Dairy farmers face tough times

The big dry is one thing, but the dairy industry has to contend with global market influences as well as technological changes. By JASON BAKER of IBISWorld.

By Jason Baker

Affected by drought and battling to cope with technological change and industry rationalisation, the dairy industry in Australia has endured lean times. And, IBISWorld predicts, the outlook for the future is only slightly better.

In the five years to 2007-08, revenue in the Australian dairy industry will grow by a measly 0.2% on average each year to $3.39 billion in 2006-07.

Dairy producers have been hit particularly hard by the drought that has swept much of Australia. And 2004 was a particularly bleak year in the sector, as a drought-caused drop in production sent revenue down by 4.5%.

An increase in consumer spending on dairy products and an initial flow of benefits from the implementation of free trade agreements with Thailand and the US caused the pick up in performance in 2006-07.

The dairy sector in Australia is dominated by three large companies, each with origins as dairy farmer co-operatives: Fonterra Co-operative Group, the Murray Goulburn Co-operative Company and Australian Co-operative Foods. Together these three dairy co-operatives account for around 39% of the market. Other players include ASX-listed Warrnambool Cheese & Butter Factory and private label companies.

New Zealand-based Fonterra controls 22% of the Australian dairy market and claims to be responsible for a third of all dairy trade around the world. Owned by a collective of Kiwi farmers, the company has more than 2300 employees.

Fonterra has enjoyed strong growth over the past three years after some weak results in 2002 to 2004. In 2005-06 revenue increased by 5.5% to just over $13 billion, thanks largely to the one-off sale of New Zealand Milk (Mexico) and the company’s stake in National Foods.

In 2005 Fonterra acquired Bonlac, one of Australia’s largest dairy producers. The company now contributes more than $750 billion in revenue to Fonterra’s bottom line.

Victoria based Murray Goulburn Co-operative commands 10% of the Australian dairy market. It has achieved strong revenue growth of 8.6% and 7.2% over the past two years thanks to improved production, good prices and investments in the Chinese market. Revenue in 2006-07 was $2.1 billion.

By contrast, Australian Co-operative Foods’ revenue declined 6.6% in 2004-05 and 2.3% in 2005-06. Revenue in 2005-06 was just over $1.2 billion.

Over the next five years to 2012-13, IBISWorld forecasts the industry will grow at an average annual rate of 0.7%.

Key factors that will determine the extent to which that forecast will be achieved or exceeded include changing consumer perceptions regarding the healthiness of dairy products and the international competitiveness of the sector, with a surge in exports from South America looming as a threat to Australian producers.

Environmental conditions, and the ability of dairy farmers to take up innovate technology and methods to improve production and quality in the face of dry conditions will also be significant.

Key success factors for operators in the industry will include:

• Guaranteed supply of key inputs: Adequate milk supplies (especially in states other than Victoria and Tasmania) are necessary otherwise operating costs are raised by seasonality of production.
• Marketing of differentiated products: Product differentiation, in particular types of butter and packaging.
• Economies of scope: The ability of the firm to produce a range of dairy and non-dairy products.
• Use of specialist equipment or facilities: The level of technology adopted which improves quality.
• Economies of scale: The scale of operation and the level of capacity utilisation.
• Output is sold under contract; incorporate long-term sales contracts: Whether the firm has sales contracts, either within Australia or with overseas buyers.

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IBISWorld supplies business information databases, including industry reports, company reports and business indicator reports. www.ibisworld.com.au