Irish Dairy Processing Sector Strategic Report Mar 03

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Strategic Development Plan for theIrish Dairy Processing Sector


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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


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Contents Page

Executive Summary 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 86challenges and opportunities

Appendices 114


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List of tables

Table 1 EU Enlargement Quota Allowances

Table 2 Seasonality of milk supply

Table 3 Peak to trough ratios

Table 4 Protein and Fat Levels (2001)

Table 5 Production cash costs

Table 6 Irish protein and fat levels (1991 vs 2001)

Table 7 Irish milk production costs

Table 8 Number of companies processing 80% of the milk pool

Table 9 Number of Irish processing plants, by product output

Table 10 Average output of plants - Ireland (average annual production)

Table 12 Average plant size Cheese

T a b l e 1 3 Average plant size Butter

Table 14 Average plant output Powder

Table 15 Capacity utilisation (%)

Table 16 Raw milk processed per employee

Table 17 Percentage of total sales turnover (2001)

Table 18 Prices obtained for main product types (2001)

Table 19 Relative profitability of main products

Table 20 Ireland - annual production by broad product type

Table 21 Gross value added from processingper tonne milk (2001)Table 22 Dairy Processing Turnover as a % of GDP

Table 23 Irish processor re-investment and new product development levels

T a b l e 2 4 R&D/New product development (2001) compared with main competitors

Table 25 Economic value added by Irish dairy processing sector

Table 26 Comparison of Economic Value Added

Table 27 Estimated EVA for NZ using average EU milk price

Table 28 Butter, SMP & WMP products as percentage of total production (excluding liquid milk)

Table 29 Volumes exported to each market

Table 30 Sales of Irish product by market type

Table 31 Sales of Irish product by distribution channel (2001)

Table 32 Intervention support for butter

Table 33 Intervention support for SMP

Table 34 Export refunds for dairy products (EAGGF / FEOGA)

Table 35 Producer milk prices

Table 36 Estimated changes in population

Table 37 Changes in sales channel by country

Table 38 Percentage of world dairy production and consumption


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List of Figures

Figure 1 Distribution of dairy farmers by quota size

Figure 2 Number of dairy farmers 1991-2001

Figure 3 Monthly deliveries of milk

Figure 4 Plant scale and fixed costs for powder production

Figure 5 Relationship between EVA and % of base product

Figure 6 International dairy sector development

Figure 7 Changes in product usage

Figure 8 International dairy markets and major trading blocks

Figure 9 Emerging-trading zones

Figure 10 Product value Vs distance to market (Step 1)

Figure 11 Product value Vs distance to market (Step 2)

Figure 12 Current and future product portfolio mix

Figure 13 Current product market focus

Figure 14 Future product market focus


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Glossary of terms

A&M Advertising and Marketing

B2B Business to Business

B2C Business to Consumer

BSE Bovine Spongiform Encephalopathy

CAP Common Agricultural Policy

CCEE Countries of Central and Eastern Europe

CEEC Central Eastern European Countries

CSO Central Statistics Office

DAF Department of Agriculture and Food

EU European Union

EPA Environmental Protection Agency

EVA Economic Value Added

FAPRI Food & Agricultural Policy Research Institute at the University of MissouriFCDF Friesland Coberco Dairy Foods

FMD Foot and Mouth Disease

FSAI Food Safety Authority of Ireland

GATT The General Agreement of Tariffs and Trade

GDP Gross Domestic Product

ICOS Irish Co-operative Organisation Society

IDB Irish Dairy Board

IT Information Technology

JV Joint Venture

MPC Milk Protein Concentrate

NAFTA North American Free Trade Association

NPD New Product Development

NZ New Zealand

QSR Quick Service Restaurant

R&D Research and Development

SMP Skim Milk Powder

TB Bovine Tuberculosis

UCC University College Cork

UCD University College DublinWMP Whole Milk Powder

WPI Whey Protein Isolate

WPH Whey Protein Hydrosolates

WTO World Trade Organisation

ZMP Zentrale Markt- und Preisberichtstelle Review Dairy 2002 Germany, EU, World


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Executive summary

Study objectives

The objectives of the Prospectus-Promar strategic study were to; examine the existing structure of theIrish dairy processing sector; identify market opportunities for dairy products; assess product options toexploit these opportunities and make recommendations on actions to improve the efficiency and long-term competitiveness of the industry. The scope of the study was the dairy processing sector in theRepublic of Ireland

The Irish dairy industry has had a very successful past. It now must take action to secure asuccessful future.

Ireland has a long and successful tradition as a major producer of quality dairy products. The grass basedproduction system has provided significant competitive advantages in terms of production costs and thenaturalness of Irish dairy produce. The dairy processing industry has become one of the countrys mostimportant indigenous industries with a turnover of over 2.5 billion in 2001 and employing over 9,000 inprocessing 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 anextensive 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 alsoa 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 orientatedand dependent with about 85% of the processed output exported. In recent years, there has been asignificant shift in Irelands mix of product output, with a decline in the volume of butter and SMP andincreased output of cheese and casein.

However, relative to the other major EU export orientated competitor countries, Denmark and theNetherlands, Ireland is still heavily dependent on commodity type products such as butter, WMP andSMP. The industry has responded effectively to market changes and challenges in the past and withstrong leadership and decisive action, it is in a good position to respond positively to the challenges andopportunities that it currently faces.

However, the Irish industry is starting to fall behind its competitors and faces significantchallenges.

The production and processing sectors are both highly fragmented in terms of the number of milksuppliers and processors. The industry is competing in international markets against much largerenterprises that are increasing their scale at a faster rate than Ireland. There has been significant andrapid industry consolidation in recent years in the major competing countries (Denmark, Netherlands andNew 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 bill ion litres.

The fragmented nature of the Irish industry is illustrated by comparison of the number of processorsaccounting for 80% of the milk pool. In Ireland six companies process 80% of the milk pool compared toone 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 fasterrate than that of its competitors. The industry is also very seasonal in its production and processingcompared 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 orcommodity type products (butter, powder, casein, and bulk cheese). These products attract lower marginsand are extremely price sensitive. The industry relies heavily on EU market intervention and other marketsupports, which are increasingly coming under threat. The industry has developed very few internationallybranded consumer products. It invests significantly less than its major competitors in terms of capital re-investment and R&D. The economic value added (EVA) to the raw milk produced is lower than theindustries in countries such as Denmark and the Netherlands. This is a reflection of the relatively highweighting of base products. However, it should be noted that Irelands EVA is significantly higher thanthat 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 oftheir even greater dependence on base products.


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Changes to the policy environment at EU and WTO level will result in reduced market supports for dairyproducts, 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, fallingmilk prices, restrictions on increasing output and improving productivity and the relative small-scalenature of dairy farms in Ireland.

Policy changes arising from CAP reform and WTO agreements are pushing EU dairy product prices closeto world market levels, which could lead to milk prices falling to below 1 90 cents a gallon. This wouldhave major consequences for the viability of many dairy farms. These policy changes however, can actas an important stimulus for the industry to make necessary changes to its existing product focus andhow 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 dairyproducts and has developed a product profile which has maximised the benefits of its lower cost ofproduction 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 productssuitable 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 needsto make major changes in how it is organised and how it utilises the raw milk it produces. The Irish dairyprocessing sector faced with this increasingly challenging market environment, have a number ofstrategic 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 tocompensate for the lower product prices and increasing processing costs - pass all the pain backto 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 rigorouslyexamining 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 thatleverage the positive image of Ireland as a producer of quality dairy products and respond andanticipate 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 theproposed 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 andthe 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, arein an environment of rising costs and are facing a milk price, which could potentially drop to 1 to 90 centa gallon or even below this level (20-22 cent a litre a potential loss of direct income from milk productionof between 375m and 480m)

1and where many are at a scale of operation that their enterprises will not

be economically viable.

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The proposed EU system of direct payments will partly compensate (probably around 50-60% of the loss) for the fallin milk prices, so this is not actual drop in income, which would occur if milk prices fell to this level.


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The options available to the milk producers are more restricted and in many cases highly unpalatable butfor 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 greaterproductivity, efficiency and scale in their dairying operations in the hope that these measures togetherwith 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 andoff-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 supportsgiven their disproportionate impact on the Irish industry

Use their important role as suppliers, members or shareholders of the processing enterprises toactively encourage the processors to share some of the pain arising from lower product prices bytaking 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 value-added 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 strategicoptions listed above are quite limited. It is unlikely and unreasonable to expect the farmers to take all thepain 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 andsubsidies 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 byinflationary pressures in the economy. The cost efficiency measures on their own without significantchanges 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 baseproduct 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 marketopportunities

Reduce the level of dependence on commodity type products and increase the value-added contentof manufactured dairy products

Get quickly to a position where the industry has a major player who has the scale, costcompetitiveness and resources to compete successfully against the major large-scale internationalcompetitors.

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 proteinfractionates; 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 Europeanmarkets.

The continued success, expansion and increasing value-added content of the infant formula sector, whichis a major purchaser of processor product, is of strategic importance to the future development of theindustry as a whole.

Through the use of a planned approach, the Irish dairy industry must develop a product portfolio forspecific 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 toquickly transform itself and deliver on the following key strategies:

Improve the international competitiveness, scale and cost efficiency of both the producer andprocessing sectors

Increase the proportion of output away from base/commodity type products and into highervalue-added products

Put greater emphasis on actions to develop and underpin the highest standards of quality andsafety 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 viableincome against a backdrop of decreasing milk prices by achieving a scale and level of efficiency thatis comparable to that in major competitor countries. In Denmark, the average annual dairy farmeroutput is around 107,000 gallons, 84,000 gallons in the Netherlands and around 77,000 gallons inNorthern 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 fromeleven to four plants. This will deliver efficiencies and savings at manufacturing and enterprise levelthrough scale processing and more efficient use of resources

Ensure cost efficiency in production of base products and increase the levels of secondaryprocessing and added value of these products. Eliminate duplicate or inefficient costs or overheadfrom milk assembly, processing overhead costs such as energy, quality controls, environmentalcompliance, 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 andnew product development. Improving the value-added content of the dairy products will also involveadopting 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 specificallytargeted at the needs and opportunities in those markets

Ensure that Ireland continues to be positioned as a quality food island by adopting a proactiveleadership position, where it is not only meeting but also exceeding the highest quality andenvironmental standards, and thereby, protecting itself from the loss of this image which couldprove very difficult to regain.

The recommended strategy will deliver real benefits.

The implementation of the rationalisation and product reconfiguration strategies recommended in thisreport will involve significant up-front costs of over 300m in the first 2-3 years for the industry in terms ofincreased capital investment requirements, increased R&D and market positioning costs together with theone-off redundancy costs.

The benefits that will accrue from the implementation of the strategies include additional operating profitsfrom 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-frontinvestments before they begin to return significant benefits. We have estimated that the payback periodwould be six years and that the net cash inflows would be around 70m per annum from year sixonwards. However, before this payback point is achieved, the industry will need to fund significant cashoutflows, 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 fundthe necessary changes required. The costs and benefits outlined in the report are only an indication of thepotential level of return to the industry. The specific business cases for the recommended strategicchange need to be done at enterprise level as more detailed and accurate information on the specificinvestment 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 representa major challenge for the industry. It requires a major step change for all of the participants in theindustry. In light of the international market and policy developments, the industry needs to decide how itis 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 rulesof the game have dramatically altered in recent years and will continue to do so with on-going andaccelerated large-scale consolidations occurring at international competitor and buyer levels together withthe 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 strategicchange 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 scaleand cost competitiveness necessary to continue to successfully compete for international business. Forthis transformation to really happen the industry requires the creation of a strong scale Irish player tocompete 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 successfullydevelop 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 developingand expanding strategic all iances

A consolidated player needs to emerge in the medium term with a scale where it is processing around70% of the processed milk. This level of consolidation may take two or three steps to be achieved. Itneeds to begin with a consolidation between some of the five largest processors and also consolidation orjoint ventures amongst some of the smaller processors.

The consolidation process within the industry needs to happen quickly, as it is highly probable, that therewill 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, thereis a real danger the industry will drift, only make incremental changes and gradually decline in terms oftotal 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 investmentin research and technology necessary to develop the level of new products and higher value productareas required at an industry level. They will not have sufficient scale or resources to meet therequirements of major international buyers.

There is also a danger that without major change in the structure of the industry, some Irish processorswill 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 playerdoes not preclude the co-existence of a number of smaller processors in the processing sector. It is bothdesirable and beneficial for the industry that there will also be a number other players in addition to thedominant player.

There are currently smaller Irish dairy processors who by their operations and product focus have beensuccessful in growing their business and delivering a good return to their suppliers and members. Thereare also examples of successful smaller enterprises in Denmark and New Zealand. These smallerprocessors 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 basetype 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 isrequired 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 productsthrough supports for research, new product development, market development, food safety and qualityassurance.

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 astrategic industry need for the emergence of a strong consolidated processing enterprise to provide theleadership and scale to drive through changes, implement the strategic actions and realise the manyexisting 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 andthe individual players in the industry. The industry either accepts or rejects the analysis andrecommendations set out in the report. If industry participants accept the reports findings, then it doeshave an obligation to make every effort to implement the recommendations or else suffer theconsequences 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 starkchoice of making major changes to how it is organised and how it utilises its raw milk or else it will finditself 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 riskattached. The stay more or less as you are option in terms of number of plants and product mix willresult in lower industry revenues and a lack of viabil ity for many of the current players in the industry. Theindustry has shown in the past that it has the ability to respond and adapt successfully to changes in themarket environment and will need to demonstrate this capability and commitment again in the newenvironment it now faces.


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Chapter 1 Irelands dairy processing industry today Page

1. Introduction 15

1.1 Study objectives and background and methodology1.2 Policy environment of the dairy industry

2. Dairy Production 18

2.1 Introduction2.2 Profile of the production sector2.3 Issues that need to be addressed at production level

3. Dairy Processing structure and efficiency 25

3.1 Profile of the processing sector

3.2 Processing structure and efficiency issues3.3 Product mix of the Irish dairy processing sector3.4 Changes to Irelands product output mix over the last decade

4. The value-added by the processing sector 37

4.1 Dairy industry turnover4.2 How does Irelands capital and R&D investment levels compare?4.3 Economic value added (EVA)4.4 Value-added issues

5. Marketing and distribution 45

5.1 How does Irelands export performance compare with itsmain competitors?5.2 Inability to influence market prices of base products5.3 Routes to market5.4 EU intervention market support5.5 Marketing and distribution issues

6. Summary of key messages from current industry status 51assessment and international competitor comparisons


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1. Introduction

1.1 Study objectives, background and methodology

The Department of Agriculture & Food and Enterprise Ireland, in conjunction with the Irish dairyprocessing industry, commissioned Prospectus and Promar International to carry out a strategic study ofthe industry. The purpose of the study is to set out options and recommendations to achieve the optimumstructure necessary to enable the Irish dairy processing Industry face future challenges. The study willalso contribute to the elaboration of national policy for the sector over the coming years, in the context ofincreased international competition and developments in comparable dairy producing and exportingcountries.

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

industryThe scope of the strategic study covers the structure and international competitiveness of the milkassembly, processing, manufacturing, marketing and distribution operations of the dairy processingsector in the Republic of Ireland. The scope of the study does not include a detailed analysis of thestructure and comparative competitiveness of the primary production end of the food supply chain, butassesses the current context and operating environment of the Irish primary production sector, its impacton dairy processing, and the requirements for change or adjustment in light of the identified marketopportunities. (A brief history and background to the current dairy industry in Ireland

2is contained in

Appendix 1.)

The main geographical areas covered are the Republic of Ireland (hereafter, referred to as Ireland, unlessotherwise 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 over83% of its output, and if it wishes to continue to compete internationally, it will need to compete withthe main exporting players of these products. Therefore, Ireland has been compared with NewZealand, 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 inthis market.

Another strategic option available to the Irish industry is to develop more added value products. TheDanish 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 competitivechallenges 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, Netherlandsand New Zealand.) Comparisons with countries, which export only small quantities of their totaloutput 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 andassesses the implications for the Irish industry. It also examines the major current and potential marketsfor Irish produce. Details of the methodology and approach are included in Appendix 3.

2Ireland throughout the report refers to the Republic of Ireland unless otherwise stated

3Throughout 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 dairypolicies arising from the CAP and WTO, global demand for dairy products reflecting growth in the worldeconomy and changing tastes and preferences, domestic economy factors, and developments amonginternational 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 includethe WTO Doha trade round, and further reform of the CAP regime following Agenda 2000 and EUenlargement.

1.2.1 WTO and dairy policy

The inclusion of dairying (and all agri-food) under the GATT/WTO trade regulations represented a policydevelopment of enormous long-term consequence. Prior to the GATT Uruguay round implementation in1995, the EU had total discretion over trade policy with regard to both tariffs (import levies) and exportrefunds. However, the GATT Uruguay round fundamentally changed this, with export refunds beingreduced 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 greatdeal 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 ifimports from the much lower priced world market can flow into the EU as a result of steadily reducingtariffs. A fundamental underlying reason for the already agreed 15% intervention price reduction 2005/6-2007/8, and an option of further reductions to 2015 as discussed later, is the apparent necessity to adjustthe CAP price support system to fit in with GATT/WTO trade agreements. In this context, the WTO traderound negotiations, and in particular, the negotiations on tariffs are vital in determining the future shape ofEU dairy policy in terms of both the level of internal price support achievable, and the price and volume ofimport access and status of export refunds. Already, informal opening positions on tariffs have beenadopted by the leading players and the course of this debate will do much to shape future global dairypolicy.

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 to2007/8

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 increaseof 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 itsMid Term Review in relation to bringing the 2005/6-2007/8 changes forward. In July 2002, the EuropeanCommission 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 2008/9to 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 milkprices and the EU budget.

The four policy options considered in the European Commission document for the period 2008/9 to2014/5 are as follows:

A: Status Quo: No policy change from final year of Agenda 2000, i.e. 2007/8 policy unchanged to2014/2015.

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 unsubsidisedinternal consumption, together with a more open unsubsidised C quota for exports, combined with thecontinuation 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 directpayments (decoupled).

While this document launches an extended discussion on policy to 2015, one may already infer from itthat 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 steptowards a longer-term move in the direction of Option D. This transition is predicted to be slow, and inresponse 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 2000proposals by one year from 2005 to 2004. This involves a 28% cut in the target price over five yearsstarting from 2004 compared with a 17% cut over three years commencing in 2005. An increase in milkquota 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 of7% per annum between 2004 and 2008, compared with SMP price cuts of 3.5% per annum. At the sametime it is proposed that the automatic butter intervention would be stopped once purchases exceed30,000 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 theexisting 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 ofthe 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 withmuch potential, the quota system and structural problems will constrain output. Also, the 75 millionpopulation 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 ofdairy quotas. The Commission agreed a revised offer to the CEEC countries in Copenhagen, withincreased quota allowances for all.

Table 1 EU Enlargement Quota Allowances

000tonnes

Cyprus Czech Estonia Hngry Lith Latvia Malta Poland Slovakia Slovenia

Original

offer131.0 2505.5 562.6 1794.3 1459.0 489.5 - 8875 946.2 463.3

CEEC

requests153.3 3110.9 900.0 2800.0 2250.0 1200.0 52.0 13740 1200.0 556.0

Revised 145.2 2682.1 624.5 1947.3 1646.9 695.4 48.7 8964.3 1013.3 560.4Add 2006 - 55.8 21.9 42.8 57.9 33.3 - 416.1 27.5 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 willcontinue. The intensity of competition will depend on the final agreement on quota size and the rate ofgrowth in domestic demand. Overall, the 10 with quota constraints should not be a major threat in theshort-term, and the major restructuring required, and growing domestic demand, could presentopportunities for the Irish industry. Chapter 2 contains a more detailed assessment of the marketopportunities within emerging EU markets.

4Prospects for Agriculture in CEEB - 2002, EU Commission


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2. Dairy production

2.1 Introduction

The importance of the Irish dairy sector has long been recognised by successive Governments, who havebeen supportive in facilitating the development and expansion of the industry. State agencies such as theDepartment of Agriculture, Teagasc, Enterprise Ireland and Bord Bia work closely with the industry. Inaddition to the state agencies, the university sector, particularly UCC and UCD, have been important inadvancing education and research in the dairy sector at both production and processing levels, and havebeen 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 risenfrom 10% to 15% of the total number of producers. This scale has facilitated increased investment atfarm 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 facil itated

by the countrys moderate climate, which makes it very suitable for grass production. The grass-basedfeeding system has been more cost efficient than the mainly grain-fed systems used in continental EUcountries. The pasture-based feeding system also has the advantage of being able to be portrayed as amore natural production for dairy cows and milk production. Ireland has been able to build on thiscomparative 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 byincreasing scale and maximising production from their farm units. This is highlighted by the difficultiesthat are being encountered in attracting sufficient numbers of young farmers into the sector, and theconstraints on the more progressive and efficient farmers to increase scale. This has been a result of anumber 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 Irelandscultural attachment to land ownership, resulting in uneconomic land prices that increases the costs ofproduction and also acts as an expansion constraint for farmers. With the cost of hiring labour or farmrelief 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 considerableattention being paid to the annual milk price audit and monthly league tables. While the importance of themilk price is understandable, given the pressures on farm incomes, it can however inhibit longer termstrategic planning for the industry as a whole. The dairy industry is critically dependent on its ability toproduce products that are in demand and that are competitive on international markets. This requirescontinuous and significant investment aimed at improving the quality, attractiveness and value-addedcontent of its products. It also requires an unrelenting focus on improving efficiency and productivity atevery level of the production chain, from pasture to the product purchaser. An over concentration on theissue of current milk prices may detract from the need for medium to longer term strategic planning andinvestment. The Irish dairy processing sector faces international competitors who have adoptedstrategies of dramatically increasing their scale, and their levels of investment in R&D and in plant. Irishdairy farmers need the processing sector to be internationally competitive, and to increase the levels ofreturns it achieves for Irish dairy products.

Going forward, it may be necessary to review and change the way in which milk production isorganised in Ireland

This would involve addressing issues such as changes in the scale of production, management of thelocation 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 Irelandsince the introduction of the quota regime in 1984, when there were 68,000 dairy farmers. Over the lastdecade, the numbers have fallen by 50%, from 57,000 to, around just 28,000 in 2001. According to theDepartment of Agriculture projections, a similar rate of reduction during the next decade will result in adairy industry containing 14,000 producers in 2010.

The quota regime has also meant that the level of total milk deliveries has remained relatively constantover the last decade, reaching 5,338,000 tonnes in 2001. The level of milk deliveries in Irelands main EUcompetitors Denmark and the Netherlands has also remained static due to the cap on production at4,418,000 tonnes and 10,683,000 tonnes respectively, in 2001. In contrast, New Zealand, which doesnot have a cap on production restriction, increased the volume of milk deliveries from 1991 to 2001 by74%, 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 fallenfrom 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 totalproducers with under 180,000 litres falling from 79% to 59%.

While the number of producers has decreased significantly, the average quantity of milkdeliveries 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 to45.7 in 2001. Over the same time period, average milk yield has risen by only 14%, to 4,375 kg perannum in 2001.

Figure 1 Distribution of dairy farmers by quota size

79%

12% 10%

59%

26%

15%

Under 180,000 litres 180,000 litres to 275,000 litres Over 275,000 litres

1996 2001

Source: Department of Agriculture and Food, 2002

However, while the scale of Irish producers has increased, the rate of this change is significantlyslower than its EU competitors

Ireland still has a relatively large number of small producers, and the average quota size for the country is189 tonnes (40,000 gallons), compared to an average quota of 362 tonnes (77,000 gallons) in Northern

Ireland.


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In Denmark, a country with a milk production level of 4,418,000 tonnes in 2001, the number of dairyfarmers has fallen from 20,000 in 1991 to 8,911 in 2001, while the average quota per farm has increasedfrom 234 tonnes (50,000 gallons) in 1991 to around 500 tonnes (107,000 gallons) in 2001, an increase of114%.

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 to394 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 itremains quite difficult for Irish farmers to significantly increase their milk quota under the currentmanagement arrangements of the quota system.

Figure 2 Number of dairy farmers 1991-2001

57,000

46,977

35,383

20,000

8,911

13,892

28,17429,071

31,65032,850

35,027

38,55737,122

27,92629,467

9,76710,56811,371

12,282

14,685

14,741 14,673 14,362 13,861

1991 1997 1998 1999 2000 2001

Ireland Netherlands Denmark New Zealand

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 dairyfarming, 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 torespond by increasing efficiency, enlarging operations, or a combination of both. The same researchgoes on to analyse the impact of milk quota elimination on farms and estimate the level of productionrequired to maintain living standards. It concludes that substantial expansion of production is required iffarmers wish to maintain real incomes. For example, the typical farm supplying just under 80 tonnes in1999 would need to increase production by 85% to 140% (by 68 tonnes to 112 tonnes) to maintain realincome. 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 ofcalving, so that through compact calving the total herd calves around the time of lowest milk productioncost. While this maximises production cost efficiency from a grass-based production perspective, it alsoresults in increasing supply levels in the peak months of March to June. The table below illustrates howseasonality 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 ratiohas gradually disimproved over the last decade, having gone as low as 4.7 in 1993.

Table 2 Seasonality of milk supply (000 tonnes)

1991 1997 1998 1999 2000 2001

Peak month milk deliveries 740 748 700 710 717 731

Low month milk deliveries 137 131 124 119 122 122

Peak to trough ratio 5.4 5.7 5.6 6.0 5.9 6.0

Source: Department of Agriculture and Food (2002)

Figure 3 Monthly deliveries of milk

0

100

200

300

400

500

600

700

800

Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec

1993

2001

000

tonnes

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 peakto trough ratios, while Irelands has gone in the other direction. It is also worth noting that milk supply inNorthern Ireland is considerably less seasonal, indeed its peak to trough ratio has fallen from 1.7 in 1996to 1.6 in 2001.

Table 3 Peak to trough ratios

1991 1997 1998 1999 2000 2001

Ireland 5.40 5.71 5.65 5.97 5.89 5.99Denmark 1.22 1.24 1.21 1.20 1.16 1.21

Netherlands 1.23 1.17 1.37 1.19 1.14 1.15

New Zealand n/a 97.73 116.91 77.42 82.88 n/a

Source: IDB, Eurostat, Dexel, (2002)

This seasonality leads to poor capacity utilisation in the Irish processing sector, adding to theoperating costs of processors

Irelands capacity utilisation (measured by 12 times peak month production as a percentage of currenttotal production) has only registered a slight increase from 57.9% in 1986 to 60.8% in 2001. Thiscompares 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 fairlyconstant all year round supply

Crucially, Irelands seasonality also restricts the types of products that can be produced, and continues toact as a significant constraint on the Irish industry. If seasonality remains it will continue to constrict theability 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 additionalpremium to compensate somewhat for the increased production costs associated with off-peak milk, isdiscussed 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 contentof Irish milk has risen from 3.55% to 3.80%, while the average protein content has risen from 3.20% to3.28%. However, as the table below illustrates, the constituent fat and protein levels in Irish milk arebelow not only the EU average, but also well below its competitors such as Denmark, Holland and NewZealand

5.

Table 4 Protein and Fat Levels (2001)

2001 Ireland Denmark Netherlands NewZealand EUAverage

% Protein 3.28 3.41 3.46 3.64 3.30

% Fat 3.80 4.33 4.44 4.84 4.12

Source: Eurostat, ZMP National Statistics (2002)

Lower fat and protein levels add to the costs of Irish processors, who have to process greatervolumes of milk to obtain value ingredients

Keane and Fingleton have developed a measure of competitiveness using cost per kg milk solids (% fatand % 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 only34% lower by 1999.

Table 5 Production cash costs ( per kg milk solids6)

Ireland Denmark Netherlands New Zealand

1989 2.22 3.38 2.45 0.85

1994 2.35 3.60 2.79 1.34

1999 2.59 3.48 2.82 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 changesover 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 ininconsistency and variability in the milk produced. This inhibits the processors as they attempt to meetthe demands of their customers, and the market, for standard products all year round. The table below

5The breed of cow used for milk production has an influence on the fat level. In the case of New Zealand they havepredominantly gone for a Jersey breed or a cross breed of Jersey & Friesian) which produces a higher fat contentlevel but at lower milk yield per cow than that obtained by Irish dairy farmers. The NZ industry works on milk solidspayment 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.

6Milk 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 lowestand highest levels for 1991 and 2001.

Table 6 Irish protein and fat levels (1991 vs 2001)

1991%

difference2001

%

difference

Lowest monthly protein level 2.91 3.02

Highest monthly protein level 3.5622.3%

3.6119.5%

Lowest monthly fat level 3.39 3.52

Highest monthly fat level 4.0318.9%

4.2019.3%

Source: CSO (2002)

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 about5% 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 inraw product than Ireland. This should in turn result in more uniform plant extraction rates, and lessensthe 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 foran extended period, and to util ise silage from the peak grass-growing period as winter feed. This reducesthe feed costs for Irish farmers in comparison to their main EU competitors. Teagasc estimates that over80% of milk produced in Ireland, and almost all used in dairy products, is produced almost exclusivelyfrom 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, Denmarkand the UK), has gradually fallen over the period from 1989 to 1999. This loss of competitiveness is duein part to the introduction of maize subsidies and reductions in world grain prices, both of which favournon-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 oneconomic costs and costs measured as a percentage of output. Economic costs take into account non-cash costs such as family labour, equity capital and owned land. Expressing costs as a percentage ofoutput value takes into account the prices received for products sold, and thus factors in higherprocessing costs and poorer market returns (poorer product portfolio) due to seasonality and low andvariable milk solids.

Table 7 Irish milk production costs

1989 1995 1999

Milk production cash costs ( per 100 kgs milk) 15 (82) 16 (82) 18 (90)

Milk production cash costs (as a % of output value) 52 (89) 61 (95) 66 (100)

Milk production economic costs ( per 100 kgs milk) 31 (96) 37 (103) 37 (105)

Milk production economic costs (as a % of output value) 111 (108) 139 (119) 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 averagein 1989, to 90% at the end of the 1990s

Measuring total economic costs per kg, Boyle found that Irelands economic costs per 100kg milk haverisen from 96% of the average in 1989 to 105% in 1999. Boyle suggests that measuring costs as a

7The Competitiveness of Irish Agriculture Updated Edition 2002, Boyle, Brown & ORegan


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percentage of output value is a more comprehensive overall measure of competitiveness. In an Irishdairying context, it reflects the idea that while milk production costs may be low relative to other EUcountries, the seasonality and low milk solids content of milk results in high processing costs and poorermarket 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% to121% of the EU average.

By analysing Irelands costs relative to the other seven EU countries in Boyles research (as indicated bythe figures in brackets), it is clear that all measures indicate that Ireland has become less competitiveover the decade. Given that dairy producers are likely to face continued price pressure, these risingproduction costs are now placing producers in a difficult position and one that must be addressed toensure 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 pricesupports are reduced in the coming years. While the processing sector needs to strive to improve thereturn it obtains for its output by increasing the value-added content of its products, the value of theincreased returns achieved may not be sufficient for the future viability of many dairy farmers, given thestrong competitive challenges in the international market place. To obtain a viable income from dairyingin the future, farmers will have to respond by a combination of increasing efficiency and substantiallyenlarging their operations. This will be difficult to achieve in the absence of a radical change in policy onthe management of the milk quotas, where currently only small increments in certain locations areavailable, 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. Howthe 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 co-operation between farmers and processors, and is likely to involve fundamental structural reform. If theindustry does not address this issue, it must accept the consequences of the reduced number ofopportunities 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 assignificant disadvantages to the Irish dairy industry as a whole. While initiatives such as the campaignrun by Teagasc, have resulted in an improvement over the last decade of 7% in fat content and 2.5% inprotein content, Ireland remains well behind countries such as Denmark, Holland and New Zealand. Thedairy industry needs to address this issue that many consider to be a fundamental weakness. While thelow fat and protein levels add to processors costs, the inconsistency of these levels can cause problemswhen marketing and selling products. Fundamentally, when processors cannot produce a consistentproduct 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 competitiveadvantage. These factors include the rate of farmer rationalisation and the relatively small scale of dairyfarms, both of which are in contrast to Irelands major competitors. The Irish industry is also facingsevere price pressure due to poor market conditions, while also encountering rising costs of operations.


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3. Dairy processing structure and efficiency

3.1 Profile of the processing sector

3.1.1 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 toeight processing 90% of the milk pool. Data for 2001 gathered from processors for this study

8, indicate

that the four largest processors account for 73% of sales, with the remaining nine processors accountingfor just 27%.

The pace of overall rationalisation in the Irish industry has been much slower than that of itscompetitors

Despite the reduction in the number of processing companies and plants that has already occurred, theIrish dairy processing industry remains fragmented, and individual processors are of a considerablysmaller 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 Ireland Denmark Netherlands New Zealand

Number of companies processing80% of the milk

6 1 2 1

Source: Promar and Prospectus research

In 2001, the four largest Irish processors handled 3.81 million tonnes of raw milk, compared to Arlas 3.97million tonnes in Denmark, Friesland Cobercos 5.20 million tonnes, and Fonterras 13.5 million tonnesduring the same period. The consolidation within the Danish, Dutch and New Zealand dairy industries hasbeen 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 scalethrough the construction of larger plants to replace smaller, older, less efficient sites. The recentannouncement that Denmarks second largest co-operative, Hellevad Omegns, is to merge with Arla, willsee 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 timeupgrading 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 inthe two major players, Friesland Coberco and Campina, accounting for 82% of all milk processed. Thesetwo players have presided over an industry that has seen the number of processing sites decline from 95to 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 co-

operatives as recently as 1992.) This is due to the fact that New Zealand does not have constrainedproduction systems, and new processing plants are generally built to process additional volumes of milkproduced. This had led to the development of super-sitesthat 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 ofsupport services such as IT, human resources, finance and management, testing, product developmentand marketing, and inefficiencies in assembly and processing.

8

As part of this study, a detailed questionnaire was completed by 13 dairy processors representing the vast bulk ofthe 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


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3.1.2 Plant product output volumes

Apart from butter, the number of processing plants in Ireland has not changed very much since1991

There is limited data available in relation to processing plants, but the table below provides an overview ofhow the number of processing plants has changed over the last decade. This data is based oninformation from various sources, including ICOS and data provided by processors for this study, thus itincludes smaller plants producing limited quantities of some products.

Table 9 Number of Irish processing plants, by product output

1991 1994 1997 1999 2002

Cheese 9 12 11 10 10

Butter 20 19 16 15 11

Powder 12 14 11 13 11

Casein n/a n/a n/a 7 7

Source: ICOS, ZMP, Promar and Prospectus Research (2002)

Average production in both cheese and butter plants has risen considerably over the last decadeThe most noticeable change in the main product plants has been the reduction in the number of butterplants, 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 from9 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 levelof concentration and the scale of individual companies that exists within an industry, it is also necessaryto investigate other measures of scale. One such measure of scale is the average size of plants, asmeasured by the average annual production of each product by each plant. Changes in production aretaken into account by determining the average plant output as measured by the average annualproduction for each plant.

Table 10 Average output of plants - Ireland (average annual production 000 tonnes)

1991 1994 1997 1999 2001/2

Cheese 8.0 7.8 7.8 9.7 12.0

Butter 7.0 6.7 8.7 9.0 11.6

Powder9

(WMP & SMP) 17.2 11.8 13.0 10.0 9.9

Casein - - - 6.6 6.9

Source: ICOS, ZMP, Promar and Prospectus Research (2002)

A significant proportion of the increased average butter production per plant has occurred in the last threeto four years, driven by the reduction in the number of plants from 15 to 11. Average cheese productionhas 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 tonnesin 1991 to just 9,900 tonnes in 2001. However, these powder production figures relate to SMP and WMPproduction only and do not take into account the use of these plants for the production of other productssuch as whey powder and fat filled milk powder (no official published production figures are available forthese products). Using the data provided by processors for this study on the production of these otherproducts 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 fromprocessors) the average output from powder plants is just under 19,000 tonnes per annum. The averageproduction of casein has remained steady at just under 7,000 tonnes for the last number of years.

9SMP and WMP only. As published industry data is not available for other products such as whey powder or fat fi lled

milk powder, it is not possible to provide an accurate average output figure with these products included. As resul t theapparent drop in average powder output is deceptive, as it does not include whey or fat-f illed powder from theseplants.


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It is necessary to look beyond average plant output and take into account the impact of large orsmall plants

It is important to look beyond simple industry average outputs of individual products. The data on plantsize supplied by processors for this study, provides a more detailed picture of the current structure of theindustry. 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 Cheese Powder4

(SMP& WMP)

Casein

Ireland - average output ofthe two largest plants (000tonnes)

33 24 19.5 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 certainproduct types where scale of production is not the critical factor, but rather product innovation andspecialisation, and the ability to produce product output levels that are appropriate to meet the demandfor their specific product or market niche. This is particularly true for the production of specialist cheesesand other high value-added products. Denmark has seen strong growth in the number of small specialistoperators in parallel with the process of major consolidation of the industry, with one player processing90% of milk. In the area of the production of commodity type products such as powder, bulk cheese andbutter, 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 isgiven to both the published data and the information provided by processors for this study, particularly inrelation 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 1991 1994 1997 1999 2001

Ireland 8.0 7.8 7.8 9.7 12.0

Denmark1 0 5.1 5.6 6.9 6.9 8.9

Netherlands11

11.912

18.5 19.2 20.8 24.7

New Zealand n/a n/a n/a n/a 31.3

Source: ICOS, ZMP, IDB, Promar and Prospectus Research, (2002)

The figures for average cheese plant size illustrate that while production output in Ireland has increasedby 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 ofboth 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 Excludes private dairy production11All data for the Netherlands for 1991 and 1994 actually refers to 1990 and 1995 respectiv ely

121990


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appear to indicate a smaller scale exists in Denmark, a more detailed analysis suggests that this is notquite the case. Of the 62 Danish cheese plants that existed in 2001, The 14 largest plants accounted for75% of cheese production, giving an average output of 17,000 tonnes for these plants, with the remaining48 plants producing only 25% of the total cheese produced. An indication of the specialised nature ofsome of the smaller plants can be obtained from the fact that 18 Danish cheese plants produced less that400 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 majorcompetitors. In chapter 3, section 3.2, consideration is given to research by Teagasc on the efficiency ofcheese production in Ireland along with other factors to consider in determining the most efficient scalefor 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 1991 1994 1997 1999 2001

Ireland 7.0 6.7 8.7 9.0 11.6

Denmark1 3 3.1 3.4 4.1 4.2 5.7

Netherlands 9.9 16.5 19.2 17.5 21.7


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 at21,700 tonnes and New Zealand at 35,200 tonnes. The average production per plant for Denmark of5,700 tonnes is again misleading, given that 3 of the 30 butter plants account for 84% of the total butterproduction, with an average size of 12,941 tonnes for these three plants, but the largest being quoted ashaving a capacity of 50,000 tonnes.

The figures for average powder plant output demonstrate that a gap exists between the plantproduct output levels in Ireland, and the plant product output levels in all three countries that

Ireland has been benchmarked againstTable 14 Average plant output Powder

14

000 tonnes 1991 1994 1997 1999 2001

Ireland 17.2 11.8 13.0 10.0 9.9

Denmark 12.5 13.4 18.1 18.9 18.3

Netherlands 7.715

14.116

12.6 18.4 16.0


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 Denmarkand the Netherlands, and one seventh of New Zealands. Although published data isnt available for wheypowders in all countries, we have used the estimates available

17to determine the average plant output

including SMP, WMP and whey powders. In 2001, the average output of SMP, WMP and whey powderper plant in Ireland was 19,000 tonnes compared to 23,400 tonnes in Denmark, 35,900 tonnes in theNetherlands and 71,900 tonnes in New Zealand. The data above suggests that the current configuration

13Excludes private dairy production

14Average 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 countries15

199016

1995

17 Whey powder estimates: Irish data based on information provided by processors for this study and includes wheypowder and fat filled milk powders, Danish data from FAOSTAT, Netherlands data from Productschap Zuivel, NewZealand data from Statistics New Zealand


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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 baseproducts 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, isdriving 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 willneed to obtain the benefits that are available from economies of scale. Scale will also be a key factor inenabling processors to meet the requirements of the buyers of commodity products for their suppliers tobe 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 andinvestment. While a more pragmatic approach has been adopted within the Irish industry over the lastdecade, with greater co-operation taking place between processors regarding cost management (forexample, in the area of milk assembly), its fragmented structure and lack of scale still poses majorchallenges for the industry in the future. A number of processors have achieved progress in operating atoutputs 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 willfind it increasingly difficult to survive unless they switch their activities to more specialised and value-added 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 theprice paid for milk, the product mix of the processor, and the efficiency of the processors productionoperations. While some exceptions exist, the data provided by processors for this study identifies astrong correlation between scale of the operation and margin achieved, with larger scale processorsachieving higher margins. This is in line with conventional wisdom that suggests that increasing the scaleof production results in greater efficiencies up to a certain optimal level, after which benefits gained areless 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 improvedefficiency that contributes to better margins.

Figure 4 Plant scale and fixed costs for powder production

100

120

140

160

180

200

2.5 5 7.5 10 12.5 15

Scale (tonnes/h)

Fixed

costs

While some smaller processors are delivering higher margins, this is often linked to the production ofhigher margin products, rather than more efficient production. The link between scale and margins ismade more difficult to determine due to the differing approaches and policies of co-ops and plcs. Thisdifference is between providing returns through a higher milk price, or through increased profits that areeither reinvested in the business or distributed to shareholders. A more detailed discussion of the needfor scale in the context of the overall future direction of the Irish industry is included in Chapter 3.

18OCallaghan 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 havebeen used. Capacity utilisation provides an indication of how efficiently plant and equipment is utilised,w

Irish Dairy Processing Sector Strategic Report Mar 03

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