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. 1 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 2 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 industry. 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 3 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. Conclusion 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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