December 28, 2018

Dairy CEOs Discuss The State of the Dairy Industry

 |  By: Anna-Lisa Laca

Last week at the 2018 MILK Business Conference, we hosted three CEOs to discuss the state of the industry. Andrei Mikhalevsky (AM) is the President and CEO of California Dairies Inc. He joined CDI in 2012. Tony Sarsam (TS) is CEO of Borden, where he leads more than 3,300 employees across 13 processing plants and nearly 100 distribution centers. Rick Smith (RS) has been president and CEO of Dairy Farmers of America since 2006.


How have the tariffs and trade tensions impacted your business?


AM. We all know that Mexico has been an issue. That’s a big market for U.S. exports. Canada, maybe not so much. For those along the borders it was important, but Canada was creating an issue for us with their Class 7, which was hurting the world market prices. Then we had China, which is a completely different situation unto itself. But it was our second or third largest trading partner in dairy. It's one of the biggest in the United States on whey, so you’ve got a big problem there. Now the other part of it is you’ve got to start looking for other partners and other places to go. The issue that we have today is the U.S. put together the USMCA, which was a good agreement. It looks like it's going to go forward, but the steel and aluminum tariffs are still in place. This means Mexico still kept the tariffs on cheese, which I believe is having an hampering effect on cheese.


Has it affected our business? Yes, it has. It's affected our direct shipments outside the country, but it's also affecting the U.S. milk price. I think we’ve seen a significant drop in price with less light at the end of the tunnel based on where we trade. Now USMCA will come back. That's a bright spot. China will take a little longer, because it's about access to the market, intellectual property rights, which is an issue.


If you look at going forward, though, what would be the most important thing that can happen to the dairy industry? That would be for the U.S. to begin to put in more bilateral free trade agreements. There's one coming up with Japan, there’s one coming up with the Philippines. When you talk about what’s next, talk about the fact that Europe has got agreements with nine of the top 10 dairy importing countries in the world, and the U.S. has three of them. That's really the next big thing.


Sounds like you're hopeful on trade, but we need to get retaliatory tariffs removed to get access back into Mexico and Canada for the deal to come to fruition?


AM. I'd say yes. I spoke on this not too long ago at a conference, and people ask the question, ‘Is the Donald Trump administration reckless with their trade policy, or are they strategic?’

And if you look at it in the context of history a year from now, it might be the most strategic thing we ever did. It just feels like it's reckless right now because dairy farmers are paying for it. So, the answer to that is yes, and I think only history will tell whether this was a good move or not. My personal feeling is that it will be a good move if we can get through the short-term pain.


RS. I agree with everything you just said. It was good to bring more certainty to Mexico and Canada, and we’ve still got the steel and aluminum tariffs, but the uncertainty was a real problem and probably impacted your milk checks most. On China, we’ve got a lot of people smarter than any of us saying the Chinese think in decades, so I think it's just a real crapshoot trying to predict what’s going to happen.


How long before we actually see the markets opening up in Canada?


AM. I’m going to go against the general policymakers and the dairy industry. The Canadian deal we're all talking about was a good deal, and it was nice to move it forward. There’s a lot of rhetoric there. But the fact of the matter is, it's a pretty poor deal. Here's why: The maximum we're going to get is a 3.5% entry, but their exports and what they can do in Class 7 actually can grow every single year. So they have growth built in, we do not. Start there. Then secondarily, if you look at Class 7, they said, ‘We’ll get rid of Class 7, but oh by the way, we're going to use basically the same price formula we always did.’ So people are calling it Class 7.5. Now they're going to base it on our Class IV prices, and you might think that's nice and a fair, level playing field, except they can set the make allowance at whatever else they want. So if they set it double to us, they’re now significantly lower in the world market. My view is going to be dependent on how strict the United States is managing that trade agreement.


Since 1935, we've seen a consumption drop 11 gallons per person. What are you doing to try to try boost domestic consumption?


TS. I don't think we at Borden and probably as an industry as a whole, have kept up with consumers as much as we should have. Eating habits have changed. Other substitutes have come in to take the place of dairy. I think we have to be thoughtful about the consumer. How do we innovate and how do we become part of their diet?


RS. One thing for all of us to remember is U.S. dairy consumption grows every year. Sure, fluid milk has been a challenge for a long time. But we grow every year. The issue is we produce a little bit more than that growth in consumption every year, which then leads automatically to needing to be in the export markets. We are in a growth industry. Not only does it grow every year in the United States, it's growing worldwide. So, most of you guys are above-average size. There’s people to eat what we're producing, we just have to think in terms of what we're making and getting into more relationships.


What else are you doing to help with domestic consumption?


AM. Rick’s right. People eat their dairy, they don’t drink it. The pricing system is set up around drinking dairy. In California we fortify milk. If you look at fairlife, which has done so well, it’s fortified milk. If you fortify milk you have a product that tastes better and is healthier. I think milk beats the pea beverage, almond beverage and soy beverage, so if you can give them more nutritious product that tastes better, that'd be a great thing. We think fortified milk is a great thing and processors across the country should be considering it. The other thing it would do is it would eat up all the excess milk solids, which would drive the milk price up.


What other opportunities do you see for the development of new dairy products?


TS. I think there’s a great many number of opportunities. Fluid milk is down, but if you look at what’s going on subcategory by subcategory, consumers are actually buying more dairy. They’re looking for healthier options, convenient options and they’re looking for indulgence. If you look at the ice cream category, it’s growing…and the growth is coming from highly indulgent and healthier options. Consumers also want meal solutions, they want to have a moment of indulgence and they want something that’s healthier for them. So, Borden is looking at all of those options.


What can the industry do to be proactive toward consumer trends?


RS. We’ve got to walk the talk in regard to innovation. We get frustrated with nut milk, and one possible good thing that could come out of this is that consumers are starting to think about what they are actually consuming. That’s to milk’s advantage. So, while it's been frustrating and annoying to have something called milk that has nothing to do with milk, I think consumers are going to educate themselves about the nutrients and other benefits of real milk and maybe something we can take advantage of.


The other thing on the farm level is that we need to change. California is getting the federal order system, but most of the people already in the federal system would say there were things in the federal system that are not helpful to innovation and to new product development. Standards of identity that we guarded fiercely for generations can be a little bit of a hindrance on new product development. We have to embrace change, and we tend to focus on what scares us instead of embracing opportunities.


Why has it been difficult for the dairy industry to embrace innovation?


TS. The industry has spent a lot of energy on regulation. It’s a horribly complicated system that we have to deal with. If you’re in the almond industry you don’t have to spend energy or time complying with complex, outdated regulation. We need the ability to fight for the share of stomach, the way other agriculture industries are. We’re stuck, and we’re stuck because of regulation.


Do you think that demand for fluid milk is lost, or do you think we can get it back?


RS. Regaining or growing market share for fluid milk will be tough. I think the first step is to stop the slide. We’ve got 15 years of decline. I think the first step is to innovate in a way that stops the decline. Then we can talk about growing. It’s not just milk, it’s packaging and convenience that have been more of a challenge.


Is DFA taking any steps to control supply?


RS. First of all, we're trying to teach ourselves not to use the term supply management. So, we’re saying growth management or something else. It’s like talking about immigration and using the term amnesty, it’s not a winner. Regions of DFA have always had base quota systems. More in the West and they were not always popular, but we only want the milk that we could effectively market. So, it's been in and out in different regions for 10 to 15 years in different parts of the West.


Last year at our annual meeting, the delegates adopted a policy for the board to look at base excess, and there's a group working on it --- producer-driven but assisted by staff, and the sentiment’s there. I don't expect everyone would agree, and I will tell you that in the boardroom, they don't all agree. It gets into philosophy. I will say this: Canada supports its dairy industry, Europe supports its industry with green payments and other things. Fonterra has been iconic in New Zealand, which has allowed it to get where it is today. To just say let it roll, survival of the fittest. The fittest will survive, I have no doubt about that. But in what condition? Because I was based in the East I always thought we need people to grow -- we need growth or we're going to die. The last four or five years have been sobering. We’re giving it a hard look. It's going to be done regionally. I just don't think we can take another three years of this. I really don't.


What are you doing to keep up with the growing milk supply?

RS. Keeping up with the growing supply in every area it’s growing is nearly impossible. For the past five years now, we’ve had greenfield plants under construction. They’re not cheap. Two months ago, we announced an 8-million-pound-a-day cheese plant in Michigan. Michigan is very long on milk. When we started planning, it was $400 million, it came in at $475 million. By the time that plant is operating, we’ll have to expand another one. It's tough. We have member farmers who are willing to partner with us now in four or five places. So, if the dairy producer’s willing to share some of the investment and some of the risk, that makes it a little easier. But Andre alluded to it before, there’s not a lot of profitability -- skim milk powder, nonfat dry milk, and bulk cheese, you can’t make the numbers work. So, it's a challenge.


TS. We’re currently focused on growing demand. We look at how we grow demand, so bringing new ideas into fluid milk in particular is our mission now. Furthermore, being able to better serve our customers is essential to increasing consumption.


AM. California is a unique situation. Up until about three years ago, all we did was chase down how to process milk. We were spending hundreds of millions of dollars chasing that down.

We've had a little bit of a reprieve where milk supply has shrunk a little bit. So now when I look at capital spending, we're no longer putting in silos, evaporators and dryers. We’re putting in membrane technology to extract things like phospholipids, which helps brain development. When you have way too much milk, you're always chasing down how to process it. When you get back in balance, spend money on innovation and the higher value products. When you chase commodity products you get small margins. When you chase the value products, the margin is higher. It’s been a nice situation recently where we've been able to focus on value added activities and less of this processing.


Why are these companies not working together and educating the consumer on how healthy dairy products really are? The plant based products “fake milks” are slamming our industry every day and the fact of the matter is if there’s only fifteen cents worth of almonds in every half gallon of almond milk how healthy can this product be? Plant based products are marketed to be the healthiest choice but the fact is huge profits because it cost very little to make and the consumer doesn’t even see that they are being played.