Every industry faces periods of growth and contraction.

Less frequent are those instances of fundamental change: airline deregulation, hospital DRGs, Japanese automobile manufacturing in the U.S. and more recently the decline in urban home values. Oftentimes, as with U.S. manufacturing of Japanese cars , the beginnings of these tectonic shifts may be hard to discern. Other times, such as the 1973/74 oil embargo, the impacts are sharp, highly visible and wrenching.

The U.S. dairy industry is facing significant challenges. In the past, when production increased and consumer demand did not at least keep pace with such growth, whole-sale prices fell, often sharply. Today herd populations, milk per cow and milk prices are all increasing faster than per capita milk consumption – which, given past relationships, would appear to be unsustainable. Counterbalancing these historic trends are increasing milk-derived exports, greater by-product (such as cheese, yogurt and whey) production and rapidly increasing input costs.

So the question remains: Are we entering a new period of market dynamics for dairy, or simply experiencing a short reprieve before the fundamentals “kick back in”? While not definitive, at a recent industry meeting of major producers, nearly 40 percent indicated they expected a “dairy depression” within the next five years.

The typical way to deal with such uncertainty is to focus on what one knows: current operations and “looking to the past” for indications of the future. Thus the increasing sophistication – especially in managing operations – typical of most dairy operations today. The problem comes when the changes experienced are totally new, unexpected or arising with such rapidity and force that the past is of little guide to the future. In such instances, new tools and frameworks are required.

Scenario planning is aptly suited for such analyses as it does not start from today and project forward. Rather, scenario planning seeks to develop several reasonable but sufficiently varied “stories” of the future, thereby “bracketing” the range of possible eventualities. From these futures, we ask, “What will it take to succeed across scenarios?” Because even in the worst situation someone wins. What are the likely changes or building blocks we must invest in today to prosper tomorrow? In this way we negate “narrow frames” – assuming that by changing only a few variables one can encompass rapidly changing futures – as well as the tendency to project past trends forward as somehow indicative of all the complexities that truly dynamic systems can create.

Four scenarios of the U.S. dairy industry in 2016
This project began in 2006 with a series of workshops attended by more than 100 dairy producers (large and small), manufacturers, veterinarians and various government and educational stakeholders. The workshops developed a draft set of future scenarios that were then refined in subsequent industry conferences and meetings. We adopted 2016 as being far enough from the present to enable significant changes, but not so distant as to be tangential to current dairy operations.

As a first step, we gathered a long list of potential future “forces” or “value drivers” that had been or were likely to be critical in supporting the growth and profitability of this market. We then split these forces into trends versus uncertainties, as shown below. Assumptions about how various uncertainties play out is what differentiates the scenarios.

To create the actual scenarios, we crossed two summary uncertainties – impact of technology and consumer attitude/perception – to create the 2 X 2 matrix shown in Figure 1*. Each axis represents an uncertainty range. After ascertaining the plausibility of each combination (i.e., matrix cells), we explored what the future might look like in each cell when considering the remaining uncertainties, all against the common backdrop of the main trends identified earlier. The range of individual uncertainties, as well as the varied interplay across these uncertainties, is what drives the distinctions between scenarios. While 2016 will not look exactly like one of these four scenarios, the wide range depicted here will likely capture the potential dairy industry environments that could plausibly face industry players then. Against these scenarios, readers should test their own views and business assumptions for future success.

Scenario A: Dairy Depression
Dairy products have become passé. Lack of innovation and poor consumer demand pushed the U.S. dairy industry to the brink of financial disaster. Demand is down as other beverages such as calcium-fortified drinks are stealing market share. Within a commodity market, low-cost global competitors are competing aggressively in the U.S. Given a depressed economy and low milk prices, the dairy industry does not have the capital to reinvest in facilities and technology. This has dampened innovation further, deepening a long-term cycle of decline.

Highlights
• Negative consumer attitudes about dairy products
• Lack of innovation
• Little investment in the industry
• Depressed dairy economy makes it hard to attract skilled labor
• More restrictive regulation for local producers
• More open to international markets and foreign competition.

How we got here

Rising public distrust
There is broad public distrust of the safety of all technologies, as well as specific concerns about the wholesomeness of milk. This has led to declining demand for dairy products.

Restrictive regulations
Local and state requirements, designed to protect residential neighborhoods from the environmental effects of large farms, have slowed the creation of large-scale dairy operations, similar to the regulation of swine farms in Florida. At the same time, price controls and supports are relaxed.

Agri-terrorism
A major agri-terrorism act in the poultry industry has affected the entire agricultural sector. The incident, the poisoning of chickens in a large Pennsylvania farm, resulted in a sharp drop in sales of all large-scale agricultural products. Led by the Department of Homeland Security, the incident also led to tighter restrictions, including employee background checks, reducing the supply of labor and increasing operating costs.

Scenario B: All bagged up and nowhere to go
This is the age of techno-cows and mega dairies. Consolidation leads to a dramatically smaller industry of large producers. New technologies support unprecedented efficiency and productivity.

Highlights
• More industry consolidation leads to large-scale, efficient production systems, using new technology
• Cows are producing more and living longer
• Increased R&D leads to increased markets for milk products
• More intrusive federal regulation tied to Homeland Security
• Shortage of skilled labor
• Consumers are skeptical about technology and production.

How we got there

Technological breakthroughs
Investments in fighting bioterror and preparing for global pandemics have led to major breakthroughs in animal science. Advances in genetic engineering and automation have led to significant improvements in milk production.

The rise of mega dairies
While technological advances have increased efficiency, they have also raised the cost and complexity of participating in the industry. Immigration restrictions have limited access to cheap unskilled labor, putting small farms at a further disadvantage. This has led to rapid industry consolidation and the emergence of mega dairies. The efficiency of large producers and new technologies have driven down milk prices to decade lows: $12.05 per hundredweight.

Public backlash
Increased public attention with farm consolidation and mega dairy farming practices has naturally led to the identification of new problems, including questions about the long-term health effects of dairy products. PETA gains its first seat in Congress. The industry has become much more susceptible to fads and targeted (online) protests.

Scenario C: American Gothic
America is in love with the farm and dairy products. Technology has only made moderate advances, and dairy products still have a very basic and wholesome image. Continued studies about the health benefits of dairy have led to increasing demand which sustains higher milk prices. However, consumers are very concerned about the application of technology to farming; organics are the fastest growing segment. Higher input costs, more stringent environmental regulations and renewed calls for “small is beautiful” have reduced industry profit margins, especially among large-scale producers. Farming may be returning to its traditional, family roots.

Highlights
• Consumer desire for simpler, more traditional farming leads to decreased investment in technology
• Consumer demand for dairy products remains strong with confirmation of health benefits
• Consolidation increases as some states aim to offset declining margins
• Increased demand and low stocks lead to lower import barriers.

How we got there

Declining technology investments
With several recent new television shows on the glories of small farms, as well as the rising environmental concerns spearheaded by former Vice President Al Gore’s book on global warming, An Inconvenient Truth, the public wants – and is willing to pay for – organic, smaller-lot, specialty products. Stock market shares in Whole Foods are booming.

Dairy consumption increases
While consumers are wary of technology, they are positive about dairy. A series of studies in The New England Journal of Medicine and Lancet have touted the benefits of dairy in preventing not only osteoporosis, but also heart disease and even some forms of cancer. Product and marketing innovations, from packaging to new products, has also helped increase demand. This public interest and government regulations sustain higher prices: milk rises to $26.00 per hundredweight.

Increased global competition
Under pressure from the WTO, global trade restrictions are relaxing, making it easier for international competitors to enter the United States. While technologies for improving production may lag, advances in transportation and processing make it easier for distant markets to compete. Supportive domestic regulations, particularly those related to pricing, have helped to keep the increased competition from eroding pricing and this has allowed U.S. firms to compete at home even as they concede overseas markets.

Scenario D: Field of dreams
It is a bold new world in the dairy industry. Consumer acceptance and rapid scientific advances have led to fundamental breakthroughs in genetic engineering and other areas. Genetic selection helps reduce health problems and improve production. The industry has become high-tech, with tremendous improvements in both quality and efficiency. The majority of farm by-products are used for energy generation (on the farm and supporting local power grids). Consumers are expanding milk consumption, driven by the proliferation of new products, leading to higher prices. Aging boomers look to dairy for its health benefits; youth have (re) discovered dairy milk as “cool.” In this “field of dreams,” if you build it, they will come.

Highlights
• Consumption is up across all age groups
• Animal health and welfare issues have diminished
• Quality, accountability and health benefits are positively perceived
• Environmental safety – manure becomes a valuable commodity with the rise of affordable, efficient renewable energy systems
• Production costs decrease by improved technology (feed, health management).

How we got there

“Got Milk”
Consumers have an insatiable appetite for dairy products. The combination of aging baby boomers’ concern for calcium intake and youthful attraction to new milk drinks and dairy products has revitalized the category. Like the growth of bottled water or coffee drinks, what were once seen as commodity products have become a growth segment. There are also specialized products and nutraceuticals. A hot category is “super-kid” milk, designed to stimulate physical and mental development, which was adopted as the standard for U.S. school lunch programs. Public awareness campaigns for milk have been discontinued as unnecessary: everyone has “got milk.”

Healthy economy
The overall U.S. economy is booming, creating a positive environment for new product investments, new business growth and consumer spending. While interest rates have continued to creep up and oil prices remain high, the overall economy remains strong. Energy costs remain a critical concern but new technologies to harness energy from manure and other waste products creates new revenue streams for dairy farms while addressing environmental concerns. Milk prices have reached record highs of $26 per hundredweight.

Increased funding for research
Given the strong demand for dairy products and public support for technology, public and private funds are readily available for dairy-related research. The industry is now seen as a critical driver of growth that should be protected and supported by the government and a significant source of opportunity for private investors. PD

Figure omitted but is available upon request to editor@progressivedairy.com.

Jim Austin
Business Strategist & Dairy Industry Consultant
for Progressive Dairyman