Domestic Dairy Companies vs. the EU in a Price War: What Are the Odds of Winning?

Dairy products have always been an indispensable part of life. Whether children, adults or the elderly, everyone drinks a little milk or yogurt. So is the road ahead for dairy companies really all roses? Competition among dairy companies cannot be ignored either, whether domestic or foreign, the pressure in this industry is enormous, and the road is not an easy one to walk.

Although the domestic milk-dumping incidents have recently eased somewhat, the competitive pressure facing domestic dairy companies has only increased. The milk quota system in EU countries has been officially abolished, and this policy change is expected to drive a rapid rise in global milk supply this year, with the ripple effects quickly reaching domestic dairy products.

According to the European Dairy Association, after the quota system was officially abolished on April 1 this year, global milk supply is expected to rise by 2% to 4% this year. The Netherlands, a major milk-producing country, predicts that by 2020 the entire EU's milk output will increase by 4 billion liters, while Ireland predicts its dairy production capacity will double in the next five years. Who will buy the doubled milk production? The answer given by EU countries is almost unanimous——China.

Although it accounts for only a small share of dairy imports, China's imports of infant formula milk powder mainly come from the EU. Data shows that in 2014, among China's imports of original-packaged infant formula milk powder, EU products accounted for 71.8% overall, holding an absolutely dominant market share.

A Look Back at Europe's Milk Production Quota System

Before 1984, EU dairy production once exceeded demand, and at its worst, unsold fresh milk was poured directly down the drain. The EU's production quota regulations at the time were designed to avoid structural overproduction of milk and to protect milk purchase prices. Under this quota system, each member state was allocated a corresponding milk production quota, which was then distributed to each farm.

The quota system established by the EU was very complicated to operate in practice. National governments first needed to measure how much quota each farm should have based on the number of dairy cows, and then also had to levy advance fees on farms that might overproduce. If a country exceeded its milk production quota, the advance tax collected was used to pay the “overproduction” fine, also known as the “Super levy.” Government quotas became a farm's “asset,” and in some countries, farms were even allowed to trade “quotas” among themselves.

Europe's milk production quota system has been in effect in EU countries for more than 30 years, with the original purpose of protecting each country's dairy industry and avoiding excessive competition. Daniel Rosario, press spokesman for agricultural policy at the European Commission, believes that abolishing milk quotas now is intended to enable milk producers in EU countries to respond more flexibly to changes in market demand. “The EU has a total of 5,400 dairy processing enterprises, providing employment for 300,000 people, and they deserve the opportunity to fully benefit from the global consumer market, especially the Asian market.” Rosario predicts that in the coming years, global imports of dairy products will increase at an average annual rate of 2%, and the EU will be able to meet this additional demand.

A spokesman for the Dutch Dairy Association said bluntly that EU quota restrictions gave the United States and New Zealand an advantageous opportunity to seize the global market, and that lifting the restrictions will bring enormous opportunities for Europe.

After the quota system is abolished, how much milk dairy farmers should produce will no longer depend on EU government documents, but will be decided by themselves according to market demand. Regarding this policy reversal, the finally independent EU milk market has mixed feelings. Especially in some EU countries where milk prices cannot even compete with mineral water, the problem becomes even more complicated.

The deregulation of EU milk production has made many small dairy farmers feel very insecure, fearing that large farms will drive down market purchase prices—because milk prices in many EU countries have indeed fallen to rock bottom. By common logic, too much milk production will cause wholesale prices to fall again, making many already disgruntled small farm owners in the EU even more pessimistic, fearing they will be pushed out of the market by large dairy farmers. Some farm owners have publicly told the media that their sons will not become dairy farmers.

But the abolition of quotas makes some happy and others worried. Agriculture is Europe's strength, with EU beef production accounting for 22% of the global market; milk production also accounts for more than 21% of global output (the United States accounts for 12.5%). At the same time, the EU holds 32% of the global cheese and skimmed milk powder market. Over the past 5 years, despite quota restrictions, the EU's dairy export volume still grew by 45%, and market value nearly doubled (up 95%).

South Korea is a particularly proud special case of EU milk exports. EU statistics show that from 2010 to 2014, EU dairy exports to South Korea doubled. Compared with South Korea, the Chinese market's contribution has actually not been significant enough, with huge room for growth.

As the EU's milk production champion, German dairy farmers are full of confidence and actively rising to the challenge. They believe that the future of the German dairy industry is not domestic sales within the EU, disrupting milk prices within the EU, but exporting to emerging dairy consumption markets in Asia, including China.

Not only Germany and France, but even Poland has quietly pushed its yogurt into the Chinese market. Fresh yogurt has a shelf life of about one week, but in order to conquer the Asian market thousands of kilometers away, Poland's ambient yogurt can have a shelf life of up to 8 months.

Understanding the Destructive Power of EU Milk Prices

Just how low are milk prices within the EU? In major milk-producing countries like the UK, France and Germany, EU farm owners receive an average wholesale price of less than 0.28 euros per liter of milk, equivalent to only about 2 yuan in RMB, which can only ensure that dairy farmers barely survive. Of course, as a daily necessity, milk is an agricultural product with special status and has always enjoyed subsidies. In the UK, for the convenience of the public, the VAT on many dairy products, including infant formula, is zero.

For example, a one-liter bottle of skimmed fresh milk under the UK supermarket Tesco's own brand sells for 0.70 pounds (about 6.85 RMB); Carrefour in France sells it at a slightly higher price, but still only 1.13 euros per liter (about 8.6 RMB).

Compared with France and Germany, the survival situation of British dairy farmers is the most worrying. British people consume large amounts of fresh milk daily, and their dependence on milk is as important as potatoes and bread. Therefore, British supermarkets prefer to use this daily necessity to trigger price wars. In order to make milk prices low enough to be sufficiently attractive, supermarkets sell their own-brand milk at a loss. Generally, only organic milk in one-liter packs can sell for more than 10 yuan in RMB.

Milk prices are cheaper than water (mineral water), and British society is beginning to worry about the fate of dairy cows——such an unhealthy price war will make free-range dairy cows a thing of the past, and the result will be that EU farms, like those in the United States, produce milk in a manner similar to battery-raised chickens. Dairy cows will never see daylight, milk prices and dairy quality will decline together, entering a vicious cycle.

The milk production capacity of EU countries varies greatly. Among the 28 EU member states, half of the milk comes from Germany, France and the UK (21%, 18% and 10%). Adding the Netherlands, Italy, Poland, Spain and Ireland, that accounts for 80% of EU milk production. The remaining 20 EU member states produce only 20% of the EU's milk. This ranking has not changed in the past 10 years. While Germany has always complained about having to comply with a quota cap on milk production, 13 EU countries still fail to reach their quota limits every year.

In 21 of the 30 years of the milk “quota” system, Germany's production exceeded the quota limit, so it had to pay fines every year. According to estimates by the German Farmers' Association (DBV): over the past 30 years, German farm owners have paid approximately 15 billion euros to purchase milk production quotas and pay fines.

European Commission data shows that Germany, France and Italy account for 60% of Europe's cheese exports; Germany and Poland add another 16%. An estimate by Ernst & Young in September last year showed that with the abolition of milk production quotas, Germany will take first place in all milk-related categories.

Take a farm called Heideland south of Berlin as an example. This farm raises 1,200 dairy cows. In order to ensure the cows can produce more milk, they bought “cow massage robot arms” and use machine arms with rotating brushes to massage the cows several times a day. It is said that this helps the cows increase milk production while being happy.

In addition, since 2012 this farm has invested a total of 8 million euros in purchasing massage devices, automatic milking equipment that can milk three times a day, and a farm methane energy conversion system.

Heideland is just one of the farms happily welcoming the “liberalization” and “marketization” of EU milk production. Many German farm owners have been buying high-quality dairy cows and advanced machinery and equipment over the past two years, planning a major push into emerging milk consumption markets in Asia, including China.

The abolition of the quota system means that from now on, milk production in EU countries will develop freely according to their production capacity and market demand, no longer subject to government quota restrictions. This will also mean an increase in the total global dairy supply.

Under the quota system, EU dairy exports still grew rapidly over the past five years, with export volume increasing by 45% and export value growing by 95%. “The liberalization of European dairy production quotas brings three direct challenges to China: First, the price advantage of products and raw milk is obvious, and those relatively cheap major European brand milk powders will become more competitive; Second, the brand advantage is obvious, especially since some Chinese consumers currently have blind faith in overseas dairy products, and Europe is the birthplace of the modern dairy industry, with hundreds of years old enterprises and brands everywhere from milk, cheese to formula milk powder; Third, Europe has strong capabilities in dairy processing technology, new product research and development and other fields, with a very mature industrial structure, close upstream and downstream linkages, and strong risk resistance.”

“If European dairy products come in force, they may impact the traditional price system of the domestic dairy industry and erode the market share of domestic enterprises. At present, the cost price of imported ambient milk is lower than the cost price of domestic ambient milk, creating a price inversion.” Dairy expert Wang Ziheng predicts that now that the European milk production quota system has been officially abolished, a large number of European imported ambient milk products and infant formula milk powder products may flood into the domestic market.

The EU's Main Sales Market Is China

Some dairy experts believe that, affected by last year's Ukraine crisis, the Chinese market will become the next outlet for EU milk. “The year before last, China imported 185,000 tons of liquid milk, which increased to 295,000 tons last year.” He predicts that this year China's consumption of imported milk will exceed 400,000 tons.

Major EU milk-producing countries also benefit the most when exporting dairy products. Many of the ambient milk products flourishing in the Chinese market come from the EU, especially Germany. For example, Germany's Mu brand, and even the German dairy company's brand Oldenburger established specifically for the Asian market. German milk is relatively cheap, giving it a very obvious cost advantage in exports. For example, Switzerland, a non-EU member state, is known for producing the world's highest-quality milk, but Swiss milk is also the most expensive. For the same type of cheese, the price of Swiss-produced cheese can reach three times that of German-produced cheese.

In January this year, Kordes, press spokesman for DMK Dairy Company, Germany's largest dairy manufacturer, which accounts for 1/4 of total production, stated that DMK has opened an office in Shanghai, with the main task of making preliminary preparations for establishing a foothold in the Chinese market.

The company's statistics say that German farm owners have invested 500 million euros over the past 5 years to purchase cheese-making and milk sterilization equipment. DMK admits that the European market is limited. Previously, Russia was Germany's largest cheese-consuming country, but since last year Russia has been banned from importing dairy products from the EU. Therefore, whether Germany, Ireland or the Netherlands, these major milk-producing countries can only target exports to Asian and Middle Eastern markets, and the Chinese market is the top priority.

In order to break out of Europe, major EU dairy companies are also forming alliances. In 2012, Danish dairy company Arla, British dairy company Milk Link and German dairy brand Mu merged with EU approval. The factory is located on the German border near Belgium and Luxembourg. The company's fresh milk is mostly supplied to the German market, ambient milk export is one of the company's advantages, and exports to China are a major priority.

Because domestic dairy companies firmly control the channels, it is also very difficult for foreign dairy companies to establish a foothold in the domestic market. For this reason, more foreign dairy companies have chosen to cooperate with local dairy companies or establish joint ventures, entering through indirect routes, trying to leverage local dairy companies' mature and well-established sales channels to seize domestic dairy market share.

The rapid growth of China's dairy product demand has made global dairy giants eye it covetously. Last year, Irish Ambassador to China Kang Baole once said that with the abolition of the EU's overall dairy production limits, China is a key market for Irish dairy companies to focus their efforts on. Similarly, Dutch dairy companies have already taken action. At the end of March, Huishan Dairy announced that it had received approval from the Ministry of Commerce to establish a joint venture with Royal FrieslandCampina to produce and sell infant formula milk powder products in China, with each side holding 50% of the joint venture's shares. The two sides will jointly develop the domestic infant formula market.

In addition to the EU, dairy companies from the United States will also increase their development of the Chinese market, pushing competitive pressure in the Chinese market to a fever pitch. Not long ago, Kasper Jakobsen, CEO of American milk powder manufacturer Mead Johnson, in an exchange with Wall Street analysts about the first-quarter report, did not avoid his expectations for the Chinese market. He also mentioned that starting in April, Mead Johnson's finished milk powder will be shipped directly from the Netherlands to China. “The production capacity of Mead Johnson's Netherlands factory will increase in the coming quarters, which will bring greater support to the company's growth in China in the second half of 2015.”

Mead Johnson's “ambition” may also come from the EU's 30-year milk quota system being abolished from April 1.

It is understood that for the above products to enter the domestic market, Mead Johnson will distribute through channels such as e-commerce, some long-term cooperative retail stores and selected maternal and infant stores. “In some channels that are still weak at present, the company is also improving relevant plans to strengthen product distribution.” Kasper Jakobsen said.