Looking abroad ... again

by Keith Nunes
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The international marketplace and the opportunities exporting offers U.S. dairy product and ingredient manufacturers have been a consistent theme at the International Dairy Foods Association’s annual Dairy Forum. In 2008, the focus was on the fact dairy exports had increased 22% in 2007 from the year before. For the first time in 15 years the value of exported dairy products edged past the total value of imports and there was much discussion at the Dairy Forum about how to further grow the presence of U.S. products abroad.

In 2009, the situation had transitioned 180 degrees. The onset of the global economic recession and worldwide overproduction of dairy products combined to shut the United States out of many markets. The United States suddenly went from exporting between 9% and 11% of its production to 5% to 6%. The sudden decline meant there was additional product available to the domestic market, which put further pressure on domestic prices and challenged many manufacturers to maintain levels of profitability.

At this year’s Dairy Forum, held in mid-January in Phoenix, the subject was a highlight of the meeting once again, except this time the industry appears to be approaching the topic in a more structured fashion.

“Our potential as an industry and as a country lies in developing new markets for our products,” said Connie Tipton, president and chief executive officer of the I.D.F.A. during the Dairy Forum’s opening session. “And vigorous international trade is a critical prerequisite to developing those markets. After a banner year in 2008, our exports were down in 2009, along with the global economy, but 2010 looks more promising.

“U.S.D.A.’s latest trade outlook for 2010 projects U.S. dairy exports up 10% with U.S. prices more competitive, since global prices have staged a dramatic recovery. Further, the recent decision by the E.U. to sharply curtail export subsidies has provided a significant boost to global dairy prices and, hopefully, will mean the days of export subsidies are numbered.”

But John A. Kaneb, the chairman, president and chief executive officer of HP Hood L.L.C., Lynnfield, Mass., noted a key challenge the industry faces.

“The problem that vexes us today, both producers and processors, and prevents us from growing on the international market is volatility, and the extreme volatility we have experienced,” he said. “The horizontal space between the peaks and valleys is becoming shorter and the peaks and valleys themselves are becoming higher and deeper. That is a huge barrier to being a relationship supplier to international buyers.”

Outlining the opportunities

To identify the various forces driving the U.S. dairy sector in the global marketplace, the Innovation Center for U.S. Dairy commissioned the consulting firm Bain & Company, New York, to assess the marketplace.

In the keynote address at the Dairy Forum, Clinton Anderson, a partner with Bain & Co., highlighted the findings of the study.

“In our view, globalization of the dairy industry will increase and continue,” Mr. Anderson said. “We think, in particular, that dairy is a place where we are going to see more globalization rather than less. What we saw two years ago was the start of a trend that has been impacted by the global economic downturn, but these trends run deeper than the broader business cycle.

“Ultimately, what we think is that demand will grow faster than supply. If you look at countries where there is a growing population, an increase in wealth, a change from plant-based proteins to animal-based proteins in the diet, there is this underlying trend that will increase demand for dairy products globally. It is driven primarily by emerging markets.

“On the good side of the equation, traditional sources of demand will not be able to keep up. If we look at the key exporting countries — Europe, Australia, New Zealand, and the United States — while these markets will continue to grow to supply milk and dairy products, they will not be able to keep up with demand.”

The Bain study also outlined several challenges facing U.S. competitors in the international market. While Europe is the largest exporter of dairy products in the world, Mr. Anderson said Bain found there is an increase in consumption taking place in the region while supply has been soft in terms of growth. In addition, in 2015 the European Union plans to end its dairy quota program and there is belief that dairy production will shift from traditional European sources to Poland and Romania.

“The big story here,” Mr. Anderson said, “is while Europe is a very large exporter and will continue to export, it will probably not grow its exports and will most likely decline.”

In Oceania, Mr. Anderson said he sees fundamental shifts in production. The three droughts Australia has endured during the past decade have led some dairy producers to exit the business and it puts future production growth in doubt.

While New Zealand is blessed with ideal conditions for dairy production and has expanded production rapidly during the past 20 years, Mr. Anderson said the country’s ability to expand further is limited by the availability of pastureland.

“My sense is there is 20%, 25%, maybe even 30% upside (in New Zealand),” Mr. Anderson said. “That is a big number for the next 5 to 10 years. But we do see by that time New Zealand will have some hard choices to make. If they go from a pasture-based system to a feed-based system they will see their costs rise. It is one reason we have seen Fonterra expand its operations into other regions of the world.”

Mr. Anderson encouraged his audience to not look at international markets the same way they view the domestic market.

“It doesn’t take that much increase in wealth to create a consumer,” he said. “Even very poor countries, when you have a small increase in wealth, tend to start to shift from a plant-based diet to an animal-protein-based diet. That will, of course, have a very significant demand for animal proteins.”

The Bain study estimated that as consumer wealth around the world increases during the next 30 years there will be an additional 800 million consumers entering the market.

“If you think about that, that is roughly the same size as what we think of as the global consumer market today,” Mr. Anderson said. “Now it doesn’t matter if those people will not have the same level of wealth as someone in Japan, France or in the U.S. What matters is their relative wealth is increasing so dramatically compared to where they were that they will become consumers of products like electronics and animal proteins.”

Threats and weaknesses

While increased demand will offer opportunity for U.S. processors, Mr. Anderson added that the Bain study showed there are areas where the United States needs to improve. As part of the study, the consultants talked to dairy product and ingredient buyers from around the world and learned quickly that there were areas where the U.S. industry needs to improve.

“What they are talking about is across the entire value chain,” Mr. Anderson said. “It is from source of supply all the way to the product’s manufacture and to the specifications that it is manufactured to.”

The good news for the U.S. dairy industry is there is agreement throughout the international community that the United States has the capacity, more than any other milk producing region in the world to expand supply to meet increased demand. The nation’s diverse supply base means U.S. manufacturers may service customers year round as well, unlike New Zealand.

International buyers also noted that the United States generally produces quality products, but they also emphasized there are gaps in quality that the United States needs to close.

“Some of the criticism we heard included the fact the U.S. is in and out of global trade,” Mr. Anderson said. “We are not committed. We are in the market and then we are gone. Second, they said the quality is not on par with Oceania and not on par with Europe. The quality they are referring to means meeting specifications and providing specified documentation.”

Another issue identified by international buyers is U.S. production doesn’t match with their needs. Mr. Anderson said this issue goes back to the U.S. industry’s standards of identity as it relates to federal price support programs.

“We are making lots of non-fat dry milk and lots of yellow cheddar (cheese) and that is not what the world wants right now,” he said.

In addition to adjusting to international specifications, dairy manufacturers also may have to adjust to new competitors. In his presentation, Mr. Anderson highlighted two future U.S. competitors: Brazil and Ukraine.

The Bain study estimated Brazil will become a formidable competitor in the global dairy market in 10 to 15 years. The challenge will be building an infrastructure that allows the Brazilians to meet future demand.

“We have seen them do it in soybeans and we have seen them do it in beef,” he said. “The Brazilians have proven very adept at leveraging their local competitive advantage to grow their industries.”

Further out on the industry development timeline is Ukraine, according to the study. The country has some of the most productive farmland in eastern Europe, but much of the country’s agricultural infrastructure was destroyed during the Soviet era, Mr. Anderson said.

“This is still a very local market with people owning only a few cows,” he said. “The chilled supply chain is also very undeveloped. But if you look closely at Ukraine you see a region where all of the factors are in place and it could become more like Poland and even Western European nations in terms of production. Long term we think Ukraine will be a significant competitor.”

Mr. Anderson ended his presentation by noting the U.S. dairy industry is facing a window of opportunity with regards to gaining a significant position in the global dairy industry.

“Ultimately, with a market as big as our domestic consumer market, we can never ignore that part of the business, because it will always be the most important part,” he said. “But these international trends also create opportunities that, if we succeed globally, it will make us better at creating demand, meeting consumer needs and being successful in our domestic market.

“Our fundamental tenet here is there is a window of opportunity. People may say it is five years or it may be 15 years. But we believe it is at least a decade period of time when the U.S. is going to be significantly advantaged to benefit.”

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