The joint venture agreement between Fonterra and The a2 Milk Company (A2M) to work together producing dairy products free of A1 beta-casein is a seismic shift for both the New Zealand and global dairy industries. Fonterra has consistently expressed strong negativity for close on 20 years about such products – known colloquially as ‘A2 milk’ – and as recently as 2016 the Fonterra CEO said it was just a ‘marketing concept’.
In essence, Fonterra has done a U-turn. It won’t have been an easy decision. There will be some challenges explaining and defending the U-turn to its 10,000 farmer members, most of whom, having listened to Fonterra’s previous messaging, have yet to start converting their herds.
Despite the challenges of the A2 versus A1 issue, Fonterra has now decided that continuing to fight against the A2 cause was a losing stance. This has to be the start of a fundamental repositioning for the future.
Within Fonterra, there have been supporters of A2 for a long time, and at least two directors began their own herd conversions many years ago, even before becoming Fonterra directors. But until now, the corporate line has been dismissive, within a framework where contrary views have to stay private.
Fonterra has now become the first of the international dairy majors to embrace the A2 concept. The other majors – such as Nestle, Danone, Arla, FrieslandCampina, Yili and Mengniu – will all have been giving thought as to how they should meet the emergent challenge of A2. But to see their ‘fellow major’ Fonterra make the first leap will have come as a big shock. The dairy world is indeed going to change.
Until now, A2M has had a Western-World plus China monopoly of bovine milk that is free of A1 beta-casein. India does produce lots of milk from both buffalo and native indicus cattle that is free of A1 beta-casein. Similarly, the native cattle of Africa are all A2. Sheep, goat and indeed human breast milk are also free of A1 beta-casein. But for mainstream milk supplies across the Western World, this is something new.
The big winner from the joint venture is going to be A2M. I have been suggesting for the last two years that the phenomenal growth of demand for A2 products would out-strip the ability of their current suppliers in New Zealand and Australia. Indeed, 78 percent of the A2M revenue and all of the ‘a2 Platinum’ infant formula comes from approximately 60 predominantly large-scale Synlait suppliers in Canterbury.
Until now, the A2M perspective has been that supply is not an issue, but with raised business horizons, that has now changed. A2M shares are currently trying to find their new value, having increased more than 35 percent in two days. However, some of this is due to the concurrently announced outstanding physical and financial results for the first half year of 2017/18. The A2M shares are now above $NZ12, having increased 150 times their value of ten years ago when they were just a few cents.
There is likely to be ongoing share price volatility for A2M. Depending on the hour of the day, the market capital value of the company can vary between either less or more than the value of Fonterra. But the big message is that A2M now has a market value, like Fonterra, of about $10 billion, despite only having between two and three percent of the milk supply that Fonterra has.
Over at Fonterra, the farm-level benefits of the joint venture will fall unevenly amongst Fonterra’s farmer members. Farmers with multiple herds can quickly test their cows and re-organise so as to have some herds that are pure A2. However, for farmers with only one herd, the herd conversions journey will take about 10 years even with DNA testing. The precise time for conversion will vary depending on starting point and the specific strategies.
There is a range of strategies that farmers can use to speed up the conversion process, but all of these come with additional cost.
The first goal for any farmer converting to A2 is to ensure that all replacement calves are A2. At that point, the typical farmer will still be six years away from having a pure herd. So, this is really something that the big farmers are going to benefit from, at least in the short and medium term.
If most farmers now choose to convert to A2, then LIC, as the major supplier of semen, is going to have a challenging task. The LIC bull-breeding chain runs for six years from when a bull calf is conceived until it is progeny tested. So, there could be a lot of bulls coming through the system that will no longer be wanted.
There will be kickback from some farmers who are not convinced of the need to ‘go A2’. Fonterra will also be very careful in its messaging to ensure that consumers are not scared off ‘A1 milk’, as they will have plenty of this to sell for the next ten years. So, all messaging to farmers will be soft messaging, and consumer messaging will be soothing.
In marketing language, one never ‘destroys the existing category’. This was precisely the message from the New Zealand Dairy Board (NZDB) in pre-Fonterra days when the question of A1 versus A2 milk first arose at the New Zealand Dairy Group, which was the biggest New Zealand dairy company at that time. From that time onward, the New Zealand dairy industry went into defence mode in relation to A2, and ran with a strategy that the best defence was to be dismissive.
For a long time, that strategy seemed to work.
Disclosure of Interest: Keith consults internationally for a range of dairy companies that hold a range of stances in relation to A2 Milk.