Dairy's international intrigue

by Keith Nunes
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The stable market forces that once governed the global dairy industry are shifting. The cost of production in many markets is rising and, as a result, U.S. dairy processors see opportunities for growth in international markets.

After years of near balance between the total quantity of U.S. dairy imports and exports, exports of U.S. dairy products in 2004 and 2005 surged ahead of imports during the same time period. Using data for January 2005 through October 2005, the total quantities of

U.S. exports grew by 35% in 2004 and were up another 15% year-to-date in 2005. More importantly, since early 2004, exports have been prompted without U.S. government subsidies.

The timing of this shift is somewhat remarkable when one considers the situation facing dairy processors during the past two years. A smaller national dairy herd drove the costs of milk up, and Hurricane Katrina drove the cost of energy up as well. The result was a higher cost of doing business for dairy processors than the period between 2000 and 2003.

"We can no longer ignore the reality of a global marketplace," said Connie Tipton, president and chief executive officer of the International Dairy Foods Association (I.D.F.A.) at the group’s annual Dairy Forum, held this past week in Palm Springs, Calif. "Part of thinking globally is understanding the United States’ role in global dairy trade. The world is going to demand high-quality dairy products and dairy ingredients, but where will they go to find them?

"In the world of textiles and telemarketing, many U.S. companies have gone off-shore for their needs. But in the case of dairy product manufacturing, we should be doing everything we can to be the source."

Ms. Tipton noted international companies like Fonterra (New Zealand), Glanbia (Ireland), Danone (France) and Saputo (Canada) are establishing partnerships with U.S. companies. Some of these partnerships have evolved because of how the international market is changing.

"For the first time in recent memory, the annual average world price in the past two years for skim milk powder has been above both the U.S. dairy support price and the benchmark price for West Coast nonfat dry milk," said Ms. Tipton. "And for cheddar cheese, the annual average world price has risen above the U.S. support price for the past two years. The gap between the world price and U.S. price for 40-lb block cheddar is the narrowest we’ve seen in a long time.

"These strengthened prices along with new markets in China have led to a rise in the level of our dairy exports to 7% of all U.S. production last year — a big increase from a few years ago when we were pretty much stuck at 3%."

The top six countries importing U.S. dairy products in 2005 included the nation’s two continental neighbors, with $419 million going to Mexico and $181 million to Canada. Other destinations with more than $50 million in U.S. exports include Japan, Philippines, Indonesia and China.

Dr. Scott Brown, a research assistant professor at the University of Missouri, Columbia, told the Dairy Forum audience the factor that will drive global demand is population growth. From his perspective as an agriculture economist, Dr. Brown said for U.S. companies to become major players in the global marketplace, they are going to need better sources of information.

"The data we see now is broken out by region and in some areas of the world we are not seeing what we need to," he said.

Noting China represents an area of growth, he also said that in the past 6 months the country has increased its dairy production 15%.

"Compared to what the U.S. is capable of producing, growth in China is still small," said Mr. Brown. "But the fact they could increase their output 15% in six months should get some people’s attention."

The potential offered by China’s growing economy was the subject of considerable discussion at the Dairy Forum, but Jim Begg, director general of Dairy U.K., put the situation in perspective.

"I travel a lot," he said. "And everywhere I go in the world everyone says they are going to sell to China, everyone says they are going to invest in China and everyone says they are going to do business in China. Mark my words — Doing business with China is going to be more competitive than doing business with Wal-Mart."

Fluid woes
The U.S. dairy industry’s generic advertising campaigns, which have featured the memorable line "Milk, it does a body good," and the now famous milk moustache, may be memorable, but they have not proven effective at helping the industry gain market share in fluid milk sales. Despite increased sales dollars during the past two years, unit volume sales of refrigerated milk have declined, according to ACNielsen.

Increased competition from soda, water and other beverages is the primary reason why fluid milk volume sales have lagged. During the past two years, dollar sales have increased for the category due to an increased interest spawned by the popularity of the Atkins Diet. In addition, the discovery of bovine spongiform encephalopathy in 2003 and the subsequent closing of the Canadian border reduced the number of milk producing cows in the country, affecting production and causing a spike in milk prices.

Total sales of fluid milk have changed little during the past 20 years, according to the I.D.F.A. In 2004, total fluid sales were down 2%, the equivalent of approximately 6.15 billion lbs. A major factor in the decrease was the record-high farm prices for farm milk. In 2004, the U.S. Department of Labor’s Bureau of Labor Statistics reported that the average retail price for a gallon of whole milk was $3.16 compared to $2.77 in 2003, a 14% increase.

Price sensitivity, limited distribution and competition in the beverage industry are all reasons for the decline in milk sales. The industry is focusing on to improve distribution beyond supermarkets, product variety, package options and branding.

At the retail level, milk sales are declining at grocery stores and rising at convenience stores and other retail outlets. Federal school programs represent a growing share of total fluid sales as well. In 2004, an estimated 5.4% of fluid milk sales were through federal school programs.

During the Dairy Forum, Ms. Tipton said greater choice will become a focal point in fluid milk product development.

"(Our processors) probably can’t make that gallon of milk or pound of cheese any more cheaply than they make it today. They’ve probably cut every penny out of processing and distribution," she said. "That’s why companies are focusing more on the product itself, or how it is sold at the end point.

"For milk, this is where an array of flavors, packaging choices, or extra nutrients comes into play. Ice cream companies caught onto this years ago. Just look at the array of flavors, ingredients, innovative packaging and product sizes we see today in the ice cream freezer."

Invoking the concept of "micro-marketing," Ms. Tipton said milk processors should follow the lead of Pepsi and Coca-Cola in product development.

"The future is not in whole, 2% or fat-free milk; or blocks of cheddar or Monterey Jack cheese; or in economy versus super premium ice cream, but in dozens of different choices in our products," said Ms. Tipton. "Focusing on the product and how it is sold forces us to acknowledge that one size does not fit all and that we are competing with thousands of other foods and beverages that serve a broad array of needs."

The largest fluid dairy processor in the country is Dean Foods, Dallas. The company accounts for between 30% and 35% of the fluid milk market and features approximately 40 brands. The company is attempting to execute Ms. Tipton’s advice. In the past few years it has introduced a number of products, including Hershey’s chocolate milk and Land O’ Lakes’ Dairy Ease line of products for lactose-intolerant consumers.

Other companies, including firms that have taken market share away from fluid processors, like Coca-Cola, Atlanta, and PepsiCo., Purchase, N.Y., are also attempting to gain a foothold in the fluid milk segment. This past August, Bravo! Foods, North Palm Beach, Fla., signed a distribution agreement with Coca-Cola Enterprises to distribute Slammers, Bravo!’s line of flavored, fortified milk products.

That same month, PepsiCo entered the fray with the addition to its non-carbonated beverage portfolio of a line of flavored milk beverages called Quaker Milk Chillers. The flavored beverages are made with 2% reduced-fat milk and fortified with calcium and vitamins.

"Many people want the health benefits of milk but they don’t like the taste of plain milk," said Chad Dick, director of marketing innovation, Pepsi-Cola North America. "Quaker Milk Chillers enable them to get many of milk’s nutrients in the form of a great-tasting beverage without all of the calories and sugar found in most flavored milks."

With a major company like Dean Foods and companies like Coca-Cola and PepsiCo stepping into the marketplace, it can make it difficult for smaller processors. Merger and acquisition activity occurred in the fluid milk category at a breakneck pace during the past decade, and industry executives predict it will continue.

"Consolidation will continue, but not at the pace that it has during the past 5 to 8 years," said Rick Beaman, chief operating officer for the southwest region of Dean Foods, during the Dairy Forum. "The volatility of the market has forced us to become better operators. The companies today are more focused and efficient, and that will slow consolidation activity."

During his presentation before the Dairy Forum, Ms. Tipton said that while the numbers of companies competing in the market are fewer, their goals are to grow.

"Over the past 25 years, the number of dairy farms has declined by 80%, while milk production per farm climbed 500%," said Ms. Tipton. "And we see the same trend with dairy processing plants. We have 60% fewer plants than 25 years ago, but output per plant has increased over 250%. We’re making more dairy products and ingredients than ever before.

"And we all expect the trend to continue. Researchers at Purdue’s Center for Food & Agricultural Business say the largest dairy producers expect to grow their businesses 41% over the next five years."

Favorable cheese trends
Cheese has been the shining star of the dairy industry. Consumption has continued rising thanks to interest in the Atkins diet, growth of the Hispanic population in the U.S. and expansion of the food service marketplace. Cheese has become a staple ingredient for restaurants and institutions, and industry experts forecast its popularity is going too continue to grow.

Consumers and food service operators are finding new uses for traditional cheeses in addition to experimenting with new varieties. The result is in 2004 cheese consumption reached a record high at 31 lbs per capita, a 2.4% increase over 2003.

American cheeses, specifically cheddar, have been the largest category in U.S. cheese sales, according to the I.D.F.A. But other cheeses have been steadily gaining ground. In 2004, the per capita consumption of American type cheeses and Italian type cheeses were equal, at 13 lbs.

In supermarkets, cheddar, mozzarella and processed American led volume sales in 2004. Processed American was the leader with nearly 556 million lbs sold followed by cheddar at 536 million lbs.

Following trends that have occurred in coffees and chocolates, the Americans have also been branching out, experimenting with artisan cheeses. In 2004, many specialty cheeses sold in supermarkets, like havarti, asiago and gruyere, saw retail sales increase 40%, 35% and 24%, respectively.

Many industry analysts believe the American population’s ever-expanding taste for a variety of cheeses will continue to drive growth. Even with the U.S. Department of Agriculture’s most recent data showing U.S. per capita cheese consumption at 31 lbs, it is still below the level of consumption in other countries. In Europe, for example, per capita consumption of cheese averages more than 41 lbs, and Iceland’s per capita consumption is estimated to be over 50 lbs.

To capitalize on the growth of the market, companies are considering expansion plans. Hilmar Cheese Co., Hilmar, Calif., announced in December the company will build a new cheese and whey protein processing plant in Dalhart, Texas. The facility will be the company’s first processing plant outside of its Hilmar facility and corporate headquarters.

"This new site will give us the additional capacity necessary to supply the growing needs of our cheese and whey protein customers and is a natural step for us to take in terms of getting closer, geographically, to our existing and new East coast and Midwest customers," said John Jeter, chief executive officer.

The new processing facility will be built in two phases, the first of which is expected to be completed in the fall of 2007.

Looking ahead
Dairy processors will tell anyone who will listen the cornerstone of their business starts on the farm with milk production. Production volume combined with pricing formulas can increase profitable margins or eliminate them.

During a c.e.o. roundtable at the Dairy Forum, Mark Davis, president of Davisco Foods International, Le Sueur, Minn., noted that despite the increase in cheese consumption in the U.S., once formula pricing is factored into the cost of milk, this past year proved challenging for his company.

"Because of pricing a couple of million dollars of margin went out of our business," he said. "For anyone to continue in the cheese industry, the only answer to the market volatility we’ve seen, with milk prices, energy costs or health insurance is to get a lower unit cost and that means running more through our plants."

The U.S.D.A.’s Economic Research Service reported this past month milk prices may ease this year as the nation’s dairy herd expands. Dairy markets in the second half of 2005 developed much as expected, according to the E.R.S. The returns dairy farmers received the last 2 years unleashed large increases in milk production that outstripped expansion in dairy demand and eroded milk and dairy product prices.

However, demand in late 2005 was enough to keep price declines small. For the year, farm milk prices averaged less than $1 per cwt below the 2004 record — even though milk production probably rose almost 4% on a daily average basis.

This year likely will look a lot like 2005, according to the E.R.S. Milk production probably will rise substantially. The year-to-year increase is projected to be significantly smaller — but simply because the comparison is with the strong 2005 output instead of the weak 2004 production. Both domestic and export demand are expected to stay brisk. Farm milk prices are projected to decrease again but to hold near the 2000-05 average.

Dairy product demand is projected to remain good in 2006. Expected economic conditions are favorable, and restaurant use should be solid. Meanwhile, exports of skim solids are likely to stay heavy. Movement probably will be brisk enough to absorb the increase in milk output with only a modest decline in prices.

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