Dairy industry must be modernised

When you sell the family silver, it's gone. It cannot be sold again.Last year was an annus horribilis for the Irish dairy processing industry

Investments and surplus assets were disposed to help bridge the gap between very low world dairy product prices and a producer milk price, which even when boosted in this way was still so low as to make 2002 one of the toughest on record for dairy farmers.

These circumstances created the impetus for a major review of the sector last year and the ensuing Prospectus Report is now receiving necessary attention and debate across the sector.

Nothing especially new is proposed in the report but the existing status and structure of the domestic industry both at processor and farm level is described and compared with the corresponding structure in our main competitor jurisdictions - the Netherlands, Denmark and New Zealand.

The analysis prompts a number of observations which, in turn, clearly point to necessary actions if Ireland is to maintain anything like as vibrant a dairy sector as we have had here since joining the European Union 30 years ago.

First, it is clear that competitive forces have greatly intensified with the buying power of multiples, brand manufacturers, and food service businesses combining to make acceptable margin achievement on sales of product far more challenging.

Second, the customer has changed and now requires more food to go, nutritional and functional foods, high and constant quality, traceability and progressive innovation to ensure variety.

These changes need R&D and process investment at much higher levels than heretofore if Irish companies are to maintain or, more importantly, improve their position with product of choice relative to competitors in the global marketplace.

Third, the EU market is about to become more crowded with the accession countries adding significant additional product and a much cheaper cost base which can only increase pressure on market prices and EU support structures going forward.

Fourth, intense seasonality in milk production in Ireland is a reality with a peak to trough output ratio of 6 : 1 creating the need for far more plant processing capacity and attendant cost here than is the case in the Netherlands and Denmark where the equivalent ratio is 1.2 : 1.

Finally, it is clear that scale is now a critically important issue for the sector to address.

In Ireland we still have six companies processing 80 per cent of the milk pool compared to one in Denmark, two in the Netherlands and one in New Zealand.

In 2001, Arla, the dominant player in Denmark, processed 3.9 million tons of milk which was about the same as that processed by the four largest businesses here.

So what actions are needed to ensure a vibrant industry in the future?

Product range and market strength are the key requisites and both of these require strong businesses with financial muscle, flexibility and scale;

financial strength to create the investment budgets for product R&D and process efficiency;

financial flexibility to accommodate the selective acquisitions needed to enhance global reach, product sector domination and to support producer milk price in difficult years;

scale to ensure selling power to match the buying power of multiples etcetera. Scale is a prerequisite and the organisations that really prosper in the future will be those that combine optimum scale and financial flexibility.

We have a number of examples in Ireland where medium and large organisations have successfully created the product range and the international focus necessary to be strong players in their chosen market segments.

IAWS (par bake bread), Kerry (specialist ingredients), Fyffes (fresh produce), Greencore (sandwiches), Glanbia (cheese) and the Irish Dairy Board (marketing/distribution) are some examples in the food sector.

Notwithstanding the sale of the family silver, the dairy sector generally is in good financial health and there is no reason whatever why another phase of aggregation could not create organisations with the scale necessary to ensure further growth in product development and the global reach necessary to sustain the industry in the future.

As might be expected, much of the debate is around which business model, plc or co-operative, is best suited to act as the co-ordination vehicle across the sector.

While this is a burning issue for shareholders and management teams, it is a less important one than the realisation which must come first - we do need to have aggregation in the sector so that efficiency, R&D outlay and market power are all enhanced through the process.

Finbarr O'Neill is managing director of Bank of Ireland, Corporate Banking