Dairy


Dairy

Introduction

The dairy industry is New Zealand’s top export earner at $7.06 billion for the year ended June 2002. This is around 23 percent by value of all New Zealand merchandise exports. The dairy industry, including downstream activities such as marketing, wholesaling and transport, contributes an estimated 7 percent to New Zealand’s GDP.

New Zealand’s total milk production for the season to 31 May 2002 was estimated at 13.9 million tonnes – a record volume for the industry for the third year in a row. Most of the increased production resulted from increased cow numbers. Approximately 1.53 million tonnes of product was exported in the year to May 2002 – up 5 percent from the previous year’s level.

Markets

New Zealand’s major dairy export markets include the EU, South-East Asia and Latin America, with other significant markets being China, the Middle East and the US. New Zealand’s key markets for its major dairy products are presented below:

New Zealand's key export destinations
Year ended 30 June 2002

New Zealand's key export destinations

Source: Statistics New Zealand

New Zealand’s major dairy exports by product type are illustrated in Table 1 below:

Table 1: New Zealand dairy export product values
Year ended June 2002 (NZ$million fob)

Milk powder 3,274
Cheese 1,417
Casein 1,173
Butter* 1,084
Other  116

*Includes related products
Source: Statistics New Zealand

New Zealand’s market access is severely restricted by tariffs, quotas and other barriers. It is estimated that New Zealand exporters paid tariffs of $1.05 billion in 2001 at overseas borders. Non-tariff barriers are significant issues in the US, UK and Japan, while production and export subsidies paid to producers in other countries impact on returns from New Zealand exports.

New Zealand's dairy exports
Year ended June 2002 (NZ$million fob)

New Zealand's dairy exports

Source: Statistics New Zealand

Overview of sector structure, size and dynamics

The New Zealand dairy industry is dominated by Fonterra Co-operative Group Ltd, complemented by Westland and Tatua Co-operative dairy companies. There are also many smaller businesses competing in the domestic and international markets.

Fonterra Co-operative Group Ltd

Fonterra Co-operative Group Ltd is owned by around 12,600 farmers, has total sales of $13.8 billion and is New Zealand’s largest company and its biggest exporter. Fonterra exports around 95 percent of the dairy products it manufactures and is the world’s largest exporter of dairy products. It is responsible for over 30 percent of international dairy trade across open borders. It is a major world player in dairy ingredient exports such as milk powder and casein and in consumer products, including through brands such as Fernleaf and Anchor. Speciality products such as ANLENE and ANMUM are leaders in their markets. Fonterra has a wide range of international marketing subsidiaries, joint ventures and other arrangements, including in the US (with Dairy Farmers of America), North and Latin Americas (with Nestle), in the UK and Europe (with Arla Foods) and in India (with Britannia Industries).

Fonterra’s global supply chain encompasses shareholder farms in New Zealand through to customers and consumers in 140 countries. It collects more than 13 billion litres of milk a year and manufactures and markets over 1.8 million tonnes of product annually, making it a world leader in large scale milk procurement, processing and management. It has around 20,000 staff in 40 countries, with over half of its staff being outside New Zealand.

Fonterra is New Zealand’s biggest private sector investor in R&D. Its shareholders are world leaders in on-farm efficiency and productivity, and its processing efficiency is also world class. Its new product development capability is significant, with considerable potential for future growth and performance delivery.

Westland Co-operative Dairy Company Ltd

Westland Co-operative Dairy Company has 370 suppliers and its total turnover in 2001/02 was $178 million. It collected 337 million litres of milk and manufactured 51,000 tonnes of milk powder, butter and casein in 2001/02. It has traditionally sold through the Dairy Board’s (more recently Fonterra’s) global networks. However, it is now directly marketing the majority of its own products. Westland plans to double its production in the next decade, largely based on a new milk powder dryer opened in November 2002. More importantly, it has a strategy in place to move away from commodities into added value products such as high value protein concentrates and specialist nutritional and nutraceutical ingredients from milk. Westland is already contracted to supply lactoferrin and other bioactive milk proteins to Tatua.

Tatua Co-operative Dairy Company

Tatua Co-operative Dairy Company (Tatua) in the Waikato processes around 106 million litres of milk annually from around 130 suppliers, focusing on the manufacture of highly processed, added value products. It had total turnover of $111 million in 2001/02. Tatua has for many years focused on R&D intensive development of new, high value differentiated products, beginning with products such as aerosol whipping cream and later moving into milkshake and ice cream mixes, sauces for the restaurant trade, and high value extracts such as caseinates and lactoferrin.

Tatua is now one of the world’s leading manufacturers of specialised dairy-based proteins and protein derivatives. It has recently reached a deal with the Victorian company Tatura Milk Industries to provide it with bioactive milk extracts, with Tatua supplying the extraction technology to the Australian company.

Tatua consistently outperforms Fonterra and Westland in per kg payout. This reflects its tight focus on niche markets and speciality high value products and the scale and focus of its R&D. It would be impossible for Tatua to achieve such premiums if it was competing in high volume, price sensitive commodity markets subject to more competitive pressure. Tatua restricts the number of its suppliers and this means that it is not under constant pressure to process and market high volumes of milk for commodity markets, but can take a longer term view of market development and product innovation.

Other dairy businesses

Apart from the bigger export companies, New Zealand Dairy Foods is a major dairy industry player supplying around 40 percent of the domestic market, and there are approximately 70 smaller companies manufacturing and marketing value-added milk-based products. There are around 20 boutique cheesemakers, as well as businesses producing fresh and cultured milk, specialist milk powders, ice-cream and edible fats. Examples of smaller, export-oriented businesses include Kapiti Cheeses (which is investing to treble its production and grow its export business), Dairy Goat Co-operative (NZ) which produces goat’s milk infant formula and other specialised products, and the Oamaru-based Whitestone Cheeses (gourmet cheeses and organic cheeses). The Open Country Cheese Company is setting up a new plant in Waharoa in the Waikato to produce high quality semi-hard and hard cheese for export to Australian and Asian markets. This processing facility will incorporate a tourist museum and restaurant, based on similar models in the wine industry.

The liberalisation of dairy exporting means there are few barriers to new businesses entering the dairy export business.

Cluster businesses

There are significant businesses clustered around the dairy industry, including:

A number of these companies, for example Trutest, are significant exporters in their own right and are in some cases businesses with substantial growth potential. Several companies that grew as suppliers to the dairy industry developed the technological platforms to diversify into completely new markets. For example, Trutest is now developing a medical electronics business and NDA Engineering has developed steel wine-vat technology.

Dynamics

The 2000/01 and 2001/02 years were exceptionally profitable due mainly to high commodity prices, low exchange rates and good climatic conditions. This profitability has been a major driver of change in the industry, for example in its expansion and intensification. In recent years, the other major dynamics in the dairy industry have included:

Productivity gains

Dexcel has calculated that for owner-operated dairy farms total productivity (i.e. the ratio of all outputs to all inputs) has averaged growth of 1.4 percent a year for the last decade. For sharemilkers the gains have been 2.1 percent a year for the last decade. Output per hectare and per cow has grown substantially, as illustrated in Table 2.

Table 2: Output per hectare and cow 1992/93-2001/02

Average kilogram per effective hectare

Average kilogram per cow

Milkfat

Protein

Milksolids

Milkfat

Protein

Milksolids

1992/93

374

279

653

148

111

259

2001/02

471

353

824

175

132

307

Source: Livestock Improvement Corporation

Increased milk solids production per cow has resulted largely from genetic gain and improved farm management, including improvements in stock nutrition.

Average output per hectare - milksolids
Years ended May
Average output per hectare - milksolids

Source: Livestock Improvement Corporation

Average output per cow - milksolids
Years ended May
Average output per cow - milksolids

Source: Livestock Improvement Corporation

Expansion and intensification of dairy farming

From 1999/00 to 2001/02 total cow numbers increased from 3.269 million to 3.692 million. This confirms a long-term pattern of expansion of dairy farming and increases in total milk processing volumes reflected in Table 3.

Table 3: Growth in milk processing volumes

Milk
processed

Milkfat
processed

Protein
processed

Milksolids
processed

(million litres)

(million kg)

(million kg)

(million kg)

1974/75

5,222

244

181

425

1981/82

5,979

282

209

491

2001/02

12,998

631

476

1,107

Source: Livestock Improvement Corporation 

While the dairy industry is predominantly based in the North Island, with approximately three-quarters of the milking herd located there, around 60 percent of the recent increases in cow numbers have taken place in the South Island. This growth in South Island dairying has occurred largely through conversions of sheep-and-beef and cropping farms in response to low land prices, high per-cow production, and in some cases access to irrigation. MAF’s 2002 Farm Monitoring analysis shows that the 2001/02 weighted average economic farm surplus for dairy farms surveyed was $1,877 per hectare compared to $229 per hectare for sheep-and-beef farms. However, it should be noted that good market performance in the sheep meat sector and high productivity gains mean that leading edge sheep farming has the potential to be very competitive with dairy farming.

Consolidation of dairy farming

Major on-farm trends in the dairy industry include the consolidation and increasing average size of farms and the rise of corporate dairy farming. This is illustrated in Table 4.

Table 4: Changes in herd numbers, size and cows per ha

1981/82

1992/93

2001/02

        

Number of herds

15,821

14,458

13,649

Total cows

2,060,898

2,603,049

3,692,703

Average herd size

130

180

271

Average effective ha

63

74

103

Average cows per ha

2.10

2.50

2.67

Source: Livestock Improvement Corporation

It should be noted that larger, corporate herds on average are achieving higher output per cow as measured by milksolids, milkfat and protein production per cow. However, it is not clear the extent to which this reflects high real productivity or more intensive feeding regimes that may not always be as profitable as low cost, grass-based grazing regimes.

Average dairy herd size
Years ended May
Average dairy herd size

Source: Livestock Improvement Corporation

Creation of Fonterra and liberalisation of dairy exporting

The 2001 formation of Fonterra involved a wider liberalisation of dairy exporting. This encompassed legislative and regulatory interventions to ensure contestability in the market for farmers’ raw milk and to foster competition on the domestic consumer market. The Dairy Board’s single desk marketing regime was abolished. These dairy reforms have created an environment more conducive to innovation and entreprenuership.

The dairy industry is subject to regulation governing open entry/exit of farmer shareholders to Fonterra, quota allocation, the supply of raw milk by Fonterra to independent processors, and herd testing and the herd database operated by Livestock Improvement Corporation (LIC). The thrust of the regulatory framework is to maintain performance incentives on Fonterra through ensuring contestability in the market for farmers’ raw milk. The framework also protects competition in domestic consumer markets and prevents Fonterra’s dominance from impeding the growth potential of smaller dairy businesses, especially where they depend on Fonterra for milk supply.

Fonterra’s size and dominance in the dairy industry means that its performance is critical to the New Zealand economy as a whole, as well as to the dairy industry. The legislative and regulatory framework put in place at the time of the merger is intended to ensure Fonterra faces incentives to perform despite its overwhelming dominance in the market for its key input – raw milk. Over time, the effectiveness of the legislative and regulatory framework will need to be assessed.

Future growth potential

It is difficult to quantify the growth potential of the New Zealand dairy industry, however the following points should be noted:

Factors determining growth potential

The future growth of the dairy industry depends on factors such as innovation, trade liberalisation, and niche product and market development.

Innovation

The dairy industry’s innovation has focused largely on productivity and efficiency gains on farm and in processing, and on new product development. New Zealand has been a leader in dairy herd improvement and has a world-leading position in grass-based dairy production systems. Biotechnology provides an opportunity to accelerate breeding for specific traits and to produce output gains and higher value niche products. Biotechnology research in New Zealand has identified several potentially important genes, including one gene which affects milk production in dairy cows discovered by BoviQuest, the joint venture between ViaLactia (Fonterra) and Livestock Improvement Corporation Ltd. This gene has the potential to optimise high value milk characteristics. Licensing arrangements for commercialisation are in place with Livestock Improvement Corporation.

The dairy industry has substantial research capacity and the skills and financial strength to carry significant new technological innovations to market. Fonterra’s research focuses largely on food and environmental assurance, food systems, bioactives and health, process technology and on-farm productivity. The Fonterra Research Centre, formerly the Dairy Research Institute, supports innovation in both dairy products and dairy product manufacture. Other major research entities within the Fonterra group are ViaLactia Biosciences (NZ) Ltd, Fonterra Enterprises and FonterraTech which have related roles in fostering the creation of new businesses using technologies developed within other parts of Fonterra or adapted from elsewhere.

The Foundation for Research, Science and Technology (FRST) is a significant funder of longer term and more underpinning dairy research and collaborates with industry funders on some major projects. LactoPharma Limited is an unincorporated joint venture between Fonterra and Auckland University funded by FRST and Fonterra over the next seven years. It aims to discover biomedical components in milk that may target advances in bone growth and in the treatment of inflammatory and other diseases.

The dairy, meat and deer industries are combining in the use of modern biotechnology techniques to improve pasture performance and extend the growing season. Pastoral Genomics, a joint venture of Fonterra subsidiary ViaLactia Biosciences, Meat NZ subsidiary Agritech Investments, DEEResearch and Crown Research Institute AgResearch, aims to lift the productivity of the farming sector by trying to establish how white clover genes influence pasture performance.

Producer-related industry good research is managed by Dairy InSight and is funded by a levy on farmers through the Commodity Levies Act framework. The major research providers are Dexcel and AgResearch. Smaller businesses such as Tatua have very good R&D and commercialisation capabilities and Westland is building up its capabilities in these areas.

Trade liberalisation

The New Zealand dairy industry would benefit greatly through trade liberalisation and improved market access. The reduction or removal of market-distorting production and export subsidies in the US and EU and improved access to these markets and to the Japanese market would generate major gains for New Zealand.

Differentiation and niche product development

There is very substantial potential for growth in exports of differentiated and niche products which are often R&D based and significantly more profitable than commodity markets. There are fewer tariff, quota and other trade barriers for such products than for high volume commodity exports such as milk powder, butter and cheese.

Constraints on and risks to sector

Constraints 

Constraints on and risks to the New Zealand dairy industry include:

Impediments to international dairy trade

Dairy markets are among the most protected in the world and dairy products are subject to larger export subsidies than any other food product. Support for the domestic dairy industries in the EU and the US distorts international dairy trade, for example through the export of subsidised dairy products on price sensitive international markets.

Water and land resources

The intensification of dairy farming has created new pressures on the environment, mainly through the effects of dairy effluent on fresh water and the contamination of groundwater and other water resources with nitrates. Fonterra is taking a lead in developing requirements on its suppliers to prevent or mitigate such impacts.

Availability of water for irrigation is a critical constraint on the future growth of the dairy industry. MAF and MfE are jointly responsible for developing an enhanced framework for the allocation and management of freshwater resources that aims to allocate water more efficiently and in a way that balances environmental and economic objectives. Substantial enhancements in the framework for water allocation will depend on use of water storage (harvesting high winter flows to manage water supply in drier periods) and on an improved legislative and regulatory framework.

The dairy industry has grown rapidly in recent years at the expense of other land uses. However, land is a scarce resource and this itself places a limit on future industry expansion.

Business structures and governance

The co-operative ownership of the New Zealand dairy industry is a key strength which has retained the industry in New Zealand ownership, and has given dairy farmers collective power in processing and marketing. However, elements of the traditional co-operative model can impede high value niche market development that may need to be de-coupled from production-based milk returns. “New generation co-operative” structures, the use of peak notes and other mechanisms, and unbundling milk payout returns from returns from more specialised product and market development have the potential to overcome the structural, governance and (arguably) capital constraints of the traditional dairy co-operative company. Fonterra is actively addressing ways in which its co-operative structure can evolve to better improve its financial transparency and to convey better signals to its farmer shareholders.

Risks

The biggest risks to the dairy industry are biosecurity threats such as foot and mouth disease, a breakdown in trade liberalisation negotiations and market access, loss of quota rents, and the potential for poor performance from Fonterra.

Biosecurity and international trade negotiations are top priorities for government and for MAF, and Fonterra is making a valuable contribution to promoting the case for liberalisation of international dairy trade. Fonterra is active in the Global Dairy Alliance, which brings together the dairy sectors of New Zealand and other unsubsidised dairy exporting countries: Argentina, Australia, Brazil, Chile and Uruguay. The Alliance is actively lobbying for trade liberalisation that will benefit dairy exporters and consumers in importing countries.

If New Zealand lost the right to administer access to quota controlled dairy markets then it would stand to lose quota rents from those markets. This is an issue MAF is playing close attention to.

The future performance of Fonterra is critical to the industry. The board and staff of Fonterra deserve credit for creating the merged business on time and under significant pressure. Perceived difficulties in its performance so far need to be seen in the context of deteriorating international market conditions, the complexities of the merger process, and the very short time the business has so far had to demonstrate its performance in the market and in response to its shareholders.

While Fonterra’s performance depends largely on that of its board, management and staff, the regulatory framework it is subject to is also significant and will need to be monitored over time.

Areas for policy to focus on

The dairy industry has recently gone through fundamental change in its market structure and its legislative and regulatory framework.

MAF will continue its ongoing policy focus relating to dairying, notably:

No new policy initiatives relating to the dairy industry are planned at this stage, however new ideas and initiatives that could “make a difference” are always actively sought, searched for and invited.

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