The U.S. dairy industry is evolving, progressing from a commodity-driven producer of domestic products to a top three exporter of dairy ingredients. More attention is being placed on creation of value-added consumer goods and the proliferation of innovative, direct-sourcing models throughout the supply chain.

Sirolli ryan
Ryan Sirolli

Other animal protein and livestock sectors have undergone significant structural changes in recent decades. As the U.S. dairy industry moves toward alternative marketing systems and opportunities, there are lessons to be learned from those transformations.

Pork industry transformation: Drivers of change

The 40-year transformation of the pork industry may offer some insights. Changes have been driven by a number of factors, ranging from genetics and infrastructure to industrialization, changing consumer tastes and demands, and export opportunities.

The pork industry went through a genetic transformation in the 1970s and 1980s, as U.S. consumers shifted preferences away from animal fats and toward leaner meats, including chicken. Traditional genetic lines, designed for survivability in harsh Midwestern winters, had created hogs with large amounts of back fat.

To naturally trim the fat, new European genetics were introduced, leading to substantially leaner, more prolific sows. However, these sows could not be raised outdoors, and new facility design and capital investment were needed.

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With this genetic and infrastructure transformation came massive leaps forward in productivity. However, the U.S. farm crisis in 1979-1980 created a tightening of available credit and a concern for long-term farm profitability and viability.

With producers needing investment capital, packers began to offer long-term contracts to producers as a way to stabilize income and reduce market volatility. Hog producers leveraged those margins into credit with their lenders. Those arrangements also provided a consistent supply of high-quality pork to serve new and more demanding market segments.

In the Midwest, cooperatives developed incentive-based quality contracts. In North Carolina, where there was virtually no pre-existing infrastructure, a rapidly growing pork industry was created. Using the vertical integration model of the state’s poultry industry, contracts specified feed formulations, production facilities, genetics, veterinary care and management strategies.

By the mid-1990s, it’s estimated more than 80 percent of hogs in North Carolina were raised under integrated arrangements with processors. Large-scale packing plants were built to match the rapid expansion in production.

Market failures drove changes in the relationship between packers and producers, with a shift from spot auction markets to more direct market channels, ultimately leading to a system-based “pork manufacturing system” incorporating new technologies and driving production efficiency.

The “industrialization” phase brought a transformation toward fewer and larger producers. However, it also brought a change characterized by a shift from a supply side/commodity mindset to one of consumer-driven demand and market differentiation.

More recently, continued evolution of the consumer and export markets have been significant drivers of change. The impact of animal well-being and demand for “antibiotic-free” pork has resulted in the newest transformation of housing systems and management practices.

Globalization and a growing middle class outside the U.S. are creating new opportunities for U.S. producers. Prior to 1995, the U.S. was a net importer of pork. In 1996, the U.S. exported 305,872 metric tons of pork. In 2015, exports totaled 2.13 million metric tons at a $5.5 billion value.

Globalization is also attracting foreign investors to the U.S. pork industry, seeking to secure ownership of pork supplies as a strategy to supply growing consumer demand for animal protein outside U.S. borders.

Dairy industry transformation: Indicators of change

Many of the key influencers of the U.S. pork industry have the potential to be indicators of change for the dairy industry.

Dairy cows have already gone through a genetic change, with increased emphasis on production of milk components. Infrastructure changes on the farm level have included climate-controlled freestall facilities and, more recently, robotics. The result has been rapid expansion in productivity.

The current milk marketing system, through farmer-owned milk cooperatives, has been a necessary system to ensure the milk produced every day finds a home. However, this structure makes it challenging for individual producers to move beyond a commodity system to value-added and transparent.

Similar to the pork industry, traditional dairy markets have failed to capture the full value, driving relationship changes between dairy producers and processors.

Increasing volatility, with boom-and-bust cycles, has also led some producers to seek out more non-traditional partnerships. April 1, 2017, marked the fifth anniversary of the first cost-plus contract between Dannon and McCarty Farms.

Alternative contracts and business relationships have proliferated since then. Through a producer/marketer business partnership, Coca-Cola is spurring innovation in the supply chain with the development of fairlife.

There’s a tremendous interest in alternative pricing or direct-sourcing models – from producers, processors and consumers – than there were just a few years ago.

Although the ongoing trend of fewer, larger dairy operations is well documented and does not appear to be slowing down anytime soon, it does not mean there aren’t opportunities in other business models.

Modern-day consumers are driving value perception through demands on animal welfare, antibiotics and housing, not just price. According to a Nielsen survey, nearly 50 percent of all growth in consumer-packaged goods is being driven by smaller brands able to provide consumers the “experience” they value in determining the goods they buy.

The ever-increasing demand for transparency and sustainability in the supply chain is reshaping how dairy producers manage their operations. The changing consumer, and their willingness to pay for quality and transparency, has already begun to shift dairy from a commodity mindset to a consumer “food” mindset, with innovative dairy food products.

Alternative instances of vertical integration exist in the organic dairy sector, where few large dairy farms have controlled their crop and forage inputs, dairy production and dairy processing to better manage risks and to stabilize their supply chain. Some companies have gone so far as to create their own consumer-facing brands.

The critical value of the export market has been recognized, and the long-term importance of exports could result in the entrance of non-traditional ownership.

Through observation of the pork industry, more coordinated vertical relationships within the dairy industry may offer significant advantages in the areas of:

  • Risk. If producers are in spot market situations, they own all the risk within their part of the supply chain. By coordinating vertically, marketing risk is aligned, shared and distributed across and up and down the supply chain.

  • Technological progress. Investment in technology can drive efficiency, but if costs and benefits are limited to one segment of the industry, technological progress cannot be fully leveraged.

  • Innovation dissemination. With consumer trends changing, traditional commodity markets do not provide clear market signals. More direct relationships within the supply chain may provide faster, more efficient means to capture and implement changes driven by consumer demand.  end mark

Co-author Ryan Sirolli is former U.S. dairy innovation leader with Cargill Animal Nutrition.

Rodrigo Carranza