Why has Fonterra gone A2?

It is now more than a month since Fonterra and The a2 Milk Company (A2M) announced that they are going to work together. After the initial shock, and with Malcolm Ellis, National Market Manager from New Zealand-dominant dairy-semen provider LIC describing it as “the biggest announcement to come out of Fonterra since its formation”, there is a need for some analysis as to what it is going to mean.

From the perspective of A2M, there is a simple answer. It will provide a supply base of milk free of A1 beta-casein that A2M desperately needs for the coming years of growth.

For Fonterra, the issues are far more complex.  Why have they made a U-turn after 17 years of condescending denigration of the A2 concept?  And why is Fonterra doing it as a joint venture rather than striking out on its own?

The reason that Fonterra has made the U-turn is that it has come to a conclusion that it could not afford the risk of further delay.  Someone influential in the company will have looked out five years or so ahead and, particularly in relation to the all-important Asian markets, will have said ‘we have no option; we have to get on-board now, or we are going to be left irrevocably behind’.

Someone else from Fonterra, with responsibility for stemming the leakage of Fonterra’s farmer suppliers to other companies back in New Zealand, will have said, ‘we need to provide an A2 option to our farmers or else more farmers will transfer their supply away from Fonterra’.

Someone else in the China part of Fonterra’s business will then have said, ‘this is a way we can differentiate and get a premium for our Chinese-produced Fonterra milk, which currently sells at commodity prices below our cost of production’.

Getting all of Fonterra’s supply across to A2 is going to take well over ten years. But New Zealand has many large-scale dairy farmers – both genuine corporate and family corporate – with multiple herds. These multiple herd owners can re-organise their herds very quickly so that about half of the corporate herds can supply pure A2 milk.

In theory, these large-scale producers have the capacity to produce some billions of litres of A2 milk within as little as two years. In practice, it won’t happen that quickly, but it is easy to see potential for several hundred million litres of A2 milk becoming available in that time period, and then rapidly expanding up from there to say four billion litres (or more) within five years.

For the smaller farmers, very few of them will achieve pure A2 herds within those five years and many will struggle to get there in ten years.  And this will be a source of tension that leads to a running sore within the co-operative.

The decision of Fonterra to go with a joint venture rather than developing its own A2 brands is linked to the failure of the Beingmate project.  The combination of Beingmate with its distribution systems and Fonterra with its international brands was supposed to be a ‘game changer’ to quote Fonterra CEO Theo Speirings. But alas, the Beingmate distribution systems related to the old world of China rather than the new and were loaded with inefficiencies.

Equally important, Fonterra’s so-called premium brands are not perceived as being lead brands by the Chinese or indeed most other people around the world. So rightly or wrongly, Fonterra has decided it needs to use the ‘a2 brand’ to sell dairy products that are free of A1 beta-casein.

If we really want to understand the brand issues facing Fonterra, we have to go right back to January 2007 when Fonterra Brands chief Sanjay Khosla departed for the more promising territory of Kraft Foods. Essentially, Fonterra at that time decided it was going to be an advanced ingredients company rather than a direct competitor of the brand leaders such as Nestle and Danone.

It was never said publicly, but at that time those involved in determining Fonterra’s strategy decided that New Zealand was ‘50 years too late to take on the big brands’. Yes, those words were indeed used in private. That private conclusion was based on judgements that Fonterra had neither the skill set nor the culture nor deep enough pockets for what would have been needed.

However, what Fonterra did not factor correctly at that time were the obvious emerging markets of Asia in general and China in particular, together with the associated disruptive opportunities. Thereafter, through an ongoing series if mis-steps, Fonterra has never found the value-add pathway to bring the brands that it does have to become front-of-mind for most Asian consumers.

So, once again Fonterra has decided – although it will never admit it in public – that it has neither the skill set nor the culture nor deep enough pockets to now strike out on its own with products free of A1 beta-casein. And that is why it is partnering up with A2M which has a first-mover brand-dominant position.

Let there be no doubt that there are no legal constraints preventing Fonterra or other companies from developing their own brands of dairy products that are free of A1 beta-casein.  In Fonterra’s case, it even held a 50 percent share of the original patent (now expired) for producing milk free of A1 beta-casein. A2M subsequently obtained its share of that patent through purchasing the other 50 percent share owned by the New Zealand Child Health Foundation.

Events have now played out such that A2M has developed a market value of more than $NZ10 billion and is New Zealand’s largest company. This is not just New Zealand’s biggest dairy company by value (yes, it does now rank above Fonterra on that measure), but also for every other type of New Zealand company.

It is indeed unfortunate for New Zealand that most A2M shares are now held by Australian and other overseas institutions. Once again, as a nation, and with our production-focused mindset, we did not see the value that others saw and let it slip away. We have only ourselves to blame.

The details of the joint venture arrangement between Fonterra and A2M are not in the public domain. But it is notable that immediately following the announcement, the A2M shares soared whereas those of Fonterra stayed becalmed and have since drifted back. So that tells us what the investor market thinks as to where the benefits will lie.

There is a number of logistical challenges that Fonterra will have to face in putting together the necessary pools of A2 milk. All other things being equal, Fonterra will prefer North Island rather than South Island supplies, as that will better fit the desired processing configurations. Fonterra will also be wanting a Victorian supply in Australia. But all things are not equal in terms of potential availability of supply. Much of the potential supply will be in the South Island.

So, one of the big questions is whether Fonterra will initially offer premiums across New Zealand or just in some regions. That decision too has potential to become a running sore within the co-operative.

Fonterra is not alone in deciding recently to ‘go A2’.  In Australia, ASX-listed firm Freedom Foods, which has access to some of Australia’s largest dairy herds, has stated recently that it plans to market A2 products under its own brand. Freedom Foods has been working towards this for quite some time.  There are other companies in various countries who are also making plans but at this stage largely working below the radar.

***
Disclosure of Interest: Keith consults internationally for dairy companies that hold a range of stances in relation to A2 Milk.

 

 

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About Keith Woodford

Keith Woodford is an independent consultant, based in New Zealand, who works internationally on agri-food systems and rural development projects. He holds honorary positions as Professor of Agri-Food Systems at Lincoln University, New Zealand, and as Senior Research Fellow at the Contemporary China Research Centre at Victoria University, Wellington.
This entry was posted in A1 and A2 milk, Agribusiness, China, Dairy, Fonterra. Bookmark the permalink.

12 Responses to Why has Fonterra gone A2?

  1. Always a pleasure to read your posts Keith. Do you have any information on what is happening in Europe re A2 milk, or the UK in particular? I also heard a story that you can sell A2 milk so long as it’s over a certain percentage A2, ie it could have some A1. Do you know if that’s true?

    • Keith Woodford says:

      Christine,
      There is no legal definition of A2 milk as such. But until recently, when some people have tried to muddy the waters, it has always meant milk free of A1 beta-casein. Yes, public awareness is less in Europe than in some other parts of the world.
      Keith W

  2. Steve says:

    Hi Keith,

    I’m a believer in the A2 juggernaut. Nestle’s announcement that they will sell “Atwo” infant formula under its Illuma brand in China, to try and go head to head with A2. I just read about your articles indicating the lead times to convert herds over (6-10 years).
    I am keen to know your thoughts on the following:
    1) How will Nestle and anyone else fare, given i don’t think even they can defeat teh A2 brand nor the fact the source product is from NZ and Australia which is paramount to Chinese consumers. Not sure where Nestle intends to source their A2 milk pool from and how long it might take them – do you?
    2) How much of an advantage does A2’s patents give them? Does Nestle have to use any of A2’s patents and therefore pay A2 an income?
    3) Who is the Goliath and David in this showdown? My gut feel still says A2 might appear to be the “David” but I somehow think they will remain kings of the A2 market.

    Thanks in advance for your reply if you do. i’ll check your blog in coming weeks and months.

    Regards,

    Steve in Melbourne.

    • Keith Woodford says:

      Steve,
      1) Nestle will get their supply of A2 milk from America where there are large scale farmers with multiple herds, who can re-organise to have some herds that are A2. This is what Nestle is doing right now.
      2) In my opinion, Nestle does not have to use any A2 patents. A2’s advantage is their first mover status, combined with not needing to protect existing A1 brands
      3) There is room for multiple Goliaths and multiple Davids, as long as they focus on building the category and not fighting each other.
      4) America, New Zealand, and China are the three countries where herd re-organisation is a way to quickly get herds of A2 milk. These opportunities are much less elsewhere.
      5) Chinese people do not, in general, trust their own milk companies or regulatory systems. That gives advantages to NZ or American-sourced milk.
      6) Of course, by re-organising herds to produce A2 milk, one also ends by creating other herds that are very high in A1 beta-casein. All very interesting!
      Keith W

  3. Steve says:

    Hi Keith,

    Thanks for your amazingly quick reply. Some comments/questions:

    2) Is there any value to the patents then? What are the best one or two things about A2’s patents?

    4) So Australian milk producers are not able to join the party? I thought for Australian market, A2 already source local Australian milk supply, but I could be mistaken, or that it’s not to significant scale and is supplemented by NZ supply. No doubt NZ has a bigger industry.

    5) You’re right. I think China produced A2 milk converted to infant formula powder will not do well (won’t be trusted) and certainly won’t command the retail premiums that A2 brand can.

    6) Interesting indeed, if that’s the case. I have no idea about animal husbandry/reproduction. Would there be a negative ripple effect? Like excess A1 herds that are not wanted, or high A1-beta-casein milk that may be unhealthy for consumption?

    In my opinion, I don’t think it’s all that important anymore for the benefits of A2 beta-casein to be scientifically proven, it would just be icing on the cake. It would appear to me that enough consumers have already believed in the product and the power of the brand is now established in the markets they are in. I truly believe they are the only ones able to be a global dairy brand one day that’s equal to Coca Cola, so long as they continue operating as a savvy marketing powerhouse.

    Regards,

    Steve

    • Keith Woodford says:

      Steve,
      I have touched on some of these issues in a new post yesterday about how A2 is moving from a brand to a category.
      KeithW

  4. farmerbraun says:

    The holy grail in adding value to dairy products is to use a brand which ticks all the boxes for the modern affluent consumer i.e. to exemplify ” consumer- friendly” in the retail dairy cabinets of the markets.
    For mine, A2 will never be that brand, because it lacks meaning in the consumer consciousness(or sub-consciousness, if you like).
    We know what attributes consumer friendly dairy needs to have. No undesirable beta casein is merely one attribute in the cluster, which currently includes ” welfare friendly” ; polled; grass- fed; organic; clean , green , and fresh, etc.
    In other words the brand must have an image of a total farm environment where sustainable dairying is the game, and third party verification assures the quality that the consumers prefer to purchase.
    The A2 milk pool has a long way to go before it can claim the high ground which is currently occupied(arguably) by organic, A2, polled, grass fed, family farms.
    Just saying 🙂

    • Captainbarnacles says:

      I have recently gone from buying organic milk to being horrified that the supply chain includes organic stockfeed from overseas, including some places I wouldn’t want to consume food from. Didn’t expect that (dirty) trick. Grass fed and family farms sounds far better to me.

    • Keith Woodford says:

      Farmerbraun
      Our markets are mainly in Asia and China in particular. plus the Middle East. Those of us who come from European cultures need to be careful that we don’t transfer our consumer perspectives to the rest of the world. Being ‘free of A1 beta-casein’ is indeed just one attribute and by itself that will not ensure success. But any farmer who continues to ignore the A2 revolution is not seeing the world the way I do.
      Keith W

  5. farmerbraun says:

    The adoption of mobile milking robots , which can milk about 100 cows, offers the opportunity to the medium to smaller farmer to segregate the herd on beta casein type. Some mobile robots are usable in pasture situations ; others have a number of docking locations around the farm.
    Smaller groups of cows spread around the farm , doing a lot less walking , is a very good look.

    • Keith Woodford says:

      Farmerbraun
      Yes, this is feasible and I know of one country where there are plans to even use the robots to identify the A2 cows as they come through the parlour and draft accordingly. You could do something similar with a herringbone, with one side for A2 and the other for non-A2, and use separate milk lines. But it does add complications and cost. In both herringbone and rotary one could do a pre-milking electronic sort. of cows. but there would have to be very robust systems to avoid contamination and that brings its own cost.
      Keith W

  6. Steve says:

    Hi farmerbraun,

    You’d be surprised how many of A2’s current affluent customers and potential new customers are buying A2 because they’ve perceived that “most expensive milk = the best milk”. I kid you not, people are buying A2 by price association and they may not even realise the differentiation in A2 milk. These are affluent, highly educated people who are time poor and may not bother to read the fine print. They are already the brand of choice for the Millennial generation for whom brand and status is all important and the perception they buying the best. Brand marketing can be very powerful in brainwashing all of us consumers.

    PS: “most expensive milk = the best milk” is from one A2 customer (so not statistically significant I know) – she’s my sister-in-law, and a doctor who 5 years ago was buying A2 and I quizzed her why? Well, she said, “it’s the most expensive milk so it must be the best milk”. She didn’t know about A2 beta casein story as well as a consumer. True story.

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