD60 billion in turnover. By 1999 the world’s top 20
dairy companies generated over USD100 million (see the accompanying table). Most
of this economic consolidation occurred via mergers and takeovers in dairy
companies’ home markets. Between 1998 and 2000 there was 415 mergers and
acquisitions of dairy companies worldwide. Many of these have occurred in Europe.
Although there has been an increasing internationalization of corporate ownership, the
major effects have been concentration in national markets. However, as the above
discussion of Australia and New Zealand suggests, internationalization is the next step
in this process.

The world’s 20 largest dairy companies, 1999

                         Turnover (US$)                              Turnover (US$)
Nestle                   12.9           Unilever                     4.5
Dairy Farmers of         7.4            Friesland Coberco            4.3
America                                 Dairy Foods
Danone                   6.4            Bongrain                     3.7
Phillip Morris (Kraft)   6.3            Land O’Lakes                 3.3
Parmalat                 6.1            Meiji Milk                   3.2
Suiza Foods              6.0            Dean Foods                   3.0
Aria Foods               5.3            Morinaga                     2.9
Lactalis                 5.1            Sodiaal                      2.8
Campina Melkunie         4.9            Dairy Crest                  2.5
Snow Brand               4.7            Nordmilch                    2.4
Source: Rabobank.


The dairy industry has tended historically to be one of the world’s most highly
regulated food sectors. It is being deregulated throughout the world, but it is likely
that extensive national regulations will remain important factors in most nations,
outside of Australia and New Zealand. Nevertheless, international mergers and
acquisitions will occur at an increasing rate, and with technological change, the
industry will likely be transformed within the next two decades.

These processes, however, are not inevitable. Stakeholders in these industries,
including unions, farmers, and governments, can play crucial roles in determining the
pace and shape of restructuring. Although economic and technological change has a
certain air of inevitability about it, the precise nature of those changes are not
inevitable. The decision of the Australian Government in 2000 to ‘soften the pain’ of
dairy deregulation through a AUD1.8 billion restructuring package shows that
governments at least can still intervene in industrial change.

These points are relevant because, although the pizza and pizza cheeses might
increasingly be seen as global food commodities, dairy products are also often
identified as icons of localness in the global food system. One of the key incidents of
the anti-globalization push of the past two years was the protests against McDonalds
by the French farmer Jose Bove. By vandalizing the local McDonald’s store in
southern France, Bove attempted to gain international recognition as a defender of
local traditions: in this case, Rocquefort cheese. In Europe, globalisation in the food
industry has been accompanied by an intensified push to codify and protect
geographical distinctiveness in the labelling of regional produce. Moreover, as the
current debate over the WTO suggests, the future direction of multilateral trade
negotiations is unclear. Hence, while there seems little doubt that in the next two
decades the global dairy industry will be transformed, the shape of that
transformation, and the roles of stakeholders such as unions and farmers within those
transformations, is yet to be determined.

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