Oct. 10 2011 08:01 AM

We have the opportunity to capture our share of the growing global dairy market. But international trade is more difficult, and corrupt, as we reach past the low-hanging fruit.

The author is an agribusiness economist with the Babcock Institute for International Dairy Research and Development at the University of Wisconsin-Madison.

In MID-2011, the Innovation Center for U.S. Dairy (ICD) updated findings of its comprehensive 2009 report on "The Impact of Globalization on the U.S. Dairy Industry: Threats, Opportunities and Implications." The updated report was commissioned by Dairy Management, Inc. (DMI) and the U.S. Dairy Export Council (USDEC) and carried out by the consulting firm Bain and Company.

The update reaffirmed the ICD's recommendation for the industry to become a consistent supplier for the global markets.

Company-specific adjustments include better tailoring of products to meet needs of foreign buyers and reducing price and supply volatility. In addition, the ICD notes, industry efforts will be required to achieve export-enhancing reforms of dairy price supports and federal milk marketing orders (FMMOs) and to negotiate new free trade agreements that reduce dairy trade barriers.

A 7-billion-pound gap
Interestingly, the ICD's 2009 report indicated that experience gained by the U.S. dairy industry as a consistent supplier might allow the industry to become a global player. Of course, a global player is a consistent supplier of foreign markets. But they also adopt an export-focused model that includes milk supply and processing assets located outside the country. Global players develop enhanced capacity for product and processing innovation.

Why not move on to a global player strategy now? This action might allow the U.S. dairy industry to capitalize more fully on the rapidly growing international dairy markets described by the ICD. The ICD update projected that a latent demand gap equivalent to about 7 billion pounds of milk will develop in international markets by 2013. This gap, which could be filled in part by U.S. companies, is the amount of export demand that dairy exporters across the globe are not equipped to supply.

Over the longer term, the demand gap will likely be even larger. This is driven by demand from China and other emerging markets. According to the ICD update, about 75 percent of the growth in nonfluid dairy product consumption from 2010 to 2015 will originate in China, India, Southeast Asia, and the Middle East/North Africa.

Babcock Institute analysts agree with most conclusions in the ICD update regarding export demand, especially those relating to robust demand for dairy products from China. A forthcoming Babcock Institute country study projects that demand for dairy products in China will rise by 3.4 to 4.7 percent annually for the next few years. China has ambitious plans to improve domestic milk production by two-thirds by 2013. But these plans (which would reduce dairy imports) will likely be stymied by miniscule gains in milk production per cow, high costs of imported feed, and diseconomies of scale on large, feedlot-type dairy farms.
The scale diseconomies on many large Chinese farms have been manifested in faulty facility layout, design, and construction. They also appear in the form of health and reproductive problems, including metabolic disorders, poor body condition during the fresh period, foot-and- mouth disease, and other foot disorders. Managers of the large farms undoubtedly are moving up the learning curve which will reduce but not eliminate such scale diseconomies.

The global player strategy appears to be within reach since the U.S. already is a substantial player in international dairy markets, as indicated by recent statistics. In 2010, U.S. dairy exports were valued at $3.71 billion, just slightly below the 2008 record total. And the value of U.S. dairy exports for the first half of 2011 was $2.3 billion, suggesting the 2008 record will fall this year.

According to the USDEC, U.S. dairy exports in 2010 were equivalent to 13 percent of the nation's total milk solids. The U.S. also has recorded a positive dairy trade balance in dollar terms since 2007 and that trade surplus ballooned to a record $1.5 billion in 2010. In 2010, the U.S. - long a net importer of cheese - exported more tons of cheese than it imported. However, the dollar value of higher-priced U.S. cheese imports exceeded the dollar value of exports in 2010.

Changes in the U.S. cheese trade balance strengthen the U.S. dairy industry in ways that will help it to become a global player. U.S. cheesemakers now produce more of the specialty cheeses once only available from Europe. U.S. imports of cheese peaked at 216,000 metric tons in 2002 but fell to 139,000 metric tons in 2010. Thus, import substitution increased domestic use of U.S. cheeses by 170 million pounds over this period.

Challenges, corruption, lie ahead
Admittedly, becoming a profitable global player would be challenging. Many big foreign markets for dairy products are difficult places to do business. For example, the World Bank's 2010 Ease of Doing Business Rankings for 183 countries gave China a ranking of 79. And the average ranking for four other leading markets for U.S. dairy exports (Mexico, Philippines, Indonesia, and Vietnam) was 96. By contrast, the U.S. ranking was No. 5, just a few notches below No. 1 Singapore.

Transparency International reports that companies doing business in countries ranking below 5.0 on its 0 (most corrupt) to 10 (least corrupt) Corruption Perceptions Index (CPI) scale often experience problems with corruption. In 2010, China recorded a 3.5 CPI score, while the U.S. had a score of 7.1. Moreover, according to surveys of Chinese entrepreneurs and European firms doing business in China, corruption in China is intensifying. These rankings and scores explain why many U.S. companies prefer to focus on the slow-growing and highly competitive domestic market.

Becoming a global player probably would require redirection of resources to emphasize company-specific efforts. In particular, the U.S. dairy industry may need to develop more domestic exporting "champions" that can compete effectively with global players such as New Zealand's Fonterra, the Kerry Group of Ireland, and Switzerland-based Nestlé Industry champions produce important demonstration effects relating to innovations, early-mover advantages in exporting, the advantages and disadvantages of foreign investment, and foster healthy competition. U.S. champions could be nurtured by the ICD, DMI, USDEC, and others.

If the U.S. dairy industry pursues a global player strategy, it might find it advisable to put reforming change-resistant price supports and FMMOs and negotiating new trade agreements on a back burner.

While pricing reforms could be pursued in parallel with company-specific strategies, such reform efforts have produced few fundamental export-enhancing effects in recent decades. This record suggests that pursuing pricing reforms would represent a less than optimal use of industry resources.