Difficult Times for US Dairy Long-Term Trends, and Insights for China’S Dairy Companies October 2020 Table of Contents
Difficult times for US dairy Long-term trends, and insights for China’s dairy companies October 2020 Table of contents
Executive summary 3
Introduction 4
COVID-19 market disruptions 5
Difficult trends for milk processors Bankruptcies and declining fluid milk consumption 7 Shrinking retail-to-farm margins on fluid milk products 8 Increasing capacity in the face of shrinking demand 9 Private labels and commodification 10 Increasing retail competition and consolidation 12 Vertical integration by retailers 14 Consolidation and vertical integration by dairy cooperatives 15 Premium milk product differentiation 16
Raw milk production and dairy farm exits Cheese and butter manufacturing drive raw milk demand 18 Traditional dairy farms cannot compete 19
Insights for China’s dairy industry 21
Contact us 24
Difficult times for US dairy: Long-term trends, and insights for China’s dairy companies | 2 Executive summary
The US dairy industry has been facing a variety of difficulties, including the COVID- their market share. Organic, grass-fed, lactose-free and ultra-filtered high protein 19 pandemic, bankruptcies of two large milk processors and thousands of dairy milk are often priced nearly twice as high as conventional pasteurised milk. farms leaving the industry. This report looks at the long-term trends and underlying Dairy cooperatives market 85% of US raw milk on behalf of farmers, and have been industry structure that led to the current challenges, as well as insights from the US consolidating for decades. These cooperatives traditionally process about 35% of market that can be used to inform the long-term strategy of China’s dairy their raw milk in their own factories, mainly into dry products, cheese and butter. manufacturers. Dairy Farmers of America (DFA) is the largest US dairy cooperative, and markets The COVID-19 stay-at-home orders hit the US market in March of this year. Retail about 30% of raw milk sold by US farms. It owned more than 40 processing plants dairy product sales surged but food service demand for dairy products fell even prior to 2020. In May, DFA agreed to acquire 44 plants from Dean Foods and will more, resulting in the dumping of more than 160,000 tonnes of raw milk. Demand likely be both the largest marketer and processer of raw milk (by volume) in the US has begun to recover due to some food service re-openings and government once the acquisition is complete. programmes to purchase agricultural products and distribute them to people in need. US per capita cheese consumption has shown a strong long-term growth trend. Driven mainly by cheese manufacturing, raw milk production has been increasing The largest US fluid milk processor, Dean Foods, declared bankruptcy in late 2019, for decades, and has nearly doubled since 1970. followed by a second major fluid milk processor, Borden Dairy Company, less than two months later. These two events represented the culmination of several long- In spite of this growth, the number of US dairy farms has fallen by about 90% since term trends. 1970, as the average dairy farm size increased from 25 dairy cows to over 172. The total number of dairy cows in the US has remained practically unchanged, as Since 1975, US per capita consumption of fluid milk has declined by 40% as improved technology and farming practices have increased milk production per cow consumers’ beverage preferences and breakfast habits changed. The difference by about 50% since 1970. With automation and technology, large farms can between the retail price of whole milk and the farm price of raw milk declined by achieve higher dairy cow productivity and economies of scale. about 30% during the years 2015-2019. But as consumption continued its decline, the number of fluid milk processing plants increased by nearly 20% between 2011 Many small, family-owned farms cannot compete. The number of licensed dairy and 2018. herds has fallen by more than 6,000 since 2017. To maintain positive cash flow, small farms must sell premium-priced products, rely on family labour and grow US grocery retailers use low milk prices to compete for customers. Customers some of their own feed or fodder when possible. usually purchase additional products, with higher margins, each time they visit a grocery retailer’s store or website. Retail chain operators often undercut Analysing the dynamics of the US dairy industry can provide useful insights for manufacturers’ brands with cheaper milk sold under their private label brands. China’s dairy companies. Strategic decisions made today could help them in the Some leading retailers have built their own factories to process private label milk future to avoid difficulties currently faced by parts of the US dairy industry. and other dairy products. In spite of anticipated long-term growth in China’s dairy consumption, China’s dairy During the past 20 years, retail competition has intensified with the rise of companies need to actively develop new products for evolving consumer supercentres, warehouse club stores and discounters that compete mainly on preferences and growing cold chain capacity. Investing in start-up companies can price. Meanwhile, consolidation among supermarket chains has reduced the pricing be more effective than in-house innovation. Companies need to periodically adjust power of milk suppliers. their product portfolios to optimise growth and profitability. With economies of scale, large-scale dairy farms will continue to displace small dairy farms. While overall fluid milk consumption is falling, premium varieties are increasing
Difficult times for US dairy: Long-term trends, and insights for China’s dairy companies | 3 Introduction
The US dairy industry has been facing several challenges, raising questions about what kind of future it faces. In recent industry news, there have been three main areas of difficulty: the impact of the COVID-19 pandemic, the bankruptcy of two well-known US milk processors, and the ongoing exits of dairy farmers from the industry. How is the COVID-19 pandemic affecting the US dairy industry? What are the long- term trends and underlying industry structures that led to the demise of these leading dairy companies and small farms? Do these difficulties reflect the overall state of the US dairy industry? What can China’s dairy companies learn from their fate? This report analyses recent difficulties and ongoing trends in the US dairy industry across the retail, processing and farming sectors. It presents some key insights from the US that could be useful to China’s dairy companies.
Difficult times for US dairy: Long-term trends, and insights for China’s dairy companies | 4 COVID-19 market disruptions
Starting in mid-March of this year, many local governments in the US issued stay-at- home guidelines and restrictions on on-site restaurant dining, resulting in a surge in Monthly retail revenue from US eating and drinking establishments and grocery sales. According to Nielsen, there was a 53% increase in retail milk sales, a grocery stores 127% increase in retail butter sales and an 84% increase in retail cheese sales for the 1 week ending on 21 March. 80 s These restrictions also led to a steep drop in demand for restaurants and institutional 70 food service. In normal times, about half of the dairy industry’s revenue is estimated 60 Grocery stores to come from restaurants, school cafeterias and other food service channels.2 Ever
USD Billion USD 50 since 2007, American consumers have spent more on food consumed outside of the 3 40 Food service & home than on food consumed at home. School cafeterias are estimated to account drinking places for about 7% of US dairy demand. On a regular school day, the government provides 30 school children with about 30 million lunches and 15 million breakfasts, with practically every meal including one serving of milk.4
Beginning in March, schools closed, and most restaurants were forced to close or Source: US Census Bureau limit their business to take-out and delivery. Monthly revenue in eating and drinking establishments was 30% below average in March and 50% below average in April.5 The rapid change in consumption patterns disrupted dairy processing and wholesale 11% of restaurant operators surveyed by the National Restaurant Association in distribution. Milk, butter, cheese and cream that are processed and packaged for March expected to close permanently due to the pandemic.6 restaurants, schools and other food service users cannot be easily shifted to retail because the product mix, portion size, packaging, and labelling are all quite different. Raw milk must be processed soon after production and cannot be frozen like meat or kept in long-term storage like grain. Many farmers were forced to dump their milk because dairy product demand from food service channels dried up. In April 2020, 1 Reuters, “US Dairy Farmers Dump Milk as Pandemic Upends Food Markets”, 3 Apr 2020 about 160,000 tonnes of milk (about 2% of total production) was dumped, roughly 10 2 CNBC, “Pandemic Fallout is Severely Threatening US Dairy Farms”, 6 May 2020 7 3 US Census Bureau times the amount dumped in April 2019. 4 School Nutrition Association, based on USDA FY18 preliminary data 5 US Census Bureau, seasonally adjusted figures 6 National Restaurant Association, “New Research Details Early Impact of Coronavirus Pandemic on Restaurant Industry”, 25 Mar 2020 7 USDA Agricultural Marketing Service, Dairy Market News, 15-19 Jun 2020
Difficult times for US dairy: Long-term trends, and insights for China’s dairy companies | 5 It appears that dairy farmers are adjusting to the demand shock. In April 2020, raw milk production was 1.2% higher than one year earlier, but May production was 1.1% Weekly average block cheddar cheese price on the Chicago Mercantile lower than last year.8 The amount of milk that was dumped returned to normal levels Exchange in May. Total US cow numbers in May fell by 11,000 compared to April (although 2.75 there were still 37,000 more than one year earlier.) Average production per cow also fell by about 1%.9 According to Progressive Dairy, this decline in productivity was 2.50 likely due to changes in feed rations to meet raw milk production limits imposed by 2.25 10 cooperatives and other buyers. 2.00 Some of the demand and supply mismatch is being resolved by efforts to redirect USD 1.75 dairy and other food products from restaurant and institutional food service channels 1.50 to programmes that distribute free food to children, the unemployed and elderly 1.25 citizens. 1.00 Many school lunch and breakfast providers are now producing free meals that Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar Apr May Jun Jul families can pick up at distribution locations.11 In April, the US Department of 2019 2019 2019 2019 2019 2019 2019 2020 2020 2020 2020 2020 2020 2020 Agriculture (USDA) announced the Coronavirus Food Assistance Program. As part of Source: Cheese Reporter this programme, it will purchase USD 300 million in agricultural products each month, including USD 100 million of dairy products, from distributors that have been affected According to data from IRI, purchases of cheese in retail stores remain 20-30% by the closure of restaurants, hotels and other food service entities, and will distribute higher than last year.13 Fluid milk prices have also seen rapid changes, as farm milk those products to food banks and other non-profit organisations for distribution to prices fell in April and May, while retail fluid milk prices in stores rose.14 people in need.12 Borden Dairy Company, which filed for bankruptcy in January, has been contracted The disruption of the market for dairy products can be seen in the Chicago Mercantile by the USDA to deliver up to 700 million servings of fresh fluid milk to non-profit Exchange (CME) prices for cheddar cheese. As demand from restaurants and food organisations in order to help people who have been impacted by the COVID-19 service dropped off, so did the market price of block cheddar cheese, falling from pandemic. This would be roughly equal to 10% of Borden’s annual production.15 USD 1.86 in March to USD 1.01 in April. Prices then rose steeply as restaurants Private companies are also working to redirect excess raw milk in order to provide began to reopen and the government announced the Coronavirus Food Assistance dairy products to people who cannot afford to buy food because of the pandemic’s Program, reaching USD 2.65 in June and USD 2.85 in July. economic impact. In May, for example, the supermarket chain operator Kroger announced that it would purchase about 760,000 litres of milk from farmers to process and redirect to a network of food banks.16 Chobani also purchased additional fluid milk and processed millions of cups of yogurt to donate to food banks and other 17 8 Production numbers include any milk that was dumped. programmes. 9 USDA, Milk Production, 18 Jun 2020 10 Progressive Dairy, “May U.S. Milk Production Shifts to Reverse”, 19 Jun 2020 11 USA Today, “School Lunch Programs are Losing Millions Feeding Hungry Kids; They Could be Broke by Fall”, 1 June 2020 12 USDA, “USDA Announces Coronavirus Food Assistance Program”, 17 Apr 2020 13 New York Times, “What’s Gotten Into the Price of Cheese?”, 22 June 2020 14 US Bureau of Labor Statistics (BLS), USDA 15 The Dallas Morning News, “For a Second Time in Borden’s 163-year History, a Government Contract Could Propel It Through a Crisis”, 26 May 2020 16 Food Navigator, “Kroger Buys and Redirects Dairy Farmers’ Surplus Milk to Feeding America Food Banks”, 1 May 2020 17 Food Navigator, “Chobani President: ‘When This is Over, Companies Will be Judged on How They Behaved…’”, 14 May 2020
Difficult times for US dairy: Long-term trends, and insights for China’s dairy companies | 6 Difficult trends for milk processors
Bankruptcies and declining fluid milk demand in whole milk consumption coincided with twentieth-century advice connecting saturated fat consumption with heart disease and other health risks.26 In November 2019, prior to the COVID-19 outbreak, Dean Foods filed for bankruptcy.18 Borden Dairy Company, founded in 1857 and one of America’s iconic Consumers are drinking more bottled water and ready-to-drink coffee instead of brands, filed for bankruptcy in January 2020.19 milk.27 Breakfast preferences have long been shifting from milk with cereal towards alternatives like yogurt or breakfast bars that can be eaten on the go. Consumption of Dean Foods had 58 dairy manufacturing plants at the end of 2018. It was the largest plant-based alternative milk beverages such as almond and soy has accelerated in fluid milk processor and the largest direct-to-store distributor (DSD) of fresh fluid milk recent years. These currently account for less than 10% of the fluid milk and milk- 20 in the US. Its DairyPure and TrueMoo brands were the largest US white milk and based beverage market,28 but growing interest in vegan alternatives will continue to 21 flavoured milk brands, respectively. Borden has 12 manufacturing plants and was negatively impact fluid milk consumption. also one of the largest fluid milk processors in the US.22 Dean Foods and Borden together accounted for over 13% of 2019 fluid milk sales in the US, according to Euromonitor.23 Both Dean Foods and Borden Dairy Company relied on fluid milk sales for the vast US per capita fluid milk consumption (1975-2018) majority of their revenues. Each of them cited the long-term decline in milk consumption and increasing consumer preferences for plant-based milk products as 110 causes of their difficulties.24 100 Indeed, per capita consumption of fluid milk in the US has declined by more than 40% since 1975.25 Consumers have gradually shifted to an ever-growing variety of 90 80 substitutes based on evolving nutrition, lifestyle and taste preferences. Early declines Kilograms 70
18 Wall Street Journal, “Biggest U.S. Milk Company Dean Foods Files for Chapter 11 Bankruptcy”, 12 Nov 201918 60 19 Bloomberg, “Borden Becomes Second Big U.S. Milk Producer to File for Bankruptcy”, 6 Jan 2020 20 Noteholders’ Response to Emergency Motion of Food Lion LLC and Maryland and Virginia Milk Producers Cooperative Association, Inc., 23 Apr 2020 21 Dean Foods 2018 Annual Report 22 Wall Street Journal, “Borden Dairy Files for Bankruptcy”, 6 Jan 2020 Per capita fluid milk consumption 23 Los Angeles Times, “As Milk Consumption Falls, Borden Dairy Co. Files for Bankruptcy Protection”, 6 Jan 2020 Source: USDA 24 Wall Street Journal, “Biggest US Milk Company Dean Foods Files for Chapter 11 Bankruptcy”, 12 Nov 2019 Note: Fluid milk includes the product weight of beverage milks: whole, reduced fat, low fat, skim, flavoured, 25 USDA buttermilk, eggnog, and miscellaneous. 26 LaBerge, A.F, How the Ideology of Low Fat Conquered America, Journal of Medical History and Allied Sciences, 23 Feb 2008 27 Wall Street Journal, “Recipe behind Coca-Cola’s Milk Success: Less Sugar, More Protein”, 1 Nov 2019 28 IBISWorld; PwC analysis
Difficult times for US dairy: Long-term trends, and insights for China’s dairy companies | 7 Shrinking retail-to-farm margins on fluid milk products As consumption of liquid milk continued its long-term decline, margins between conventional fresh milk retail prices and farm-gate raw milk prices shrunk drastically between 2015 and 2019. The difference between the supermarket retail price of a litre of whole milk and farm price of a litre of raw milk fell from USD 0.57 in January 2015 to only USD 0.40 in December 2019.29, 30 Raw milk prices dropped in April and May 2020 due to COVID-19-related disruption in dairy product demand from restaurant and institutional food service channels. This has temporarily benefitted dairy processors’ profitability for dairy products sold in hypermarkets/supermarkets, but most processors have also been hurt by loss of revenue from the food service industry. Unless industry-wide fluid milk processing capacity is reduced, the downward trend in profitability for traditional fresh milk will likely continue when the economy returns to normal.
Difference between US retail whole milk price per litre and raw milk farm price per litre (2014-2020)
1.00
0.75 USD 0.50
0.25 Jul 17 Jul 18 Jul 19 Jul Jul 16 Jul Jul 14 Jul 15 Jul Jan 17 Jan 18 Jan 19 Jan 20 Jan 16 Jan 14 Jan 15 Mar 17 Mar 18 Mar 19 Mar 20 Mar 16 Mar 14 Mar 15 Nov 16 Nov 17 Nov 18 Nov 19 Nov 15 Sep 16 Sep 17 Sep 18 Sep 19 Nov 14 Sep 15 Sep 14 May 17 May 18 May 19 May 20 May 16 May 14 May 15
Class 1 raw milk base price Whole milk retail price Difference
Source: BLS monthly retail whole milk prices and USDA Federal Milk Order Class 1 base prices
29 Note: Because the retail price of milk is largely driven by volatile raw material commodity prices (e.g. raw milk, feed and fodder), the absolute difference between retail milk and raw milk prices is more indicative of per unit income for transportation, processing and retail selling of milk than gross margin measured as a percentage of retail price. 30 Based on US BLS monthly retail whole milk prices and USDA Federal Milk Order Class 1 base prices
Difficult times for US dairy: Long-term trends, and insights for China’s dairy companies | 8 Increasing capacity in the face of shrinking demand In spite of excess fluid milk processing capacity, companies have many reasons for building new plants. These include the deployment of updated technology for Between 1970 and 2011, US fluid milk processing capacity consolidated from 2,216 improving efficiency, freshness, sanitation, and shelf life. Newly-built plants can plants processing an average of roughly 11,000 tonnes of milk per factory annually to incorporate modern processing capabilities for high-value dairy beverages such as 388 plants processing an average of 63,000 tonnes per year. But since 2011 the organic, ultra-filtered or reduced-lactose milk. number of fluid milk processing plants has increased, reaching 459 in 2018,31 even as total milk beverage production fell from 24.6 million tonnes to 21.6 million tonnes. For example, Coca-Cola’s Fairlife converted an auto parts factory in Michigan to a Expanding production capacity in the face of falling demand contributes to pressure dairy processing plant about ten years ago in order to produce its new ultra-filtered on processor margins for fluid milk products. milk product,32 and is building a new dairy plant in Arizona to increase production.33 Many relatively niche milk products, such as organic milk, use ultra-high temperature (UHT) processing facilities. Because volumes of these products only amount to a small fraction of overall milk demand, a single organic processing plant often must Number of fluid milk processing plants and total fluid milk consumption serve a much larger geographic area than a traditional pasteurised fresh milk plant. in the US (2008-2018) UHT processing (without aseptic packaging) extends shelf life to two months, facilitating distribution to more distant retail outlets as well as more efficient inventory 460 management. UHT processing with aseptic packaging can extend shelf life to more 450 25 than six months. 440 As grocery giants such as Walmart or Kroger have vertically integrated, they have 430 24 built new plants to meet specific product and geographic requirements. These plants 420 410 Million tonnes can be very large, and sometimes serve hundreds of supermarkets, supercentres or 400 23 warehouse stores. With the latest biosecurity and cold chain technologies, a single 390 plant can distribute pasteurised milk products over a much greater geographic range 380 22 than in the past. 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 The shrinking margins on fluid milk are being driven by several trends in addition to Number of fluid milk processing plants (left axis) Total beverage milk consumed falling consumption and excess production capacity. Commodification, industry (right axis) consolidation and vertical integration are also influencing margins for fluid milk Source: USDA products in the US.
31 USDA 32 Mlive, “Fairlife, Coca-Cola’s New Milk Drink Made in Coopersville, Expected to ‘Rain Money’”, 12 Feb 2015 33 Azcentral, “Fairlife Milk Company Plans to Open $200 Million Plant in Goodyear”, 11 Apr 2019
Difficult times for US dairy: Long-term trends, and insights for China’s dairy companies | 9 Private labels and commodification Dean Foods estimated that milk drives about 14% of retail shopping trips,34 and a Consumer Reports survey found that low prices was consumers’ top reason for Fluid milk products sold in the US mainly consist of fresh pasteurised milk containing choosing a store to buy groceries.35 various levels of milk fat content. These include whole milk (3.3% milk fat), 2% milk (2% milk fat), low fat milk (1% milk fat) and skim milk (less than 0.5% milk fat). There Once customers have entered a supermarket, supercentre or warehouse store, they are also organic, lactose-free, ultra-filtered/high protein and flavoured (usually often purchase many other items that bring higher margins.36 While a gallon (3.8 chocolate) variations for each of these categories. litres) of milk may only cost about four US dollars, customers generally spend 10-20 times that amount on higher-margin merchandise each time they visit. A study by the Food Marketing Institute found that each week the average household makes 2.5 2019 US fluid milk sales volumes by 2019 US organic fluid milk sales grocery shopping trips and spends more than USD 110 on groceries.37 product type volumes by product type With online grocery shopping becoming more popular in the US, the motivation to lure customers with low milk prices is even more compelling. In 2019, Walmart’s average Fat-free milk Whole milk order size for US in-store shoppers was about USD 50 with 13 items, but the average Low fat (1%) (skim) 58% 38 12% 7% Reduced fat (2%) size of online “click-and-collect” orders was more than USD 120 with 31 items. Flavoured 23% milk 11% Organic 6% Buttermilk Organic Reduced 1% fat (2%) 30% Others 1% Low fat (1%) 10%
Fat-free (skim) Whole milk 9% 32%
Source: USDA
Retailers of all sizes often sell conventional milk at aggressively low prices in order to draw customers into their stores. Because American consumers’ milk-buying habits are based on a history of consuming fresh pasteurised milk, (which normally reaches its shelf life within 1-2 weeks of purchase), they tend to purchase milk at least once per week, in half-gallon (1.9 litres) or one-gallon (3.8 litres) packages. 34 Dean Foods 2018 Annual Report 35 Consumer Reports, “Best Grocery Stores and Supermarkets”, 16 Apr 2019 Conventional fluid milk product specifications and packaging have been standardised 36 Johnson, Justin P, “Unplanned Purchases and Retail Competition”, American Economic Review, 2017 37 Food Marketing Institute, US Grocery Shopper Trends, 20 Jun 2019 across all brands for decades, so consumers can easily compare advertised prices 38 Numerator, “Walmart’s Grocery Pickup is Picking Up”, 30 Apr 2019 for various milk products. Price is the major differentiator between brands and between stores.
Difficult times for US dairy: Long-term trends, and insights for China’s dairy companies | 10 The growth of private label brands, (i.e. brand names that are owned by the retail outlet itself), is another factor driving down fluid milk prices. Private label brands account for about 60% of the retail refrigerated milk sales in the US.39 For example, Walmart, which sells over 20% of groceries in the US,40 sells milk under its own Great Value brand. Kroger, the largest traditional supermarket chain operator in the US, sells milk under its own Kroger, Simple Truth and Private Selection brands. Costco, the largest warehouse club store chain, sells milk under its Kirkland Signature brand. Roughly half of Dean Foods’ 2018 revenues came from supplying unbranded dairy products for private label brands. Retailers usually choose their private label fluid milk supplier based on price and shipping distance, and often via competitive bidding. Dean Foods mentioned that intense competition among suppliers of milk for private labels had negatively impacted both the pricing and volume of its fluid milk sales.41 Aggressive pricing of private label milk not only contributes to pressure on the prices paid to processors like Dean Foods, but it also draws retail consumers away from Dean Foods’ own branded milk products. Private label milk is usually priced well below manufacturer branded milk. For example, Walmart sells both its private label Great Value whole milk and Dean Foods’ DairyPure whole milk in its stores. Walmart’s retail price for Great Value whole milk is 18% lower than for DairyPure whole milk sold in the same store,42 although both were likely produced and sold to Walmart by Dean Foods. Walmart was Dean Foods’ largest customer, accounting for 17.5% of revenues in 2017 and 15.3% in 2018.43 The other half of Dean Foods’ 2018 revenue came from dairy products sold under its own brands, of which there were more than 50. DairyPure was Dean Foods’ flagship fluid milk brand. In 2019, it accounted for around 10% of all unflavoured refrigerated whole and low fat/skim fluid milk retail sales in the US.44
39 Frozen & Refrigerated Buyer, “Top Refrigerated”, Sep 2019, based on IRI date for 12 weeks ending 14 Jul 2019 40 Including both Walmart and Sam’s Club stores 41 Dean Foods 2018 Annual Report 42 Walmart.com, accessed on 8 February 2020 for US postal code 95113 43 Dean Foods 2018 Annual Report 44 Frozen & Refrigerated Buyer, “Top Refrigerated”, Sep 2019, based on IRI date for 12 weeks ending 14 Jul 2019
Difficult times for US dairy: Long-term trends, and insights for China’s dairy companies | 11 Increasing retail competition and consolidation Supercentres/warehouse club stores’ combined share of the retail grocery market grew from 6% in 1992 to about 30% in 2012. During that same period supermarket/grocery The retail grocery industry has consolidated significantly during the past 25 years, stores’ share fell from 87% to less than 70%.50 driven by the growth of Walmart and Costco, and by M&A activity among leading supermarket chains. Consolidation of the retail sector has added to the price pressure on milk manufacturers such as Dean Foods and Borden Dairy Company. In 1983, Walmart launched its Sam’s Club warehouse club stores, and 1988 launched US grocery market share by type of establishment (1992-2019) the Walmart supercentre format, which includes a full grocery offering. Now nearly 80% of Walmart’s 5,355 US stores are supercentres or warehouse club stores.45 90% Walmart’s share of the US grocery market has grown to over 20%,46 and its local 80% market share can be much higher in individual metropolitan areas. 70% Kroger acquired a number of supermarket chains in the 1990s, including Fred Meyer, 60% QFC and Ralphs; it acquired Harris Teeter in 2014 and Roundy’s in 2015. Kroger is 50% the largest traditional supermarket chain operator in the US and the second largest 40% grocery seller with over 10% market share.47 30% Costco was founded in 1983 and merged with Price Club in 1993. It has grown to 20% become the largest US warehouse club chain and the third largest seller of groceries 10% with around 6% market share.48 0% Albertsons merged with Safeway in 2015 to become the fourth largest grocery retailer in the US, with a market share of about 5%. Ahold and Delhaize merged in the same 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2016 2017 2018 2019 year to become the fifth largest grocery seller, with a market share of nearly 5%.49 Supermarkets & grocery stores Supercentres & warehouse club stores Supercentres and warehouse club stores compete using low prices and are generally Convenience stores cheaper than traditional supermarkets and grocery stores. Their low-price private Source: US Census Bureau; Annual reports; PwC analysis label brands are one of the main factors that attract customers. During the past 30 years they have taken market share from supermarkets.
45 Walmart 2020 Annual Report 46 US Census Bureau; Annual reports, PwC analysis; Note: in this report retail grocery market refers to retail sales from supermarkets, grocery stores, convenience stores, the estimated grocery sales from supercentres and warehouse club stores, and excludes gas stations. 47 US Census Bureau; Annual reports; PwC analysis 48 US Census Bureau; Annual reports; PwC analysis 49 US Census Bureau; Annual reports; PwC analysis 50 US Census Bureau; Annual reports; PwC analysis
Difficult times for US dairy: Long-term trends, and insights for China’s dairy companies | 12 Warehouse club stores and supercentres differ in their offering of products, brands Their private label conventional milk products are often priced even lower than and package sizes. A typical warehouse club store carries only about 3,700 stock supercentres or warehouse club stores.53 keeping units (SKUs),51 while a supercentre carries more than 100,000 SKUs.52 This Aldi, a privately held German-owned chain with more than 1,800 stores in the US, gives warehouse club stores extra leverage to negotiate directly with manufacturers aims to have 2,500 US stores by 2022. Aldi stores carry only about 1,400 SKUs, (including milk processors) for low prices, because they usually only carry the lowest and private label products account for about 90% of their sales.54 priced brand – often their own private label brand. The growing market share of supercentres, warehouse club stores and discount grocery Traditional supermarkets, which usually stock about 40,000 SKUs, are also facing stores is adding to the downward pressure on milk prices and milk processors’ margins. growing price competition from discount chains like Aldi and Lidl. These stores compete aggressively on price, aiming be 50% cheaper than traditional supermarkets.
51 Costco 2019 Annual Report 52 Walmart 2019 Annual Report 53 CNN, “How a cheap, brutally efficient grocery chain is upending America’s supermarkets”, 17 May 2019 54 CNBC, “Grocer Aldi targets nearby rivals in its bid to boost its US Footprint”, 9 Aug 2018
Difficult times for US dairy: Long-term trends, and insights for China’s dairy companies | 13 Vertical integration by retailers dairy plant in Pennsylvania in 2017 and now owns 20 food processing plants, including seven milk processing plants, and two ice cream plants.65 Large supercentre, club warehouse and supermarket chains continuously revisit their “make or buy” decisions for all of their products, and many have decided to process Publix, a large supermarket chain that operates three dairy plants, recently expanded its their own milk. This upstream vertical integration has accelerated the shrinking of Atlanta plant in order to manufacture its private label extended shelf life dairy products.66 demand for fluid milk processors like Dean Foods and Borden Dairy Company. In 2012, Meijer, a chain of more than 200 supercentres, acquired a dairy plant in With private label brands accounting for about 60% of refrigerated milk retail sales Michigan to supply its 101 stores in that state with private label milk.67 Those stores 55 value, and given the limited shelf life of pasteurised milk, it is not surprising that had previously been supplied by Dean Foods. In 2014, Meijer built its second dairy retailers have acquired or built their own milk processing plants. Vertical integration plant in Ohio, where it had about 40 stores.68 into food processing helps retailers to better manage quality, shelf-life, factory utilisation, distribution and profitability of their private label products. Fluid milk processing companies are increasingly competing with their own customers.
Dean Foods lost about 475 million litres worth of annual sales when Walmart opened its first dairy processing plant in 2018.56 The new, state-of-the art plant is one of the largest in the country, supplying over 500 Walmart and Sam’s Club locations – nearly 10% of the company’s US stores. The plant was built to produce whole milk, 2%, 1%, skim and chocolate milk for Walmart’s private labels.57 This was Walmart’s first entry into food production.58 Both Dean Foods and Borden Dairy Company cited vertical integration by retailers as a factor leading to their bankruptcies.59
Kroger replaced Dean Foods as its milk supplier in the Denver area in 2014 when it built a new, fully-automated plant in that city.60 By 2017, Kroger produced all of the fresh milk sold in its stores.61 Kroger is estimated to be the 13th largest dairy processor in the US, with its 2018 dairy product output amounting to roughly 40% that of Dean Foods (by value).62 Currently Kroger owns 17 dairy plants throughout the US that manufacture its private label milk, cultured products (e.g. yogurt, cottage cheese), 63 ice cream, novelty treats and non-carbonated beverages. Kroger also processes its 55 Frozen & Refrigerated Buyer, Sep 2019, IRI data for 12-weeks ended 14 Jul 2019 own high value dairy beverages, such as organic, ultra-filtered, high protein, lactose- 56 Dean Foods 2018 Annual Report 57 64 Walmart, “Walmart Selects Indiana for New Milk Processing Plant, 200+ Hoosier Jobs”, 18 Mar 2016 free, UHT and aseptically packaged milk. On top of this, the retailer also owns 20 58 TheStreet, “Got Milk? Walmart Starts Production at its Own Dairy”, 13 Jun 2018 other food manufacturing plants, including two cheese plants. 59 Bloomberg, “Borden Becomes Second Big U.S. Milk Producer to File for Bankruptcy”, 6 Jan 2020 60 Dairy Foods, “Mile High excellence”, 6 Apr 2015 61 Wall Street Journal, “Retailers Are Bottling Their Own Milk, Raising Pressure on Dairy Companies”, 13 Oct 2017 Albertsons’ private label products account for about 25% of its grocery sales, and 10% 62 Dairy Foods, “2019 Dairy 100”, 13 Aug 2019 of its private label products are produced in its own plants. The company opened a 63 2018 Kroger fact book 64 Dairy Foods, “Mile High excellence”, 6 Apr 2015 65 Albertsons Companies, Inc. 2018 Form 10-K; Wall Street Journal, “Retailers Are Bottling Their Own Milk, Raising Pressure on Dairy Companies”, 13 Oct 2017 66 The Shelby Report, “Publix Adding 40,000 S.F. to its Atlanta Dairy”, 9 Nov 2017 67 Mlive, “Meijer’s decision to go into the dairy business could impact 200 employees at Dean Foods in Evart”, 29 Mar 2012 68 Dayton Daily News, “Meijer breaks ground on new dairy facility that will employ 103”, 4 Jun 2014
Difficult times for US dairy: Long-term trends, and insights for China’s dairy companies | 14 Consolidation and vertical integration by dairy cooperatives Dairy Farmers of America (DFA), the largest cooperative in the US, was formed by the merger of four cooperatives in 1998. In 2018, DFA marketed about 30 million Dairy cooperatives handle almost 85% of milk sold by US dairy farms, up from 67% in tonnes, or 30% of total US raw milk production.73 Prior to May 2020, DFA had dairy 1964. The number of dairy cooperatives in the US consolidated from 1,244 in 1964 to processing plants in about 46 locations.74 118 in 2017, even as US raw milk production grew from about 55 million tonnes to 98 million tonnes. In 2017, the four largest cooperatives marketed 41% of the raw milk In May 2020, DFA purchased 44 plants from Dean Foods, following the latter’s sold by US dairy farms.69 bankruptcy filing. This transaction could make DFA both the largest marketer of dairy farms’ raw milk and the largest dairy processor (i.e. raw milk purchaser) in the US when the acquisition is complete.75 Number of dairy cooperatives in the Share of US raw milk marketed by With their processing assets, dairy cooperatives have an especially high market US (1964-2017) cooperatives and processed by share in the manufacturing of dry milk products, cheddar cheese and butter. Prior to cooperative-owned plants (1964-2017) May 2020, dairy cooperatives had only a minor share of packaged fluid milk and cottage cheese production,76 but this share will be much larger after DFA’s 1250 100% acquisition of plants from Dean Foods.
1000 80% 60% 750 40% 500 20%
250 0%
0 % of US raw milk marketed by cooperatives 1964 1968 1972 1976 1980 1984 1988 1992 1996 2000 2004 2008 2012 2016 % of US raw milk processed by cooperative- Source: US Government Accountability Office owned plants Source: USDA
Dairy cooperatives sell milk to processors, but they also own their own processing plants. In 2017, cooperatives owned and operated 198 dairy processing facilities, about 69 USDA, Marketing Operations of Dairy Cooperatives 2017; US Government Accountability Office, Dairy Cooperatives: Potential Impacts of Consolidation and Investment in Dairy Processing for Farmers, 27 Sep 2019 15% of all dairy plants in the US (including plants for fluid milk, cheese, butter, yogurt, 70 70 US Government Accountability Office, “Dairy Cooperatives: Potential Implications of Consolidation and ice cream, etc.). About 35% of the raw milk handled by cooperatives on behalf of their Investments in Dairy Processing for Farmers”, 27 Sep 2019 members was processed in plants owned by cooperatives themselves,71 equal to just 71 USDA, Marketing Operations of Dairy Cooperatives 2017 72 USDA, Marketing Operations of Dairy Cooperatives 2017; USDA Dairy Marketing Tables, 15 Sep 2012 under 30% of total US raw milk production. While the percentage of US raw milk 73 Dairy Farmers of America, “DFA Reports 2018 Financial Results”, 20 Mar 2019 marketed by cooperatives has increased, the percentage that is processed by 74 Dfamilk.com, “Where our products are made”, accessed in June 2020 cooperative-owned plants has decreased from 37% in 1987.72 75 Lancaster Farming, “Its Assets Sold, Dean Still Faces Challenges”, 28 May 2020 76 IBISWorld, Dairy Product Production in the US, June 2019
Difficult times for US dairy: Long-term trends, and insights for China’s dairy companies | 15 Premium milk product differentiation Estimated US organic processed fluid Estimated US non-organic processed The vast majority of both Dean Foods’ and Borden Dairy’s revenue came from milk sales (2006-2019) fluid milk sales (2006-2019) conventional fluid milk, a commodified product with decreasing demand and increasing production capacity. Other fluid milk products, however, have shown 1.2 25 positive consumption growth and higher retail pricing. 24 While US consumption of conventional milk has been falling, consumption of many 1.0 niche milk products has been increasing, albeit from a small base. Sometimes 23 Million tonnes referred to as “designer milk”,77 these milk products include organic, grass-fed, Million tonnes lactose-free, ultra-filtered and protein-fortified milk. These often have retail prices that 0.8 22 approach double the price of conventional milk. Each of these products come in whole milk, 2% fat, fat-free, chocolate-flavoured and other varieties. 21 0.6 In 2019, Dean Foods’ DairyPure was the leading refrigerated liquid milk brand, with 20 roughly 10% market share (by retail value), but the next three leading brands included a lactose-free brand (Lactaid), an organic brand (Horizon Organic, owned by Danone 0.4 19 North America), and an ultra-filtered brand (Coca-Cola’s Fairlife).78 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019
Organic milk accounts for less than 6% of total US fluid milk consumption by Organic fluid milk Non-organic fluid milk volume,79 but more than 11% of retail sales value.80 From 2006 to 2019, organic milk sales volume grew by 143% from 480,000 tonnes to 1.2 million tonnes. During that Source: USDA AMS, Estimated Fluid Milk Products Sales Report Note: include whole milk, flavoured whole milk, 2% milk, 1% milk, fat free milk, flavoured reduced fat milk, buttermilk, eggnog, same period, conventional (i.e. non-organic) fluid milk output fell by 19%, from 24.6 and others million tonnes to 19.8 million tonnes. Horizon Organic branded milk had roughly 6% retail market share (by value) for refrigerated milk in 2019.81 Lactose-free milk accounted for about 3% of fluid milk production (by volume),82 but much more by value. Hood’s Lactaid brand accounted for more than 5% of refrigerated milk sales (by value) in 2019.83 During processing, lactase is used to break down lactose into the simple sugars, glucose and galactose. This enables lactose intolerant consumers to enjoy milk products, and for some products, can make the flavour sweeter without adding sugar.
77 Bloomberg, “Coke Thinks Designer Milk Could Be a Billion-Dollar Brand”, 17 Mar 2016 78 Frozen & Refrigerated Buyer, Sep 2019, “Top Refrigerated”, based on IRI data for the 12 weeks ending 14 Jul 2019 79 USDA AMS, Estimated Fluid Milk Products Sales Report; Note: fluid milk products include whole milk, flavoured whole milk, 2% milk, 1% milk, fat free milk, flavoured reduced fat milk, buttermilk, eggnog, and others. 80 Frozen & Refrigerated Buyer, “Organic Sales up 9.1% in 2018”, Mar 2019, based on Nielsen data for the 52 weeks ending 29 Dec 2018 81 Frozen & Refrigerated Buyer, Sep 2019, “Top Refrigerated”, based on IRI data for the 12 weeks ending 14 Jul 2019 82 Hoard’s Dairyman, “Lactose-free milk sales up 10 percent”, 16 July 2018; USDA, PwC Estimates 83 Frozen & Refrigerated Buyer, Sep 2019, “Top Refrigerated”, based on IRI data for the 12 weeks ending 14 Jul 2019
Difficult times for US dairy: Long-term trends, and insights for China’s dairy companies | 16 Fairlife ultra-filtered milk can have 50% more protein and 50% less sugar than regular milk, appealing to some consumers’ evolving nutritional demands. This product was launched in 2014 and by 2019 already accounted for 3% of the US milk market (by value).84 Fairlife, LLC started out as a joint venture in 2012, but became a fully-owned subsidiary of Coca-Cola in January 2020.85 Coca-Cola’s investment indicates that there are still opportunities to grow profitably in the fluid milk category, and that these opportunities are likely to be found in specialised, value-added products. Several other leading dairy companies now offer high-protein and ultra-filtered milk under their own brands. Dean Foods previously owned Horizon Organic, the leading organic milk brand, and Silk, the leading plant-based milk brand, as well as leading premium coffee creamer brands. But these were all sold when Dean Foods spun off its Whitewave subsidiary. When Whitewave launched its IPO in 2012, its Silk brand had 58% of the US plant-based milk market and its Horizon Organic brand held 45% of the US organic milk market.86 Dean Foods also sold its Morningstar Farm subsidiary. This resulted in a significant cash inflow for Dean Foods and its shareholders, but left it with a product portfolio focused on the shrinking fluid milk market and low-margin private brand dairy products. Borden Dairy Company launched a low-fat high-protein milk called Kid Builder in August 2019, but this new product introduction was not enough to avoid bankruptcy.87 In contrast with Dean Foods and Borden Dairy, other leading dairy companies have actively managed their product portfolio to maintain focus on high-growth and/or high- profit categories. Nestle’s North American dairy product revenue was larger than that of Dean Foods,88 but its portfolio is focused on higher-value products, such as ice cream, coffee drinks, powdered milk drinks and coffee creamers. In 2017, Danone acquired Whitewave to add leading US organic and plant-based milk brands to its leading US yogurt brands. Lactalis acquired Stonyfield Farm, an innovative organic dairy manufacturer in 2017, and in 2018 acquired Siggi’s, a start-up focused on Icelandic-style strained yogurt. Private label brands account for less than 10% of US yogurt sales,89 compared to about 60% of fluid milk sales.90 Other leading processers in the US, such as Agropur, Kraft Heinz and Schreiber Foods are more focused on cheese.91 In 2017 Dean Foods moved to re-establish its participation in high-growth organic, probiotic and plant-based markets, with the acquisition of Uncle Matt’s Organic, a 84 Wall Street Journal, “Recipe behind Coca-Cola’s Milk Success: Less Sugar, More Protein”, 1 Nov 2019 85 Fairlife.com, “The Coca-Cola Company Acquires Fairlife”, 3 Jan 2020 partnership with Organic Valley, and an investment in Good Karma, a plant-based 86 The Whitewave Foods Company IPO Prospectus, 2012 milk and yogurt manufacturer.92 These moves were not enough to stave off 87 Dairy Business, “Borden Dairy Launches New Kid Builder Product Just in Time for Back to School”, 21 Aug 2019, 88 Dairy Foods, 2019 Top 100, 13 Aug 2019 bankruptcy. 89 Store Brands, “Riches Galore”, 27 Aug 2019, based on IRI data for 52 weeks ending 24 Feb 2019 90 Frozen & Refrigerated Buyer, Sep 2019, “Top Refrigerated”, based on IRI data for 12 weeks ending 14 Jul 2019 91 Dairy Foods, “2019 Top 100”, 13 Aug 2019 92 Food Dive, “Dean Foods expands outside of dairy with Uncle Matt’s Organic purchase”, 26 Jun 2017
Difficult times for US dairy: Long-term trends, and insights for China’s dairy companies | 17 Raw milk production and dairy farm exits
Cheese and butter manufacturing drive raw milk demand Together, cheese and butter manufacturing consume nearly 60% of all raw milk produced on US dairy farms. Not only do these products consume a lot of raw milk, While per capita fluid milk consumption in the US fell by more than 40% during the but next to milk powder, they are the most suitable dairy products for storage and years 1975-2018, per capita yogurt consumption grew by 580%, per capita cheese shipping. These aspects make cheese and butter manufacturing attractive for vertical consumption grew by 112% and per capita butter consumption grew by 23%. integration by dairy cooperatives. US per capita consumption of cheese, ice cream, yogurt and butter (1975-2018) Fluid milk consumption has been dropping for more than 40 years, and its production only accounts for about 12% of US raw milk. Yogurt consumption has driven 18 significant revenue growth for the industry but its impact on raw milk demand has 93 16 been very small. 14 As overall US dairy consumption has continued its long-term growth trend, cheese and 12 butter have long since replaced pasteurised fluid milk as the main drivers of raw milk 10 8 demand.
Kilograms 6 4 US raw milk production (1970-2019) 2018 US raw milk usage by final dairy 2 product (based on milk fat content) 0 100 Residual & others Cheese 19% 43% 90 Cheese Ice cream & other frozen Yogurt Butter Yogurt (nonfrozen) 1% Source: USDA 80 Million tonnes Producing one kilogram of whole milk requires only about one kilogram of raw milk, Ice cream & 70 other frozen but products like butter and cheese require much greater amounts. 7% 60 Raw milk required to produce one kilogram of various dairy products Fluid milk 50 beverages 12% Butter 18%
Butter 1970 1974 1978 1982 1986 1990 1994 1998 2002 2006 2010 2014 2018
Cheese Source: USDA Source: USDA Greek yogurt Ice cream Whole milk 93 USDA 0 5 10 15 20 Kilograms Source: USDA Note: In this chart, cheese refers to varieties such as cheddar and Monterey
Difficult times for US dairy: Long-term trends, and insights for China’s dairy companies | 18 Traditional dairy farms cannot compete Distribution of US milk cows by scale of farm (1982-2017) During recent years there have been many headlines about small dairy farms selling Milk cows their herds or going bankrupt because they cannot make a profit under current market conditions. Between 2017 and 2019, the number of licensed dairy herds in the US fell 10,000,000 by about 6,000, a drop of more than 10%.94 In recent years, the decrease in dairy farms has mainly been among farms with less than 100 cows. 8,000,000 While the difficulties faced by dairy farms are pressing, the trend is not new. Since 6,000,000 1940, the number of US farms with dairy cows has fallen by 99% and since 1970, that number has fallen by more than 90%. At the same time, the average scale of US 4,000,000 dairy farms has increased dramatically, from about 4 cows in 1940, to 25 cows in 2,000,000 1970 and to 172 in 2017. - US farms with dairy cows and average number of dairy cows per farm (1970- 1982 1987 1992 1997 2002 2007 2012 2017 2017) Size of farm: 1-49 50-99 100-199 200-499 175 500-999 1000-2499 2500-4999 5000 or more 600,000 150 Source: USDA, US Agricultural Census 500,000 125 Since 1970, US annual raw milk production has steadily increased from 55 million 400,000 100 tonnes to more than 99 million tonnes in 2019. The growth in production has been 300,000 75 entirely due to increased dairy cow productivity, as the number of cows in the US has remained fairly constant. Average annual production per cow increased by about 200,000 50 50%, from 7.1 tonnes in 1970 to 10.6 tonnes in 2019. This was due to significant 100,000 25 advances in technology, veterinary care and farm automation. - - 1970 1975 1980 1985 1990 1995 2000 2007 2012 2017
Farms with dairy cows (left axis) Avg. dairy cows/farm (right axis) Source: USDA, The Changing Landscape of US Milk Production; US Agricultural Census The average farm size is growing because of new large-scale farms in the Pacific, Mountain, Southeast and Southern Plains regions. In 1982, 64% of dairy cows in the US were on farms with less than 100 cows. By 2017, that number had fallen to less than 13%. During the same period, the share of US dairy cows on farms with more than 500 cows grew from 8.5% to 66%. More than one-third of the US dairy herd is now on farms with more than 2,500 dairy cows.95
94 USDA, Milk Production Report, 20 Feb 2020; USDA, Milk Production Report, 12 Mar 2020 95 USDA, US Agricultural Census
Difficult times for US dairy: Long-term trends, and insights for China’s dairy companies | 19 The production cost per unit of raw milk produced on a small farm is double that of a farm Number of milk cows and average annual production per cow (1993-2019) with 1,000 or more cows after accounting for the opportunity cost of unpaid labour (i.e. owner and family labour). The main driver of the cost difference is the amount of labour per unit of raw milk. 9 12 8 To break even on a cash basis, small farms need to produce premium-priced products 10 7 such as organic milk, grass-fed milk or artisanal dairy products. To control cash costs, 6 8 5 they generally need to rely on owners and family members for labour, and grow at least 4 6 some of their own feed or fodder. 3 4 Tonnes 2 2 Millions of dairy cows 1 - 0 Average production cost per litre of raw milk by size of farm 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 Number of milk cows (left axis) Avg. production/cow (right axis) Source: USDA 0.90 0.80 Increasingly large farms are able to invest in industrial farming technology and 0.70 0.60 infrastructure to capture economies of scale. Smaller farms are unable to compete 0.50 with industrial farms’ productivity and raw milk production costs. This cost differential 0.40 USD/ litre is the main reason for small dairy farms selling their herds and leaving the dairy 0.30 industry. Raw milk production per cow on small farms is lagging that of large farms. 0.20 0.10 - US average annual milk production per cow for various farm sizes <50 cows 50-99 cows 100-199 200-499 500-999 1,000-1,999 2,000 or cows cows cows cows more cows Taxes & insurance Land opportunity cost <50 cows Machinery & equipment depreciation General farm overhead 50-99 cows Other operating costs Opportunity cost of unpaid labour 100-199 cows Hired labour Feed costs 200-499 cows Source: USDA 500-999 cows 1,000-1,999 cows 2,000 or more cows
0 1 2 3 4 5 6 7 8 9 10 11 Tonnes Source: USDA
Difficult times for US dairy: Long-term trends, and insights for China’s dairy companies | 20 Insights for China’s dairy industry
The dynamics of the US dairy industry can provide useful insights for China’s dairy Cold chain capacity and refrigerated products companies. Strategic decisions made today can help them in the future to avoid the difficulties currently faced by parts of the US dairy industry. Locally produced fresh milk and refrigerated dairy products have dominated the US market for more than 100 years. Ambient products Long-term growth prospects have never captured significant market share. In contrast, aseptically- packaged UHT milk and ambient yogurt still account for roughly half of In contrast to the US, China’s dairy consumption is expected to continue China’s fluid milk consumption, but that share is shrinking as cold chain growing. Per capita dairy product consumption was estimated to be 34 capacity grows and consumers increasingly prefer fresh and kilograms in 2019 and is forecast to reach 49 kilograms in 2029.96 Three refrigerated products. products accounted for about 80% of China’s 2019 dairy consumption (by weight): UHT milk, pasteurised fresh milk, and yogurt.97 The long shelf life and easy distribution of UHT milk enables a few large manufacturers to compete nationally in China’s ambient dairy product Although the market is highly competitive, China’s domestic raw milk market. production is only enough to meet about two-thirds of consumer demand for dairy products. In contrast, the US dairy industry is challenged by Cold chain limitations provide some protection to small- and oversupply. medium-size dairy manufacturers to bring their refrigerated products to local retail channels. At the same time, consumers are willing to pay In China, there should be long-term growth in demand for both existing more for refrigerated pasteurised milk and fermented products due to and new dairy products, as well as for raw milk. freshness and probiotic properties. These conditions foster opportunities for regional brand building and product innovation to meet Changing consumer behaviours and priorities local preferences. Similar to their counterparts in the US, China’s consumers are open to trying new dairy products and consumption occasions (e.g. breakfast, snack, desert, etc.). This creates opportunities for manufacturers to compete based on innovation and quality rather than price. Health and nutrition trends, work and lifestyle changes, and demographic shifts have resulted in a long-term trend of US consumers shifting from fresh milk to bottled water, coffee and plant-based dairy alternatives. Consumption of ice cream (since 1993) and yogurt (since 2014) have also been decreasing. China’s per capita dairy consumption is still increasing across all product categories. Rising disposable income and increasing attention to quality, health and nutrition are driving demand for products that 96 MARA, China Agricultural Outlook Report (2020-2029); USDA, China Dairy and Products Semi-annual, 20 May 2020 97 address preferences for lower calories, higher protein, lower fat, USDA, China Dairy and Products Semi-annual, 20 May 2020 probiotics, organic and grass-fed dairy ingredients, etc.
Difficult times for US dairy: Long-term trends, and insights for China’s dairy companies | 21 Hypermarket/supermarket retail structure Actively manage product portfolios The US supermarket/hypermarket/warehouse club market is relatively In the US dairy market, companies like Nestle, Danone and Lactalis concentrated, with the top five chain operators holding about 50% have actively managed their product mix to stay focused on high- of the retail grocery market. Those large chains prefer to deal with growth and/or high-profit categories. Dean Foods and Borden Dairy very large manufacturers who can supply hundreds or even Company are examples of companies that were left with commodified thousands of stores. But there are many regional supermarket chains products that are increasingly produced by their vertically-integrated with sophisticated sourcing and distribution that provide opportunities customers and suppliers. for small or artisanal manufacturers to bring their premium and With ongoing demand growth, China’s dairy products have not yet reached innovative products to market. that level of commodification. The hypermarket/supermarket and dairy Products that succeed in small supermarket chains of 10-50 stores farming sectors are still too fragmented to build their own dairy can often move up to leading supermarket chains with hundreds or processing plants on the scale that would change the competitive balance. thousands of stores. With demand from a top-ten grocery store chain Nevertheless, China’s dairy companies need to manage their product operator, small- or medium-sized dairy product manufacturers can portfolios and focus their investment on those categories that will easily attract investment from private equity funds or large consumer maximise growth and profitability, while reducing their exposure to packaged goods (CPG) corporations in order to rapidly increase products with diminishing returns. production. China’s dairy companies should have a long-term strategy for cheese, China’s hypermarket/supermarket sector is highly fragmented, with the as it is still a blue ocean market. China’s annual per capita top 200 hypermarket/supermarket chain operators only accounting for consumption of cheese is only 0.1 kilogram, compared to 2.6 kilograms only about 20% market share. Small retail chains could provide in Japan, 3.0 kilograms in Korea, 18 kilograms in the US and opportunities for smaller dairy manufacturers to bring innovative 24 kilograms in Germany.98 products to market. As disposable income rises outside of tier-one and tier-two cities, these opportunities will increase. The fragmented structure of the retail industry also makes it difficult for small- and medium-sized manufacturers to achieve nationwide distribution. In this area, China’s largest dairy manufacturers have a distinct advantage.
98 China Daily, “Dairy Firms Eye Growing Appetite for Cheese”, 18 Apr 2019; USDA; 2019 China Dairy Data Report
Difficult times for US dairy: Long-term trends, and insights for China’s dairy companies | 22 Invest in innovative companies Ensure stability for dairy farms In-house corporate innovation rarely captures the creativity, drive and Dairy farms in the US have been consolidating for more than 60 years, passion of entrepreneurs and their start-ups. with the total number of farms falling by 99% since 1940, and the In the US, many small companies with innovative food products have average number of cows per farm growing from 4 to over 170. The been acquired or funded by giant corporations. For example, General number of farms with dairy cows in China has fallen from 2.7 million farms in 2008 to 660,000 in 2018, but the average number of dairy cows Mills’ venture capital arm, 301 Inc., which calls itself the “emerging 105 brands elevator”, has led two rounds of funding for Kite Hill, a company is only 13 per farm. At the same time, China’s new, large-scale farms specialising in plant-based yogurt and cheese.99 Coca-Cola invested in are even larger than those of the US. Fairlife in 2014, and acquired full ownership in 2020.100 Emmi, a Swiss The US dairy farm experience shows that large-scale farms’ production dairy company, acquired a 22% stake in Siggi’s in 2013, which it then costs will continue to fall, and small farms will be not be able to sold when Lactalis acquired 100% of Siggi’s in 2018.101 compete. Even as raw milk demand increases, the smallest farms will Many dairy companies have their own venture capital arms. Unilever continue leaving the industry, the average farm size will continue to and Nestle both launched venture capital funds in 2002.102 Fonterra increase, and today’s medium-sized farms will be seen as small farms in Ventures and Danone’s Manifesto Ventures were both launched in the future. 2016.103 Other leading dairy companies connect with start-ups through Only China’s largest dairy manufacturers have the resources and their incubators and accelerators. The Chobani Incubator and Land market power to ensure a stable economic environment as the dairy o’Lakes Dairy Accelerator provide start-ups with small amounts of farming sector goes through an extended consolidation equity-free funding, advice, training and networking.104 and transformation. With a fragmented retail market and rapidly evolving consumer preferences, China’s leading dairy manufactures should look to acquire shares in innovative small companies in order to diversify and drive This report was written by Brian Marterer of PwC China. innovation in their product portfolio. In addition to providing capital, a large parent company can help with technology, compliance and scaling up production and distribution.
99 301INC.com; Food Navigator-USA, “Kite Hill Seals $40m Investment Round Led by General Mills 301 INC”, 22 Oct 2018 100 Fairlife.com, “The Coca-Cola Company Acquires Fairlife”, 3 Jan 2020 101 Foodbev Media, “Lactalis buys yogurt brand Siggi’s, as Emmi sells its stake”, 5 Jan 2018 102 Unileverventures.com; Nestle.com, “Nestle: Venture Capital Fund Established”, 5 Mar 2002 103 Danone.com, “Bringing the Food Revolution to Life by Partnering with a Tribe of Disruptive Entrepreneurs”; Fonterra.com, “Fonterra Ventures Partners with High Growth Active Nutrition Start-up”, 2 Mar 2018 104 Chobaniincubator.com, Dairyaccelerator.landolakesinc.com 105 2019 China Dairy Data Report
Difficult times for US dairy: Long-term trends, and insights for China’s dairy companies | 23 Contact us
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