April 9, 2007

 

New Zealand's dairy industry ponders whether to globalise

 

 

As globalisation intensifies, New Zealand's dairy industry is doing some soul-searching and wondering if it should stay on as an export business or venture out into the world to establish an international business.

 

The old stance of relying on exports is weakening as developing countries are catching up with New Zealand and are increasingly capable of producing milk products of similar quality.

 

Venturing out would require implementation of New Zealand's technology, management skills and capital around the world.

 

While decisions are made by boards of directors in multinational companies, New Zealand's dairy co-operative, Fontera would have to convince thousands of currently sceptical owner-farmers that taking its business abroad would be the right path to take.

 

Even as it announces optimistic payouts and rosy outlooks, it is facing scepticism from its owners. 

 

The co-op had recently raised its forecast of this season's payout  and forecasted an even better payout next season.

 

Milk prices are at record highs, more than double the long-term average of US$1800.

 

On the international markets, various factors driving up milk prices: water shortages in Australia and China are weakening milk supply; and sharply higher grain prices, thanks to sudden, strong demand from biofuels are boosting cattle feed prices which in turn raises milk prices.

 

On top of that, there is the expectation that consumption would continue rising. Worldwide consumption of dairy products would grow by 2.7 percent a year in the decade to 2014, Fonterra expects.

 

Moreover, as incomes rise, consumers worldwide are choosing higher value products such as liquid milk, yoghurts and deserts.

 

However, these consumption trends also necessitate changes in production: liquid and chilled products need to be processed near consumers. So, in China, and in some other markets, local dairy production is rising fast.

 

Rising local production meant falling imports, thus  Fonterra expects cross-border trade to grow at only 1.2 percent a year, less than half the rate of growth of world dairy consumption.

 

Fonterra has been responding to these trends by becoming an increasingly global business: In the first half of this season, a quarter of the milk products it sold were made from non-New Zealand milk.

 

To further emphasize it is embarking on a global strategy, the company is setting up a model farm in China to bring New Zealand farming technology, and thus high productivity, to the country.

 

The milk, to be processed in a plant owned by San Lu, a Chinese dairy company, would earn profits for Fonterra through a profit-sharing agreement.

 

By diversifying, Fonterra can supply major customers on a more reliable, less seasonal basis, helping it gain a sizably larger market while enabling it to focus on other aspects such as product development, logistics and marketing.

 

Because of the sheer amount of milk it trades in, Fonterra could also exert more influence in international commodity markets to smooth out volatility on milk prices.

 

Still, despite these achievements and rosy outlook, farmers remain sceptical.

 

For example, it ended last season with high inventories, then quickly ran them down by November. Some farmers argued Fontera should have sold the stock later at higher prices.

 

Farmers also do not see eye to eye with Fonterra's global strategy as the company has failed to explain how internationalisation benefits New Zealand farmers at the ground level.

 

Even as Fontera expands its overseas operations, the rising cost of that capital required lessens the amount of capital farmers have on hand to finance their own operations in New Zealand.

 

Farmers also worry what their role would be in the globalised Fontera. The more successful Fonterra is in lower-cost countries overseas, the harder it will be for farmers here to profitably supply commodity milk there.

 

Meanwhile, Affco, the meat company has announced its entry into the country's milk market through the building of four milk processing plants.

 

Critics have said this is bad news for the dairy industry as the company was expected to shortchange local farmers to gain supplies without establishing a market internationally. 

 

Although Affco would be expected to earn money in the short term in this manner, New Zealand's farmers would suffer eventually when other countries begin to dominate the commodity milk market through lower costs, critics said.