Over-supply, pricing pressures, increased imports and rising costs have combined to put huge pressure on the SA dairy industry. However, reports Susan Unsworth, there are bright spots on the horizon for producers willing to move with the times.
A milk surplus, lower producer prices and a glut of cheap imports - these are the realities of the present South African dairy industry.
But who is skimming off the greatest profit? Is the current controversy just a storm in a milk jug? Views differ, but something is definitely interrupting the smooth flow of this vital industry.
Market forces have seen the number of dairy farmers drop from 30,000 in the mid-80s to fewer than 2,800 today. Although, in recent months, smaller players have managed to hold on, many are said to be under severe pressure given milk processors’ decision to reduce the price they are willing to pay for raw, or unprocessed, milk.
Parmalat was the first to make a move, reducing its price to producers by 30c a litre in July, with plans to follow that with a further 20c in September. A combination of factors prompted the decision, says the company's marketing executive Kobus Smit. 'Oversupply, weak consumer demand for dairy products, the continued influx of imports and poor export opportunities have taken their toll,' he says.
Other processors followed, citing their need to remain competitive in spite of the oversupply of milk for reasons including a production boost afforded by a favourable maize price, the changeover to more intensive production in drought stricken areas and the very high level of imports, possibly in anticipation of a shortage in 2010.
A report by Dr Koos Coetzee, economist of the Milk Producers’ Organisation (MPO), indicates that milk production in the first seven months of the year was 4,1% higher than during the corresponding period in 2009, making this year the second highest production period in seven years. Exacerbating the situation was the 79% hike in imports to 52-million litres for the first seven months of 2010, against the corresponding period in 2009, when new exports stood at 12-milion litres.
Chairman of the Milk Producers Association Philip Blanckenberg was quoted in August as saying that producers were being paid a similar price for raw milk as they were in 2008, between R2,50 and R2,70 a litre, against costs that have increased by 14 percent.
However, says South African Milk Processors’ Association (Sampro) chief executive officer Alwyn Kraamwinkel, recent media reports regarding reduction in the prices of raw milk are most likely ‘the reaction of the market, or segments of the market, to the high level of raw milk production, the increases in the price of raw milk up to June 2010, which exceed those of other agricultural products and dairy products, and the demand for dairy products, a factor that is closely linked to the spending ability of consumers, which is under pressure’.
The production of raw milk in the last quarter of 2009 and the first seven months of 2010 was high, he says, with record levels during three of the months between January and July 2010.
‘From 2000 to the end of 2006, the price index of raw milk and that of dairy products moved together,’ he continues. ‘The increase in the production price index of raw milk from January 2007 to June 2010 was also higher than that of other agricultural products.
‘In the year ended April 2010, the retail prices of four dairy products decreased, three increased by 2% or less and the price of two products increased higher than the inflation rate.’
A continuation of the trend for raw milk prices to outperform those of other products will impact very negatively on the competitiveness of the dairy industry, he adds. ‘The South African dairy industry is competing not only with imported dairy products, in the export market and with substitute products, but also with very different industries that wish to enjoy a share of the consumer spending and that are aggressively marketing their products and services to consumers.’
Clover chief executive officer Johann Vorster spearheaded his company's recent ‘resetting’ process, which included withdrawal from the bulk cheese and powdered milk markets, which previously took care of its surplus milk purchases. Vorster stresses that consumer behaviour is complex and that arguments that dairy products enjoy guaranteed shares of consumer spending, are unrealistic. 'In essence,' he says 'the industry will grow only if the competitiveness of dairy products, which includes price, continuously improves.
Sustainability of producers and processors depends on competitiveness, which is not necessarily linked to size. Determining factors for producers, for example, include location of the production unit, feed and breeding regimes, the quality and composition of the milk produced, the seasonality of production and cost effectiveness.'
Dr Coetzee points out that the price index of dairy products at processor level from 2000 to 2010 shows that, except for a short period at the beginning of 2009, processor prices have increased continuously, even at times when producer prices decreased, such as during the years 2004 to 2007.
Kraamwinkel counters that it is unfair to compare raw milk with the products that reach the supermarket shelves, as much value is added during processing, including pasteurisation, homogenisation, fat content adjustment, packaging, labelling and marketing. Consumers favour convenience, he adds, which means more plastic bottles and more detailed labels.
Naturally, higher input costs affect all players, primary or secondary, large or small. 'We are all subject to Eskom's price hikes, salary increases and rising transport costs,' says Douglasdale Dairy' chief executive officer Michael Collins. 'But there are ways of compensating. At Douglasdale, all employees are leaders who are encouraged to make improvements in the workplace. Our staff recently identified that our crates could be improved in design and quality, and we have now patented our own design and manufacture it in-house, which has brought substantial savings. Small improvements daily yield massive results annually.'
In the current environment, Dr Coetzee cautions, sustainability may boil down to smaller producers’ ability to cut costs and, in the longer term, to investigate ways of adding value to their products, supported by a limit on imports. ‘Nevertheless, I do not see the situation continuing indefinitely,’ he says. ‘In time, the market will reach a new equilibrium, probably at higher production prices.’
Collins predicts greater pressures particularly on inland producers, as raw milk volumes coming into Gauteng from the Western- and Eastern Cape are increasing. Douglasdale Dairy is known for its support of smaller farmers, through approaches such as ‘accommodating smaller loads, varying payment terms, efficient planning and building relationships with suppliers’.
Parmalat's Smit echoes the sentiment that producers must ensure optimum effectiveness and efficiencies, adding that so too should processors. 'Exports are not particularly viable given the high price of local raw milk, so the only option is cut costs, drive efficiencies and sell products at low prices on the domestic market,' he says.
Who in the supply chain is making money?
At this stage, not the product manufacturers, says Smit. ‘We cannot speak for farmers and retailers, but Stats SA and industry data show that manufacturers are currently bearing the brunt in terms of profit margins.’
Margins are being squeezed across the board, says Collins. ‘Douglasdale Dairy works with each supplier in the chain to achieve a macro result rather than micro-managing each transaction.’
National Agricultural Marketing Council figures show that although producer and retail prices began to fall in July 2008, rising again in January the following year, the rate of the drop and increase was not proportional. By the time the producer price had been restored to R3,10 a litre, the retail price had increased almost 15% from R6,41 to R7,33. Thus the consumer has not benefited from the lower producer prices, an issue that has angered certain dairy farmers.
But the cream may yet rise to top in the dairy industry, with many expecting a rosier outlook in the months to come.
Says Kraamwinkel: ‘The demand for dairy products in South Africa is determined largely by economic growth and it is generally accepted that this will improve over the next year.’
There is good news for farmers too, says the MPO, if they heed market demands and consumers’ concerns about global warming, the environment, animal welfare and social responsibility. ‘In other words,’ states a recent article in the MPO newsletter, The Dairy Mail, ‘farmers will have to farm in a sustainable way.
‘Profitability will depend on technical efficiency in the use of resources. It makes economic sense to use less chemical fertiliser and to limit cultivation. Farmers can save money with biological farming methods and convince the consumer that they are more in tune with nature. Biological production methods also limit run-off that pollutes water. Well-treated animals produce more. For a milk producer cow comfort is crucial. At the same time, the consumer demands high-quality products produced under hygienic conditions by well-treated workers.
‘Whilst global changes put a lot of pressure on farmers, they also provide huge opportunities for those who are prepared to take up the challenges of sustainable farming.’
Smit says that although failure to curtail the supply of raw milk will see the industry and its manufacturers enter 2011 on a poor footing, the situation will improve. ‘We foresee a more balanced supply and demand situation during 2011, which will put the dairy industry back on track for long-term, sustainable, competitive growth,’ he says. ‘Dairy products are increasingly recognised as healthy, convenient and great-tasting. Once the macro economy recovers, our products will continue their high growth curve.’
Collins is equally upbeat. ‘We are very positive about the outlook for the industry,’ he says. ‘The 2010 World Cup demonstrated the nation’s collective ability. We are the captains of our own destiny and the dairy market’s players need to share a vision and focus to optimise opportunities across the industry.’
