of dairy CONSOLIDATED CONSOLIDATED ANNUAL REPORT ANNUAL Creating the future Creating
Arla Foods Consolidated Annual Report 2016 Contents
Management review Consolidated financial statements 2 2016 in short 80 Consolidated financial statements 4 Arla’s milk wheel 82 Primary statements 6 Moving forward after a volatile 90 Notes year by Chairman of the Board 136 Independent auditor’s report of Directors, Åke Hantoft 138 Statement by the Board of Directors Branded growth in a volatile 8 and the Executive Board market by CEO, Peder Tuborgh 10 Significant events in 2016 14 Strategy 30 Governance 42 Performance 58 Risk and opportunity 68 Values and considerations
Project management: Corporate Finance and Corporate Communication, Arla Copy, design and production: We Love People Translation: TextMinded Photos: Jens Bangsbo, Hans-Henrik Hoeg and Arla
The consolidated annual report is published in Danish, Swedish, German, French and English. Only the original Danish text is legally binding. The translation has been prepared for practical reasons.
Financial statement of the parent company Under section 149 of the Danish Financial Statements Act, this consolidated annual report represents an extract of Arla’s complete annual report. In order to make this report more manageable and user-friendly, we have decided to publish a consolidated annual report without the financial statements of the parent company, Arla Foods amba. The annual report of the parent company is an integrated part of the full annual report and is available on www.arlafoods.com. Profit sharing and supplementary payment from the parent company are set out in the equity section of the consolidated annual report. The full annual report contains the statement from the Board of Directors and the Executive Board as well as the independent auditor’s report. Glossary
Brand share is the ratio of revenue from strategic branded products of Arla’s total revenue. Strategic branded products are defined as products sold under one of the three global brands - Arla®, Lurpak® and Castello® and strategic brands.
Capacity cost includes costs such as staff, maintenance, energy, IT, travelling and consultants.
Conversion cost is the total cost of production per kg raw milk excluding the cost for milk and materials within the production site which are related to the production of goods.
EBIT is an abbreviation of earnings before interest and tax.
EBITDA is an abbreviation of earnings before interest, tax, depreciation and amortization.
EBIT margin is EBIT as a percentage of total revenue.
Equity ratio is the ratio between equity excluding minority interests and total assets.
Interest cover is the ratio between EBITDA and net interest costs.
Leverage is the ratio between net interest-bearing debt inclusive of pension liabilities and EBITDA.
Net interest-bearing debt inclusive pensions is defined as current interest-bearing liabilities less securities, cash and cash equivalents and other interest-bearing assets plus non-current liabilities.
Organic revenue growth is revenue adjusted for the effect of mergers, acquisitions, divestments of businesses and currency effects.
Peer group index evaluates the relative performance of Arla compared to competitors without considering the retainment policy calculated as the performance price for Arla divided by the weighted average performance price of the peer group.
Performance price for Arla is defined as the prepaid milk price plus net profit per kilo member milk weighed in within the period.
Prepaid milk price equals the on-account payment owners receive per kg milk delivered during the settlement period. The price is primarily based on the milk’s constituents, i.e. fat and protein, and quality.
Net working capital is the capital that Arla has tied up in inventories, receivables and payables including payables for owner milk.
Net working capital excluding owner milk is defined as capital that Arla has tied up in inventories, receivables and payables excluding payables for owner milk.
Retail and foodservice volume driven revenue growth is defined as revenue growth associated with growth in retail and foodservice volumes while keeping prices constant.
Scalability is defined as the ratio between retail and foodservice volume driven revenue growth and growth in total capacity cost adjusted for special items.
Strategic branded volume driven revenue growth is defined as revenue growth associated with growth in volumes from strategic branded products while keeping prices constant. Strategic branded products are defined as products sold under one of the three global brands - Arla®, Lurpak® and Castello® and strategic brands.
Trading share measures the total milk volume used to produce commodity products compared to the total milk consumption in Arla. A commodity product is sold with a lower amount of value added or no value added at all.
Volume driven revenue growth is defined as revenue growth associated with growth in volumes while keeping prices constant. 2016 in short Peer group index*
We evaluate our performance and the success 105 of our strategy and business model by utilising key performance indicators. We have chosen 2016 105 2015 104.6 to measure these key performance indicators 2014 103.8 because we believe they best demonstrate how Target range 103-105 Target for 2016: 103-105 √ we are driving the business and creating value for our owners. Brand share**
Our strong performance in 2016 reflects the successful execution of our strategy, Good Growth 2020. Despite a lower milk price and volumes, we achieved nearly all of our key performance indicators. 44.5% 2016 44.5% 2015 42.1% 2014 41.2%
Scalability
√ Target achieved. (√) Target not fully achieved. X Target not achieved. All key performance indicators include the gain from sale of Rynkeby. >2.0
* Peer group index for 2016 is preliminary before year-end results have been published for Royal FrieslandCampina N. V. and 2014: >2.0 2015: >2.0 2016: >2.0 Deutsches Milchkontor eG. ** Brand and International shares are based on retail and foodservice revenue excluding third party manufacturing (TPM) revenue. Trading share is based on milk consumption. *** Based on profit allocated to owners of Arla Foods amba. Target for 2016: >2.0 √ Milk volume Revenue Strategic branded volume driven revenue growth
6% 13.9 9.6 5.2% 4% billion kg billion EUR 2% 3.4% 5.2%
0%
2015 2016 2016 13.9 bkg 2016 9.6 EURb Strategic branded volume driven revenue 2015 14.2 bkg 2015 10.3 EURb growth rate for 2014 is not available due 2014 13.6 bkg 2014 10.6 EURb Target for 2016: 4-5% √ to the restructure of the organisation.
Retail and International Trading Conversion cost foodservice volume share** share** driven revenue growth
2.7% 18.0% 20.1% 99.2 2016 2.7% 2016 18.0% 2016 20.1% 2016 99.2 2015 3.9% 2015 16.5% 2015 21.5% 2015 98.0 2014 3.5% 2014 15.5% 2014 20.9% 2014 95.0
Target for 2016: 3-5% (√) Target for 2016: 98.5 X
Leverage Profit share*** Performance price 30.9 EUR-cent/kg 2.4 3.6% 45 of revenue 41.7 40
35 33.7 2016 2.4 2016 3.6% 30 2015 3.3 2015 2.8% 30.9 2014 3.7 2014 3.0% 25 Target range 2.8-3.4 Target range 2.8%-3.2% 2014 2015 2016
Target for 2016: 3.2 √ Target for 2016: 2.8-3.2% √
6 Annual report 2016
Performance price (EUR-cent/kg) “In a tough year, 50 the Board of 40 41.7 41.0
Directors found 36.9
30 33.7
it very reassuring 30.9* to have a solid 20 strategy in place to guide the 10 business.” 0
Åke Hantoft, Chairman of the Board of Directors 2012 2013 2014 2015 2016
* Including gain from sale of Rynkeby. Business review | Strategy | Governance | Performance | Risk and opportunity | Values and considerations | Consolidated financial statements 7
Mission To secure the highest value for our farmers’ milk while creating opportunities for their growth. Moving forward after a volatile year
How would you autumn. This really highlighted the tough as 2016, the Board of amba in the coming years. If we summarise 2016? pressure that every single farmer Directors found it very reassuring succeed in doing this, it would In 2016, we experienced had been under as a consequence to have a solid strategy in place to certainly be a true milestone in the unprecedented market volatility in of the tough market conditions. guide the business. history of our multinational raw milk production, as well as farm On a positive note, it does look like cooperative. gate prices. However, Arla’s strong we now have a period of recovery The Board of Directors and brands and broad product portfolio, ahead of us. Board of Representatives have What are the biggest combined with the presence in been working on the new challenges and opportunities markets across the world, prevented What role does Arla’s owner strategy. What is the that lie ahead? our milk price from hitting the strategy, Good Growth 2020, impact of the decisions and Through our strategy we have extremely low levels we saw in the play for the owners? direction set out in 2016? identified key opportunities. industry. Unfortunately, the market Good Growth 2020 is the vehicle Following the mergers between Demand for natural and healthy situation meant the effort was not to execute our mission. It was 2011 to 2014, we decided to align products, e-commerce and other sufficient to secure a sustainable developed to take account of our local democratic structures trends will guide our business and income on our farms. every kg of raw milk supplied and to strengthen the dialogue brands towards 2020. We will to create the highest possible between members, elected continue to tell our cooperative How would you describe value for us as owners. representatives and management. story and share with consumers the situation among owners This also enables us to streamline and customers the effort every during the year? As a result of our high quality milk, administration and ensure a single farmer puts in to their farm It was extremely challenging. Arla has become one of the world’s harmonised approach. every day of the year. This includes Reactions were different from largest dairy companies. Our care for animals and nature and owner area to owner area, which business is based on many building Face to face meetings once again the pride taken in producing mirrors the local market, political blocks from brands, products, proved to be the backbone of our nutritious, high quality milk. The and industry issues. From a milk markets to production sites and cooperative. We want to further challenge is to grow our business price perspective, 2016 was a core processes. Put together, they strengthen this dialogue and in a year in which we expect the terrible year, during which we drive Arla and our milk price. Our engagement among our owners. same level of raw milk from our experienced unsustainably low current strategy provides very The Board of Directors is also owners. This requires strong prices for our milk. The relief from clear guidance on Arla’s focus investigating if it is possible, prioritisation from the business, my farmer colleagues was huge areas, not only to employees from a legal and cooperative and again, we will be guided by our when we were able to start working to deliver our strategy, but perspective, to offer all owners strategy. increasing the Arla milk price in also to our owners. In a year as direct membership in Arla Foods
Our cooperative story Arla’s cooperative foundation has a long history. More than 100 years ago, the first dairy cooperatives were founded in Scandinavia with the purpose of buying, processing and selling owners’ milk in the best possible way. Today, our cooperative owners are still both owners and suppliers of Arla. This is the cooperative’s key strength: long-term, mutually obliging cooperation. Arla’s owners are obliged to supply milk to Arla thereby securing supply of our most important raw material and Arla is obliged to buy their milk at the highest possible price. 8 Annual report 2016
“2016 proved our strategy to be the right one for Arla.”
Peder Tuborgh, CEO Business review | Strategy | Governance | Performance | Risk and opportunity | Values and considerations | Consolidated financial statements 9
Vision Creating the future of dairy to bring health and inspiration to the world, naturally. Branded growth in a volatile market
2016 was the first year of supply chain delivered savings of unsustainably low milk prices in working with the new strategy, EUR 100 million. the same way as other European Brand share Good Growth 2020. How did it dairy farmers did in autumn 2016, play out? Can you give some examples and we experienced significantly Good Growth 2020 has truly of how Arla contributed to the decreasing milk volumes. 44.5% guided our business in 2016 and market in 2016? 2015: 42.1% we have already come far on our A very successful example is our Currently, increasing milk prices strategy journey. We are more Puck® portfolio. A relaunch of the are generating renewed trust in International share focused than ever on brand and brand combined with a new the future, and hopefully, Arla will category development as well as compelling campaign has boosted see increasing milk volumes geographies. We managed to sales in the Middle East and North coming from owners in all mitigate the impact of the Africa. In Europe we are also countries in the coming years. 18.0% extremely volatile market in strengthening our business and We need the milk to keep the milk 2015: 16.5% Europe, and in many regions we the Arla® brand. Examples are the wheel turning and pursue the full succeeded in building our market Arla® branded skyr and protein growth potential of our brands and Scalability shares with our International products, which are resonating markets. business. Furthermore, with a extremely well with consumers. focused effort, we increased our This is just one example of how we What is the outlook for 2017? >2.0 brand share from 42.1 per cent in continuously respond to consumer You will see Arla take an even 2015: >2.0 2015 to 44.5 per cent in 2016. trends for natural and healthy stronger position in the market as We also improved our equity and products. These characteristics are an innovative and responsible leverage. I have no doubt that in also the essence of Arla products farmer-owned dairy company, 2016 we proved our strategy to be and have been for many years. which provides natural and healthy the right one for Arla. food to consumers and customers. It is in Arla’s cooperative In 2016, the new Executive DNA and company mission to We aim to significantly increase our Brand portfolio Management Team and welcome and process all engagement in the foodservice Our strong brand portfolio is the new organisational owner milk, unconditionally, sector, as Arla has solid experience at the core of our business structure was introduced. however, in 2016 volumes and unique solutions to offer. and an important driver for What was the thinking behind decreased. How does this We will build on the current growth our success. Our strategic these changes? affect Arla going forward? in e-commerce. Guided by our brands are Arla®, Lurpak®, In spring we restructured the Arla has the processing capacity vision, identity and strategy, I am Castello® and Puck®. organisation to match our new and logistics solutions in place to convinced that we will create strategic scope with a functional handle more milk than our owners growth in the market and generate set-up driving synergies and clear are currently supplying. In 2015, a stronger performance price for responsibilities across the business. and during the first months of our owners. Following a very Through a more unified and 2016, when our milk volumes challenging and volatile 2016, the lean approach, we made more were still increasing, our dairies entire organisation has never been than 500 administrative roles operated at full speed, improving more committed to deliver in 2017. redundant. At the same time, an our conversion costs. However, efficiency programme within Arla’s owners responded to the 10 Annual report 2016
Significant business events in 2016
Contributing to local dairy production in Nigeria Arla has officially committed to contribut- ing to local dairy production in Nigeria. In For Arla, 2016 was characterised by change from both the internal and doing so, Arla contrib- external environments. Following the restructure of the organisation utes to the sustainable and cross-market alignment of our business, we stepped up value development and creation as outlined in our strategy, Good Growth 2020. This is clearly growth of the dairy sector in the country. reflected in the business highlights for the year.
Q1
New strategic partnership in the US ONE cooperative created in the UK Arla and the world’s largest farmer-owned cooperative, Following the merger between Arla Milk Link and Arla Milk Dairy Farmers of America, entered into a cooperation that Cooperative, on 1 January, Arla’s owners in the UK united to includes a new dairy plant for cheddar cheese production and form a new cooperative, the UK Arla Farmers’ Cooperative Ltd. the exploration of premium product opportunities. This has ensured a more aligned approach for the UK members, thereby maximising efficiency within Member Relations.
Q1 Q1
The new organisation goes live On 1 March, the organisational restructure went live. As part of the restructure the workforce was reduced by more than 500 white collar colleagues. The new functional organisation is Closure of Hatfield designed to deliver the strategy, Good Growth 2020, and Peverel dairy optimise Arla’s performance in a highly competitive global dairy Following a review of the market by strengthening value creation and efficiency. processing requirements across the UK and significant investments in the Aylesbury facility, the decision was made to Responsible Growth Natural close the milk processing Growth production facilities at Good Hatfield Peverel dairy in Growth Cooperative the UK. Growth
Healthy Growth
Q1 Q1 Business review | Strategy | Governance | Performance | Risk and opportunity | Values and considerations | Consolidated financial statements 11
Q1 First quarter Q2 Second quarter Q3 Third quarter Q4 Fourth quarter
Corporate responsibility plan towards 2020 The Executive Management Team approved the corporate responsibility plan underlining Arla’s pledge to drive a responsible business. Part of this plan is to ensure that responsibility in Arla is embedded throughout the business.
Q2
Arla incentivises non-genetically modified feed Sale of Based on commercial opportunities, the Board of Directors Rynkeby Foods A/S decided to actively encourage farmers to produce milk using In order to focus on the non-genetically modified feed by paying an extra one EUR-cent core business and per kg milk. In Sweden, all dairy products are already produced following the sale process from non-genetically modified feed. initiated in 2015, Arla sold Rynkeby Foods A/S to the largest producer of Q2 fruit-based beverages in Europe, Eckes-Granini Group GmbH. Rynkeby 1 billion SEK bonds was the last major issued non-strategic asset. Arla issued 5-year SEK bonds for a principal amount of SEK 1 billion targeted at professional investors. The issue refinances elements of New packaging site Arla’s existing bank debt as Q2 opened in Senegal a supplement to other A new Dano® long-life financing sources. milk powder packaging Full ownership of Westbury Dairies Ltd. facility opened in Dakar, Arla took full ownership of the operations at Westbury Dairies Senegal with the capacity Ltd. in the UK, and strategically moved a substantial proportion to handle 5,000 tonnes of butter production from Lockerbie to Westbury to secure of milk powder. Senegal economies of scale. will be an important gateway for further expansion in West Africa.
Q2 Q2 Q4
New business in Ghana Democratic structure alignment In line with the strategy, Good Growth 2020, Arla established with new owner strategy a fully-owned subsidiary in Accra, Ghana. The goal is to create Following the mergers during the period 2011 to 2015, the opportunities for European farmers by promoting the Board of Representatives decided to align Arla’s democratic Dano® brand. Ghana is the second largest economy ownership structure and processes across the seven owner in Africa and an effective gateway to other opportunities in countries. West Africa.
Q4 Q4 12 Annual report 2016
Significant marketing events in 2016
Brands successfully delivered the majority of our growth in 2016, helped by the launch of new innovative branded products and strong marketing campaigns. To create further awareness of our cooperative roots among consumers, we continued to strengthen our farmer-owned campaign. All of these developments are clearly reflected in the marketing highlights for the year. Launching Arla® B.O.B In the UK, Arla successfully launched Arla® ‘Best of Both’, which is a unique and innovative fat-free milk product that tastes as good as semi-skimmed milk. Arla® B.O.B exemplifies our focus on Arla cheese spread launches in the Philippines launching healthy ® In April, Arla Cheesy Spread was launched in the Philippines, and has products and inspiring been a game changer in the market. The natural product made from real good food habits. milk is perceived to be of higher quality compared to competing products. Arla® B.O.B was also ® The successful campaign raised extensive awareness of the Arla brand, commended by The and helped us grow five per cent in the ambient cheese spreads category. Grocer and won ‘best dairy launch’ of 2016.
Coffee you love, with a twist In 2016, a new campaign introducing everyone’s favourite hot beverage in a chilled and accessible on-the-go size was launched. Arla Lactofree® champions dairy revolution The Starbucks chilled coffee drink is continuing its strong Responding to the increasing consumer demand for lactose momentum and is available in 28 markets worldwide. Finishing free products, new Arla Lactofree® products were launched, the year on a high note, distinctive Christmas packaging was supported by a marketing campaign in the UK. In Denmark, released and consumers were invited to share a moment of the Arla Laktosefri® brand hit retailers’ shelves. This is the connection with Arla’s first-ever Snapchat campaign in the UK, fastest growing fresh milk product launch ever. which helped us reach nearly five million users. Business review | Strategy | Governance | Performance | Risk and opportunity | Values and considerations | Consolidated financial statements 13
Farmer-owned campaign Growing is going strong speciality cheeses Our farmer-owned To inspire more everyday campaign raises consumer consumption of speciality awareness, differentiates Puck® wins gold cheeses, a successful us from competitors and In the Middle East and North Africa the Puck® brand won a Gold smorging campaign and instills higher consumer Effie at one of the world’s most acclaimed marketing events. impactful TV commercials trust in our products. By the The relaunch campaign celebrating the everyday chef proved were released to drive end of 2016, we have highly successful and led to brand leadership in the region, growth and value. Our integrated the marque on where Puck® holds the number one position in jar cheese Castello® brand is a strong 70 per cent of all Arla® across core markets. Puck® also reached thousands of cooking performer in a long list of branded packaging, which enthusiasts through sponsorship of Top Chef, a popular reality markets, particularly in the means it is visible on more cooking show. The campaign achieved a gross rating point UK, Australia and Sweden. than 750 different products. 55 per cent above expectations.
Nothing but great taste It has been nothing but a great year for the signature chocolate milk, Cocio®. The brand celebrated its 65th anniversary by delivering double digit growth and rapid global expansion. Cocio® is now available in 17 markets, with India and Israel being the latest additions. Global Lurpak® campaign kicked-off By getting consumers back in the kitchen, the global Lurpak® campaign ‘Game on, Cooks’ aims at strengthening its position as the world’s biggest butter brand. The campaign has reached 34 million people through digital content in the UK alone. Since the start of the campaign brand awareness showed an increase of 13 per cent and there was a 35 per cent increase in sales of Lurpak® block butter in the UK, driven by value rather than volume. Strategy Good Growth 2020
Our strategy, Good Growth 2020, sets out how we will grow our business in eight global dairy categories and six market regions around the world as ONE effective and unified cooperative.
EXCEL FOCUS WIN in eight categories on six regions as ONE Arla
Content
16 Responding to change 18 Creating Good Growth towards 2020 20 Excel in eight categories to increase value creation 22 Focus on six regions to strengthen and expand our footprint 24 Win as ONE to create a global, coherent and efficient Arla 26 Seven essential business priorities is an enabler for Good Growth 2020 28 Seven essential business priorities for 2016 29 Seven essential business priorities for 2017 16 Annual report 2016
Responding to change
Key market dynamics impact the global dairy market as we move towards 2020. The exponentially changing world is presenting new challenges and opportunities for Arla. We have identified the trends that will impact Arla significantly in order to respond to them efficiently. The transformational drivers embedded in our strategy, Good Growth 2020, will determine our future success.
Supply and demand of milk PIN code of the world A branded business drives earnings The dairy industry is global but the supply Developed markets are stable, however they Prices are volatile and will continue to be and demand for milk are increasingly have low growth rates, while emerging volatile in the future, which emphasises the geographically detached. Some regions like markets are growing significantly but also need to improve the underlying business Europe, USA and Oceania have a milk carry higher risk. Approximately 95 per cent composition. With strong brands as a key surplus, while regions like Asia, the Middle of dairy growth is generated outside of differentiator the business can be close to East and Africa have a milk deficit. Europe and the growth outlook remains consumers, driving trust, loyalty and better unchanged. returns. The price premium of a branded
KEY MARKET DYNAMICS MARKET KEY In Europe, the low price level in 2016 drove business generates higher margins than volatility in milk production. Milk volumes The PIN code of the world identifies the trading and private label alternatives. In the decreased in 2016, which was a big change world population as we know it. In 2016, long run, the branded business will win over compared to the expectations a year ago. the code is 1114; 1 billion people living in the commodity market through increased As a result, the latest outlook shows a Europe, 1 billion people in the Americas, stability and higher prices. postponement of the expected increase in 1 billion in Africa and 4 billion in living in Asia. milk intake towards 2020. However, with In 30 years this combination will change to the the milk price increase towards the end of PIN code 1125, doubling the population of Our branded business has grown dramatically 2016 renewed trust in the future is being Africa and indicating massive growth in Asia. in recent years and now represents generated. Meanwhile, the demand for milk 44.5 per cent of total revenue and generates globally is unchanged. approximately 80 per cent of Group Understanding the way the world is growing earnings. As a result, brand growth is key for and the shift to urban locations is a global stronger profitability and to drive less volatile We need to ensure that we create the most differentiator. Until now, Arla has been very earnings. Increasing marketing spend is value possible for the existing milk pool. We Europe-centric with 66.1 per cent of sales in critical to ensure continued delivery on will channel our milk to the markets in which Europe. Our long-term growth opportunities branded sales growth towards 2020. the highest value can be added, irrespective in Europe are challenged by low growth rates, of origin. To support this ambition, we have whilst International is delivering solid double established ONE European milk pool to digit growth rates and a positive growth ensure a more holistic use of our raw milk outlook for the foreseeable future. To sustain across Arla. Please read more about ONE double-digit International growth and OPPORTUNITY FOR ARLA milk pool on page 76. balance risks, we need to broaden our distribution networks and strengthen our production footprint. Our growth focus needs to be balanced between Europe and International towards 2020 and our strategy is designed to turn these changes into local opportunities for Arla. Business review | Strategy | Governance | Performance | Risk and opportunity | Values and considerations | Consolidated financial statements 17
On-the-go snacking Digital and e-commerce Health agenda is accelerating and convenience products are game changers Global dairy trends point towards health and Convenience and on-the-go consumption of The digital consumer trend has the potential wellness, and conscious living. A growing healthy and filling snacks is expected to to become a disruptive factor for the dairy concern regarding health and wellness continue to grow significantly and growth is industry. Digitalisation of the industry is among consumers leads to the creation of exceeding expectations. The dairy category progressing at a fast pace and on multiple new dairy products, as well as dairy-free is strong within snacks with yogurt and levels with, for example, digital platforms alternatives. Consumers are increasingly milk-based beverages, and cheese snacks and digital marketplaces expected to rapidly looking for transparency and authenticity in are expected to be the next big trend. gain ground in 2017. In China, e-commerce products and packaging. Rapidly changing Furthermore, on-the-go products in grew approximately 100 per cent from 2011 macro trends lead to diverse consumer convenient packaging for consumers on the to 2014. requirements for products, formats and road, in schools and in offices are expected packaging. to continue to grow at a fast pace in 2017. Another digital trend potentially affecting the dairy industry is mobile consumers requiring a Retailers increasingly seek differentiation new operating model, where the consumer’s and focus on non-genetically modified feed To be a leading dairy company we need to experience becomes more important than and animal welfare product claims and develop strong concepts that support the product itself. It is important to adapt to they are pushing for continued ways to market trends. As a result, we will explore the new commerce landscape in order to differentiate milk in order to gain consumer our opportunities within new categories, for stay relevant to consumers. loyalty. example, within milk-based beverages and high-protein products. We will invest in innovation and product development Digitalisation is essential to creating the Our success will be defined by our ability making it easy for consumers to meet their future of dairy and has the power to to turn consumer trends into assets, rather daily nutritional needs on-the-go. fundamentally change Arla’s business model, than considering them to be external with e-commerce, digital marketing, as well disruptions, and we are in a good position to as product development and packaging. We do so. For Arla, naturalness is at the core of need to stay ahead of the game and become our identity, Good Growth, and being more experimental, bold and collaborative in farmer-owned is in our DNA. With our focus our ways of working and digital is the perfect on healthy products and authenticity, we platform to spearhead this journey. build trust and credibility with consumers. We continuously work with product The traditional way of working with innovation to meet consumers’ demands distribution and in store product placement and we will drive initiatives for the benefit are still a vital part of Arla’s business. of the commercial business, production However, sales from e-commerce platforms and owners. offer not only an online store, but also a new distribution setup and this will increasingly We will create credible market claims to change the way of doing business for Arla. differentiate and leverage trends and develop strong product concepts. 18 Annual report 2016
Creating Good Growth towards 2020
In December 2015, Arla presented a new corporate strategy for the next five years called Good Growth 2020. The strategy is our response to the changing world around us where supply and demand for milk are increasingly geographically detached, competition is fierce and there are new demographic realities and consumer trends. We strongly believe that Arla now faces new opportunities for global growth and creating value for our owners.
With Good Growth 2020, we have a clear focus on growing our brands and volumes through innovation that has consumers and customers wants and needs at its core. This helps us create the most profitable value for our owners’ milk. With the strategy, Arla sets out to grow our business by focusing on increased value creation, strengthening and expanding our footprint and creating a global, coherent and efficient business.
Our vision Create the future of dairy to bring health and inspiration to the world, naturally. Good Growth 2020 makes a strong start A year into our Good Growth 2020 strategy, we remain convinced that it is absolutely the right EXCEL FOCUS WIN direction for Arla. Following the restructure of in eight categories on six regions as ONE Arla the organisation in 2016, Good Growth 2020 is now even more strongly anchored within the business and progress against targets is monitored closely on a regular basis.
We initiated 25 strategic bets to drive Good Growth 2020, within our categories, regions Our identity and efforts to unite Arla as ONE. By the end of Healthy, natural, responsible and cooperative growth. 2016, we experienced strong traction on each of the strategic bets. Throughout the organisation, we have numerous ambassadors, Our mission including owners of strategic bets who drive To secure the highest value for our farmers’ milk a strong focus on execution, speed and while creating opportunities for their growth. cross-functional collaboration.
Ambitious targets for Good Growth 2020 We have set ambitious targets for the key performance indicators of Good Growth 2020 and continuously work to deliver based on these targets.
Read more about how we performed in 2016 in the financial review on page 45.
Baseline in 2015 Target in 2020 Peer group index 103-104 103-105 Retail and foodservice volume driven revenue growth 2% 4% Brand share 42% >45% Trading share 22% <20% International share 17% >23% Business review | Strategy | Governance | Performance | Risk and opportunity | Values and considerations | Consolidated financial statements 19
Our strategy will help Arla to create 2020 2019 the future of dairy towards 2020. 2018 2017 2016
Excel in eight The eight prioritised product categories are categories to increase focused around our global brands: 5 Butter and spreads: we will be a global value creation leader with world class products made from The global dairy industry is developing at high natural ingredients. speed and is characterised by a constant evolution of consumer habits and preferences. We have analysed consumer needs and trends and matched these to our own strengths. 1 Milk and powder: we will lead and shape 6 Speciality cheeses: we will be a leading As a result, we have identified eight product the market with nutritious value-added player with creatively crafted products and categories that will be the core focus for our products. concepts. efforts to shape the dairy market, by offering 2 Milk-based beverages: we will shape the new products with natural ingredients, great market for on-the-go products that are made Foodservice sales taste and good nutrition, thereby making it from natural ingredients. 7 Mozzarella: we will create a global easier to live healthy lives. 3 Spreadable cheese: we will be a leader foodservice position with high quality in cream cheese that is made from both mozzarella. Within these eight categories, we want to excel natural ingredients and high quality processed and increase value creation with innovative cream cheese. Business to business sales products, a world class supply chain, compelling 4 Yogurt: we will build a strong market 8 Ingredients: we will be the global leader in marketing and strong partnerships with our position that is based on health benefits and value-added whey. customers. We will grow the categories through natural ingredients. our global brands, as well as through foodservice Read more about how we excel within eight and business to business sales. Furthermore, to categories on page 20. be a leading dairy company, Arla needs to focus on expanding leading category positions to grow across markets, regionally or globally.
Focus on six regions Over the years, Arla has built a strong position in North Africa. We are focusing our innovation, to strengthen and Northern Europe, where we are the preferred investments and competences in these expand our footprint dairy company for consumers, and the Middle markets. We have identified the markets in which Arla East where our brands are among the strongest has the biggest potential to grow a long-term in the food industry. Arla has also begun to build Read more about how we focus on six regions profitable business. Between now and 2020, we a business in new growth markets such as China on page 22. expect approximately 50 per cent of our growth and South East Asia and Sub-Saharan Africa. to come from Europe, while the remaining With Good Growth 2020, we will continue to share of growth will come from regions outside expand these market positions, whilst further of Europe that we manage in International. stepping up our efforts in the Americas and
Win as ONE to create We will improve our skills and use the same These changes will help us achieve our a global, coherent and processes and tools across the organisation. new ambitious cost improvement target of efficient Arla We will put clear focus on strengthening our accumulated EUR 400 million over four years. Arla has grown significantly in Europe with global category and brand building, our mergers and acquisitions in Central Europe, the innovation across borders and our commercial Read more about how we win as ONE Arla UK and Sweden. The past few years have been acumen. Our marketing will become more on page 24. spent aligning the different companies into one, global and we will drive innovation. Our entire thereby harvesting the synergies that the supply chain will become more efficient as we mergers created. With Good Growth 2020, we established ONE European milk pool to ensure will take this unity to the next level. a more holistic use of our milk across Arla. 20 Annual report 2016
Excel in eight categories to increase value creation
The eight product categories, which are prioritised in our strategy, Good Growth 2020, are focused around the Arla® brand, Lurpak®, Castello® and Puck®. In 2016, we delivered exceptional brand growth in a challenging market, attributable to a focused effort within these eight categories.
Milk and Speciality Spreadable Butter and powder cheeses cheese spreads
Milk-based Mozzarella Yogurt Ingredients beverages
Deep dive on adjacent page.
Strategic branded volume driven revenue growth in 2016 of 5.2 per cent driven by:
The dairy champion that Champion Creatively crafted Celebrating brings health and natural of good food. cheeses. the everyday chef. goodness to the world. 4.5% 7.7% 3.0% 10.6% 2015: 2.5% 2015: 6.1% 2015: 0.1% 2015: 9.9%
2016 showcased the strength of by exceptional performance in the increased the brand’s awareness, In 2016 we inspired more everyday our global and strategic brands. Middle East and North Africa, strengthening Lurpak® as the consumption of speciality cheeses Our brands performed well, where the brand now holds the butter champion. for any occasion. Our Castello® exceeding our overall expectation number one position in jar cheese brand is a strong performer across range of four to five per cent by across all core markets. Arla® showed strong strategic many markets, particularly in the achieving a strategic branded branded volume driven growth of UK, Australia and Sweden. volume driven revenue growth of Lurpak®, our hero in the butter, 4.5 per cent, mainly due to Castello® achieved a strategic 5.2 per cent. spreads and margarine category, increased investment in innovative growth rate of 3.0 per cent in 2016, delivered strategic branded and specialised product ranges showing positive performance Puck® is the leading performer, volume driven growth of 7.7 per such as Arla Natural®, Arla compared to last year. delivering a strategic branded cent, compared to 6.1 per cent in Lactofree®, skyr and other high volume driven revenue growth of 2015. We kicked off a global protein products, as well as infant 10.6 per cent on top of 9.9 per cent campaign in 2016 ‘Game on, nutritional formulas such as Arla last year. This was strongly driven Cooks’, which significantly Baby & Me®. Business review | Strategy | Governance | Performance | Risk and opportunity | Values and considerations | Consolidated financial statements 21
Expanding the milk-based beverages category
An important strategic bet is to in Northern Europe, as well as one plans for expansion of the category subsidiary and its cooperation with capture the opportunities within of the leading importers in Asia, the combined with innovative Starbucks®, through which coffee the beverage market with a portfolio Middle East and North Africa. packaging. This will create new drinks and new innovative including healthier milk-based sales opportunities for us in places milk-based beverages have been alternatives. Supporting the Arla® Modern urban lifestyles have led outside traditional retail channels. introduced in 2016. brand growth, we successfully set people across the world to an ambition to triple our business increasingly snack, thereby getting Within beverages, Arla has had outside standard white milk in the their nourishment outside of their success through its Cocio® beverage market towards 2020 homes. Mealtimes are blurring, from EUR 230 million in 2015. more women are working and more people are living in bigger The global market for milk-based cities. As a result, we have an beverages is approximately EUR 100 opportunity to provide people with billion in annual retail sales, equaling nourishment when they need it, the size of the global standard white based on the natural goodness of milk market. However, the market for our high quality milk. Our milk milk-based beverages is growing should not only be enjoyed from much faster. Going forward, we will litre-sized packages bought in approach the milk-based beverage supermarkets, it should also be market more strategically and available as tasty beverages on double the size of our playing field the go. for liquid milk products. A sparkling milk and fruit drink, a By 2020, we aim to be the leading milk and tea drink and a protein provider of milk-based beverages rich energy drink are part of the
The butter and spreads category is growing fast
The butter and spreads category also the brands present in our key and North Africa show great innovative packaging, the products is key for Arla in creating Good markets. For Arla, the European opportunities for Arla if we themselves and communication. Growth towards 2020. It is a highly markets and the Middle East and maintain our strong performance. In 2016 we started this journey by branded category and so butter North African markets are vital to launching the Lurpak® Spreadable and spreads are strong profit the butter and spread category as Our focus areas for butter and Infusion range and our new global contributors for Arla. these regions amount to 90.8 per spreads are the story behind them, campaign ‘Game on, Cooks’. cent of total revenue. Overall, the butter and spreads category showed strong results in Lurpak® is contributing especially 2016. Volume driven revenue positively to the category growth, growth was 10.5 per cent in 2016 with increasing sales and a growing Lurpak® revenue (EURm) compared to negative growth rates International share moving from in 2015 and as a result, we have 12.7 per cent in 2015 to 13.5 per managed to grow the category cent in 2016. 482 significantly more than expected in 465 2016. Furthermore, we succeeded To deliver our growth ambition in growing our market share in the towards 2020 and become the majority of our markets. butter champion, we must continue to build leading market Within the category, we delivered positions, drive category growth, a brand share of 74.8 per cent in and strengthen our brands. We 2016. The Arla® and Lurpak® have a clear and consistent brands are important for the strategy with a number of great category, amounting to 74.5 per initiatives enabling us to succeed. 2015 2016 cent of total revenue. These are Especially the Middle East 22 Annual report 2016
Focus on six regions to strengthen and expand our footprint
The six regions, chosen as strategic focus areas in our strategy Good Growth 2020, are embedded in our two commercial zones: Europe and International. This allows country management to strengthen its commercial focus on consumers, customers and categories, supported by strong marketing driven from a global category perspective.
Europe is our core commercial and delivered 14.9 per cent of Our International business zone and contributed to 66.1 per Group revenue in 2016. Arla achieved the largest volume driven cent of Group revenue. The Foods Ingredients, our growing revenue growth rate of 9.5 per International commercial zone innovative whey business, cent in 2016, primarily due to encompasses the Middle East and contributed with 5.7 per cent of strong performance in North Africa, Russia and others, Group revenue, whilst other Sub-Saharan Africa and China Americas, China and South East revenue, for example revenue and South East Asia. Asia as well as Sub-Saharan Africa from trading activities, comprised 13.3 per cent of Group revenue.
Europe Volume driven revenue growth in 2016: 1.3% Russia 2015: 3.3% and others Volume driven revenue growth in 2016: 15.7% 2015: -3.8%
China and South East Asia Volume driven revenue growth in 2016: 31.2% 2015: 63.7% Americas Volume driven revenue growth in 2016: 3.4% Middle East 2015: -1.8% and North Africa Volume driven revenue growth in 2016: 3.8% 2015: 8.3% Sub-Saharan Africa Volume driven revenue growth in 2016: 15.8% 2015: 8.6%
Deep dive on adjacent page. Business review | Strategy | Governance | Performance | Risk and opportunity | Values and considerations | Consolidated financial statements 23
China and South East Asia is booming
The aim for China and South East Naifu® was test launched in China Asia towards 2020 is to maintain and, for the first time, e-commerce high growth rates, working towards and digital channels played a Revenue in China the target of quadrupling revenue central role in the launch. and South East Asia (EURm) from retail and foodservice by ® 2020 compared to 2015 when the Arla Baby & Me is one of our +32.4% strategy was originally launched. flagship product ranges within Currently, we are on track to deliver organic milk powder products for 158 this strategic target, with sales children aged up to five years. In growing 32.4 per cent to EUR 158 2016, a new campaign was 120 million in 2016 from EUR 120 launched to support this brand. million in 2015. This was our first initiative with Chinese dairy company Yashili, The population in China and South which is part of the Mengniu East Asia is growing and the middle Group, that we collaborate with class is booming. The majority of closely in this important category. this growth is attributable to China, South East Asia where we are focusing on several China is a crucial market for Arla’s China product categories to further success in the region. However, 2015 2016 pursue the growing demand for other markets in South East Asia dairy products. For example, remain equally important to Arla is aiming to be a leader within maintaining growth rates. In the cheese category in China, 2016, Bangladesh significantly particularly focusing on contributed to the growth in the foodservice. Furthermore, we will region, with retail and foodservice use digital and e-commerce volume driven revenue growth of platforms to engage with and sell 24.0 per cent. to consumers. In 2016, Arla ASCX
Ambitious goals in the Middle East and North Africa
With Good Growth 2020, we aim to 11.7 per cent in 2016 compared to double our revenue from retail 9.4 per cent in 2015 in the region. and foodservice in the Middle East The Middle East and North Africa and North Africa by 2020 have a population of approximately compared to 2015 when the 380 million people. In the region, strategy was launched. This dairy products are incorporated ambitious goal should be achieved into most meals, therefore serving by a combination of increasing as a great opportunity for Arla. Our sales of branded cheese, butter, Puck® range fills a gap in the spreads and cream cheese across market, helping local consumers to both retail and foodservice, be the star at the dinner table. The developing our business in Egypt Puck® brand also won a Gold Effie at and entering the liquid category one of the world’s most acclaimed with the Arla® brand. marketing events. Using the Puck® website and social media channels, In 2016, we managed to deliver the brand celebrated mothers as volume driven revenue growth in the everyday hero chef. the region of 3.8 per cent.
The Puck® product range is especially popular, showing volume driven revenue growth of 24 Annual report 2016
Win as ONE to create a global, coherent and efficient Arla
Winning as ONE is a continuous effort to unite Arla across business functions and commercial zones. The strategic bets identified are the foundation and building blocks for creating Good Growth towards 2020. The initiatives are tracked continuously by the organisation and at the end of 2016 we are progressing according to plan.
Win as ONE building blocks for Good Growth 2020
Measure and manage performance securing the business delivers on key performance indicators. Take more informed and effective Innovation decisions. Improve accountability in the Supply chain Performance organisation. as a competitive management enabler
Read more on page 40.
Organise Marketing to Win and brands
Increase marketing spend and Commercial improve spend effectiveness. excellence ONE European Strengthen global brand Strengthen commercial in Europe and milk pool building. excellence to lead the Increase brand share. customer agenda. International Master price management to restore product margins. Execute the strategy locally. Read more on page 76.
Deep dive on adjacent page.
’Organise to Winʼ is the name we gave to the indicators of our strategy, and engaging marketing spend in 2016 and a continuous restructuring of our organisation, that was everyone in the organisation. It will bring focus on increasing our brand share. Read more successfully implemented during 2016. data-driven, outside-in insight to how we steer, on page 44. The restructure supports our ambition to course-correct and manage our business. This create commercial excellence in our Europe will enable us to better drive conversations and The establishment of ONE European milk pool and International market zones. Read more make clearer decisions, helping the organisation supports our ambition of channelling our about the restructure on page 40. take more informed and effective actions. owners’ milk into the markets where the highest possible value can be added, irrespectively of Performance management is about measuring Another important strategic bet for creating origin. Read more about ONE milk pool on and actively managing performance, securing Good Growth towards 2020 is our focus on page 76. the business to deliver the key performance marketing and brands, supported by increased Business review | Strategy | Governance | Performance | Risk and opportunity | Values and considerations | Consolidated financial statements 25
Creating the future of dairy with bold innovation
Innovation is at the core of a considering packaging from a EUR. As a result, we have tested branded business with a broad fresh perspective and adding new skyr in China and the Middle East product portfolio. Arla needs functionalities to the product with good results. The next step is innovation to create the future of portfolio. to establish local production to get dairy, remain attractive to the great tasting skyr products to consumers and customers around The global innovation team will consumers in these markets. the world and to stay ahead of boost our innovations and the new An example of how Arla transformed future trends. Competition is Arla Innovation Centre, which innovative ideas into a European getting tougher and consumers opens in 2017, will be the success is skyr. A few years ago, have more choices, which is why epicenter for this. Their main task is skyr was a novelty and a niche innovation has an important role to to find new ways of making the product. Today sales in Europe are play in adding value to our milk. milk from our owners into products booming, with growth rates of with the highest possible value. 200 per cent from 2014 to 2016. Consumers and customers want Following the introduction of skyr healthy, natural food that is New science and technology in the UK, Germany and the produced responsibly. They want enable us to keep transforming Netherlands, sales access to food and information milk into new kinds of dairy outside Denmark about it through interesting products. By constantly rethinking now make up half channels, including online and challenging what the business of the skyr business. shopping, eating out, creating their is able to do, we are more likely to own products to fit their needs or create growth and stand out from According to the to get exciting inspiration on how our competitors. Innovation is international to eat. As a result, innovation is about taking risks and sometimes consultancy Future not just about developing new we make mistakes, but we learn Market Insight, there products. It is also about from our mistakes and use the is a global market for experiences to create new ideas. skyr worth billions of
Supply chain as a competitive enabler
In 2016, supply chain activities EUR 100 million, clearly indicating reorganisation of inbound logistics programmes have delivered great were simplified and streamlined that working as ONE integrated in Germany with the new central results. Our cost improvement into ONE function encompassing team is paying off. warehouse in Heidenau and the initiatives build on existing production, procurement, QEHS closure of Hatfield Peverel dairy in efficiency programmes, such as and logistics. Supply chain is now This achievement was the result of the UK. LEAN, OPEX, Total Cost of in a position to deliver on cost, many factors, from individual site Ownership, Design to Value and quality and service targets, specific projects to large scale In addition, many ongoing our net working capital project, supporting our strategy, Good structural projects, such as the continuous improvement Programme Zero. Growth 2020. We can create centres of excellence rather than However, the success in 2016 has producing all products in all not been without significant countries, generate efficiencies on Cost savings in supply chain challenges, as several factors a global scale and utilise our milk (EURm) outside of supply chain’s control pool in the best possible way. put pressure on the function. The strategy means supply chain has to At the beginning of 2016, Arla set be more consumer-oriented than an ambitious cumulative cost 100 100 100 100 ever before, increasing complexity improvement target of accumulated at sites with expanding product EUR 400 million over four years. ranges. Another challenge was Over time, all business functions that supply chain planned to and commercial zones will process more milk in 2016, but contribute to the cost savings, Arla experienced a decline in milk but initial focus will be on cost intake, which impacted improvements in supply chain. efficiencies. 2016 2017 2018 2019 In 2016, the supply chain delivered targeted cost savings of 26 Annual report 2016
Every year Arla focuses on seven essential business priorities to support our strategic objectives. In 2016, one essential priority was to strengthen leading positions in International, including the Middle East where our brands are among the strongest in the food industry. In 2017, we will continue to focus on building leading market positions in International measured by volumes and market shares. Business review | Strategy | Governance | Performance | Risk and opportunity | Values and considerations | Consolidated financial statements 27
Seven essential business priorities are an enabler for Good Growth 2020
We define our annual business plan as the seven essential priorities. Our business plan should not be confused with our strategy. It complements our strategy with more detail and activities that are implementable and measurable within the course of 12 months. We consider our seven essential priorities to be an enabler for our strategy, Good Growth 2020, as they consist of critical priorities that we need to achieve on our journey to success.
In order to continuously deliver strong results for our owners and ensure the success of our strategy, the Executive Management Team determines the seven essentials business priorities each year, subject to approval by the Board of Directors. The seven essentials are a set of clear and aligned business priorities, with a defined and coherent approach on how to succeed on each of them.
The seven essentials are cascaded throughout the organisation, with all business functions and commercial zones setting goals and activities to ensure that all teams are aligned and deliver as ONE united Group.
Connecting our essentials with our strategy
External environment Good Growth 2020 2019
2018
2017 Internal realities = Seven essentials
The seven essentials aim to support the growth agenda and direction for the business set out in our 2016 strategy and are developed with consideration of the external environment and the internal realities of the Time business. 28 Annual report 2016
Seven essential business priorities for 2016
The seven essential priorities Volume is king Deliver significant growth Improve Central Europe are the outcome of our on brands peer performance* annual business planning process, outlining the core Target: Add an additional Target: Deliver significant growth on Target: Improve Central Europe peer ® priorities for the coming year, 400 million kg owner milk into retail strategic brands, covered by Arla , performance by addressing cost and and foodservice. Lurpak®, Castello® and Puck®. brand performance and competitively key activities, as well as export milk into retail and foodservice associated key performance Status: Status: outside the EU. indicators and targets that define success. The seven Result: In 2016, we delivered retail and Result: Delivering strategic branded Status: foodservice volume driven revenue volume driven revenue growth at essential priorities are utilised growth of 2.7 per cent, slightly below 5.2 per cent is an all-time high for Arla. Result: The business delivered throughout all business our target of three to five per cent. We In 2016, almost the entire growth in significant cost improvements functions and commercial successfully increased retail and our core retail and foodservice business according to plan in supply chain, zones to ensure delivery of foodservice volumes by 341 million kg. has been driven by our brands. across administrative and commercial This was a great delivery close to target, Intensified sales efforts and increased functions, as well as significantly our most important strategic despite total milk volumes being more investment in marketing have resulted improving the results in the German priorities as ONE united group. than 800 million kg less than initially in our branded growth being driven by cheese business. In addition, branded expected. Certain tradeoffs between the Arla® brand (4.5 per cent), Lurpak® positions grew by 3.4 per cent, a solid volume and price were made during the (7.7 per cent), Castello® (3.0 per cent) achievement in a difficult market. second half of 2016 based on the and Puck® (10.6 per cent). With a brand Milk supply and price volatility have increasing raw material shortage and share of 44.5 per cent, the proportion unfolded more rigorously in Germany rapidly increasing milk prices. The of high profit products is the strongest than any other region, and the market reduction in milk intake expectations in years. has become even more fragmented, during 2016 exemplifies this change in tough and competitive. This proved strategic perspective. to be even more challenging than expected, although some improvements have become visible towards year-end.
Strengthen market positions Structurally reduce Improve cash flow Strengthen the in International** the cost level Arla cooperative
Target: Strengthen leading positions in Target: Volume driven revenue growth Target: Improve cash flow to achieve Target: Establish a process with the China, the Americas, Nigeria, Middle should be >2.0 times higher than the leverage of 2.8 to 3.2 and release EUR Board of Directors, National Councils East and North Africa measured by growth in capacity costs. Deliver a 130 million*** in cash within net and Board of Representatives to create volume and market share. conversion cost in production at an working capital. strong owner relations. index level of 98.5. Status: Status: Status: Status: Result: In 2016, we have succeeded in Result: In 2016, we achieved leverage Result: The new owner strategy will growing volumes in these International Result: Our strong cost performance is, of 2.8, which is at the low range of our prepare Arla for the future and ensure a regions by 9.5 per cent and our in part, due to huge efforts to run an long-term target range of 2.8 to competent and aligned fundamental branded business by 10.7 per cent. efficient supply chain, however, our 3.4, underpinning the Group’s strong owner structure that unites owners China and South East Asia grew by conversion cost has fallen short of the financial position. Including the gain on across countries. In October, the Board 31.2 per cent, Sub-Saharan Africa grew target at 99.2, impacted by the lower divestment of Rynkeby, leverage is 2.4. of Representatives decided on an by 15.8 per cent, the Middle East and milk volume. Scalability ensures that Our primary net working capital aligned structure, annual calendar and North Africa grew by 3.8 per cent, and capacity costs are increasing at a lower position, excluding owner milk, was to explore if the UK and Central the Americas grew by 3.4 per cent. In a rate than revenue. Our scalability met significantly improved and a cash European owners can be offered direct volatile year impacted significantly by the target of >2.0 due to firm control of release of EUR 165 million was membership in Arla Foods amba. The low oil prices and the spill over capacity costs. EUR 100 million of our achieved. first elements of the strategy will come economies in the Middle East and new ambitious cost improvement into effect in 2017. Nigeria, we are satisfied with the results, target of EUR 400 million in supply although they are below our 15 per chain has been delivered in 2016. cent growth target.
* After the restructure, Consumer Central Europe is referred to as Central Europe. The priorities remain unchanged. Target not achieved. ** After the restructure Consumer International is referred to as International. The priorities remain unchanged. Achievement on major components. *** Changed at mid-year from EUR 150 million due to a higher share of sales in International. Target fully achieved. Business review | Strategy | Governance | Performance | Risk and opportunity | Values and considerations | Consolidated financial statements 29
2017
Seven essential business priorities for 2017
Our ability to translate the Deliver price increases Control costs, Drive bold brand growth price increases into higher and drive margin focus drive operational efficiencies and bold innovation retail prices will be the key and release cash to our success. We must continue transforming our To deliver appropriate retail price We will deliver strong cost control by We believe increasing our share of business, prioritising increases across all European and continuously improving our cost branded sales is the most important International markets and categories, positions within supply chain, structural change we can make to high-margin branded products we will introduce enhanced price administrative and commercial ensure higher growth and profitability and keeping strong discipline management analytics and processes functions. Our aim is to achieve a going forward. Although the growth on our cost and cash agendas that optimise the balance between conversion cost index in supply chain of rate will be under pressure in 2017 due to best position us for the highest potential margin for our <100 and attain scalability of >2.0. to our focus on price increases, we products with minimal market share We will also continue our strong cash remain committed to achieving a goal future. To support these impact. With commercial and financial delivery orientation to ensure of >45 per cent of our sales coming ambitions, we will increase our discipline, we are confident that we can appropriate capital is available to fund from Arla®, Lurpak®, Castello® and focus on price management, ensure a competitive milk price for our our Good Growth 2020 ambitions. To Puck® by 2020. With the new global strengthen our innovation owners, as well as strong peer group do this, we will expand our successful Innovation Centre opening this year, performance. working capital programmes and we plan to visibly increase our short, pipeline, grow targeted brand deliver a financial leverage within our medium and long-term innovation investments and drive long-term target range of 2.8 to 3.4. pipeline. We will again increase our efficiency in our supply chain marketing spend to drive globally and administrative cost focused big bets in markets and categories with the biggest impact. programmes.
Make leadership matter Build leading Partner for Strengthen in the milk, yogurt and powder market positions in growth with leading the important German category International customers market position
We are committed to showcasing clear In markets outside Europe, we will Across Europe, we will strengthen our In 2017, we will strengthen our most market leadership in our biggest accelerate growth of our global customer-centric business and focus on challenging market, Germany, by product category. We will demonstrate categories and brands. This means winning with leading customers. This creating a winning plan, executing best-in-class innovation and brand growing both on an absolute level, but requires special focus on growth, focused commercial bets and building, particularly around speciality also expanding market share in focus profitability, customers, category enhancing operational basics. An offerings such as organic, lactose free, regions. Whether it be the Middle East collaboration and delivery of service, increased focus on brands and as well as skyr and protein. We also plan and North Africa, Sub-Saharan Africa, amongst others. Core initiatives will be innovation will be crucial to improve to expand cross-regional product the Americas, China and South East category management, mutual quality and profitability. Within launches, moving winning products Asia or Russia and distributor sales, our category and brand plans, collaboration supply chain, we will focus on cost and competencies more quickly into goal is to improve our relevance with across functions to lift online sales and competitiveness, as well as continued multiple markets. We will continue to consumers, through increased market the utilisation of digital opportunities. development of our production innovate with non-genetically modified investments and strengthened Within foodservice, we will launch a footprint. feed and other dedicated innovations, partnerships with local distributors. new organisation in Europe. as well as improve customer service. Lastly, leading in the white milk category also requires winning with private label products. Governance ONE is a continuous effort to unite Arla on three levels:
ONE | Shared Focus At the core are the ideas and beliefs that unite us and drive everything we do.
ONE | Aligned Leadership Shared management practices align leaders.
ONE | Aligned Functions Functions are united by ways of working encompassed within global ONE programmes.
Content
32 Governance framework 35 Inclusion and Diversity 36 Executive Management Team 38 Board of Directors 40 A global organisation fit for the future 41 A living cooperative true to its principles 32 Annual report 2016
Governance framework
Arla is a cooperative owned by dairy farmers. Being a large cooperative is an important differentiator for us. Operating it across seven owner countries is both very rewarding and challenging. In 2016, Arla’s governance structure was improved with a successful reorganisation of the mangement structure further streamlining the democratic structure of the cooperative.
Corporate governance stands for responsible and transparent management and corporate control, oriented towards a sustainable increase in value. We are convinced that good corporate governance is an essential foundation for sustainable corporate success and enhances the confidence placed in our Group by our owners and colleagues. Business review | Strategy | Governance | Performance | Risk and opportunity | Values and considerations | Consolidated financial statements 33
Arla’s governance model “Over the years Arla has 11,922 Owners grown through a number
Different democratic structures of mergers. We have in DK, SE, UK, DE, District councils BE, NL and LUX focused on aligning basic principles in recent * 191 Board of Representatives years. This is a huge achievement. Now the 18** Board of Directors 4 national councils time has come for us to align how we work within Executive Board 2 our democratic structure.”
Åke Hantoft, Chairman of the Board of Directors 5 Executive Management Team
Functional areas and 7 commercial zones
18,765 Colleagues
* Including 12 employee representatives. ** Including three employee representatives.
Cooperative governance Board of Representatives In 2016, the attendance rate at the The Board of Representatives is the supreme Board of Directors meetings was Arla’s democratic structure gives decision-making governing body comprising 191 members of authority to the Board of Directors and to the whom 179 are cooperative owners, while Board of Representatives. Their primary tasks 12 are Arla colleagues. Cooperative owners are 98% are the development of the ownership base, elected every other year in odd years. The safeguarding the cooperative democracy, Board of Representatives makes decisions National councils embedding decisions and developing including appropriation of profit for the year Arla has four national councils that are competencies. and elects the Board of Directors. The Board of sub-committees of the Board of Directors Representatives meets at least twice a year. and consist of members of the Board of Owners Directors, as well as members of the Board of 11,922 milk producers in Denmark, Sweden, Board of Directors Representatives. The national councils are the UK, Germany, Belgium, Luxembourg and the Together with the Board of Representatives, established in the four democratic areas of Netherlands were joint owners of Arla in 2016. the Board of Directors is responsible for Sweden, Denmark, Central Europe and the UK As a cooperative, all of our farmers have the decisions relating to long-term strategies, to take care of the matters that are of special opportunity to influence significant decisions. major investments, as well as mergers and interest to the owners in each country. As we expand into new markets, our diverse acquisitions. The Board of Directors consists of group of owners elect representatives from 15 elected Arla farmers and three employee New owner strategy their ranks to the company’s governing bodies. representatives with the knowledge, skills and In 2016, the Board of Representatives took the professional expertise required to properly first steps in developing the new owner strategy. District councils perform their tasks. The composition of the Read more about the new owner strategy on Each owner country has its own democratic Board of Directors reflects Arla’s ownership. page 41. structure resulting in different local The Board of Directors is responsible for organisations. Each year, the cooperative monitoring the company’s activities and asset members convene for a local annual assembly management, satisfactorily maintaining the in Denmark, Sweden, the UK and Central accounts and appointing the Executive Board. Europe (Germany, Belgium, the Netherlands, The Board of Directors is also responsible for and Luxembourg) to ensure the democratic ensuring that Arla is managed in the best influence of the cooperative owners in the interest of its owners and making decisions seven owner countries. The members in the concerning the ownership structure. district council elect the members who represent their district on the Board of Representatives. 34 Annual report 2016
Arla is made up of thousands of people who share an aspiration to make a difference in the world. While we each have an important individual role to play in achieving our mission and vision, our shared success is best assured if we are united as ONE global company.
Corporate governance Functional areas and commercial zones Colleagues The Leadership Teams within the functional Arla has 18,765 colleagues globally, who are In the first half of 2016, a restructure of the areas and commercial zones are Arla’s executive represented in the Board of Directors and the organisation was efficiently executed in order to bodies and focus on ensuring that Arla is Board of Representatives. deliver the strategy, Good Growth 2020, faster, result-oriented across organisational units, stronger and in a more united way. Read more while also defining policies, as well as sharing about the restructure of the business on page 40. and implementing best practices.
Executive Board The Executive Board consists of Arla’s CEO and Arla remuneration philosophy vice CEO appointed by the Board of Directors. The remuneration package is designed to ensure attraction and retention of the right senior They are responsible for independently managing leaders, at the same time driving both short and long-term business results. This is achieved the company, ensuring the proper long-term by offering a benchmarked remuneration package with the right balance of fixed and variable growth of the company from a global perspective, pay. The competitive remuneration package is reviewed annually by external advisors using driving the strategic direction, following up on market data sources. targets for the year and defining company policies, while striving for a sustainable increase Executive Board in company value. Furthermore, the Executive The remuneration package for members of the Executive Board is based on external benchmarks against European and International ‘fast-moving consumer goods’ companies, providing a Board ensures appropriate risk management competitive and sustainable mix of fixed and variable pay. The fixed pay component consists of and risk controlling, as well as compliance with an annual base salary, a pension contribution, as well as an executive benefit package. The statutory regulations and internal guidelines. variable pay component consists of both an annual variable incentive plan, as well as a three-year This is where the Group’s ambitions are defined long-term incentive programme. for cross-disciplinary efforts. The members of the Executive Board are employed on terms according to international standards, Executive Management Team including adequate non-compete restrictions as well as confidentiality and loyalty restrictions. The Executive Management Team is responsible for Arla’s day-to-day business operations and for preparing strategies and planning the future operating structure. The Executive Whistleblower service Management Team is based around specific Arla is an organisation with a strong sense of responsibility and integrity. Arla’s Code of Conduct functional areas such as Supply Chain, contains general guidelines for conducting business. In addition to this, Arla has a whistleblower Marketing and Innovation, Human Resourses service to enable its colleagues in all companies that are majority owned or controlled by Arla to and Corporate Affairs, Milk, Member and Trading, report information about possible irregularities. It is also a channel to voice concerns regarding potential violation of Arla’s Code of Conduct or legislation. as well as Finance, IT and Legal. It also includes two commercial zones, Europe and International. Since the implementation in 2012, Arla has received 52 reports from its whistleblowing service. Irrespective of their overall responsibility, the The reports have come from most parts of the organisation and include areas such as auditing, members of the Executive Management Team accounting, theft, anti-bribery, entertainment, as well as health and safety. In 2016, the are individually responsible for managing their whistleblowing service received 25 reports of which 15 led to further investigation. Depending respective business areas. The members of the on the outcome of the investigation, appropriate measures have been taken. Ten reports have Executive Management Team keep one another been classified as inappropriate behaviour towards an individual, which means that we cannot informed on all significant developments in register and process these due to legal reasons. Instead, the reporter is informed of which their business area and align on all cross-func- person to contact within Human Resources. tional measures. Business review | Strategy | Governance | Performance | Risk and opportunity | Values and considerations | Consolidated financial statements 35
Inclusion and diversity
In Arla, we believe that inclusion and diversity are imperative to our business and that diverse teams lead to enhanced commercial outcomes. We define diversity broadly as differences between people with a diverse range of backgrounds, while inclusion is about valuing differences among individuals to create synergies. As an organisation, we strive for an inclusive and welcoming culture for all colleagues.
Diversity from an owner perspective Gender in the Board of Directors** In January 2016, the appointment of two In compliance with legislation, Arla has set females to the Executive Management 2016 a target for the underrepresented gender in 7% 93% Team was announced bringing the female the Board of Directors. As men are highly 2015 representation to 29 per cent. This is a overrepresented in our industry, the target significant achievement and has established reflects the gender composition among our Striving for Good Growth 2020 a foundation for further progress. owners. We consider the demographics of the As part of our strategy, Good Growth 2020, Board of Representatives to be representative of we aim to drive change in the composition of Gender in the Executive the owner group due to elections in a our teams by ensuring that a maximum of Management Team democratic process every other year. 70 per cent of members in any given team 2016 29% 71% represents the same set of criteria. These In 2016, the representation of females in criteria include nationality and ethnic 2015 0% 100% the Board of Representatives was 13 per cent background, gender, generation, educational Since 2013, we have aimed at having more compared to seven per cent in the Board and professional background. than 20 per cent of our employee population at of Directors. Our aim is that female director level and above as female. In 2016, our representation in the Board of Directors Gender representation in 2016 population at director level and above improved reflects the female representation of the We have focused primarily on reporting gender modestly, with female representation following Board of Representatives following the composition in 2016. Women comprise 28 per our recent restructure amounting to 22 per cent. election in 2019. cent of Arla's entire workforce, representing an increase in scope coverage versus the prior year. Gender at director level and above Gender in the Board of Representatives* 2016 22% 78% Gender in Arla 2016 2015 21% 79% 13% 87% 2015 2016 28% 72% 2015 28% 72%
Examples of inclusion and diversity activities in 2016 In 2016, we have worked with several inclusion and diversity initiatives.
Relaunching ‘Our Leadership’ framework Future 15 Graduate Programme Talent Accelerator Programme We have refreshed and relaunched Arla’s ‘Our The Arla ‘F15® Graduate Programme’ allows Our ‘Talent Accelerator Programme’ draws Leadership’ framework, making all materials promising candidates to experience a versatile together some of the brightest and most transparent and available to everyone. The picture of Arla. The programme consists of ambitious young leaders, giving them the refresh includes clear statements that three global job rotations in diffferent functions. opportunity to broaden their leadership skills. demonstrate great leadership is available to all Across 2015 and 2016, Arla welcomed 18 In 2016, managers were asked to nominate colleagues, irrespective of job type or hierarchy, different nationalities in the application process, their best female and best male high potentials, with clear guidance as to how best to show consisting equally of male and female removing any gender bias. This resulted in the these capabilities at any career stage. To candidates. In 2015, there was a female same number of males and females being given support the relaunch of ‘Our Leadership’, all the representation of 50 per cent, compared to the opportunity to join the programme. Of leadership programmes have been redesigned 75 per cent in 2016. For the 2017 application the nominees who were successful in their to support colleagues to realise their full round, we received 1,485 applications from assessment, 53 per cent were female, constituting potential in Arla. 72 countries, with an equal gender distribution. an increase of 18 per cent from last year.
* Excluding employee representation in the Board of Representatives. ** Excluding employee representation in the Board of Directors. 36 Annual report 2016
Executive Management Team
Executive Board Other Executive Management Team
1 3 5 7 Peder Tuborgh Natalie Knight Hanne Søndergaard Tim Ørting Jørgensen CEO CFO CMO Executive Vice President, International Head of Milk, Members and Trading Executive Vice President, Executive Vice President, Head of Arla Foods Ingredients Finance, IT and Legal Marketing and Innovation Year of birth: 1964 Nationality: Danish Year of birth: 1963 Year of birth: 1970 Year of birth: 1965 Nationality: Danish Nationality: American Nationality: Danish 2016: Executive Vice President, International, Arla Foods 2005: CEO, Arla Foods 2016: CFO, Arla Foods 2016: CMO, Arla Foods 2012: Executive Vice President, Consumer 2002: Executive Group Director, 2015: Senior Vice President, Group 2012: Senior Vice President, Global Central Europe, Arla Foods Arla Foods Functions Finance, adidas Categories and Brands, Arla Foods 2007: Executive Vice President, Consumer 2000: Divisional Director, Denmark 2011: Senior Vice President, Brand and 2010: Senior Vice President, Butter, International, Arla Foods Division, Arla Foods Commercial Finance, adidas Spreads and Margarines and Arla Brand, 2001: Divisional Director, Denmark 1994: Marketing Director, Denmark 2008: CFO, North America, adidas Arla Foods Division, Arla Foods Division, MD Foods 2004: Vice President, Mergers and 2007: Vice CEO, Arla Foods UK 1999: Group Project Manager, MD Foods 1990: Marketing Manager, Danya Foods Acquisitions and Investor Relations, adidas 2001: Marketing Director, Arla Foods UK 1996: Commercial Manager, MD Foods do Saudi Arabia 1999: Vice President, Head of Investor 1999: Sainsbury’s BU Controller, Brasil/Dan Vigor 1987: Product Manager, Germany, Relations, adidas MD Foods UK PLC 1993: Product Manager, Danya Foods MD Foods 1998: Investor Relations Manager, BASF 1996: Category Controller, 1992: Trade Marketing Manager, France, 1995: Investor Relations Specialist, MD Foods UK PLC MD Foods Bankgesellschaft Berlin 1994: Cheese Product Manager, 1991: Trade Marketing Assistant, Cheese MD Foods UK PLC Division, MD Foods
2 4 6 Povl Krogsgaard Ola Arvidsson Peter Giørtz-Carlsen Vice CEO CHRO Executive Vice President, Europe Executive Vice President, Supply Chain Executive Vice President, HR and Corporate Affairs Year of birth: 1973 Year of birth: 1950 Nationality: Danish Nationality: Danish Year of birth: 1968 Nationality: Swedish 2016: Executive Vice President, Europe, 2004: Vice CEO, Arla Foods Arla Foods 2000: Executive Group Director, 2007: CHRO, Arla Foods 2014: Executive Vice President, Consumer Arla Foods 2006: HR Director, Arla Foods UK, Arla Foods 1998: Executive Group Director, 2005: HR Vice President, Unilever Nordic 2011: Executive Vice President, Consumer Denmark, Arla Foods MD Foods 2003: HR Director, Unilever Home and 1994: CEO, Mejeriernes Personal Care Europe 2010: Vice CEO, China, Bestseller Fashion Group Produktionsselskab 2001: HR Director, Unilever 1991: Director, Home Market Division, 2008: Managing Director, Cocio 2000: HR Director, Lever Faberge Nordic, Chokolademælk A/S MD Foods Unilever 1989: Production Manager, 2003: Vice President, Corporate Strategy, 1998: HR Director, Diverseylever Nordic, Arla Foods Yellow Cheese, MD Foods Unilever 2002: Business Development Director, 1988: Head of Home Market Division, 1995: HR Manager, Unilever MD Foods Semco/Bravida 1988: Officer, Royal Combat Engineering 1987: Head of Mejeriselskabet 1999: Management Consultant, Corps, Swedish Army Accenture Strategy Practice 1979: Danske Mejeriers Fællesorganisation Business review | Strategy | Governance | Performance | Risk and opportunity | Values and considerations | Consolidated financial statements 37
1 4 2 5
7
6 3 38 Annual report 2016
Board of Directors
Åke Hantoft Jan Toft Nørgaard Chairman Vice Chairman
Year of birth: 1952 Year of birth: 1960 Nationality: Swedish Nationality: Danish Member of the board since 2000 Member of the board since 2000
Thomas Johansen Viggo Ø. Bloch
Year of birth: 1959 Year of birth: 1955 Nationality: Danish Nationality: Danish Manfred Graff Member of the board since 2002 Member of the board since 2003 Year of birth: 1959 Nationality: German Member of the board since 2012
Jonas Carlgren Bjørn Jepsen
Year of birth: 1968 Year of birth: 1963 Nationality: Swedish Nationality: Danish Member of the board since 2011 Member of the board since 2011
Markus Hübers
Year of birth: 1975 Nationality: German Member of the board since 2016 Business review | Strategy | Governance | Performance | Risk and opportunity | Values and considerations | Consolidated financial statements 39
Palle Borgström Heléne Gunnarson
Year of birth: 1960 Year of birth: 1969 Johnnie Russell Nationality: Swedish Nationality: Swedish Member of the board since 2008 Member of the board since 2008 Year of birth: 1950 Nationality: British Member of the board since 2012
Manfred Sievers Jonathan Ovens
Year of birth: 1955 Year of birth: 1957 Nationality: German Nationality: British Member of the board since 2013 Member of the board since 2014
Torben Myrup
Year of birth: 1956 Nationality: Danish Member of the board since 2006
Harry Shaw Ib Bjerglund Nielsen Employee representative Employee representative Steen Nørgaard Madsen
Year of birth: 1952 Year of birth: 1960 Year of birth: 1956 Nationality: British Nationality: Danish Nationality: Danish Member of the board since 2013 Member of the board since 2013 Member of the board since 2005
Haakan Gillström Employee representative
Year of birth: 1953 Nationality: Swedish Member of the board since 2015 40 Annual report 2016
A global organisation fit for the future
In February 2016, Arla announced significant structural changes to the organisation that will enable the business to deliver its ambitions. The restructure included the creation of a new Executive Management Team, as well as a more efficient, global and functional orientated structure, which enables markets to strengthen their commercial and consumer focus.
Arla has grown its business organisation drives clear functional are seven members of the innovation has been elevated to significantly in recent years, both responsibilities and efficient Executive Management Team, the Executive Management Team, organically and through mergers. execution in global functions and compared to nine previously. to deliver global brands and However, more milk is expected to develops more collaborative ways category leadership. Similarly, two be produced globally and Europe is of working, while reducing The main changes commercial zones have been experiencing pressure on prices duplication across countries. Arla Arla has streamlined and simplified formed: Europe and International. and very little growth, which made more than 500 white collar the global organisational structure This allows country management means competition is fierce. In employees redundant across and prioritised its resources to to strengthen its commercial focus addition, consumers’ needs are markets and removed them from support the Good Growth 2020 on consumers, customers and becoming more diverse and the business by June. We expect to work streams. categories supported by strong customers expect increased levels achieve the cost improvement in marketing driven from a global of service. In order to increase our 2017 and beyond. The new operating model, following category perspective. competitiveness, Arla changed its the restructure of the organisation, ways of working to be more agile A new Executive is based on a functional logic Furthermore, ONE European milk and cost efficient. Management Team with deep capabilities and clear pool and ONE global supply chain The changes commenced at accountability. The model ensures functions have been formed, The new organisation is designed the top of the organisation. On our global functional ambitions encompassing production, to optimise Arla’s performance in 1 March, the new organisational meet the realities of our markets in procurement, QEHS and logistics a highly competitive global dairy restructure went live, with a new order to create Good Growth on to utilise our milk in the best market, by strengthening value Executive Management Team built our journey towards 2020. possible way, generate efficiencies creation and functional efficiency around specific functional areas on a global scale and ensure that as outlined in the strategy, and commercial markets organised With the new organisation, the capacity across our 60 sites Good Growth 2020. The new into two geographical areas. There responsibility for marketing and is optimised.
Operating model: From farmers to consumers
Milk, Supply Chain Marketing Europe Members and Become ONE and Drive 50 per cent of Good Growth Trading with global Innovation 2020, enhance synergies and increase Drives ONE responsibility Drive the value in our European markets. global milk pool and strong category and ensures a customer focus. agenda across strong farmer Arla building agenda. strong global International brands and Be the growth engine of Arla towards increasing 2020 and double in turnover. value.
Human Resources and Corporate Affairs Build organisational capability, drive strategy execution and engage stakeholders.
Finance, IT and Legal Drive performance management and support Arla’s globalisation journey. Business review | Strategy | Governance | Performance | Risk and opportunity | Values and considerations | Consolidated financial statements 41
A living cooperative true to its principles
As a thriving cooperative democracy, we are continuously working to further develop our democratic processes. In 2016, we reviewed our cooperative owner structure, as well as the democratic bodies that oversee the interests of cooperative owners through elections, meetings and decision making. In the coming year our new owner strategy will drive change in all owner countries.
In 2015, the Board of Directors, in October. At the meeting, the Today, the UK and Central decision-making processes. in cooperation with the Board of 191 elected members decided European farmers, unlike owners The new structure is also Representatives, decided to create on a course of action that will from Denmark and Sweden, expected to improve dialogue a more streamlined structure for result in a more streamlined are members through their across the Group. Arla’s member democracy. A democratic structure over the cooperatives, which in turn are structural change was needed to coming years. Going forward, the members of Arla Foods amba. The Progress on the owner strategy is align different structures following aim is also to achieve harmonised Board of Representatives decided expected to continue in 2017. several mergers which occurred processes for meetings among to further explore whether it would Specific priorities include focus on between 2011 to 2015, and it is a Arla’s cooperative owners and be possible to offer all Arla farmers amendments to the Articles of natural step in achieving representatives, and for the election direct membership in Arla Foods Association to support the new harmonisation. of farmer representatives to the amba. If possible, each cooperative structure, as well as on potential various bodies. and its farmers would be able to direct membership for the Based on the founding principle decide through a local democratic cooperative owners in Central from the 1880s, ‘One man, one Creating a uniform and process. Europe and the UK. vote – in a cooperative owned and transparent structure managed by farmers for farmers’, Cooperative democracy allows the Improving communication the aim of the new owner strategy individual member to influence across the Group is to further develop and prepare decision-making in Arla and stay The strength of an owner-managed Arla as a cooperative for the future. informed about the development company relies on the cooperative The majority of Arla’s elected of the business. This structural democracy to be alive and healthy, farmer representatives were overhaul will make the owner and its members engaged. As a involved in this discussion during structure more uniform and result, harmonisation must ensure 2016 including discussions at the transparent across all seven owner prompt communication and Board of Representatives meeting countries. transparency concerning
The new owner strategy process
February 2016 Spring 2016 May 2016 Summer 2016 October 2016 2017
The new owner strategy Discussions among Principle discussions at Further discussions The Board of Implementation of kicked-off with the elected representatives the Board of amongst members, Representatives elements decided Board of in the National Representatives. National Councils decided on an aligned at the Board of Representatives. Councils. and within the Board structure, annual Representatives of Directors ahead calendar and to explore meeting in October of the Board of if the UK and Central 2016: Representatives European owners can Governance structure meeting in October. be offered direct Eligibility and elections membership in Arla Annual meeting cycle Foods amba. Discussions continue on the cooperative structure in the UK and Central Europe, corporate governance and further develop- ment of Arlagården®. Performance Our owners are counting
2020 2019 on us to add 2018 2017 value to 2016 every kg of their milk.
Content
44 Market overview 45 Financial review 49 Financial outlook 51 Five year financial overview 52 Segment overview 54 Europe 55 International 56 Arla Foods Ingredients 44 Annual report 2016
Market overview
Milk prices at year-end were the highest in two and a half years, and have improved strongly versus the low mid-year levels. However, farmers realised significant losses on their farms throughout the year and despite increasing optimism driven by higher prices, they remained cautious given the brutal price environment of recent years.
2016 was a challenging and highly downward quickly and reached Global markets initially trailed but significant declines and, in some volatile year for the global dairy historically low levels in May to eventually equaled these trends categories, real shortages in the industry. Big swings in European June 2016. With limited impulses by year-end. As a result, milk second half. Although milk prices supply were the primary driver of from other regions, Global Dairy commodity prices grew 90 to at year-end were the highest in volumes and prices, while Trade (GDT) prices followed the 100 per cent in Europe and 70 per two and a half years, farmers American supply grew modestly trend and finished the first half of cent on the GDT, within six to realised significant losses on their and Oceania supply continued to 2016 at five year low prices, with seven months and completely farms throughout the year, and contract, as a result of low global whole milk powder prices of USD reversed the negative pricing despite increasing optimism driven milk prices that characterised the 2,000 to 2,100 per metric tonne. trends of the last two years. by higher prices, they remained market during the first seven to cautious given the brutal price eight months of 2016. Demand In stark contrast, milk supply in In total, the 2016 milk supply environment of recent years. grew in line with Gross Domestic Europe declined significantly declined by approximately Product (GDP) in most markets, during the second half of 2016, one per cent in Europe versus which translated to low single-digit which led to the fastest milk price 2015. However, this development growth in most countries. This rally ever recorded. Supply growth, masks a huge discrepancy in development also included most which had slowed in the second oversupply in the first half versus emerging markets and the major quarter, stabilised and then oil exporting regions of the world decreased sharply as the year such as the Middle East and progressed. This development was Sub-Saharan Africa, which grew largely driven proactively by more slowly than in recent years. farmers, who quickly reduced milk output by five per cent in the fourth The European milk supply grew quarter, due to unsustainable milk sharply in the first four months prices. Following record cullings, G o a a r ra e eve o en n o e o er of the year, mirroring the farm closures and rigorous political S t nne annualisation effects of the lobbying, the EU also introduced abolition of the EU quota system an intervention programme to in April 2015. Farmers who were help stabilise the market. With now able to produce unlimited supply decelerating quickly and no quantities of milk for the first time measurable changes in demand, ever, produced five per cent more milk prices finally began to milk in the first quarter of the year. increase early in the second half of In countries with particularly 2016. Improvements started in the strong dairy industries, such as European yellow cheese and Ireland and the Netherlands, butter categories as a direct result growth rates were the highest at of the increasing scarcity of raw 25 and 12 per cent respectively. material in the European milk Although these increases market. Price inflation quickly moderated later in the first half of spread to European powder 2016, given no matching increase products and then to other dairy u in demand, prepaid prices moved commodities traded on the GDT. an e ar r ay un ug Se t v e Business review | Strategy | Governance | Performance | Risk and opportunity | Values and considerations | Consolidated financial statements 45
Financial review
Arla maintained a solid business performance throughout 2016, despite highly volatile milk markets. While revenue declined due to the external price environment, we responded to the change in milk supply by improving the quality of our revenue through focusing on our brands. We continued to drive innovation in order to ensure sustainable growth in our branded portfolio. We delivered financial results above our targets on most measures, with net profit at 3.6 per cent of sales (including the divestment of Rynkeby), a strategic branded volume driven revenue growth of 5.2 per cent and a growth in brand share to 44.5 per cent. The performance price for the year was 30.9 EUR-cent/kg.
Arla’s business performance 30 per cent or 7.25 EUR-cent/kg. Strong profit level supported million. Net profit was also impacted reflected the year’s market This is the most rapid increase in by divestment of Rynkeby mainly by losses experienced by volatility to a limited extent. This the prepaid milk price that Arla has Despite lower sales and milk our associated company in China, was the result of our ability to ever recorded. volumes, Arla's net profit grew Mengniu, and currency availability utilise low milk prices in the first 20.7 per cent for the 2016 financial and devaluation in Nigeria. Despite half to grow market share and The 2016 performance price year, to EUR 356 million from EUR having an unfavourable impact volumes in core European and decreased 8.3 per cent to 295 million in 2015. As a percentage on net profit, we deliberately international markets. In the 30.9 EUR-cent/kg, compared to of sales, 2016 profit, excluding increased the prepaid milk price in second half of the year, financial 33.7 EUR-cent/kg in 2015. The minority interest share of the result, the last quarter of the year to results were less strong for the performance price reflects the was 3.6 per cent versus 2.8 per cent support our farmer owners. Group as we made the strategic ability of the Group to add value to in 2015, and therefore above the choice to increasingly focus on our owners’ milk and hence the previously communicated target Milk volume declines raising prices at the expense of ability to add value through range of 2.8 to 3.2 per cent. 2.2 per cent after turbulent volumes, driven by lower supply our innovation, brands, cost production year availability. Similarly, as prices programmes, global growth, and Our net profit was influenced by Total milk volumes declined improved, we focused on paying other strategic and operational significant one-offs in 2016. On the 2.2 per cent to 13.9 billion kg in out as much to farmers as quickly efforts. The performance price is a positive side, the sale of Rynkeby 2016, compared to 14.2 billion kg as possible to help our owners key element in measuring Arla's increased net profit by 1.2 of volume intake in 2015. Milk realise market improvements and relative performance versus our percentage points or EUR 120 volumes from farmer owners support their farm economies. peers, which is done consistently through our peer group index, Arla’s milk prices closely linked to our mission. reflect a challenging and volatile market The preliminary peer group index Pre a m r ce The generally low price level for for 2016 is 105. This shows that cent g commodity products that Arla generated an average of five per characterised the majority of 2016, cent more value per kg of member impacted Arla’s ability to safeguard milk than the average of the peer the milk price for our owners. The group in 2016. The peer group average prepaid milk price for includes all publicly available 2016 was 9.4 per cent lower at competitors in Northern European 29.0 EUR-cent/kg, compared to markets, such as Germany, the 32.0 EUR-cent/kg in 2015. It is Netherlands, the UK, Denmark and important to note, however, that Sweden, representing 80 per cent of the development of the prepaid all milk produced in the region. The prices improved significantly in index is a solid measure on Arla’s the latter part of the year, driven ability to pay a competitive milk price by strong price management. in the market. Our strategic ambition Between August and December is to deliver a peer group index of 2016, Arla announced increases 103 to 105 as stated in our strategy, u in the prepaid milk price of nearly Good Growth 2020. an e ar r ay un ug Se ct ov ec 46 Annual report 2016
reduced by 1.1 per cent to 12,320 There is a delay in achieving price result, sales volumes in this million kg, from 12,463 million kg increases at retail due to a varying channel grew 2.7 per cent in 2016. Strategic branded volume in 2015. Contract milk, speciality degree of contract negotiation driven revenue growth in 2016 milk and milk acquired to meet windows across our European and In addition to a shift to retail and local market demands, reduced by international markets. This is most foodservice, Arla is strongly 10.1 per cent to 1,554 million kg, notably seen in Germany, the UK, committed to increasing our share versus 1,729 million kg in the Sweden and Denmark where of branded products. We believe previous year. notice periods to retail customers this is the strongest opportunity vary. Retail products represent we have to drive maximum value Despite the challenges we have 80 per cent of Arla’s business, of for our products. Consumers pay a faced in the market, few members which 44.5 per cent is branded premium for brands they know and have left the cooperative other business. This makes our business trust. They are more loyal to than through expected develop- composition significantly more brands that ensure the right 4.5% ments such as retirement. brand-driven relative to our balance between value, innovation competitors and has had a and a positioning they identify 2015: 2.5% Revenue declines negative impact on our peer with. As a result, we believe that 6.8 per cent in 2016 group performance in the second consistently improving the At Arla, there are four primary half of 2016. percentage of branded sales in our components that determine sales portfolio strengthens our position development: milk prices, volume, Significant steps forward on in the long-term. In 2016, sales product mix and exchange rates. business health and structure volumes of our strategic branded In 2016, revenue declined 6.8 per We are committed to realising our products grew 5.2 per cent, which cent to EUR 9.567 million, strategy and pursuing growth in a is the highest rate ever and double compared to EUR 10.262 million volatile market. The core of the the rate of 2015. Branded sales in 2015. This is primarily a result of strategy is a focus on improving now total 44.5 per cent of total 7.7% lower milk prices, which dominated the quality of our revenue with sales, increasing 2.5 percentage the market for the first three significant increases in our points compared to 2015. To 2015: 6.1% quarters of the year. Unfavourable branded and international sales, as support this development, exchange rate developments, well as maintaining a tight control marketing spend increased to primarily as a result of the on costs. EUR 309 million from EUR 283 weakened GBP in the UK, which million in 2015. comprises 25 per cent of Group Improving the quality of revenue, also negatively impacted revenue, strengthening brand A further area of strong strategic overall revenue development. performance and growing focus is growing our International Read more on page 91. international positions business. 50 per cent of Arla’s Improving the quality of our topline ambition in Good Growth Price rally in the second half revenue is a core element of our 2020 comes from growing sales of 2016 strategy, Good Growth 2020. in our above-average margin 3.0% Price management has enabled a Historically, more of our products International markets, where milk visible increase of 7.25 EUR-cent/kg were sold via trading and other supply shortages exist, population 2015: 0.1% in the prepaid milk price from commodity-like channels. This is growth is high and an emerging August 2016, Arla being one of the still the case for the majority of our middle class all support increased first to do so. This has been competitors. In an effort to get demand for high quality dairy achieved by a rapid rollover of closer to consumers, reduce sales products. In 2016, International commodity prices into Arla’s retail volatility and achieve higher mid volume driven revenue growth was and foodservice channels, as well and long-term profitability, we 9.5 per cent. Although this was as our branded business. have chosen to move significantly beneath our 15 per cent target for more milk into the retail and the year, it still allowed us to add Price increases are expected to be foodservice channel. Despite lower significant incremental value to targeted on an annual basis in the overall milk intake, Arla was able to our owners’ milk and achieve an 10.6% retail and foodservice business move more than 340 million kg 18.0 per cent International sales sectors when looking forward from trading to this significantly share versus 16.5 per cent in 2015: 9.9% into 2017. more profitable channel. As a 2015. Another key high-margin Business review | Strategy | Governance | Performance | Risk and opportunity | Values and considerations | Consolidated financial statements 47
commercial segment is Arla Foods cost across two key metrics: inflation, dairy closures and improvement of EUR 372 million. Ingredients. Sales in this segment scalability and conversion costs. increasing relative capacity costs in The released funds were partly increased in 2016 due to very These communicate how our production caused by lower milk used to pay out a supplementary strong growth in value added costs are progressing across critical volumes. To support our conversion payment of EUR 108 million related protein sales. dimensions versus changes in sales cost ambition, our strategy includes to the 2015 profit appropriation. volumes. Within the Group, we an ambitious cumulative cost This was in line with our practice of As a result of the shifts to retail and regularly monitor these metrics improvement target of EUR 400 paying out 1 EUR-cent/kg of foodservice, branded and across all key commercial and million. Over time, all zones and member milk to our owners. International business, Arla was functional areas. functions will contribute to these Furthermore, EUR 22 million was able to reduce sales to the savings, with the primary focus paid out to leaving or retiring commodity-driven trading channel Scalability is a core cost measure being on cost improvements farmers to reimburse their to 2,936 million kg milk. This within Arla, as we believe it within supply chain. The efficiency individual capital. The remaining represented 20.1 per cent of sales, provides an objective criterion to programme kicked off at the amount was used to repay debt, compared to 21.5 per cent in evaluate the overall efficiency of beginning of 2016 and has significantly improving our 2015. While a base of sales in this our core operations when milk resulted in a EUR 100 million financial position. channel is important to ensure volumes are increasing. Scalability saving during its first year. flexibility with seasonal and is the ratio between volume driven demand volatility, Arla is pleased revenue growth and capacity Delivering strong cash flow with this development and it is costs. Capacity costs measure our improvements in line with our Good Growth fixed cost base and hence also the In 2016, Arla delivered a very 2020 strategy target to reduce foundation for our scalability strong cash flow. Cash flow from trading business to less than measure. We want to consistently operating activities increased 20 per cent of sales by 2020. grow our volume driven revenue 20 per cent to EUR 806 million growth at twice the pace as our compared to EUR 669 million in Maintaining tight control capacity cost base and hence 2015, primarily due to stronger on costs consistently grow our margins cash flow from underlying As a low margin business, keeping through rigid cost control. operational activities, i.e. EBITDA, strict control on costs and rigorously In 2016, Arla's scalability was and improvements in net working optimising processes is critical to >2.0, which was in line with our capital position. our success and competitive communicated target and positioning. To ensure that these exemplifies firm control of capacity Cash flow from investing activities opportunities are maximised, Arla costs. In the first half of 2016, we reduced by 26 per cent to puts continuous focus on restructured the organisation by EUR -305 million compared to minimising growth in both supply making more than 500 white collar EUR -410 million in 2015, mainly chain and administrative costs to employees redundant in order to as a result of lower investments in the greatest extent possible. drive a functional and aligned property, plant and equipment. agenda throughout Arla. The This reflected our ability to utilise Development in free cash flow Costs for Arla include three major majority of the resulting cost our production capacity at existing sites more efficiently, which areas: production, sales and savings will be visible in 2017. distribution and administration. allowed us to temporarily reduce These costs declined six per cent Supply chain efficiency, expressed capital expenditure. Capital to EUR 9,254 million in 2016, as our conversion cost index, expenditure at Arla decreased by compared to EUR 9,847 million in measures how supply chain costs 25 per cent to EUR 263 million 2015. The decrease of EUR 593 develop in relation to volumes. After from EUR 350 million in 2015. million is mainly attributable to strong first half year performance, The Rynkeby divestment also lower milk prices, lower milk lower milk intake in the second contributed EUR 138 million to volumes, savings and currency half of the year, drove our full year Arla’s cash flow from other translation effects. Read more on conversion cost index of 99.2 investing activities. page 92. versus our target index of <98.5. Nevertheless, this development As a result of the developments, More important for us than cost highlights a lower absolute free cash flow for 2016 grew 239 development by line item, expenditure for supply chain costs per cent to EUR 639 million, versus however, is the development of versus the prior year despite EUR 267 million in 2015, an 48 Annual report 2016
Building a strong financial strong cash flow focus. Net opportunities, deliver our strategy, position for the future interest-bearing debt (excluding Good Growth 2020, and thereby Our strong free cash flow had a pension liabilities) declined secure the highest possible favourable impact on our net debt 25 per cent to EUR 1.648 million in milk price for our farmers. Our position, and therefore on our 2016, compared to EUR 2.203 performance and ability to pay a healthy leverage of 2.4 (including million in the previous year. EBITDA competitive milk price to farmers the divestment of Rynkeby) at (including the divestment of in 2016, while significantly year-end, compared to 3.3 in 2015. Rynkeby) improved 11 per cent to strengthening our financial position, EUR 839 million in 2016, versus was due to strict financial discipline The Group has a strong and EUR 754 million in the prior year. in the business and a determined improved financial position and As a result, Arla’s year-end financial effort to shift more volumes of standing with credit institutions. leverage ratio improved to 2.4, milk into higher-margin products. Financial leverage is our most compared to 3.3 in 2015, Following the restructure in 2016, important balance sheet key surpassing our long-term target we have become an even stronger performance indicator at range of 2.8 to 3.4, which cooperative, operationally, financially Arla, because it is the measure underpins the Group’s strong and in our mindset. This gives us the used by external parties to financial position. This is supported momentum needed to achieve measure our financial strength and by an improved solvency ratio of Good Growth towards 2020. creditworthiness. It is calculated as 34 per cent. the ratio of net interest-bearing debt to profitability, i.e. EBITDA, and Building a strong balance sheet for in 2016 both components of the future enables Arla to make leverage improved, signaling Arla’s strategic choices and utilise