porter analysis of the dairy supply chain in western ... · porter analysis of the dairy supply...

PORTER ANALYSIS OF THE DAIRY SUPPLY CHAIN IN WESTERN AUSTRALIA.

Michael Porter of Harvard University (Wikipedia, 2016) provided a framework that models an industry as being influenced by five forces. The

strategic business seeking to develop an edge over rival firms can use this model to better understand the industry context in which the firm

operates.

I. Rivalry

Firms strive for a competitive advantage over their rivals. The intensity of rivalry among firms varies across industries, and strategic analysts are

interested in these differences.

With only a few firms holding a large market share, the competitive landscape is less competitive.

In pursuing an advantage over its rivals, a firm can choose from several competitive moves:

1. Changing prices - raising or lowering prices to gain a temporary advantage.

2. Improving product differentiation - improving features, implementing innovations in the manufacturing process and in the product, itself.

3. Creatively using channels of distributions - using vertical integration or using a distribution channel that is novel to the industry. For example,

with high-end jewellery stores reluctant to carry its watches, Timex moved into drugstores and other non-traditional outlets and cornered the low

to mid-price watch market.

4. Exploiting relationships with suppliers - for example, from the 1950's to the 1970's Sears Roebuck and Co. dominated the retail household

appliance market. Sears set high quality standard sand required suppliers to meet its demands for product specification and price.(ORZ-L, 2016)

This approach can be applied to other situations.

The following charts discuss various relationships within the Western Australian dairy industry.

Competitive moves(After Porter, 1979)

WA Retail Sector WA Processing Sector WA Farm Sector

1 Changing prices - raising orlowering prices to gain atemporary advantage.

The price of milk has beenused as an attractant forcustomers ever sincederegulation in 2000. Fordrinking milk, there is a three-week cycle where onecompany is on special (often at$1 per litres every week. Thiswas noted and graphed as farback as 2003

Long term prices for themanufactured product are set byrenewable contract, margins are set.The actual commercial agreementsare commercial in confidence.

Prices vary from month to month.These are set by the purchasingcompany. Farmers can onlybargain once – at the timecontracts are agreed on. Thesecontracts often are set for severalyears, regardless of world prices.There are instances where bothsides of the contact have won orlost.

Notable is the instance in Far NorthQld where Lion contracted milk at aprice of approximately $0.50 perlitre for 2 years – JUST BEFORE THEGlobal financial crisis. The globalprice dropped significantly (almost½) but Lion had to pay more for theduration of the period. Now themilk supply in FNQ is approx. 1/3 ofits original volume.

At other times the Farmers havenot benefited from significant pricerises – unless they are part of a co-operative.



Improving productdifferentiation - improvingfeatures, implementinginnovations in themanufacturing process and inthe product, itself.

The development of privatelabel products is the maincompetitive move for retailers.

One supermarket chain hasspecific (2 only) farmers milkcontract packed – it is brandedas such and commands apremium.

The processing sector develops newproducts and presents them to thedistributers purchasing desk.

There are occasional packagingdifferences, and flavour changes in thedrinking milk / flavoured milk sector

The only development in thelast decade is thedevelopment of A2 milk andsome breed specific milks suchas Jersey milk.

The milk quality has developedwith measures such as fat andprotein for payment.Monitoring Somatic CellCounts (SCC) which indicatecow health. These have beennormal testing and monitoringitems for decades.

Creatively using channels ofdistributions - using verticalintegration or using adistribution channel that isnovel to the industry. Forexample, with high-endjewellery stores reluctant tocarry its watches, Timexmoved into drugstores andother non-traditionaloutlets and cornered thelow to mid-price watchmarket.

There has been little change allalong the supply chain.

The notable differences havebeen dedicated on farmprocessing plants and thedevelopment of specificbrands.

Some major distributors now“Cross Dock” cutting outintermediate distributionoperators. They also now dohome deliveries.

The distribution channels have notchanged a lot since deregulation. Thenumber of vendors has reducedsignificantly.

Not applicable as the farmersare contracted.

In some states, supplycooperatives have been setup.

Some farms have developedon farm processing, such aspasteurised and packagedmilk, Ice cream making andcheese making.



Exploiting relationshipswith suppliers - forexample, from the 1950's tothe 1970's Sears Roebuckand Co. dominated theretail household appliancemarket. Sears set highquality standards andrequired suppliers to meetits demands for productspecification and price.

Retailers have in house qualitysystem requirements forprocessors. The companies areregularly audited. Price andquality are the main bargainingpoints.

Some processors are setting volume limits,chemical composition limits, health limitssuch as somatic cell counts andmicrobiological limits.

The farm sector works with thesupplementary feed sectorand the fertiliser sector, butthey are weak compared withthe supermarkets.

(ORZ-L, 2016)

The intensity of rivalry is influenced by the following industry characteristics:COMPETITIVE FORCES SHAPING THE DAIRY PRODUCT MARKET IN WESTERN AUSTRALIA.1

Characteristic(After Porter, 1979)


1 Many firms increase

rivalry as they

compete for the

same customers

The retail concentration,

consists of 3 major

players, being Metcash,

Coles and Woolworths.

Metcash has a higher

market share in WA than

in the nation.

Of the 3 chains – 2 have

private label milk being

Coles and Woolworths.

The processors find it

difficult to compete with

their own branded

products and there are

reports of preferential

shelf space allocation to

supermarket branded

milk.

Therefore, rivalry is low.

Three market milk processors supply a population

of 2.6 million people. The competitive nature of

this market is shown by the high level of

branded milk discounting in WA SINCE

DEREGULATION. This was absent in most other

markets until 2010 when the $1 per litre milk price

was introduced.

Several smaller, processors compete with artisan

cheese and yoghurts. They compete against four

interstate processing groups supplying national

brands, supported by national distribution and

marketing networks. The WA cheese and yoghurt

markets are characterized by frequent discounting

and lower average SKU prices.

Export markets are skewed to lower than “realistic”

prices by policy decisions and subsidization by

major players such as the USA and the EU. Since

deregulation, Ice-cream, cheese, butter and milk

powders are no longer made in the state.

The prices paid by the processors vary,

based on the product and sales mix of

individual companies. Companies that

include market milk in their product

mix pay a premium to ensure that they

have the correct volumes of milk all

year round. This means that they are

favoured customers of the farmers by

returning a suitable price that rewards

the extra costs of year-round supply.

The large number of farmers (150)

relative to the number of processors

(3), coupled with specialized, capital

intensive production of a perishable

product results in farmers having a

weak bargaining position. there is no

co-operative processor in WA, so there

is no guarantee that all milk will be

purchased.

1 Porter, M. (1979) "How competitive forces shape strategy", Harvard Business Review, March/April 1979



2 Slow market growthcauses firms to fightfor market share.

Population growth hasslowed to approximately1.5% per year and milkconsumption per capitais approximately 2 litresper person per year,however most of this isin the cheese area andso is imported.

New markets for dairyproducts are notdeveloping via theexisting population.

Taking market sharefrom other retailers isthe most effectivemethod of increasingsales volumes.

Population growth is not equivalent to volumes ofmilk available. Per capita growth is also small.Therefore, new markets for dairy products are notopening via the existing population.

Taking market share from other processors isthe most effective method of increasing salesvolumes.

Processing plants are small in world scale andthere is not enough milk to fill them, so they arenot competitive and are the first to be droppedwhen international prices drop.

The farm sector is dependent on theprocessing sector for demand.Currently the options of milk exportsare reducing. There is a local marketfor cheese and butter which is beingsupplied from out of state. There isno commercial will to buildprocessing facilities to address thisdemand.

Due to lack of scale, local processorsare unable to extract an acceptablereturn from the export marketcompared with the large Victorian andNZ companies and co-ops.

Corporate processors will pass thebenefits of high export prices toshareholders rather than suppliers.



3 High fixed costs result in aneconomy of scale effect thatincreases rivalry. When totalcosts are mostly fixed costs,the firm must produce nearcapacity to attain lowest unitcosts. Since the firm must sellthis large quantity of product,high levels of production leadto a fight for market share andresults in increased rivalry.

Supermarkets rely on volumeof traffic and sales to maketheir profits. Their overheadsare land, buildings andequipment. Turnover isparamount in making a profitin this industry. Turnover ismeasured in $/square metre ofstore space. Milk is said toprovide 4.5% of the turnover ofa supermarket.

WA milk processors have largeinvestments in dairy-specific plant. Fixedcosts are a major component of their coststructure.

Winning high volume house brand milkcontracts (often through national tender)is a key strategy to increase throughputand dilute fixed costs.

This process is highly competitive andreduces both processor and farmermargins.

Introduction of national tenders sawsupermarket milk prices fall by nearly 20%.

As there are 2 companies asking forhouse brand products and threeprocessors, one processor misses outregularly. This encourages maximumcompetition.

Fixed costs represent morethan 40% of milk productioncosts in the farm sector.

Diluting fixed costs byincreasing production /Ha hasbeen a key strategy on manydairy farms since deregulation.This has maintained milksupply in the face of areduction in farm numbersfrom 400 to 150.



5 Low switching costs increasesrivalry. When a customer can

freely switch from one productto another there is a greater

struggle to capture customers.

Consumers perceive milk, yoghurtand cheddar cheese asundifferentiated products andreadily switch between brandsbased on price.

This is demonstrated by thegrowth of supermarket housebrands’ share of the WA fresh milkmarket from 11% to more than50% in the three monthsfollowing deregulation.

Retailers have low switching costs– they only receive a differenttruck from a different processor.

Processors have the option ofbuying top quality milk from mostof WA’s 150 dairy farms.

There is an oversupply of milk forshort shelf life products inWestern Australia.

Milk trading between dairyprocessors and collaborative

transport arrangements make iteasy for processors to switch

supply sources, although longterm contracts ensure stable

supplies. This results in supplierloyalty.

Processors have low switchingcosts – they only change thetanker pickup route. Contractsincrease the switching cost.

Dairy farmers can switchprocessors easily unless bound bycontracts. Processing companieshave several contractual weaponsto lock in supply.

These include exclusive supplyand specific volumerequirements.

These change the switching costsfor the farmer from low to high.

6 Low levels of productdifferentiation are associatedwith higher levels of rivalry.Brand identification, on theother hand, tends to constrainrivalry.

Milk and cheese are “Prescribed”products. This means that mostthe product characteristics areidentical between brands.

Rivalry is significant.

High quality milk for drinking andmanufacturing is easily obtainedfrom the WA farm sector.


Milk quality is generally highacross the Western Australiandairy industry.




7 Strategic stakes are high when afirm is losing market position orhas potential for great gains.This intensifies rivalry.

Consolidation of the retail sector isless advanced in Western Australiathan in other Australian states.Considerable scope remains forthe major chains to increasemarket share, while independentshave powerful incentives tomaintain market share. This leadsto a very competitive marketplace.

Supermarkets are the major outletfor dairy products. Winning andkeeping house brand milkcontracts is essential forprocessors to maintain their shareof the fresh milk market.

Processors contracted to supplyhouse brand milk also receivefavourable shelf space allocationfor branded milk andmanufactured products.

Submitting a losing house brandmilk tender would have a majorimpact on processor market share.

Processors’ ability to offer accessto market milk premiums makes itrelatively easy to negotiatefavourable contract terms withfarmers or to detach individualsfrom collective negotiation.

Farmers who choose not to entersupply arrangements withcorporate fresh milk processorsrisk significant loss of income.



8 High Exit barriers place a highcost on abandoning theproducts. The firm mustcompete. High exit barrierscause a firm to remain in anindustry, even when theventure is not profitable. Acommon exit barrier is assetspecificity. When the plant andequipment required formanufacturing a product that ishighly specialized, these assetscannot easily be sold to otherbuyers in another industry.

The exit costs are LOW for dairybrands.

Retailers must maintain acategory, but low differentiationbetween the products means thatunprofitable products can bechanged easily.

Retailers install expensiverefrigeration systems to cater forthe short shelf life of “fresh milk.”A change to long life UHT milkwould reduce their costssignificantly.

Dairy represents approximately4% of a retailer’s turnover.Retailers commit to dailypasteurised milk as a draw cardand could function quite well ifthey did not have any specificbrand.

The existing refrigerators could beused for other goods with aminimum of cost.

The exit costs are HIGH.

The equipment used forprocessing milk and other dairyproducts is very specific. Thereare some other beverages thatcan be produced in market milkplants. Cheese, butter andpowder production plants rarelycan be converted to process otherproducts.

This results in high exit costsand therefore difficulty inrationalizing current overcapacity within the WAprocessing industry.

The exit costs are HIGH.

Total farm investment in dairyproduction is estimated to be tentimes total processing investmentfor a given volume of milk.

Milking sheds and plant ispurpose specific and dairy cowsunsuited for beef breeding.

Falling farm numbers reducesdemand for cows or second handplant, increasing barriers to furtherexits.

Alternative land uses will notgenerate the cash flow to servicethe high debt levels found onmany dairy farms.



9 A diversity of rivals withdifferent cultures, histories andphilosophies make an industryunstable. There is greaterpossibility for mavericks and formisjudging rivals moves. Rivalryis volatile and can be intense.

Rivalry is volatile and intense.

This is reflected by intense rivalrybetween independent grocersand the major supermarketchains. The arrival of Aldi iscausing strategic changes in thedistribution sector.

Milk processing in WA has movedfrom predominantly local topredominantly foreign owned.The major players are:

1. A locally based corporateprocessor wholly owned by aSydney based Venturecapitalist company

2. A national fresh milkprocessor owned by a brewerfrom Japan.

3. A national fresh milkprocessor owned by a Frenchmultinational dairy companywith an Italian subsidiary.

It is likely that differences inphilosophy and history willbecome increasingly apparentbetween these companies.

There is evidence that the WAfarm sector is dividing into twocamps.

One seeks to deal pragmaticallywith the existing marketenvironment throughproductivity gains and businessimprovement. The other desiresgovernment intervention toincrease address inequities in thesupply chain.

The different objectives of thesetwo groups will have importantimplications for the success ofindividual and collective pricenegotiation by dairy farmers.

10 Industry Shakeout. A growingmarket and the potential forhigh profits induce new firms toenter a market and incumbentfirms to increase production. Apoint is reached where theindustry becomes crowded withcompetitors, and demandcannot support the newentrants and the resultingincreased supply. The industrymay become crowded if itsgrowth rate slows and themarket becomes saturated,creating a situation of excesscapacity with too many goodschasing too few buyers. Ashakeout ensures with intensecompetition, price wars, andcompany failures

The move by supermarkets tocapture wholesale as well as retailmargins by the introduction ofhouse brands and their aggressivepricing policies have dramaticallychanged the fresh milk market.

The potential profits to be madefrom fresh milk processing sawHarvey Fresh enter that marketduring the 1990s.

The existence of three players inthe processing sector seems to bea major factor behind theaggressive discounting ofbranded milk that characterisesthe WA marketplace.

Increasing opportunities to supplymanufacturing milk encouragedrapid expansion of milk supply bylower cost producers during the1990s.High cost producers wereprotected by the quota system.Removal of quota protectionlowered fresh milk premiums andeffectively spread remainingpremiums across a largerproduction pool.

Early predictions of high valueexport demand growth afterderegulation have not beenrealised. Falling demand, lowinternational prices and a risingAustralian dollar all slowed exportgrowth in 2001/02.

(ORZ-L, 2016)

A similar and more graphical analysis tool has been developed by Michael E. Dodds, AssistantProfessor of Management, Eastern Illinois University Management, (Google Scholar, 2016)

The original templates follow. These have been transposed into spread sheets and the threesections (Farmer, Processor and Major Domestic Distributor) of the supply chain have beencompared and graphed.

(Dobbs, Guidelinesfor applying Porters five Forces framework: a set of industry anaysis templates., 2014)Michael E. Dobbs , (2014) "Guidelines for applying Porter's five forces framework: a set of industry analysistemplates", Competitiveness Review, Vol. 24 Iss: 1, pp.32 – 45

(Dobbs, Guidelines for applying Porters five Forces framework: a set of industry anaysis templates.,2014)

(Dobbs,Guidelines for applying Porters five Forces framework: a set of industry anaysis templates., 2014)

(Dobbs, 2013)

Dobbs, M. E. (2013). Internal Analysis in Practice: Templates for Firm and Case Analysis. J o u r n a l o f t h e N o r t h A m e r i c a nManagement Society, 7(1 ), 40 to 53. Retrieved from http://mbaa-nams.org/NAMS/JNAMS_files/jnams6summer2013.pdf#page=41

Dobbs, M. E. (2014). Guidelines for applying Porters five Forces framework: a set of industry anaysis templates. Competitiveness Review, 24, 32to 45. Retrieved from http://www.emeraldinsight.com/doi/pdfplus/10.1108/CR-06-2013-0059

ORZ-L, M. (2016). Porters 5 Forces. Retrieved from MICHAEL ORZ-L: http://www.michaelorzl.com/?q=node/14Wikipedia. (2016, Nov). Retrieved from https://en.wikipedia.org/wiki/Michael_Porter

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