Thanks to popular media, there is a common belief in Australia that milk prices are controlled, and kept low, by the supermarket chains. Dairy farmers suffer, legend has it, because major players Coles and Woolworths are fighting an endless price war and the biggest and best indicator of price, for the supermarkets, is milk.
However, this is far from the truth – in Victoria at least – explains Australian Dairy Farms Group CEO and director Peter Skene. The dairy industry in Australia’s biggest milk-producing state is, in fact, similar to the oil industry in the way fortunes ebb and flow according to international stimuli.
The biggest driver of milk prices at farm level is the global milk price, Skene says. This is particularly true for Victorian dairy farmers who produce six billion of Australia’s nine billion litres of milk annually and who export – or realise an export parity price for – 60 to 70 per cent of their product.
In a territory where the population consumes 100 per cent of what dairy farmers produce, supermarkets likely have a noticeable influence on milk prices. But in the export countries, that’s simply not the case.
“If there’s a slight increase in production in New Zealand, Australia, the US or European Union, without any change in demand, there will be a reduction in price,” Skene says, describing the typical result of a glut in any market.
“There is a continuous relationship between price and demand, but this industry is unique as it is in a situation [where] it takes about two years to build up a herd, or a year to decrease it.
“So, when milk prices are high, it encourages more farmers to grow their herd, perhaps from 350 cows to 600 cows. They also feed the cows more grain, which results in greater milk production – one kilo of grain generally equals a kilo of milk. When prices are high it takes two years for supply to catch up to demand.”
Prices shot through the roof when China began consuming more dairy products inside the last decade, so all five Australian export territories increased production. A few years later the world was producing too much milk, which brought the price back to a natural floor at which it has sat for three or four years. This has made life very difficult indeed for dairy farmers and dairy businesses.
“Over the last couple of years, the cost of production on the farm, for the farmers, is not far different from the income they were earning for their milk,” Skene says.
“But sometimes, farmers don’t take a rational look at their return on capital because farming is simply their way of life.”
In this flat, uninspiring market, Australian Dairy Farms Group saw its share price more than double in a single week (in late March 2018). How could such positive movement have occurred in an environment of doom and gloom? Easy, Skene says – the business simply developed an entirely new strategy.
A long career in the dairy industry
Skene, perhaps unsurprisingly, is a man of the land. He was born in Camperdown, southwestern Victoria, a rich dairy region that produces 23 per cent of Australia’s milk, or around two billion litres annually.
His father worked at the Camperdown Cheese and Butter company for 50 years and Skene’s first job was in the same factory, sweeping floors and doing odd jobs, before moving to a full-time role with the same company, which became part of Bonlac Foods (which, at the time, boasted 40 per cent market share of all dairy in Australia). The Camperdown dairy factory closed in 2000, after 110 years of manufacturing on a massive 15-acre site. (The small town was without a dairy for 10 years, until Skene founded Camperdown Dairy Company in 2010.)
As he learned the art of cheese, butter and powder making, Skene sought education, including a diploma and degree in food science and dairy technology from the University of Melbourne, then a commerce degree from Deakin University. In the meantime, he was promoted to production supervisor then production manager, factory manager and then into a head office sales and commercial role.
“I left the dairy industry briefly and went to George Weston Foods,” he says.
“I was the general manager of Weston Milling. That was very similar to dairy, only the farmers supplied grain rather than milk. I then returned to the industry as general manager at King Island Company just after it floated on the ASX.”
“We decided to convert our farms to organic, then we looked at all of the different products we could produce.
What he’d been learning throughout his career was not only how various types of food are processed, but also how the market itself operates. He was absorbing knowledge about the levers that could be pulled in order to create various effects. This would come in handy when he found himself in charge of Australian Dairy Farms Group, as would knowledge gained from the intensive two-month, full-time executive course he completed at Harvard University after leaving King Island Company, and other executive education from both Melbourne and Stanford universities.
“I obtained first-hand knowledge of the dairy industry by making the products,” Skene says. “I qualified in management both on the job and through further education. Plus, I also had a scientific understanding of dairy products through further education.”
When shareholders of Murray Goulburn voted to sell its assets to Canadian dairy business Saputo, it was a moment of truth for the dairy industry. If what was once the nation’s largest dairy business couldn’t successfully navigate the competitive landscape, what hope was there for the rest of the industry?
“If we didn’t make a strategic change, if we kept on going along the same road we’d been travelling, Australian Dairy Farms Group would have struggled to make sustainable financial returns,” Skene says. “We would have had to embark on an acquisition program to gain scale that, by itself, may never have achieved optimised returns for shareholders. In 2012 and 2013, everyone said the world was going to run out of dairy because of [demand in] China, but that didn’t happen.
“What happened instead was global oversupply because everyone believed that story. Australian Dairy Farms Group was now facing a very stiff head wind to make money and a competitive landscape very different to that contemplated when entering the dairy industry.”
Organic farming comes of age
Skene and the board’s solution was simple – as an idea, at least. The business would abandon traditional dairy farming and instead adopt organic methods. It’s a strategy that would have had dairy farmers stomping angrily on their Akubra hats even just five years ago, but today it makes a lot of sense.
“The organic market is very interesting,” Skene says. “It’s a market that five to 10 years ago was very small and very niche. However, now it’s growing quite considerably and while not becoming mainstream is getting some decent volume in the marketplace. It’s a space that’s very attractive to us because of our size, but is too small to be attractive to the larger players in the industry.”
Larger organisations face numerous barriers to entry, including the fact that individual farmers from whom they source their milk may not be interested in converting to organic farming methods. Such a conversion often means a reduction in milk output, greater expense over the one- to three-year period in which the conversion is carried out and, of course, the simple fact that dairy farmers on family-owned farms like to do things the way they always have.
However, this was not an issue at Australian Dairy Farms Group, where all six Victorian farms are owned by the business and run by managers employed by the group. The business, which owns the Camperdown Dairy Company, runs 3660 head of cattle and produces almost 18 million litres of milk annually.
Rolling out new systems into its own farms would not be vastly different to the way a leadership group in any organisation might introduce change into various outlets, offices or departments.
“We studied the organic industry supply chain from consumers to organic diary farms.”
“We studied the organic dairy industry supply chain from consumers to organic dairy farms,” Skene says. “We realised the current market supply chain includes farms all over Victoria and inbound logistics would be very expensive. After having a good look at that model, we thought we could do it much better.
“We decided to convert our farms to organic, then we looked at all of the different products we could produce. Milk is an amazing raw material – it can become anything from cheese, butter, yoghurt, bottled milk, UHT milks and milk powders to infant formula. Where along that chain were the best opportunities in terms of organic produce? Organic infant formula gives you the absolute best return by a considerable margin from each litre of milk compared to anything else in the market. Plus, there’s only one material player in the Australian organic infant formula market, which is Bellamy’s.”
Unlike most dairy producers, Bellamy’s has been a share market darling, but the business makes no secret of the fact it imports much of its milk ingredients from Europe. Australian Dairy Farms Group could go one step better and produce organic milk onshore.
Over a period of six to 12 months, Skene and his senior management consulted with their farm managers and staff, explaining the reasoning behind the shift to organics. They received enormous interest and support. Rather than the business forcing change onto employees, its farm managers actively assisted the change program. The strategic shift to organic milk production was announced to the market in March, along with a feasibility study on organic infant formula.
“The share market has been very happy with our direction,” Skene says. “The way I look at it is that at this point in time we’re a bottler of milk. We produce butter and we produce yoghurt and we own farms. In each of those three categories, in each state, there would be at least 10 to 12 competitors. We’re in a highly competitive market where it’s very hard to differentiate.”
Breaking from the herd
Skene’s willingness to adapt Australian Dairy Farms Group’s focus to an evolving market, which is increasingly health conscious and mindful of the production process, has proven crucial. Not content with this success, Skene also has plans to expand the business further, which is where the bold move into infant formula comes into play.
“When you go into organics, the trust factor is [already] there. If you go into infant formula, the trust factor is essential because it’s what people are going to feed to their babies,” Skene says.
“Subject to final feasibility outcomes, we’re moving this business from being focused on milk, butter and yoghurt to one that provides nutrition for newborns.
“We’ll have a completely different focus in an area where product is quite scarce and where differentiation is absolutely possible and very powerful. This will be market-driven rather than supply-driven and will include building brand equity based on trust, providence and quality.”
In the newborn formula business, Skene is hoping to find new fortunes for Australian Dairy Farms Group. It wouldn’t be the first time a pivot pays off for Skene, and don’t bet the farm on it being the last.
By: Chris Sheedy