Irish Dairy Processing Sector Strategic Report Mar 03

Strategic Development Plan for the Irish Dairy Processing Sector
Strategic Development Plan for the Irish Dairy Processing Sector on behalf of Department of Agriculture and Food Enterprise Ireland Irish Co-operative Organisation Society Irish Dairy Industries Association of IBEC
March 2003
Contents
Executive Summary
Page
8
Chapter 1
Irelands dairy processing industry today
14
Chapter 2
Market developments and future market opportunities
54
Chapter 3
What the industry needs to do to respond to the market challenges and opportunities
86
Appendices
114
List of tables Table 1 Table 2 Table 3 Table 4 Table 5 Table 6 Table 7 Table 8 Table 9 Table 10 Table 12 Table 13 Table 14 Table 15 Table 16 Table 17 Table 18 Table 19 Table 20 Table 21 Table 22 Table 23 Table 24 Table 25 Table 26 Table 27 Table 28 Table 29 Table 30 Table 31 Table 32 Table 33 Table 34 Table 35 Table 36 Table 37 Table 38 EU Enlargement Quota Allowances Seasonality of milk supply Peak to trough ratios Protein and Fat Levels (2001) Production cash costs Irish protein and fat levels (1991 vs 2001) Irish milk production costs Number of companies processing 80% of the milk pool Number of Irish processing plants, by product output Average output of plants - Ireland (average annual production) Average plant size Cheese Average plant size Butter Average plant output Powder Capacity utilisation (%) Raw milk processed per employee Percentage of total sales turnover (2001) Prices obtained for main product types (2001) Relative profitability of main products Ireland - annual production by broad product type Gross value added from processing per tonne milk (2001) Dairy Processing Turnover as a % of GDP Irish processor re-investment and new product development levels R&D/New product development (2001) compared with main competitors Economic value added by Irish dairy processing sector Comparison of Economic Value Added Estimated EVA for NZ using average EU milk price Butter, SMP & WMP products as percentage of total production (excluding liquid milk) Volumes exported to each market Sales of Irish product by market type Sales of Irish product by distribution channel (2001) Intervention support for butter Intervention support for SMP Export refunds for dairy products (EAGGF / FEOGA) Producer milk prices Estimated changes in population Changes in sales channel by country Percentage of world dairy production and consumption
Table 39 Table 40 Table 41 Table 42 Table 43 Table 44 Table 45 Table 46 Table 47 Table 48 Table 49 Table 50 Table 51
Market requirement and industry structures EU Opportunity matrix based on points of differentiation Eastern Europe Opportunity matrix based on points of differentiation North Africa and the Middle East Opportunity matrix based on points of differentiation Mexico Opportunity matrix based on points of differentiation US Opportunity matrix based on points of differentiation China Opportunity matrix based on points of differentiation Opportunity matrix based on points of differentiation Opportunity size based on tonnage increase to 2015 (000T) Market opportunities Estimated Product Volumes (2015) Future industry plant numbers and outputs Increasing industry capital expenditure (% of turnover)
List of Figures
Figure 1 Figure 2 Figure 3 Figure 4 Figure 5 Figure 6 Figure 7 Figure 8 Figure 9 Figure 10 Figure 11 Figure 12 Figure 13 Figure 14
Distribution of dairy farmers by quota size Number of dairy farmers 1991-2001 Monthly deliveries of milk Plant scale and fixed costs for powder production Relationship between EVA and % of base product International dairy sector development Changes in product usage International dairy markets and major trading blocks Emerging-trading zones Product value Vs distance to market (Step 1) Product value Vs distance to market (Step 2) Current and future product portfolio mix Current product market focus Future product market focus
Glossary of terms A&M B2B B2C BSE CAP CCEE CEEC CSO DAF EU EPA EVA FAPRI FCDF FMD FSAI GATT GDP ICOS IDB IT JV MPC NAFTA NPD NZ QSR R&D SMP TB UCC UCD WMP WPI WPH WTO ZMP Advertising and Marketing Business to Business Business to Consumer Bovine Spongiform Encephalopathy Common Agricultural Policy Countries of Central and Eastern Europe Central Eastern European Countries Central Statistics Office Department of Agriculture and Food European Union Environmental Protection Agency Economic Value Added Food & Agricultural Policy Research Institute at the University of Missouri Friesland Coberco Dairy Foods Foot and Mouth Disease Food Safety Authority of Ireland The General Agreement of Tariffs and Trade Gross Domestic Product Irish Co-operative Organisation Society Irish Dairy Board Information Technology Joint Venture Milk Protein Concentrate North American Free Trade Association New Product Development New Zealand Quick Service Restaurant Research and Development Skim Milk Powder Bovine Tuberculosis University College Cork University College Dublin Whole Milk Powder Whey Protein Isolate Whey Protein Hydrosolates World Trade Organisation Zentrale Markt- und Preisberichtstelle Review Dairy 2002 Germany, EU, World
Executive summary Study objectives The objectives of the Prospectus-Promar strategic study were to; examine the existing structure of the Irish dairy processing sector; identify market opportunities for dairy products; assess product options to exploit these opportunities and make recommendations on actions to improve the efficiency and longterm competitiveness of the industry. The scope of the study was the dairy processing sector in the Republic of Ireland The Irish dairy industry has had a very successful past. It now must take action to secure a successful future. Ireland has a long and successful tradition as a major producer of quality dairy products. The grass based production system has provided significant competitive advantages in terms of production costs and the naturalness of Irish dairy produce. The dairy processing industry has become one of the countrys most important indigenous industries with a turnover of over 2.5 billion in 2001 and employing over 9,000 in processing related activities, and with around 27,000 dairy farmers. The industry has developed strongly since Irelands entry to the EU in 1973 and has developed an extensive infrastructure both in Ireland and overseas. Kerrygold is a major food brand and a number of Irish dairy companies have become significant and successful players on the world stage. Ireland is also a major global centre for the manufacture of infant formula. The industry has for a long time grown beyond its own domestic market to become very export orientated and dependent with about 85% of the processed output exported. In recent years, there has been a significant shift in Irelands mix of product output, with a decline in the volume of butter and SMP and increased output of cheese and casein. However, relative to the other major EU export orientated competitor countries, Denmark and the Netherlands, Ireland is still heavily dependent on commodity type products such as butter, WMP and SMP. The industry has responded effectively to market changes and challenges in the past and with strong leadership and decisive action, it is in a good position to respond positively to the challenges and opportunities that it currently faces. However, the Irish industry is starting to fall behind its competitors and faces significant challenges. The production and processing sectors are both highly fragmented in terms of the number of milk suppliers and processors. The industry is competing in international markets against much larger enterprises that are increasing their scale at a faster rate than Ireland. There has been significant and rapid industry consolidation in recent years in the major competing countries (Denmark, Netherlands and New Zealand) where dominant players have emerged. The total pool of milk processed in Ireland (including raw milk supplied from Northern Ireland) in 2001 was 5.6 billion litres. The fragmented nature of the Irish industry is illustrated by comparison of the number of processors accounting for 80% of the milk pool. In Ireland six companies process 80% of the milk pool compared to one in Denmark, one in New Zealand and two in the Netherlands. Irelands competitiveness is being eroded with the cost of doing business in Ireland increasing at a faster rate than that of its competitors. The industry is also very seasonal in its production and processing compared to its major EU competitor countries, which has implications for product mix. The Irish dairy industry produces a high proportion of its output (over 60%) in the form of base or commodity type products (butter, powder, casein, and bulk cheese). These products attract lower margins and are extremely price sensitive. The industry relies heavily on EU market intervention and other market supports, which are increasingly coming under threat. The industry has developed very few internationally branded consumer products. It invests significantly less than its major competitors in terms of capital reinvestment and R&D. The economic value added (EVA) to the raw milk produced is lower than the industries in countries such as Denmark and the Netherlands. This is a reflection of the relatively high weighting of base products. However, it should be noted that Irelands EVA is significantly higher than that of New Zealand if New Zealands EVA was calculated at average EU milk prices and not at the significantly lower prices that prevail in that country. This lower EVA for New Zealand is a reflection of their even greater dependence on base products.
Changes to the policy environment at EU and WTO level will result in reduced market supports for dairy products, and consequently, lower prices paid to processors and milk producers. The future viability of dairying for a majority of farmers is under threat due to the increasing costs, falling milk prices, restrictions on increasing output and improving productivity and the relative small-scale nature of dairy farms in Ireland. Policy changes arising from CAP reform and WTO agreements are pushing EU dairy product prices close to world market levels, which could lead to milk prices falling to below 1 90 cents a gallon. This would have major consequences for the viability of many dairy farms. These policy changes however, can act as an important stimulus for the industry to make necessary changes to its existing product focus and how it is organised in both dairy processing and production.
The Irish industry does not have the luxury of trading on its successful past. The Irish dairy has made effective and pragmatic use of the EU market supports available to dairy products and has developed a product profile which has maximised the benefits of its lower cost of production from its grass-based production. This grass-based system has resulted in a highly seasonal milk supply and necessitated the conversion of most of the raw milk supplied into low moisture products suitable for storage such as butter, milk powder and cheddar cheese. However, given the major challenges and competitive threats it is now facing, the industry urgently needs to make major changes in how it is organised and how it utilises the raw milk it produces. The Irish dairy processing sector faced with this increasingly challenging market environment, have a number of strategic options available to it, which, at their basic level are: Reduce the price they pay for their raw material, which accounts for over 75% of their costs to compensate for the lower product prices and increasing processing costs - pass all the pain back to the dairy farmers option and try to maintain their already relatively modest margins Look at ways of achieving savings and efficiencies from their processing operations by rigorously examining employee productivity, spending on overheads, utilisation of capital resources and any areas of duplication or inefficiency achieve cost efficiencies option Seek to extract greater value from the processed milk by producing products that are growing in demand, returns a higher margin and reduces the dependency on commodity type products increasing the volume of value-added products option Become much more market focused and driven in developing and positioning dairy products that leverage the positive image of Ireland as a producer of quality dairy products and respond and anticipate changes in buyer/consumer needs and demand the strategic marketing option Try to convince the EU, with the active support of the Irish Government, of the need to ameliorate the proposed policy changes to EU supports given their disproportionate impact on the Irish industry the policy change dilution option Exit or scale back significantly the production of certain products where there is declining demand and/or it is no longer economic to produce within the cost base prevailing in the Irish economy and the product price attainable in international markets the downsizing option
The position and outlook for the Irish dairy farmers is considerably weaker. They, like the processors, are in an environment of rising costs and are facing a milk price, which could potentially drop to 1 to 90 cent a gallon or even below this level (20-22 cent a litre a potential loss of direct income from milk production of between 375m and 480m) 1 and where many are at a scale of operation that their enterprises will not be economically viable.
The proposed EU system of direct payments will partly compensate (probably around 50-60% of the loss) for the fall in milk prices, so this is not actual drop in income, which would occur if milk prices fell to this level.
The options available to the milk producers are more restricted and in many cases highly unpalatable but for which there are no viable alternatives. These options include: Take the full hit in terms of lower milk prices paid by processors and try to achieve greater productivity, efficiency and scale in their dairying operations in the hope that these measures together with income support in the form of direct payments from the EU will generate an economically viable dairy farm enterprise Exit from dairying Reduce the scale of their existing dairy operations and through a combination of direct payments and off-farm income seek to maintain a reasonable level of income Try to convince the EU, of the need to ameliorate the impact of the proposed changes to EU supports given their disproportionate impact on the Irish industry Use their important role as suppliers, members or shareholders of the processing enterprises to actively encourage the processors to share some of the pain arising from lower product prices by taking aggressive and decisive steps to achieve significant processing cost efficiencies, to re organise operations and structures to make efficient use of resources and to increase the valueadded content of output so as to minimise as much as possible, the drop in milk prices.
The actual choices and room for manoeuvre for the Irish dairy processors in respect of the basic strategic options listed above are quite limited. It is unlikely and unreasonable to expect the farmers to take all the pain in terms of lower milk prices to compensate for lower product prices. The trend of EU policy appears inevitably to be leading to further reductions in product price supports and subsidies and any relief that might be achieved for the Irish industry will be marginal. Actions to improve processing cost efficiency will only be of limited value and will be quickly eroded by inflationary pressures in the economy. The cost efficiency measures on their own without significant changes to the existing product portfolio, will only defer for a short period the need to increase the value added content of Irish dairy products. The only real alternative is for the industry to: Embrace the strategic changes recommended in this report and to build on the existing strengths, resources and successes that the dairy industry has built up over the years Achieve cost efficiencies through plant rationalisation and economies from increased scale in base product production and realise the savings from consolidation amongst the players Provide the scale and capacity to invest and avail of existing and emerging product and market opportunities Reduce the level of dependence on commodity type products and increase the value -added content of manufactured dairy products Get quickly to a position where the industry has a major player who has the scale, cost competitiveness and resources to compete successfully against the major large-scale international competitors.
There are market and product opportunities for the Irish dairy industry. Some of the key fast growing market opportunities for Ireland include: dairy ingredients such as protein fractionates; customer solutions for food service and industrial ingredients; functional and health foods; and the production of a wide range of base, ingredient and some branded products into affluent European markets. The continued success, expansion and increasing value-added content of the infant formula sector, which is a major purchaser of processor product, is of strategic importance to the future development of the industry as a whole. Through the use of a planned approach, the Irish dairy industry must develop a product portfolio for specific markets that meet local market needs and capitalises on the values that are uniquely Irish.
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A clear strategic focus for the future is required. The future success and long term survival of the Irish industry is critically dependent on its ability to quickly transform itself and deliver on the following key strategies: Improve the international competitiveness, scale and cost efficiency of both the producer and processing sectors Increase the proportion of output away from base/commodity type products and into higher value-added products Put greater emphasis on actions to develop and underpin the highest standards of quality and safety of Irish dairy produce
The recommended actions underpinning these strategies are: Allow cost efficient producers to move up to an output level that enables them to generate a viable income against a backdrop of decreasing milk prices by achieving a scale and level of efficiency that is comparable to that in major competitor countries. In Denmark, the average annual dairy farmer output is around 107,000 gallons, 84,000 gallons in the Netherlands and around 77,000 gallons in Northern Ireland compared to around 40,000 gallons in the Republic of Ireland. Rationalise the number of processing plants for butter, powder and casein production down from eleven to four plants. This will deliver efficiencies and savings at manufacturing and enterprise level through scale processing and more efficient use of resources Ensure cost efficiency in production of base products and increase the levels of secondary processing and added value of these products. Eliminate duplicate or inefficient costs or overhead from milk assembly, processing overhead costs such as energy, quality controls, environmental compliance, administration right through to marketing and distribution costs Increase and leverage the spending levels by processors and the industry as a whole on R&D and new product development. Improving the value-added content of the dairy products will also involve adopting a solutions-based approach to product development Maintain, defend and grow a solid base in the home market with a full product range Target other geographic areas beyond the home market with a selected range of products specifically targeted at the needs and opportunities in those markets Ensure that Ireland continues to be positioned as a quality food island by adopting a proactive leadership position, where it is not only meeting but also exceeding the highest quality and environmental standards, and thereby, protecting itself from the loss of this image which could prove very difficult to regain.
The recommended strategy will deliver real benefits. The implementation of the rationalisation and product reconfiguration strategies recommended in this report will involve significant up-front costs of over 300m in the first 2-3 years for the industry in terms of increased capital investment requirements, increased R&D and market positioning costs together with the one-off redundancy costs. The benefits that will accrue from the implementation of the strategies include additional operating profits from the higher margin yielding higher value-added products (70m p.a.) and savings from rationalisation (50m p.a.) and greater economies of scale (20m p.a.). Much of these benefits will require the up-front investments before they begin to return significant benefits. We have estimated that the payback period would be six years and that the net cash inflows would be around 70m per annum from year six onwards. However, before this payback point is achieved, the industry will need to fund significant cash outflows, particularly, in the first four years. This up front net cost in the first few years could have major implications for the industrys ability to fund the necessary changes required. The costs and benefits outlined in the report are only an indication of the potential level of return to the industry. The specific business cases for the recommended strategic change need to be done at enterprise level as more detailed and accurate information on the specific investment requirements, cost outlays, efficiency savings and product margins will be available.
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Radical action is required to bring about strategic change. The issues facing the Irish dairy industry and the strategies to respond to them outlined above represent a major challenge for the industry. It requires a major step change for all of the participants in the industry. In light of the international market and policy developments, the industry needs to decide how it is going to respond and the speed and depth of this response. Prospectus and Promar strongly believe that radical and decisive change is urgently required. The rules of the game have dramatically altered in recent years and will continue to do so with on-going and accelerated large-scale consolidations occurring at international competitor and buyer levels together with the dismantling of the industry supports at EU level. The critical question is how the industry is going to bring about change. We believe that the strategic change outlined in the report will be extremely difficult and painful to achieve. Major consolidation and rationalisation at producer and processor level is required to achieve the scale and cost competitiveness necessary to continue to successfully compete for international business. For this transformation to really happen the industry requires the creation of a strong scale Irish player to compete successfully internationally and that is capable of: Encouraging and stimulating changes at production level, driving through the rationalisation of base product plants and delivering the cost savings Leveraging and commercialising investments in R&D and new product development to successfully develop and market higher value-added products Competing for business against scale competitors in international markets and on the home market Building and expanding existing and new investments in international infrastructure and developing and expanding strategic alliances
A consolidated player needs to emerge in the medium term with a scale where it is processing around 70% of the processed milk. This level of consolidation may take two or three steps to be achieved. It needs to begin with a consolidation between some of the five largest processors and also consolidation or joint ventures amongst some of the smaller processors. The consolidation process within the industry needs to happen quickly, as it is highly probable, that there will be further consolidation amongst international competitors and rationalising of suppliers by buyers. Without the development of a strong major entity to act as a catalyst to drive the changes required, there is a real danger the industry will drift, only make incremental changes and gradually decline in terms of total output and value, while the international competition continues to expand aggressively. Individual processors will remain too small to successfully to make and leverage the scale of investment in research and technology necessary to develop the level of new products and higher value product areas required at an industry level. They will not have sufficient scale or resources to meet the requirements of major international buyers. There is also a danger that without major change in the structure of the industry, some Irish processors will increasingly invest outside of Ireland to achieve a level of growth and a return on investment greater than that available within Ireland, given its fragmented industry structure and product focus. The recommended consolidation of the processing sector with the emergence of a major dominant player does not preclude the co-existence of a number of smaller processors in the processing sector. It is both desirable and beneficial for the industry that there will also be a number other players in addition to the dominant player. There are currently smaller Irish dairy processors who by their operations and product focus have been successful in growing their business and delivering a good return to their suppliers and members. There are also examples of successful smaller enterprises in Denmark and New Zealand. These smaller processors can continue to be successful but they will need to be innovative and focus on higher value added products and niche markets. Smaller processors who are predominately in the production of base type products will be unable to stay competitive in the medium to long term. Going forward the industry needs strong and decisive leadership to bring about the transformation that is required to meet the major challenges facing the industry. The Department of Agriculture and Food, Enterprise Ireland and other bodies have an important and valuable role in encouraging and facilitating
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this transformation, to increase the level of added value and market attractiveness of Irish dairy products through supports for research, new product development, market development, food safety and quality assurance. However, the necessary drive, commitment and speed of action must come from within the industry itself. This is unlikely to happen within the current industry configuration with up to 24 different organisations involved in the assembly, manufacture, marketing and distribution of Irish dairy products. There is a strategic industry need for the emergence of a strong consolidated processing enterprise to provide the leadership and scale to drive through changes, implement the strategic actions and realise the many existing and potential market opportunities that are available to the Irish industry. The task of implementing the recommendations of the strategic study falls to the dairy industry itself and the individual players in the industry. The industry either accepts or rejects the analysis and recommendations set out in the report. If industry participants accept the reports findings, then it does have an obligation to make every effort to implement the recommendations or else suffer the consequences of the gradual erosion of the competitiveness of the sector. The threats of the down sizing and decline of the Irish dairy industry are real. The industry faces the stark choice of making major changes to how it is organised and how it utilises its raw milk or else it will find itself squeezed out of markets due to reducing product demand and competitiveness. The stakes are very high. The recommended changes require significant up-front investment and have a high degree of risk attached. The stay more or less as you are option in terms of number of plants and product mix will result in lower industry revenues and a lack of viability for many of the current players in the industry. The industry has shown in the past that it has the ability to respond and adapt successfully to changes in the market environment and will need to demonstrate this capability and commitment again in the new environment it now faces.
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Chapter 1 Irelands dairy processing industry today
Page
1.
Introduction 1.1 1.2 Study objectives and background and methodology Policy environment of the dairy industry
15
2.
Dairy Production 2.1 2.2 2.3 Introduction Profile of the production sector Issues that need to be addressed at production level
18
3.
Dairy Processing structure and efficiency 3.1 3.2 3.3 3.4 Profile of the processing sector Processing structure and efficiency issues Product mix of the Irish dairy processing sector Changes to Irelands product output mix over the last decade
25
4.
The value-added by the processing sector 4.1 4.2 4.3 4.4 Dairy industry turnover How does Irelands capital and R&D investment levels compare? Economic value added (EVA) Value-added issues
37
5.
Marketing and distribution 5.1 5.2 5.3 5.4 5.5 How does Irelands export performance compare with its main competitors? Inability to influence market prices of base products Routes to market EU intervention market support Marketing and distribution issues
45
6.
Summary of key messages from current industry status assessment and international competitor comparisons
51
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1. 1.1
Introduction Study objectives, background and methodology
The Department of Agriculture & Food and Enterprise Ireland, in conjunction with the Irish dairy processing industry, commissioned Prospectus and Promar International to carry out a strategic study of the industry. The purpose of the study is to set out options and recommendations to achieve the optimum structure necessary to enable the Irish dairy processing Industry face future challenges. The study will also contribute to the elaboration of national policy for the sector over the coming years, in the context of increased international competition and developments in comparable dairy producing and exporting countries. The overall objectives of the strategic study are to:
Examine the existing structure of the Irish dairy processing sector Identify market opportunities for dairy products Assess product options to exploit these opportunities Make recommendations on actions to improve the efficiency and long-term competitiveness of the industry
The scope of the strategic study covers the structure and international competitiveness of the milk assembly, processing, manufacturing, marketing and distribution operations of the dairy processing sector in the Republic of Ireland. The scope of the study does not include a detailed analysis of the structure and comparative competitiveness of the primary production end of the food supply chain, but assesses the current context and operating environment of the Irish primary production sector, its impact on dairy processing, and the requirements for change or adjustment in light of the identified market opportunities. (A brief history and background to the current dairy industry in Ireland 2 is contained in Appendix 1.) The main geographical areas covered are the Republic of Ireland (hereafter, referred to as Ireland, unless otherwise stated) and a detailed analysis of Irelands major competing dairy exporting countries Denmark, the Netherlands and New Zealand. The rationale for benchmarking Ireland against these countries is as follows:
Ireland is recognised as a significant exporter of base dairy products3 within Europe, exporting over 83% of its output, and if it wishes to continue to compete internationally, it will need to compete with the main exporting players of these products. Therefore, Ireland has been compared with New Zealand, arguably the leading base dairy product supplier globally. One of the key strategic options for the Irish industry is to increase its presence in Europe. Therefore, comparison is made with the industries in the Netherlands and Denmark, which are major traders in this market. Another strategic option available to the Irish industry is to develop more added value products. The Danish industry has pursued this strategy, and thus it is again relevant for comparison. Consideration was given to the benchmarking of other countries such as Germany and France. However it was felt that Denmark, the Netherlands and New Zealand best represent the competitive challenges to the Irish, and the opportunities that are available to the Irish industry in the future. (Appendix 2 contains overview profiles of the three benchmark countries Denmark, Netherlands and New Zealand.) Comparisons with countries, which export only small quantities of their total output are of only limited value, and have therefore, been excluded.
The study examines the current position and potential future developments at EU and global level and assesses the implications for the Irish industry. It also examines the major current and potential markets for Irish produce. Details of the methodology and approach are included in Appendix 3.
Ireland throughout the report refers to the Republic of Ireland unless otherwise stated
Throughout the report we use the term base products to cover SMP, WMP, casein, whey powder, bulk cheese and butter unless otherwise stated
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1.2
Policy environment of the dairy industry
The external environment facing the Irish dairy industry is subject to many influences, including dairy policies arising from the CAP and WTO, global demand for dairy products reflecting growth in the world economy and changing tastes and preferences, domestic economy factors, and developments among international competitors and buyers, including changing ownership and industry structure. The main factors in the policy environment over the next decade are discussed in this section and include the WTO Doha trade round, and further reform of the CAP regime following Agenda 2000 and EU enlargement. 1.2.1 WTO and dairy policy
The inclusion of dairying (and all agri-food) under the GATT/WTO trade regulations represented a policy development of enormous long-term consequence. Prior to the GATT Uruguay round implementation in 1995, the EU had total discretion over trade policy with regard to both tariffs (import levies) and export refunds. However, the GATT Uruguay round fundamentally changed this, with export refunds being reduced by 21% and 36% in volume and value terms, import tariffs being reduced on average by 36%, and special low import tariffs for specified and growing import volumes (the in-quota tariffs). While a great deal of focus has been on export refunds, the gradual reduction of import tariffs is arguably of even greater long-term consequence. Ultimately, the whole CAP support system comes to be undermined if imports from the much lower priced world market can flow into the EU as a result of steadily reducing tariffs. A fundamental underlying reason for the already agreed 15% intervention price reduction 2005/62007/8, and an option of further reductions to 2015 as discussed later, is the apparent necessity to adjust the CAP price support system to fit in with GATT/WTO trade agreements. In this context, the WTO trade round negotiations, and in particular, the negotiations on tariffs are vital in determining the future shape of EU dairy policy in terms of both the level of internal price support achievable, and the price and volume of import access and status of export refunds. Already, informal opening positions on tariffs have been adopted by the leading players and the course of this debate will do much to shape future global dairy policy. 1.2.2

EU dairy policy
Dairy policy for the years up to 2007/8 has been agreed under the Berlin agreement as follows: Intervention prices unchanged to 2005, but reducing by 15% in three equal steps from 2005/6 to 2007/8 Direct payments rising in three equal steps from 2005/6 to 2007/8 Quota increases by 2.4% at EU level from commencement of Agenda 2000, with a flat rate increase of 1.5% to come in 2005/6 to 2007/8.
While Agenda 2000 is likely to hold firm, there has been recent proposals by the EU Commission in its Mid Term Review in relation to bringing the 2005/6-2007/8 changes forward. In July 2002, the European Commission document Report on Milk Quotas provided a comprehensive review of dairy policy to date, and went on to outline a set of four policy options for the period beyond 2007/8, i.e. for the years 2008/9 to 2014/5. The results of a study of the consequences of implementing these options were outlined, including the estimated effect on milk product consumption, production, trade and prices, producer milk prices and the EU budget. The four policy options considered in the European Commission document for the period 2008/9 to 2014/5 are as follows: A: Status Quo: No policy change from final year of Agenda 2000, i.e. 2007/8 policy unchanged to 2014/2015. B: Repeat Agenda 2000: A further lowering of intervention prices by an average of 10% in three steps, combined with a 3% rise in quotas and a further increase in direct payments. C: A two-tier quota regime (A and C quota): The A quota would equate to the level of unsubsidised internal consumption, together with a more open unsubsidised C quota for exports, combined with the continuation of the Agenda 2000 direct payments at 2007/8 levels to 2014/15. D: Abandonment of Quotas: Quota abandonment from 2007/8, with a doubling of Agenda 2000 direct payments (decoupled). While this document launches an extended discussion on policy to 2015, one may already infer from it that Option B for the period 2009-2015 is close to Commission thinking currently, not least because it may
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fit well with the WTO trade round. However, there are some commentators who see this option as a step towards a longer-term move in the direction of Option D. This transition is predicted to be slow, and in response to increasing pressure from the WTO. Recent developments Under the mid term review of Agenda 2000 the European Commission is seeking deeper cuts in EU support prices during the period of 2004-08. The Commission has brought forward agenda 2000 proposals by one year from 2005 to 2004. This involves a 28% cut in the target price over five years starting from 2004 compared with a 17% cut over three years commencing in 2005. An increase in milk quota of 1% in 2007 and 2008 is proposed as well as compensation on the same basis as agenda 2000, at less than 60% of the price cuts, with the quota system being extended for a further six years to 2014. It is also proposed to tilt the intervention cuts more towards butter with intervention price cuts for butter of 7% per annum between 2004 and 2008, compared with SMP price cuts of 3.5% per annum. At the same time it is proposed that the automatic butter intervention would be stopped once purchases exceed 30,000 during the March August each year (there would be no intervention outside of the March August period) and be replaced with a tendering system. This would operate in a similar way to the existing scheme for SMP, where the current annual buying limit is 109,000T. The Commission has also published its proposals for WTO negotiations calling for improved market opening and reduction in trade distorting support commencing in 2006 for 6 years. The key elements of the proposals include:
Opening markets for farm imports by cutting tariffs by an average of 36% Scaling back all forms of export subsidies by 45%
Further cutting trade distorting domestic farm support by 55% 1.2.3 EU enlargement The major issues are the size of quota for the applicants, the future dairy market balance of the 10 (ultimately 12), and food safety/hygiene issues. While Poland, especially, has a large dairy industry with much potential, the quota system and structural problems will constrain output. Also, the 75 million population of the 10 CEEC countries, together with increasing prosperity, will represent a growing market. The current negotiations between the applicant countries and the Commission highlighted the issue of dairy quotas. The Commission agreed a revised offer to the CEEC countries in Copenhagen, with increased quota allowances for all. Table 1 EU Enlargement Quota Allowances 000 tonnes Original offer CEEC requests Revised Add 2006
Cyprus Czech Estonia Hngry Lith Latvia Malta Poland Slovakia Sloveni a 463.3
131.0
2505.5
562.6
1794.3
1459.0
489.5
8875
946.2
153.3 145.2 -
3110.9 2682.1 55.8
900.0 624.5 21.9
2800.0 1947.3 42.8
2250.0 1646.9 57.9
1200.0 695.4 33.3
52.0 48.7 -
13740 8964.3 416.1
1200.0 1013.3 27.5
556.0 560.4 16.2
Source: Agra-Europe Dec 2002 Recent European Commission estimates4 indicated that the 10 applicants might go from being net exporters of 2.3 million tonnes milk equivalent in 2001, to 1.3 million tonnes net importers in 2009. Despite this, competing exports, especially at the commodity end, from Poland and the Baltic States will continue. The intensity of competition will depend on the final agreement on quota size and the rate of growth in domestic demand. Overall, the 10 with quota constraints should not be a major threat in the short-term, and the major restructuring required, and growing domestic demand, could present opportunities for the Irish industry. Chapter 2 contains a more detailed assessment of the market opportunities within emerging EU markets.
Prospects for Agriculture in CEEB - 2002, EU Commission
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2. 2.1
Dairy production Introduction
The importance of the Irish dairy sector has long been recognised by successive Governments, who have been supportive in facilitating the development and expansion of the industry. State agencies such as the Department of Agriculture, Teagasc, Enterprise Ireland and Bord Bia work closely with the industry. In addition to the state agencies, the university sector, particularly UCC and UCD, have been important in advancing education and research in the dairy sector at both production and processing levels, and have been instrumental in developing a cadre of technically proficient talent to the industry. Irish dairy farmers are considered to be both technically competent and commercially focused, with major changes having taken place in the structure of the industry at production level Significantly, over the last five years, the percentage of farmers producing over 275,000 litres has risen from 10% to 15% of the total number of producers. This scale has facilitated increased investment at farm level, and the adoption of a more commercial focus. Ireland has enjoyed a comparative advantage in the production of milk within the EU This competitive advantage is due to the grass-based feeding system for its dairy herd. This is facilitated by the countrys moderate climate, which makes it very suitable for grass production. The grass-based feeding system has been more cost efficient than the mainly grain-fed systems used in continental EU countries. The pasture-based feeding system also has the advantage of being able to be portrayed as a more natural production for dairy cows and milk production. Ireland has been able to build on this comparative advantage to develop an industry in which over 80% of its processed output is exported. However, dairy farmers are facing some significant challenges and issues at a structural level There is widespread concern about the future viability of dairy farming in a sector facing increasing costs, static or falling prices for their milk, and major restrictions on their ability to improve efficiencies by increasing scale and maximising production from their farm units. This is highlighted by the difficulties that are being encountered in attracting sufficient numbers of young farmers into the sector, and the constraints on the more progressive and efficient farmers to increase scale. This has been a result of a number of factors, including the restrictive nature of the quota system, an increase of 40% in industrial wages over the last decade widening the gap between industrial and agricultural incomes, and Irelands cultural attachment to land ownership, resulting in uneconomic land prices that increases the costs of production and also acts as an expansion constraint for farmers. With the cost of hiring labour or farm relief also rising, it is likely that retaining and attracting dairy farmers will remain a challenge. There is a strong focus within Irish dairy farming on the price that is paid for milk, with considerable attention being paid to the annual milk price audit and monthly league tables. While the importance of the milk price is understandable, given the pressures on farm incomes, it can however inhibit longer term strategic planning for the industry as a whole. The dairy industry is critically dependent on its ability to produce products that are in demand and that are competitive on international markets. This requires continuous and significant investment aimed at improving the quality, attractiveness and value-added content of its products. It also requires an unrelenting focus on improving efficiency and productivity at every level of the production chain, from pasture to the product purchaser. An over concentration on the issue of current milk prices may detract from the need for medium to longer term strategic planning and investment. The Irish dairy processing sector faces international competitors who have adopted strategies of dramatically increasing their scale, and their levels of investment in R&D and in plant. Irish dairy farmers need the processing sector to be internationally competitive, and to increase the levels of returns it achieves for Irish dairy products. Going forward, it may be necessary to review and change the way in which milk production is organised in Ireland This would involve addressing issues such as changes in the scale of production, management of the location of the milk pool, and providing appropriate encouragement to the next generation of farmers. These changes are discussed in chapter 3.
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2.2 Profile of the production sector The number of milk producers has continued to fall since 1984 There has been a continual reduction in the number of producers involved in milk production in Ireland since the introduction of the quota regime in 1984, when there were 68,000 dairy farmers. Over the last decade, the numbers have fallen by 50%, from 57,000 to, around just 28,000 in 2001. According to the Department of Agriculture projections, a similar rate of reduction during the next decade will result in a dairy industry containing 14,000 producers in 2010. The quota regime has also meant that the level of total milk deliveries has remained relatively constant over the last decade, reaching 5,338,000 tonnes in 2001. The level of milk deliveries in Irelands main EU competitors Denmark and the Netherlands has also remained static due to the cap on production at 4,418,000 tonnes and 10,683,000 tonnes respectively, in 2001. In contrast, New Zealand, which does not have a cap on production restriction, increased the volume of milk deliveries from 1991 to 2001 by 74%, reaching 12,322,000 tonnes in 2001. As the number of producers has fallen, producer size has risen Since 1996, the percentage of total quota held by farmers with a quota under 180,000 litres has fallen from 51% to 34%, with a consequential rise from 49% to 66% in the percentage with a quota over 180,000 litres. The absolute number of farmers has also followed this trend, with the percentage of total producers with under 180,000 litres falling from 79% to 59%. While the number of producers has decreased significantly, the average quantity of milk deliveries by producers has consequently increased The average delivery by milk producers has risen from 76,000 litres in 1984 to 180,000 litres in 2001. The average number of cows per farm has increased by 89% over the last decade, from 24.2 in 1991 to 45.7 in 2001. Over the same time period, average milk yield has risen by only 14%, to 4,375 kg per annum in 2001.
Figure 1 Distribution of dairy farmers by quota size

79%
59%
26%
15% 12% 10%
Under 180,000 litres
180,000 litres to 275,000 litres 1996 2001
Over 275,000 litres
Source: Department of Agriculture and Food, 2002 However, while the scale of Irish producers has increased, the rate of this change is significantly slower than its EU competitors Ireland still has a relatively large number of small producers, and the average quota size for the country is 189 tonnes (40,000 gallons), compared to an average quota of 362 tonnes (77,000 gallons) in Northern Ireland.
19
In Denmark, a country with a milk production level of 4,418,000 tonnes in 2001, the number of dairy farmers has fallen from 20,000 in 1991 to 8,911 in 2001, while the average quota per farm has increased from 234 tonnes (50,000 gallons) in 1991 to around 500 tonnes (107,000 gallons) in 2001, an increase of 114%. Likewise, in the Netherlands, dairy farmer numbers have declined from around 47,000 in 1991 to about 28,000 in 2001, and the average quota size has increased from 234 tonnes (50,000 gallons) in 1991 to 394 tonnes (84,000 gallons) in 2001. The approaches and attitudes to quota policy and how quota is managed differ between countries. However, the practical effect of these policies and approaches has meant that in Northern Ireland, Denmark and the Netherlands, farmers have been able to substantially increase their quota size, while it remains quite difficult for Irish farmers to significantly increase their milk quota under the current management arrangements of the quota system. Figure 2 Number of dairy farmers 1991-2001
57,000
46,977 38,557
37,122 35,383
35,027 32,850 31,650
29,467 27,926 29,071 28,174
20,000 14,741 14,685 12,282 11,371 10,568 9,767 14,673 14,362 13,861 13,892 8,911
1991
1997 Ireland
1998 Netherlands
1999 Denmark New Zealand
2000
2001
Source: Eurostat, 2002 Concern has been expressed about the future viability of the smaller dairy farming enterprises, which are facing a price-cost squeeze Research by Boyle (2002) on the competitiveness of Irish agriculture, found that in relation to dairy farming, Ireland lacks the necessary scale to adequately remunerate owner labour and assets. Likewise, research by Teagasc (Hennessy 2001), suggests that dairy farmers are facing a price-cost squeeze. High rates of inflation will increase production costs, with fixed costs projected to rise by 15 to 20% impacting negatively on farm net margin. Thus, the Teagasc research indicates that farmers will have to respond by increasing efficiency, enlarging operations, or a combination of both. The same research goes on to analyse the impact of milk quota elimination on farms and estimate the level of production required to maintain living standards. It concludes that substantial expansion of production is required if farmers wish to maintain real incomes. For example, the typical farm supplying just under 80 tonnes in 1999 would need to increase production by 85% to 140% (by 68 tonnes to 112 tonnes) to maintain real income. Even at 200 tonnes, this is only at 40% of the average size of Danish dairy farmers. The seasonality of milk supply is a major feature of production in Ireland With the exception of liquid milk producers, Irish dairy farmers have continually adjusted the date of calving, so that through compact calving the total herd calves around the time of lowest milk production cost. While this maximises production cost efficiency from a grass-based production perspective, it also results in increasing supply levels in the peak months of March to June. The table below illustrates how seasonality has actually gradually disimproved over the decade. In 2001, the peak month production
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(May), as measured by milk deliveries, was six times the lowest months production (January). This ratio has gradually disimproved over the last decade, having gone as low as 4.7 in 1993. Table 2 Seasonality of milk supply (000 tonnes) 1991
Peak month milk deliveries Low month milk deliveries Peak to trough ratio 740 137 5.4
1997
748 131 5.7
1998
700 124 5.6
1999
710 119 6.0
2000
717 122 5.9
2001
731 122 6.0
Source: Department of Agriculture and Food (2002) Figure 3 Monthly deliveries of milk
800 700 600 500
000 tonnes
400 300 200 100 0 Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec
1993 2001
Source: Department of Agriculture and Food (2002) and CSO (2002) Irelands main EU competitors do not have a seasonality problem Irelands main EU competitors, Denmark and the Netherlands, have both managed to improve their peak to trough ratios, while Irelands has gone in the other direction. It is also worth noting that milk supply in Northern Ireland is considerably less seasonal, indeed its peak to trough ratio has fallen from 1.7 in 1996 to 1.6 in 2001. Table 3 Peak to trough ratios 1991
Ireland Denmark Netherlands New Zealand 5.40 1.22 1.23 n/a
1997
5.71 1.24 1.17 97.73
1998
5.65 1.21 1.37 116.91
1999
5.97 1.20 1.19 77.42
2000
5.89 1.16 1.14 82.88
2001
5.99 1.21 1.15 n/a
Source: IDB, Eurostat, Dexel, (2002) This seasonality leads to poor capacity utilisation in the Irish processing sector, adding to the operating costs of processors Irelands capacity utilisation (measured by 12 times peak month production as a percentage of current total production) has only registered a slight increase from 57.9% in 1986 to 60.8% in 2001. This compares to capacity utilisation levels of 92.3% for Denmark and 92.9% for the Netherlands, facilitated by their low peak trough ratios of 1.21 and 1.15.
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Seasonality also causes a mismatch between market need, which for many products is for fairly constant all year round supply Crucially, Irelands seasonality also restricts the types of products that can be produced, and continues to act as a significant constraint on the Irish industry. If seasonality remains it will continue to constrict the ability to produce certain products that require year round milk supply. The opportunity and viability of altering the product mix to higher value products and, consequently, the ability to pay an additional premium to compensate somewhat for the increased production costs associated with off-peak milk, is discussed in chapter 3. The fat and protein levels of Irish milk is below that of its main competitors Both the fat and protein content of Irish milk has improved over the last decade. The average fat content of Irish milk has risen from 3.55% to 3.80%, while the average protein content has risen from 3.20% to 3.28%. However, as the table below illustrates, the constituent fat and protein levels in Irish milk are below not only the EU average, but also well below its competitors such as Denmark, Holland and New 5 Zealand . Table 4 Protein and Fat Levels (2001) 2001
% Protein % Fat
Ireland
3.28 3.80
Denmark
3.41 4.33
Netherlands
3.46 4.44
New Zealand
3.64 4.84
EU Average
3.30 4.12
Source: Eurostat, ZMP National Statistics (2002) Lower fat and protein levels add to the costs of Irish processors, who have to process greater volumes of milk to obtain value ingredients Keane and Fingleton have developed a measure of competitiveness using cost per kg milk solids (% fat and % protein combined). Their research, set out in the table below, found that over the last decade, Ireland has become less competitive relative to its main EU competitors. For example, Irelands production costs using this measure were 52% lower than Denmark in 1989, but this had fallen to only 34% lower by 1999. Table 5 Production cash costs ( per kg milk solids6) Ireland
1989 1994 1999 2.22 2.35 2.59
Denmark
3.38 3.60 3.48
Netherlands
2.45 2.79 2.82
New Zealand
0.85 1.34 2.08
Source: Keane 2002 (Derived from Boyle 2002) The dramatic rise in New Zealand production costs can be explained, in part, by exchange rate changes over the period. There is an inconsistency and variability of milk produced from grass-based production The predominance of grass-based production, and the seasonality of that production in Ireland, results in inconsistency and variability in the milk produced. This inhibits the processors as they attempt to meet the demands of their customers, and the market, for standard products all year round. The table below
The breed of cow used for milk production has an influence on the fat level. In the case of New Zealand they have predominantly gone for a Jersey breed or a cross breed of Jersey & Friesian) which produce s a higher fat content level but at lower milk yield per cow than that obtained by Irish dairy farmers. The NZ industry works on milk solids payment system, where value is got from the % of protein and % of fat, but there is a discount applied for volume. This explains why the industry has moved towards a higher milk fat and lower volume cow.
6
Milk solids = % fat and % protein combined
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illustrates the variance that exists in both protein and fat levels by comparing the months with the lowest and highest levels for 1991 and 2001. Table 6 Irish protein and fat levels (1991 vs 2001) 1991
Lowest monthly protein level Highest monthly protein level Lowest monthly fat level 2.91 3.56 3.39 18.9%
% difference
22.3%
2001
3.02 3.61 3.52
% difference
19.5%
19.3%
Highest monthly fat level Source: CSO (2002)
4.03
4.20
The table shows that over the last decade, Ireland has continued to have a difference of roughly 19% between peak and low months for both fat and protein. This compares with average variations of about 5% in Denmark and 8% in the Netherlands between peak and low months for fat and protein percentage. This difference would suggest that dairy processors in these two countries would have less variation in raw product than Ireland. This should in turn result in more uniform plant extraction rates, and lessens the need for seasonal adjustments to plants to optimise product yields. There has been erosion of Irelands competitiveness in recent years The Irish climate, with its moderate winters, enables farmers to feed their cows on grassland pasture for an extended period, and to utilise silage from the peak grass-growing period as winter feed. This reduces the feed costs for Irish farmers in comparison to their main EU competitors. Teagasc estimates that over 80% of milk produced in Ireland, and almost all used in dairy products, is produced almost exclusively from grazed grass. Research by Boyle et al7, on the competitiveness of Irish dairy farming, found that Irelands cost advantage over seven other EU countries (Germany, France, Italy, Belgium, the Netherlands, Denmark and the UK), has gradually fallen over the period from 1989 to 1999. This loss of competitiveness is due in part to the introduction of maize subsidies and reductions in world grain prices, both of which favour non-grass based production. However, Irelands high rate of inflation has also been a contributory factor. The table below provides data on simple cash costs of Irish producers, but also provides data on economic costs and costs measured as a percentage of output. Economic costs take into account noncash costs such as family labour, equity capital and owned land. Expressing costs as a percentage of output value takes into account the prices received for products sold, and thus factors in higher processing costs and poorer market returns (poorer product portfolio) due to seasonality and low and variable milk solids. Table 7 Irish milk production costs 1989 Milk production cash costs ( per 100 kgs milk) Milk production cash costs (as a % of output value) Milk production economic costs ( per 100 kgs milk) Milk production economic costs (as a % of output value) 15 (82) 52 (89) 31 (96) 111 (108) 1995 16 (82) 61 (95) 37 (103) 139 (119) 1999 18 (90) 66 (100) 37 (105) 140 (121)
Source: Boyle et al. (2002), (Number in bracket is Ireland as a % of EU average) Irelands cash costs per 100kgs of product volume have increased from being 82% of the average in 1989, to 90% at the end of the 1990s Measuring total economic costs per kg, Boyle found that Irelands economic costs per 100kg milk have risen from 96% of the average in 1989 to 105% in 1999. Boyle suggests that measuring costs as a
7
The Competitiveness of Irish Agriculture Updated Edition 2002, Boyle, Brown & ORegan
23
percentage of output value is a more comprehensive overall measure of competitiveness. In an Irish dairying context, it reflects the idea that while milk production costs may be low relative to other EU countries, the seasonality and low milk solids content of milk results in high processing costs and poorer market returns. Using both cash costs and economic cost measures as a percentage of output value, Boyle again found that Ireland has become steadily less competitive relative to EU rivals over t he 1990s, with cash costs rising from 89% of the EU average to 100%, and economic costs rising from 108% to 121% of the EU average. By analysing Irelands costs relative to the other seven EU countries in Boyles research (as indicated by the figures in brackets), it is clear that all measures indicate that Ireland has become less competitive over the decade. Given that dairy producers are likely to face continued price pressure, these rising production costs are now placing producers in a difficult position and one that must be addressed to ensure future viability.
2.3
Issues that need to be addressed at production level
There is a need to ensure that there is a viable future for farmers who remain in dairying The average size of Irish dairy farms is considerably below that in competing countries. The price cost squeeze facing the production sector will accelerate the exodus from dairying, as the value of EU price supports are reduced in the coming years. While the processing sector needs to strive to improve the return it obtains for its output by increasing the value-added content of its products, the value of the increased returns achieved may not be sufficient for the future viability of many dairy farmers, given the strong competitive challenges in the international market place. To obtain a viable income from dairying in the future, farmers will have to respond by a combination of increasing efficiency and substantially enlarging their operations. This will be difficult to achieve in the absence of a radical change in policy on the management of the milk quotas, where currently only small increments in certain locations are available, and the relatively high cost of land. The seasonality of milk supply needs to be addressed Seasonality is a major issue facing the industry, but it is also one that has existed for a long period. How the industry deals with the countrys seasonal milk production will determine, in large part, the type of products produced by the industry and the markets served. Addressing this issue will require cooperation between farmers and processors, and is likely to involve fundamental structural reform. If the industry does not address this issue, it must accept the consequences of the reduced number of opportunities available, and confine itself to products that are low in moisture and capable of storage. Improving fat and protein levels and consistency Irelands low fat and protein levels, and the inconsistency of these levels throughout the year, act as significant disadvantages to the Irish dairy industry as a whole. While initiatives such as the campaign run by Teagasc, have resulted in an improvement over the last decade of 7% in fat content and 2.5% in protein content, Ireland remains well behind countries such as Denmark, Holland and New Zealand. The dairy industry needs to address this issue that many consider to be a fundamental weakness. While the low fat and protein levels add to processors costs, the inconsistency of these levels can cause problems when marketing and selling products. Fundamentally, when processors cannot produce a consistent product year round, they face major problems selling certain products where consistency of texture, flavour, functionality and year round supply are essential. Maintaining Irelands competitiveness There are a number of factors that have reduced, and continue to reduce, Irelands competitive advantage. These factors include the rate of farmer rationalisation and the relatively small scale of dairy farms, both of which are in contrast to Irelands major competitors. The Irish industry is also facing severe price pressure due to poor market conditions, while also encountering rising costs of operations.
24
3. 3.1 3.1.1
Dairy processing structure and efficiency Profile of the processing sector Level of industry consolidation
While the structure of the Irish dairy processing sector has changed considerably over the last decade, it remains fragmented in nature when compared to its major competitors At present, six companies process 80% of the milk pool of 5.338 million tonnes, with this number rising to eight processing 90% of the milk pool. Data for 2001 gathered from processors for this study8, indicate that the four largest processors account for 73% of sales, with the remaining nine processors accounting for just 27%. The pace of overall rationalisation in the Irish industry has been much slower than that of its competitors Despite the reduction in the number of processing companies and plants that has already occurred, the Irish dairy processing industry remains fragmented, and individual processors are of a considerably smaller scale than processors in competing countries such as Denmark, Holland and New Zealand. Evidence of the fragmented nature of the industry is illustrated by comparing the number of processors that account for 80% of the milk pool in these countries. Table 8 Number of companies processing 80% of the milk pool Year 2001 Number of companies processing 80% of the milk Source: Promar and Prospectus research Ireland 6 Denmark 1 Netherlands 2 New Zealand 1
In 2001, the four largest Irish processors handled 3.81 million tonnes of raw milk, compared to Arlas 3.97 million tonnes in Denmark, Friesland Cobercos 5.20 million tonnes, and Fonterras 13.5 million tonnes during the same period. The consolidation within the Danish, Dutch and New Zealand dairy industries has been achieved through the adoption of deliberate strategies to create large -scale international dairy operations. Due to capped production, the European operators have looked to gain economies of scale through the construction of larger plants to replace smaller, older, less efficient sites. The recent announcement that Denmarks second largest co-operative, Hellevad Omegns, is to merge with Arla, will see Arla processing 91% of the countrys total milk pool. In conjunction with this expansion of operations, the company has earmarked 9 plants for closure within the next two years, while at the same time upgrading existing plants to increase throughput and constructing higher capacity new facilities. Like the Danes, the Dutch have also consolidated their processing industry in recent years, resulting in the two major players, Friesland Coberco and Campina, accounting for 82% of all milk processed. These two players have presided over an industry that has seen the number of processing sites decline from 95 to 63 in the period between 1990 and 2001. Meanwhile, the consolidation of the New Zealand dairy industry has, in the main, been at a company, rather than a plant level. (The formation of Fonterra actually came from a base of 15 separate dairy cooperatives as recently as 1992.) This is due to the fact that New Zealand does not have constrained production systems, and new processing plants are generally built to process additional volumes of milk produced. This had led to the development of super-sites that process up to 15m litres of milk per day, that operate together with older, smaller plants. The relatively large number of processors in the Irish industry leads to duplication of effort, particularly of support services such as IT, human resources, finance and management, testing, product development and marketing, and inefficiencies in assembly and processing.
As part of this study, a detailed questionnaire was completed by 13 dairy processors representing the vast bulk of the milk processed in Ireland. The processors were Arrabawn, Carbery, Connacht Gold, Dairygold, Donegal, Glanbia, Kerry, Lakelands, Newmarket, North Cork, Town of Monaghan, Tipperary and Wexford
25
3.1.2
Plant product output volumes
Apart from butter, the number of processing plants in Ireland has not changed very much since 1991 There is limited data available in relation to processing plants, but the table below provides an overview of how the number of processing plants has changed over the last decade. This data is based on information from various sources, including ICOS and data provided by processors for this study, thus it includes smaller plants producing limited quantities of some products. Table 9 Number of Irish processing plants, by product output 1991 1994 1997 11 16 11 n/a 1999 10 15 13 7 2002 10 11 11 7
Cheese 9 12 Butter 20 19 Powder 12 14 Casein n/a n/a Source: ICOS, ZMP, Promar and Prospectus Research (2002)
Average production in both cheese and butter plants has risen considerably over the last decade The most noticeable change in the main product plants has been the reduction in the number of butter plants, falling from 20 plants in 1991 to 11 plants currently, with butter production falling by just 8.6% during the same period. It is also worth noting that while the number of cheese plants has only risen from 9 to 10 over the last decade, production of cheese has risen by 67% in this period. While the number of companies processing the majority of the milk pool provides an indication of the level of concentration and the scale of individual companies that exists within an industry, it is also necessary to investigate other measures of scale. One such measure of scale is the average size of plants, as measured by the average annual production of each product by each plant. Changes in production are taken into account by determining the average plant output as measured by the average annual production for each plant. Table 10 Average output of plants - Ireland (average annual production 000 tonnes) 1991 1994 1997 1999 9.7 9.0 10.0 6.6 2001/2 12.0 11.6 9.9 6.9
Cheese 8.0 7.8 7.8 Butter 7.0 6.7 8.7 9 Powder (WMP & SMP) 17.2 11.8 13.0 Casein Source: ICOS, ZMP, Promar and Prospectus Research (2002)
A significant proportion of the increased average butter production per plant has occurred in the last three to four years, driven by the reduction in the number of plants from 15 to 11. Average cheese production has increased to 12,000 tonnes due to greater use of existing capacity. The figures for powder production are in stark contrast to cheese and butter, with average production falling from 17,200 tonnes in 1991 to just 9,900 tonnes in 2001. However, these powder production figures relate to SMP and WMP production only and do not take into account the use of these plants for the production of other products such as whey powder and fat filled milk powder (no official published production figures are available for these products). Using the data provided by processors for this study on the production of these other products it is clear that processors have switched to producing powders other than SMP and WMP. Indeed, when whey powder and fat filled milk powder production are included (using data from processors) the average output from powder plants is just under 19,000 tonnes per annum. The average production of casein has remained steady at just under 7,000 tonnes for the last number of years.
SMP and WMP only. As published industry data is not available for other products such as whey powder or fat filled milk powder, it is not possible to provide an accurate average output figure with these products included. As resul t the apparent drop in average powder output is deceptive, as it does not include whey or fat-filled powder from these plants.
26
It is necessary to look beyond average plant output and take into account the impact of large or small plants It is important to look beyond simple industry average outputs of individual products. The data on plant size supplied by processors for this study, provides a more detailed picture of the current structure of the industry. The table below illustrates the average output of the two largest plants, based on the data supplied by processors. Table 11 Largest Irish plants Butter
Ireland - average output of the two largest plants (000 tonnes)
Cheese
Powder4 (SMP & WMP)

19.5
Casein
33
24
14.2
Promar and Prospectus Research (2002) The respective plants accounted for 52% of the total butter production in 2001, 40% of the cheese, 36% of the total powder and 59% of total casein production. This suggests that there are already a number of plants within the country of comparable competitive scale. However, there are also some plants producing very small amounts of product. There are also certain product types where scale of production is not the critical factor, but rather product innovation and specialisation, and the ability to produce product output levels that are appropriate to meet the demand for their specific product or market niche. This is particularly true for the production of specialist cheeses and other high value-added products. Denmark has seen strong growth in the number of small specialist operators in parallel with the process of major consolidation of the industry, with one player processing 90% of milk. In the area of the production of commodity type products such as powder, bulk cheese and butter, however, the trend is for larger scale plants to achieve economies of scale and greater efficiency. In determining an appropriate future plant configuration for the industry in chapter 3, consideration is given to both the published data and the information provided by processors for this study, particularly in relation to the production of products such as whey powders and fat filled milk powders. The average output of Irish cheese plants is less than half that in the Netherlands The tables below provide the average plant size for cheese, butter and powder plants in Ireland, Denmark, the Netherlands and New Zealand. Table 12 Average plant size Cheese 000 tonnes
Ireland Denmark10 Netherlands
11
1991
8.0 5.1 11.9
12
1994
7.8 5.6 18.5 n/a
1997
7.8 6.9 19.2 n/a
1999
9.7 6.9 20.8 n/a
2001
12.0 8.9 24.7 31.3
New Zealand
n/a
Source: ICOS, ZMP, IDB, Promar and Prospectus Research, (2002) The figures for average cheese plant size illustrate that while production output in Ireland has increased by 50% over the last decade, both Denmark and the Netherlands have increased by roughly double this, at 94% and 106% respectively. In absolute terms, Ireland, at an average of 12,000 tonnes per plant, is well behind the output levels of both the Netherlands (24,700 tonnes) and New Zealand (31,300 tonnes), although as indicated above, the largest Irish plants are similar in scale to these countries average plant output. While the figures
10 11
Excludes private dairy production All data for the Netherlands for 1991 and 1994 actually refers to 1990 and 1995 respectiv ely 12 1990
27
appear to indicate a smaller scale exists in Denmark, a more detailed analysis suggests that this is not quite the case. Of the 62 Danish cheese plants that existed in 2001, The 14 largest plants accounted for 75% of cheese production, giving an average output of 17,000 tonnes for these plants, with the remaining 48 plants producing only 25% of the total cheese produced. An indication of the specialised nature of some of the smaller plants can be obtained from the fact that 18 Danish cheese plants produced less that 400 tonnes in 2001. While it is difficult to determine the scale of production for bulk cheeses in Ireland, the data suggests that Ireland currently has a smaller scale of bulk cheese production than its major competitors. In chapter 3, section 3.2, consideration is given to research by Teagasc on the efficiency of cheese production in Ireland along with other factors to consider in determining the most efficient scale for the Irish industry. The output from Irish butter plants is also considerably below that of their main competitors Table 13 Average plant size Butter 000 tonnes Ireland Denmark13 Netherlands New Zealand 1991 7.0 3.1 9.9 n/a 1994 6.7 3.4 16.5 n/a 1997 8.7 4.1 19.2 n/a 1999 9.0 4.2 17.5 n/a 2001 11.6 5.7 21.7 35.2
Source: ICOS, ZMP, IDB, Promar and Prospectus Research (2002) The average Irish butter plant output, at 11,600 tonnes per plant, is well behind both the Netherlands at 21,700 tonnes and New Zealand at 35,200 tonnes. The average production per plant for Denmark of 5,700 tonnes is again misleading, given that 3 of the 30 butter plants account for 84% of the total butter production, with an average size of 12,941 tonnes for these three plants, but the largest being quoted as having a capacity of 50,000 tonnes. The figures for average powder plant output demonstrate that a gap exists between the plant product output levels in Ireland, and the plant product output levels in all three countries that Ireland has been benchmarked against Table 14 Average plant output Powder14 000 tonnes Ireland Denmark Netherlands New Zealand 1991 17.2 12.5 7.7
15
1994 11.8 13.4 14.1

16
1997 13.0 18.1 12.6 n/a
1999 10.0 18.9 18.4 n/a
2001 9.9 18.3 16.0 69.6
n/a
n/a
Source: ICOS, ZMP, IDB, Promar and Prospectus Research (2002) The average powder (SMP and WMP only) production per plant in Ireland is just over half of Denmark and the Netherlands, and one seventh of New Zealands. Although published data isnt available for whey powders in all countries, we have used the estimates available 17 to determine the average plant output including SMP, WMP and whey powders. In 2001, the average output of SMP, WMP and whey powder per plant in Ireland was 19,000 tonnes compared to 23,400 tonnes in Denmark, 35,900 tonnes in the Netherlands and 71,900 tonnes in New Zealand. The data above suggests that the current configuration
13 14
Excludes private dairy production Average production of SMP and WMP only it is not possible to directly compare average production of all powders using official data as only published data on SMP and WMP is available in all countries 15 1990 16 1995 17 Whey powder estimates: Irish data based on information provided by processors for this study and includes whey powder and fat filled milk powders, Danish data from FAOSTAT, Netherlands data from Productschap Zuivel, New Zealand data from Statistics New Zealand
28
of Irish processing plants fails to gain the economies of scale, such as reduced capital and labour costs, that are being achieved by its competitors. This is of particular importance in the production of base products such as butter, powder and bulk cheeses, where cost competitiveness is essential. 3.1.3 Efficiency of processors
The downward price pressure facing commodity products over the medium to long term, is driving processors of these products to focus on scale and efficiency To compete effectively in commodity markets, the Irish industry will have to be cost competitive, and will need to obtain the benefits that are available from economies of scale. Scale will also be a key factor in enabling processors to meet the requirements of the buyers of commodity products for their suppliers to be able to supply large volumes. To achieve this scale will require significant capital investment and co ordination between processors at an industry level, to avoid unnecessary duplication of effort and investment. While a more pragmatic approach has been adopted within the Irish industry over the last decade, with greater co-operation taking place between processors regarding cost management (for example, in the area of milk assembly), its fragmented structure and lack of scale still poses major challenges for the industry in the future. A number of processors have achieved progress in operating at outputs levels, which bring them advantages from economies of scale. However, there are still a relatively high number of processors producing small quantities of base products and these operators will find it increasingly difficult to survive unless they switch their activities to more specialised and valueadded products. Data provided by processors indicates that larger scale processors achieve higher margins While many factors influence the margins achieved by processors, the most important factors are the price paid for milk, the product mix of the processor, and the efficiency of the processors production operations. While some exceptions exist, the data provided by processors for this study identifies a strong correlation between scale of the operation and margin achieved, with larger scale processors achieving higher margins. This is in line with conventional wisdom that suggests that increasing the scale of production results in greater efficiencies up to a certain optimal level, after which benefits gained are less than the additional costs incurred. Research by Teagasc 18, illustrated in the graph below, found that the greatest increases in efficiency for Irish processors came from moving from small to medium scale operations. The larger processors have the ability to produce larger quantities of product with improved efficiency that contributes to better margins. Figure 4 Plant scale and fixed costs for powder production
200 180 Fixed costs 160 140 120 100 2.5 5 7.5 10 12.5 15
Scale (tonnes/h)
While some smaller processors are delivering higher margins, this is often linked to the production of higher margin products, rather than more efficient production. The link between scale and margins is made more difficult to determine due to the differing approaches and policies of co-ops and plcs. This difference is between providing returns through a higher milk price, or through increased profits that are either reinvested in the business or distributed to shareholders. A more detailed discussion of the need for scale in the context of the overall future direction of the Irish industry is included in Chapter 3.
18
OCallaghan et al, A Cost Model Approach to Capital Re-Investment Choices for Competitive Milk Powder Manufacture in Ireland, 2000
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3.1.4
Plant capacity utilisation
In order to compare the efficiency of Irish processors with other countries, a number of measures have been used. Capacity utilisation provides an indication of how efficiently plant and equipment is utilised, while raw milk processed per employee captures the efficiency of employee input. It should be noted, however, that measures that rely on reported employee numbers must be used cautiously, given the potential distortions caused by part time employees, and the differences in time of year the data is gathered. Table 15 Capacity utilisation 19 (%) 1991 Ireland Denmark The Netherlands New Zealand 58.7 89.8 90.4 n/a 1997 58.6 91.9 92.2 52.1 1998 60.6 92.0 88.8 51.8 1999 60.2 92.2 91.2 48.1 2000 60.0 92.3 93.6 52.2 2001 60.8 92.3 92.9 n/a
Source: Derived from CSO data, Eurostat (2002)
The capacity utilisation figures demonstrate the negative impact that seasonal milk supply has on the processing sector in both New Zealand and Ireland While difficult to quantify accurately, it is clear that there is a cost associated with lower capacity utilisation that is borne by the processors. Put simply, those with higher capacity utilisation levels are able to make their investment in plant and equipment work harder for them, and produce greater quantities of product. While Irelands lower capacity utilisation enables processors to switch between products in response to short term market trends, it does put Ireland at a disadvantage relative to countries such as Denmark and the Netherlands, which continue to operate plants all year round at close to full capacity. To counter the advantage of those with higher capacity utilisation levels, those with lower levels need to have lower input costs and/or lower overhead processing costs (labour, energy, etc), and/or higher value yielding products, or a combination of all three. New Zealand has countered its lower utilisation levels by having significantly lower input costs, and going for plant scale to handle peak volumes and obtain economies of scale from larger plants. Ireland has also used lower input costs to help maintain competitiveness, but with increasing domestic cost pressures and a difficult trading environment, this approach will become harder to sustain going forward, and the processing sector will have to turn its attention to improving cost efficiencies, and improving the value-added content of its output. This will require some movement on addressing the low capacity utilisation levels. 3.1.5 Raw milk processed per employee
Interpretation of the data on raw milk processed per employee, included in the table below, must take into account the potential discrepancies caused by the collection and make up of employee numbers in each country. However, given the increasing production and large scale of plants in New Zealand, it is not surprising that they consistently process larger volumes of milk per employee. The higher volumes of milk processed in the Netherlands is consistent with the fact that it has some of the largest plants in Europe. Thus, Ireland at 560 tonnes per employee in 2000, is only ahead of Denmark using this measure of efficiency. Given the level of consolidation that has occurred within the Danish industry in recent years, one would have expected a higher productivity but using official Danish figures for the number of employees in dairy processing the raw milk tonnage processed per employee is significantly below that of Irish employees.
19
The capacity utilisation measure used here is defined as (annual milk deliveries)/peak month production x 12
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Table 16 Raw milk processed per employee (tonnes) Ireland

1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 547 521 522 504 505 511 528 532 555 560
Denmark
436 489 458 448 436 440 433 444 439 451
20
Netherlands
60021 n/a 614 663 770 878 894 917 929 881
New Zealand
n/a n/a N/a N/a N/a 1,237 1,202 1,340 1,434 1,120
Source: CSO, Danmarks Statistik, Nederlandse Zuivel Organisatie (NZO), Statistics New Zealand, ZMP (2002)
3.1.6 Role for smaller niche processors While much attention and focus is given to the larger players that dominate the dairy sector in countries such as Denmark and New Zealand, the smaller niche processors also play an important role in the industries of those countries. Examples of two processors that have succeeded through innovation and specialisation are included below. Tatua Dairy Co-operative While arguably operating in the shadow of Fonterra, this small 135 supplier co-op is one of New Zealands dairy industry success stories. Established in 1914, in the past decade the company has paid a premium price to its shareholders for milk by processing it into high value dairy ingredients. Based in the Waikato, the historic home of the New Zealand dairy industry, the company has followed a technology-led approach to the manufacture of dairy ingredients from 100 million litres of shareholders milk annually, and selling these to customers world-wide. 90% of all its manufactured goods are exported. Total annual company turnover in 2001 was 54m. The company states that its success is based around a customer and technology-led approach to generate new product solutions. These solutions see the company re-invest in NPD and research above the New Zealand dairy industry standards. Most of the products are sold through direct trading relationships between the company and its clients. Interestingly, this was also the case prior to the formation of Fonterra, when the New Zealand Dairy Board controlled the export of all dairy products. Thise Mejeri, Jutland Founded in 1988, this small niche player has created a market position through providing higher value branded consumer goods, including organic and Channel Island milk products. Based in the Northern part of Jutland, Thise Dairy markets a wide variety of dairy products through the large supermarket chains, including Irma in Copenhagen. The company is seen as an innovator, and has recently launched a number of new products using Channel Island (Jersey and Guernsey cows milk). In addition to the Danish market, the company also exports goods to Sweden, France and the UK, having recently gaining a listing with Sainsburys for its organic spreads under the supermarkets own-label. The success of Thise can be attributed to its commitment to innovation, and filling a market void left for niche products caused through the consolidation of the Danish dairy industry, driven in the main by Arla (MD Foods). 3.1.7 Infant formula manufacturers
Presence of international infant formula food manufacturers in the Irish market Over the last two decades, Ireland has become one of the worlds leading producers of infant nutritionals. The presence in Ireland of some of the worlds leading infant nutrition manufacturers Wyeth, Abbott and Numico provides an important outlet for milk powder. The recent investment of 88m by Abbott Ireland in its Cootehill facility, doubling its capacity, is a positive sign for the industry, and was achieved against
20 21
Full-time equivalents except 1991; excludes ice-cream plants 1990
31
strong competition from other countries. Indeed, the success of the infant nutrition business in Ireland is an indication of the dairy processing sectors ability to produce the highest quality dairy products that meet the needs of demanding multinational organisations. An indication of the importance of this sector is provided by estimated labour and raw material costs of 226m per annum, with 840 people employed. Up to now, the infant formula manufacturers based in Ireland produced relatively basic products, a large proportion of which was exported outside the EU, with export refunds being important for their international competitiveness. However, in recent years and with increasing potential going forward, the enhancement and extension of these products provides excellent potential to increase the value of these products to the industry. There are also opportunities for processors to work in partnership with the infant formula manufacturers to provide enhanced ingredient solutions. For example, enriched or fortified ingredients to improve the nutrition, well-being and/or health of a wider range of consumers, from infants to the elderly. The spin-offs from these partnerships are not only increased value for the products they supply, but also open up opportunities for the processors to utilise the technologies and skills acquired, to identify other applications and demand niches for enriched ingredients. Recent announcements of significant major expansions in this sector augurs well for the continued expansion and increasing valueadded content of its output. 3.2 Processing structure and efficiency issues Aging plant in need of replacement in the medium term There has been ongoing investment by processors in plant since the last round of significant capital investment, supported by FEOGA funding, in the 1980s. However, there are indications that another round of major capital investment may be required to replace existing plant in the medium term. Over 70% of the processors surveyed as part of this study indicated that part of their current technology was either in need of upgrade, or only adequate for current needs. Some processors are already beginning to find it difficult to meet certain product specifications of their customers with existing equipment. Irish processors selling within EU markets will continue to face pressure from buyers for greater product customisation. Many processors are therefore, likely to need to invest in plant and equipment to hold onto their customers. A number of processors could well come under pressure to upgrade facilities and face difficulty securing and/or affording the funding necessary for the capital investment due to low profitability levels and cash reserves. Increasing costs and compliance requirements placed on processors to meet environmental, food safety and quality demands Processors are likely to continue to face increasing pressure from numerous sources to improve their quality assurance systems so that they will be able to meet the increasing levels of environmental and food safety standards. There are concerns not just about water and energy consumption, but also about effluent discharge and by-product management, in particular. This pressure is not only coming at an EU level through enforcement of existing regulations, but is also being driven down the food chain by consumers and retailers, bringing issues such as traceability to the forefront of the debate. The changes required to meet these environmental, quality and safety requirements will impose major costs on both producers and processors. While some processors have invested in these improvements on an on-going basis, it is likely that some processors will need to make significant investments, imposing a significant cost that will be difficult to absorb. In planning for the future, the Irish dairy industry must continue to be vigilant and to be more proactive in its approach to food safety, quality and environmental standards. There are great risks in this whole area and just one incident could cause significant damage to the entire food industry and the reputation of Ireland as a quality and safe supplier of food products.
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3.3 3.3.1
Product mix of the Irish dairy processing sector Product sales values
Fresh milk products, butter and cheese accounted for over 50% of total sales of the thirteen dairy processors in 2001 The table below is based on data supplied by processors, and shows the average sales turnover breakdown for the thirteen processors for the main product types in 2001. Table 17 Percentage of total sales turnover (2001) Product type % of total sales turnover
Fresh milk products (liquid milk, cream, yoghurt) 17% Butter 19% Cheese 18% Casein 14% SMP 7% WMP 7% Whey powder 2% Whey protein 2% Other (e.g. unprocessed milk, whole & skim milk, choc 14% crumb, functional foods, lactose, alcohol etc) Source: Promar / Prospectus research There were significant variances in the market prices obtained by different processors for their products in 2001 Based on data supplied by processors, the following average prices were obtained for the main product types (excluding fresh products). Table 18 Prices obtained for main product types (2001) Product type Butter Cheese SMP Casein WMP Whey powder Whey protein Source: Promar / Prospectus research Average price per tonne (domestic and export sales combined) 3,030 3,620 2,310 7,110 2,420 710 1,540
There are a number of factors, which can influence the variances in the price achieved by different processors for the same product type. These include the level of product branding, product differentiation (properties, packaging, portions, etc.), the level of value-added to the base product, the proportion of domestic sales to export sales, the distribution channels used, the impact of seasonality (particularly, the time of year products are sold on markets), and the nature of the relationship between the processor and buyer.
3.3.2
Profitability
The table below outlines the relative profitability of the main products. This table is based on gross margin data provided by processors as part of this study. It provides a broad picture of the relative profitability within Irelands product mix.
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Table 19 Relative profitability of main products Gross margin Higher margin products Medium margin products Low margin products Source: Promar / Prospectus research The data received from processors in relation to the relative profitability of Irelands product mix is in line with conventional wisdom. Fresh products such as liquid milk, cream and yoghurt achieve higher margins. Relatively high margins are also being achieved in the high technology end of dairy ingredients for protein fractions and isolates such as WPI and WPH. There is then a significant gap to the products in the medium category, namely, casein and cheese (however, it is important to note that bulk/commodity cheese is generally a low margin yielding product). The products achieving low margins include both WMP and SMP, with butter achieving the lowest margins. The particular product mix largely influences the profitability of the different processors Those processors having a higher weighting in fresh milk products, protein fractions, cheese and/or casein, are achieving higher profitability levels than those processors with a high reliance on butter and SMP in their product mix. In 2001, based on information supplied by 13 processors, the average profitability22 for the processors was 2.7%. The better performers achieved a profit margin in excess of 6%. This compares with 3.2% for Arla, 0.9% for Campina, 3.8% for Friesland and -0.06% for Fonterra. However, those Irish processors who had a product weighting in butter and SMP, accounting for in excess of 50% of their total product sales, achieved profit margins of less than 1% in 2001. The higher the weighting the processors had in these products, the lower the profit margin achieved. 3.4 Changes to Irelands product output mix over the last decade23 Liquid milk Cream Yoghurt Casein (ates) Cheese WMP SMP Butter Product
Irelands current more diversified product mix is reflected in the changes in Irelands production figures for key products from 1991 to 2001, as illustrated in the table below. Table 20 Ireland - annual production by broad product type (000 tonnes) 1991 1997 1998 1999 546 135 97 36 94 46 77 7 10 2000 545 137 96 35 88 46 75 7 10 2001 556 128 120 34 75 48 75 7 10 % 1991/2001 9.2 -8.6 66.7 47.8 -59.0 77.8 -2.6 16.7 25.0
Liquid milk 509 549 559 Butter 140 139 131 Cheese 72 86 92 Whole milk powder 23 34 31 Skim milk powder 183 109 100 Casein (ates) 27 42 42 Chocolate crumb 77 84 75 Butteroil 6 9 8 Cream 8 10 10 Source: Eurostat, IDB, Dept. of Agriculture, ZMP (2002)
An overview of Irelands product mix and that of its main competitors is included in appendix III.
22
23
Profitability measures are just indicators of performance and have to be used with caution, particularly, when looking at cross-country comparisons as there can be many varying factors influencing the declared profit level achieved by a company, for example, levels of re-investment, depreciation policy, tax planning etc. Appendix 4 contains an overview of the product mix of the Irish industry and that of its main competitors
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3.4.1
Comparison of changes in competitor product mix
The Danes and the Dutch have reduced their butter production significantly over the last decade Irish butter production has fallen by only 8.6% over the last decade, compared to a decrease of 35% in Danish production24 and 20% in Dutch production during the same period. During the same time period, the Danes have also increased the production of other products within their dairy portfolio in response to changing market conditions; for example, the production of chocolate milk, buttermilk powder and SMP have increased by 34%, 112% and 138% respectively, while WMP has declined by 19%. Increasing volumes of the Irish SMP production is being absorbed on the home market by the infant formula manufacturers based in Ireland. In relation to Irelands product mix focus, the dairy industries of Denmark and the Netherlands have shifted their production in different directions The Danes have increased production of more consumer-orientated products. This is a result of the dominance of the Danish industry by Arla, and its strategy to become more involved in branded consumer foods. This explains some of the increase in the production of liquid milk products by 71%, crme fraiche by 21%, and yoghurts by 12%. This is not to say that the company is winding down the production of its base or more commodity type dairy products. The growth in products such as SMP is increasingly being accounted for by domestic purchasers (exports decreased by 14%, while production has increased by 138%). The domestic markets for SMP are in the manufacture of added value dairy products for sale within Denmark or for further sale outside Denmark, rather than being exported as a basic product or sold into EU intervention. This trend is mirrored in the Netherlands, where during the past five years, SMP production has increased by 29,000 tonnes (Source: ZMP), while exports have actually declined by 4,500 tonnes (Source: ZMP), suggesting a greater utilisation of the product by domestic food industries that are adding value through the production of consumer and/or added value dairy products. Over the past decade, the Danes have also increased their cheese production. However, within this overall increase, there have been distinct differences in growth between cheese types. Production of semi-soft, semi-hard, hard and fresh cheeses have increased by 87,000 tonnes, while production of soft and extra-hard cheeses declined by 56,000 tonnes. This, again, reflects changing consumer habits that have seen the consumption of semi-soft and fresh cheese types grow at a faster rate than the total cheese market in past years. Meanwhile, New Zealands total dairy production has grown by 12.5% in the past four years, but in the past decade, the relative product mix make-up has differed little, with butter, SMP and WMP accounting for 66% in total output in 1991, and 65% in 2001 This reflects the dependence of New Zealand on products that can be exported to distance markets in Asia, the Americas and Europe, rather than domestic consumer dairy foods markets. This said, the New Zealand dairy industry has invested in consumer product companies in many of these markets, to manufacture consumer dairy food and liquid milk for sale using milk powders from New Zealand. When reviewing the trends in dairy product usage over the past ten years, the largest growth area has been the consumption of cheese During the period, per capita usage has grown by 22%, while butter consumption has remained static, and liquid milk consumption declined by 4.3%. In particular, there has been significant growth in the usage of fresh and softer varieties of cheese, not a traditional strength of the Irish dairy industry. In addition, the growth in value-added consumer foods has driven the demand for SMP with this demand being matched by companies focused on the supply of branded dairy products, for example Arla and Friesland. In contrast, the production of SMP has declined in Ireland in response to declining world (and intervention) market prices and through switching to production of products such as casein. In chapter 2 we will assess future market demand for the different product types. The impact of the product mix changes of the various products is reflected in the margin achieved per tonne of milk set out in the table below.
24
The reduction in Danish butter production may be due to increased production of Kaergaarden a mixed fat product with approximately 75% of its fat content coming from butterfat
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Table 21 Gross value-added from processing per tonne milk (2001) Output value per tonne Country (Sales value / milk tonnage processed) Gross margin per tonne (Value per tonne cost of milk per tonne) 177 per tonne 331 per tonne 208 per tonne 76 per tonne Variance from output value achieved by Irish industry % Variance from output value achieved by Irish industry
Ireland 470 per tonne Denmark 656 per tonne The Netherlands 531 per tonne New Zealand 281 per tonne Source: Promar / Prospectus research
+ 154 per tonne + 31 per tonne - 102 per tonne
+ 87% + 17% -57%
The shift away from butter and towards higher value products has enabled these countries to achieve higher margins per tonne of milk. When reviewing the industry margins achieved by the various dairy industries benchmarked within this study, there is a inverse correlation between percentage of output of base dairy products and the value creation of the industry as measured by EVA. This is discussed in more detail in chapter 3. 3.4.2 Product mix issues
3.4.2.1 Impact of seasonal milk supply on product mix The seasonality of milk supply in Ireland has been discussed as a production issue, but from the processors perspective, seasonality has an extremely negative impact. The inability to store short shelf life products from summer to winter, limits the options available in terms of overall product mix, effectively locking processors into making storable products such as butter, hard cheese, milk powders and casein. 3.4.2.2 Raw product quality The poorer quality and consistency of off-peak supply creates inconsistencies in terms of product quality, and also reduces the competitiveness of processors through poor capacity utilisation and increased storage costs for year round products. All of these factors combine to create tensions and difficulties for processors, when dealing with buyers who are attempting to meet market demands for consistent year round products.
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4.
The value-added by the processing sector
4.1 Dairy industry turnover The Irish dairy processing sector is a significant contributor to Gross Domestic Product, although this has declined in relative terms in recent years The contribution of the dairy processing sector has been measured using CSO figures for turnover from the operation of dairies and cheese making. By comparing this to overall GDP, the table below illustrates that while the absolute turnover from dairy processing has increased over the last decade, its relative contribution as measured by dairy processing turnover as a percentage of GDP, has fallen significantly from 5.57% in 1992 to 2.46% in 2000. This fall is due to the rapid growth achieved in other sectors of the economy, particularly since 1995, where growth in GDP from 1995 to 2001 has been 95%, and not due to a decline in the dairy processing turnover, which grew by 16% over the same period. Table 22 Dairy Processing Turnover as a % of GDP Year 1992 1993 1994 1995 1996 1997 1998 1999 2000 Source: CSO, 2001 GDP (m)25 40,034 43,240 46,503 52,641 58,080 67,098 77,569 89,770 102,910 Dairy processing 26 turnover (m) 2,231 2,206 2,107 2,184 2,375 2,236 2,217 2,279 2,530 Dairy processing turnover as % of GDP 5.57 5.10 4.53 4.15 4.09 3.33 2.86 2.54 2.46
4.2
How does Irelands industry capital and R&D investment levels compare?
4.2.1 The levels of R&D / new product development and capital re-investment in Ireland are quite low in comparison to its major competitors The levels of re-investment and new product development (NPD) by the dairy processing industry have been determined using the data gathered from processors as part of this study. The level of new product development has been measured by calculating research and development expenditure as a percentage of turnover 27. Re-investment by the industry was measured using capital expenditure as a percentage of turnover. Table 23 Irish processor re-investment and new product development levels Measure New product development Re-investment Calculation R&D expenditure as a % of turnover Capital expenditure as % of turnover 2000 (%) 0.17 2.94 2001 (%) 0.18 2.63
Source: Promar / Prospectus research
25 26
Euro figures are calculated by converting Irish pounds to euro at 0.787564 Turnover from operation of dairies and cheese making, (SIC code 15.51), manufacture of ice cream not included 27 Only the investment in R&D by the 13 processors included in the benchmarking survey are included in this comparison. R&D by State bodies or by universities is not included.
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Irelands R&D expenditure is substantially lower than its major competitors The table below compares both R&D expenditure and re-investment rates as a percentage of turnover. The comparison utilises industry data and information on leading companies within Denmark, the Netherlands and New Zealand, as well as benchmark data provided by Irish processors for this study. Table 24 R&D/New product development (2001) compared with main competitors Industry/company Industry Arla Foods amba Industry28 Netherlands FCDF Campina Industry New Zealand Fonterra Source: Promar / Prospectus research Ireland Denmark R&D expenditure (% of turnover) 0.2 n/a n/a 0.4 0.6 0.4 0.6 Re-investment rate (% of turnover) 2.6 4.5 2.8 3.1 2.2 4.829 5.0
The comparison clearly illustrates, that Ireland is lagging behind its main competitors in terms of both R&D and capital expenditure. Irelands R&D expenditure, at just 0.2% of turnover, is well below the 0.4% and 0.6% of leading processors in the Netherlands and New Zealand. Irelands re-investment rate at 2.6% of turnover is also lower than the industry average of 2.8% in the Netherlands (but ahead of the Campina rate), 4.8% in New Zealand and 4.5% of the leading Danish processor, Arla. While there may be some distortion of these figures due to the different definition/classifications of R&D expenditure in each country, the overall picture strongly supports the views of many industry commentators that Ireland is behind its competitors in terms of R&D expenditure and investment. Interviews conducted as part of this study identified criticism from some quarters of the nature of existing R&D expenditure and the overall level of innovation within the dairy sector. Some felt that the Irish industry had too often adopted a me too approach, simply replicating the innovations of others rather than taking the lead. Others criticised the industry for its production-led approach, suggesting that the industry needs to adopt a more market-led approach to innovation, where R&D expenditure is based on identified and validated market opportunities. 4.2.2 Using joint ventures and strategic alliances to boost product innovation
There was also evidence of a relative reluctance to work with buyers on product innovation, a finding that is supported by the relative lack of joint ventures involving dairy processors. Although there are a number of important and valuable exceptions to this, with a number of Irish processors engaged in joint venture or strategic partnership arrangements, compared to companies such as Arla, Fonterra and Campina, the scale and volume is still quite small. The best examples of market joint ventures by international competitors are provided by the recent movement by Fonterra, which has seen the formation of a number of companies to support the marketing of New Zealand dairy products, and sales of products that are produced locally by the various companies. These include: Fonterra and Nestl establish Dairy Partners Americas joint venture In March 2002, Fonterra and Nestl signed an alliance deal that created a joint venture company to operate in North, Central and South America. The alliance will initially employ 10,000 staff and have an annual turnover of 1.4 billion. Nestl will provide technologies in the branded food market and product development, while Fonter ra will use its expertise in on-farm production and dairy processing. The alliance will initially market products into Brazil, Argentina, Paraguay, Uruguay and Venezuela. The venture will include the co-operative processing and distribution of shelf-stable dairy products such as UHT milk, refrigerated milk-based products such as yoghurts and dairy desserts, liquid milk and ingredient milk powders. The deal does not include the marketing of cheeses or butter. Joint venture with Arla in UK butter market Fonterra has formed a joint venture with Arla that sees the European giant responsible for the packaging and marketing of the Anchor brand of butter. The JV
28 29
2000 1999
38
will be 75% owned by Arla, and combines the Anchor and Lurpak brands in the UK market, using up to 76,000 tonnes of butter that is allowed under current quota restrictions. It is also intended that the Anchor range of products could be expanded to include other consumer goods, for example cheeses, liquid milks and yoghurts. Fonterra and Britannia Foods in India NZ Milk, Fonterras consumer products division, and Britannia Foods of India have set up a joint venture to enter the worlds largest dairy market. The new company is based in Bangalore, and will market a wide range of dairy products using Britannias extensive distribution network. It has been estimated that the Indian dairy sector is growing at a rate of 9% per annum, and Fonterra sees this joint venture as one of the best ways of establishing a position within this important market. Fonterra and Dairy Farmers of America The companies have agreed to extend their existing DairiConcepts joint venture. This 50/50 joint venture was established to develop the market for dairy products in Mexico. The extension to this deal will see the expansion of the companys facility to enable the first large-scale production of milk protein concentrate (MPC) in the US, and the manufacture of other dairy ingredients. Fonterra has stated that the establishment of a US source of MPC is an essential step in meeting the needs of its customers in the NAFTA region. Export deal with Dairy America As production of SMP has declined somewhat in favour of WMP, Fonterra has formed an alliance with Dairy America (a marketing company representing US Dairy Coops) to supply SMP for marketing by Fonterra in this region. Fonterra will receive a margin on all sales, avoiding the duplication of resources that has occurred in the past. Meanwhile, Arla has formed a joint venture with the National Food Product Company in the UAE, in addition to its long-established Danya Foods subsidiary in Saudi Arabia. The Middle East market is the largest for the company outside of the EU. This new company will be responsible for the marketing of some of Arlas more westernised products on a consumer base that is willing to experiment with new foods. Within its home markets, Arla Food Ingredients has formed a joint venture with Nordzucker (German sugar company) for the production of the sweetener Gaio tagatose. This facility is expected to be operational from early 2003. This new German investment also demonstrates the companys commitment to invest in new profitable uses for what, traditionally, have been lower value (and in some cases, waste) products from its dairy processing plants. The dominance of both Fonterra and Arla within their home markets has seen them both internalise a large part of the industry R&D capability. This enables the companies to have first option on the development of new technologies, or products from these teams to enhance their own operations, and in some cases, lead to the launch of new products into the marketplace. This level of R&D, new technology application and product development commitment within the Danish industry results in Arla launching 160 new products annually, and dedicated R&D resources of 200 staff. 4.3 Economic value added (EVA)30 The economic value added of the Irish dairy industry has changed very little over the last decade although it has improved over the last five years The economic value added (EVA) ratio used in this study is used as an indicator of the value-added to raw dairy products through the processing and marketing activities of the industry. In other words, the value-added by the industry to each 1 worth of raw milk delivered for processing. For example, the
30
For the purposes of this study we are using a variation of the standard EVA measure, which is calculated using the following formula Net Operating Profit after tax (NOPAT) (Cost of Capital x Capital). This measure is applicable only to individual companies. To develop an industry level type measure we have looked at the value added by the dairy industry to the raw milk it receives. The EVA measure used in this study is calculated by using the following formula: (Total sales revenue/ (average milk price times the volume of raw milk deliveries)). This provides us with cross country industry comparator utilising official industry data. The measure as we have used it, is confined to the value added by activities performed within the particular country. For example, it does not include the value added by Irish owned overseas operations. To include these type of activities would cause major common definition difficulties as to what should and should not be included, it would make it almost impossible to do meaningful cross country industry comparisons and accurate and reliable data is not available to do this.
39
calculated EVA ratio for the Irish dairy industry in 2000 was 1.72. So for every 1 worth of raw milk processed by the industry an additional 72 cent was added in economic added value, which is determined by the sales revenue generated by the industry for its milk inputs. Enhanced values as reflected in a higher EVA ratio, suggests that the industry is able to extract greater value from milk through the particular types of products manufactured and/or the markets serviced. However, it is important to note that the EVA ratio is a basic measure to provide an indication of the level of value -added to raw milk and needs to be used with caution. It is recognised that EVA does not take into account higher manufacturing costs as it only looks at input and output values, but given the major influence of raw milk prices on total costs, a higher EVA suggests higher margins are being achieved. It also recognised that the EVA can be impacted by a lowering of raw milk prices and by price movements for dairy products. Table 25 Economic value added by Irish dairy processing sector
Year 1992 1993 1994 1995 1996 1997 1998 1999 2000 EVA 1.66 1.53 1.46 1.41 1.53 1.58 1.54 1.61 1.72
Sources: Promar / Prospectus research derived from CSO and Department of Agriculture data The EVA by the Irish dairy processing sector has been calculated using the sales turnover for the operation of dairies and cheese making, along with industry milk production and milk prices, using data all sourced from the CSO. These figures include the value -added from enterprises related to dairy processing, such as infant nutrition and chocolate crumb manufacturers, but exclude the activities and contribution of ice cream manufacturers. The EVA of the dairy processors is lower than the industry EVA To determine more accurately the value-added purely by the dairy processing sector, EVA was also calculated using benchmark data provided by the 13 dairy processors who participated in this study. This resulted in an EVA of 1.48 in 2000 and 1.45 in 2001. Comparing the 2000 figure of 1.48 from the data provided by the dairy processors against the industry figure of 1.72, suggests that in 2000, the amount of value-added by the other dairy processors not included in study, such as infant nutrition and chocolate crumb manufacturers, was significantly greater than that added by dairy processors. However, some of the difference may also be due to inaccuracies and inconsistencies between the data gathered by the CSO, and data provided by processors for this study. 4.3.1 Irish EVA compared to that being achieved by its main competitors
Irelands industry EVA is significantly lower than Denmark, and since 1996 has not kept pace with the Netherlands The table below benchmarks Irelands EVA against its competitors, using industry data.31 It is worth noting that the industry EVA figures for each country included below relate to the value -added in each country and do not include the value-added in subsidiary operations outside of each country. Clearly, significant value is added to the dairy output of each country by subsidiary and non-domestic operations but it is not possible to obtain a meaningful comparison of value-added including these operations.
31
The data used for other EU countries relates to the same prodcom / sic code as that used for Ireland ( 15.51 Operation of dairies and cheese making). A similar code from the Statistics New Zealand has been used for data from New Zealand.
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Table 26 Comparison of Economic Value Added (Total sales revenue/(average milk price x raw milk deliveries)) Ireland
1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 1.66 1.53 1.46 1.41 1.53 1.58 1.54 1.61 1.72 n/a
Denmark
2.14 2.25 2.04 2.14 1.98 2.03 2.37 2.39 2.10 n/a
The Netherlands
n/a 1.55 1.46 1.44 1.60 1.78 1.75 1.94 1.80 1.83
New Zealand
2.22 1.96 1.89 1.89 1.96 1.79 1.87 2.04 1.23 1.53
Source: Promar and Prospectus Research (using CSO, Danmarks Statistik, Productschap Zuivel, Statistics New Zealand) The data clearly illustrates that the Danish industry has had consistently high levels of value-added, only falling below 2.0 in 1996. These figures are even more impressive when one considers that the Danish processors have consistently paid a higher price for their milk (11% higher in 2001 ZMP). The figures for New Zealand in the last two years, reflect the changes in commodity prices, upon which they are highly dependent. The output of the Dutch dairy industry has long been regarded as similar to Ireland in being heavily weighted towards base/commodity type products, and this was reflected in similar EVA levels from both industries. However, since the mid 1990s, the value-added by the Netherlands has shown strong improvement (but has levelled off somewhat in the last two years). The Irish processing sector has gradually increased its value-added over the last decade, but remained below both Denmark and the Netherlands in 2000. The strategies and product portfolios being adopted by the Danes and Dutch that are influencing this EVA performance are discussed later in section 5.2 below. The New Zealand EVA, by definition, is influenced by the lower milk price paid by Fonterra for raw milk. However, this said, when comparing Fonterra (New Zealand) with other processors on factors such as return on investment and turnover per employee, they are in fact less efficient than their European counterparts. This is due primarily to their seasonal supply curve that sees plants only operating at peak to trough ratios of 80.5 compared to Ireland at 5.99, Denmark at 1.16 and the Netherlands at 1.14. While the EVA is impacted through the lower milk price, it could be suggested that the profitability of Fonterra has not been overly enhanced through this, as it is at best on a par with that of the other companies investigated. The advantage gained by the low milk price paid in New Zealand is exhibited by the table below, which includes the EVA for New Zealand using the average EU milk price paid. The table would suggest that given its current product and market mix (dominated by base products), the New Zealand dairy industry would be unable to add value to its dairy products if it were required to pay average European prices for its milk. Irelands EVA performance is significantly higher than that of New Zealand if New Zealands EVA was calculated at average EU milk prices and not at the significantly lower prices that prevail in that country. This lower EVA for New Zealand is a reflection of their even greater dependence than Ireland on commodity products and demonstrates the need for European players, including to Ireland to look for product alternatives to base type products to extract greater value and returns from the raw milk processed, particularly, in given that they are operating in higher cost environment and are in a policy environment where market supports and protections are being reduced. Table 27 Estimated EVA for NZ using average EU milk price 1998 0.85 1999 0.96 2000 0.70 2001 0.89
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Higher EVA is linked to the level of base product percentage of total production EVA is higher in Denmark and Netherlands as a result of the different product mixes. In particular, when looking at the percentage of butter, SMP and WMP products, it is significantly lower for these two producers (See table below). Also, there is a greater percentage of milk used in liquid milk products and fresh dairy products in both of these cases, suggesting that higher margins are achieved through these dairy product sales. Table 28 Butter, SMP and WMP products32 as percentage of total milk processed33 Ireland 1997 1998 1999 2000 2001 55.01 53.56 52.78 52.65 47.71 Denmark 23.88 23.68 23.52 23.19 21.80 Netherlands 11.38 13.46 13.44 12.20 12.90 New Zealand 62.66 60.86 61.40 60.54 -
Source: ZMP, IDB, Prospectus/Promar Research The graph below illustrates the relationship between EVA and percentage of butter, SMP and WMP products produced by each of the industries included in the benchmarking exercise. Figure 5 Relationship between EVA and % of Butter, SMP & WMP products
2.4
2.2
Denmark
Netherlands
1.8 EV A
New Zealand Ireland

1.6
1.4
1.2
1 0 10 20 30 40 50 60 70
Butter, SMP & WMP product %
The EVA as calculated, attempts to provide a guide as to the effectiveness of the dairy processing industry to add value to raw milk through its manufacturing and marketing efforts. In essence, this measure is influenced by two factors the cost of the raw milk to the processors, and the value of the sales output. Therefore, it is expected that industries that are able to sell greater volumes of products into
32
In order to compare the impact that the proportion of base products within the total product portfolio has on the EVA ratios of the different benchmark countries, it is important to compare similar type products produce by the different countries. Butter SMP and WMP is produced in all of the countries and the product is broadly similar. However, it is not possible to compare cheese produces, as are major variances within the cheese product category and it is not possible to make plausible cross-country comparisons. For example, the Dutch industry produces large quantities of edam and gouda cheese, which are mainly commodity type products and are not produced to any extent in the other countries. As a result, the only base products we compare to assess their impact on EVA are butter, SMP and WMP. 33 This percentage is calculated using milk equivalence ratios (as determined by the IDF) to estimate the volumes of total milk that are used in the production of butter, SMP and WMP by each industry.
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higher value markets, should have greater EVAs. A more detailed discussion of EVA is included in chapter 3. When comparing the product make-up of the various industries, the reliance of Ireland and New Zealand on butter, WMP and SMP dairy products becomes evident. For example, the production of butter, WMP and SMP 34 accounts for around 40% of all dairy products output from Ireland and just over 60% in New Zealand. However, these same products account for only about 22% and 30% of the output of the Netherlands and Denmark respectively. This product make-up goes some way to explaining the lower EVA level for Ireland, especially, as it is competing head to head with lower cost producing countries such as New Zealand in base product markets. New Zealand, due to its lower cost (and unsubsidised) production system, pays less for milk (18.40 per 100kg vs. 29.22 ZMP 2002), and can pass some of these lower costs on to buyers by means of reduced market prices. Despite New Zealands apparent reliance on butter, WMP and SMP dairy products, its strong EVA is strongly influenced by its lower raw milk costs. Given that butter, WMP and SMP as a percentage of the total production in the Netherlands is much lower than that of Denmark, one might expect a higher EVA for the Netherlands compared to that of Denmark. However, the Danish EVA is significantly higher and this is due to the very high proportion of base type cheese products in the Dutch product mix, which results in a lower EVA than Denmark. 4.4 4.4.1 Value-added issues Comparable margins and levels of profit
In 2001, the operating margins achieved by Irish processors from their dairy processing business ranged from minus 0.3% to 6.7%, with an average of just 2.7%35. These margins are lower than those of Arla and Friesland, which returned results of 3.2% and 3.8% respectively in 2001, but are significantly higher than the results of Campina and Fonterra36. The large variation across the Irish industry suggests that some companies have successfully changed their product mix or manufacturing technologies. However, when analysing profitability it is not possible to isolate a single factor as a range of factors including milk price, investment in R&D and capital expenditure will affect overall profitability. Those Irish processors with low levels of profitability will find increasingly difficult to obtain/afford investment funding. The scale of the investment required, and the individual financial performance of processors will be major influences on their ability to fund future capital investment and as a result, it is likely that some processors will struggle to raise sufficient investment capital in the future. 4.4.2 Increasing cost of doing business in Ireland
While the Irish economy has outstripped other EU countries in terms of growth over the last number of years, it has also had a higher rate of inflation, which has driven up costs and impacted negatively on competitiveness. Irish inflation peaked at 5.6% in 2000. It was 4.9% in 2001, and forecast to be 4.5% for 2002. This puts Ireland at the top of the league table in terms of EU inflation. The reality is that many of the costs faced by the dairy processors have risen in line with the general level of cost increases in the overall economy, and this is starting to impact significantly on their competitiveness. There was recent confirmation of the challenges facing the Irish economy in terms of competitiveness, in the annual policy statement of the National Competitiveness Council, published in November 2002. Ireland is now ranked second highest out of the 16 countries surveyed in terms of wage growth per employee in 2002, with other indicators also pointing to a sharp rise in unit labour costs. Ireland is also second highest for projected growth in unit labour costs in 2002 and 2003. The Council found that, if current trends continue, the EU Commission estimates place Irelands average nominal compensation per employee 13 per cent higher than the EMU average, implying a severe and rapid competitive loss across the labour market.
34 35
Estimates based on IDF milk equivalent factors and volumes of milk processed by each industry. Profitability measures are just indicators of performance and have to be used with caution, particularly, when looking at cross-country comparisons as there can be many varying factors influencing the declared profit level achieved by a company, for example, levels of re-investment, depreciation policy, etc. Also it should be noted, that 2001 was a particularly strong year in terms of profitability in the Irish Dairy industry.
36
Fonterra returned an operating loss of 4.2 million in its first year of operation.
43
Examples of cost pressures faced by the dairy processing industry include insurance, labour and environmental compliance. FAPRI-Ireland predicts that costs such as labour, energy and services will increase by 25% over the next ten years. ICOS recently highlighted the extent of this problem by revealing that some co-ops experienced increases of 125% for the cost of insurance in 2002. They also indicated that for every 100 paid in insurance by an Irish company, the UK equivalent charge would be 34, and only 13 in Holland. Information received from IBEC regarding their members experience would also point to significant insurance premiums increases in recent years. IBEC is greatly concerned that insurance costs are impacting on competitiveness. The evidence clearly indicates that Ireland is gradually becoming a more expensive country in which to do business, and this is impacting on the overall competitiveness of dairy processors. Given rising labour, insurance and energy costs, the challenge for the industry is to determine the means by which it can reduce other processing costs to ensure it remains competitive. 4.4.3 Increasing R&D and product innovation
Given the higher prices that can be achieved in EU markets through effective market segmentation and customisation, product differentiation, branding, etc, to compete effectively the Irish industry will require a greater market and customer focus. A key element in building this market focus is the requirement for continuous re-investment through research and development and product innovation. Benchmarking the Irish industry against its major competitors indicates that, at present, Ireland is well behind in the level of R&D re-investment. The issue for the industry is not simply to increase the overall level of R&D spend, but to identify the type and nature of investment required. The focus of R&D expenditure should fit within the overall strategy and vision of the dairy processing sector, and is likely to involve co-ordination and interaction with retail, food service and industrial purchasers of dairy products.
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5. 5.1
Marketing and distribution 37 How does Irelands export performance compare with its main competitors? Table 29 Volumes exported to each market in 2001 (000 tonnes) Ireland
Butter - UK - France - Germany Cheese - UK - France - Germany WMP - UK - France - Germany SMP - UK - France - Germany 9.1 2.1 4.4 1.3 0.5 1.5 1.6 9.8 8.7 0 0 0 2.5 0.5 1.5 <1 <1 1.0 0.9 0.4 7.7 0 0 0 90.5 4.3 3.8 20.8 7.5 84.1 16.4 49.2 189.3 14.8 0.5 2.5 21.9 18.5 32.9 13.5 1.6 4.3 1.2 25.8 36.0 37.6 0 -0.3
Denmark
Netherlands
New Zealand
Source: ZMP, IDB, Statistics New Zealand, Danmarks Statistik, Eurostat, Productschap Zuivel Within its three major European markets, the Irish dairy industry is well represented in the butter market relative to the industries of Denmark, the Netherlands and New Zealand. The new marketing initiative between Arla and Fonterra within the UK branded butter market, will need to be watched with interest. The two-pronged approach of using Lurpak as a premium brand and Anchor as an everyday offering, could well crowd the market, especially given the proposed marketing support of 40 million for its products in the UK market. When comparing the volumes of cheese traded, the Irish performance can only be considered to be in a strong position in the UK market, with a large percentage of this product actually sold as own label in UK retailers. This is a price sensitive market that is likely to continue to be under pressure from other players. However, as long as the UK market is dominated by cheddar cheese, Ireland should remain well placed to provide significant volumes to this market. 5.2 Inability to influence market prices of base products
Relative to the Dutch and the Danes, Ireland offers significantly greater volumes of butter, SMP and WMP type dairy products to market. Irish butter, SMP and WMP accounts for around half of all production, while these products account for only about 15% of Dutch production (however, the Dutch produce large volumes of base type cheese products) and 23% of that of Denmark. Base or commodity product markets are influenced significantly by world prices and could be even more so in future, if the level of intervention purchasing and export refunds declines, and the production levels of other countries such as New Zealand. Even large-scale producers are unable to influence the market price. For example a study 38 by Finlayson et al (1998) suggested that even if a large player like New Zealand, was to reduce exports by 10%, this would only increase world prices by less than 0.5%. As a result, while good products to produce, the prices received will continue to be volatile in the future. In an attempt to insulate their industry from the impact of declining world prices for base type products, the Dutch and the Danes have set about a strategy of developing and expanding branded dairy products for both their local and near-by export markets
37 38
A profile of Irelands product sales and exports is contained in Appendix 5 Bob Finlayson, Ralph Lattimore and Bert Ward (1998) New Zealands Price Elasticity of Export Demand Revisited. N.Z. Economic Papers 22, pp.25-34.
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Friesland Coberco has established a number of subsidiary companies to market products from its processing facilities. The company currently has ownership of 21 key brands, of which seven are aimed internationally, with another 14 concentrating on regional and local markets. These key brands account for 80% of the marketing investment by the company, and are designed to move the company closer to its end-consumers. One example of this attitude to developing a brand strategy is Frico Cheese, which operates across a number of European markets to develop and promote a range of branded cheese products. This up and coming branded player currently employs over 2,000, and is responsible for the marketing and promotion of Gouda, Edam, Friesian, Leiden and Maasdammer cheeses. Arlas market approach has been similar. The company has entered a number of branding strategies with both retail and ingredient products. It uses the Lurpak brand for butter across Europe, and supports the growth of this product with significant resources. Arlas success has in the past been based around capturing significant amounts of the local liquid milk market, and supporting this with branded dairy foods, including cheeses, butters and added value dairy foods. This is the approach that it has used with mixed success in Denmark, the UK and Sweden. The Irish Dairy Board has packaging, distribution and marketing subsidiaries in the UK, Belgium, Germany, France and the USA. A number of the Irish processors also have dairy subsidiaries abroad, particularly in the UK and the US. However to date, Ireland has few examples of branded dairy food products across a number of markets, with the best known being Kerrygold butter, which is particularly strong in the Irish, UK and German markets.
5.3
Routes to market
There is limited data available on the routes to market or distribution channels employed by the Irish dairy processing sector. However, the Irish Dairy Board (IDB) in its 2001 annual report, has broken down sales of Irish product by product type, and the processors surveyed for this study have provided data for 2001 sales. The figures from the IDB annual report, in the table below, indicate a significant movement away from commodity products towards consumer brands and food ingredients.
5.3.1
Sales of Irish product by market type Table 30 Sales of Irish product by market type
% of sales
Consumer brands Food ingredients Commodity
1990
26 20 54
1996
33 24 43
2001
41 32 27
Source: IDB(2002) (from Teagasc study Strategic Directions for the Irish Dairy Industry in a Freer Market) While there are always difficulties in agreeing common definitions of what is covered by these categories, and the classification of sales into these categories, the overall trend of IDB sales has been away from commodity type products. The consumer brands figure includes product sold under retailer own label.
5.3.2
Sales by distribution channel
Retail is the most important distribution channel for butter The following table of distribution channels employed by the dairy processing sector is based on data gathered from processors and the Irish Dairy Board for 2001.
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Table 31 Sales of Irish product by distribution channel (2001) % of sales

Retail Industrial ingredients Wholesale Further processing Foodservice Other
Butter
45 29 13 7 1 5
Cheese
33 27 14 8 7 11
WMP
19 15 4 58 4 0
SMP
2 59 35 4 0 0
Source: Promar / Prospectus research These figures indicate that retail is the most significant channel for butter, with 45% of sales, followed by industrial ingredients representing 29%. Cheese sales to retail are also strong at 33% but are dispersed across all channels, including 7% in foodservice. WMP sales are predominantly for further processing, while 59% of SMP is sold as an industrial ingredient.
5.4
EU intervention market support
Ireland is a major user of EU market intervention support for butter and SMP The figures in relation to the use of EU intervention as a market support mechanism, indicate that Ireland has relied heavily on this EU support as a means of selling both butter and skimmed milk powder. Table 32 Intervention support for butter (000 tonnes) 1999
Tonnes Ireland Spain Germany UK Netherlands Total 14.6 12.6 8.1 7.7 0.3 54.4 % of EU total 27 23 15 14 0.6
2000
Tonnes 15.5 13,0 0.4 6.7 0 44.1 % of EU total 35 29 0.8 15 0
2001
Tonnes 13.7 4.0 0 1.1 12.9 38.9 % of EU total 35 10 0 3 33
2002*
Tonnes 44.3 31.1 13.3 13.5 12.5 151.5 % of EU total 29 21 9 9 8
Source: Department of Agriculture (* Figures to October 2002) The table above illustrates that over the last four years, Ireland has accounted for between 27% and 35% of the EU intervention for butter, while during this period accounting for only roughly 8% of production. Table 33 Intervention support for SMP (tonnes) 1998
Tonnes Ireland Germany UK Total 38.7 25.6 32.5 102.6 % of EU total 38 25 32 Tonnes 26.2 21.4 17.6 94.1
1999
% of EU total 28 23 19
2002*
Tonnes 38.8 46.3 21.0 148.6 % of EU total 26 31 15
Source: Department of Agriculture (*Figures to June 2002) The figures for SMP also indicate that in the last three years where there has been intervention for SMP (1998,1999 and 2002) Ireland has accounted for between 26% and 38% of the total. This is in comparison to Irelands production, which accounted for between 7% and 8% of total EU production during the same period.
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The data for butter and SMP intervention clearly demonstrate that Ireland has relied much more heavily on this support compared to all other EU countries. Indeed, with the exception of butter intervention in 2002, Ireland has accounted for the largest percentage of intervention in all the years analysed. In the medium to long term, it is likely that intervention support will become less attractive (Agenda 2000 will result in cuts in the intervention prices by 5% each year from 2005/06 2007/08), or indeed be phased out altogether by the EU. Thus, there are concerns about Irelands heavy reliance on intervention, given this likely shift by the EU in the medium to long term away from this type of support mechanism. Effectively, this means that in the future, the Irish industry will need to look for new markets for these products, and prepare for the day when it will not be able to use intervention as an outlet for 30% of its butter production and 11% of its SMP production, as is currently the case. The extensive use of intervention, while pragmatic in the short term, creates a dependency on this form of market support. This dependency reduces the need to seek out and develop products and markets that will provide a higher return than intervention, and the need to develop the customer focus of processors. The fact that there is a less stressful and demanding outlet for their product reduces the need or urgency of the processor to respond to or anticipate customer requirements. Extensive reliance on the intervention system also reduces to need to invest in developing competencies in market assessment, product development, market development and distribution systems. While some view the changes in CAP as a continuation of the current system at lower prices, the fact remains that this market will become increasingly less attractive. Irelands export refunds have risen over the last decade Irelands export refunds for dairy products have risen from 88m in 1991 to 97m in 2000, an increase of 18%. However, differing market conditions have meant that refunds have been as high as 122m in 1992 and as low as 76m in 1998. During the same period, export refunds to Denmark have fallen from 421m to 177m, a decrease of 58%. The reduction in the export refunds to Denmark can be explained by greater sales within EU markets and the change in their product mix. In particular, the shift away from production of feta has helped to reduce Danish export refunds for cheese from 185m in 1991 to just 39m in 2000. Table 34 Export refunds for dairy products (EAGGF / FEOGA) million Ireland 1991 88 2000 97 1991/2000 % 17
Denmark 421 177 -58 Source: Department of Agriculture, Directorate of Food, Fisheries and Agri Business It is worth noting that Ireland still claims fewer export refunds than Denmark suggesting that Ireland is relatively less dependent on third country (non EU) markets. While the use of intervention support and export refunds by the Irish have been profiled, there are other measures available to the European dairy industries. Support systems including pastry support (to encourage the use of butter in pastry production) and casein production assistance are used to differing degrees across Europe. The usage of these various schemes varies from country to country, however, the overall trend is away from these types of market supports. Thus European dairy industries will need to adapt outputs to be more closely aligned to world market prices for all base dairy products. 5.5 5.5.1 Marketing and distribution issues Insufficient customer service ethic
The dairy processing sector has been criticised for not adopting a sufficiently customer focused approach or customer service ethic. As discussed above, the availability and willingness to make extensive use of both intervention and export refunds is also seen as having had a negative impact on the industry, by reducing the requirement for a greater customer focus and the development of more value-added products for EU markets. A number of major customers of the processing sector were critical of the responsiveness of the sector to their needs and requirements. For example, the failure of the industry to address the problems of seasonality is seen by many as a failure to respond to the needs of the market. Part of the challenge for the Irish industry in the future will be the necessity of adopting a greater market and customer focused approach and attitude. This will be of even greater importance to the industry if it
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wishes to focus on more value-added products, where buyers, whether retail, industrial or foodservice, expect their specific requirements to be met. 5.5.2 Threats to Irelands green and clean image
Ireland has a strong reputation internationally for being a green and clean country, which creates a positive image for Irish dairy products, particularly when combined with the natural grassland production. The processing sector has a long track record of producing quality dairy products for international markets. Given the increased focus on food safety, this image is a very powerful asset when selling Irish dairy products. This image is being underpinned by marketing initiatives by processors and organisations such as Teagasc, FSAI and Bord Bia. These initiatives have worked hard to develop the green and clean image of Ireland, and emphasise the natural and pure attributes of its dairy produce. For example, the goal of Bord Bias Ireland The Food Island campaign is to position Ireland as a place where excellent food is produced with uniquely Irish values. The value of the positive green and clean image may not always have been properly utilised and leveraged in generating a competitive advantage for Irish dairy products, and its strategic importance is not always fully recognised and protected. While there has been success in developing brands, notably Kerrygold in Germany where the green and clean image has a particular appeal, the investment required to continue to develop and enhance existing brands, and create new brands, is substantial. Thus, the Irish industry continues to sell large volumes of basic products at relatively low prices, rather than develop and sell greater proportions of consumer products and other higher value products that leverage Irelands positive image and obtain a price premium. There are also concerns that Irelands positive green image is at risk from recent developments and is being questioned by competitors. The continued presence of brucellosis in the national herd, the reemergence of TB and the minor outbreak of foot and mouth in 2001 are all contributing to a dilution of this image. There are also some concerns about the ability of some companies to continue to be able to afford the cost of being in compliance with the ever increasing food safety and environmental standards at both production and processing level. 5.5.3 Sales / marketing / distribution structure
The Irish Dairy Board (IDB), originally known as Bord Bainne, was founded in 1961 to market Irish dairy produce to export markets. The IDB has developed enormous expertise in the marketing and distribution of Irelands main dairy products. IDB has developed an extensive international packing and distribution infrastructure. It provides a vitally important marketing and distribution capacity to Irish processors, particularly, to the smaller to mid-sized processors who distribute the vast majority of their output through the IDB. Kerrygold, its main brand, has been developed over the last 40 years into a major international dairy brand, which is now sold in over 60 countries. Although butter remains the leading product, the Kerrygold portfolio now includes a range of cheeses, milk powders and other diversified products. Since its foundation, the IDB has played a key role in promoting a positive image of the industry internationally. However, the export marketing of Irish dairy produce has evolved to a position at present where Ireland has a sales, marketing and distribution structure that involves significant duplication of effort between some of the larger processors and the IDB. The reality of the current position is that in many instances, Irish processors and the Dairy Board are directly competing in the same markets. There are several reasons why this structure has negative implications for the Irish dairy processing sector. The duplication of effort creates inefficiencies, and puts Ireland at a disadvantage to its main competitors who have integrated marketing and distribution systems. In fact, the creation of Fonterra, joining New Zealands two largest dairy processors and the New Zealand Dairy Board, was justified to shareholders as it was expected to lead to significant savings through minimising the duplication of resources between the parties involved. There is also a danger that this structure can negatively impact communication between buyers/consumers and processors, and delay market signals back to processors. One damaging aspect of this structure is the negative impact of numerous Irish brands and similar product offerings competing against each other in export markets. This adds extra competition in markets where Irish products are already facing stiff competition from local producers and the other major exporters such as Denmark and New Zealand. It also can potentially dilute the image of Irish produce. To give an indication of the levels of support that are required to maintain branded products, Arla has just announced that it spent 16 million to support the Lurpak brand in the UK alone. In the coming year, it expects to spend another 23 million to promote Lurpak Spreadable and Lurpak Lighter Spreadable products in the market. In addition to this amount, Arla is also planning on investing 7 million in Anchor
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branded butter in the UK. Some observers are of the opinion that the increasing costs of brand support in European markets was one of the major reasons that Fonterra signed the joint venture agreement with Arla for the use of the Anchor brand. This joint venture company is expected to increase the range of products that utilise the Anchor brand, and increase sales volumes. 5.5.4 Peripheral location
For the dairy processing industry, Irelands peripheral location and island status puts it at a commercial and logistical disadvantage to its competitors based on mainland Europe. Irish processors face market access costs caused mainly by the additional transport costs involved in getting their product to market. It also has a restrictive impact on the product mix by limiting the number of accessible markets for high moisture or short shelf life products. While advances and innovation in both the transport of dairy products and the products themselves has reduced this disadvantage, it remains a key challenge for the industry.
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6.
Summary of key messages from current industry status assessment and international competitor comparisons
Some of the key messages that have emerged from the analysis of the current status of the Irish industry and its comparison with international competitors are set out below. The picture that has emerged is that of an industry that is facing major challenges due to a combination of external and internal factors. Externally, there is the pressure of increased competition that is being encouraged by developments such as trade liberalisation and EU enlargement. Internally, the industry collectively needs to address its falling competitiveness, and the need for significant change in its output and structure. Ireland has developed a strong dairy industry The industry has made effective and pragmatic use of EU supports develop a product mix, which makes best use of the highly seasonal milk supply. It has developed and expanded its product portfolio moving into higher value-added such as ingredients. It has invested and developed processing and distribution capacity internationally. It has developed a number major internationally successfully enterprises who diversified and expanded their product range. Changes to the policy environment (agreed and predicted) will result in reduced market supports for dairy products, and consequently, lower prices paid to processors and milk producers The twin developments of CAP changes (Agenda 2000 and further planned revie ws) and WTO trade agreements (Doha) will result in intervention price cuts, and likely reductions in the value of export refunds and import tariffs. The effect of these reductions will be felt most strongly in the area of base/commodity type products. But changes in the market supports could provide a needed impetus for processors to change and re-invigorate product mix and change structures at production level. The CAP price support structures encouraged a risk averse to product diversification and development and resulted in the pragmatic large-scale utilisation of milk into butter and powder. The reduction of these supports will necessitate a greater market-led approach by processors to product selection. The future viability of dairying for a majority of farmers is under threat due to the increasing pricecost squeeze, the restrictions on increasing productivity, and their relative efficiency Irish dairy farmers are smaller, less productive and more seasonal in their production than the dairy farmers in Irelands major EU competitor countries Denmark and the Netherlands. The table below illustrates that Denmark and the Netherlands have both consistently paid a higher milk price than Ireland39. The gap between the Irish and competitor milk prices has narrowed over the period. In 1991, the producer milk price was 25% higher in Denmark than in Ireland and 16% higher in the Netherlands. By 2001, the milk price was only 11% higher in both Denmark and the Netherlands. However when analysing differences in milk prices it is important to also consider the impact of other factors such as levels of investment in R&D, capital expenditure and profitability. The milk price paid is just one element in a whole range of factors which need to be considered and should not be viewed in isolation. Table 35 Producer milk prices (/100kg) 1991
Ireland Denmark Netherlands New Zealand 25.05 31.42 29.17 9.0
1997
28.23 30.87 29.17 18.0
1998
27.92 30.80 30.59 13.89
1999
26.66 30.26 26.77 13.65
2000
27.20 30.86 29.98 16.64
2001
29.22 32.47 32.38 18.40
Source: Eurostat, ZMP
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The milk prices used are from officially published prices to enable cross-country comparison. The levels of subsidisation in the different countries, is not taken into account. However, when examining Irish milk prices against Danish and Dutch prices, there is a range of factors, which should be borne in mind, as milk price cannot be viewed in isolation. For example, The Danish and Dutch milk supply is broadly even throughout the year whereas, the Irish milk supply is highly seasonal. Also it would appear that the Irish processors pass back more of the value they receive for their output in terms of milk price. In 2001, the gross margin (sales turnover value less raw milk cost) was 51% in Denmark, 39% in the Netherlands and 38% in Ireland. The output value per of the Danish industry in 2001 was 41% higher than the Irish industry but the differential in milk price was only 11%.
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The future economic viability of Irish dairy farmers will largely depend on their ability to substantially increase productivity and improve cost efficiency. Farmers will have to maximise the output from their land and their cows, and bring them up to levels comparable to those being achieved in major competing countries. Irish dairy farmers also need to achieve the same scale of production levels as the Danish and Dutch farmers. The number of Irish dairy farmers has declined from 68,000 in 1984 to 28,000 in 2001, and is forecast to decline to 14,000 by 2010. However, given the expected increased pressures on the viability of dairy farming, the rate of decline is likely to be greater. There has been a reduction in Irelands competitiveness Ireland is falling behind its competitors in its competitiveness. This is threatening not only the future viability of farming, but also the future viability of many of the processors as well. Significant further change is required in the structure and nature of production to improve overall efficiency and competitiveness. There are significant weaknesses in Irelands processing structure and efficiency Rationalisation of Irish processors has been at a slower rate than that of their competitors, and has resulted in a smaller scale of production for base products, and relatively few small innovative processors focusing on value-added products. A number of processors are producing relatively small volumes of base products, and are not in a position to enjoy the economies of scale being enjoyed by larger operators (both in Ireland and in competing countries), and at the same time, the cost of doing business in Ireland has risen and continues to rise. When this is combined with the downward global trend in commodity product prices, processors find themselves in a very difficult trading environment. There is a need for a change in the industry configuration to create greater specialisation and scale in the production of base products, improve overall efficiency, replace aging plants, and meet the growing demands of environmental, food safety and quality standards. While there has been a continual shift away from base type products further more radical adjustments are required in the product mix There has been a significant shift in Irelands product output, with a decline in butter and SMP and increased output of cheese and casein. Ireland however, is still heavily dependent on base products such as butter, WMP and SMP. Ireland needs to increase the speed at which it is shifting its product mix away from these low margin products. Price competitiveness is the critical factor for success in the international markets for base products such as butter and powder, and the Irish industry is in danger of losing market share if it does not respond aggressively and quickly to the need to maintain and enhance its competitiveness Given the generic or commodity type characteristics of these products, the key focus of processors operating in this product segment has to be on process and cost efficiency. Therefore, everything that affects or that can improve the cost efficiency of processing is of vital importance to the industry. Costs need to be tightly managed, and constantly scrutinised to identify waste and efficiency improvements. The major competitor countries (Denmark, Netherlands and New Zealand) have adopted a number of aggressive strategies in their ruthless pursuit of efficiency and cost competitiveness on international markets. The Irish industry needs to be equally driven in its focus on price competitiveness. The Irish dairy processing industry is adding relatively less added value to its outputs compared to its competitors When compared to countries such as Denmark and the Netherlands, the Irish industry has a lower level of economic value-added. (However, it would have a higher EVA measure than New Zealand if the added value of its output was measured using average EU milk prices). This reflects Irelands higher weighting of base products and the low levels of capital reinvestment and spending on R&D and product innovation, that ultimately, results in lower margins and lower profits. Developing a strategy whereby Irish processors can increase the value-added to dairy products, is a fundamental requirement for the future success of the industry.
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The Irish dairy sectors marketing and distribution structures will need to adapt as Irelands product mix continues to change Ireland is dependent on export markets for its dairy products, so the efficient and effective marketing and distribution of these exports is vital to the industry. The current marketing and distribution structure is sub optimal, and faces significant challenges. The structure has evolved to a position where there is significant duplication of effort between individual processors and the Irish Dairy Board. It can also be argued that the Irish industrys reliance on supports such as intervention have somewhat reduced the customer service ethic. As the industry changes its product mix, the marketing and distribution structure must adjust so that the structures are appropriate to the needs of the different routes to market and the products being supplied. In meeting the challenges summarised above, the Irish processing sector needs to develop its own unique strategy best suited to its requirements and industry strengths, rather than simply trying to follow similar strategies to those of either an Arla or Fonterra Both Fonterra and Arla represent companies that have set about dominating the raw milk supply of their respective countries. The rationale for doing this varies in the detail, but in essence, it is about maximising profitability through the collection and processing of large volumes of milk to capture plant economies of scale, and to be key (dominant) players in home markets to enable a degree of market power to be exerted. Even though there is a degree of similarity between the approaches, their actual situations are quite different. Arla has to operate within a confined (quota controlled) supply system, forcing them to consolidate their operations around two prongs one the creation of added value products, and the other the cost reduction of base product production. This has meant that Arla has quickly moved to close smaller base dairy product processing plants, demonstrated by its current planned plant closures in both Denmark and Sweden. At the same time, the company is investing in technologies for added value dairy products, from consumer to functional foods. They are developing scale operations in these areas as fast as they can, as the time from niche product to lower value mass produced food in the European dairy sector is very short. Fonterra has two distinct advantages low cost milk (18.40/100Kg compared with 29.22/100Kg milk in Ireland ZMP 2002) an input price differential of over 37%, and a non-quota production environment. The combination of these two factors has seen the company encourage increased milk production within New Zealand, enabling both processors and producers to capture economies of scale. This has resulted in large increases in the average herd size within New Zealand, and, despite its distance to market, ensured an ability to compete on price in the base dairy products on the international market. It is difficult for Ireland to follow the Fonterra example, as milk production quotas are currently fixed, and there is a degree of inflexibility in transferring and consolidating the production into areas that are geographically best suited for milk production. This restricts the ability of producers to capture economies of scale, and the benefits from more cost efficient production locations. It also lessens the ability of the processing industry to take advantage of lower collection costs from having a smaller number of farms in tight defined areas of the country. In addition, the market for base dairy products is becoming increasingly competitive, and the continued sale of these into intervention markets is unlikely to yield high returns. Similarly, following Arlas example would also have implications for the Irish dairy industry. The large markets of Europe are more easily accessed from Denmark. Arlas home market expansion strategies in Europe have involved developing a presence in the liquid milk market. Irish dairy companies have already tried this strategy in the past, in the UK at least, without success. To follow the Arla lead would require heavy investments in consumer brands and a wider presence in the European liquid milk market and given past experience in the liquid milk market, this could be difficult to achieve. Ultimately, the Irish industry must learn from the experiences of its main competitors, rather than simply replicating any one of their strategies. Chapter 2 identifies the market opportunities available to the Irish industry, and chapter 3 outlines the strategies that are most appropriate to enable the industry to take advantage of these opportunities.
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Chapter 2 Market developments and future market opportunities Contents 1. Market development within the international dairy sector 2. Drivers for changing dairy demand within the zones 2.1 Product types 2.2 Changing population levels 2.3 Changes in distribution channels 3. International dairy markets 3.1 Trading zones 3.2 Fonterra: an example of a player using international trading zones 4. The Afro European zone 4.1 The north south divide within the zone 5. Changing market opportunities 5.1 5.2 5.3 5.4 Western European markets Emerging markets of Eastern Europe Middle Eastern North African markets Other international markets Mexico, USA, China 75 68 66 63 Page 55 57
6. Strategic market options for the Irish dairy processing industry 6.1 First step 6.2 Second step 7. Global market opportunities for Ireland 7.1 7.2 Key market opportunities for Ireland Fast growing market opportunities
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8. Summary of key messages from the international market opportunity review
82
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1. Market development within the international dairy sector Dairy products are one of the few foods that are consumed by all sectors of the international community. That said, at the moment, the type of product varies greatly from one region to another, as does the per capita level of consumption. In developing countries, the market is dominated by milk powders; in developed markets, such as Europe and North America, a greater and ice cream, is consumed. As economies develop and consumers become more affluent, however, the mix of consumed dairy products will become more varied, and include an increased volume of value -added products. This is already happening in Europe, where the volume of goods sold is decreasing, as consumers consume more added value, luxury dairy products at the expense of fluid milk; but the value is rising. The Northern Hemisphere markets are also home to the large players of the dairy food industry, including companies such as Danone, Nestl and Kraft. Local dairy industries, from producers to processors, have developed within these affluent markets, and now produce a wide range of dairy consumer foods that meet evolving market demands. While these products are high value, many of them, (e.g. yoghurt), are made using much smaller quantities of milk than, for example, cheese, butter, or dairy ingredients. These higher value products are usually required to be fresh, and in many cases have short shelf lives. When reviewing international dairy markets over a period of time, it is possible to determine a series of development cycles relative proportion/volume of added value dairy foods, such as yoghurts, dairy desserts to dairy consumption, processing capability and production. To assist in the understanding of this situation, the following framework has been constructed. The level of demand for various types of dairy product tends to follow the nature of the consumer, distribution and competition base in any country. These bases are closely related to the prevailing level of economic development, as a major factor of consumer freed om and affluence. It is possible to argue, for the purposes of this report, that all countries follow the same basic pattern of economic development (albeit with regional variations) that takes place across five stages from most economically disadvantaged to the most developed. The process is a succession of lifecycles, as represented below: Figure 6 International dairy sector development
Stage 1 Less developed
Dairy consumption patterns Low dairy consumption Mostly liquid and fresh Low value-added Key dairy industry characteristics: Small fragmented herds Small individual holdings Cottage in nature Technologically deficient Dairy consumption patterns Value consumption Functional/ised Local supply mostly fresh
Stage 5 Re-invention
Key dairy industry characteristics: Decline in local production Decline in local processing Imports of commodity Imports of ingredients
Major product lines: Local produce
Major product lines: Luxury products Functional/ised Speciality and niche
Dairy consumption patterns Increasing consumption Imported dairy products Powder UHT
Key dairy industry characteristics: Indigenous industry is small Excessive fragmentation Stagnant herd numbers Cool chain developing
Dairy consumption patterns Volume consumption stagnates and even declines Value-added products dominate
Major product lines: Powder UHT Cheese
Stage 2 Developing
Major product lines: Powder (decreasing) UHT (flat) Fresh milk Cheese Butter Dairy consumption Key dairy patterns industry characteristics: Increasing consumption Sizeable dairy herds Added value products Large retailers emerge UHT Cool chain developing Fresh liquid Cow numbers decline
Key dairy industry characteristics: Increasing local production Investment in processing Imports decline Cow numbers decline while yields p/c increase
Major product lines: Luxury products Value-added Fresh Some UHT in value-added
Stage 4 Advanced
Stage 3 Developed
2002 Promar International
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Stage 1 represents countries still in the very early stages of economic development. These countries are typically less industrialised, with a very fragmented economy and prevailing rural population. Dairy consumption may or may not be large (depending on the country), but is necessarily local in terms of production. Importantly, cow milk may not be the basis of the industry, with large volumes of milk available from other species including buffalo, goats and sheep. Dairy production is mostly cottage in nature, with most basic processing to suit local needs (butter, cream, curds etc). Street trade and loose vending dominate. In most Stage 1 countries, consumption is concentrated almost exclusively around centres of production; pan-national dairy trade is almost non-existent. Stage 2 depicts industrialised market economies that are opening up to world competition In these markets, systems and individuals have greater freedom, companies are often privatised and restructured, and individuals are encouraged to set up businesses. The drivers of this intense phase are political and social. Increasing affluence leads to an increase in consumption of dairy products, generally based on liquid milk products with some increase in preserved dairy products, including cheeses. The local dairy industry cannot normally cope effectively with this increase in demand (be it for reasons of infrastructure, capacity or technology). A clear lag develops between growing consumption and undersupply by the local dairy productive sector. As a result, imports proliferate, especially in the form of powder for reconstitution into liquid milk and UHT dairy products. In time, inward foreign investment in technology and infrastructure at both a production and processor level encourages the domestic sectors growth. Stage 3 represents markets that have successfully moved through stage 2, and need to refine their industrial base as the level of competition intensifies Accessing new technologies and new methods/systems to remain competitive is critical to avoid slow down in the economy. Generally, these markets have cheap access to imports, and successfully sell their products into markets that are not protected by tariffs or other trade barriers, or where they are able to compete on cost against more expensive Western commodities. At this stage, dairy production becomes industrialised, with volume output prevailing. At the same time, local consumers are becoming more discerning as a result of increasing affluence, with a noticeable shift to value-added products. Importantly, countries become mostly self sufficient in liquid milk. Stage 4 markets are well developed economically, with a pronounced shift towards a service economy (as opposed to a conventional industrialised one) At this stage, access to a new dairy product idea, concept and brand is more business crucial than simple access to the ingredient base or processing capacity as such. This becomes particularly clear as volume consumption stagnates, and food assumes new roles beyond basic nutrition. At this stage, dairy products are particularly vulnerable to decline in volume consumption as substitutes proliferate. Excess production of basic dairy commodities is exported, thus facilitating overseas expansion (NZ). In some markets, most notably the EU, governments strive to limit dairy production in some shape or form. On a company level, new product development in the areas of packaging, flavour and so on to maintain consumption, underpins moves to increase the value-added components of basic dairy output. This is the area into which the majority of Western European markets currently fall. Stage 5 This stage is more difficult to characterise as it represents the future It is envisaged that at this stage the population will be self reliant and assertive, having seen the government withdraw most of its support. Economies will be totally driven by technology and service. The mass market, as we currently know it, will disappear, with many fragmented niches emerging. In particular, income disparities will increase, polarising the indigenous population into the haves and the have nots. Importantly for dairy products, overall consumption will continue to decline, while the total sector value will continue to increase. Clearly, this means a massive shift to value-added products, away from commodity ranges. Success within these sectors will be dependent on providing product solutions for consumers. Within this solution provision aspect of the market, issues such as packaging and route to market will become more and more important. It is likely that similar products will be increasingly differentiated, to meet the demand of diverse consumers, utilising a range of distribution options (retail, foodservice, vending, home delivery). Running parallel to the increasing affluence of consumers is the increasing production costs of dairy products within these markets. In many cases, the cost of resources to the productive sector especially
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labour and land result in higher priced base dairy products. This creates a situation where local production of dairy products becomes uncompetitive. This can force a consolidation of the industry in an effort to reduce per unit production costs through economies of scale. Another response is for the local industry to concentrate on higher value dairy products, where margins are great enough to offset production costs. This creates opportunities for the importation of base dairy products for use as ingredients in manufactured food or unbranded (own-label) retail products. 2. 2.1 Drivers for changing dairy demand within the zones Product types
As mentioned earlier, the primary driver for changing consumption patterns in dairy products is consumer affluence Increase in consumer spending power is generally closely related to increasing employment levels, and decrease in the amount of leisure time. This includes time available for cooking. Living patterns are also changing, with the rise in single occupancy households and a decline in cooking skills. The net effect of these changes is a greater demand for convenience. When this move towards convenience is combined with greater spending power, two results are seen: a greater demand for higher value luxury items, as a greater number of consumers have the ability to pay for such products, and a move towards more convenience orientated food products as consumers are prepared to pay others to undertake food preparation for them. As a result, the dairy sector has witnessed a growth in manufactured food items at the expense of base dairy products; for example, ice cream consumption relative to butter. Austria provides an example of how this transition occurs. Although westernised, it has experienced significant consumer spending growth since joining the EU in 1995. The World Bank now rates consumer spending at $US24,970, comparable with Ireland at US$25,520. In the period since 1995, there have been significant shifts in the pattern of dairy product consumption. In summary, per capita consumption of milk has declined by 1.2% from 65.29kg to 64.53kg (RTS Associates and US Census), while during the same time total cream consumption decreased by 11.5% and ice cream grew by 1.8%. When reviewing dairy product consumption changes with consumer affluence growth across a wide range of markets, the following trends are identified: Figure 7 Changes in product usage
As consumer spending increases, cheese consumption appears to be the major dairy product beneficiary Even in markets that are considered to have high levels of dairy product consumption, for example France, cheese consumption has continued to rise in the past decade. In fact, within the French market, cheese consumption has grown by 10% to 21.6kg in 2001 (ZMP). However, when looking at the cheese market in particular, its growth within more affluent markets appears to be limited to soft and fresh
Product usage
Cheese
Butter
SMP
WMP
Affluence growth
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cheeses at a retail level, rather than semi-hard cheese varieties, including cheddar. This should be of concern for semi-hard cheese producers. There has also been growth in SMP usage, particularly as an ingredient in consumer dairy foods Historically, large volumes of SMP have been used in the production of animal feeds in the developed markets of the EU, even to the point where inclusion rates of the product in calf feeds was regulated by central government. Apart from the widespread usage in animal feeds, SMP is increasingly used as an ingredient in the production of consumer dairy foods, including yoghurts, dairy desserts and some cheese production. Consequently, the growth in luxury and consumer foods has resulted in larger quantities of the product being used in goods for human consumption. Increasing demand for added value dairy products is driving the growth of SMP usage in affluent consumer markets. This is best demonstrated in Denmark and the Netherlands, where high production and consumption of consumer dairy foods has resulted in SMP production increasing, albeit from a low base, by 138% and 37% respectively over the past decade, while at the same time exports have decreased by 14% and 38%. The increase in SMP production in the Netherlands in 1998 to its current level may also be related to the reduction in cheese production in that year in order to achieve an increase in cheese prices. Butter consumption in western markets has been mainly static or falling Butter has been the mainstay for many dairy industries, and is seen as a staple ingredient in Western breakfasts. However, in recent years, changing eating patterns, including the increase in breakfast cereal usage, has seen a reduction in retail butter sales across most advanced dairy markets. Also impacting on the popularity of the product has been concerns about its higher fat content, and the suggested link between butter and increased cholesterol levels. At the same time as these concerns were being expressed, many margarine and butter-like spreads have been entering the market, and positioned themselves as healthy alternatives to butter. A number of these products are also produced by leading food companies (Unilever with Flora), and these products are supported with large advertising and marketing (A&M) budgets. Margarine products have also been targeted at younger health-conscious and time-constrained consumers who have welcomed the opportunity for a butter alternative. Even in traditional butter markets like the UK and Ireland, consumption has fallen by 5% and 2% (ZMP 2002). However, butter is fighting back, and after a decade of declining demand, the launch of lower -fat butters is arresting this fall, and they are now taking sales from margarine. While this is positive, the actual quantity of yellow fats in these products is reduced compared to traditional butters, and as such we could expect to see butter sales remaining relatively flat in the future. Within the last year, the UK market alone experienced a decline of 4% (to 1,184mn) in block butter sales, while dairy spreads increased by 5.4% (to 317mn) and functional spreads by 18% (to 28mn). At the same time, margarine sales showed only a modest increase of 2% to 907mn (Independent Retail News 2002). With the increasing focus on healthy diets, lower fat, functionally based spreads can be expected to grow further. Butter is increasingly being used as an ingredient product in the manufacture of bakery and confectionery products (driven in part by the subsidies available for its usage), which are later sold through the retail sales channels. This area of sales is expected to offset some of the loss in retail sales of block butter. Declining WMP WMP has primarily been used as a product for reconstitution into liquid milk products. The greatest use of WMP is in hot country markets where local production is unable to meet the demand of increasing dairy consumption. In advanced markets, the usage of WMP relative to fresh liquid milk is small. As consumers become more taste-conscious, there is increased demand for fresh liquid milk products, and as a result the demand for WMP has declined.
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Key points While absolute consumption values vary between markets, the trends in product usage remain consistent, and it is these that are critical to the understanding of the market opportunities in the future. The critical factors are that as markets develop:

2.2
Cheese consumption increases especially in the softer and fresh cheese varieties SMP increases, but at a slower rate than cheese Butter consumption is static (at best) WMP usage declines Changing population levels
Changes in consumer affluence impacts on the relativity of the product mix within individual markets The change in population levels increases or decreases the total volumes of dairy consumption in the individual markets. In Western European markets, most populations are not predicted to increase significantly, in terms of total numbers. This is a result of declining birth rates, with the major trend being the increase in the age of the consumer. Table 36 Estimated changes in population
Country
Population 2000 (Millions)
Population 2015 (Millions)

8.0 10.3 61.6 80.0 59.7 38.8 9.4 9.9 3.8 32.1 80.7
Average annual population growth rate (2000 2015)

-0.1 0.0 +0.3 -0.2 0.0 0.0 -0.4 -0.2 +1.8 +2.9 +1.6
Austria Belgium France Germany United Kingdom Poland Hungary Czech Republic United Arab Emirates Saudi Arabia Egypt
8.1 10.3 58.9 82.2 59.7 38.7 10.0 10.3 2.9 20.7 64.0
Source: World Bank, 2002 From this comparison, the population growth in the Middle East and North Africa is dramatic, and will provide an increased market for dairy produce. The growth in Egypts population and increasing consumer affluence is expected to create demand for an additional 94,000T of cheese, 28,000T of butter, 2,300T of WMP and 3,700T of SMP annually in the next 15 years. 2.3 Changes in distribution channels
Further complicating market opportunities in the future is the changing market channels In the past ten years, the role of foodservice distribution has grown, and is currently estimated to account for between 30% and 40% of all food sales 40 within the almost 800bn Western European food market. The growth in retail sales and foodservice are in response to changing consumer purchasing patterns that result, on the one hand, in less time spent in the preparation and eating of food, and increased variety of food recipes on offer. Factors driving this include the move towards greater female employment, the increase in working hours, and the rise in single person households. This combination has resulted in a greater demand for out-of-home eating and pre-prepared foods (for example ready meals). Growth in convenience eating has meant that the sales of ingredient products at retail level have declined significantly. For example, across the EU, the sales of culinary fats and oils used primarily for in-home
40
Promar International reports into the European foodservice market, 2002 estimates.
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preparation of meals has declined by 0.2% during the past 5 years (RTS Associates), while during the same period, sales of processed and packaged foods have increased by 5.4%. To demonstrate the impact of these changes the following table estimates the changes over the next 15 years in the relative strength of the various sales channels across some selected Western European markets for cheese. Table 37 Changes in sales channel by country Country
United Kingdom France Germany Sweden Italy
Year
2002 2015 2002 2015 2002 2015 2002 2015 2005 2015
Industrial %41
17 25 5 6 7 20 10 20 5 15
Retail %
60 45 60 58 69 50 70 55 70 55
Foodservice %
23 30 35 35 24 30 28 30 28 30
Promar International trade estimates Across all markets reviewed, there is a trend towards greater use of dairy products in industrial and foodservice channels at the expense of retail The speed of this transition away from retail is very dependent on the products and the markets concerned. For example, in France 42, where cheese sales are steeped in tradition and dominated by specialist cheese counters and retailers, change will be slow. Meanwhile, in the UK, where pre-packed mild cheeses sold through multiple retailers dominate the market, change is likely to occur at a faster rate. The changes in distribution by sales channel have a large impact on product usage, and in the case of the UK, it is predicted that while there will be an overall increase of 87,000T annually over the next 15 years, the retail sales channel will actually lose 42,000T, while industrial use will increase by 65,000T and foodservice by 64,000T. This has serious consequences for branded retail products, as they appear most at risk from the changes to the market channels. The arrest of this decline in volume will be dependent on gaining market share from other competing brands, with this most likely to be achieved through large investments in A&M a costly strategy. 2.3.1 Changes in retailing Increasingly, retailing is being dominated by large multi-national players These include Wal-Mart with its operations on both sides of the Atlantic, and pan-European operators such as Auchan and Royal Ahold. The size of these operations results in the retailers having the ability to exert enormous purchasing power, and place downward pressure on price. Together with this downward pressure on price, most retailers are also keen to offload costs onto suppliers. Strategies to do this include the requirement for joint funding of A&M, through to involvement in new product development (NPD) to assist the retailer to achieve market differentiation. With the scale of multi-national retail operations, suppliers into this format are increasingly asked to be category managers, responsible for the provision of the full range of dairy products, from fresh milk through to added value dairy products, often in branded and own label ranges. As a result of this requirement, suppliers must have sufficient scale and product portfolios (or distribution access to products) to meet this demand 365 days a year. This poses difficulties for a number of dairy processors.
41
Industrial uses of dairy include processing into food products for later sale. This includes pizza and bakery products that can be sold later through retail. Retail is for direct product sales only.
42
Hard cheeses only (excludes soft and fresh cheeses)
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Requirements for successful retail supply:

The ability to access a full product range, and ability to manage a dairy category Sufficient scale to supply products required Ability to innovate to create product solutions for retailers Financial resources to assist in joint marketing campaigns
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Retailers are also facing competition from foodservice outlets, with many looking to adopt formats that enable them to access the growing out-of-home eating market through the provision of ready meals and eating facilities. Across Europe, there is a wide range of business formats being adopted to provide market segmentation for multiple retailers The growth of the hard discount format that dominates the German retail market is expected to spread across Europe through the expansion of companies such as Aldi. At the same time, operators including Wal-Mart and Tesco are also expected to expand their formats across European markets, while other players will continue to move their offerings upmarket to capture the aspirational consumer who is prepared to pay for quality attributes. The end result will be a repositioning of some individual retailers as they attempt to carve out a market niche for themselves. There will be opportunities for existing (and potentially new) suppliers to these multiples to supply products in their expanded markets. 2.3.2 Changes in foodservice During the past decade, foodservice sales have increased at a rate of between 2.5% and 5%, with some variation between countries, but on the whole at twice the rate of retail food sales growth This has been in response to changing consumer demands for more convenience, and the rise in the snacking or grazing food culture. The growth is now beginning to slow in some markets, in particular Germany, while others such as Italy are growing rapidly. This variation is expected to continue into the future. It is often commented that the retail food sector is becoming increasingly consolidated and competitive; the same is true of foodservice. Even countries with fragmented foodservice industries, for example France, are seeing an increase in more organised distribution channels. This will create purchasers of greater power, who will place greater demands on suppliers. Currently, suppliers to the foodservice market need to concentrate on the following issues:

Flexibility the ability to supply what is required, when it is required, to a service-demanding customer Consistently high quality product and service Establishment of long-term supply relationships Reliability
In the future, the bases of competition will be:
A focused approach specific products for foodservice, not just another outlet for retail products. (This is best demonstrated by the investments in new cheese technologies for foodservice by some Irish dairy processors) Targeting of key accounts with dedicated resources this channel is expected to be larger than retail by 2015, so requires at least as much effort Push into high value areas. Suppliers will be increasingly asked to provide customised bespoke solutions based on in-depth understanding of operators needs The marriage of R&D with in-depth customer/channel understanding and commercial astuteness Increased product flexibility.
43
Within the UK there is a trend towards the use of category management by large multiple retailers (e.g. Asda).
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2.3.3
Changes in industrial uses
Historically, the industrial and food manufacturing uses of dairy products were limited. However, the rise in out of home eating has resulted in significant growth of the prepared foods markets up by 45.5% (RTS Associates) across Europe in the last six years Other areas of convenience foods, for example sandwiches, have increased by 49.6% during the same period, and pizzas by 12.4%. These products are accounted for by what is termed the industrial sector, as they are manufactured by specialist food processors for sale as branded and own label products through the retail channel. Like foodservice, this channel is becoming increasingly specialised, with the requirement for product solutions by dairy processors to meet the specific demands of the manufacturing processes involved. In the future, the bases of competition will be similar to those of foodservice:

A realisation that this is a distinct market, with defined requirements, not repackaged retail products Solution provision and a need to work closely with clients to match demands Willingness to supply tailored and differentiated products that are customised for a particular customer Ability to supply consistent quality when and where required
When reviewing the market channel changes, one factor remains retail is decreasing in importance in volume terms, while industrial uses of products and foodservice continue to account for larger shares of dairy usage. Retail branded consumer goods While retail branded dairy products is a key area, they are facing significant challenges. The mature retail market for dairy products (in total) is resulting in the need for constant product innovation to drive increased sales values. The resultant investment required for new product development (NPD) is large. Conversely, suppliers of branded retail dairy products (butter, cheese) are being forced to spend ever increasing amounts on advertising and marketing to maintain sales volumes. As an example, it is reported that Arla invests between 16m and 23m annually to support the Lurpak brand in the UK alone. In future, the trade off will be between increasing investments in NPD, or ongoing A&M spend. This decision will need to be made in light of the specific markets in which the product is positioned; for example, the ongoing investment in weaker brands in declining markets may indeed be questionable.
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3.
International dairy markets
Despite the seemingly considerable value of the global dairy market per se, the intercontinental trade in dairy products is fairly limited Most trade takes place at the intra-regional level, often within the major trading blocs such as NAFTA and the EU. This increasing trend in region trading of products is supported by a recent US Treasury Report, stating that growth in trade between the US and Mexico has increased relative to that of the EU. (Mexican imports are up 167% since 1994, EU imports increased by 86% during same period; exports to Mexico have grown by 100% since 1994, while exports to the EU grew by 50%.) The major reason behind dairy regionalisation is the protection of the indigenous dairy industries by their respective governments44. As a result, only around 7% of the global dairy production is moved around the globe. Export-wise, New Zealand is a clear leader, exporting close to 95% of its dairy output (which accounts for almost 30% of the internationally-traded volume). Figure 8 International dairy markets and major trading blocks
The majority of dairy products are produced and consumed within domestic markets. Table 38 Percentage of world dairy production and consumption Dairy production (% of total world production)
European Union USA Japan 39 16 1
Dairy product consumption (% of total world consumption)

37 20 1.5
Source: Promar International 2001 This reflects a not uncommon trend in the food and drinks industry. Companies in large domestic markets tend to remain domestic (US), while successful companies in small domestic markets eventually outgrow these, and are driven internationally for growth. Examples of this include Nestl in Switzerland, the original Unilever food company in the Netherlands, Carlsberg in Denmark, and the Dutch pork and dairy industries. The threat is that as domestic markets mature and the large domestic players outgrow them, the large players need to look internationally to sustain growth, bringing extra scale and cash flow to their operations, with the result that international competition increases.
44
Where trade is not regulated, such as in whey products, intercontinental traffic flows are greater.
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This relatively small trade in dairy products would appear to be counter to international trade liberalisation initiatives advocated by organisations such as the WTO, and agreed to during the last round of talks in Uruguay. However, running against these freer trade policies are the actions of large fir st world economies to protect domestic dairy industries. The most recent example of this is the revised Farm Bill in the US, which will effectively increase the support to US dairy producers through a combination of the Dairy Exporters Incentives Program (DEIP) and the National Dairy Markets Loss Assistance Program. These programmes have also been reinforced with a market price support package managed by the US Department of Agriculture, for the purchase of milk powder, cheese and butter. Despite this internal policy change, on the world stage the US continues to advocate a move towards freer international trade. Given the slow progress on liberalisation through the WTO, it is difficult to see the US changing its double-handed stance, although it is likely that as part of the Doha Round of talks, it will be placed under pressure to reverse some of its local industry support measures. While the US Farm Bill action is designed to encourage the well being of domestic producers, there are other policy tools that are used on a wider scale to discourage a greater trading of dairy products internationally. The EU, for example, is managed as a single market, with the free trade of products between countries inside the Union, and less advantageous trading conditions for third country exporters into the region. This policy has hindered the ability of other international producing nations to access one of the worlds largest dairy markets. The NAFTA agreement in the Americas has also encouraged the trade of product within the region, rather than the use of third country imports. While not on the same scale, there are also flotillas of free trade agreements within Asia under the banner of APEC (Asia Pacific Economic Area). Those countries not belonging to any particular trading bloc at the moment are engaged in mutual bilateral trade arrangements, as is the case between Poland and the Czech Republic. The combination of such agreements has led to a slowing of the trade in international dairy products between the three trading zones (America, Europe and Asia). In part, this is due to the enhanced productivity of a number of dairy industries within the zones, and a decline (in volume terms) in the consumption of dairy products within some developed markets. This is particularly true of North America and Western Europe. This drop in volume consumption has been countered by an increase in the value of dairy products consumed, as consumers have become more interested in branded dairy products and added value dairy goods, including yoghurts and dairy desserts instead of liquid milk and butter. For example, the consumption of liquid milk across the EU has fallen by 2.3% since 1996, while during the same period yoghurts, dairy desserts and ice cream have increased by 3.3%, 3.5% and 7.4% respectively (RTS Associates data).
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Through the combination of slowing global trade in dairy products and an increase in the number of regional free trade agreements, the world is quickly developing into a three-zone market place Figure 9 Emerging-trading zones
Region 1 - Americas Region 2 - Afro-Europe Region 3 - Asia
3.1 Trading zones Free trade agreements and advantageous trading arrangements between nations are driving the development of the zones In many instances, these new trade relationships are similar to those that existed between European countries and their colonies in the past designed to supply low cost goods to higher value markets. In addition to these trade arrangements, additional business factors are also hastening the development of the process. Within each of the zones, there is a developing ability for self-sufficiency. In particular, base ingredient products from South and Latin America are able to service the demands of the manufacturing sector in the US and Canada. The same is true in Europe, with the developing production systems in the East potentially able to supply shortfalls in products in the West. And also in Asia, with the large natural resources of Australia and New Zealand being used to deliver raw products for increasing numbers of consumers in Asia. Reduced transportation costs Within zone trading has the ability to reduce transportation costs for traders This is of particular importance, as many of the products supplied are lower value commodity-type products including grain, meat and dairy products. In the future, the direct costs associated with shipping are expected to increase. Decreased trading risks Also supporting the creation of these three distinct trading zones are the decreased risks associated with business transactions Of particular concern are financial risks involved in the use of different currencies. Within each zone, most currencies, although floating, tend to be loosely tied to each other. Also, events that impact on one currency within a zone tend to impact on others, and any relative currency depreciation or appreciation tends to be minimal in the short-term. 3.2 Fonterra: an example of a player using the international trading zones New Zealands newly created integrated dairy processor and marketer has embarked on an ambitious programme to consolidate its global position. However, the investments that have been made have
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concentrated on one or two zones. While continuing to trade in Europe in some base dairy products, the company has rationalised its investments in consumer foods by creating a joint venture with Arla Foods of Denmark. Under this arrangement, a joint venture company 75% owned by Arla and 25% by Fonterra will manage Fonterras Anchor butter brand. This will lessen Fonterras direct involvement with the UK butter market, and possibly see the brand used on a wider range of consumer goods. Fonterra will profit through an enhanced dividend stream. Within the South American market, Fonterra has formed a joint venture with Nestl for the production and marketing of consumer dairy products. This will see Fonterra provide expertise in the running of largescale production facilities, and Nestl will bring resources in the areas of brands and marketing expertise. While the South and Latin American markets currently use large quantities of base dairy products from New Zealand, in the future a larger proportion of local consumption will be provided by domestically produced milk. As with the UK butter market, Fonterra is as likely to derive future value through dividend streams as from direct dairy product sales. In the meantime, the New Zealand based company has been consolidating its business operations within the Asian region to utilise NZ produced milk. This has been done through acquisitions in Australia and Asia in production and consumer goods manufacturing and distribution operations. (e.g. Britannia Foods India.) The best opportunities in the future for Ireland could well lie within the Afro-European zone Given the development of world trading zones, it is predicted that the best opportunities for the Irish dairy processing industry could lie within the Afro-European zone. Despite this, there will be opportunities outside of this zone for some differentiated or traded products, but these are unlikely to account for large volumes of milk, and may be opportunistic in nature. Longer-term opportunities in other trading zones do exist; however, they will require Irish investment with hands-on local involvement and even local sourcing, rather than exports from Ireland. 4. The Afro-European zone
Net dairy exporters like Ireland have the ability to supply products to most stages of the development cycle, as dairy products are consumed at all points This said, however, the type and range of products required will vary depending on the stage of development of the different markets, and Ireland may be better placed to supply these markets due to factors such as geographical position or cost. The summary market requirements and industry structures for various products within the development cycle are profiled in the following table: Table 39 Market requirement and industry structures Stage Consumption
Liquid milk products Traditional preserved products (ghee) Liquid milk Cheeses Liquid milk UHT milk Cheeses Butter Some added value products (yoghurt) Liquid milk Cheese Butter Added value dairy Functional foods
Local production
Liquid milk Ghee Liquid milk Cheeses Milk powders Liquid milk Cheese Butter Powder Added value products Liquid milk Added value Butter Cheese
Major distribution channels

Fragmented door to door Local markets Fragmented retail Consolidating retail Direct sales
Import opportunity
Milk powders for reconstitution Milk powders Some cheeses Smaller amounts of powder Cheese Butter
Organised retail Foodservice Direct sales Vending E-commerce
Powder Cheese Butter Functional additives
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Stage
Consumption
Liquid milk Cheeses Butter Added value dairy Functional foods
Local production
Liquid milk High value dairy products Branded consumer foods Functional foods
Major distribution channels

Foodservice Industrial Organised retail
Import opportunity
Powder Cheese (industrial) Butter (industrial) High value ingredients Functional additives
Given Ireland's present product portfolio, the market's best opportunities at this moment in time appear to be in countries within stage 2 of the framework, that are developing dairy product demand greater than supply. Additional requirements for imported dairy products also exist within stage 5 of the framework, due to the increasingly uncompetitive production costs of the local industry, which results in a move away from the manufacture of lower value dairy products by domestic processors. As a result of this conscious move away from base products by local processors, these countries will increasingly import greater percentages of base dairy products for use within the food manufacturing sectors. The best example of this to date is the increased imports of butter by France. During the next 10 years, other Western European markets, including the UK and Germany, are expected to follow similar trends and develop demand for products to substitute the fall in local production of some low value dairy ingredients. However, while base dairy product opportunities also exist in stages 3 and 5, they are limited. Instead, there is an increasing demand for added value dairy solutions in stages 4 and 5. The consumer trend towards more differentiated products has dairy processors competing to deliver new and innovative products that utilise milk. In many cases, these will involve the use of convenience-orientated packaging, branding, or the use of food functionality (claim of additional health benefits from the use of the product). In effect, the basis for competition in stages 4 and 5 is as much about being different to gain market share - with many consumer dairy markets mature, product innovation and differentiation will be the key tools available to processors to drive continued consumer demand. As a result, to capture opportunities in these markets, Ireland will need to move away from product-oriented trading to market-oriented supplies. 4.1 The North-South divide within the zone
It is possible to further split the Afro-European zone according to the stages of the development cycle. In particular, there is a distinct North-South divide, with the developed first world economies of Norway and the EU and their demands for greater value -added dairy products rather than volume. In contrast to this grouping, countries in the African area are generally less economically advanced, and food is still consumed as a need, rather than being tailored towards convenience or indulgence. The greatest requirements within these poorer markets for the foreseeable future will be based around base dairy products for reconstitution into liquid milk. The same is true in the Middle East, albeit for climatic, rather than economic, reasons. In between these two extremes are the markets of Eastern Europe, which with their increasing social development, are creating greater demands for added value products, while at the same increasing consumer demand is enabling the domestic industry to gain critical mass, usually through outside investment (for example, Campinas investment in Romania). This in effect creates three areas of interest for dairy processors looking for export market opportunities within the Afro-European zone, Western Europe and Scandinavia (approaching stage 5), Eastern Europe (between stages 3 & 4) and thirdly North Africa and the Middle East (stages 2 & 3). Other opportunities may exist within the zone in stage 2 countries, however the majority of dairy produce trading is likely to be accounted for within these geographical areas. The opportunities within the Afro-European zone Given the current economic viability, eating habits and distribution systems employed within the region, it is unlikely that all of the zone will provide viable across-the-board opportunities for the Irish dairy sector. In fact, given the present situation, there are likely to be few options beyond those presented by Europe, the developing Eastern European markets, the Middle East and North Africa; but these can be maximised through individual product-to-market alignment. 5. Changing market opportunities While it is tempting to look at past developments and historical data on markets within this strategic framework, it is critical to look at the developing trends within the market for dairy products within the
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Afro-European zone and wider international market. It is important to consider what is changing, given that within these changes lie the greatest opportunities in the medium term. 5.1 Western European markets
Includes current EU states. These markets can be characterised by high levels of consumer affluence, and well developed domestic dairy industries that have evolved to being able to supply a complete range of dairy products, from base dairy ingredients to value-added consumer foods In the main, the dairy industries are constrained by the production caps imposed through the EUs CAP legislation. As a result, milk production is static, and increased industry efficiency has resulted in falling cow and farmer numbers. Most countries have undergone significant rationalisation of the dairy sector, including both producers and processors. For example, in the Netherlands, dairy farmer numbers have declined by 41% since 1990 to 27,926, and dairy processing sites from 95 in 1990 to 63 in 2001. Across the markets, the high levels of consumer affluence (average US$24,000) are well above the global average. This has translated into a very discerning consumer base that is increasingly prepared to pay for convenience and service, with large growth in the foodservice and ready meal sector. It is predicted that the market channels for dairy products will change significantly, with foodservice and industrial uses for dairy products growing at the expense of retail, as consumers increasingly prefer meal solutions to home cooking. These changes in sales channels represent a significant shift in dairy market opportunity. In the past, retail sales of dairy products have been dominated by the power of brands. With falling sales of dairy products through retail, brands will come under greater pressure, and may need to be considered as part of a product portfolio, rather than as a single stand-alone product within a market. In fact, a large supplier of packaging solutions to the dairy industry predicts that the liquid milk market in Europe will be dominated by one local brand in each country, with retailer own labels accounting for the remainder of the market. Specific market opportunities Cheese Consistent with the advanced markets internationally; the growth in the cheese market is expected to be dominated by fresh and soft varieties not a traditional strength of the Irish dairy industry Aside from this, a number of other market opportunities have been identified, including:
Opportunities exist in the UK for innovative products within the cheese sector, as this market becomes more European in its eating tastes. Cheddar, with 4% sales growth in the period 1998 to 2002, is increasingly, losing out to speciality and continental cheeses, which have increased at a rate of 26%. Success will be dependent on the building of a strong market position, based on positive defendable values and technical attributes. Ireland already exports 90,492T of cheese to the UK, and with an estimated market share of 13% is well established in the market, and ideally positioned to take advantage of some of the predicted 87,000T increase in consumption. Given Irelands track record in cheese technology and the UKs taste for cheddar, this should make Ireland better placed than most to build upon its market position. The growth of regional foodservice operators in Germany could also provide opportunities. The use of milder cheeses in this sales channel should also enhance the Irish offering of cheddar, gouda and mozzarella into this market. At this stage, the growth in cheese through foodservice is estimated to be 112,000T, but any opportunities are likely to be price sensitive, and based on providing differentiated products specifically suited to customer needs. The Scandinavian pre-occupation with animal welfare and wholesome foods could play into the hands of the Irish. In addition, the size of the hard cheese market could well provide some opportunities. The Scandinavian market is also very health motivated, and would appear open to functional food opportunities with cheese. Success in this market will be based on NPD. The growth of the French QSR market will require larger amounts of cheese. The wider foodservice market is expected to grow by 41,000T, and industrial cheese usage by 59,000T. With the move towards the production of more added value and branded consumer goods by the domestic
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French dairy industry, opportunities could exist in this market for a lean low cost commodity cheese supplier to French foodservice players. While it is possible that the indigenous industry players will try to capture some of this hard cheese market by diverting resources from other branches of milk processing (e.g. powder manufacture, etc.), the requirement for a highly efficient and competitive cost structure could represent a challenge for local processors.
Organics is an important category across a large number of EU markets, most notably in the North and Scandinavia. Its rate of growth far exceeds that of other foodstuffs; similarly, prices of organic products may be as high as 150% compared to their conventional counterparts. In the UK, for example, organics today accounts for just 1.5% of all grocery trade (with organic baby foods rumoured to have a much larger share). However, its share is expected to increase to 5% by 2010, and as high as 10-12% by 2015. Functional foods are another potential area of application for the Irish dairy sector. The EU functional food market today is estimated at 13 billion; it is growing in excess of 15% annually. Importantly, most successful functional products so far have been based on dairy (yoghurts, pro-/pre/sym-biotic drinks, etc). Coupled with a strong research base available in Ireland, green Irish dairy may be in a winning position across many European markets.
Butter The growth of foodservice and industrial uses of butter dominates the opportunities for Ireland. In general, branded retail products will continue to be under pressure in light of the growth of own label products45 (through hard discounters) and ongoing competition from non butter based spread, without significant investments in NPD (to make them functional or health focused) or large ongoing A&M spend.
Specialist butters for use in the production of confectionery and bakery products would appear to offer the greatest opportunities. This is particularly true in markets where local production has moved towards branded retail products, away from more base dairy butters. Unfortunately, this market will be dominated by price. Organic butter is another opportunity to increase penetration of Irish dairy within Europe. As in the case with cheese, Ireland is inherently in a very advantageous position to promote herself as a key supplier of organic butter into many markets. It is estimated that the market for industrial butters will grow by 29,000T in France, 19,000T in Germany and 12,800T in the UK. At the same time, the total market for butter will grow by only 17,000T in France, on the back of increasing population and increased usage in French cuisine, will remain static in the UK, and fall by 16,000T in Germany.
Powders The majority of powders are used within the industrial sector of the market. In the next few years, this is not likely to change. This said, however, the market for the sale of base milk powders will continue to be very competitive.
Success will be based on the ability to provide specialised product solutions, often using proprietary technologies. This is particularly true, of the baby food sector, where significant opportunities exist for Ireland to capitalise on its clean and green image and build on its already strong position in this market segment. Other market opportunities will be based on price, particularly in Germany and France, as none of the products supplied will be consumer facing, so will not represent any opportunity to capture brand value. The ongoing viability of supplying these markets will be based on the ability to provide product solutions to specific client-facing manufacturers. Overall, powder growth is expected to be small in volume terms, with most of the increase in demand for production of added value products utilising SMP that has in the past been used for animal feeds. This volume used for animal feeds is likely to fall in response to declining cattle numbers across Europe.
45
This is not the case in the UK, where own label butters have only a small market presence.
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Table 40 EU Opportunity matrix based on points of differentiation Point of differentiation

Natural
Cheese
Germany Scandinavia UK Scandinavia UK UK Germany EU UK UK Germany France Scandinavia
Butter
Scandinavia UK Scandinavia UK UK UK Germany EU UK UK Germany France Scandinavia
Base powders
Value-added powders
Whole of the EU esp. UK Scandinavia UK Whole of the EU Not relevant Not relevant Not relevant
Not relevant Scandinavia UK UK
Technology Quality+ Culture/Affiliation Cost Location
Isolation from food scares
EU UK UK Germany France Scandinavia
Whole of the EU
EU intervention markets The EUs market intervention policies have helped to underpin the production of butter and SMP in the past. In years when it has been possible to sell products into intervention, Ireland has taken advantage of this (see chapter 1). The Agenda 2000 reforms reduced the level of interve ntion price by 15% for SMP and butter. This change is intended to reduce the cost and level of market intervention required in the future. Agenda 2000 also confirmed the usage of the current quota system until at least 2006. As part of the CAP review, the commission looked at a range of alternatives for dairy sector reform, and highlighted the implications of these in terms of markets and policy 46. In general, the Commission suggests that if liberalising reforms were introduced, it would almost certainly enhance the EUs and Irelands export potential. While some within the Irish dairy industry do not believe that much will change in relation to EU policy in the future, this view (although justified on the rate of change during the past 10 years) would appear to be at odds with most market commentators in the long-term. Regardless of this view, international dairy industries that have adopted a market-focused approach, and adapted to supply greater added value products, have gained strength and competitive advantage relative to Ireland in the past ten years. This is particularly true of the Danes (see chapter 1). It is difficult to see a long-term future within the intervention markets. Irelands dairy industry must be encouraged to develop new strengths to re-position itself on the European and international dairy markets. 5.2 Emerging markets of Eastern Europe
These markets are characterised by lower levels of consumer affluence For example, Poland, Czech Republic and Hungary have consumer spending levels of US$9,000, US$13,780 and US$11,990 respectively, well below the EU average of about US$24,000. Following accession to the EU, it is anticipated that consumer spending will increase, and while not reaching the levels of other EU member states, will be much improved (World Bank). In terms of expected dairy market developments (based on the market framework), we should witness increasing consumer demand for all dairy products initially, then a switch from volume consumption increase to one of value increase. While the local dairy industry will adapt to these changes (it is currently self-sufficient in basic dairy products), production caps imposed as part of the accession process will limit milk output, and it is possible that in the medium term, there could be opportunities for the importation of some base dairy products to fill the gap between supply and demand.
46
The Commission have recently come forward with their proposals, which are currently under discussion at Council level. These proposals would result in further price support reductions and an extension of the quota system until 2015 with further direct payments to farmers
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Even given this opportunity, Ireland may be a little late out of the blocks, as a number of leading dairy companies in Europe (for example Campina) have already invested in dairy processing facilities in the region. Given that in the longer-term, consumer demand could well be based around added value dairy goods, this investment should ensure that these players are well placed to supply these developing markets with fresh liquid milk and processed products. In addition to this, some Western European dairy processors believe that processing capability within these markets could provide them with cheaper sources of raw milk for the manufacture of base dairy products for use in manufactured food products within their own domestic markets. While the economic development within Eastern Europe can be expected to increase the costs of dairy production in this region, it is likely that they will remain less than those of the more developed dairy industries of Western Europe for the foreseeable future. This represents a significant longer-term threat to base dairy product producers such as Ireland. Based on the experience of East Germanys reunification, the rate of economic development could also be varied across countries, resulting in pockets of affluence with quite different product demands. Despite this range of demand, it is expected that the best opportunities in the short-term could be for the sale of base dairy products into these markets to fill gaps between local demand and supply. In the longer-term, the low production costs in Poland and other accession countries could pose a serious threat to Ireland within the EU market for base dairy products. This will make it critical for Ireland to actively seek a new market position within Europe to ensure its longer-term profitability. Table 41 Eastern Europe Opportunity matrix based on points of differentiation Point of differentiation
Natural Technology Quality+ Culture/Affiliation Cost Location Isolation from food scares
Cheese
Butter
Base powders
Not relevant
Value-added powders
Not relevant Not relevant
5.3 Middle Eastern North African markets These countries have consumer affluence levels well below those of the preceding countries (Egypt US$3,670, Algeria US$5,040, Saudi Arabia US$11,39047) and, generally, have no well-developed dairy industries, or high levels of per capita consumption of milk. Many of the regions governments have recognised this and implemented policies for the increase in milk consumption; for example, the Algerian programme to increase milk consumption to 110 litres per capita. Given the present state of the local dairy industries, such initiatives are expected to drive demand for milk powders in the future. The economic development of this region is dependent on political stability, and this is far from certain Current information from the World Bank suggests that the economies (measured as GDP) are growing at less than 5.0% (Algeria 1.6%, Saudi Arabia 1.6%, United Arab Emirates 2.9%, Egypt 4.4%). Despite this rate of growth, the local dairy industries will be unlikely to be able to provide the necessary production to meet growing consumer demand for basic liquid milk products due to a combination of production, processing and logistical constraints. The modest GDP growth suggests that the growth in consumer affluence will also be slow, resulting in the market for dairy goods being volume rather than value-based in the medium term. The lack of well developed and integrated cool-chains for the distribution of fresh dairy goods will see a continuation of a market dominated by milk powder for reconstitution into liquid milk and UHT products
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While having a higher consumer spending power, this market is included in this area as it is reliant on supplies of powdered dairy products for reconstitution into liquid milk. This is due to the fact that the country is unable to develop its dairy industry to meet demands due to climatic constraints, so will remain reliant on importation of dairy products.
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This is not to say that there are not opportunities within cosmopolitan centres for higher value goods, but these opportunities will be limited, and will require large investments in branding and product support. Other dairy industries have a strong presence in the region, in particular, New Zealand through Fonterra. This position has been built around a series of reconstitution plants and associated distribution businesses that are used to provide liquid milk products to the market using New Zealand milk powders. The reliance of the market on milk powders is set to continue, and given predicted population increases (5.1% in UAE, 2.9% in Saudi Arabia and 1.6% in Egypt), will continue to grow by 6,000T in Egypt, 40,000T in Saudi Arabia, 8,000T in the United Arab Emirates, 56,000T in Algeria and 7,600T in Bahrain, Oman, Kuwait and Qatar. These are significant opportunities, but they will be based on price, and could require investment by processors in further processing facilities in these countries to maintain market access Table 42 North Africa and the Middle East Opportunity matrix based on points of differentiation Point of differentiation
Cheese
Butter
Base powders
Not relevant
Value-added powders
5.4 5.4.1
Other International markets Mexico
The Latin American market is one of the few that is expected to develop significantly in terms of both consumer affluence and volume during the period. As such, it offers opportunities for both base dairy products and added value consumer foods. When reviewing the opportunities in Mexico, the following were identified:
Growth in industrial and foodservice demand for cheeses (78,000T) as the market develops for out of home eating. In the main, this growth is expected in harder varieties for QSR, and semi-soft mozzarella for use in foodservice. Retail demand for cheese is expected to be static. Milk powders will continue to be demanded to support government initiatives for the stateassisted supply of dairy products to schools and lower income families. The trend for increasing powder consumption will primarily be driven by population growth, slowing in the longerterm in response to increasing local liquid milk production.
While this market would appear to represent a good opportunity for dairy exporters, the regions involvement in the NAFTA agreement means that many dairy exporters outside of this treaty will find in increasingly difficult to compete with imports from the US after 2008. Initially, a tariff rate of 20% on imported products will be applied on butter from 2003, and will be extended to milk powders from 2008. Table 43 Mexico Opportunity matrix based on points of differentiation
Point of differentiation Natural Technology Quality+ Culture/Affiliation Cost Location Isolation from food scares Cheese Butter Base powders Not relevant Not relevant Not relevant Value-added powders
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5.4.2
The USA
The US appetite for dairy products is expected to continue to grow. This will be driven by economic growth influencing dairy product consumption patterns, and a predicted population increase of 12.8% from 281.6m to 317.8m in the next 15 years. There are a number of counter trends within the US market; the nation is increasingly concerned about diet, but is reporting increased rates of heart disease and obesity ; t he demand for health products and dietary supplements is increasing at the same time as the fast food market In the short-term, growth in out-of-home eating will continue to drive demand within the industrial and foodservice sales channels In addition to this, some sectors of America are expected to become more cosmopolitan in their eating tastes, which will open up opportunities for more European-style foods. The following opportunities have been identified in the market:
Cheese consumption is expected to increase by 25% (967,000T) during the next 15 years. This will be driven by foodservice and industrial growth. The decline in retail cheese sales ( -45,000T) is as a result of consumers switching to stronger flavoured cheeses, and a fall in volume sales of milder cheese, as their use in home cooking is replaced by pre-prepared food products. Significant opportunities may also be stimulated through the WTOs Doha Round, where it is expected that the US will be put under pressure to increase market access for semi-hard and semi-soft cheese varieties. Contrary to most other markets, butter usage in the US has increased in the past few years (up 14% since 1997 ZMP). The majority of this growth has been in the industrial area, stimulated in part by the changes in payment structure placing greater value on protein relative to fat. This has effectively made butter (vis a vis other yellow fat products) more cost competitive. It is predicted that butter sales will slow in the future, and actually decline on a per capita basis as consumers switch to perceived healthier alternatives, including margarine spreads. The powders markets in the US will grow on the back of industrial processing into addedvalue food products. While standard opportunities exist for yoghurts, ice cream etc, the US market offers the greatest opportunities for high added value dairy powders for use as functional additives. Access to this market will be based on new technologies and high R&D spend; however the rewards should be high. Currently, Americans spend in excess of US$15 billion per annum on dietary supplements, and this is expected to increase in the future. Historically, US dairy processors have not been aggressive in this area, and have concentrated their efforts on volume milk sales and the production of consumer foods.
Consumers in the US are becoming increasingly technology savvy, and this is increasing demand for technology-based foods. In contrast with the Japanese market, Americans are inclined to look for dietary solutions through a combination of standard food and dietary supplements, taken separately. The Japanese and Europeans are demanding food-based dietary solutions functional foods. This creates a market in the US for high value dietary aids for inclusion into standard foods. In the longer-term, functional foods are expected to grow; however, it may be a case of creating functionality for American food, rather than dairy-based functional foods like yoghurts Table 44 US Opportunity matrix based on points of differentiation Point of differentiation
Cheese

Butter

Base powders

Value-added powders

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5.4.3
China
The Chinese dairy industry, although developing, will struggle to meet the expected increase in demand for liquid milk As a result, it is expected that China will remain a net importer of base dairy products for some time to come. The market is split between developed areas on the East Coast, the large cities of Shanghai and Beijing, and the relatively undeveloped hinterland. This divide creates difficulties in predicting future product demand, as added value consumption will increase in isolated pockets of affluence, while the majority of the market will continue to be dominated by the need for milk powders. This difference in dairy consumption patterns within the country is best demonstrated by a recent USDA report stating that fresh milk consumption in urban areas is currently 11.9kg/person/year, while in rural areas it is only 1.2kg/person/year. This demand for milk powders will be underpinned by Chinese government initiatives to increase milk consumption. The current strategy is to increase dairy consumption to 10kg in 2005, 16kg by the end of 2010 and 23kg by 2015. This would create a huge demand for milk products. In reviewing the market, the following opportunities have been identified:
The market will be dominated by growth in milk powders for the production of liquid milk products. The increasing consumption of liquid milk as a result of population (and to some extent, consumer affluence) growth is expected to create demand for at least another 57,500T of WMP and 74,500T of SMP. Some of the growth in demand for milk will be met by local production; however, this will be wel l short of the demand. Most local milk will be used in fresh or UHT form. There is expected to be continued growth in the use of yoghurts, while some affluent areas could well follow the trend in Japan towards the use of dairy-based functional foods. This market is likely to be dominated by branded products, manufactured locally using domestically produced milk.
While the gross market opportunities in China are large, the ability of Ireland to capture large portions of this is questionable. Geographically, other lower cost producers are better placed to supply base dairy powders to this market, and the competition for market share will be price. The costs of transport (which currently disadvantages European exporters) will become increasingly important if Europes subsidisation levels are to decline. In addition to this, others, including New Zealand, have established relationships with distribution partners within the market. There is likely to be demand within the Chinese market, but in the foreseeable future it is expected to be a more opportunistic rather than long-term user of Irish dairy products. Table 45 China Opportunity matrix based on points of differentiation Point of differentiation
Cheese
Butter
Base powders
Value-added powders

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6. Strategic market options for the Irish dairy processing industry Given the market factors considered elsewhere in this report, it becomes clear that competing in the commodity end of the dairy spectrum, at least as far as the Irish dairy processing sector is concerned, will be an increasingly difficult proposition:
Trading in commodities is becoming less and less profitable due to the decline in many commodity prices in real terms, and inherent price volatility associated with commodity trading, that requires international competitiveness in raw material costs and processing efficiency to remain viable. In addition, difficulty in predicting exact demand fluctuations in the target markets makes the commodity export policy less manageable. The New Zealanders (and other competitors) are managing to produce commodity products 48 cheaper through lower production costs and greater scale at production level, leading to lower raw material prices paid by processors, and also through major scale at processing level to achieve greater processing efficiency, which is an all important consideration in a commodity business. Central and Eastern European countries, especially Poland and the Czech Republic, represent a real threat of further depressing commodity trade through their cheaper production costs. Subsidies and market supports are not guaranteed in the future, and any decline in these could impact on producer prices paid for milk.
As a result, the longer term options for the Irish dairy seem to be limited either stay largely in commodities or base products as a proportion of overall product mix (and be eventually beaten at this game by leaner and hungrier competitors with more rationalised and cheaper production base), or opt to produce a far greater proportion of higher value-added and consumer oriented products and industry ingredients. 6.1 6.1.1 First step Development of a home market
In order to sustain (and hopefully, expand) market share, the Irish dairy industry would need to consolidate its position within what it considers to be its home market. (Note: home market in this sense is not just necessarily limited to the island of Ireland) Figure 10 Product value Vs distance to market (Step 1)
Trade value
Full range
Selected products Targeted markets
Base products
Distance to market
At its most general level, the graph above reflects this idea. This development will necessitate the provision of a complete range of dairy products to support the demands of this market, from liquid milk, fresh dairy products, powder, cheese and butter through to branded consumer goods and added value ingredients. To create such a position would require access to liquid milk products, as they are still critical to the support of a home market. This dominance of the home market is required in sufficient scale to support market partners, especially in retail and foodservice, which require a one-stop shop for the supply of goods.
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On an unsubsidised level. Prices from the EU and US are currently competitive through export subsidy programmes.
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This home market, while naturally including Ireland, may need to be greater for reasons of market size. The decision on what constitutes the home market must be based on two critical factors:

The ability to supply the complete range of dairy products (including liquid milk) Markets that have an affinity with what Ireland has to offer, i.e., which appreciate the difference and the value of the offering. This could be based on issues such as history, culture, clean and green, or simply price. Ireland has already established the Kerrygold brand for some consumer foods. There could well be opportunities to build a better defined product portfolio around the attributes of this brand.
Admittedly, the question of the home market is open to interpretation. In an ideal world, we would want Ireland to be a dominant player in most European countries; however, this is clearly a very difficult task, given the strong national industries of many European neighbours. At the very least, it would be desirable to attempt to displace out-of-market importers (such as New Zealand and Ukraine) in the commodity ranges in countries such as Italy, followed by advances on the traditional domains of indigenous producers in Germany and the Iberian peninsula. Ireland is currently not very strong in consumer facing products and this will need to be rectified in order to harness opportunities in France and, especially, the UK. But whatever the message, it must be consistent across all products within what is defined as the home market. Dominance of this market is critical for the ongoing success of the industry. While the exact market share is difficult to estimate given the different dynamics evident in every individual market, it would certainly help if Ireland were to become the largest importing agent locally. While the creation of a home market is the first step in the process, it is imperative that the Irish dairy processing industry identifies what it actually is, and the attributes that an Irish dairy product has to offer. Why is it different? Where is its value? Clearly, the above step is built on utilising and enhancing the current mix of products. As a result, due to their price sensitivities, the trade values of the more commodity type of products in the mix will decline the further the distance to the target market (as the graphic above demonstrates). 6.1.2 Identification of key markets
Further away from its home markets, the industry must match products on offer with local market conditions Clearly, there may be less profit in the future from volume sales of WMP or SMP in Eastern Europ e, or commodity cheddar cheese in the Middle East. Every market is a complex entity, which needs different communication messages (even for the same product) to buy into a product or a concept. Furthermore, the product portfolio available must be market-tuned to the specific needs and requirements of that market (in terms of packaging, etc), rather than manufacturer-led:

Middle East powders (or even liquid milk), value cheeses Eastern Europe quality butter and value cheese North Africa commodity powders and cheese
As we have indicated above, the long-term prosperity of the Irish dairy processing sector will be closely dependent on its unique differentiation from other similar industries. In particular, we have identified the following points of differentiation that may be used to positively distinguish Irish dairy produce from other competitors: Natural the fact that Irish dairy products are produced from a less industrialised source, plus pasturebased feeding, is an important competitive advantage, particularly given the increasing organic consumption and widespread consumer concern about environmental issues Technology this point is two-fold. On the one hand, the message of minimal use of contemporary technology may be used with the products naturalness above. On the other hand, utilisation of substantiated technology (i.e. in functional foods) will be advantageous in more developed markets. Ireland is very well positioned to take advantage of the latest functional food technology, as some pioneering research is conducted in the country itself, and the research base is strong (e.g. UCC and Teagasc)
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Quality+ Ireland has a widespread reputation as a quality dairy producer, often above that of its competitors. This is a very important attribute that must be used extensively when marketing Irish dairy, especially to higher-margin customers Culture/Affiliation the industry has long known that Irish produce has considerable recognition in many European countries and the US. Part of this recognition is rooted in human migration (US), but the importance of more famous Irish exports (such as Guinness, Irish salmon, Baileys, Irish whiskies etc) must not be underestimated. The Irish dairy must simply build aggressively on this product awareness to extend it into the dairy sector Cost Ireland is still one of the lowest cost producers in the EU. This message, while not unique in itself, will provide some important competitive advantage in cost-driven markets, especially when coupled with other points of differentiation discussed here Location as a member of the EU, Ireland is an integral part of the community. This means no trading barriers within the market, while on the outside it allows the creation of an association with all things western. Clearly, the Irish Sea is an expensive one to cross if you trade exclusively in commodity, but the industry will find that this factor will diminish as the overall portfolio changes to include value-added ranges Isolation from food scares is perhaps one of the most potentially valuable points of advantage for the Irish dairy industry in todays climate of consumer preoccupation with food sourcing. Ireland, like most European countries, has had to combat FMD, BSE and similar, and it is vitally important for the country to continue to take every possible measure to prevent a major food scare from occurring. This isolation from food scares can then be used as an advantage in developed countries with high levels of consumer concerns and/or purity expectations, especially the UK, Northern Europe and France. However, while the opportunities may be diverse, and require different sets of supporting messages depending on the market, it is critical that the points of differentiation for the products in individual markets be tuned to the specific expectations of those markets. Effectively, this means that a limited number of messages (a maximum of 3) must be used in every target market to support Irish products; the choice of these points of differentiation will depend on the degree of market maturity and sophistication. Different messages for different markets and different products, but all based around a similar theme. After all, the Irish dairy industry needs to give its customers and consumers what they want, rather than what it has to sell The most important thing here is to make sure that profitability is built not on throughput alone, but also on a portfolio management approach. In the conditions of commodity trading, one of the best trade rationalisation tools available is a tight portfolio inventory. In other words, providing only what is needed, where it is needed may not increase price, but it will certainly help to decrease costs. This means that product stockpiling must be avoided, with just-in-time deliveries introduced and internal supply management tightened (although this may present significant challenges to Irelands dairy processors due to the seasonal nature of milk supply). 6.3 Second step It is our belief that if Ireland is to be a successful dairy player, it needs a smart targeting approach, coupled with a strong consumer franchise built on a uniquely Irish, hard-to-emulate competency
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Figure 11 Product value Vs distance to market (Step 2)
Value-added products Trade value
Full range
Selected products Targeted markets
Base products
Distance to market
While the basic core approaches remain important to support volume sales (full range to protect and expand in the home markets, tailored products to specific markets, and commodity exports for further afield), a new dimension is added. Developing branded/ unique products (most likely te chnology driven) will enable Ireland to build and maintain value sales. These could include technologies to add functionality to cheeses, building on technologies already adopted by some processors for mozzarella production for the foodservice market. Other examples include products to assist with oral hygiene, and the extraction of specific proteins as enhancements to other food products. Because product differentiation is a key to market protection, sales of such products should be more immune to fluctuations in base dairy product prices, and will help to smooth out seasonality in sales volumes. In addition, because cost of transportation is more easily accommodated by product margin, Irish processors will be able to tap into markets previously unavailable to them due to prohibitively high logistics costs. The use of high tech products could also open up opportunities across trading zones, further insulating the Irish dairy sector from local market volatility. In order to illustrate the importance of a differentiated product, consider the matrix below. In the section on opportunities in some selected national markets, we would argue that commodity supplies represent little potential profit (in some instances, due to strong competition from NZ or the Netherlands). Indeed, there may be no opportunity at all in the longer-term in certain markets, as is the case in Central and Eastern Europe, where strong local industries are expected to dominate the dairy sector. However, it becomes apparent that opportunities do exist as soon as the points differentiating Ireland from other suppliers are amplified. Table 46 Opportunity matrix based on points of differentiation Point of differentiation
Natural
Cheese
Germany Scandinavia UK Scandinavia US Japan UK US UK CE Europe North Africa Middle East Germany EU UK
Butter
Scandinavia UK US Scandinavia US UK UK US UK CE Europe Middle East EU UK
Base powders
Not relevant Japan US UK Scandinavia US UK Russia US North Africa Middle East EU UK
Value-added powders
Important globally, especially in the US, Japan, UK Japan US UK Scandinavia Important in all markets Not relevant
Technology
Quality+
Culture/Affiliation
Cost Location
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Point of differentiation
Isolation from food scares
Cheese
UK Germany France Scandinavia
Butter
Base powders
Value-added powders
Crucial in all markets
As the matrix above demonstrates, a switch from a product to a market mentality helps in identifying potential niches to be exploited by the Irish dairy industry. It helps the industry to build not only product opportunities, but also a portfolio of products that meet specific consumer demands within a particular market. Lower cost dairy producers and some retail formats are combining to erode the margins within the base dairy product market (and in some cases consumer foods markets due to own label). Higher margins are to be made in the niche, rather than mainstream alone, and these should offer greater margin opportunities in the future. The table below demonstrates the overall increase in tonnage in selected markets over the next decade and a half; Irish dairy producers may be in a position to successfully capture some of this tonnage. In addition, there is a possibility that some of the competitors products in these markets can feasibly be displaced by the application of the above points of differentiation. Table 47 Opportunity size based on tonnage increase to 2015 (000T) Country/Area
European Union US Emerging markets (i.e. Poland, Czech Republic, Hungary) Mexico Middle East (i.e. KSA, UAE and Gulf Cooperation Council) North Africa (i.e. Egypt and Algeria)
Cheese
+549.3 +967.0 +130.4 +78 +25.1
Butter
-1.6 +105.8 +22.7 +6.4 +22.3
WMP
+1.5 +2.0 +3.8 +41.7
SMP
+52.2 +53.4 +4.4 +77.4 +14.7*
+100.9
+143.1
+31.2
+31.0
*excluding United Arab Emirates As seen from above, the largest opportunities present themselves across different markets, and cover different products. This gives Irish dairy producers the opportunity to mix and match product opportunities and solutions, to deliver the best returns for the industry as a whole. It is usually more profitable to trade in a niche market due to the relatively higher margins that can be obtained, and reduced exposure to price fluctuations, although retention of market premiums will be dependent on investments in NPD as todays niche products can easily become tomorrows commodities. Ensuring the industry continues to be at the leading edge will require ongoing investment, and it may be appropriate for the dairy processing sector to look at combining resources in some areas to capture economies of scale, especially in logistics, distribution and marketing matters, by clustering. In the case of Ireland, a cluster may represent an amalgamation of products from a particular part of the country (geographic cluster), or a complementary portfolio of dairy products. While it requires an initial effort to create such a cluster, the benefits are usually apparent very soon after its inception. In attempting to capture these opportunities, there is a requirement for the Irish dairy industry to work as one towards achieving a market-led goal.
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7. Global market opportunities for Ireland Based on the two-step approach detailed above, it is possible to revisit the market opportunities identified earlier, and attempt to prioritise those that represent the best options in the future. The potential market openings are estimated assuming that Ireland maintains its current market share (based on imports as a percentage of total market consumption) within the individual countries. In this respect, the opportunities can be considered as the base market, and it is possible that additional opportunities (as identified in the previous section) could be achieved with correct market positioning. The opportunities identified within the major markets for Ireland vary across the various distribution channels, particularly in relation to cheese. The change in the relative importance of the various sales channels (declining retail relative to industrial and foodservice) brings into play a different set of skills. Table 48 Market opportunities Tonnes (000)
Butter SMP WMP Total cheese Semihard49 Semi-soft50 Other cheeses51
EU
120.6 73.8 20.1
Emerging Europe
-
Middle East
7.9 6.7 13.0
Americas
1.3 3.4 9.5
Asia
30.0 -
Total
129.7 113.8 42.6 (169.2) 73.7 37.7 57.8
62.8 36.1 55.5
7.0 -
1.1 -
2.7 1.6 2.3
Source: Promar Trade Estimates Clearly not all these opportunities can be supplied simultaneously within the constraint of the milk quota. As always, there is the need to prioritise market opportunities so as to maximise the return to the member milk suppliers and the plc shareholders. Descriptions of the possible product mixes, which might result from this prioritising process are given in Table 49 below. 7.1 Key market opportunities for Ireland
Given the issues with production quota levels, the best opportunities lie in playing to Irelands strengths. These include markets close to home, and in products where the production system places the country at an advantage. In relation to this, Ireland is best placed to concentrate its efforts on opportunities within:

Developed European markets of the EU Developing Eastern European markets The Middle East and North Africa, and The Americas,
with a product portfolio of butters, SMP, WMP, semi-hard and semi-soft cheeses. Included in these volumes will be opportunities for enhanced value dairy products as solutions for various customers in the industrial and foodservice markets. It is expected that up to 5% of butter, 20% of WMP, 30% SMP and 50% of cheeses52 could fall into this category. These opportunities would result in the following future estimated product volumes.
49 50 51 52
Includes cheddar, edam, maasdam and gouda varieties Includes processed mozzarella and feta varieties Includes soft, fresh branded specialist cheeses positioned to trade on a point of difference u nique to Ireland. Enhanced value cheeses, including, proprietary recipes used for the supply of specialised customers. It is possible, that a large proportion of this market, while considered added value, will need to maintain cost competitiveness in the market.
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Table 49 Estimated Product Volumes (2015) 53 000 Tonnes

Butter SMP WMP Total cheese Semi-hard cheese Semi-soft cheese Other cheeses 35.3 15.3 9.0 35.3 15.3 1.0
Primary Processing
123.2 58.7 26.5
Secondary Processing
6.5 25.1 6.6
Total Output
129.7 83.8 33.1 (111.2) 70.6 30.6 10.0
Source: Promar Trade Estimates The various market opportunities are dependent on Ireland being able to provide a range of products and market messages to meet the various demands. These may not the same for each market, and will require the industry to work together to ensure the delivery of products to meet specific market opportunities. 7.1.1 Developed European markets
The greatest market opportunities identified for Ireland are in the developed EU markets. The success in this area will be based on the provision of products to the various distribution channels within each market. In the Irish market, opportunities for the complete ranges of dairy products need to be met, while in more distant markets the growing foodservice and industrial ingredient markets could well be the most attractive. Key requirements for success:

A complete range of dairy products on the home market to supply all sales channels Close working relationships with clients in the foodservice and industrial ingredients markets A commitment to NPD for key market opportunities in both the Irish and wider European markets The ability to develop new technology products to grow with functional foods markets solutionbased NPD Cost competitiveness in base product production Emerging European markets
7.1.2
These markets, while providing some opportunities in the short-term, are likely to become competitors in the supply of base dairy products to EU markets in the future. In the longer-term, there may be opportunities for cheeses into these markets. Key success factors will include:

Close working relationships with clients in the foodservice and industrial ingredients markets A commitment to NPD for key market opportunities in both the Irish and wider European markets
Cost competitiveness 7.1.3 Middle East / North Africa Continuing population growth will continue to drive demand for powders for reconstitution into liquid milk products. Due to climatic issues, the local dairy industry is unlikely to develop sufficient scale to meet the demands of the population. Internal distribution systems will develop; however, growth in the consumption of dairy products is expected to be dominated by powders.
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This table only relates to certain product types for which there are internationally available statistics. It does not covers product areas such as high value dairy ingredients, which will need to form an important part of Irelands future product portfolio. Estimated product volumes assume Ireland maintains its current market share in each of these markets
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Key success factors will include:
The ability to form strong relationships with key producers of liquid milk products using milk powders. This is likely to require investment/joint venture arrangements in such facilities (as the New Zealand Dairy Board has done in the past) Relationships with major distribution agents in markets
Supplies of cost effective products 7.1.4 Americas The Americas market is split between the increasing technology-savvy North American market and the requirements for base dairy products by Latin and South American countries. The USs ability to produce base dairy products means that there may be few opportunities within this market. However, as consumers become more health conscious, there are growing demands for health additives. Technologies developed in Ireland for the extraction of key proteins from milk could well find a home in this market, as food and beverage companies look to create functional and health foods from standard fare. Key success factors:

The ability to create novel product solutions Some opportunities for Irish cheese and other consumer dairy products trading on the Irish ancestral roots of a significant proportion Americans but this will require significant investment in A&M and may be regionalised Commitment to ongoing NPD in functional foods areas Low cost base product opportunities in Latin America in the short-term Asia
7.1.5
The Asian market, as with the Middle East / North Africa market, will be dominated by powders, as increasing dairy consumption demand is unable to be met by local production. However, due to the geographical location of the major Asian markets, Ireland could well find it difficult to compete in this market, as it will be doing so against low cost products from New Zealand. Key success factors:
Cost competitiveness in base dairy products
7.2 Fast growing market opportunities Within the various opportunities that exist for Ireland there are a number of opportunities within fast growing market segments. Some of the key fast growing market opportunities include:
Functional and health foods Protein fractionates Customer solutions for food service and industrial ingredients e.g. blends Private label manufacturing New forms of food e.g. such as geriatric foods and life stage / life style specific nutrition
8. Summary of key messages from the international market opportunity review The international dairy market continues to develop as both consumer tastes and distribution channels change at different rates between the various international markets. Although dairy products are one of the few goods that are consumed in every country, the types of opportunities that this presents for Ireland vary considerably. Trade in traditional dairy products will increasingly occur within regional zones The development of free trade agreements across the globe have resulted in the creation of a number of trading regions enabling an easier flow of products within, rather than across, zones. In addition to the creation of preferential trading arrangements within the zones, the relatively high (and increasing) costs of
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transportation of base dairy products when compared to their value, is making the global trade less attractive, while the risks of dealing across currencies adds another complicating factor to the equation.
To secure and develop strong and strategic partnerships, major international processors are investing in key growth markets Those operators that are choosing to operate across regional trading zones are doing so through a network of production and processing facilities. This is best demonstrated by Fonterras strategy of investing in the Americas with processing and production facilities, while effectively exiting the consumer foods market in the UK by forming a joint venture with locally-based Arla. The best opportunities for the Irish dairy sector could well lie in a smaller number of markets, with closer relationships with key clients, rather than a wider range of diverse and geographically dispersed countries. The next 10 15 years will see major growth in volume terms in the foodservice and industrial channels, at the expense of retail Currently, foodservice is growing at a faster rate than retail, and it is expected that by 2015 it will account for a greater value of sales. However, success in the foodservice and industrial markets will be based on the ability to supply specialist products to discerning end users requiring product support and solutions, not simply repackaged retail products. This ability to provide solutions will require a close working relationship between processors and their clients, and in many cases significant investments in NPD. Retail in the developed markets will be dominated by a few multiples who will rationalise their number of suppliers of own label and branded consumer goods While foodservice and industrial markets will grow, there is likely to be further consolidation within the retail sector. These larger, global players will be looking to form relationships with players that can provide a wide range of dairy products and increasingly act as category managers, able to supply, source and co-ordinate the portfolio of retail dairy products. This will require scale and locally based support networks. Success in the other channels will depend on the suppliers ability to deliver cost efficient and novel solutions Retail, foodservice and industrial consumers are themselves operating within a competitive market, and will be looking to establish cost effective product sourcing relationships. These same players are likely to require the development of novel and proprietary solutions to meet specific market demands or product positioning. For the Irish dairy industry this will require ongoing investments in NPD to deliver both novel and cost competitive product solutions. Establishment of a strong and dominant base in the home markets to leverage and build growth in other markets (securing the home market focus) The Irish dairy industry must consolidate its position within its home market of Ireland. This is achieved through the delivery of the complete range of dairy products. The industry must have the ability to capture the value from this market for base, consumer and added value dairy products. It must be the product champion in Ireland. Targeting proximate geographic markets with a selected range of products specifically targeted at those markets (market driven focus) Through the use of a planned approach, Ireland must develop a product portfolio for specific markets that capitalises on the values that are uniquely Irish. There are opportunities for a wide range of base, ingredient and some branded products into affluent European markets. Other opportunities exist for milk powders for reconstitution in the Middle East and North Africa, and speciality cheeses in Eastern Europe. Achieving cost efficient and competitive production of base products (production cost driven focus) At the same time as developing a strategy to enhance the product portfolio, Ireland must act to maintain its position as a cost competitive producer of base products. The seasonal production pattern of Ireland, while it could be improved, is likely to remain in the medium term. Therefore, the industry must retain this cost competitiveness in order to ensure its ability to market base products competitively in the future on the one hand, and secure greater margin retention on value -added products, on the other.
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Development of specifically Irish (including branded) products marketed on unique Irish competencies for wider exports within EU and selected overseas markets (market/ product differentiation driven focus) Due to a range of factors, Irish dairy products are seen as offering a set of attributes that have a wide range of appeal to consumers and customers (both industrial and retail/foodservice). These attributes include naturalness, technology, quality, cultural affiliation, cost, and the location of Ireland away from some of the most recent food scares of Europe. This is a diverse set of attributes with a varying degree of appeal to consumers, dependent on their market location, level of consumer sophistication, and distribution channel development. Similarly, the strength of the Irish R&D institutions and their pioneering research into functional foods make the domestic dairy industry a perfect vehicle to deliver these innovations to their intended end-users in the industrial sector. The Irish dairy industry must develop a clear strategy for what an Irish dairy product is, and tailor the messages for specific markets and products to carve out a defendable position. In addition, it must invest in a defendable dairy technology to protect its markets and retain old, and acquire new, business customers. Active pursuit of innovation is key to the future success of the industry In this time of mass-market fragmentation and eventual marginalisation, any producer catering exclusively for the commodity trade is risking its future. With many Irish competitors already strong in the market, and yet more developing their industries, cost competition alone is not likely to be feasible. As a result, Ireland must leverage its intellectual potential (in functional products, for example), to stay ahead of the competition, while at the same time minimising its R&D curve and extending its products lifecycles.
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Chapter 3 What the industry needs to do to respond to the market challenges and opportunities
Contents 3.1 Key industry strategies
Page 86
3.2
Actions to deliver key strategies
91
3.3
Requirements to facilitate changes and implications of change
102
3.4
What is the prize for implementing the recommended strategies and changes to the industry? What needs to be done to make it happen?
105
3.5
109
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3.1 Key industry strategies chapter 1 showed that the Irish dairy industry has been extremely successful in the past in developing an industry of strategic national importance and that the industry has a strong base upon which to build future growth. However, the industry is facing major challenges and needs to make significant changes to its market and product focus, to how its is configured and organised and to improve its efficiency and long-term competitiveness. Three key strategies have been identified that the Irish dairy processing industry needs to implement if it is to meet the challenges it faces and secure its long-term viability and success. These strategies are: Improve the industrys international competitiveness and cost efficiency by increasing the scale, productivity and cost efficiency of enterprises at both producer and processor level Increase the volume of higher value-added products through increased expenditure on R&D and NPD and the adoption of a solutions based approach to product development Put greater emphasis on actions to develop and underpin the highest standards of quality and safety of Irish dairy products
Below, we discuss each of these strategies in more detail and the changes in the product mix that are required to support these strategies. 3.1.1 Improve the industries international competitiveness and cost efficiency by increasing the scale, productivity and cost efficiency of enterprises at both producer and processor level A fundamental element of the industrys future is to ensure the cost competitiveness of the dairy products produced by Ireland particularly, those that can be termed base or commodity type products. Base products include products such as butter, powders, casein and bulk cheeses and are characterised by the generic or easily replicated nature of the products. Generally, entry to the product segment is relatively easy, the technology utilised is well known and there are a wide-range of alternative suppliers of these products available. Given the generic or commodity type characteristics of these base products, the key focus of processors operating in this product segment has to be on process and cost efficiency as the core basis for competition is price. Therefore, everything that affects or that can improve the cost efficiency of processing is of vital importance to processing operators producing these product types. The following are some of the key cost drivers, which need to be tightly managed and constantly scrutinised by processors to reduce waste and identify efficiency improvements: The quality and constituents of the raw material delivered The consistency of the raw milk supply (both quality and volume) The cost of getting the raw material from the producer to the processor The efficiency of plant operations The numbers and costs of direct and indirect labour employed The level and cost of other overheads such as energy, water, effluent treatment, environmental management, inspection and testing, insurance , finance, IT, administration, marketing and distribution.
The major competitor countries (including Denmark, Netherlands and New Zealand) have adopted a number of aggressive strategies in their ruthless pursuit of efficiency and cost competitiveness on international markets. These have included: major increases in scale at production level (number of dairy cows, output, etc); productivity improvements in yield and constituents at farm level; rationalisation and consolidation of milk assembly (picking up larger quantities from fewer and more concentrated suppliers); increased capitalisation utilisation of plant and facilities through planned and relatively constant supplies throughout the year (this not applicable to New Zealand who continue to have a greater problem with seasonality than Ireland); rationalising the number of primary processors involved in base products and eliminating duplicate or overlapping functions and systems (finance, IT, testing, distribution, etc); and going for scale by installing bigger and more efficient plants and equipment and substantially increasing plant throughput and achieving greater economies of scale.
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The Irish industry needs to respond to the initiatives of competitors to ensure it remains cost competitive in the production of base products. This will necessitate changes at all levels, production, processing and support. The key actions required by the Irish industry include: Bringing producer scale up to the levels of our international competitors Rationalising the number of plants and processors involved in the production of base products Eliminating of duplication, cost inefficiencies and unnecessary overheads Reducing the seasonality of milk supply and increasing plant capacity utilisation Ensuring the price competitiveness of base products
These actions are discussed in detail in section 3.2 below. 3.1.2 Increase the volume of higher value-added products through increased expenditure on R&D and NPD and the adoption of a solutions based approach to product development The Irish industry must continuously seek to improve and enhance the added value and differentiation of its products. The key focus of non-base type products is to add value to base products by various means and to create points of differentiation in the products wherever possible. This is achieved through a number of measures including branding, flavour, functionality, segmentation/customisation, developing specific food solutions, portion control, packaging, etc. Examples of added value products include; yoghurt type products, dairy desserts, branded cheeses, ice cream, solution based/value-added ingredients blended powders, protein concentrates, isolates and fractions (e.g. WPC80, WPI, WPH), nutraceutical ingredients (proteins & peptides), organic products and functional foods (e.g. probiotic drinks). The key characteristics of processors in this value-added segment include: Major investment in research and development to improve products and develop product solutions. (It is very much a science led and technology enabled business) Product differentiation the products need to offer something that differentiates the product from other similar product offerings (taste/flavour, packaging, functionality, customisation, branding/image service quality, etc) Continuous new product innovation and development, which is an important requirement from customers to develop/enhance points of differentiation Increasingly lengthy and onerous product approval cycles particularly, in the area of neutraceuticals and functional products Having a strong market and customer focus Business to business (B2B) partnerships, which can be a very important dimension of the relationship between seller and buyer, particularly, in the food service and industria l routes to market. Strong emphasis on solution provision, quality, supply logistics, partnerships in product development, customisation, etc. Branding and product promotion is important in the retail route to market particularly, for fresh products and consumer products Having close customer relationship management with buyers/customers, which is very important for understanding and responding to their specific requirements and for identifying new requirements and opportunities.
These changes required are discussed in detail in section 3.2 below.
3.1.2 Put greater emphasis on actions to develop and underpin the highest standards of quality and safety of Irish dairy products With consumers increasingly demanding to know what goes into their foods, and with health scares abound, it is imperative for food producers to ensure the quality and traceability of their suppliers. As discussed in chapter 1, Irish dairy products generally enjoy strong perception of quality in the industry and
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in international markets however, it is critical that the image and reality of Ireland as a clean and green island is pro-actively sustained and leveraged. There are also some concerns about Irelands future ability to continue to afford to meet the increasing environmental and food safety compliance standards at both production and processing level. As outlined in chapter 1, it is imperative to ensure that Ireland is a quality food island and that this is how the Irish dairy industry needs to be positioned and sold to international markets. As a result, the Irish dairy industry needs to put a greater emphasis and importance on the quality of its products. On one hand, maintaining this image will ensure a positive product differentiation on the supplier/food industry level. On the other hand, communication of safe food and quality messages to the wider consumer base will enhance product recognition and appreciation, and ultimately increase sales. Ireland, as a quality food island needs to be a cornerstone of any strategy to develop and enhance the Irish dairy industry. However, it needs to be more than just a slogan, and must cover all aspects of the food chain. Ireland should be adopting a proactive leadership position, where it is not only meeting but also exceeding the highest quality and environmental standards, and thereby, protecting itself from the loss of this image which could prove very difficult to regain. Otherwise, the Irish industry narrows its market options and is restricted to lower margin returning products and markets that will not pay a premium for safety and food quality.
3.1.3
3.1.4 Irelands product mix must change in response to these strategies
The delivery of the strategies outlined above will require a re -adjustment of the industrys current product portfolio with greater emphasis on the development of higher margin products. It has been identified during the course of this study, that to remain competitive well into the future, Ireland needs a mix of dairy products targeted at the markets it strives to serve. The range of products should consist of: Ingredients These are important to preserve and develop the place of Ireland as a key link and major international player in the food manufacturing chain. Industrial ingredients should offer unique benefits to the buyer/further manufacturer (e.g. through formulation, functionalisation or use of technology, etc) or indeed can be customised to the buyers individual requirements. This will be a significant growth area and it will be important for the Irish industry to build on its successes to date in this sector. There will also be significant supply and value-added growth opportunities with the expansion of the infant formula sector in Ireland into functional ingredients and product extension. Consumer-facing products It is imperative that the Irish dairy industry develops and maintains a direct consumer franchise. Admittedly, some consumer products do already exist (e.g. Kerrygold and other consumer branded products from individual processors), but more are needed to increase market penetration. Consumer-facing products will be important in maintaining a strong home market base and in identifying selected products for specific geographic markets. Key areas to watch and assess within consumer products include dairy desserts, liquid milk product variations, yoghurts, ice cream, butter/spreads, cheese, creams and formulated powders. Base commodity products Competing in the base products (including bulk cheese, butter, WMP, SMP and casein) will always be important segment of the overall product mix for the Irish dairy producers. Price competitiveness and processing efficiency will be critical to maintaining market presence. However, it should not take the focus away from trying to add value to the final product, rather than focusing on minimising the production costs alone. In addition, these base products will continue to be needed to be used as a buffer to accommodate seasonal production peaks inherent in the Irish dairy model. Functional products Functional foods constitute a major growth area with demand being driven by greater consumer interest in the diet and health relationship, aging populations and advances in food technology. It is a product segment, which presents exciting potential opportunities to the Irish industry. In order to take advantage in this rapidly developing sector, Irish dairy processors must harness the science research capacity available to them from the Irish food research institutions and leverage their existing inhouse competencies and resources. The application of science will particularly, benefit the development of functional solutions and applications for cheese and butter produce. Current examples of such products include, bioactive spreads, yoghurts, protein extracts used for health enhancement and new developments including cheeses with oral hygiene benefits.
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Organic products This is another growth area and one that has been mainly neglected to-date by the Irish industry. The Irish organic food market is still very small, however, the Irish and other geographic markets are growing rapidly from its low base and is forecast to treble over a 5-7 year period. The positive forces driving the market are health benefits linked to consumers concerns regarding food safety and the environment, and improved taste as perceived by consumers. In addition, further market growth will be facilitated by the perceived image of organic produce as ethical, responsible and more environmentally friendly. The optimal shape of the product portfolio for each individual market will clearly depend on that markets stage of development and sophistication, its trading environment, and proximity to Ireland. That said, we would estimate the optimal overall product breakdown 54 by volume for the industry as a whole as depicted below (all shapes are approximate): Figure 12 Current and future product portfolio mix 55
15%
Functional & organic foods Consumer products
5%
20%
Value added Ingredients
20% 30% 45% Base Products
65% Base Products
Current product portfolio mix
2015 product portfolio mix
The key strategies and supporting actions required to bring about this type of product portfolio mix shift are discussed in sections 3.1.1, 3.1.2 and 3.1.3 above. To take full advantage of the emerging opportunities, the Irish dairy industry will need to reshape its product market focus as indicated in the graphics below. Irelands geographic trading area may be considerably broadened through the development of products with higher margins that are better able to sustain transportation costs. (The relationship between distance to market and trade value for various different product categories was discussed in section 6.2 of chapter 2)
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Base products: butter, SMP, WMP, bulk cheese and casein. Ingredients: products that are customised to meet specific manufacturing consumer demands (includes fortified milk powders or specialist cheeses) Consumer products: branded consumer goods included dairy foods and branded butters. Functional products: specifically designed products that utilise proprietary technologies to deliver enhanced benefits to end-users. Examples include high value protein extracts and functional foods. Organic products: those produced in a natural way without excessive use of pesticide, industrial farming and yield intensifying technologies. 55 Figure 12 is only for illustration purposes to demonstrate the type of shift in the product portfolio that needs to occur. The percentages are approximate, given the difficulties in agreeing standard definitions and measures of what constitutes a base type product. For example, the cheese product category can contain both base type products and high value-added consumer products
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Figure 13 Current product market focus
Functional products
Consumer products
Current product market focus
Ingredients
Base products European Union Middle East Central Eastern Europe Americas Asia
Figure 14 Future product market focus
Functional products
Consumer products
Future product market focus
Ingredients
Base products European Union Middle East Central Eastern Europe Americas Asia
The key message emerging from the required change in Irelands product market focus is the need for the processing sector to reduce the amount of base type products it manufactures and to increase the quantity of higher valued-added outputs.
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To achieve the desired future product portfolio and product market focus as outlined above will require significant effort. The challenge of delivering this change should not be underestimate d. The overall objective for the Irish industry should be to reduce the volume of purely base products it sells and to expand its ingredients and consumer product offerings, while at the same time, tapping into the hitherto, largely unexploited functional and organic foods segment. Chapter 2 gave details of some of the opportunities for the Irish industry that exist in different markets. Ultimately, however, each individual processor will need to assess these market opportunities and conduct more detailed and customised strategic market assessment to identify the opportunities that are most attractive for them and most suited to their existing (or potential) competencies. This shift in the industrys product mix will require: Greater levels of product specialisation by individual processors. Processors in determining their optimal product portfolio, will need to assess their own competencies and competitive strengths in light of the market opportunities and the requirements and imperatives in successfully availing of those opportunities Significantly increased levels of investment in plant, technology, product and market research and analysis. Developing higher value products and establishing points of differentiation will require a market driven approach to research, identify develop and successfully convert market opportunities and niches. This will require focused investment. Processors will need to identify and develop further strategic alliances and partnerships to give greater access to new technologies, products and markets.
The changes required to implement these strategies and the benefits that would accrue to the industry from an improvement in the economic value-added to milk are discussed in section 3.2 and 3.4 below. 3.2 Actions to deliver key strategies Changes are required at all levels of the dairy industry to successfully implement the strategies identified in section 3.1. Changes are required in the following areas:
Milk production Product processing and plant configuration Industry positioning Industry supports
3.2.1 Milk production The production sector is an integral part of the dairy industry and any strategic actions to improve the competitiveness of the processing sector must also include co-ordinated actions to address a number of the weaknesses and challenges facing the production sector. The processing sector is dependent on an efficient and economically viable production sector and to achieve this going forward will require radical changes to how the sector is structured and supported. As highlighted in chapter 1, the production sector is facing a number of major challenges. The key challenge is the future viability of dairying for a majority of the farmers given the price -cost squeeze and the restrictions on increasing productivity and efficiency. Irish dairy farmers are smaller, more seasonal in their production and than the dairy farmers in Irelands major EU competitor countries Denmark and the Netherlands. The future economic viability of Irish dairy farmers will largely depend on their ability to substantially increase productivity and improve cost efficiency. While some Irish dairy farmers are highly efficient, many will have to greatly improve their productivity to bring them up to comparable levels to those being achieved in major competing countries or else exit the sector. Irish dairy farmers also need to achieve the same scale of production as the Danish and Dutch farmers. The achievement of the necessary improvements in productivity and cost efficiency will require the following recommended changes to policy and structure of dairy production.
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Recommendation 1 Allow the scale of producers to increase significantly The changes to how the quota system is operated and managed will be needed to enable the average annual quota size, currently at 189 tonnes (40,400 gallons), to move closer to levels prevailing in countries like Denmark (107,000 gallons), the Netherlands (84,000 gallons) or even Northern Ireland (77,000 gallons). The stayers in the industry must be facilitated in obtaining the substantial increase in quota at an economic cost. Changes to the quota management system will need to allow for freer movement of milk quota to areas where it is economically more efficient to produce milk and for a greater clustering of production around processing locations. This will have the benefit of improving both the cost of production and the cost of assembly. Ireland is competing against countries, which allows much greater freedom of milk production to move to locations where it is more cost efficient to produce and thereby, enabling more efficient producers generate a greater return from their milk. Recommendation 2 Include conditions and/or price signals regarding the production of out of season milk as part of the increased supply capacity of dairy farmers (in conjunction with recommendation 1 above) This is needed to address the problem of Irelands highly seasonal milk supply, which is costing the industry in terms of very low levels of capacity utilisation in the processing sector and restricts the product options available to the industry. At the height of the peak the industry is currently at close to 100% utilisation but this falls off dramatically in the off peak. However, if the seasonality of supply is to be properly addressed, this change must be in conjunction with efforts by processors to identify higher valueadded products to utilise the increased supply of off-season milk and enable a price premium (in relation to the peak milk price) to be paid to compensate somewhat for the higher production costs of off peak milk. Others measures to address the seasonality issue include, differential milk pricing for peak and off peak milk supply. The increased costs of producing an even supply of year round milk currently exceeds the benefits that would be achieved from increased capacity utilisation. Without price signals and incentives for producers, it is unlikely, that much improvement will happen. The seasonality issue needs to be examined further by the industry participants in light of the overall changes being recommended for the industry and the costs and benefits that would accrue. The recommended changes to the management of the quota system will have far reaching effects for the structure of the production sector. It would see the average quota size moving towards 107,000 gallons and a greater clustering of production around more cost efficient production locations. There is a danger however, if the scale and efficiency improvements were to occur at producer level w ithout measures to address the seasonality issue that the seasonality position would worsen further. Given the erosion of the relative competitiveness of pasture -based production, due in part, to increased subsidies for maize feed and silage and the reduction of grain prices, consideration should be given to seeking an EU subsidy for grass-based fodder to offset the competitive disadvantages to Ireland arising from the grain feed subsidies. Failure to achieve these changes in milk production in a planned way will result in many farmers with earnings significantly below the average industrial wage and this will accelerate the exodus out of farming without improving the lot of those who choose to remain. The potential for dairy farmers to secure higher prices for their output to compensate for their increasing costs and declining incomes is very limited given the downward pressure on product prices (particularly, for commodity/ base products) and policies at EU level to lower the value of price and market supports. The stark choice facing dairy producers is to get bigger and more productive extremely quickly or continue to face a sustained period of falling real incomes.
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3.2.2
Product processing and plant configuration
The approach adopted in determining the future configuration of the industry is discussed in Appendix 7. Recommendation 3 Rationalise the number of plants processing butter, powder, casein and whey products to create four major sites for these products It is clear from the estimated future product volumes developed in chapter 2 and included in Appendix 7, that the production of base products such as butter, powder and casein will continue to represent a significant proportion of Irelands output. The key requirement in supplying markets for these products is cost competitiveness. To achieve this requires competitiveness, not just in terms of raw milk production but also through efficiencies at processing level. Having taken into consideration the various factors discussed in chapter 2, above in sections 3.1 and 3.2 (as well as other factors discussed in Appendix 7), it is our view that there are significant benefits to be achieved from concentrating the processing of butter, powder, casein and whey products into four large sites, most importantly achieving savings that will ensure the cost competitiveness of the production of base products. This would result in the following average output per plant. Table 50 Future industry plant numbers and outputs
Butter Current number of plants Future number of plants Future average output (000 tonnes) Future total output (000 tonnes) 11 4 32.5 130 Powder 11 4 29.2556 117 Casein 7 4 12.0 48
These four sites would operate at an efficient scale with increased capital investment required to upgrade existing equipment and to purchase new equipment. This configuration would also provide the flexibility required to process Irelands seasonal milk supply as efficiently as possible. For example, specific investment may be required for a 7.5 tonne an hour dryer. But this dryer could be combined with smaller dryers in the same plant that are more efficient to operate when milk supply is low. These sites would also retain some of the flexibility that exists in the Irish industry, particularly, the switching of production between different powder products in response to market demands. Strategically identifying these plants throughout the country, two in Munster, one in Leinster and one in the northern half of the country, will result in efficiencies in both milk assembly and production of dairy products. Once the changes at production level in terms of location, scale and seasonality outlined earlier in this section are implemented it will be possible to consider reducing the number of sites focusing on primary processing to three. However, this may require the establishment of a greenfield site with significant implications in terms of the level of capital investment required. The proposed configuration will leverage the existing investment that has been made by the industry but will remove the plants producing small amounts of base products, often inefficiently. The significant efficiency gains to be made from this change are outlined in detail in section 3.4 below. The key outcomes associated with implementing this recommended plant configuration include four to five less processors being involved in the primary production of butter, powder, casein and whey products and up to seven less plants producing these products.
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Average output of SMP and WMP only. Average output of powder plants including other whey and fat filled powder products will increase to close to 50,000 tonnes. This is estimated using processor data, as no official published industry data is available for the production of whey and fat filled powders.
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Recommendation 4 Ensure cost efficiency in production of bulk cheeses and increase the levels of secondary processing and added value within larger cheese plants The Irish industry currently has the plant infrastructure to efficiently produce the volumes of bulk cheese required in the future. Thus three or four of the larger plants need to continue to produce bulk cheese as cost efficiently as possible at levels above 20,000 tonnes per annum. The main change required in these larger cheese plants is to shift their focus away from purely primary processing (of bulk cheeses) by increasing the levels of secondary processing and the value -added content of the cheese products. Effectively these processors need to invest in the technology, product development and innovation required to gradually increase the levels of value-added to the cheese produced. The large-scale cheese processors need to look at developing mild/semi hard cheeses to avail of market opportunities in continental EU markets and in the growing foodservice and industrial markets. This is necessary to reduce the current dependence on the bulk cheddar market in the UK. There are also opportunities for smaller processors to develop added value products through targeting particular market niches such as speciality cheeses or through secondary/further processing or the production of non-bulk cheeses. For example, a processor may enter an agreement to purchase bulk cheese from one of the four large processing plants and add value through branding, product differentiation or further processing to meet the exact requirements of a customer. Recommendation 5 Increase the levels of secondary processing, plant specialisation and improve overall innovation levels Smaller processors can play an important role in developing the secondary processing sector of the industry and increasing the value-added to dairy products by the Irish industry. These processors should focus on identifying niche opportunities through the application of technical and scientific innovation that will result in new products, novel product solutions and in the creation of close working relationships or partnerships with customers that are all fundamental parts of increasing the value of outputs. While the production of bulk cheese should be concentrated in four large-scale plants, however, the overall number of cheese plants may increase as smaller specialist processors identify market niches to service. Similarly, there will be some opportunities for secondary processing of powders on a small scale, for example, to develop ingredient solutions to meet specific and specialised customer needs. Indeed specialisation by smaller processors and increased levels of innovation that can be generated in smaller organisations will be vital in the development of unique products such as functional products that are a key element of the overall recommended industry strategy. There are, however, certain higher value added products, where scale of manufacturing capacity and technology investment are critical to longterm success. 3.2.3 Irish industry positioning
Recommendation 6 Maintain and defend a solid base in the home market with a full range of products The importance of the home market has been discussed in section 6.1 of chapter 2. Business experience suggests that, almost irrespective of the industry, home market dominance is the key to international success. The situation is the same in the dairy industry, where a strong market presence in the home market is even more important due to inherent relatively low margins. This means that costs of transportation must be minimised by selling more of the produced volume in the home markets and not transporting low margin goods overseas, where margins may be easily offset by prohibitively high transportation costs. As a rule of thumb, the higher value-added content of the product, the further away it can be transported without negative impact on the products profitability. Specifically, in Ireland, having a solid base in the home market with a full range of dairy products should enable the indigenous dairy manufacturers to:
Capture higher margins for the products it supplies on the home market compared to the prices obtained for its exported products
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Increase domestic consumption of dairy products both in absolute volume terms and in terms of Irish industry generated value. RTS associates recently reported that Irish consumption of dairy products in 2001 was 176.3 kg per capita. While above the EU average of 139.5 kg and the UK (152.1kg) it is still behind others including the Sweden (192.9kg), the Netherlands (211.7kg), and Denmark (184.3kg), suggesting there are opportunities for future market growth Increase indigenous commercial product utilisation and added value applied to products in Ireland thus reducing the reliance on intervention mechanisms and policy support Leverage promotional and product development expenditure for other markets (activity subsidisation) Test new products and their uptake at home prior to wider roll-out Limit competitors power and influence Create a greater awareness of Ireland as a key dairy supplier Appreciate the difficulties and intricacies involved in using various routes to market Understand the importance of understanding, anticipating and responding to consumer and market demand.
It is possible to argue that, for a country with a reasonably high reliance on the dairy industry such as Ireland, that in the future, there may be a requirement to consider an expansion of what it considers to be its home market. Some may consider that it could extend into some EU markets in addition to the island of Ireland. Unfortunately, this is not possible for a full product range due to factors such as the cost of transportation, local market regulation and the growth of food nationalism. As a result, Ireland needs to concentrate on the Irish domestic market first, and could secondly look at the UK market where it could position itself as a key supplier of a wide range of dairy products (both base and value-added). The UK must become an important extension of the Irish home market, especially, in higher value-added dairy products. Clearly, at the present time, this excludes liquid milk since its transportation across the Irish Sea is not economically feasible. The supply of a full range of products in the UK market would require control of a liquid milk pool in the UK. However, given the relatively recent negative experiences of a number of Irish processors who previously entered and subsequently withdrew, re-entry to the UK liquid milk market is unlikely in the short-term. Therefore, the focus for the UK markets needs to be the extension of the product range supplied as far as possible particularly, higher value-added products and the building up of market share for those products. While the exact market share necessary to secure dominance will vary from market to market and by product range, we would estimate that 90% and above of the total share of the dairy market (both consumer foods and ingredients) is a good benchmark, certainly for the Irish dairy industry in Ireland. It is estimated by industry observers that Arla, for example, supplies over 95% of all dairy products in its home market, while the Irish dairy industry is less than this (some suggest as low as 75% in certain product categories) due to the level of imported consumer dairy foods sold in Ireland. Consolidation of the position of Irish dairy products in the Irish market will involve increased focus and investment in value-added products as a key part of the full range of products. Greater levels of investment in new product development will need to be combined with increased spending on advertising and marketing to build and extend brands. This investment should provide a springboard for the sale of an extended range of products into other EU markets and the UK in particular. The Irish industry must determine the key attributes of its dairy products and develop uniform messages that will extend beyond the domestic market. This will require greater levels of investment in A&M and branding with this spending being made in a co-ordinated and efficient manner.
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Recommendation 7 Target other geographic areas beyond the home market with a selected range of products specifically targeted at the needs and opportunities in those markets It is our belief that Ireland, if it is to continue to be a successful international dairy player, needs to adopt a smart targeting approach to different markets built on uniquely Irish, difficult to emulate competencies. (An example of a successful application of this strategy has been the creation of the Irish cream liqueur market where the Irishness is an integral feature of the product). Today, consumers are looking for more than just food, but for what that food can do for them in other words, they are looking for points of value. Most of these points of value have already been mentioned in the chapter 2 of the report, i.e. naturalness, technology, quality+, culture/affiliation, cost, location, and isolation from food scares. Their application in practice, would enable the Irish dairy industry to:
Differentiate Irish produce from other competitors thus expanding sales in the value segment of the market Position the industry as a supplier of value-added and differentiated dairy products Extend the geographic reach of Irish products into the areas and markets not available or economically viable on a pure base product/commodity proposition Create long-term relationships and partnerships with consumers and customers alike Build and expand a strong consumer franchise through branding and positioning in home and proximate markets Generate consumer market pull in addition to the sales push by making sure that the consumers are actively seeking out and demanding Irish dairy products as a result of consumer campaigns in addition to trade campaigns (B2C and B2B promotions appropriate to the product and route to market) Carve out for itself a unique niche within the consumer base and create a (positive) consumer/ buyer image
A key component of targeting specific markets with selected products is about selling what the market wants to buy and not merely what is relatively easy to produce and we have to sell. In the section on opportunities in some selected national markets in chapter 2, we argued that supplying base type products presented very few real growth opportunities and these sales would be at a low margin for the Irish industry. In some instances, due to strong competition from NZ (powders) or the Netherlands for bulk cheese, opportunities in these markets may prove very difficult to secure growth and in some cases, hold existing relationships, without improvements in price competitiveness and/or acceptance of lower margins. Indeed, there may be no opportunity at all for base type products in the longer-term in some of these markets, as is the case in Central and Eastern Europe, where the development of strong local industries are expected to dominate the dairy sector in these product segments. However, it becomes apparent that opportunities do exist as soon as the points differentiating Irelands dairy products from other suppliers are amplified. (See opportunity matrix in section 6.2 of chapter 2) As the matrix developed in chapter 2 demonstrates, a switch from a product production focus to a market supply mentality helps in identifying potential niches to be exploited by the Irish dairy industry. Individual processors need to develop and build skills and competencies in the area of strategic marketing to enable them to assess existing and emerging opportunities in different markets and customer segment and to determine how their enterprises can exploit these opportunities. In the more sophisticated markets, such as Western Europe, points of differentiation may need to be varied by the route to market for example, quality+ is of more importance to the foodservice sector than to industrial usage. In the less sophisticated markets, general communication of these points across the board may be sufficient. It is important to note, however, that the type of differentiation point used must be utilised to communicate the difference of the product to its intended consumption base. This means that the approach to sales of consumer-oriented (branded) cheese in Germany will differ from that in the UK, even though approach to the sales of bulk cheese may be similar in both markets. Generally, points of differentiation will vary by route to market. In retail trade, where consumers are interfacing with the product directly, qualities such as culture/affiliation, location and functionality become more important. At the same time, in the industrial and foodservice sectors cost, quality+ and technology are key. As a result, the Irish industry needs to tie
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their differentiating messages with the intended market audience. As discussed in chapter 2, most of the growth/expansion opportunities for the Irish dairy industry in the future will be in the industrial food production and foodservice. In order to capture these, the industry will need to:
Offer continuity of supply at all times Continue to be competitive with price differentials not exceeding 5-10% Provide consistent batch quality throughout the year Attempt to offer customised product solutions to key customers Create partnerships with key customers to further customise products and continue R&D innovation.
This report demonstrates that the main opportunities for the Irish dairy processing sector present themselves across different markets, and cover different products. In respect of base products, it is critical for the processing sector and individual processors to concentrate on the market segments in which it is likely to have most advantage, for example:
Cheese the EU and the US Butter EU, Northern Africa SMP EU, Mexico, Asia WMP Middle East and Northern Africa
While Ireland has been very successful in the US casein market in recent years, changes to US legislation have the potential to have an adverse impact on opportunities in the area with a large volume of US SMP stocks being allocated for conversion into casein. If this programme is successful it could displace a significant amount of imports. The identification of selected markets for higher added value products will be dependent on providing product solutions for specific end uses. In many cases, this will involve increasing investments in new product development and for clients in industrial manufacturing, the ability where appropriate or necessary, to jointly own such technologies. It is also important to realise, that, as far as ingredient solutions and functional technologies are concerned, the industry will need to concentrate on customers, rather than markets alone. This means that the industry needs to continue to identify and develop partnerships/strategic supply relationships with major players such as the Nestles and the Unilevers of the food manufacturing world, and McDonalds and Burger Kings of the foodservice universe, and leave to them the task of putting their products into the supply chain. For these players, the industry will need to provide: Joint R&D capabilities Product development and customisation partnerships Ability to service their requirements in whatever markets they are present Market knowledge and market research support.
Irish processors must move from an over reliance on trading type relationships with buyers, which are typical of base product trading to developing more partnership type relationships. For industrial and manufacturing suppliers, the challenge is to fully understand the needs of end customers and become a solutions provider. Irish food processors have been relatively successful to date at developing these types of business-to-business partnerships. However, Irish dairy processors need to have a greater focus on this area and to transition more of their buyer relationships from traders to business partners. Success in developing and sustaining these new type of relationships will be difficult, placing major demands on the industry in terms of investment and cost competitiveness, will only return relatively small improvements in margins obtained but they have the potential to provide more secure and longer-term relationships than those typically enjoyed in a purely trading relationship where price competitiveness is central. At the same time, developing consumer-facing products will require investment in partnerships with retailers on one hand, and familiarity with the needs of end consumers on the other. In particular, further
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creation of, and support for Irish brands will be paramount in reaching the consumers. As a result, the creation and on-going support of a consumer-aware marketing structure will be increasingly important as the industry moves into more value-added products. The opportunities involving consumer-facing products require investment and focus to develop brands and to leverage the experience of developing these products in the home market. While this has not been a traditional strength of the Irish dairy industry (and the wider food industry) and it will be difficult given the scale of established brands and large advertising and marketing spend of competitors, however, it is not impossible and establishing strong Irish brands is an important element in the future strategy of the industry. This is particularly, relevant for securing a strong home market base and for selected products to specific target markets and niches. This will involve the extension of brands developed in the home market as well as the acquisition of local brands. There have been some notable success stories that have created good Irish food and drink brands and the requirement now for the dairy industry is to develop brands in selected products that are built around uniform messages such as Irelands green and clean image and Ireland as a food island.
Recommendation 8 Maintain price competitiveness in base products The absolute amount of base products sold by the Irish industry needs to be reduced but these products will always be an important part of the Irish dairy output. As outlined in section 3.1.4 above, using a broad definition of base products to include butter, powders, casein and bulk cheese, we estimate that the Irish industry needs to reduce its volume of base products from 65% to 45%. In section 3.4.1 below for the purposes of calculating the impact on the level of economic value added (EVA) from a shift in the product mix we use a narrower definition of base products including only butter, SMP and WMP, and using this definition the strategic stretch target for the Irish industry is for these products to make up 34% of the industrys portfolio by 2015, as opposed to the 40% they account for at present. That said we would expect a significant proportion of this volume to be sold in markets in Ireland and within the Euro-Africa zone. In the case of Ireland, this will require a greater demand from within the secondary dairy-processing sector for the usage of these products. For example, a significant expansion of the baby food industry may help increase the level of internal market demand, as could the usage of dairy products in black-box solutions. These same base products also form part of the selected products for selected markets strategy (see recommendation 7 above), particularly, as far as butter and cheese sales to the EU are concerned. Again, as the base product markets are becoming more advanced and Ireland is forced to compete with lower cost producers, it must endeavour to create products and/or product messages that set it apart. A closer, more applied and leveraged approach by the research organisations and the dairy industry will be critical in developing such initiatives. It is interesting to note that both Arla and Fonterra have internalised a large proportion of the dairy industry R&D resources within their respective countries. However, a small part of base products (and this may vary year to year) can be sold to the cost-conscious markets such as those of North Africa. While the return is not likely to be great, cost-based trade in base products will enable Irish manufacturers to: Maintain their cost competitiveness, which is paramount for less developed products and less developed markets. Ireland must maintain cost competitiveness while it develops alternative product strategies. Build a long-term position of the Irish dairy industry as a potential value supplier. Establishing a greater stronghold in the economically developing markets will enable Ireland to extend and expand its product penetration once they become more advanced. This may involve local market investment, joint ventures or strategic alliances in processing facilities, distribution networks, etc. Recommendations 3, 4 and 5 above will deliver processing efficiencies, economies of scale, reduced overheads and greater capacity utilisation, all of which are key elements in ensuring the cost competitiveness of Irelands dairy products. Sporadic trading in base products in distanced markets will continue to be important for the industry; however, it must not become a prevailing strategy. It must only be used as a means to off-load excess products, rather than a sustainable trade opportunity.
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However, it is clear that the processors that continue to produce base products and those responsible for selling these products must leverage the wealth of existing experience that the Irish industry has in this area. However, within some geographical markets it may be necessary to develop additional or new sales support infrastructures to encourage the ongoing use of Irish dairy products (sales support, inmarket facilities to add value reconstitute, repackage, etc). This is particularly, true of developing dairy markets in Africa where the sales of milk powders may be assisted through arrangements with providers of re-constitution plants in the area, as the major markets are for liquid dairy products.
Recommendation 9 Develop and market unique value-added (including branded) products for wider export within the EU and overseas The continual identification and development of unique value -added products should become one of the most important focal points for the Irish industrys internal development. Success in this area should be to enable manufacturers to maintain and even increase their margins, not reduce them. Functional products could potentially become a very significant market growth opportunity for the Irish dairy industry. Considerable scientific potential is available to the industry from a number of domestic academic and research institutions and this coupled with a favourable international image of the Irish dairy industry on the whole, should pave the way for success should the industry choose to pursue this opportunity area. Innovation will be key to avoid the commodity trap, (i.e. excessive dependence on base/commodity/ generic products). The industry has to create a climate of increasing the commercial application of scientific research and new (and existing) technology. The defendable market opportunities within the Afro-European zone are for solution-based dairy products into manufacturing and industrial users, and for branded functional products ready for consumer use. High value dairy ingredient solutions, high value dairy goods and those products that utilise proprietary technologies have the ability to be sold across all markets. Due to their enhanced value, the costs of transportation are relatively small enabling global market opportunities to be reached and serviced. The industry should move quickly, to create a market-led and technology driven dairy industry and capture opportunities that currently exist and that will emerge over the next decade or so. There is an opportunity for the Irish industry to capture a market within the high value ingredient markets that utilises Irelands track record in innovation and enables it to create greater value from its base dairy products for markets both within and beyond Europe. Successfully developing unique products for wider export will necessitate a fundamental shift from the current product focus to a more market driven focus. The objective must be to fully understand the market requirements and to develop products that will create a demand chain for unique Irish products. Irish companies in other industries and within the dairy industry have proved that they are capable of being world leaders in product innovation and in the application of the latest technologies. Irish dairy processors can build off the successes and experiences achieved to-date and on strong academic infrastructure and move to the forefront in new product development and technical innovation. But, this will require significant ongoing investments in R&D and a determined effort to be world-leading providers of such products to international purchasers.
3.2.4 Industry supports need to be structured around core needs at each level of the value chain As outlined above, there is a clear distinction in the needs and focus required at the different levels of the value chain from production to primary and secondary processing. This distinction also extends to the industry supports required at each level. Production level support requirements The Department of Agriculture & Food (DAF) will need to take a leadership role in communicating the future outlook for dairy farming and the implications of this outlook for the sector in terms of its current structure and the need for major change in terms of the scale, productivity, cost efficiency, milk quality and seasonality if the industry is to avoid declining incomes and loss of market share. The DAF will need to take a leadership role in overhauling the quota management system to achieve the changes
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recommended above. The DAF will need to play an important role in encouraging the strategic shift in focus that needs to take place in the industry as a whole to improve and sustain its international competitiveness and to increase the value-added content of Irish dairy produce. Teagasc will need to continue to play an important support role in assisting those farmers who remain in dairying to maximise their productivity, cost efficiency, product quality and reducing seasonality from the increased quota available to them. The dairy processors also have a vital role in assisting the production sector make this transformation by assisting in the management of the transfer of quotas, providing technical advice and assistance to improve efficiency and quality and by improving the value-added component of their output to protect or minimise the fall in the return to the producers. The processors also have an important role in communicating to their farmer suppliers the requirements and implications of being internationally competitive and the need to invest to improve the value content of Irish dairy produce.
Primary processing (base products) support requirements Marketing and distribution Given the importance of cost competitiveness in base products, the marketing and distribution of primary processing outputs (base products) must be carried out in the most cost effective manner. The marketing of base products can still benefit from the economies that a centralised marketing agency like the Irish Dairy Board (IDB) can offer. The benefits and cost effectiveness, however, from centralised marketing and distribution must be demonstrated so that it is clear and transparent to the users of the centralised service. However, if the recommended strategy is implemented fully, it is likely that the percentage of base products in the overall product mix will fall and the volumes of product going through the IDB would be reduced which may necessitate a refocusing of the role and of the structure of the IDB. Anot her factor that may require a refocusing of the IDB role may arise from the scale and individual capacity of the remaining base product manufacturers to conduct their own marketing and distribution if base production is concentrated in four plant sites and by a consolidated number of processors. Process efficiency Support in the research area for primary processors, by state and academic bodies, needs to focus on improving process efficiency and reducing manufacturing costs. Teagasc will continue to play a key role in supporting the industry in this way but must ensure that it provides appropriate support to meet the specific needs of producers, primary processors and secondary processors. Secondary processing (non base products or added value base products) support requirements Marketing and distribution It is envisaged that greater levels of marketing and distribution conducted directly by secondary processors will be necessary as these processors develop business to business partnerships with their customers. However, a marketing cluster support infrastructure will be required to support those smaller processors who will be operating as niche innovators producing value-added products and where a central marketing body with the relevant skills is cost effective and more economically viable than for each of the operators to develop their own competencies and resources. R&D and market development Research and development within secondary processing will be increasingly market focused and should result in the application of innovation and greater levels of new product development at processor level. Organisations including Enterprise Ireland, Teagasc, and UCC must ensure that they are providing sufficient support to the industry to ensure that adding value through all possible means is facilitated and encouraged including R&D supports, NPD and market development. Enterprise Ireland currently have a number of R&D solutions for industry, which need to be exploited and leveraged more fully and where necessary, improved to meet the need to significantly increase the level of research and product development in the industry. These solutions include; the research technology and innovation (RTI) competitive grants initiative; the innovation management initiative; intellectual property assistance; the technology transfer initiative and innovation partnerships and networks with colleges to leverage knowledge transfer.
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Industry wide support requirements Food quality and safety Several organisations including the Food Safety Authority of Ireland (FSAI), Teagasc and the Environmental Protection Agency (EPA) have played valuable and needed roles in ensuring that the quality, safety and image of Irish dairy produce is protected and enhanced. Indeed the recent announcement of a strategic alliance between the FSAI and Teagasc to develop the highest standards for food safety and hygiene at all stages of the food chain is to be welcomed. A key point of differentiation for the industry going forward will be the promotion and support of the image and reality of Ireland as a food island and a producer of natural produce of the highest quality and safety standards. Food safety and quality will be of critical strategic importance to the future of the industry. Ireland needs to a take a leadership position in this area. This will require the imposition, implementation and independent inspection of stringent quality, environmental and safety standards to re-enforce the quality image of Irish dairy produce and reassure the buyers and consumers that the standards are real and verifiable. The development of Irelands quality food island status has to start with the production sector and be followed right through the value chain to the purchasers and consumers. Independent bodies such as the FSAI and EPA need to have a strong role in setting and inspecting these standards, while Teagasc need to have a role in assisting farmers in meeting the required standards effectively and efficiently. The cost of achieving and policing these quality standards have to be borne by the industry at each element of the value chain since it will become an essential standard requirement to operate successfully in the food industry in the future. Given the vital strategic importance of this whole area for the industr y, a coordinating function to pull together and oversee the different strands of food safety and quality is required.
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3.3 Requirements to facilitate changes and implications of change A number of implications and requirements necessary to facilitate changes in the industry have been identified and are discussed below. Competition issues relating to the dairy processing industry are discussed in Appendix 10. 3.3.1 Greater levels of specialisation and co-operation by processors The savings associated with improved efficiency from increased plant scale (see section 3.4.2 below) will provide some of the necessary funding for investment in the development of greater levels of secondary processing and ultimately, the addition of greater value to the dairy products made by the industry. However, for increased value-added to happen will require greater product and processing specialisation and increased co-operation within the industry. Primary and secondary processing requires different disciplines and skill sets and should be run as separate commercial entities. In some cases, both primary and secondary entities can operate within the same organisation, but to be successful they need to run almost independently of each other for their core functions. It is likely in the future industry configuration, that two or three processors will be involved in both primary and secondary processing but the other processors in the industry will need to specialise in either primary or secondary processing. Increased co-operation between processors will therefore, be required. This could involve, for example, secondary processors contracting out their primary processing requirements to scale primary processors or the establishment of joint venture primary processing operations between processors to achieve a more optimal cost efficient scale and to share the capital investment costs involved. 3.3.2 Phased change to plant specialisation with a reduction in the number of co-operatives The change to the new plant configuration will involve a gradual shift in the focus of processors so that greater product specialisation is achieved. The four sites for the large scale production of base products should be identified quickly so that future investment is channelled into these sites. Consideration should be also given to an eventual ideal plant configuration for three plants for base product production. This will leave other sites, and processors, not involved in the production of base products to identify areas within secondary processing where they can specialise and make appropriate investment to move into these areas. Ultimately, this phased approach is likely to result in the closure of some plants and a reduction in the overall number of processors in the industry. The cost savings to be achieved from these changes are discussed below in section 3.4. Benefits of reducing the number of base product processors The benefits for the entire industry of moving to a position where three to four processors dominate the production of base products include: Driving the implementation of necessary strategic imperatives Effective leadership, clarity of purpose and speed of action at processor level are all required to implement the changes necessary to ensure that the industry delivers on the strategic imperatives identified and ultimately, achieves its future vision. The current position, with over twenty -four enterprises, is not conducive with clear and decisive decision-making and driving through major change. Facilitating investment in an efficient manner Irelands last round of significant capital investment was in the 1980s and while many of the plants have been well maintained, modernisation of plant and equipment is required in the short to medium term. Rationalisation and product prioritisation is necessary to avoid unnecessary duplication of investment. On a practical level, rationalisation is likely given that smaller processors are likely to encounter difficulties in obtaining the necessary levels of funding for capital investment and product innovation. Achieving the scale and depth of expertise required to realise specific opportunities Many of the opportunities identified as the way forward for the Irish industry are limited to operators who have both the scale and resources to meet market requirements. Buyers are increasingly reluctant to risk establishing or maintaining a long-term relationship with smaller players and are looking to build strategic partnerships with a small number of larger suppliers. For retailers, this may involve obtaining one or two suppliers to provide a full range of dairy products or for industrial buyers it may include joint ventures for product development or guaranteed supply.
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Rationalising the processing sector will create a smaller number of Irish players involved in base product manufacture. These will be better positioned to build these partnerships with large buyers of dairy products, while leaving room for smaller processors to focus on niche or specialist market opportunities. Ensuring environmental and hygiene standards are achieved Processors are facing increasing pressure from consumers and buyers for higher quality and environmental standards. The cost of compliance may be uneconomic for smaller processors. Larger scale production of base products will enable processors to make the investment necessary to ensure environmental requirements and standards are met. 3.3.3 Addressing the seasonality of supply The key industry strategies outlined in section 3.1 above are based on Irelands current seasonal milk production and the current processing capacity utilisation of just 60% that this seasonal supply causes. Addressing the seasonality of milk supply has the potential not only to increase capacity utilisation but would also deliver more opportunities for the industry to add further value to Irish dairy products. The potential savings to the processing industry from reducing the seasonality of milk supply so that capacity utilisation could increase from 60% to 90% are estimated to be in the region of 35m. This is based on research by Teagasc 57 that identified a reduction in fixed costs of 0.7 cent per litre associated with increasing capacity utilisation from 65% to 96%. This is in line with a more recent study also by Teagasc,58 which also estimated a 0.7cent per litre saving in increasing capacity utilisation from 55% to 80%. However, the costs of reducing the seasonality of milk supply include higher production costs and potentially lower product yields. Indeed the research by Teagasc suggests that the increased production costs outweigh the gains for processors from higher capacity utilisation. The net cost of moving away from our seasonal production, again based on Teagasc figures, is estimated to be approximately 58 million, driven mainly by higher production costs. The issue of seasonal milk production is not new to the Irish industry and will not be easily addressed. While this issue is not within the scope of this study, given its significant impact on the processing sector this study suggests that efforts should be made to reduce seasonality. To reduce seasonality will require the encouragement of off-peak production through a combination of:
Differential pricing that penalises peak production and pays a premium for off-peak i.e. paying a higher milk price to contribute to the higher production costs of non peak milk supply Identification of products that will utilise the off-peak milk and deliver higher margins
Ultimately, both producers and processors both have a contribution to make in addressing this issue. However the changes must be driven by the market and commercial requirements and are unlikely to be addressed without a clear price signal and the effective communication of the business rationale/necessity for changes in milk supply patterns. Identifying the higher value products that require off-peak milk and contribute towards higher production costs is a significant challenge for the industry. It is important to note that seasonality is much lower in the northern half of the country and in Northern Ireland milk production is much closer to continental levels with a peak to trough ratio of 1.6, which demonstrates it is possible to improve seasonality significantly in Ireland but this basis for this shift needs to be co-ordinated and agreed between processors and suppliers.
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Development of a Combined Milk Production and Processing Strategy for Competitive Manufacture of European Pressed and Non-Pressed Cheeses using a Cost Model Approach OCallaghan, Guinee and Kelly 2000 58 Strategic Directions for the Irish Dairy Industry in a Freer Market (Pitts, OReilly 2002)
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3.4 What is the prize for implementing the recommended strategies and changes to the industry? The first part of this section outlines the net industry benefits of implementing the strategy outlined in this report. Some of the main benefits and costs of implementing the recommended strategies and changes are then discussed individually in greater detail in sections 3.4.2 and 3.4.3. The timing and realisation of these benefits and costs will vary and will not all be achieved immediately. Section 3.5 below, discusses phasing and prioritisation of the necessary actions. 3.4.1 Net Industry Benefits In determining the net benefits to the industry of implementing the strategy outlined in this study, it is important that all the costs and benefits are viewed collectively rather than individually. This is necessary given the interdependence of the various costs and benefits and the different nature of each; for example capital expenditure versus rationalisation costs. The timing of the investments and returns are interlinked and will need to ultimately, be assessed and determined by each individual processor on a return on investment basis. This is not practical or meaningful to determine at an industry level. It should be noted that the estimates of the net industry benefits only provide an indication of the potential level of return to the industry. The figures do not attempt to provide a means of calculating a full business case for capital expenditure with a return on investment at an industry level. This has to be done at an individual enterprise level. Delivery of the strategy, and ultimately, the industry benefits, will require significant front loading of costs. In particular, it is likely that the redundancy and capital expenditure costs will be heavily weighted towards the first two to three years of the strategic change programme. The rationalisation of the processing of base butter and powder products will involve absorbing an estimated one-off redundancy costs of between 50 and 100million. The requirement for additional capital expenditure, detailed in section 3.4.2 below, necessary to complete the rationalisation of plants and to facilitate the product shift into greater volumes of value-added products, has been estimated to be around 430m over a ten year period. Around half of this amount would be required in the first three years. Again the specific capital requirements needed, will vary depending on how the rationalisation actually occurs and which players take lead roles. This is another reason why the specific business cases need to be done at enterprise level as more detailed and accurate information of the specific capital requirements into the context of their own existing plant capabilities and capacity will be available. This additional capital investment will facilitate the development of the four main processing sites and deliver the savings from economies of scale and processor rationalisation, estimated at between 40 and 70 million per annum. But it will also be part of the process to provide the investment needed in plant, technology, R&D and NPD necessary to begin the process of increasing the value-added content of the product mix and to deliver the increased revenues as a result. The level of capital expenditure required will raise significant capital funding issues for the industry particularly, given that the investment and additional costs will be largely front-loaded and the benefits flow in additional net revenues will be more back-ended. The plcs will need to build a strong business case that will convince their shareholders that the return is sufficient to justify the risk and effort. This business case will have to compete with alternative investment opportunities within the dairy sector outside of Ireland, and against other investment opportunities outside the dairy sector altogether. Equally, the co-operatives must convince their members of the returns and logic for investment. In both ca ses, even when there is support from shareholders or members, there still will be significant hurdles to be overcome in obtaining the funding from banks or other funding sources. The difficulty of obtaining this funding is recognised but does not diminish the importance of making the required changes for the industry and the negative consequences of failing to make the required investment and staying within the same processing set-up and product mix. The real danger facing the industry, is that if insufficient or delayed action is taken in response to the changing policy and market environment, combined with the continuation of the decline of the industrys competitiveness, is that there will be a significant downsizing of the industry with overall industry revenues earned declining substantially. While co-ordinated and efficient investment and capital expenditure should deliver efficiencies and economies of scale, the real prize that the industry must aspire towards will result from the shift in the product portfolio in favour of added value and technology products. This is expected to deliver enhanced profitability margins when compared to existing products, dominated by base dairy outputs. In the main, the new products, yielding 280m in additional gross revenues as outlined in section 3.4.3 below, will be at a significantly higher margin than base type products and more akin to margins applicable to food and
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technology products. Major food companies return significantly higher operating returns than those reported by the dairy processing sector. As such, these new added value and technology products are expected to deliver increased returns, in the order of 15% - 25% versus the current overall dairy industry level of 2.7% 59. However, while the returns from the new additions to the product portfolio will assist in lifting average returns, they still will only represent about 10% of the total industry turnover. Despite this low overall volume, the margins generated have the impact of lifting overall industry operating profit margins. This new overall product portfolio mix and industry changes should result in the dairy industry generating operating profitability levels of 5%. It is important to remember, however, that as with any investment, there is considerable risk involved and it is likely that there will be failures and set backs to be overcome along with the anticipated successes on the road to delivering greater returns from new products. The net benefit of the suggested restructuring, with the costs and benefits as outlined in detail in sections 3.4.2 and 3.4.3 below, will be a gradual increase in profit generation over and above current levels. The heavy investment in new capital resources, restructuring costs and investments in R&D and promotion will result in significant costs in early years. However, the delivery of efficiency gains from industry reconfiguration and increased revenue with improved margins from the value -added strategy will ultimately deliver higher overall profitability. It is estimated that the delivery of efficiency gains from industry reconfiguration and higher margins on the added value product portfolio will ultimately, result in growth in annual net cash inflows of approximately 70 million. While these net cash inflows are dependent on the speed at which changes are implemented, it is estimated that the pay back on the investment could be achieved within six years. Again it is worth re-emphasising, that the net industry benefit and payback period are included merely as guidelines as to the level of opportunity that exists for the industry. Conversely, the negative implications and potential loses associated with not implementing radical change cannot be calculated but should be highlighted when outlining the argument for industry restructuring. The ability to capture the rewards for change is dependent on the implementation of a staged approach, detailed in section 3.5 below. It is worth re-emphasising that the rewards for this programme are interlinked and cannot be considered in isolation. The industry must consolidate to redress some of its declining cost efficiency, while at the same time repositioning its product and market portfolio to capitalise on the market opportunities that play to its strengths. Costs It is estimated that industrys reconfiguration will require considerable additional costs, particularly, in the first few years of change. These costs vary in nature including capital expenditure, one-off redundancy costs and increased investments in R&D and advertising and marketing. These are additional to the existing costs of the industry and are calculated at an industry level. In reality, the decisions on these investments and the allocation of these costs will need to be taken at individual processor level. The implications of this are addressed in section 3.5 below, which outlines what needs to be done to make it happen and in particular, the requirement for consolidation of processors. Redundancy costs Achieving the future industry configuration will involve significant change, with the likelihood being that several plants will either change production or close down altogether. In determining the size of the gain to the processing sector from implementing the recommended strategy, it is important to factor in an estimate of the costs associated with the redundancies required. Using the data provided by processors, in particular, the data in relation to the number of direct employees, we have included an estimate for a front-loaded total redundancy cost of between 50 and 100 million spread over the first 3-4 years. A cost range 50-100m is included due to the difficulty in determining the exact number of redundancies that would occur and the potential variance in the terms of the redundancy packages that can be negotiated. However, if the historical package norms were to prevail, the redundancy costs are likely to be at the upper end of the estimated range. The exact cost will also be dependent on the ability of some of the smaller plants currently producing base products to find alternative opportunities in secondary processing. The negotiation of redundancy terms and the impact of length of service will also mean that redundancy costs will not be evenly spread
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Based on data provided by processors See Chapter 1. As an aside, if the industry operating profitability was at the level achieved by the best performer in 2001, an additional 100m in operating profit would have been generated.
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across the industry. As outlined in section 3.3.1, the transition to the new industry structure will require cooperation between processors and the negotiation of this co-operation, whether through joint ventures or other means, will determine the level and how redundancy costs are met. Re-investment costs /increased capital expenditure A fundamental element of delivering the strategies outlined earlier in this section is the need for a major increase in the level of capital expenditure by Irish processors. This additional capital expenditure will enable targeted investment in larger scale plants and in particular, will be necessary to have the four main base product sites in place operating at the scale envisaged in the future. Significant investment may be required in new equipment and technology for key sites while other investment will be spread across processors to improve and upgrade existing facilities. The increased investment will also be required to enable secondary processors to invest in the latest technology, a key means of differentiating their product and adding value. The table below outlines the additional annual cost to the Irish industry of matching the rates of capital expenditure that currently exist in other countries. Table 51 Increasing industry capital expenditure (% of turnover) 2001 (Capital expenditure as a % of turnover)
Ireland 2.63 Matching capital expenditure levels of other major competing countries Denmark The Netherlands New Zealand 4.5 2.8 4.8 43.1 3.9 50.0
Increased annual cost of matching other countries rates of capital expenditure m
The levels of capital expenditure made by our main European competitors have been used as a guide as to the level of increased capital investment Ireland will need to make. To match the capital expenditure of Denmark, 4.5% of turnover in 2001, will require an annual increase in capital expenditure of 43 million. This would bring the total annual capital expenditure of the Irish industry to over 100 million per annum. However, as discussed in section 3.4.1 above, the likely requirement for the Irish industry would be to front-load this investment with over 200m of this additional cost invested over the first 3 to 4 years. This will result in a total level of industry capital expenditure in the order of over 400 million over the first three years of the change programme to achieve the restructuring and repositioning required. Increased spending on Research and Development (R&D) In chapter 1, the relatively low level of spending on R&D by Irish processors compared to countries such as New Zealand and the Netherlands was highlighted. Greater spending on R&D by Irish processors, particularly, those involved in secondary processing, will be required to deliver changes in the product mix and to improve the added value content of the products. This spending will be needed to create sources of differentiation, enable greater product innovation and assist in new product development. While the spending by processors on R&D will be spread across all processors, the changes to the industry configuration should enable more efficient and leveraged allocation of R&D spend, for example, primary processors focusing on research of processing efficiencies, with secondary processors, and smaller processors in particular, focusing spending on specific product innovation to meet identified market opportunities. By increasing the annual spending by processors on R&D by 10 million per annum the Irish industry will move above the rates of R&D spending of key competitors such as Denmark and the Netherlands. Section 3.5 below outlines the actions required to ensure that this increased spending on R&D is implemented in a co-ordinated and efficient manner. Increased advertising, marketing and positioning of Irish dairy products The need for a direct consumer franchise has been emphasised above. While it is possible to market some foods by 'word of mouth', this is not possible for consumer foods and technology-based dairy products. As a result, there will be a requirement for greater additional expenditure to be targeted to the
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active promotion of Irish dairy products on a consumer and on B2B (business to business) levels, including proactive marketing, promotion and advertising campaigns. These additional investments in marketing (over and above current spend) will need to be targeted at the new product initiatives suggested in the proposed strategy. As with any investment programme, there will be larger requirements for funding in the first years, (up to 30m per annum), after that top-up investments of around 10 million annually will be required to keep the marketing momentum going. These levels, over and above current spending, are needed to maintain and develop market awareness of the new added value and technology-based dairy goods. Clearly, a focused marketing plan will be needed to make this investment work; however, it must take into account the shape of product portfolio and implemented marketing structure. 3.4.3 Benefits
The benefits to the industry of implementing the changes outlined in this study and investing in the areas detailed in section 3.4.2 above will occur gradually rather than immediately. The scale of the benefits will only really start to increase after the significant up-front investments and costs have been incurred. It is envisaged that cost savings from economies of scale and rationalisation can be achieved more rapidly than the increased turnover and margins associated with implementing a greater value-added product strategy. The benefits to the industry cannot be separated and treated as independent and are considered at an industry level. A range of the potential annual savings is included for both economies of scale (10m - 20m) at a manufacturing level and processor rationalisation and site efficiencies (20 60 50m) . The savings associated with lower labour costs are captured partially in each of these categories, and as with the redundancy costs above, the exact extent of these savings will vary, depending on the eventual number of actual redundancies. However, based on the range of redundancy figures used in section 3.4.2 above, the industry wage costs would fall by between 25m and 35m per annum. Economies of scale at manufacturing level from plant rationalisation would yield 10m to 20m per annum in savings The manufacturing level savings associated with moving the production of butter, powder, casein and whey products to four main sites are estimated to between 10 million and 20 million per annum. In calculating these savings, it is assumed that the majority of the savings at manufacturing level will result from larger scale production of powder and casein. However, it is likely that some savings will also accrue from more efficient production of other products such as butter. The reduction from eleven to four powder plants will increase the average powder output per plant from just under 10,000 tonnes per annum to just under 30,000 tonnes per annum. As discussed in chapter 1, these output figures are based purely on the production of SMP and WMP, as there is no official published industry data for the production of other whey products such as whey powders or fat filled milk powders. However, using the data provided by processors for this study it is estimated, that the average output of powder plants including other whey and fat filled powder products will increase from 19,000 tonnes61 per annum to close to 50,000 tonnes per annum. Similarly, reducing the number of casein plants from seven to four will bring the average casein output per plant up from 7,000 tonnes per annum to 12,000 tonnes per annum (based on current capacity utilisation). The manufacturing level savings from increased scale of pr oduction will be achieved gradually over the next five years in line with the increased capital expenditure and rationalisation costs. Further details of the savings at a manufacturing level are outlined in Appendix 8. Savings from processor rationalisation and site efficiencies can deliver 30m to 50m per annum The future industry configuration will result in savings not just at a manufacturing level (as discussed above) but also at an enterprise level. These savings will accrue from the concentration of production of base products into four large sites and the reduction in the number of processors involved in the production of base products. These savings have been estimated to be worth between 30million and 50 million per annum.
60
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We would consider the estimated savings from economies of scale and rationalisation to be on the conservative side and likely to be at the upper end of the range. A number of industry participants expressed confidence that the savings could be substantially higher than those estimated in this report See chapter 1 for details
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While some of the savings associated with reducing the number of processors and moving to four large sites, are captured in the estimated economies of scale above, further additional savings would accrue beyond the savings in purely manufacturing costs. The concentration of the production of butter, powder, casein and whey products into four main sites will result in reductions in overheads such as gas, electricity, water and effluent treatment/disposal, as well as reductions in marketing and distribution, administration and indirect labour costs. We have used data provided by processors on the breakdown of their costs and their current product outputs to estimate the savings in the above categories. The total savings from processor rationalisation and site efficiencies are estimated at between 30 million and 50 million per annum. As is the case with economies of scale above, the realisation of these savings will occur gradually over the next number of years in line with increased capital expenditure that will facilitate the move to four main base product processing sites. Based on international experience, anecdotal evidence from Irish processors and past research these savings are considered to be realistic. Increase in value addition and portfolio revitalisation is capable of bringing an extra 280 million in gross revenue to the industry A significant benefit available to the Irish dairy industry is through portfolio reconfiguration towards higher value-added products, rather than through cost-efficiencies. We estimate that as much as 280 million additional gross revenue may be captured by the industry annually by shifting from its current 40% of the total product portfolio consisting of butter, SMP and WMP to 34%, as outlined in recommendation 8 above. However, the achievement of this increased revenue is dependent on the implementation of all of the strategies outlined in this study and the associated investment as detailed in section 3.4.1 above. Full details of the how the increased value was estimated are included in Appendix 9.
Summary of the net benefit position The implementation of the rationalisation and product reconfiguration strategies outlined above will involve significant up-front costs for the industry in terms of increased capital investment requirements, increased R&D and market positioning costs together with the one-off redundancy costs. The benefits that will accrue from the implementation of the strategies include additional operating profits from the higher margin yielding higher value products and savings from rationalisation and greater economies of scale. Much of these benefits will require the up-front investments before they begin to return significant benefits. We have estimated that the payback period would be six years and that the net cash inflows would be around 70m per annum from year six onwards. However, before this payback point is achieved, the industry will need to fund significant cash outflows, particularly, in the first four years. This up front net cost in the first few years could have major implications for the industrys ability to fund the necessary changes required in the above recommendations. The costs and benefits outlined above are only an indication of the potential level of return to the industry. The specific business cases for the recommended strategic change need to be done at enterprise level as more detailed and accurate information on the specific investment requirements, cost outlays, efficiency savings and product margins will be available. The task of implementing the recommendations of the strategic study falls to the dairy industry itself and the individual players in the industry. The industry either accepts or rejects the analysis and recommendations set out in the report. If industry participants accept the reports findings, then it does have an obligation to make every effort to implement the recommendations or else suffer the consequences of the gradual erosion of the competitiveness of the sector. The threats to the down sizing and decline of the Irish dairy industry are real. The industry faces the stark choice of making major changes to how it is organised and how it utilises its raw milk or else find itself squeezed out markets due to reducing product demand and competitiveness. The stakes are very high. The recommended changes require significant up-front investment and have a high degree of risk attached. The stay more or less as you are in terms of number of plants and product mix will result in lower industry revenues and a lack of viability for many of the current players in the industry.
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3.5 What needs to be done to make it happen? The issues facing the Irish dairy industry and the strategies to respond to them outlined above represents a major challenge for the industry It requires a major step change for all of the participants in the industry. In light of the international market and policy developments documented and evaluated in chapters 1 and 2, the industry needs to decide how it is going to respond and the speed and depth of this response. Prospectus and Promar strongly believe that radical and decisive change is urgently required. The rules of the game have dramatically changed and continue to move with the on-going and accelerating largescale consolidations occurring at international competitor and buyer levels and the dismantling of the industry supports at EU level. Enterprises with heavy reliance on the processing of commodity type products will find it is increasingly difficult to remain profitable and will require major moves to improve cost efficiency and improve the value-added content of their output. The critical question is how is this change going to happen in the Irish industry. We believe that the required strategic change outlined above will be extremely difficult and painful to achieve. The change envisages major consolidation and rationalisation at producer and processor level to achieve the scale and cost competitive levels necessary to successfully compete for international business in the medium to long term. The industry going forward needs strong and decisive leadership to bring about the transformation that is required to meet the major challenges facing the industry While the different state bodies can play a valuable role in encouraging and facilitating this transformation, the necessary drive, commitment and speed of action must come from within the industry itself. This however, is unlikely to happen within the current industry configuration with up twenty-four different organisations involved in the manufacture, marketing and distribution of Irish dairy products. There is a strategic industry need for the emergence of a strong consolidated processing enterprise to provide the leadership and scale to drive through changes, implement the strategic actions and realise the many existing and potential market opportunities available to the Irish dairy industry. For this transformation to really happen the industry requires the creation of a large-scale Irish player to compete successfully internationally and that is capable of: Encouraging and stimulating changes at production level Driving through the rationalisation of base product plants and delivering the cost savings Leveraging investments in R&D and new product development to successfully develop and market higher value-added products Competing for business against scale competitors in the home and international markets Building and expanding existing and new investments in international infrastructure and entering and expanding strategic alliances A consolidated player needs to get quickly to a scale where it is processing in excess of 70% of the processed milk62 This level of consolidation may take two or three steps to be achieved. It needs to begin through a consolidation between some of the five largest processors and also requires consolidation amongst some of the smaller to mid-sized processors. The consolidation process within the industry needs to happen quickly, as it is highly probable, that there will be further consolidation amongst international competitors and rationalising of suppliers by buyers. There are a number of options and approaches as to how the consolidation may occur. It could potentially occur through merger, acquisition, joint ventures or some form of pooling of resources to complete certain activities (for example, primary processing activities).
62
Excludes the 10% of milk supply utilised as liquid milk
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Without the development of a strong single entity to drive the changes required, there is a real danger the industry will drift, only make incremental changes and gradually decline in terms of total output and value, while the international competition continue to expand aggressively. Individual processors will remain too small to successfully leverage the investments in research and technology necessary to develop new products and move into higher value areas and they will not have sufficient scale, resources or market presence to meet the requirements of major international buyers. There is also a danger that some Irish processors will increasingly invest outside of Ireland to achieve a level of growth and return on investment greater than that available within Ireland given its fragmented industry structure. The recommended consolidation of the processing sector with the emergence of a major dominant player does not preclude the co-existence of a number of smaller processors in the processing sector. It is both desirable and beneficial for the industry that there will also be a number of other players in addition to the dominant player. There are currently smaller Irish dairy processors who by their operations and product focus have been successful in growing their business and delivering a good return to their suppliers and members. There are also examples of successful smaller enterprises in Denmark and New Zealand. These smaller processors can continue to be successful but they will need to be innovative and focus on higher value added products and niche markets. Smaller processors who are predominately in the production of base type products will be unable to stay competitive in the medium to long term. The creation of a dominant entity controlling in excess 70% of the milk processed and a large proportion of the base product output would have major implications for the future role and operation of IDB. If this recommended scenario was to emerge, the functions marketing and distribution infrastructure and the capabilities and skills of the IDB would have to be reviewed, particularly, the nature of its ongoing relationship with the dominant player. The route to market and the resources required to market and distribute the product of the other processors in the industry would also need to be considered as part of this review. Many of the issues identified in this study have already been pointed out in previous reports and studies such as the ICOS strategic review in 2000. However, since the publication of the ICOS review, the policy environment, market position and competitive landscape have all deteriorated (from the Irish industrys perspective). Staying with broadly the same product mix, as today will mean lower margins, eroding markets and decline. At an absolute minimum, the industry must tackle the cost competitiveness and scale issues. It is recognised that moving up the value-added curve will be difficult, risky and require significant investment but there is no sustainable alternative to the radical change proposed. Inaction or limited action will result in the industry facing a future where: Product prices move close to world market prices Margins are seriously eroded due to rising costs and lack of economies of scale and duplication of infrastructure and overhead Limited resources available to invest in research and capital and as a result unable to fully exploit new product opportunities The milk producer base, which is increasingly financially stressed in the face of rising costs, a milk price close to or below 1 to 90 cent a gallon (20-22 cent a litre a potential loss of income from milk production of between 378m and 482m if no compensating measures were put in place63) and where many are at a scale of operation that their enterprises are not economically viable and dairy farming is unattractive to new entrants.
63
The proposed EU system of direct payments will partly compensate for the fall in milk prices
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The only real alternative is for the industry to: Embrace the strategic changes recommended in this report and to build on the existing strengths, resources and successes that the dairy industry has built up over the years Achieve cost efficiencies through plant rationalisation and economies from increased scale in base product production and realise the savings from consolidation amongst the players Provide the scale and capacity to invest and avail of existing and emerging product and market opportunities Reduce the level of dependence on commodity type products and increase the value-added content of manufactured dairy products Get quickly to a position where the industry has a major player who has the scale, cost competitiveness and resources to compete successfully against the major large-scale international competitors
Implementation The changes required within the industry are significant and will not be achieved immediately. Prioritisation and phasing of the key initiatives will enable the industry to achieve savings in the short term but these savings must be reinvested to fund on-going development of the industry. The immediate priorities must be rationalisation and increased spending on R&D. The suggested phasing of recommended actions is as follows: Phase 1 (Months 1- 6) Evaluation of the study findings and strategic recommendations by all participants in the industry Development of business strategies by individual processors in response to changing market environment and identification of their future role and focus Assessment (under the auspices of DAF) of options to enable major increases in the average quota size held by dairy farmers Assessment by Teagasc of the necessary future scale, cost efficiency and productivity requirements of dairy farmers and the implications of implementing the changes recommended in this study on the production sector. Also an examination of potential measures to address the erosion of cost of production competitive advantage enjoyed by Irish farmers Assessment of the implications and exploration of the options regarding the achievement of industry consolidation particularly, amongst the larger processors Commencement of actions to start the process of industry consolidation, plant rationalisation and cost savings Development of an action plan by Enterprise Ireland in conjunction with other relevant bodies (e.g. UCC, Teagasc, Science Foundation Ireland) to stimulate, facilitate and co-ordinate greater investment and commercial application of R&D and to improve the access and awareness of existing supports and resources Review of the industrys future quality and safety requirements and the infrastructure to support and champion this area.
Phase 2 (months 6 - 12) Development and implementation of product and market development strategies of individual processors (areas of specialisation, actions to strategically assess market opportunities and to convert opportunities into commercial business) Commencement of the process of disengagement by certain processors from base type products
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Acceleration of the process of consolidation with at least two large sized players engaging due diligence assessment and movement/co-operation between some of the smaller to mid sized players Development of capital investment plans and identification of the four larger scale plant sites for base product manufacture
Phase 3 (months 13 - 24) Announcement of first step in the industry consolidation process and commencement of the process to realise rationalisation savings and cost efficiencies Review of future role of IDB in light of industry and market developments Acceleration in the level of capital investment and R&D spend (at both processor and indu stry levels) Implementation of policies and plans to enable producers to increase scale
Phase 4 (months 25+) Acceleration of the industry consolidation process and realisation of cost savings Ramp-up R&D and market development programmes to increase value-added and exploit new product and market opportunities
Increasing spending on R&D by processors by 10 million per annum should be married with the use of state supports to encourage the creation of greater value by the industry in line with the strategy outlined in this report. In particular, Enterprise Ireland will need to play a key role in providing grants support for R&D and new product development. Implementation of these changes by the industry will ensure that the value-added by the industry increases gradually and delivers sufficient returns for the industry to repay its original investment. The key challenge is for the industry to take the decision to take a long term view recognising that it will only be in the medium to long term that the industry will get a positive return on the capital invested. The recommended strategies and supporting actions are for the most part inter-dependent and will require a number of related actions to happen if the strategy is be successful and the benefits to be realised. The cost savings and achievement of scale at producer and processor level can be achieved by the industry without necessarily having to address the issue of seasonality. However, this significantly increased scale at both producer and processor level may facilitate measures to even out milk supply. It is likely to require other developments, such as an increased volume of higher value and higher margin products being successfully manufactured, and for differential pricing mechanisms to be in place before any significant change in seasonality of supply occurs. The task of implementing the recommendations of the strategic study falls to the dairy industry itself and the individual players in the industry. The industry either accepts or rejects the analysis and recommendations set out in the report. If industry participants accept the reports findings, then it does have an obligation to make every effort to implement the recommendations or else suffer the consequences of the gradual erosion of the competitiveness of the sector. The threats of the down sizing and decline of the Irish dairy industry are real. The industry faces the stark choice of making major changes to how it is organised and how it utilises its raw milk or else it will find itself squeezed out of markets due to reducing product demand and competitiveness. The stakes are very high. The recommended changes require significant up-front investment and have a high degree of risk attached. The stay more or less as you are option in terms of number of plants and product mix will result in lower industry revenues and a lack of viability for many of the current players in the industry. The industry has shown in the past that it has the ability to respond and adapt successfully to changes in the market environment and will need to demonstrate this capability and commitment again in the new environment it now faces.
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Appendices
Page
1 2 3 4
History and background of the Irish dairy industry Overview profiles of benchmark countries Project methodology and approach Overview of the product mix of the Irish industry and that of its main competitors
114 116 120 123
5 6 7
Profile of the Irish industrys product sales, exports & imports The Irish industry compared summary Approach adopted in determining the future configuration of the dairy processing industry
128 133 135
Savings from economies of scale at manufacturing level from plant rationalisation Estimating benefits using EVA analysis Competition issues
137
9 10
139 144
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Appendix 1:
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History and background of the Irish dairy industry
Ireland has a long track record of producing and exporting quality products. Irelands dairy industry has its origins in farm produced butter, which was one of Irelands main exports until the late 19th century. In the late 19 th century, Ireland moved from largely farm based to factory based production, with the establishment of creameries and co-operatives, and up to 1920 experienced improved prosperity an d increased turnover. There was significant downturn in the industry in the 1920s, which led to the creation of the Dairy Disposal Company (DDC), which purchased most of the privately owned creameries, and some of the cooperative creameries. In 1928, the State put in place a licensing system to control the establishment of new creameries. By the 1930s, therefore, the dairy industry was firmly in co-operative or public control, and a regulatory system for controlling production and entry into the industry was in place. Butter making was the predominant processing activity and Britain the principal export market. The decline in butter prices in the 1930s and an economic war with Britain resulted in heavy duties on Irish exports. This led the government to introduce price support. However, milk supply levels remained low due to poor prices right through to the 1940s, and this inhibited the growth and diversification of the industry. During this period, the number of co-operative creameries fell from 274 in 1929 to 193 in 1951. In the early 1950s market conditions improved and exports to Britain resumed, and together with improvements in farming, milk yields and supplies increased. Milk output increased from 480 million gallons in 1960 to 740 million gallons in 1973. In response to EU membership, more favourable markets and increasing milk supplies, a dynamic phase of growth and reorganisation in the industry began in the 1970s. There was greater product diversification and investment. Milk powder became more important, new milk dryers were installed, and the manufacture of chocolate crumb became an outlet for milk supplies with the establishment of plants in Ireland by companies such as Rowntree Mackintosh and Fry Cadbury. The lack of a co-ordinated approach to the marketing of exports was a problem up to the establishment of a co-operative marketing agency for Irish milk powder products through an arrangement with Unigate in 1959, and with Bord Bainne, the Irish Dairy Board (IDB) in 1961. Previous attempts had failed due to lack of support from creameries. In the 1960s, IDB launched Kerrygold, a branded Irish butter, on the British market, and later extended it to Middle Eastern, American and European markets. The signing of the Anglo Irish Free Trade agreement with Britain in 1965 helped the industry considerably by doubling the existing butter quota. In the lead up to entry to the EU in 1973, ICOS and the government stressed the need for rationalisation and amalgamations in the dairy industry to achieve economies of scale and diversification. This period saw the takeover of DDC creameries by co-operatives, the closure of smaller creameries, the centralisation of processing facilities, and bulk collection ex-farm by milk tanker. Out of the reorganisation in the north and west of the country, Lough Egish, North Connacht Farmers and Donegal emerged. In the south, seven major groups emerged, including Avonmore, Ballyclogh, Golden Vale, Mitchelstown, Waterford, North Kerry and a group of creameries based in County Tipperary. As well as the seven large dairy groupings, there also emerged a second group of six dairy co-operatives, ten at the next level, and a further 20 smaller co-operatives. In the 1960s and early 1970s, there was some diversification away from butter to cheese manufacture. Cheese production increased from 5,000 tonnes in 1960 to 45,000 tonnes in 1973. During this period, the practice of returning skimmed milk to farmers declined, as processing facilities for the manufacture of skim milk powder developed. The manufacture of casein also developed into the early 1970s in Waterford, Mitchelstown, Avonmore and Kerry. Infant food also became an outlet for milk powder, with the establishment of facilities in Ireland by companies such as Unigate, Nutricia, Wyeth and Abbot. Up to Irelands entry to the EEC in 1973, IDB had operated as a statutory marketing agency with almost exclusive control over dairy product exports. This situation was not compatible with EEC policy, and the board was changed into a co-operative in which the dairy product manufacturers were shareholders.
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Ireland throughout the report refers to the Republic of Ireland unless otherwise stated
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In the 1970s, competition between the main dairy co-operatives increased. It was also a period of major capital investment. The introduction of quotas in 1984 marked the end of an era in the dairy industry, as up to this point the industry had developed by focusing on continuously increasing milk supply, and it could rely on intervention as an outlet for surplus products. Milk quotas placed a limit on the expansion of milk production, and consequently limited the scope for expansion by dairy processors in Ireland, and led to overseas expansion through the acquisition of existing facilities, mainly in the UK and US. The introduction of quotas has also led to a greater focus on yields, waste elimination, added value products and manufacture of dairy ingredients for specific end uses. In the 1990s, consolidation in the industry continued, and by 2002 the four biggest processors accounted for 71% of the total milk pool.
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Appendix 2: 2.1 Denmark
Overview profiles of benchmark countries
The Danish dairy herd has been gradually falling over the last ten years, from 708,000 in 1992, to 628,000 in 2001. Similarly, the number of dairy farms has fallen from 20,000 in 1991 to 8,911 in 2001, a reduction of 55%, and has fallen a further 800 during the last year. However, the average quota held by dairy farms has increased from 234 tonnes in 1991 to 500 tonnes in 2001, and reached 550 tonnes in 2002, while output per cow has risen from 6,212kg/cow in 1990 to 7,328kg/cow in 2001. Improved feeding programmes and a move to more extensive cattle housing and less pastoral grazing have contributed to this increase. Denmark now has the second largest herd size in the EU, with an average of 70.1 cows per farm, behind only the UK.
Milk production is gradually moving west in Denmark. Since 1991, the volume of milk produced on the three islands of Zealand, Lolland and Falster has declined by 21%, to account for just 5.6% of milk deliveries in 2001. Quota is freely tradable, and Zealand farmers are continuing to sell their quota, primarily to farmers in Jutland. Milk production on Zealand is no longer sufficient to meet the daily consumption demands of the island, requiring milk to be transported to the island daily. Today, the majority of milk is produced in South, West and North Jutland. Production in East Jutland and Funen is also declining.
The Danish dairy industry has altered considerably over the last ten years. Key product categories in the processing sector are liquid milk products (by volume), cheese (and within that, blue and feta cheeses, and traditional Danish cheese such as Danbo and Havarti), butter and canned/powdered milk. The countrys focus on exports is reflected in the bias towards more shelf stable products. In line with growing consumer concern for health, the liquid milk sector has seen a visible switch in production (and consumption) from whole milk to semi- and skimmed milk. Interestingly, semi-skimmed milk production peaked in 1996, since when levels have dropped off in favour of skimmed milk. Total liquid milk production levels have remained largely unchanged over the last decade. While remaining export-oriented, processors have also become more versatile in developing new and/or novel products for domestic consumers, such as drinking yoghurts, flavoured milks and fromage frais. Total turnover for Denmarks dairy industry was reported to be DKK21.8 billion (2.9 billion) in 2000, a fall of almost 9% on the previous year. Key dairy industry figures Year
1999 2000 2001
Total turnover (DKK million)

23,965 21,841 21,592
Total turnover ( million)

3,223 2,925 2,897
% of total turnover 3 largest

82.2 88.4 89.9
5 largest
88.2 90.6 92.0
10 largest
92.9 95.0 95.9
Source: Danmarks Statistik The dairy industry is extremely concentrated, with 89.9% of total turnover generated by the three largest processors, although within that, one processor Arla Foods clearly dominates. Below Arla, the industry is characterised by a large number of very small private players.
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2.2 Netherlands The Netherlands has a total of 1,550,000 dairy cows on nearly 28,000 farms. Both have been falling over the last ten years, with the number of dairy farms declining from almost 47,000 in 1990 to just under 28,000 in 2001. The figures demonstrate a greater consolidation at the dairy production level, as a greater percentage of farms have over 70 dairy cows. Conversely, the number of dairy farms stocking between 1 and 29 dairy cows has fallen from almost 39% of the total to just over 20% in 2001. Today, Dutch dairy herds are, on average, the third largest in Europe, with 55.4 cows per farm, behind only the UK and Denmark. The average quota held by dairy farms has grown by almost 70%, from 234 tonnes in 1991 to 394 tonnes in 2001. Output per cow has also increased, from 6,223 kg/annum in 1991 to 7,304 kg/cow in 2001, while both fat and protein content has shown marginal improvement over the last decade. Total annual milk production in the Netherlands has remained relatively stable over the last five years. Production in 2001 was approximately 11,155 tonnes, only a slight decrease on the year before. Over production during the second half of 1999 resulted in lower production in 2000 to avoid super levy charges. The key product categories in Dutch dairy production are liquid milk, yoghurts and factory cheese. Liquid milk for drinking has remained relatively stable. Cheese production has experienced an increase of 6.9% over the last ten years; the most significant growth occurred between 1991 and 1997 (an increase of 15%), but was followed by a decline of some 8% in 1998. Some recovery occurred during 1999 and 2000, but reduced export demand/competitiveness in 2001 has encouraged a further fall. Moreover, more milk has entered the manufacture of high added value dairy drinks. Production of butter declined in both 1999 and 2000, primarily following declining demand from recipients in Russia and Asia as a result of economic crises, and also as a result of an increased level of cheese production. However, signs of recovery were evident in 2001. Production of WMP and condensed milk, while still strong, has declined over the last decade, while SMP has increased significantly, albeit from a small base. The markets for canned and evaporated milks have continued to decline in traditional producing countries such as the Netherlands. Production is growing in other parts of the world, especially where manufacturing is based mainly on the reconstitution/recombination of dairy ingredients. Unlike the rest of Europe, cheese production has fallen over the last few years. The industrys co-operatives have instead moved from bulk production to custom production, specifically tailored to their export markets. Cheese production is primarily of its traditional semi-hard varieties Gouda, Edam and Maasdam, with the latter experiencing the best growth over the last decade. Production has increased marginally for block Gouda, predominantly for the hotel and catering industry. The use of cheese as an ingredient, for pizza and fast food for example, will be the primary growth market. Domestic consumption trends have moved towards fresh dairy products, hence the decline in consumption of condensed milk. Liquid milk consumption, however, is in gradual decline, though this is parallel to growth in the cheese and quark product sectors. The Dutch consumer is increasingly searching for new and healthier dairy products, fuelling large investment in new product development. Both manufacturers and retailers are aiming to satisfy this demand alongside the development of the growing indulgence market. Of the two large dairy processors, Campina is more dependent on the domestic market than Friesland Coberco. Campina has 28% of the branded white dairy sector (milk, yoghurt, desserts), and an estimated 65% of all liquid milk products, once private label volume is taken into account. It is worth noting, however, that the Netherlands has historically held a significant role as a trader and key entrept provider. This role has not reduced in importance, and therefore can distort import and export figures, given the volume of re-exports that occur. The dairy industry in the Netherlands has experienced significant rationalisation, with the number of enterprises halving in the last ten years to just fifteen in 2001. Co-operatives account for about 70% of all processing sites, and continue to have the strong ties between producers and processors within the industry.
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Number of enterprises and factories (co-operatives and non-co-operatives) 1990

Enterprises Total factories Co-operatives Non-co-operatives 31 95 79 16
1995
19 80 62 18
1999
15 71 56 15
2000
15 66 46 20
2001
15 63 44 19
Source: Productschap Zuivel Though the Dutch dairy industry is dominated by two giant enterprises (Friesland Coberco (FCDF) and Campina), there has also been a rise of small, mostly privately owned, dairy companies, some of which have grown out of farm dairies, and which operate in specific niches within the dairy market. Latest figures available from the Dutch Dairy Board (May 2002) indicate that there are only 13 companies in operation, following FCDFs purchase of the smaller dairy Friese Ecologische Zuivel and FCDFs merger with Coperatieve Zuivelindustrie Dinkelland B.A, from January 2002. Since May 2002, a further dairy, Swenty Milk, has gone bankrupt, while Friesland Coberco has also purchased Nutricia Dairy and Drinks Group from Royal Numico, leaving just 11 enterprises in operation. Further developments have seen Wessanen divest its European dairy interest, and the French dairy player, Fromageries Bel, has acquired the cheese company Leerdammer. Campina, by comparison, has more recently pursued cross border activity, merging with German dairy group Milchwerke Kln/Wuppertal (MKW) in 2001, to form one of Europes largest dairy co-operatives with 3,500 members in Germany, in addition to its 8,500 in the Netherlands.
2.3 New Zealand The New Zealand dairy industry has continued to expand during the past decade due to a combination of factors, including no production quotas. Most notably, the end of the New Zealand Dairy Group Moratorium (December 2000) on new dairy farm conversions has facilitated an increase in cow numbers, which reached 3.3 million in 2001, but also New Zealands 13,900 dairy farms have improved per animal performance by 6.9%, as a result of a concerted research and extension programme to enhance on-farm profitability. Fewer land constraints than Europe, combined with the amalgamation of smaller farms, has seen the average herd size in New Zealand more than double over the last decade to reach 251 per farm, more than five times larger than Irelands 45.7 cows. The New Zealand dairy industry has set an ambitious on-farm productivity target of 4% per annum. This level has been determined as one of the strategies by which the industry can maintain its international production cost advantage, and successfully market dairy products into Northern Hemisphere markets. The majority of New Zealands dairy industry is based in the Waikato, Taranaki, Manawatu and Northland in the North Island, and Otago and Southland in the South Island. In recent years, the industry has grown at a faster rate in the South Island, with a large number of sheep farms converting to dairy production due to the declining profitability of sheep meat and wool production relative to dairy, as well as cheaper land. This has seen the South Islands milk production grow from 9% of the total production in 1980 to 23% in 2001. In fact, dairy farm numbers in the historically strong dairying areas of the Waikato and Taranaki have declined in recent years, as many farmers have moved to larger farms and better opportunities in the South, and urban sprawl has increased the pressure on farms in the North. However, consistent rainfall and increased availability of animal feed on the North Island is enabling farmers there to also expand milk production. New Zealands dependence on a pasture-fed milk production system results in a very seasonal supply curve. It is, in fact, the most seasonal of all major dairy nations, and creates a number of logistical issues for the sector. The issue of seasonality introduces periods of overcapacity in the processing sector that imposes greater costs on the industry. In the past, these have been offset by low on-farm production costs, but other developing dairy industries are now challenging New Zealands low cost systems, leading
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the industry to investigate new techniques to assist in flattening the curve. In the past few years, a number of systems have been employed to encourage farmers to produce milk out of peak season. These have included differential milk pricing during winter months, and research into extended lacta tion lengths. However, as farmers have increased production they have, by default, accentuated the peak milk flow problem. Unlike most other dairy nations (with the exception of Ireland), the New Zealand industry is totally exportfocused, with in excess of 97% of all production being sold outside the country. As such, the vast majority of products are shelf-stable, enabling them to be exported to markets in Asia and the Northern Hemisphere. The New Zealand dairy industry has increased production of all broad product groups over the last decade, particularly the manufacture of WMP, cheese and butter concentrates. Butter production, however, has grown by a relatively small amount, only 19%, reflecting the difficulties of selling more of this product in overseas markets, and the decision to focus production on cheese and powder production. Total turnover for the New Zealand dairy industry was reported to be 2,828 billion in 1999, while exports alone increased by 50% over the next two years to reach 3,460 million by 2001. The New Zealand dairy sector now represents one of the most concentrated globally. Since the formation of Fonterra Dairy Cooperative in 2001, the country now has only three major dairy processors, with Fonterra collecting and processing over 96% of all raw milk produced. The remaining two dairy processors are also co-operatively owned, with Tatua Co-operative Dairy Company concentrating on the production of higher value dairy consumer and ingredient foods. The other player, Westland Milk Products (previously Westland Co-operative Dairy Company), is based on the West Coast of the South Island, and in general produces similar products to Fonterra for both the local and export markets. The New Zealand dairy industry, through Fonterra, has invested heavily in Latin America and Asia, and is committed to growing these markets, while at the same time forming a joint venture with Arla to market the Anchor butter brand in the UK.
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Appendix 3:
Project methodology and approach
A multi-staged approach was adopted in order to meet the specific needs of this study. The following diagram outlines the key activities during each stage. Key activities summary
Stage 1: 'Where are we?' Stage 2: 'Where do we need to be?' Stage 3: 'How?'
Irish Dairy industry today: Irish Dairy industry today: Markets Markets Products and production Products and production Processing Processing Distribution Distribution Production efficiency Production efficiency SWOT SWOT Current international Current international dairy industry: dairy industry: Products Products Capability Capability Distribution Distribution Production efficiency Production efficiency Consolidation Consolidation International dairy International dairy markets: markets: Geography Geography Consumption Consumption Requirements Requirements Competitors Competitors
In-market forces for change: Consumerism Raw product supply Processing base Distribution
Learning from experience of others: Same industry Similar competitive environment Similar challenges
Future international dairy Future international dairy sector: sector: Trends Trends Supply/demand Supply/demand Structure Structure Future opportunity Future opportunity
Implications for the Irish Implications for the Irish dairy industry: dairy industry: Organisation Organisation Production Production Distribution Distribution Products Products
Strategic evaluation of, Strategic evaluation of, and recommendations and recommendations for, the Irish dairy for, the Irish dairy industry: industry: International/Global International/Global market opportunities for market opportunities for dairy products identified dairy products identified Product options to exploit Product options to exploit these opportunities these opportunities assessed assessed
Global forces for change: New technology Globalisation Trade policies International agreements GMOs
Gap analysis: Review Strategic imperatives Markets and marketing Products and production Adjustment to change
Actionable Actionable recommendations: recommendations: To improve the industry's To improve the industry's long term competitiveness : long term competitiveness : Key markets Key markets Key products Key products Necessary future structure Necessary future structure
Stage 1: In-depth research and review of market changes The initial part of the study involved a review of the changes that have occurred within the dairy market. This involved extensive industry interviews and primary research together with a review of published and in-house research work to summarise the market changes in the dairy supply chain that have occurred in the international dairy sector during the past five years. As part of this process a detailed benchmark questionnaire was completed by the following organisations: Arrabawn Co-Operative Society Ltd. Carbery Milk Products Ltd. Connacht Gold Co-Op Society Dairygold Co-Operative Society Ltd. Donegal Creameries Plc Glanbia Plc Irish Dairy Board Kerry Group Plc Lakeland Dairies Co-Operative Society Ltd. Newmarket Co-Operative Creameries Ltd. North Cork Co-Op Creameries Ltd. Tipperary Co-Operative Society Ltd. Town of Monaghan Co-Op Wexford Creamery Ltd.
In particular, this stage concentrated on the following blocks:
120
Irish dairy industry today A comprehensive analysis of the current Irish dairy sector Current international dairy industry A snapshot of the dairy industry today and information on the current international dairy industry. International dairy markets In-depth research into the industry state and changes taking place within key dairy markets. Stage 2: Competitive analysis and future market makeup This stage built both on the information obtained in Stage 1 and on additional research carried out in parallel. An assessment of the international dairy sector in the future was a key element of this stage. The analysis of the likely effect on the market for dairy products in the next 5-10 years considered issues including the market trends for dairy products, the likely impact of new technologies, international trade policy changes and changes in structure and ownership of major players. Based on this analysis, the implications for the Irish dairy industry were projected. Most importantly, the above analysis enabled the study team to determine: The market opportunities for dairy products in different geographic locations, and their particular requirements, and The products required to exploit these opportunities
Stage 3: Document the evaluated recommendations and industry actions Stage 3 effectively summarised and brought together results obtained in Stages 1 and 2. It marks the path for the Irish dairy leading to improving the industrys long-term competitiveness. It also involved the development of a recommended approach and strategic change action plan for the industry to bring about the necessary changes and to exploit the identified market opportunities. Project structure Throughout the project the study team worked closely with the Study Secretariat consisting of representatives from the Department of Agriculture and Food, Enterprise Ireland, IBEC and ICOS. Meetings with the Project Steering Group were conducted at the start of the project and at the end of each stage. The Steering Group was comprised of the following: James Murphy - Arrabawn Co-Operative Society Ltd. Gus OBrien - Bandon Co-Operative Society Ltd. Peter Dineen - Barryroe Co-Operative Dan McSweeney - Carbery Milk Products Ltd. Tom Commins - Centenary Co-Op Michael Farrell - Connacht Gold Co-Op Society Denis Lucey - Dairygold Co-Operative Society Ltd Philip Carroll Department of Agriculture Tom Moran Department of Agriculture Tom ODonnell Department of Agriculture John Keon - Donegal Creameries Plc Joe O Sullivan - Drinagh Co-Operative Ltd. Mike Feeney - Enterprise Ireland Eddie Hughes Enterprise Ireland Seamus MacLoughlin Enterprise Ireland
121
Billy Murphy - Glanbia Plc Pat Ivory - IBEC John Tyrrell - ICOS Noel Cawley - Irish Dairy Board Jerry Houlihan - Kerry Group Plc Ed Prendergast - Lakeland Dairies Co-Operative Society Ltd. Pat Dineen- Lisavaird Co-Op Creamery Ltd. Michael Cronin - Newmarket Co-Operative Creameries Ltd. Sean McAuliffe- North Cork Co-Op Creameries Ltd. Noel Horgan - Tipperary Co-Operative Society Ltd. Vincent Gilhawley- Town of Monaghan Co-Op Seamus OBeirne - Wexford Creamery Ltd.
The contributions and co-operation of the Secretariat, Steering Group members and individual industry participants was an essential element in the successful completion of the project and was greatly appreciated by the study team.
122
Appendix 4: 4.1
Overview of the product mix of the Irish industry and that of its main competitors
Raw milk utilisation by Ireland and its major competitors
The level of raw milk deliveries that is used as liquid milk in Ireland is comparable to its European competitors In 2001, just under 90% of raw milk deliveries in the Irish market were used for processing, with the remaining 10% utilised as liquid drinking milk. These figures are consistent with other leading European processors, with Denmark processing 88% and the Netherlands 92% of their raw milk deliveries. The data for these countries in previous years produces similar levels of milk used for processing as 2001 data. Comparison of raw milk utilisation (2001) Raw milk deliveries (000 tonnes)
Ireland Denmark The Netherlands New Zealand 5,338 4,418 10,683 12,322
% drinking liquid milk production

10.4 11.8 8.1 4.0
% milk used for processing

89.6 88.2 91.9 96.0
Source: ZMP, Eurostat, IDB (2001) The utilisation of whole milk for butter has declined while cheese has increased The changes over the last decade in the utilisation of whole milk and skim milk, illustrate the move towards a more diversified Irish product mix. In the last decade, the utilisation of whole milk for butter production has fallen from 70% to 60%, with its use for cheese production rising from 16% to 24%. During the same period, the utilisation of skim milk for casein production has risen from 27% to 51%, with utilisation for production of skim milk powder falling from 59% to 28%. There has been a significant shift in product output in Ireland, with a decline in butter and SMP and increased output of cheese and casein Over the last decade, the Irish industry has responded to changing market conditions, taking advantage of opportunities to diversify and add greater product innovation, and reducing the dependence on butter and skim milk powder. However, many would argue that the safety net (or the commercial pragmatism) of heavily utilising the EU product intervention market price support mechanisms, and the significant export subsidies for certain commodity products, has skewed the Irish product mix to over rely on these product types. It has also stunted a more proactive approach to product diversification and the development of new markets. The production of cheese and casein has increased significantly over the last ten years The current more diversified product mix is also reflected in the changes in Irelands production figures for key products from 1991 to 2001, as illustrated in the table below.
123
Ireland annual production by broad product type (000 tonnes) 1991

Liquid milk Butter Cheese Whole milk powder Skim milk powder Casein(ates) Chocolate crumb Butteroil Cream 509 140 72 23 183 27 77 6 8
1997
549 139 86 34 109 42 84 9 10
1998
559 131 92 31 100 42 75 8 10
1999
546 135 97 36 94 46 77 7 10
2000
545 137 96 35 88 46 75 7 10
2001
556 128 120 34 75 48 75 7 10
% 1991/2001
9.2 -8.6 66.7 47.8 -59.0 77.8 -2.6 16.7 25.0
Source: Eurostat, IDB, Dept. of Agriculture, ZMP (2002) Ireland annual production by broad product type (000 tonnes)
183
140 139 131
135
137 128 120

Butter Cheese Skim milk powder Chocolate crumb Whole milk powder Casein(ates)
109 100 86 77 84 72 42 27 23 34 75 42 77 46 92 97 96 94 88 75 75 46 48 34 35
31
36
1991
1997
1998
1999
2000
2001
Source: Eurostat, IDB, Dept. of Agriculture, ZMP (2002) The most significant change in Irelands product portfolio has been the increase of 67% in the production of cheese. However, while the trend over the last decade has been towards increased production of cheese, the figure for 2001 may be artificially high due to increased demand for cheese in the UK during the foot and mouth outbreak in that year. Casein production has gradually risen to its current level of 48,000 tonnes, while SMP output has fallen by 59% to 75,000 tonnes. While butter and SMP production has fallen in relative terms over the last decade, they h ave remained key products for the Irish industry. It is worth noting, that while there are discrepancies and differences between the various sources of production data, the overall production trends (based on the data in the table above) are consistent across the majority of data sources.
124
4.2
Denmark annual production by broad product type (000 tonnes) 1991 1997
513.4 27.8 39.2 10.0 41.6 35.4 58.7 50.2 289.6 103.8 22.8 4.5 0.2 56.3
1998
518.6 24.5 39.8 9.8 44.2 40.2 60.6 48.5 289.3 106.3 22.0 4.2 0.2 57.1
1999
518.7 24.5 37.8 11.1 44.6 42.2 67.8 47.9 292.8 97.1 34.4 4.6 0.2 57.9
2000
518.1 22.8 36.0 10.8 47.6 42.2 67.1 45.8 305.8 97.1 38.0 4.1 0.1 62.5
2001
519.9 22.3 38.4 10.8 49.8 41.8 73.0 46.0 317.9 87.8 40.2 3.6 0.1 64.5
% 1991/2001
2.0 -32.6 -0.8 21.3 11.7 33.5 71.0 -34.8 10.8 -19.1 137.9 111.8 0.0 23.3
Liquid milk Buttermilk Cream Crme frache Yoghurt Chocolate milk Other liquid milk products Butter Cheese Whole milk powder Skim milk powder Buttermilk powder Cream milk powder Others inc. sterile cream
509.7 33.1 38.7 8.9 44.6 31.3 42.7 70.5 286.9 108.5 16.9 1.7 0.1 52.3
Source: Mejeriforeningen (Danish Dairy Board) Denmark annual production by broad product type (000 tonnes)
317.9 305.8 286.9 289.6 289.3 292.8
108.5
103.8
106.3
97.1
97.1 87.8
70.5 50.2 16.9 22.8

1991 1997
48.5
47.9 34.4
1999
45.8 38
46 40.2
22
1998
2000
2001
Cheese
Whole milk powder
Butter
Skim milk powder
Source Promar / Prospectus research, 2002 The major shift product production that has occurred in Denmark over the last decade has been the decline in butter and WMP production. The production of cheese and SMP increased. While there are no official figures for production of casein in Denmark it is estimated that roughly 13,000 tonnes was produced in 2001.
125
4.3
Netherlands annual production by broad product type (000 tonnes) 1991 1997
881 727.7 24.5 134.5 692.7 11.5 112.3 39.0 328.9 280.5 160.2
1998
855 707.0 24.6 149.0 638.0 11.5 115.2 60.8 290.1 260.6 157.8
1999
860 721.5 28.4 139.9 645.6 13.1 110.1 74.8 288.5 240.0 155.2
2000
864.1 713.1 26.2 126.2 671.1 12.5 96.7 69.3 273.5 242.4 164.5
2001
866 713.6 24.5 130.4 641.3 10.5 107.9 68.0 304.5 219.2 155.4
% 1991/2001
-6.3 8.9 -39.7 -20.1 6.9 -23.4 -38.4 37.9 -24.9 -18.5 34.0
Liquid milk Yoghurt, sour milk products, dairy desserts Cream Butter Cheese Quark Whole milk powder Skim milk powder Condensed milk Whey powder Lactose
924 655.0 40.6 163.3 599.9 13.7 175.1 49.3 405.3 269.0 65 116.0
Source: ZMP, Productschap Zuivel Netherlands annual production by broad product type (000 tonnes)
692.7 638 599.9 645.6
671.1
641.3
405.3 328.9 290.1 269 175.1 163.3 134.5 112.3 49.3 1991 Cheese 39 1997 Condensed milk 149 115.2 60.8 1998 Whey powder 139.9 110.1 74.8 1999 Whole milk powder 126.2 96.7 69.3 2000 Butter 2001 Skim milk powder 130.4 107.9 68 280.5 260.6 288.5 240 273.5 242.4 304.5 219.2
Source Promar / Prospectus research, 2002 There has been a significant shift in production in the Netherlands over the last decade, with lactose up 34%, SMP has increased by 38% (although from a low base), yoghurts, milk products and dairy desserts are up 9% to 713,600 tonnes, in 2001 and cheese is up 7%. Butter production has fallen by 20%, condensed milk by 25% and whey powder by 19%. As with Denmark no official figures for casein production are available but it is estimated that the Netherlands produced in the order of 35,000 tonnes in 2001.
65
1990
126
4.4
New Zealand annual production by broad product type (000 tonnes) % 1991/2001
18.3 115.9 106.4 87.3 84.6 44.0 103.3 48.2 -
1991
Liquid milk Butter Butter concentrates (AMF) Cheese Whole milk powder 66 Skim milk powder Buttermilk powder Whey powder Casein(ates) Lactose n/a 218 44 140 275 136 23.4 12.3 74.2 25.0
1997
850 292 59 254 374 172 32.7 21 92.2 40.5
1998
866 271 73 266 396 177 37.8 22 103.7 40.4
1999
820 260 79 250 381 172 30.4 22 86.7 42.9
2000
850 255 89 297 450 187 31.5 25 97.2 41.8
2001
885 258 95 289 515 251 33.7 25 110.0 -
Source: ZMP, Statistics New Zealand New Zealand annual production by broad product type (000 tonnes)
515 450 396
374
381
275 218
292
297 271 266 260 250 255 187 289 258 251
254
140 136 74.2
172
177
172 110
92.2
103.7
86.7
97.2
1991
1997
1998
1999
2000
2001
Whole milk powder
Butter
Cheese
Skim milk powder
Casein(ates)
Source Promar / Prospectus research, 2002 Over the last decade, the output of all product type In New Zealand has increased, with the greatest growth occurring in cheese (106%), WMP (87%), SMP (85%) and casein (48%), while butter output increased by only 18%.
66
Includes infant formula
127
Appendix 5: 5.1
Profile of the Irish industrys product sales, exports and imports
The Irish dairy industry is very dependent on exports, with over two thirds of its total output having to be exported
Irelands entry to the EEC in 1973 played a major role in the development and growth of the Irish industry in opening new markets for Irish products, and also providing a guaranteed outlet and support price structure for much of Irelands product output. Historically, Ireland has exported a significant proportion of its dairy production, and data gathered from processors for this study supports this, indicating that over 60% of the processors dairy sales value comes from exports. Industry data for 2001 from IDB and Eurostat indicates that 63% of the volume of Irish dairy production was exported (when liquid milk for drinking is included). However, over 83% of its butter, SMP, WMP and bulk cheese output is exported. This heavy reliance on finding markets for products is a significant challenge for the industry, but has driven product diversification and innovation. Some significant differences and inconsistencies exist between the various sources of data on Irish dairy exports. However, the trends captured in the tables below for both the volume and value of Irish exports, remain consistent across the various sources of data. The focus is on these trends and the picture they paint of the change in Irelands exports over the last decade. Irish sales accounted for 33% of total product sales by processors in 2001 (excluding other product sales) Based on an analysis of data supplied by the processors, the table below shows the split between home market sales and export sales (either via the IDB or directly by the processors themselves). 5.2
Product type
Home market and export sales in 2001

% of total sales Value of export sales via IDB or direct (000s) 407,387 330,156 138,371 292,772 178,682 65,792 8,707 38,826 0 41,816 1,460,692 % of total sales
Value of sales within Ireland (000s) 67,883 107,799 42,050 47,456 5,722 39,916 87,828 1,618 306,609 254,699 706,882
Butter Cheese SMP Casein WMP Whey powder & protein, Lactose Yoghurt & Cream Functional foods Liquid milk Other67 Total (excl. other)
14% 25% 23% 14% 3% 38% 91% 4% 100% 86% 33%
86% 75% 77% 86% 97% 62% 9% 96% 0% 14% 67%
Source: Promar / Prospectus research Almost all the processors fresh dairy products are sold on the Irish market, together with significant proportions of cheese and SMP. The vast majority of sales for the other products are export based. 84% of all butter, cheese, SMP, WMP and casein sales in 2001 were from exports.
67
The other product category consists of mainly surplus/third party milk sales, which are sold on to other processors
128
Total dairy exports, by volume (000 tonnes) 1991

Butter Cheese WMP SMP Chocolate crumb Casein(ates) Butteroil Cream Whey powder 68 All other dairy products Total 128 71 26 71 59 25 7 2 42 41 472
1997
123 82 39 96 17 32 8 6 46 155 604
1998
119 87 41 51 18 32 7 3 47 180 585
1999
109 87 46 83 21 37 7 4 40 165 599
2000
107 88 47 124 23 40 6 3 48 168 654
2001
100 116 40 44 27 35 5 3 55 n/a n/a
% 1991/2001
-21.9 63.4 53.8 -38.0 -54.2 40.0 -28.6 50.0 31.0 n/a n/a
Source: IDB, Eurostat, ZMP 5.3 Export market destination
Over two thirds of Irish dairy exports went to the EU in 2001 with the UK being the largest single market 2001 export sales country breakdown
37.2%
30.5%
15.0%
6.5% 2.8% 2.6% 0.1% UK Other EU Other Europe North America Latin America Africa South East Asia Central Asia China & Russia Middle East
1.8%
1.6%
1.7% 0.3% Other Incl Japan & Korea
Source Promar / Prospectus research, 2002 Cheese export markets Ireland remains hugely dependent on the UK as a market for its cheese, with 83% of total cheese exports (90,500 tonnes) going to that market in 2001 This level has remained consistently high throughout the last decade. The fact that the Americas, Irelands second largest export market for cheese, accounted for only 4% (4,800 tonnes) of total exports in 2001 is an indication of the importance of the UK market for cheese. A breakdown of cheese exports by type illustrates that the majority of Irelands cheese exports are of cheddar, accounting for just under 70% of all cheese exports in 2001. The on-going dependence on the UK cheddar market remains,
68
Includes liquid milk, butter milk, yoghurt, butter spreads and infant formula
129
despite the efforts of some producers to reduce this dependence through diversification into other cheeses such as mozzarella. Exports of cheese have grown dramatically over the last decade In volume terms, the key change in exports over the last decade has been the 63% increase in the exports of cheese. However, this figure has been inflated by a significant increase in 2001 in exports of cheese to the UK, caused by the substitution of cheese for meat during the foot and mouth outbreak. Butter exports Butter exports have fallen by just under 22% over the last decade to 100,000 tonnes in 2001, with 90% of butter being exported within the EU Exports of butter to Germany doubled between 1991 and 1997, and despite minimal growth over the last five years, it remains the key export market for butter purchasing 33,000 tonnes in 2001 or one third of total butter exports. The UK and France are the other main export markets for Irish butter, accounting for 22% and 19% of exports respectively in 2001. WMP exports The volume of WMP exports doubled between 1991 and 1997 In 2001, Ireland exported the same volume of WMP that it exported in 1997 39,700 tonnes. The export markets for WMP have changed significantly over the last decade, with a steady rise in the volume of WMP exported to EU countries, so that in 2001 exports were evenly split between intra and extra-EU markets. SMP exports The volume of SMP exported by Ireland has varied significantly from year to year since 1991 The drop in exports from 124,000 tonnes in 2000 to just 44,000 tonnes in 2001, illustrates this volatility. While the split between exports of SMP intra and extra-EU has remained relatively even, there have been significant changes in the export markets. For example, exports of SMP to Italy rose from 5,900 tonnes in 1999 to 16,300 tonnes in 2000, but then fell to just 700 tonnes in 2001. While this volatility is not surprising given the commodity nature of the product, it illustrates the difficulty that the Irish industry faces in selling this product, where price rather than reliability, quality or any other factors is the key criterion for buyers. Casein exports Casein exports have risen by 40% in the last 10 years to reach 35,000 tonnes in 2001 In 1991, 92% of Irelands casein exports went to the US, which remains the key export market. However, Irelands dependence on the US has reduced, with this market accounting for 60% of exports in 2001, and intra-EU exports representing 38% of the total. There is concern regarding the ongoing viability of this US casein market. This is due to possible US Government action that may result in the disposal of large volumes of SMP within the domestic US market, with this product potentially being able to be used as a substitute for imported casein. Large quantities have been allocated by the US Government and small quantities have begun to be sold under this casein conversion programme. While it remains to be seen how successful the programme is, it could severely impact on a market that accounts for 21,300 tonnes (60%) of all casein exports and 44% of casein production from Ireland. The export figures for Irelands main products illustrates the overall importance of Irish exports within the EU In 2001, over 90% of butter exports and 93% of cheese exports by volume were to EU countries. Over the last four to five years, EU countries have also accounted for roughly half of Irelands export volumes of SMP and WMP. Therefore, a key issue for the industry in the future is the focus to be placed on EU markets, and the implications of the continued importance of these markets. Chapter 2 of this study investigates the predicted trends in consumption and changes in distribution channels within these markets, and ultimately, the opportunities that exist for Ireland. Irelands export markets are important to overall industry profitability. With 63% of all liquid milk production being exported, it is critical that the product mix of Irelands dairy processors is in tune with consumers or the food processing industrys requirements. The reliance of Ireland on export markets is far greater than that of Denmark and the Netherlands, but well below that of New Zealand. Other dairy
130
industries in particular Denmark and the Netherlands have greater levels of internal liquid milk consumption. This is due in part to higher populations, and the fact that both of these markets have greater ranges and consumption levels of liquid milk products, including drinking yoghurts, flavoured milks and buttermilk products. Irelands greater reliance on export markets for sales of its output has impacted the product make-up, which historically has needed to be transported over distances in a shelf-stable form to meet the demands of distant consumers. Given this need to export products, the sector has concentrated primarily on base product production (butter, powders, casein and bulk cheddar cheese). But in the recent past, the international dairy market has demanded a greater range of higher value dairy products for direct consumption products that geographically-isolated producing countries like Ireland and New Zealand find difficult to supply. New Zealands strategy has been to invest in added value production facilities in some key markets to utilise lower value base dairy products, and convert these into higher value products. Ireland faces a challenge to adapt its product mix to better suit the market requirements, or invest in technologies to utilise its products within the affluent Northern Hemisphere consumer markets. Ireland has been reducing its proportion of base products over the last decade; however, as will be discussed in chapters 2 and 3, the industry needs to shift even further out of these product types. 5.4 Export values Export value of dairy products ( million)69 % 1991/20 01
-15.8 87.0 69.0 -0.8 -49.6 121.5 -42.0 75.0 n/a n/a n/a
1991
Butter Cheese WMP SMP Chocolate crumb Casein(ates) Butteroil Cream Whey powder All other dairy products70 Total 352.7 206.6 59.8 106.8 87.6 86.0 19.3 4.0 24.5 27.2 974.5
1997
388.3 277.0 89.7 186.6 25.6 135.5 15.7 11.3 40.6 91.0 1,261.3
1998
390.3 278.9 86.6 95.0 28.0 125.4 18.4 5.8 40.0 91.8 1,079.9
1999
320.2 273.5 89.7 155.1 35.3 141.0 16.4 7.3 38.8 90.6 1,167.9
2000
320.1 285.8 105.2 244.6 36.7 185.1 13.5 5.1 45.0 99.7 1,340.9
2001
296.9 386.3 101.0 105.9 44.2 190.5 11.2 7.0 n/a n/a n/a
Source: IDB, Eurostat The value of Irish cheese exports has risen by 87% over the last decade against an increase in volume of 63% The price achieved in the UK market is the key determinant of this average price, given Irelands reliance on this market as a purchaser of cheese. While the average price achieved in the UK rose from 2,930 per tonne in 1991 to 3,400 per tonne in 1997, the price has fallen over the last five years, and was just 3,280 per tonne in 2001. This price trend is reflective of the influence of the average UK cheddar prices achieved by Ireland, which peaked in 1997 at 3,540 per tonne, but fell back to 3,360 per tonne in 2001. While the volume of butter exports fell by 22% over the last decade, the value of these exports fell by only 16% This was due to an increase in the average price achieved in both the UK and French markets, with UK prices rising from 2,860 per tonne in 1991 to 3,100 per tonne in 2001, and French prices going from 2,970 per tonne to 3,210 per tonne during the same period. This is in contrast to the price achieved in Germany, which in 2001 was back at its 1991 level of 3,020 per tonne.
69
NB: 19911998 values in ECUs, figures are based on customs values and do not take into account refund value of third party trade 70 Includes liquid milk, butter milk, yoghurt, butter spreads and infant formula
131
Over the last decade, Irish exports of WMP increased by 54% in volume terms, but this was outstripped by an increase in value of 69%. This was due to increases in the price of WMP sold to markets such as Africa and the Americas, with prices rising by 30% and 19% respectively from 1991 to 2001. At the same time, the prices achieved in key EU export markets fell, with a fall of 11% in Dutch prices having a significant negative impact. The average price obtained for Irish exports of SMP has risen by 60% in the last decade. This has been due to a significant increase in the price paid by extra-EU countries, and resulted in a situation in 2001 where there was minimal variance between the price for SMP in all Irelands main export markets. 5.5 Import volumes and value
Irelands imports of cheese and other dairy products has grown strongly over the last five years Irish dairy imports, by volume (000 tonnes) 1991
Butter Cheese WMP SMP Chocolate crumb Casein(ates) Butteroil Cream Whey powder All other dairy products71 Total 0.9 12.7 0.1 2.1 0.2 2.2 0.2 2.4 21.4 58.7 100.9
1997
1.5 17.7 0.6 3.5 1.2 2.0 0.1 14.2 12.4 215.4 268.5
1998
3.3 15.4 0.9 2.7 1.1 2.2 0.2
1999
2.8 20.6 1.0 6.5 0.1 2.9 0.2 19.0 8.8 387.6 449.6
2000
2.8 22.2 0.6 5.9 0.2 3.4 0.4 11.9 12.4 308.1 367.8
2001
5.1 23.5 0.6 5.5 0.3 1.3 0.5 7.6 9.5 230.2 283.0
% 1991/2001
277.8 89 60.0 142.9 50.0 -40.9 150.0 216.7 -52.8 292.2 180.5
41.8
14.0 291.4 372.9
Source: Eurostat The most significant Irish imports, in volume terms, of the main product types is the importation of cheese. The volume of cheese imported has risen gradually over the last decade from 12,700 tonnes in 1991 to 23,500 tonnes in 2001. This is against total production figures of 120,000 tonnes in 2001. The average value of the cheese imported in 2000 (the last year where values were available) was 3,617 per tonne, considerably higher than the average value of Irish exports in the same year at 3,256 per tonne, and probably reflects the import of softer cheeses, which usually command a higher price than the harder cheeses. The volume of cream imported over the last decade has been high relative to Irelands production. In 2000, 11,900 tonnes was imported, compared to Irish production of just 9,800 tonnes. This may be addressing the shortage of supply from the Republic of Ireland due to seasonality of production. However, there does seem to be a wide variance in the production and import figures for cream from the various data sources available. A significant volume of imports are categorised as other dairy products, which includes liquid milk, butter milk, yoghurt and unsweetened condensed milk. In 2000, 308,100 tonnes of these products were imported; however, the average value of these imports was just 398 per tonne.
71
Includes imports of liquid milk, butter milk, yoghurt and unsweetened condensed milk
132
Appendix 6:
The Irish dairy industry compared summary Ireland (industry)

2,530m 2.5%
Comparative measure
Dairy processing turnover and as a % of GDP
Denmark (industry)
2,930m 1.7% 4.418
Netherlands (industry)
5,681m 1.4% 10.683
New Zealand (industry)

2,356m 4.5% 12.322
Milk delivered (million tonnes) Average quota per farm (000 tonnes) Average number of cows per farm Average milk yield per cow kg per annum Average milk price (/100 kg standard milk72) Seasonality peak to trough ratios Protein levels % Fat levels % Production costs per kg of milk solids45 Number of companies processing 80% of the milk pool % of milk drinking milk production Number of butter plants in 2002 Number of cheese plants in 2002 Number of powder plants in 2002
5.388
189
500
394
None
45.7
70.1
55.4
251
4,600
7,300
7,415
3,341
28.15
31.01
29.98
18.94
5.99
1.21
1.15
82.8873
3.28 3.80 2.59
3.41 4.33 3.48
3.46 4.44 2.82
3.64 4.84 2.08
10.4%
11.8%
8.1%
7.2%
11
20
10
10
60
26
11
11
11
72 73
2000 figures Source ZMP 1999 figures Source: Keane 2002
133
Comparative measure
Average plant output of butter (000 tonnes) Average plant output of cheese (000 tonnes) Average plant output of powder (000 tonnes) Capacity utilisation Annual butter production (000 tonnes) Annual cheese production (000 tonnes) Annual SMP production (000 tonnes) Annual WMP production (000 tonnes) Annual casein production (000 tonnes) EVA % of dairy production exported by volume (incl liquid milk for drinking) Use of EU intervention support for butter Use of EU intervention support for butter78 Average profitability 79 R&D expenditure (as a % of 80 t/o) Reinvestment rate (as a % 81 of t/o)
74
Ireland (industry)
11.6
Denmark (industry)
5.7
Netherlands (industry)
21.7
New Zealand (industry)

35.2
12.0
8.9
24.7
31.3
9.9
28.0
35.9
68.1
60.8% 128
92.3% 46
92.9% 130
52.2% 258
74
120 75 34
318 40 88
641 68 108
289 251 515
48
13
75
3575
110
1.72
76
2.1
77
1.83 54.9%
1.53 79.3%
63.4%
35.6%
13,700 tonnes 35% (% of total) 38.800 tonnes 26% (% of total) 2.7% 0.2%
12,900 tonnes 35% (% of total)
N/a
N/a
3.2% N/a
3.8% 0.4%
-0.06% 0.6%
2.6%
4.5%
3.1%
5%
75
76
2000 figures Source CSO data, Eurostat
Estimate only, official statistics unavailable
2000 data - Average for 13 dairy processors in 2001 was 1.45 77 2000 data 78 Figures for 2002 (June) 79 Profitability figures for DK, NL, and NZ refer to their largest processors and are given for indicative purposes 80 See above 81 See above
134
Appendix 7: Approach adopted in determining the future configuration of the dairy processing industry A market led approach has been adopted to determine the optimal industry configuration in line with the overall approach to this study. The key market requirements and the strategic imperatives for responding to these market requirements are the main drivers of the future industry configuration and have been discussed in chapter 2 and sections 3.1 and 3.2. Outlined below are some the remaining factors that have been taken into consideration in determining an appropriate future configuration for the industry. These include specific details of the estimated primary and secondary product volumes to meet the market opportunities, research and evidence of the most efficient plant size and some practical considerations. Estimated primary and secondary processing product volumes As outlined at the end of chapter 2, the key opportunities that Ireland is best placed to concentrate its efforts on will result in a product portfolio consisting mainly of butter, SMP, WMP, semi-hard and semi-soft cheeses. However, it is expected that up to 5% of butter, 20% of WMP, 30% of SMP and 50% of cheese output will be used to meet opportunities for enhanced value dairy products as solutions for various customers in the industrial and foodservice markets. This has resulted in estimated primary and secondary processing product volumes as set out in the table below. Estimated primary and secondary processing product volumes (2015)82 000 Tonnes
Butter SMP WMP Total cheese Semi-hard cheese Semi-soft cheese Other cheeses 35.3 15.3 10.0 35.3 15.3 -
Primary Processing
123.2 58.7 26.5
Secondary Processing
6.5 25.1 6.6
Total Output
129.7 83.8 33.1 (111.2) 70.6 30.6 10.0
Source: Promar Trade Estimates The configuration of the industry going forward must be such that it can produce these estimated outputs of primary and secondary processed products. Identifying the most efficient plant size suitable to the future needs of the Irish dairy processing sector There has been a major drive in competitor countries to increase economies of scale by substantially increasing the scale of plant size for base product production. For example, the Netherlands is continuing to increase its scale of production to reduce fixed costs and achieve its objective of being a cost leader. The leading Danish co-operative Arla, have recently announced plans to double the size of its largest cheese plant in Taulov to 70,000 tonnes per annum. Meanwhile, the New Zealand industry has built some of the largest plants in the world. As discussed in chapter 1, the data gathered from processors for this study, provides evidence to suggest that the larger scale producers of base products achieve higher margins. While the data is not consistent for all processors, it does suggest that there is a positive relationship between higher margins and larger scale, particularly in the production of base products. This finding supports the research conducted by academics both in Ireland and internationally. In determining the most efficient Irish plant size for each of the main base products, both academic research and practical experience have been used as inputs. This involved balancing the decreasing
82
Estimated product volumes assume Ireland maintains its current market share in each of these markets
135
average processing plant costs that are achievable with increasing plant scale, against the corresponding increasing collection costs that can arise as plant scale increases. Research by Teagasc83 on the optimum scale of powder plant for Ireland concluded that 7.5 tonne per hour plants provided the best option, providing economies of scale while retaining some flexibility. Based on Irelands existing capacity utilisation, these plants would have an output of roughly 30,000 tonnes84 per annum. While this research may need to be updated to reflect increased cost of production its overall findings remain relevant. While there has been no recent Irish research on the optimal butter plant size the recent international 85 trends have been towards larger scale plants. Consideration was also given to research by Keane that focused on the optimal configuration of cheese plants in Ireland. This research combined manufacturing and collection costs and found, as previous studies had, that there are considerable economies of scale up to about 20,000 tonnes per annum. Practical considerations that need to be factored in There are a number of practical considerations that have been taken into account in determining efficient plant size and the number of plants required in Ireland to effectively and cost efficiently meet prod uct demand. The factors considered include: Location of the milk pool - the location of plants must take into account where milk is produced within the country and in particular, should avoid unnecessary transport of liquid milk. The seasonality of milk supply within different regions also impacts on the practicality of locating certain types of plants in different regions. Joint services - clustering of plants enables processors to drive out cost savings through economies in joint services such as gas, electricity, water source, effluent treatment / disposal and environmental control compliance. Existing sites - the current scale and suitability of existing plant sites for increased production impacts on whether sites can be upgraded, leveraging the existing investment in infrastructure such as manufacturing equipment, water and electricity, or if new green field sites are required. Compatibility of different product processes - much of the research on plant efficiency focuses on the manufacturing plant, but does not take into account overall enterprise level issues such as multi-product sites. However, taking an industry wide perspective, it will be necessary to have multi-product sites to achieve overall economies, the most obvious example of this being sites combining production of both butter and powder. Current returns and requirement for capital re-investment - Chapter 1 identified the lack of significant capital re-investment by Irish processors with the last round of major re-investment being in the 1980s. While there has been on-going investment by processors this has mainly been to maintain rather than to significantly improve plant and equipment. The Irish processing sector is fast approaching a point where it must re-invest significant amounts of capital. This is being driven by demands from customers and regulators for investment to address environmental, food safety and quality concerns. Capital investment is also necessary to achieve efficiencies at plant level and meet the specific product requirements of customers. The challenge in determining the appropriate future plant configuration for the industry is to determine the most efficient areas and way in which to re-invest. In particular, given the current profit margins it is likely, that certain processors will find it difficult to obtain the funding required to reinvest without a significant change in the focus of their production away from base products into higher margin products. Other considerations -numerous other practical considerations will impact on the future configuration of the industry including proximity to transport infrastructure and population centres. For secondary processors there may be greater importance and emphasis on these factors.
83
OCallaghan and Kelly, A Cost Model Approach to Capital Re-Investment Choices for Competitive Milk Powder Manufacture in Ireland, 2000 84 30,000 tonne output is based on operating for 20 hours a day at 7.5 tonnes per hour for 200 days per year. 200 days represents current capacity utilisation. 85 Keane, Structural Change & Economies of Scale and International Competitiveness in Dairying, 1998
136
Appendix 8: Savings from economies of scale at manufacturing level from plant rationalisation In calculating the reduction in fixed costs or contribution to capital costs, the square root rule of thumb is usually applied to determine these savings. This approach suggests that a doubling of scale results in a 41% increase in the contribution to fixed costs, effectively a saving of 30%. The relationship between scale and fixed costs is well documented internationally and to illustrate this relationship included below is a graph from research by Teagasc1 on the influence of production scale on fixed costs for milk drying (at 60% utilisation) Plant scale and fixed costs for powder production
200 180 Fixed costs 160 140 120 100 2.5 5 7.5 10 12.5 15
Scale (tonnes/h)
International and Irish studies indicate a significant fall in direct labour input as scale increases. Research by Teagasc on powder plants86 found that a doubling of scale results in a 27% drop in direct labour input. There are also numerous other benefits such as improved quality control, standards and specification of products, but these are difficult to quantify in financial terms. Many commentators also believe that increasing scale can result in savings in collection and assembly costs. They argue that having fewer larger plants facilitates the efficient planning of milk collection and reduces the unnecessary expense associated with several plants collecting milk from farms in the same towns or local regions. However for the purposes of this study it is assumed that these savings are outweighed by the increased cost of assembly associated with larger scale and reduced number of plants and in particular the significant cost of transporting liquid milk longer distances. Cost increases: The impact of scale on collection or assembly costs involves numerous factors and complexities. Detailed research by Teagasc 87 on this cost element factored in route distances, road conditions, supplier herd size, frequency of collection and seasonality, and estimated the influence of catchment radius and shape, factory location, supplier volume and milk production density. Their conclusion was that expanding manufacturing capacity and/or centralised production would lead to an enlargement of the catchment area within which milk is collected and hence an escalation of assembly costs. Similar research of collection costs by Keane 88 also indicates rising collection costs with increases in scale. Using data provided by processors for this study, the views of industry experts and published estimates of 89 powder manufacturing costs and the impact of scale on these costs ; it has been possible to estimate the savings and costs associated with the anticipated change in the scale of powder production.
87
OCallaghan et al, A Cost Model Approach to Capital Re-Investment Choices for Competitive Milk Powder Manufacture in Ireland, 2000 88 Keane, Structural Change and Economies of Scale and International Competitiveness in Dairying 89 A cost model approach to capital re-investment choices for competitive milk powder manufacture in Ireland (OCallaghan & Kelly (Teagasc), 2000)
137
The net impact of the increased scale of powder production has been estimated to result in a 2.46 cent per gallon reduction in the manufacturing cost of SMP and WMP. Applying this saving to the whole milk equivalent of SMP and WMP production (260 million gallons), results in a saving of 6.5 million per annum. Using the data provided by processors to include the production of other whey products the savings from the increased scale of production are lower per gallon but given the larger volume of milk the total saving is slightly greater than for just SMP and WMP. While there is less data available on the manufacturing costs of casein, it is assumed that similar savings and costs are associated with increasing the scale of casein production. Indeed given that reductions in fixed costs are greater when moving from lower levels of scale, the savings in casein manufacturing costs may be greater than with powder. However, the savings in casein manufacturing costs are estimated to be one cent per gallon, based on the estimated increase in casein plant scale. This saving applies to a milk equivalent of 379 million gallons resulting in a saving of 3.8 million per annum. A conservative approach has been adopted in estimating the manufacturing level sav ings from economies of scale. Savings have been calculated for powder and casein production and have not factored in any potential savings from the production of butter or other products. The reality is that savings, while less significant, are also likely to be made from larger scale manufacturing of butter and other products.
138
Appendix 9: Estimating benefits using EVA analysis The economic value added (EVA) ratio is used as an indication of the value -added to raw dairy products through processing and marketing activities. Enhanced values suggest that an industry is able to extract greater value from milk through particular types of products manufactured and/or the markets serviced. As discussed in chapter 1, the Irish dairy industry has a lower EVA than its competitors used to benchmark the sector. This in part reflects the Irish reliance on lower value products due to the seasonal supply pattern, its utilisation of EU price and market supports, and to some extent its geographical location. To demonstrate this fact, the EVA as calculated for this study, is shown for a number of European dairy industries. While in the benchmark section of the report New Zealand was used for comparative purposes, in this case it has been removed as its EVA is significantly enhanced through its lower milk price. In addition to this, New Zealand sells a vast volume of products into the Asian market, rather than Europe, and as a result its inclusion in this calculation is of limited value. For comparative purposes, the dairy industries of Denmark, the Netherlands and Germany have been compared with that of Ireland for the period 1997 200090. EVA of major competitor dairy industries 1997 2000 Ireland91
1997 1998 1999 2000 1.58 1.54 1.61 1.72
Denmark
2.03 2.37 2.39 2.10
Netherlands
1.78 1.75 1.94 1.80
Germany
2.18 2.12 2.02 1.99
Source: ZMP, IDB, CSO, National Statistics, Prospectus/Promar Research The challenge for all international dairy industries is to create greater value from the raw milk, through the combination of products and markets. Many opportunities can be considered as possible, especially those that add additional value to milk, but it is imperative that such tactics are undertaken in a manner that ensures that added costs in processing and marketing do not outweigh the benefits. The prominence of butter, SMP and WMP to the Irish dairy industry is shown below. There are a number of well understood reasons for these products historical manufacture, but it would appear that they tend to negatively impact on the industrys ability to create additional value from raw milk. The following table provides an indication of the relative importance of butter, SMP & WMP dairy products to the Irish dairy industry. The dairy industries of each country are compared using the volume of milk used in the manufacture of butter, SMP and WMP as a percentage of the total volume of milk processed. A milk equivalence method has been used to estimate the relative volumes used in the manufacture of each product. Despite some ongoing debate over some of the actual indices used, this system remains an internationally accepted method for this type of comparison. While other methods, including the volumes of processed products, could be used, after consultation with a number of industry groups, it was decided that the milk equivalence method was the more appropriate for this type of comparison.
90
These industries have been chosen as they produce and distribute products in the European markets. New Zealand is not included, as the EVA is enhanced through the lower producer milk price. 91 Irish EVA figures for 1997 to 2000 based on industry data from CSO.
139
% Butter, SMP and WMP products92 % for major competitor industries 1997 2000 Ireland
1997 1998 1999 2000 45.32 45.00 44.71 43.30
Denmark
29.35 28.95 30.40 30.39
Netherlands
21.17 24.39 24.15 21.87
Germany
30.48 30.04 30.07 28.75
Source: ZMP The rationale for the increased reliance on butter, SMP and WMP has been discussed earlier, but in the main these products have limited ability to return premiums to processors, as they are continually under price pressure because many international producers are able to manufacture base dairy products. It is often said that the world is awash with milk powder. This said the Irish dairy sector is more reliant on the sale of these base products to provide industry returns. In effect, it is a price taker for a significantly larger proportion of its processed milk than other European dairy industries. Within the Irish dairy industry, many draw attention to the fact that their European counterparts are able to supply greater volumes of fresh dairy products into their domestic markets, and therefore have a decreased need for the manufacture of base products for sale in (arguably) the more competitive international marketplace. In addition, the others in this comparison have more uniform seasonal milk production curves reducing the need for base products to soak up seasonal milk. While the domestic market in Ireland is smaller in population terms, per capita consumption of dairy products is mixed. Large volumes of liquid milk are consumed, but residents purchase significantly less butter and cheese than the European per capita average. Cultural traditions may explain some of this variation, but there would appear to be opportunities to increase dairy consumption in some areas, to improve this current situation to the benefit of the local dairy sector. Relationship between EVA and base product % (Butter, SMP and WMP) In chapter 1 the relationship between the percentage of milk used in the manufacture of butter, SMP and WMP was profiled, using the benchmark industries of Denmark, the Netherlands and New Zealand. This same relationship exists when plotting EVA (as calculated) against the percentage milk used in the manufacture of butter, SMP and WMP when Germany replaces New Zealand.
92
In order to compare the impact that the proportion of base products within the total product portfolio has on the EVA ratios of the different benchmark countries, it is important to compare similar type products produced by the different countries. Butter, SMP and WMP are produced in all of the countries, and the products are broadly similar. However, it is not possible to compare cheese as there are major variances within the product category, and it is not possible to make plausible cross-country comparisons. For example, the Dutch industry produces large quantities of edam and gouda cheese, which are mainly commodity type products, not produced to any extent in the other countries. As a result, the only base products we compare to assess their impact on EVA are butter, SMP and WMP on a milk equivalence basis.
140
Relationship between base product percentage and EVA
2.30 2.25 2.20 2.15 2.10 2.05 2.00 1.95 EVA 1.90 1.85 1.80 1.75 1.70 1.65 1.60 1.55 1.50 20.00 Ireland Netherlands Germany Denmark
25.00
30.00 Base product %
35.00
40.00
45.00
This chart suggests (as in chapter 1) that there is a negative relationship between volume of milk used to produce base products percentage, and a dairy industrys ability to add value to the milk processed. The chart strongly suggests that rewards, in terms of enhanced EVA, are available for industries that can reduce their reliance on the production and marketing of these types of products (butter, SMP and WMP). The effect of raw milk price By definition, it is possible for dairy industries to enhance their EVA through the payment of a lower milk price. This is certainly the case in New Zealand. However, when comparing the European industries used in constructing the curve above, it is noted that Denmark, the Netherlands and Germany have all paid greater prices (in absolute terms) for the raw milk purchased from suppliers (ZMP data). Average producer milk price 1997 2000 Ireland
1997 1998 1999 2000 28.23 27.92 26.66 27.20
Denmark
30.87 30.80 30.26 30.86
Netherlands
29.17 30.59 26.77 29.98
Germany
28.32 29.72 28.47 30.00
Source: ZMP Over the period under review, the other industries have in fact paid between 6% and 12% more for their raw milk than Ireland. Despite these higher milk prices, these same European industries have managed to create greater value from dairy processing using their respective structures, markets and product portfolios. This suggests that in this case, added value gained from marketing less base product, has in fact delivered added value throughout the total value chain, including producers. Impact of product mix and EVA change Through using the EVA / base product curve as shown, it is possible to extrapolate the estimated impact of changing the percentage of milk used in the manufacture of butter, SMP and WMP. In 2000, the base product percentage for the Irish dairy industry was approximately 43%, (43% of all milk processed was manufactured into butter, SMP and WMP), and this resulted in an EVA of 1.72. This in effect meant that the industry, through its processing and marketing initiatives, was able to add 172% to the value of the raw milk price paid to producers.
141
Impact of product mix change on EVA
2.30 2.25 2.20 2.15 2.10 2.05 2.00 1.95 EVA 1.90 1.90 1.85 1.80 1.75 1.70 1.65 1.60 1.55 1.50 20.00
34%
25.00 30.00 Base product % 35.00 40.00 45.00
The strategy as suggested in chapter 3, proposes to create a situation where the Irish dairy industry changes its product mix to one less dependent on base products. It proposes the move towards the creation of added value, differentiated dairy products utilising Irelands distinct attributes and technologies. This shift creates a situation where only 34% of its raw milk would be used in the manufacture of non-differentiated butter, SMP and WMP (i.e. products that are sold into markets with very limited ability to set price). Using the trend line above, this move is expected to create a situation where the Irish dairy industry could generate an EVA of 1.90, adding 190% to the value of the raw milk purchased, compared to the present level of 172% - an extra 18%. Based on current milk volumes (5,338,000 tonnes) and a milk price of 29.22/100Kg, this equates to an estimated 280 million in additional turnover from the milk processing industry. While the product shift is considered to be the major driver for the increased EVA factor, it must be remembered that other aspects including industry restructuring and rationalisation of the delivery of products to market, may also assist in delivering this increased industry efficiency. An example of this Ireland The impact of changing product portfolio and EVA enhancement has been demonstrated in a number of dairy industries, including Ireland. In the past 4 years, Ireland has managed to decrease the percentage of milk used in the manufacture of butter, SMP and WMP, with this translating into an increased EVA.
142
EVA base product percentage Ireland

1.74
1.72
2000
1.7
1.68
1.66
1.64 EVA 1.62 1999 1.6 1997 1.58 1.56 1998 1.54 1.52 43.00
43.50
44.00 Base product %
44.50
45.00
45.50
While the shifts in base product percentage have been relatively modest compared to that which is being proposed, the trend is well demonstrated. In the past 4 years, the reduction in raw milk used in the manufacture of butter, SMP and WMP from 45.32% in 1997 to 43.30% in 2000, has resulted in an EVA enhancement of 0.14. The proposed strategy will result in a further growth in the EVA of 0.18 over and above the enhancement that has occurred since 1997, resulting in an estimated 280 million in dairy industry turnover.
143
Appendix 10: Competition issues Competition in the domestic market Within the domestic market it is envisaged that the strong competition that currently exists within the liquid milk market, with local processors competing with the larger players, will continue following the implementation of the changes outlined in this study. However it may be necessary for some processors to divest of certain domestic activities, as has been the case in other countries where major rationalisation has occurred. The recommendation of this study to create a large single player will ensure the international competitiveness on global markets of 80% of Irelands total output from dairy manufacturing that is exported. However this should not reduce the competition within the domestic market, particularly for liquid milk where local processors will continue to play a key role in the market. The fact that Ireland is an open economy will ensure that there is competition within the domestic market for consumer dairy products, particularly from other EU countries. Competition is required in the home market and this competition should enable processors to utilise the home market to develop and test new products that the market is demanding so that consumers choose Irish products rather than being forced into buying them due to a lack of alternatives. Ultimately it will also result in greater opportunities for the exportation of these products to other EU markets where Ireland sells the majority of its dairy products. The rapid consolidation of both Danish and New Zealand dairy industries has brought into question whether the two major companies in each market (Arla and Fonterra) are able to act in an anti-competitive manner due to their size. In fact, both of these operators were formed with government approval, although questions are still regularly asked regarding market behaviour. Denmark Until the recent past, it appeared that the Danish Competition Authorities were not too concerned about the creation of the MD (and now Arla) operation. In fact, at a number of stages the Authority approved the growth. However, recently the Competition body has be en asked to rule on the companys strategy, in particular during the merging with Clovermilk and the cross-border merger between MD Foods and Arla to form Arla Foods. The merger between the Swedish and Danish dairy giants also avoided EU Competition Authorities as it fell below the value threshold for such investigations, resulting in the merger being subject only to approval by the Danish and Swedish Authorities, which was granted. The Authorities approved the merger on condition that some smaller operations were sold off to ensure a degree of local competition. Despite ongoing approvals by the market watchdogs, Arla continues to be investigated on a regular basis, including as recently as December 2002. To date, the reaction to Arlas plans has been favourable, but these approvals have failed to slow the level of questioning by concerned groups within the Danish and Swedish dairy markets. New Zealand Fonterra was formed through the combining of the countrys two largest dairy processors and the New Zealand Dairy Board. This combination resulted in the new company controlling over 95% of the raw milk supply and the domestic milk market. The New Zealand Government was asked to enact legislation that would enable Fonterras formation to bypass the Commerce Commission, a group that was almost certain to veto the creation of the new company. This bypass was granted, as it was considered it was in the national interest to form a single large dairy processing and marketing company to compete on the international dairy market. As with the Arla example, Fonterra was forced to relinquish some of its domestic market operations to maintain competition in consumer dairy products in the local market. In addition, two other dairy processors (Tatua and Westland) continue to operate in both the domestic and international dairy markets beside Fonterra, providing some small degree of competition. Questions are still asked about Fonterras dominance of the New Zealand dairy industry, especially in its ability to set raw milk prices. However, due to its co-operative ownership structure, some consider that the Governments ability to interfere is limited, and that the company is unlikely to face any severe legislative restrictions on its future strategies as long as these are approved by its 14,000 supplier shareholders.
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Strategic Development Plan for the Irish Dairy Processing Sector

Strategic Development Plan for the Irish Dairy Processing Sector

Irelands dairy processing industry today

Market developments and future market opportunities

Strategic Development Plan for the Irish Dairy Processing Sector

Strategic Development Plan for the Irish Dairy Processing Sector

Strategic Development Plan for the Irish Dairy Processing Sector

Strategic Development Plan for the Irish Dairy Processing Sector

Strategic Development Plan for the Irish Dairy Processing Sector

Strategic Development Plan for the Irish Dairy Processing Sector

Strategic Development Plan for the Irish Dairy Processing Sector

Strategic Development Plan for the Irish Dairy Processing Sector

Strategic Development Plan for the Irish Dairy Processing Sector

Strategic Development Plan for the Irish Dairy Processing Sector

Strategic Development Plan for the Irish Dairy Processing Sector

Chapter 1 Irelands dairy processing industry today

Strategic Development Plan for the Irish Dairy Processing Sector

Introduction Study objectives, background and methodology

Strategic Development Plan for the Irish Dairy Processing Sector

Policy environment of the dairy industry

Strategic Development Plan for the Irish Dairy Processing Sector

3110.9 2682.1 55.8

900.0 624.5 21.9

2800.0 1947.3 42.8

2250.0 1646.9 57.9

1200.0 695.4 33.3

13740 8964.3 416.1

1200.0 1013.3 27.5

556.0 560.4 16.2

Prospects for Agriculture in CEEB - 2002, EU Commission

Strategic Development Plan for the Irish Dairy Processing Sector

Dairy production Introduction

Strategic Development Plan for the Irish Dairy Processing Sector

Figure 1 Distribution of dairy farmers by quota size

15% 12% 10%

Under 180,000 litres

180,000 litres to 275,000 litres 1996 2001

Over 275,000 litres

Strategic Development Plan for the Irish Dairy Processing Sector

35,027 32,850 31,650

29,467 27,926 29,071 28,174

1999 Denmark New Zealand

Strategic Development Plan for the Irish Dairy Processing Sector

Strategic Development Plan for the Irish Dairy Processing Sector

Milk solids = % fat and % protein combined

Strategic Development Plan for the Irish Dairy Processing Sector

Highest monthly fat level Source: CSO (2002)

Strategic Development Plan for the Irish Dairy Processing Sector

Issues that need to be addressed at production level

Strategic Development Plan for the Irish Dairy Processing Sector

Strategic Development Plan for the Irish Dairy Processing Sector

Plant product output volumes

Strategic Development Plan for the Irish Dairy Processing Sector

Powder4 (SMP & WMP)

Strategic Development Plan for the Irish Dairy Processing Sector

1994 11.8 13.4 14.1

1997 13.0 18.1 12.6 n/a

1999 10.0 18.9 18.4 n/a

2001 9.9 18.3 16.0 69.6

Strategic Development Plan for the Irish Dairy Processing Sector

Strategic Development Plan for the Irish Dairy Processing Sector

Plant capacity utilisation

Source: Derived from CSO data, Eurostat (2002)