Infant formula week 3: putting a price on reputation

At a time when co-ops, operating on thin 1-2% margins, dug into their balance sheets over the last two years to support milk prices, the infant formula multinationals never had it better, benefiting from lower raw material prices that helped them return huge margins of up to 25%.

Meanwhile, as farmers are exposed to the full vagaries of volatile commodity markets, the price of a tin of infant formula in Ireland, London or even China remains relatively flat thanks to the power of their well invested brands thus insulating these multinationals from dairy commodity fluctuations.

These stock exchange-listed companies are driven by the need to increase profits, earnings and dividends every year.

And one of the ways to get these increases is to squeeze prices to farmers by benchmarking their raw material ingredients against the likes of Dutch dairy commodity indices.

Firstly, we are not selling a commodity. Commodities are fungible, meaning that each unit of a commodity is exactly like every other unit.

For example, in the grain world, every bushel of number 2 corn can be substituted for every other bushel of number 2 corn. This means that the price on any given day, at any given location, is the same for all farmers.

Farmers who produce commodities understand they are price takers and have no control over the price.

Specialised ingredients

In stark contrast, the infant formula ingredients Irish co-ops supply are highly specialised, differentiated products.

Tins of baby powder sit in supermarkets in Beijing, Shanghai or Shenzhen emblazoned with the word “imported” and an Irish flag alongside because the infant formula multinationals know that consumers there trust the integrity of the Irish brand which translates to high-quality, safe and traceable.

Irish dairy offers these brands traceability and a measured focus on lowering the environmental impact of food production, all of which feeds into their respective corporate social responsibility goals as large multinationals.

So they are making claims that if it is Irish it will have more value to the consumer and they can sell it for a higher price.

But will anyone buy the product at that price? The fact that Ireland is now China’s second-most-important infant formula supplier, in a market of 800,000t worth an estimated $20bn, suggests yes. The fact that Irish-made infant formula sells for the highest prices in the “super premium” category four times the price of other brands reinforces that they will.

If Irish infant formula was a car brand, Irish dairy farmers are making the components for a Rolls Royce. This is not a commodity. It is differentiated product which should allow the co-ops to be price makers rather than price takers.

Is it sustainable?

The infant formula multinationals are highly focused science-based businesses that invest a significant amount in R&D to achieve these very strong margins. There is nothing wrong with this.

The margins are not in question, rather how they are passed back along the chain. The Government has invested significantly in attracting these multinationals here over the last three decades. It has an interest in ensuring that they stay – but at whose expense?

These infant nutrition multinationals have leveraged the Irish farmer and the image of a safe, traceable and highly sustainable producer of grass-based dairy ingredients for their own gain to consumers who want the very best for their children.

They might think they are doing well with a cheap milk supply and commodity-based pricing model. Meanwhile, in times of low milk prices, farmers take the hit on margin, while these companies enjoy fat margins. In the long term, this model is not sustainable.

Up to now, some of the co-ops were reliant on these multinationals for processing capacity. But that is changing. With the lifting of quotas and the corresponding investment in capacity, the co-ops now have options.

This poses a risk to these multinationals where co-ops begin to develop alternative options beyond supplying commodities at reducing premiums.

Perhaps the time has come when farmers and co-op boards need to realise the value of the product they sell and be brave and ready to walk away. However, there is also the risk of competing co-ops eating each other’s margins.

Three decades ago, as much as 95% of the average company’s value consisted of tangible assets. Today, 75% of that average value is intangible. In other words, a business’s most valuable asset is its good name, its brand and reputation.

These companies buy into Irish dairy for its reputation and to protect their brands. After all, a food scare or contamination is by far and away the greatest threat to their business models.

So is it right that Abbott, Danone, Mead Johnson and Wyeth (Nestlé) pay as little as 5% above the commodity market price to Irish processors and farmers for dairy ingredients they use to make infant formula which sells for four times the price of a regular product or a 25% profit margin? Clearly it is not.

So any focus on improving Ireland’s reputation should be through the lens of increasing farmer profits as opposed to the multinationals keeping these premiums for their own gain.

The problem is that the industry up to now has never put a defined value on reputation and trust. And if Irish dairy wants to differentiate itself in a commodity marketplace, we have to be very clear that it is reputation we are selling first and foremost.

But how do processors and co-ops go about getting a higher price for the trustworthiness of our dairy industry? Last week, we looked at the idea of creating an infant formula brand for Ireland, which could potentially require a €2bn investment before we even started competing head on with companies like Danone or Nestlé.

And while an infant formula brand may be a discussion worth having within the industry, it’s something that won’t happen overnight.

The starting point has to be getting more for the 140,000t (which is the equivalent of around 10% of the milk pool) of primary ingredients the industry currently supplies, especially as farmers and processors offer a differentiated product by investing in the sustainability and traceability of Irish production.

Origin Green

Thanks to the work of Bord Bia, the infant formula companies will find it more difficult to get anything like Origin Green if they left Ireland tomorrow. Also thanks to the Moorepark Technology Centre, the industry has the capacity to research and develop the unique ingredients required.

The simple answer for dairy CEOs might be if you don’t ask for more, you don’t get. It also raises the question are we good enough at selling or are we competing with each other?

Yes, the presence of the infant formula players offers a major release valve on all the increased milk production.

As a result, is it being viewed as an outlet for volume rather than an outlet for value, which obviously plays into their hands?

If the industry is serious about the quality, safety and traceability of Irish dairy then it needs to collaboratively start putting a higher value on it. We also need to define the value of Ireland’s clean green image because it is currently delivering more for shareholders in the likes of Abbott and Wyeth than it is for Irish farmers.

Ultimately this is the only way to disrupt this race to the bottom trend where Irish dairy’s investment in reputation is commoditised to the lowest amount just like everything else.