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A perspective for the dairy industry 2010

Liam Donnelly1 and Seamus Crosse2

1Teagasc, Dairy Products Research Centre, Moorepark, Fermoy, Co. Cork
2Teagasc, Moorepark Research Centre, Fermoy, Co. Cork


Introduction

The dairy industry is one of the most important sectors of Irish Agriculture and accounts for 33 % of Agricultural output with the production of 1.1 billion gallons of milk per annum. The Dairy Industry also makes a significant contribution to sustaining rural communities. Milk producers in Ireland have received a relatively high milk price in recent years. However, the application of a milk quota regime within the EU as well as other measures such as tariffs on imports, export refunds etc. were necessary to support milk price. European Community membership in 1973 provided Ireland with a good degree of policy stability as the wider international political and market situation was reasonably predictable in the 1970's and 80's. Now however, the political changes in Central and Eastern Europe, the completion of the Single Market and policy changes in the CAP (Common Agricultural Policy) and world trade agreements (WTO), all suggest a more unstable and unpredictable time ahead. The purpose of this paper is to develop a vision of the dairy industry at the end of the next decade and describe some of the changes, opportunities and challenges that are likely to confront the industry in a different policy environment.

Future policy environment and industry structure

The current policy environment for the dairy industry is the Agenda 2000 agreement on CAP reform. This provides a stable outlook until 2008 subject to review in 2003. A perspective on the outlook beyond 2008 is critical for strategic planning in the immediate years ahead. Eventual movement to the free market seems inevitable and the only question is how rapidly this will occur. For the purposes of developing a 2010 scenario, we have assumed a relatively rapid timetable leading to many of the elements of the free market being in place by 2010 or shortly afterwards. While this timing is undoubtedly debatable, it does provide a clearer focus for strategic analysis than exists in much current discussion.

The free market elements which we assume for 2010 or thereabouts include the following: abolition of quotas, elimination of export refunds and other forms of support, absence of an intervention system other than aids to private storage and tariff reductions to 10-15%. In relation to industry structure, it is assumed that considerable consolidation will have taken place by 2010 and that something close to the following picture will exist. The processing sector will have consolidated into 2/3 major processing sites and 2/3 smaller sites; the number of milk producers will have declined to at most 20,000. In reaching these assumptions, we have taken into consideration the conclusions in Technology Foresight Ireland, ICOS recommendations for industry restructuring and current trends in producer numbers. A final assumption is that milk output will expand post-quota and will have increased by 30% in or about 2010. The potential for increased output is discussed later in this paper.

Dairy Production 2010

It is envisaged that the dairy production sector will be very different in 2010 than it is today as we move towards freer trade.

A national milk pool of ~1.45 Billion gallons is a realistic target. Up to 20,000 dairy farmers each on average producing ~70,000 gallons of milk per annum, with much larger herd sizes (~60 cows). The likely distribution of dairy farms by milk pool size is shown in Table 1.

TABLE 1: The structure of dairy farms by milk pool size now and the envisaged structure by milk volume sales in 2010

 

1997/98

2010

 

Number

(`000)

%

Number

(`000)

%

< 20,000 Gallons

11

34

0

0

20,000 - 55,000 Gallons

16

52

8.0

40

55,000 - 100,000 Gallons

3

11

9.0

45

> 100,000 Gallons

1

3

3.0

15

Total

31

100

20.0

100

Source: (current structure) Dept. of Agriculture: 2010 data based on authors' estimate

Competitiveness of dairy industry

Competitiveness is a complex term given it's multi-dimensional aspects (Boyle, 1998). It is however central to all agricultural and rural development policies. Competitiveness in the past generally referred to cost competitiveness. It now has to be considered in broader terms. Issues such as type of technology used to produce food, the environment, animal welfare, scale of enterprise, Government regulatory policies as well as development and taxation policies, education level of farm work force, rate of adoption of new technologies, milk processing sector structure etc also need to be considered. Production systems will need to incorporate many of these issues as well as being cost competitive.

Cost competitiveness in milk production

Cost competitiveness at farm level is an important determinant of the success of the dairy industry. It also has an important bearing on what policy strategies might best suit the future development of the industry. Fingleton (1998) reviewed recent trends in relation to the cost competitiveness of milk production in Ireland (Table 2).

TABLE 2: Itemised costs of milk production for specialised creamery herds (1990-1998)

Year Direct Overhead Total Net
Receipts
Margin Cost/
Receipt
Ratio

1990

30.0

29.0

59.0

-

-

-

1991

29.0

28.0

57.0

-

-

-

1992

30.0

28.0

58.0

-

-

-

1993

31.8

29.5

61.3

-

-

-

1994

33.6

28.1

61.7

106.4

44.7

0.58

1995

35.4

30.4

65.8

111.2

45.4

0.59

1996

35.3

31.0

66.2

107.5

41.3

0.62

1997

30.9

29.5

60.4

102.1

41.7

0.59

1998

33.0

30.0

63.0

105.4

42.4

0.60

Source: Fingleton, 1999 and NFS data

The total input cost in 1991 was 57.0 p/Gallon compared with 66.2 p/Gallon in 1996. The average total cost of production in 1998 was 63 p/gallon. The direct costs were higher than the overhead costs. Family labour is not included in these costs. The margin per gallon of milk in 1998 was 42 p/Gallon. The ratio of total costs to value of output was generally around 0.6. The overall costs (1998) ranged from 45.2p /gallon for the lowest cost group of farms (lowest 20% of farms) to 80.4 p/gallon for the highest cost farms (highest 20 % of farms). This data shows that there is great scope for reducing costs on many farms, nationally (Table 3).

TABLE 3: Cost variation by quintile in 1998 for specialised dairy farms (p/Gallon)

 

Q1

Q2

Q3

Q4

Q5

Total

45.2

55.2

62.1

68.5

80.4

Direct Costs

24.5

28.3

32.2

36.1

41.6

Overhead Costs

20.7

26.9

29.9

32.4

38.8

Q1 = Lowest cost 20% of farms. Q5 = highest costs 20 % of farms

Costs of milk production expressed on a per gallon basis do not reflect the scale of operation at farm level. Many farmers are now leasing quota. The average cost associated with quota leasing in 1998 was 4 p/gallon.

Cost comparison with other countries

Economic costs are often used in assessing the competitiveness of milk production. "Cash Costs" refer to the actual cost outlays by producers. Total economic costs include as well estimated resource costs to cover family labour etc... Ideally economic costs should be considered as well as cash costs when assessing the competitive strength of the dairy industry. Table 4 shows measures from the 1992 AIB / Farmers Journal study.

Ireland generally emerges as competitive in terms of "cash costs" but much less so in respect of "economic costs". This is probably because of the large number of small farms in Ireland, which cannot support a full time labour unit. The analysis in Table 4 is now relatively out of date and is in need of updating.

TABLE 4: Competitiveness of Irish Agriculture Production Costs £/100kg (1997 *)

 

Production Costs

£ /100 kg (1997)

Production Costs as % output values

 

"Cash Costs"

"Economic Costs"

"Cash Costs"

"Economic Costs"

Germany

20

31

60

119

France

15

25

60

112

Italy

21

52

52

128

Netherlands

18

28

57

114

Denmark

24

33

74

130

Ireland

13

29

52

130

UK

18

27

64

117

US

22

26

77

92

Australia

8

NA

64

NA

Canada

15

30

52

100

New Zealand

6

NA

68

NA

* Update of AIB / Farmers Journal 1992 study (Source: Boyle, 1998)

More recent information (EDF, 1999) although on a more limited data set is likely to be more representative of dairy farming in 2010 (Table 5).

TABLE 5: Costs, Returns and Result of the Dairy Enterprise

Euro / 100 kg milk (FCM)

Country

Total Receipts

Total Costs

Net Margin

Cost /Receipt Ratio

Belgium

35.8

32.5

8.5

0.91

Germany

35.2

32.7

5.1

0.93

Ireland

34.3

25.0

13.9

0.73

Holland

37.1

36.6

6.4

0.99

Sweden

36.0

32.0

7.4

0.89

UK

33.5

28.5

11.1

0.85

Source: EDF analysis 1999: FCM - Fat corrected milk

Family labour is included in these costs. The results show that Ireland and the UK have the lowest receipts /100 kg milk (FCM). There is a large difference in cost of production between countries. The costs of production in Ireland are significantly lower than the other countries. The margin /100 kg milk (FCM) for Ireland is much better than the other countries mainly as a result of the low production cost structure. This supports the previous analysis in that Ireland is cost competitive in term of cash costs. There is no obvious reason why Ireland should loose its comparative advantage in terms of production costs in the foreseeable future.

Can Ireland compete after 2006

The structure of the milk production sector of the industry is poor. It is likely that considerable change will occur over the next decade. It is important that innovative strategies are put in place to facilitate an increase in the scale of the farm business while maintaining the maximum number of farm families in rural areas. These might include, milk quota policy changes, taxation policy, strategies to facilitate entry of young farmers to the industry, development plans, education etc... Farm partnership is also an attractive option for future development. It is however, likely that the number of farmers will continue to decline and the relative size of farm will continue to increase.

Milk producers in Ireland will be increasingly dependent on subsidies after 2006 if income is to be maintained in a scenario where milk quotas are removed. While the farm margins may seem relatively good in nominal terms now, the real value of the returns on dairy farms will be much reduced. The question arises as to what extent Irish dairy farmers can adjust to these changes. It is argued that for a net exporting country like Ireland, two key parameters matter in addressing the impact of price reductions on any sector (Boyle, 1998 and Sheehy, 1996). The first is the supply elasticity or the responsiveness of production to price changes and the second is the underlying rate of technological change within the sector. Faced with price reductions, a sector with relatively low supply elasticity would experience a relatively lower income loss than a sector with a relatively high elasticity. Similarly, a sector with an inherently faster rate of technological progress could expand production to a greater extent at all price levels. It is argued that a sector, which is favourably endowed with these two parameters, has the potential to enhance market share in a scenario of price cuts.

Boyle (1998) suggest that "cash costs" expressed as a ratio of the value of output gives a proxy of supply elasticity. The smaller the ratio the smaller the supply elasticity. Ireland has a favourable cost /receipt ratio relative to other countries and consequently Ireland should suffer less severe production and profit effects in the face of price reductions than most other countries (Boyle 1998, EDF 1999, Fingleton, 1996). Ireland also has the capacity to reduce costs faster than other European countries. The cost of labour may be an exception to this.

The underlying rate of technological progress for different countries is more difficult to define. Little comparative data for European countries is available. Continued technical innovation is very important for competitiveness long term. Dillon (1998) evaluated the change in milk production technology at Moorepark over a period since quotas were introduced 1984 up to 1996. These results are summarised in a systems context in Table 6.

TABLE 6: Change in herd productivity at Moorepark

 

Moorepark 1983

Moorepark 1996

 

Pre-Quota

MGI*

HGI**

Milk Yield (gal/Cow)

1,084

1,407

1,632

Stocking Rate (Cows /Ac)

1.17

1.05

1.00

Grass (t/Cow)

3.30

3.69

3.88

Silage (t /Cow)

1.40

1.56

1.65

Concentrate /Cow)

0.63

0.63

0.63

Total Intake (t DM /Cow)

5.33

5.88

6.16

*MGI - Medium Genetic Index Cows ** HGI - High Genetic Index Cows

Considerable progress was made in milk production technology over the years and this progress is likely to continue into the future. Productivity at farm level is influenced to a large extent by the level of animal performance from a forage-based diet. The costs associated with the cow can be diluted when a higher level of animal performance is achieved. It is important that the relatively stable economic environment ahead is used to apply the best technology on dairy farms. Continued innovation in milk production technology is necessary to maintain competitive advantage.

Moving toward an increase of 30% in milk output by 2010

The policy environment for milk production at the end of the Berlin agreement will depend on many factors. A detailed discussion of these is outside the scope of this paper. It is assumed here that milk quotas will be abolished from 2008. An assessment of the potential to increase milk output from farms to compensate for a likely drop in milk price is assessed. Competition in the form of cow premiums etc. is not considered.

Latent milk output increase in the national herd

There is considerable scope within the national herd to increase milk output/cow. The potential productivity improvement at farm level has not reached full potential over the years. Milk yield per cow is an indicator of productivity at farm level. Data from specialised herds (NFS 1997) shows that the average milk yield per cow is 960 gallons per cow. Milk quota per cow is 880 gallons. This would suggest that milk deliveries to dairies per cow are low. A significant amount of milk is fed to calves. Table 7 shows the distribution of farms by level of milk yield per cow and by level of milk quota per cow.

The data in Table 7 shows that an alarming number of farms have low herd productivity as measured by milk yield per cow. This is mirrored to a large extent by the low level of milk quota per cow, available on these farms. This would suggest that a high proportion of farms have too many cows on their farms for the quota available. DairyMis data and data from milk recorded herds shows clearly that lactation length is declining over the years. This trend is associated with a drop in milk yield per cow.

TABLE 7: Distribution of farms (%) by level of milk yield /cow and milk quota /cow

 

Milk yield /cow

Quota available /cow

< 700 gallons /cow

9

17

700-800 gallons /cow

11

13

800-900 gallons /cow

13

18

900-1,000 gallons /cow

23

24

1,000-1,100 gallons /cow

25

20

1,100-1,200 gallons /cow

12

5

> 1,200 gallons /cow

7

3

Total

100

100

Source: NFS

The milk production of the national herd should be ~1,100 gallons /cow taking cognisance of the national breeding programme over the last 20 years. It is argued that low herd productivity is due to milk quotas and the administration of milk quotas in Ireland rather than a failure in technology transfer. Farmers are keeping too many cows for the quota available. This is done in anticipation of obtaining additional quota. There are significant costs associated with this strategy. Using data from DairyMis herds, it is estimated that restricted performance due to Quota, costs a minimum of 5p /gallon. This additional cost is likely to be much larger on dairy farms generally. It should also be noted that some farmers have made significant amounts of money in some years by gambling on additional quota being available. A significant number of farmers are also loosing potential income by not filling the quota available. These tend to be smaller farms who are generally more risk adverse.

It is likely that rapid adjustments can be made in herd productivity if milk quotas were removed. A realistic expectation is that an immediate increase in volume of milk sales per cow, of 150 - 200 gallons per cow is achievable. This assumes that milk feeding to calves would discontinue. The additional on farm cost associated with delivering this additional milk to dairies is minimal. The costs would mainly relate to additional milk storage on farm, some additional feed for cows and also costs associated with calf rearing.

Farmers currently leasing milk quota

Currently, significant proportions of dairy farmers are leasing milk quota with a view to growing the dairy business. Data from the National Farm Survey (NFS) shows that costs associated with quota are now 4 p/gallon. Data from DairyMis farms shows that quota lease charges amount to 11 p/gallon (range 0-30 P). Quota lease charges will increase significantly in the immediate future, as the proportion of milk available for leasing is likely to increase and many dairy farmers will be farming with a net milk price of 70-80 p/gallon prior to the abolition of milk quotas. Their milk pool will be large and they will be well placed to expand further when quotas are finally abolished. These farmers are unlikely to experience a major shift in actual net milk price, as milk quota lease charges would cease and they will have the necessary farm structure to grow rapidly post milk quota.

Modelling change in farming system if milk quotas are removed

The economics of milk production in a situation where no milk quotas apply is very different to a milk quota scenario. In order to maximise income in a milk quota situation; the average production costs on the farm should be reduced to a minimum. Cow numbers should then be reduced until the milk output equals the quota available. In a non-quota environment, production should increase until the value of the marginal output equals the marginal revenue (~Milk price).

Farm systems analysis was carried out to investigate the potential for increasing milk output if quotas were removed. It should be noted that many dairy farmers might not react in a similar way to milk price change for a variety of reasons. A model farm was used for this analysis. This farm represents many dairy farms where quota is limiting before land. A two-year-old beef system was used as the companion enterprise to dairying. Table 8 gives a brief description of the model farm. Changes were modeled using resources within the farm.

TABLE 8: Model farm for farm systems analysis

Enterprises

Dairying and Beef

Farm Size

80 Acres

Quota Size( year 0)

40,000 Gallons

Number of Cows in year 0

38

Other livestock units in year 0 (beef cattle and replacement heifers)

42

Other assumptions:

Milk yield per cow - 1,100 gallons of which 50 gal./cow was fed to calves

Optimum quota management (year 0)

Inputs, outputs and costs based on current information

Capital infrastructure and labour available for this scale of enterprise

In this analysis, the base year (year 0) refers to the period when milk quotas apply (year 2007/8). The farming system was allowed to change from year one. Cow numbers increased rapidly until the land area became a constraint to further expansion. Replacement heifers were always reared within the system.

The effect of removing quota constraints (year 1) on cow numbers and milk volume sales for model farm is shown in Table 9.

The results show that an increase of ~30 % in milk output is a realistic target over a 3 year period. The rate of increase in the first 2 years is lower than later years as it takes time to replace the beef enterprise with dairy cows. This time lag could be reduced if farmers had advance notice of when quotas were likely to be removed.

TABLE 9: Change in cow numbers and milk volume sales over time

 

Cow

Numbers

Milk Sales

(gals)

Change in milk sales*

Year 0

38

40,000

100

Year 1

42

45,676

114

Year 2

45

49,070

122

Year 3

60

65,860

164

Year 4

69

77,378

193

Year 5

70

79,800

200

*Year 0 (Base year = 100)

The effect of milk quota removal on farm cash income is shown in Figure 1.

Figure 1.

Figure 1: Change in farm cash income if quotas are removed from year 1.

The horizontal line represents farm cash at a milk price of 93 p/gallon (likely milk price at the end of Berlin Agreement period). Various levels of milk price below 93 P /gallons were also assessed. A milk price of 83 p/gallon post quota would be dependent on a good product portfolio. Milk price has a large influence on farm cash income. Cash income drops significantly in year 2 because of changes in the structure of the herd (i.e. drop in calf and cattle sales). The data shows that income could be recovered by year 4, if milk price dropped to 73 p/gallon. This analysis takes no account of a possible drop in input costs. While short-term borrowing would facilitate the transition over the first 3 years post quota, it is preferable if compensation mechanisms could be geared towards addressing this issue. Methods of compensation, which are likely to be discussed if quotas are to be abolished, are not considered here. The main issue here is to deal with cash flow problems. If no compensation mechanism is available then short-term borrowing is needed. Studies of farm structures (Clare UCD/Teagasc study) indicate that cattle facilities could be modified at low cost for dairy cattle.

The data shown in Figure 2 allows for some short term borrowing of capital (£10,000 in year one and £10,000 in year two) to finance some capital development and to deal with cash flow problems in the transition period.

Figure 2

Figure 2: Change in Farm cash income over time if quotas are removed from year1 (short-term loan used)

The data in Figure 2 shows that farmers should prepare for cash flow problems in the early years after quota removal. Investment in facilities should be kept to a minimum during this period and the priority for investment should be for milking and milk storage facilities.

Production Technology

Production technology has a large influence on the ability of the farm business to recover from a low price scenario. The data in Table 10 shows the effect of production technology and removal of milk quota on farm milk sales (Model farm).

TABLE 10: Changes in cow numbers and volume of milk sales (year 5)

 

Cow Numbers

Milk Sales

(Gallons)

% change in milk sales (Base = 100)

Medium Technology - Milk Quota

(1,100 Gallon Herd)

38

40,000

100

Medium Technology - No Milk Quota

(1,100 Gallon Herd)

68

74,000

185

High Technology - No Milk Quota

(1,400 Gallon Herd)

67

93,000

233

Very High Technology - No Milk Quota ( 1,700 Gallon Herd)

65

110,000

276

The results show the enormous potential to increase milk output if quota constraints are removed and high levels of technology are applied. The combination of high milk output per cow and increased cow numbers has a large effect on milk sales. The effect of production technology on farm cash income is shown in Figure 3.

fig0503.gif

Figure 3: Effect of production system on farm cash income at various levels of milk price in a no-quota situation.

It is evident that high levels of herd productivity can compensate for a drop in milk price.

Summary on moving towards an increase of 30 % in milk output

It is likely that in practice, increases in milk output will come from improved output per cow as well as from an increase in cow numbers. The actual drop in milk price post quota for many farmers may not be that significant since they are likely to be paying high lease charges towards the end of the Berlin Agreement period. An increase of 30% in milk output is a realistic target by 2010.

Margin from milk production 2010

The data in Tables 2 and 3 give the current margins in milk production. There is great variation in margins, which cannot be explained by soil type, weather etc. Targets for direct costs, common costs and total costs in 2010 are 25-30, 35-40 and 50-55 p/gallon, respectively. Assuming milk receipts of 80 P /Gallon (milk and livestock sales), the contribution margin is 25 to 30 p/gallon. This is equivalent to £25,000 to £30,000 for 100,000 gallons of milk quota.

Dairy farming systems 2010

Dairy farming system in 2010 will evolve to incorporate the following:

  • Consumer demands for a wider range of quality products, which are assured for safety, protection of the environment and animal welfare will increasingly be enshrined in legislation. These developments may provide market opportunities for the Irish dairy industry because of the potential in Ireland to meet consumer demands at least cost.
  • There will be very few part-time dairy farmers but household income will not be dependent on farming alone (spouse working off farm). Smaller farms with surplus labour may supply some farm services, which are not time critical (eg spreading fertiliser) to larger farmers.
  • Family labour (spouse and children) will be less involved in dairy farming in future. Partnerships tailored to Irish conditions will assume greater importance. Hired labour will demand a share of the equity of the business. Contractors will carry out more farm operations in addition to silage harvesting and slurry spreading.
  • Ecological and organic farming will assume much more importance. Ecological farming will be science based.
  • The feed resource will be predominantly based on grazed grass especially for spring-calving herds. Grass silage will assume less importance especially if concentrate prices continue to fall and if progress continues in relation to maize production (improved varieties etc). Concentrate feeding levels will increase.
  • Milk production systems will be more technologically driven and will increasingly use the products of production technology, biotechnology and information technology.
  • The skill level of dairy farmers will incorporate more business skills, computer skills as well as a high level of dairy production skills. Continuous updating of skills will be the norm as part of the annual work programme. Dairy farmers will also be far more aware of consumer requirements.
  • Future farming systems will have to conform to regulations in relation to the environment; food safety and animal health and these regulations will be enshrined in legislation. It is probable that farming systems will fall into one or more of the following categories:
  • Large High Tech Farms:
    • Economies of scale.
    • Units of ~200-500 cows or greater.
    • High merit dairy cows (predominantly Holstein-Friesian).
    • Very high output per cow.
    • 40-50% of calves will be beef/dairy crossbreeds.
    • Spring and autumn-calving systems and some combination of both.
    • Large capital input and multiple ownership.
    • Managed by salaried professionals.
    • Uses all products of production technology and biotechnology.
    • Intensive information systems and high output milk harvesting systems including some automated systems.
    • Very high skills used sourced through specialist consultants.
  • Ecological Milk farms:
    • Similar to current evolving Moorepark Blueprint for dairy production.
    • Science based production system.
    • Predominantly based on spring-calving herds.
    • Works in harmony with the ecosystem and evolves to improve ecosystem.
    • Nutrient management plans.
    • Dairy cattle breeds selected for medium to high yields of milk solids and high fertility indices.
    • 40-50% of calves will be beef/dairy crossbreeds.
    • Some premium on milk price.
    • Some level of monitoring for compliance.
    • High level of animal health and welfare.
    • Farm labour mainly supplied by farm owner.
  • Specialist winter milk farms:
    • Herds based on autumn calving.
    • Milk produced on contract.
    • Large premium on milk price.
    • Herds clustered together to facilitate milk assembly.
    • Dairy cattle breeds selected for medium to high level of milk solids and for high fertility indices.
    • Feed source will be maize silage; some grass silage and a high level of concentrate feeding.
    • Herds may fall into one or more of the other systems listed above.
  • Farming to Consumer Rules:
    • Farms accredited to meet "clean, green, natural, healthy, fashionable" standards.
    • Premium on milk price.
    • High quality backed by ethical integrity.
    • Dual-purpose cows.
    • Very high levels of animal health and welfare.
    • Environmental resource management.
    • Traceability.
    • Absence of `contaminants'.

Some issues in relation to the debate on the future development of the industry.

Comparative advantage

The issue in relation to comparative advantage of dairy farming needs to be addressed. Dairying is the most profitable livestock farm enterprise. This is likely to continue to be the most profitable enterprise even if milk price is reduced. The question arises as to whether such a large land resource in Ireland should be devoted to other livestock enterprises, which return such, low profit margins. This question can only arise if no milk Quotas apply. This means replacing other enterprises with dairy farms. Farmers who currently have no milk quota will be interested in milk production in future. The enormous benefit from scale of operation needs to be considered. There is no merit in thinking that we can get a good farm income from small farms always.

Seasonality

The present milk supply profile is likely to be a constraint to product development. The national strategy should be to have a portion of the national herd calving in the autumn. This is best achieved by having specialist autumn calving herds. The cost of this strategy is minimal in relation to the potential of adding value to milk and to better plant utilisation in the industry. Farmers have to be compensated for the extra costs involved as well as getting an additional margin over spring-calving production systems.

Labour

The cost, availability and skill level of farm labour is now becoming a critical issue for dairy farmers. It is likely that highly skilled farm labour will insist on getting equity in the farm business in future. This practice is widespread in New Zealand. New strategies are required to deal with this issue. Farm partnerships offer good opportunities. Access of young people into farming needs to be facilitated.

Land use

It is likely that land purchase prise will continue to be high. It is important that land use policies facilitate the availability of land for dairying. Land rental charges in future will depend on government strategy and subsidies for non dairy farm use of land. The method of decoupling subsidies can influence the availability and cost of land for dairying in future. Many farmers are constrained by farm size and farm fragmentation. Herd size can increase if access to land is available at a reasonable cost.

Environment and animal welfare

Farming systems need to be sustainable in terms of the environment and animal welfare. Ireland has a good track record in this regard. We need to build on this strength. There need be no conflict between profitable dairy farming and ecological sustainability.

Dairy Processing

The Dairy Processing Industry faces major strategic questions when confronted with the challenges of the free market. With a current product mix dominated by subsidised commodities, the direction for milk price is towards world market prices. Our relatively poor penetration of non-commodity markets leaves limited options for diversification in the short-term. On the other hand, we do not have the economies of scale to be cost leaders in bulk product manufacture. In the remainder of this presentation we focus on some of the factors which we believe are central to the development of a product strategy for the free market.

There are many who would argue that the best strategy for the future is to continue and consolidate our current emphasis on butter and milk powders based on seasonally produced milk from grass. In 1998, the proportion of milk converted into butter/butteroil was still close to 70% with cheese representing less than 20% of milk utilisation and only about 17% if one looks at the overall pattern over the past 10 years (Table 11).

TABLE 11: Irish whole milk utilisation - cheese

Year

%

1988

17.4

1989

16.2

1990

14.9

1991

15.6

1992

18.4

1993

18.7

1994

17.6

1995

15.1

1996

17.8

1997

17.1

1998

19.1

In spite of successive attempts through national strategic planning to promote diversification away from butter powder our traditional products have remained very resilient over many years. In a free market, we can be sure that our bulk commodities will return close to world market prices, which will be considerably below current prices, and therefore, if we maintain our current commodity mix, we will have to pursue a cost leadership approach in product manufacture in order to survive and be competitive. This is analogous to the strategy of New Zealand which many would see as our role model. However, there are others who would not find such a strategy acceptable on the basis that it minimises the value of our industry, leaves us exposed to the uncertainties of international bulk prices and underestimates our ability to achieve much greater product differentiation and to penetrate in a more substantial way premium consumer and industrial markets. From the perspective of the state, whose main concern is employment and wealth creation there is not much attractive about the prospect of a dairy industry producing only basic products and it is likely that grant supports, insofar as they will exist, will continue to favour added value projects..

Scale economies in milk powder production

In a commodity strategy our competitive position in powder production will be of critical importance in light of trade liberalisation and greater market dominance by non-EU countries. Australia and New Zealand have seen almost unlimited expansion in recent years and their plans for further expansion are even more impressive. Australia is pursuing a plan to almost double milk powder output and New Zealand aims to expand its dairy industry more than 3-fold in output value. These developments have been accompanied by significant technological investment in large-scale powder plants with accompanying economies of scale. In the meantime, EU quota restrictions have indirectly led to a slowing of technological investment, particularly in milk drying, in Ireland.

How competitive can Ireland be in milk powder production? We have put together a cost model for milk drying taking into consideration the most important cost elements in a typical powder plant i.e. capital contribution and milk assembly (Table 12).

TABLE 12: Typical costs of milk powder production

COST ELEMENT

p/gal

Packaging

1.6

Fuel and Power

1.3

Direct Labour

1.2

Direct Expenses

0.2

Interest

0.5

Collection*

4

Total variable cost

8.8

Contribution to Fixed Costs

5 - 10

Milk

100

Total

113.8 - 118.8

*O'Callaghan et al. private communication

We estimate that there are potential scale economies of 1-1.5p/gal in going from present dryer capacities of around 5t/h to capacities of 10-20t/h. However, these can be eroded by an increase in milk assembly costs if scale consolidation requires a large extension in the milk catchment area. Economies of scale therefore might only be realised when there is an increased intensity in milk production in a confined catchment area or where expansion improves the shape of the catchment area such that the processing plant is more ideally located at its centre. In a milk quota situation the latter condition would be essential to the achievement of scale economies through amalgamation.

If a processing site, in allocating its milk pool to different product streams, gives priority to the powder plant such that its operating season can be extended, a gross capital cost saving of 2p/gal, attributable to increased throughput, is possible. Such a strategy would marginalise other products, such as cheese, into the peak milk flow season, but would be consistent with the more capital-intensive nature of powder production. In New Zealand where large multi-functional processing sites exist or are planned, this most cost efficient approach to powder production can be pursued. In the context of our 2010 scenario, we could envisage three major processing sites for milk powder, each with a 30t/h drying capacity. If these were to operate at a maximum throughput of 75%, from a seasonal milk supply, each plant would require a milk pool of 450m gals and would have a powder output of 160,000 tonnes (whole milk powder equivalent). Milk utilisation into powder would be 66% leaving 150m gals for diversion to other products such as cheese or casein. Processing costs would come close to those in New Zealand, perhaps within 1p/gal. However, a disadvantage of about 1-2p/gal in milk assembly costs relative to New Zealand would still exist. The capital investment required for a complete renewal and expansion of production facilities to match the above output is in the order of £300m.

The differential in milk processing costs relative to New Zealand is considerably less than differences in milk production costs. Currently, as shown earlier in this paper, there is a differential in cash costs of milk production of over 30p per gallon. Even assuming that this differential can be halved by improved technology and farm structure, it is obvious that we cannot be cost-competitive with New Zealand, and the main cost-disadvantage by far, is associated with milk production.

The foregoing shows that the pursuit of scale efficiency as the central focus of industry strategy can improve our cost base somewhat in powder production. In some other respects, however, the consequences may be negative. Large dryers are inflexible and make it difficult to supply a diverse range of powder products for different markets and different customer specifications. The very short manufacturing season for other products, necessitated by a milk powder focus, would militate against the development of value added markets. Hence, the product range could be even less diverse than today. A shortening of the production season for non-powder products has its own implications for the processing costs of these products which can diminish the benefit of maximising throughput in the powder plant. Achieving market share for our powder output might not be simple because of a residual cost disadvantage relative to our competitors and in view of the massive expansion in output which they are aiming for. In Australia, where a rapid expansion of milk powder production is anticipated, the emphasis has been placed more on flexibility than scale and, in one example, a decision was made to build two driers of 7.5t/h capacity rather than one of 15t capacity.

Many of the efficiencies of a mega processing site can be achieved by a smaller site if operation through the winter was possible. Our model shows that year-round operation of a 5t/h drier can be as efficient in capital costs as a larger drier operating at lower capacity. Scope for near-continuous operation of smaller dryers does exist by co-operation between companies in the pooling of winter milk into a single site, and, where this can be achieved, there is no scale disadvantage. However, it is difficult to envisage such a strategy accounting for more than a small proportion of powder output in an expanded milk pool.

Our conclusion is that Ireland's future investment in milk powder production should be based on driers of capacity of no more than 7.5 - 10.0 tonnes/h. The benefits of having these located in a small number of 'mega' processing sites, rather than a larger number of medium output sites, will depend on a number of factors. One of these is location relative to the milk catchment area and if this is not optimal the benefits of scale consolidation can be neutralised by additional milk transport costs.

Specialised commodities

The wisdom of consolidating our industry into bulk products, largely undifferentiated, for disposal at world market prices, would be questioned by many. Indeed many Irish companies already try to specialise and differentiate their commodity business and thereby increase the degree of customer focus in their operation. This imposes a need for flexibility in product manufacture which can act counter to the relentless pursuit of scale as a central strategy for competitiveness. However, specialisation in powder commodities in itself would be an inadequate platform for future growth and development. Current markets are finite and relatively easy for competitors to access. Development prospects for butter are equally constrained and while steady progress is being made in premium butter exports, the additional milk volume represented by the growth will be modest. Opportunities to develop our other major product, Cheddar, are also limited. While there is growth in the premium mature end of the market, which Irish companies are well aware of, competition is stiff in this market segment and it does not necessarily reflect a growth in Cheddar consumption overall. In general, we must conclude that, with our present product mix, opportunities for adding further value may be limited and, in the case of cheddar, growth opportunities will be difficult to find. The implication of this is that any expansion of milk output in the future will be channelled into basic powder products unless a clear strategy is pursued to diversify our present product range.

Prospects for cheese

Any search for an alternative to basic powder products inevitably leads to an examination of prospects for cheese. There are good reasons for this. Internationally and in particular, in advanced consumer markets, cheese consumption is growing. The OECD forecast that cheese consumption in OECD countries will grow by 6.3% between 1996 and 2001. In the EU increase in cheese consumption is expected to be 1.1%/annum until 2000 and around 1% up to 2005 (Table 13). Growth is related to increasing affluence and to the high nutritional value and continuing product innovation associated with cheese. These factors should continue to sustain growth in consumption into the future.

TABLE 13: Forecast European cheese consumption

000t

2002 v. 1997

Self-sufficiency

Germany

1,771

3%

94%

France

1,444

2%

111%

Italy

1,234

5%

77%

Netherlands

335

6%

216%

UK

652

6%

56%

Denmark

101

NC

254%

Spain

262

36%

71%

Greece

238

7%

78%

Sweden

166

6%

69%

Austria

143

6%

68%

Finland

93

9%

94%

Ireland

29

12%

297%

Belgium

192

3%

38%

Portugal

84

9%

80%

EU-15

6,743

4%

95%

Source: Dairy Industry Newsletter

Today the prevailing view is that there may have been relatively little advantage in producing commodity cheese instead of butter/SMP over the past 10 years. Statistics on price variations for cheeses sold in the EU show that among the main commodity cheeses, Gouda, Edam, Cheddar, Emmenthal and Camembert, only Emmenthal substantially outperformed butter/SMP while Dutch Gouda was a significant under-performer (Table 14). Some lower volume cheeses (Brie, Danablu, Havarti) however, performed much better . The conclusion might be that, in order to gain market premium, the best products are specialised cheese varieties of intermediate volume where growth potential can be realised. This has been the strategy of the Danish dairy industry in recent years. Their main processor, MD Foods has consistently pursued an aggressive development strategy, based on cheese, which overall, represents almost 60% of export value of the Danish dairy industry. Five years ago there was a dramatic loss of markets for Danish produced feta cheese but a successful marketing and product development strategy since then has seen that loss recovered through increased cheese sales in the EU, in particular in the German market. The main focus of their strategy was to move away from bulk type cheeses, such as feta, towards more value added products that would be less affected by support policy reforms. This move from volume to value was primarily based on building greater market share through brands and own label, in a range of cheese varieties, many of which they were already producers of. Today the profitability of cheese is substantially greater than butter/SMP.

TABLE 14: Increase/decrease in selected wholesale dairy prices 1989* - 1997*

PRODUCT

COUNTRY

ECU - INCREASE/DECREASE %

SMP

Europe

2%

WMP

Europe

-2%

Butter

Europe

1%

Cheese types:

Brie Laiter

France

22%

Danablu

Denmark

16%

Havarti

Denmark

14%

Havarti

Germany

13%

Emmental

France

8%

Tilsiter

Germany

6%

Cheshire

UK

6%

Cheddar

UK

4%

Edam

Netherlands

4%

Provolone

Italy

3%

Grana

Italy

2%

Cheddar

Netherlands

1%

Camembert

France

1%

Edam

Germany

-1%

Gouda

Germany

-1%

Gouda

Netherlands

-6%

*Refers to three year averages centred on the year named

The Danish model is a difficult one for Ireland since Irish companies have a much smaller range of cheese products and a much lower market penetration to build from than MD Foods. Nonetheless there are many reasons why greater emphasis on cheese would be to our advantage in the future. Firstly, cheese as a commodity product for consumer markets should offer greater price stability in a free market than butter and milk powders. Secondly, cheese is a growth product both in advanced western society and in the world overall. Thirdly, the opportunities for product differentiation and hence for adding value above basic commodity value, are more diverse for cheese than for butter or milk powders. A unique feature of cheese is its versatility as a food. Three distinct market channels have developed i.e. food retailers, the food service sector and food processors. In the food retail sector, developing major new volume brands is extremely difficult and there are relatively few examples on a European scale over recent years. Differentiation within existing brands offers continuing opportunities (examples would be bio-cheese, low-fat, 'territory and taste') but may have a modest impact on volume. The best example of a new variety from Ireland is Dubliner cheese, which, in its original concept, was an attempt to modify some of the sharp taste features of cheddar to suit a continental palate. Dubliner, and similar concept cheeses for table consumption, can be an important part of future milk utilisation, but they do rely on the taste preferences of individual consumers and, as such, face a most difficult marketing challenge. Nonetheless, there are many possibilities for modifying both the flavour and texture of cheddar to suit entirely new markets, with the advantage that existing cheddar plant can be used, without the need for substantial capital investment. Indeed, if we moved to year-round production, there is the capacity in existing plant to increase output of cheddar and related cheeses to 150,000t. Current research at Moorepark is aimed at exploring the potential of this 'hybrid' cheddar concept, and the facilities of Moorepark Technology can ease the way into markets by providing a pre-industrial scale contract manufacturing service.

In the food services and food processing sectors the buyer of cheese is an industrial customer. These companies have different expectation in terms of packaging, customer care, logistics and product specifications. Varying requirements for taste and functionality provide unlimited opportunities for product differentiation. Consumer trends suggest that growth in the food service and food processing sectors will continue to be strong. Currently, the breakdown of cheese consumption in volume terms in the EU between retail, food service and food processing is 70:20:10, compared with an even split (1/3:1/3:1/3) in the US. The trend throughout Europe is in the direction of the US split. In recent years the success of Mozzarella is noteworthy and, while that market is increasingly competitive, differentiated cheese products for catering and food processing would appear to offer the best option for Irish companies for value added and growth.

In the EU, there is a steady if modest growth in cheese retail sales and per capita consumption. Much of this increase in consumption is in fresh cheese which, is not a major product category for Irish companies. Certain technological and logistical barriers exist to entry by Irish companies into mainstream fresh cheese markets of the EU where the preference is for fromage frais type products. A more accessible market for Irish companies may be S.E. Asia where the market is still immature and where the main opportunities may be for cream cheese which technologically is a more suitable product for Ireland. While Oceanic countries will be stiff competitors, nonetheless, S.E. Asia is a significant area of growth potential for the future and should be included in strategic planning for 2010.

A significant contributor to returns from cheese is the value of the whey products. Irish companies are to the fore in whey processing technologies and, through continued innovation, can channel greater volumes of whey into differentiated ingredients in the future. Casein manufacture, which is an alternative source of whey, may be a less attractive option than cheese in a free market, and hence our ability to continue to expand in whey technology may be directly linked to cheese output.

Functional foods

In Europe the market for functional foods is still very much in its embryonic stages, as consumers are becoming more aware of the health associations of these products. As this link becomes more evident the market for these products will develop at a significant rate. It is forecast that product developments in functional foods will surpass developments in diet and low calorie foods and that the functional foods share of the total food market could ultimately reach 5% over the next 15 years although this will probably be higher for dairy foods. The functional food market offers special opportunities for the dairy industry since dairy products have already strong health associations and can provide a natural medium as fermented products for probiotic cultures. Opportunities will exist for joint ventures with non-dairy companies such as pharmaceutical and health companies that have developed consumer confidence and integrity in their brands as healthy and functional products. It is expected that innovative manufacturers can benefit greatly from the functional food market.

The challenge for the future

The growth in consumption of dairy products is driven by consumer trends which arise from increased affluence, demand for greater variety and greater health awareness. It is not the purpose of this paper to analyse these trends, which are already well documented. What is clear is that exploitation of the opportunities presented by consumer trends will only be possible for companies with a clear commitment and strategy for innovative product development, backed-up by appropriate investment in technology, R&D and marketing. It is this challenge that provides one of the most cogent reasons for rationalisation of the dairy industry into larger units.

The future direction of Ireland's dairy industry will be set by actions taken over the next few years. If we do nothing, we will face the world commodity markets with an uncompetitive cost base. Scale consolidation can improve our competitiveness, but if pursued with the single objective of cost reduction, will drive our industry into an inflexible commodity corner with little potential to generate a margin above basic bulk value. Scale consolidation, accompanied by a strategy for product diversification, will bring cost economies for bulk products, but its most important consequence would be to provide the resources and marketing power to achieve greater product differentiation and value added. Whichever course of action is pursued, the industry faces major capital investment in advance of the free market. The producer, who has the greatest vested interest in the industry and in decisions taken about its future direction, should consider how he might participate in financing future change and thereby influence the direction of change to suit the best interests of the next generation of dairy farmers.

Summary

  1. A national milk pool of ~1.45 billion gallons is a realistic target in 2010. Up to 20,000 dairy farmers each on average producing ~70,000 gallons of milk per annum with much larger herd sizes (~60 cows). There will be no farmer producing less than 20,000 gallons.
  2. Ireland is cost competitive relative to our competitors in Europe. The dairy industry will have to incorporate other issues in relation to competitiveness such as technologies used to produce food, food safety, animal welfare and the environment.
  3. Ireland can compete in 2010, because of our cost competitiveness and the great potential for technological change. The structure of dairy farms should be much improved in 2010.
  4. An increase in milk output by up to 30% in 2010 is achievable. The productivity of the National herd is low currently. An increase of 150-200 gallons per cow is achievable if milk quotas are removed. A large proportion of dairy farmers will be leasing milk quota or paying off milk quota purchase loans (short-term loans) in the short to medium term. They will be well placed to expand when lease charges etc are removed. It is technically possible to increase farm milk sales by 60 % within a four year period on farms where the dairy herd accounts for less than 50 % of all livestock units on the farm (increase in cow numbers mainly). Cash flow problems will arise in years 2 and 3. The application of improved technology has the capacity to increase milk output significantly. A combination of some or all of these strategies makes an increase in National milk output a realistic target by 2010.
  5. Targets for direct costs, common costs, total costs in 2010 are 25-30, 35-40 and total costs of 50-55 p/gallon, respectively. Assuming milk receipts of 80 p/gallon (milk and livestock sales), the contribution margin is 25-30 p/gallon. This is equivalent to £25,000 to £30,000 for 100,000 of milk quota.
  6. Systems of production will evolve to incorporate consumer concerns, many of which will be enshrined in legislation.
  7. Ireland's cost base for dairy commodity manufacture is considerably higher than New Zealand's. Most of the cost differential is on-farm. In pursuing scale economies in milk processing there is a trade-off between cost reductions on the one hand, and product flexibility and milk assembly costs on the other hand. There will be a need for massive re-investment in milk dryers in preparation for the free market. A maximum dryer capacity of 7.5-10t/hr is more appropriate than the jumbo dryers of New Zealand.
  8. With our current product mix, Ireland's milk price in a free market will be close to world market prices and the expanded milk output after quota abolition will be channelled into milk powder for the world market. Opportunities for commodity specialisation will continue to exist but will not provide an adequate platform for future development.
  9. Opportunities exist for the Irish dairy industry to achieve growth in value-added markets and thereby to do better than basic commodity returns. The key to value-added is product differentiation. The main volume opportunities for value-added are in cheese. Cheese markets which should be targeted are medium volume speciality cheeses for the EU, the food service and food processing sectors and cream cheese for the Asian market.
  10. Ireland can be a leader in ingredient product differentiation mainly through exploitation of whey technology. Opportunities will also exist for added value in the growing functional foods market.
  11. The most important benefit of consolidation of the Irish dairy industry into bigger processing units may be the ability to finance product differentiation rather than the improvement of costs.
  12. The producer can best influence the future direction of the Irish dairy industry by investing in its development programme.

REFERENCES

Boyle, G. ( 1998 ). The competitiveness of Irish agriculture, Agricultural Science Association annual conference.

Dillon, P., Buckley, F. and Cliffe, D.(1998). Achieving high intakes and performance from spring-calving cows at pasture. The production of high quality milk from grass and other feeds. Conference Proceedings. Teagasc Publication.

Fingleton, W. (1996). Cost competitiveness in milk production - a key issue.

Competitiveness of the agricultural and food industries. Agri-Food Economics Conference.

Fingleton, W. (1998). Major fall in milk production costs. Todays farm, November/December, 1998.

Sheehy, S. (1996). Are milk Quotas still the best national strategy for Ireland. Proceedings of the 50th Anniversary Dairy Conference, Irish Grassland Association.