The mood of US dairy executives has deteriorated, as flat growth, trade tensions, and changing consumer tastes have dampened prospects for the coming years. With regions beyond the United States experiencing growing demand, rising numbers of US dairy companies have begun to pursue exports in the past several years. Other market factors, including the move by some consumers to nondairy alternatives, will also present challenges. New McKinsey research1 sheds light on the mind-sets of US dairy executives and their recent evolution as they attempt to jump-start growth.
Executives on dairy exports
In 2015, several developments in the global dairy industry suggested cause for optimism. The European Union removed its milk production quotas, and observers anticipated that a growing middle class in Asia would consume more dairy products. In our 2015 survey, 78 percent of CEOs believed that despite declining demand, the US market had ample opportunity for growth. In the ensuring years, milk supply grew faster than demand, and prices and profitability have remained depressed ever since. As a result, in 2018 63 percent of survey respondents thought the downturn was not cyclical but structural, caused by a global surplus of milk and a fast-changing consumer environment (Exhibit 1).
Considering the changing landscape, US dairy companies have changed their perspectives on expanding beyond US borders. The importance of and participation in exports have continued to increase. In 2015, 34 percent of those surveyed had no exports and no plans to export. In 2018, that number dropped to only 11 percent. The share of companies that already export but have no plans to expand and those with continued plans to expand exports also rose from 34 percent in 2015 to 51 percent in 2018 (Exhibit 2). These increases likely reflect the growing importance of exports despite the current trade environment.
In the 2018 survey, opinions were split regarding how long current trade disputes would last: 53 percent of those surveyed believed that trade disputes were short-term in duration, whereas 47 percent believed they were here to stay. However, the impact of the trade disputes seemed to be universal, with 90 percent of the respondents reporting that they had already incurred a margin decrease between 0–10 percent and 95 percent expecting to incur a margin decrease of the same magnitude (Exhibit 3).
It is not clear whether the magnitude is low because trade disputes have a low impact or because the prices and margins were already on the decline before the disputes started. However, for those companies with significant export exposure (7–10 percent of the respondents), the impact of trade disputes has been significant in terms of discounts or lost opportunities, with margin decreases of 10–15 percent.
The results show that 82 percent of revenues from the surveyed companies come from the US domestic market, with just 18 percent from exports. As other countries face surpluses and focus on foreign direct investment to complement dairy exports, the production capacity of US dairy companies outside the United States is also growing. In 2018, 36 percent of the respondents had expanded their capacity outside the United States (over the course of five years), compared with only 7 percent in 2015. Fifty-seven percent of the respondents had the same capacity in 2018, compared with 18 percent in 2015, and 7 percent reported to have less capacity in 2018 compared to 2015 (Exhibit 4). This investment in foreign capacity is a hedge against the risk of losing out on the opportunity to capture more value and move away from commodity pricing and cycles. Winners in this space have transitioned from being commodity suppliers to functioning as strategic global partners.
In 2018, the results show US dairy exports are mainly consolidated into two markets, Asia and Mexico, which represent 45 and 46 percent of the export revenues, respectively. As other countries gain access to compete in these markets, margins are expected to decline. Less than 10 percent of export revenues are associated with Africa and the Middle East, regions that will grow with their populations and economies and where several European and New Zealand companies already have a direct presence.
Risk and volatility management
Survey respondents also indicated a sustained concern about volatility and ways to address it. In 2015, price volatility was the third-highest concern, right after consumption decline and food safety. The number of respondents reporting the use of financial instruments to mitigate price volatility has increased. Companies securing long-term fixed contracts with vendors and customers have increased as well (Exhibit 5). Demand volatility continues to be the top concern in 2018: 47 of 51 respondents reported being concerned and 32 of 51 very concerned about demand volatility. The evolution of consumer preferences seems to be connected to these concerns.
The top four perceived drivers of consumer demand have been stable from 2015 to 2018, but their order has shifted. Taste was the most important factor in 2015 and fell to number three in 2018, whereas price moved from number two in 2015 to number one in 2018. Health and wellness also rose from number three in 2015 to number two in 2018. Convenience remained number four in both 2015 and 2018 (Exhibit 6).
The survey results suggest CEOs are reassessing their companies’ competitive advantages in a consumer landscape that is shifting toward small brands and a different set of preferences compared with older generations. In 2015, 21 percent of dairy CEOs had confidence in their customer service capabilities, followed by brand management. Only a minority considered customer insights to be a source of competitive advantage. In 2018, dairy CEOs had the most confidence in their operational capabilities, but very few listed brand management capabilities. Again, only a few cited consumer insights as a competitive advantage, which is surprising considering the influence of consumers on demand volatility. (Exhibit 7).
Operational capabilities, while important, are just one element of a winning proposition; after all, efficiently making products that consumers don’t want doesn’t support growth. Successful companies have an efficient, agile, and global supply chain powered by consumer insights.
The results suggest companies are responding to the new landscape by increasing the speed of innovation. The number of companies changing more than 5 percent of their portfolio increased from 73 percent in 2015 to 83 percent in 2018. According to the survey, new products represent 6 percent of the total portfolio of products for companies with growing portfolios and 3 percent for products with decreasing portfolios (Exhibit 8).
Milk alternatives and millennials
Our interviews with CEOs revealed a sense of frustration over the speed of change in consumer preferences, including the emergence of natural, healthy, and socially oriented trends (Exhibit 9). Even so, executives recognize the necessity of listening to consumers and are trying to adjust strategy accordingly, with some expressing the desire to enter into a business partnership with their nondairy counterparts.
Executives exhibited moderate confidence in understanding such trends as clean labeling, which has a variety of meanings (Exhibit 10), and preferences for plant protein but not fat. As millennials become the largest demographic in the United States, companies need more insights into these consumers, who are more diverse, more sophisticated, and more demanding than other generations and prefer to shop in channels beyond the mass markets. Millennials also gravitate toward up-and-coming brands rather than established ones.
The views of dairy CEOs on the milk alternatives market has shifted significantly. In 2015, only 38 percent of the respondents believed that the nondairy alternatives market would continue to grow. In 2018, this number increased to 51 percent (Exhibit 11). Successful companies can respond by understanding the areas in which dairy has an advantage and exploit those markets, such as infant formula, geriatric, clinical, and others where nutrition is valued and price sensitivity is not a factor. Or they can invest in adding dairy alternatives to their portfolios; as one CEO noted, “We need to build relationships with these plant-based protein companies.”
Dairy-alternative products appear to be here to stay, so market insights and an openness to work with nondairy companies will be critical elements of strategy moving forward.
Between 2015 and 2018, themes top of CEO’s minds have stayed consistent. As shared in our previous article we believe North America dairy companies should use a combination of four strategies:
- Serve demand growth in areas with projected deficits through exports.
- Invest directly or form partnerships to serve those deficit markets locally (based on a perspective on market attractiveness through economic cycles).
- Serve demand niches with a more agile and flexible supply chain.
- Drive innovation based on deeper consumer insights powered by analytics.
A rapidly changing consumer and global environment requires a bold new outlook, and a growth model that can deliver on this challenge.