A sustainable dairy industry in Jersey - Promar International

A SUSTAINABLE DAIRY INDUSTRY IN JERSEY

FINAL REPORT

December 2006

Prepared by: Promar International Rookery Farm Lane Tilstone Fearnall Tarporley

Cheshire CW6 9HY

Contents

1. INTRODUCTION 5
   1. Background 5
   2. Acronyms 7
   3. Acknowledgements 7
2. EXECUTIVE SUMMARY 8
3. BACKGROUND 24
   1. The Way It Has Been 24
   2. The Way It Is Now 28
   3. The Way It Might Be 30
4. THE JERSEY MILK MARKETING SCHEME 33
   1. Background 33
   2. Milk Price s 35
   3. Butterfat Bonus and Deductions 35
   4. Total Viable Bacteria Count (TVC) 36
   5. Somatic Cell Count 36
   6. Transport Costs 37
   7. Seasonality 37
5. THE INDUSTRY RECOVERY PLAN 40
   1. Introduction 40
   2. The Five Oaks Dairy 41
   3. Other Site Options 43
   4. Better Genetics 45
   5. Product Mix 48
6. PERFORMANCE OF THE DAIRY HERD 51
   1. Financial 51
   2. Technical 58
   3. Conclusions 59
   4. Dairy Performance In Relation To Genetics 60
7. THE IMPACT OF LIQUID MILK IMPORTS 62
   1. Background 62
   2. Pros 63
   3. Cons 64
8. OPTIMUM MILK PRODUCTION LEVELS 66

1. Introduction 66
2. Milk Production 66
3. Dairy Product Demand 69
4. Matching Supply and Demand 71
5. Milk Returns 71
6. Summary 76

9. EXPORT MARKETS 78
   1. Introduction 78
   2. Ingredients 78
   3. Consumer Products 80
   4. Challenges for JD Export Marketing 80
   5. Summary 83
10. THE SITUATION IN GUERNSEY 85
    1. Background 85
    2. Scrutiny Review - Milk Distribution Proposals 85
    3. Other Relevant Issues 86
    4. Conclusions 86
    12. MILK MARKETING OPTIONS 88
    2. Introduction 88
    3. Option 1 – Modification of the MMS 89
    4. Option 2 – The JMMB is retained, but only deals with liquid milk 93
    5. Option 3 – A Totally Free Market 97
    6. Option 4 – Free – er Market, Some Import Controls Removed 101
    7. Option 5 – Creation of A Farmer Controlled Business 105
    8. Implementation 110
    9. Key Steps on the Scott ish MMB Dissolution 113
    10. What Lessons Can Be Learnt From This Process? 114
    11. Key Points Regarding Assets 115
11. THE FUTURE STRUCTURE OF THE DAIRY INDUSTRY IN JERSEY 117
    1. Case Studies 117
    2. The Northern Ireland Dairy Sector 117
    3. The Cypriot Dairy Industry 119
    4. The King Island Dairy, Australia 120
    5. Summary of Key Lessons 124
12. THE FUTURE STRUCTURE IN JERSEY 126

1. Future Vision 126
2. Change Mechanisms 127

APPENDIX I - OVERVIEW OF FARM VISITS 130

1. Objectives 130
2. Backgrounds and Current Circumstances 130
3. Producing Milk on Jersey 131
4. The Current Dairy Industry and Future Intentions 131
5. Future Scenarios 132
6. Future Dairy Structure 135
7. Summary 135

1. INTRODUCTION

1. Background

Promar International[1] was asked by the States of Jersey to carry out a review of the dairy sector on the Island. This report sets out our detailed findings on the current situation in the Jersey dairy sector. The Terms of Reference (TOR) for the assignment were as follows:

• to critically assess the Jersey MMS as operated by the JMMB and its processing, distribution and marketing arm, Jersey Milk

• to assess the dairy industry recovery plan, which involves the relocation of the dairy processing plant to the proposed site at Howard Davis Farm (HDF), improving the farm efficiency and improving the genetic status of the Jersey Island breed

• to evaluate the optimum level of milk production in Jersey in light of current liquid milk consumption on the Island and the effects that this level will have on the marketing strategy of Jersey Milk, the price paid for liquid milk by customers and consumers in Jersey and the returns paid to milk producers

• to assess the comparative situation in Guernsey and draw any valid comparisons

• to identify mechanisms to allow for a change in the optimum level of production, which leads to an orderly shift in production as needed, which maintains the production above the liquid milk market and which creates value that can be realised by those that would wish to leave the sector

• to identify, compare and then consider the advantages and disadvantages of differing milk marketing structures for the dairy sector in Jersey in order to comply with the current competition legislation

• to consider the impact of the States controls on the import of liquid milk on the future development of the Jersey dairy sector

• to identify the most appropriate future structure of the dairy industry in Jersey (based on the various potential models already identified) in order to provide value for money for consumers and provide an adequate return for the efficient milk producer and cost effective States aid payment

Promar made an initial visit to Jersey in late July 2006 and work was formally commenced in the second week of August. A series of meetings and consultations have been held with a wide range of interested industry stakeholders on the Island in the subsequent period, mainly between August and September 2006. This included meetings with individual farmers across the Island and a summary of the findings from this research is given as Appendix 1. Between October and November a series of additional meetings have been held on the Island to discuss the draft findings and conclusions of our report. This document now serves as the Final Report.

2. Acronyms

The following are commonly used throughout the report:

AMPE Actual Milk Price Equivalent

FBA Farm Business Accounts (produced annually by Promar International) DICS Dairy Industry Costings System of Jersey

FCB  Farmer Controlled Business

HDF  Howard Davis Farm

IMPE Intervention Milk Price Equivalent

JCRA Jersey Competition Regulatory Authority

JD Jersey Dairy

JMMB Jersey Milk Marketing Board

MDC Milk Development Council

MMS Milk Marketing Scheme

MOPF Margin Over Purchased Feed

PIN Profit Index

PPE Public Policy Exemption

ppl pence per litre

SMP Skim Milk Powder

USP Unique Selling Point

3. Acknowledgements

We would like to thank the following in particular for their help and support throughout the course of the study:

• Dr P Le Miere - Director, Environmental Management and Rural Economy, Economic Development and Planning and Environment

• Mr J Jackson – Environment Division, Planning and Environment Department

• Mr K Keen - Jersey Dairy

• Mr A Le Gallais - Jersey Milk Marketing Board

• Dr D McQueen - Consultant

as well as all the other respondents and key industry stakeholders we met on the various visits made to Jersey in the course of the assignment. This is much appreciated.

2. EXECUTIVE SUMMARY How It Has Been

1. The Jersey Milk Marketing Board (JMMB) was first set up in 1955. Clearly since that time, much has changed both on and off the Island. Marketing boards, such as the JMMB, originally operated on a world wide basis – not just in the dairy sector – but in many other areas too – meat, fruits and vegetables and the cereals sector to name a few. Accepted as "the way to do it" 40 years ago, around the world over the last 10 – 15 years, the role of monopoly marketing boards has increasingly been seen as "not the way to do it (anymore)".

How It Is Now

2. The Jersey dairy sector has existed for the last 30 years against a background of highly competitive international food markets, deregulated markets and less protection for primary producers and a reduction – or in some cases a total removal of the monopoly powers marketing boards, existed. The Jersey dairy sector has been operating in isolation of the UK and other EU markets for most of this time. However, it is recognised that the current management of the JMMB and JD has made a number of improvements to the business in difficult circumstances over the last 3 of these in particular.

The Future

3. There are a whole plethora of challenges to the future of the dairy sector on Jersey that have to be faced up to in the next few years ahead – and in some cases the timespan is much shorter. The external challenges of what happens if liquid milk imports come on to the Island and the critical need to build exports to the UK are fundamental to the future development of the Jersey sector. Other challenges include the following:

• a ruling likely on the status of the JMMB as a monopoly buyer and seller of milk on the Island in light of challenges to this position from an individual farmer

• there is need for better genetics to survive – even if it takes up to 10 years to see the full benefit of this and the ban on imports on to the Island is challenged

• the States of Jersey wants to preserve "brown cows in green fields" with a sustainable dairy sector that move forward in the future

There are too many challenges to the Jersey dairy sector, with the implications being too significant in terms of impact, to carry on along the somewhat isolationist route of the past for too much longer. This is despite some of the more positive changes made by the JMMB and the JD in the last 3 years.

4. UK mainland co-operatives and plc's alike in the dairy sector are very aggressive in the purchase of milk, price setting and encouraging supply when they want it and perhaps even more importantly - when they do not want it – not least they are very strong on secondary balancing and processing. Across a full range of criteria, all of the JMMB market price signals (compared to mainland UK processors) to producers are weak, if not actually misleading.

Industry Recovery Plan

5. The strategy is, on paper, relatively straightforward. As is often the case the theory of the strategy is relatively straightforward and to our mind makes a good deal of sense but the actual implementation of it is proving more difficult.

Factory Location

6. The current dairy is 40 years old. It needs substantial investment in order to replace some of the very inefficient manufacturing equipment. The dairy as it is currently, will not easily pass the sort of quality assurance inspection that the higher value market buyers (e.g. Waitrose, Marks and Spencer) would expect from their suppliers.
7. The indicative value of the site could be around £9 million, and so the first aspect of strategy would work. With planning consent, the JMMB net assets would be in the region of £6.5 million, after the pension deficit and redundancy costs are paid. The idea that the sale of the Five Oaks Site solves all of the problems of the JMMB and the JD seems somewhat fanciful.
8. Ongoing delays in the search and identification of a new site for the JD will prove to be damaging. HDF is the best available site and the go ahead should be given to move to here as soon as possible.
9. The overall costs between leasing and buying are probably over a period of time not that much different. Leasing might be the less risky to the JD in the short term, but buying outright might give more stability in the mid to long term. It also reduces the chance of a small number of farmers making a move for what might be seen as a "cash pile" resulting from the sale of the Five Oaks site.

Genetics

10. The use of imported genetics to guard against inbreeding within the Island population or to improve specific traits has been considered on several occasions, the most recent of which was in 2003. This followed the production of a very thorough report into this issue by Dr Maurice Bichard, entitled "Sustainable Development of the Island's Dairy Cattle". This report clearly recommended that imported genetics should be used. It would take approximately seven years for any additional initial investment in imported genetics to become cash positive for a typical 120 herd farm on the Island.

Jersey Dairy Product Mix

11. In terms of product mix supplied from the JD, the strategy is to supply Jersey with Jersey produced local milk, currently c. 9 million litres pa. The objective of reducing their wholesale price of milk, so that it could be retailed at around 70 – 72 ppl is entirely correct. It is also important to recognise that to maintain a given volume of wholesale milk supply to customers 365 days per year, there has to be a structural surplus of milk. This suggests a minimum ex-farm production of 11.5 – 12 million litres per annum to satisfy the Jersey liquid and fresh product market. SMP and butter are world traded low price commodity products.
12. Jersey will never compete with the worlds' lowest cost, but high volume milk producers in New Zealand, Australia or Latin America. The strategy is therefore correct, to move away from commodity product that cannot compete with the UK on price, let alone the rest of the world.
13. However, it also that means that the JD must find a higher value market for these structural surplus products, in what is an aggressive international market place. The plan for the new dairy is for 14.5million litre capacity, which infers the need for a substantial market for products from 5 million litres of milk. These have yet to be secured. And it might take a further 12 – 24 months before any tangible success is really achieved.

Financial and Technical Performance

14. A comparison of the financial performance of the Jersey dairy herd vis a vis the mainland UK clearly shows the strengths and weaknesses of the average Jersey dairy farm. Total direct production costs are 11.9 ppl greater for Jersey dairy farms, when expressed per litre of milk produced. The relevance of this large difference in milk production costs is that if Jersey retailers choose to import milk at some future date, and if they are able to in law, then it is from the UK that milk is likely to be sourced. There is a bigger range between the performance of the top 25% dairy farmers and the average in Jersey than on the UK mainland, suggesting that improvements can still be made by many.

Liquid Milk Imports

15. The import of liquid milk onto the Island is a highly emotive issue on Jersey and has been for some time – and as such it needs to be handled with a degree of sensitivity. There are both plus and minus points regarding the situation which impact on the future structure of the industry and the desire that government has to see "brown cows in green fields". If milk was to be imported, the farming sector would be put under severe pressure. The industry would go into free fall - in its current state. Government objectives of "brown cows in green fields" would be thrown into turmoil.

Supply of Milk

16. Figure A shows the natural variation in milk production in Jersey over the last 4 years. Although these peak to trough ratios are relatively low, they still mean that at times of peak production (between May and June in particular) the Jersey dairy industry would be producing upto 35% more milk than was required. This situation is not unique to Jersey, and is a situation faced by dairy companies all over the world.

Figure A - Jersey Dairy Raw Milk Supply

Raw Milk Intake by Week (2003 - 2006)

350,000

300,000 Litr 250,000

es

200,000 150,000 100,000

1 4 7 10 13 16 19 22 25 28 31 34 37 40 43 46 49 April Jul Oct Jan

High Average Low

17. To minimise this cost, most dairy companies use a range of tools and incentives to try and minimise production of "buffer milk" by better matching their milk intake curves with the milk demand curves. In the past, the main method for dairy companies was to produce enough milk to cover the base level of demand for fresh dairy products, such as milk and yoghurt. They would then convert any milk produced above that level into longer life products such as cheese and SMP. The markets for products such as SMP, cheese and butter are becoming increasingly competitive and the profitability from these products is decreasing.

Controlling Supply

18. This decrease in profitability is forcing companies – and the JD is no exception here - to either specialise in certain products or develop differential pricing for milk at various times of the years. When used effectively, these policies "flatten" milk intake curves and better match supply with demand. While specialisation and outsourcing of milk supply provide best-practice examples, they are not tools that the Jersey industry can in its current situation easily use at the moment.
19. This is not least due to the historical development of the sector (i.e. no imports of liquid milk and the role of the JMMB as essentially a farmer facing organisation). The only option open to the JD to modify its current milk intake pattern is via strong seasonal price signals to farmers. The price signals given to farmers by the JMMB are weak in comparison to UK co-operatives and "plc" dairy companies alike. Making changes to milk intake through demand price signalling is a difficult, but not an impossible task. However, the impact of the above factors means that in the short term, the JD is likely to maintain its seasonal milk supply and therefore a requirement to convert seasonal buffer milk into long life products such as milk powders, butter or cheese etc.

Matching Market Demand and Supply

20. Liquid milk dominates JD's consumer products business and accounts for around 63% of whole milk intake. The need to satisfy liquid milk demand at all times, means that the JD has to run a larger than average buffer to ensure that there is always sufficient milk to cover possible variations in demand.
21. Combining the supply and demand curves along with our "worst case" buffer levels clearly indicates that at all times of the year there is a significant gap between demand for liquid and soft dairy products and raw milk intake (as shown by the bars in Figure B). This gap can be described as true "excess milk". The degree to which this excess milk is defined as over an optimum level of production depends, in our view, largely dependent on the returns made from that excess milk.

Figure B - Jersey Dairy Supply and Demand

Worst Case: Jersey Dairy Supply & Demand

350,000 300,000 250,000 200,000 150,000

100,000 50,000 0

1 3 5 7 9 11 13 15 17 19 21 23 25 27 29 31 33 35 37 39 41 43 45 47 49 April Jul Oct Jan

Low Supply (-10%) High Supply Low Demand High Demand (+10%)

Market Returns

22. There is a wide range of gross profit levels made on the core product lines currently produced at the JD. Premium yoghurt is the most profitable item while SMP is the least profitable, and actually incurs a straight loss.
23. In an ideal world, 100% of the JD's raw material intake would be allocated into product lines that provide a positive return. Under current conditions, these products would include  cream,  yoghurt,  liquid  milks,  ice  cream  and  retail  packed  butter.  However, analysis of the JD production data indicates that substantial raw milk volumes (up to 25% of total intake) are being allocated to products such as SMP and bulk butter that currently provide a negative gross margin.
24. Given the current levels of excess milk, in most situations, the logical step would be to reduce milk intake immediately and then slowly rebuild milk volumes as the various initiatives  listed  above  took  affect.  However,  the  closed  nature  of  the  Jersey  dairy industry (particularly, the lack of milk-flow, and breeding stock in and out of the system) means that responses and strategies which work in the UK or elsewhere may not always work on Jersey. Given the above factors, the challenge for the JD is to fully implement the remaining elements of its dairy industry recovery plan - as quickly as possible.

Exports

25. One of the key components of the industry's recovery road map is the development of export markets. The market for commodity dairy products is extremely competitive and largely driven by supply and demand. Given the low cost basis and cyclical nature of these markets, it is highly unlikely that the Jersey dairy sector could profitably compete in this arena.
26. Competition amongst retailers and development of supermarket brands over the last 10 years has created massive competition for food manufacturers and squeezed margins to the minimum. Despite the challenges, development of consumer preference for products through development of strong brands remains a key method for food producers to gain an increased share of the final value of their product.
27. The JD's successful consumer business in Jersey provides a good test market and platform for expansion into retail markets outside Jersey. However, there a number of key challenges that the JD face in developing a retail presence in UK mainland and/or other international market. The "Jersey from Jersey" marketing message is potentially an attractive and unique proposition. However, it is not at this stage sufficiently unique or valuable to command a significant price premium in the market over and above that gained from other premium brands. The decision to target and develop the UK export market is a natural and logical decision for the Jersey dairy industry, but the limited resources available at the JD mean that the export development programme needs to be approached in a highly structured manner.

Future Options

28. There are a number of possible options for the future development of the Jersey milk marketing system. These are set out as follows along with the key points to take in to consideration for each:

Option 1 – Modifying the Current MMS

• this would see a change of the JMMB being a prescriptive monopoly to a statutory organisation

• it would in effect buy some time for the Jersey dairy sector, but probably not much more than this. This can only be justified if the time is used to maximum effect, and the key aspect here would be to be make full use of this time to build the new JD factory which is so badly needed

• however, it only deals with the internal threats that exist on the Island as to the position of the JMMB. It does absolutely nothing to deal with the threat of imported liquid milk, which is a critical issue for the successful development of the sector

• the JMMB and JD might well argue that protecting the domestic market in the short term is essential to allow them time to lower costs and develop export markets – and to a degree they are right. The reality is that the time they have to do this is beginning to slip away and action needs to be taken now to safeguard the future structure of the dairy sector

• the legal possibility of actually achieving this modification is not proven – and it may take some time (at least 6 – 9 months) to actually be put in place even if it can be achieved. It is likely that even if it were achievable, it would be challenged almost straight away

• another damaging and energy sapping legal case is the last thing that the Jersey dairy sector needs – not least it sends out very negative signals to potential customers, both on the Island and even more importantly potential new customers on the mainland

• it would also highlight the lack of internal certainty as to the future of the industry, one that is constantly under challenge and therefore produces a lack of confidence in the industry, low investment etc.

• rather than look to modify the existing scheme, the buying of time that is required can be achieve by the application of a PPE which will achieve the same end result but only for a specified time. However, again it does not deal with the real issue of beginning to position the Jersey dairy sector to deal with the external rather than the internal threats to the sector that  exist  and  which  are  the  real  drivers  for  the  mid  to  long  term development of the industry

• there is only limited consumer benefit to be derived from Option 1, but government objectives – brown cows in green fields – are largely met. This option maximises the number of cows in Jersey and provides the highest (short term) returns at least to farmers

Option 2 - the JMMB Remains, But Only Deals with Liquid Milk

• Option 2 is what we believe to maybe be the "worst of all worlds" – the liquid milk market on the Island is still under the control of the JMMB. However, the JD has no opportunity to operate in the growth markets of exports to the UK and then the more modest growth that might be achieved in the local added value markets

• the JMMB in effect remains a statutory type body for the local market. This option does nothing to deal with the threat of imported milk on to the Island and acts as a hindrance to exports. Cow numbers will decline over a period of time - as a result Government objectives – green fields, brown cows - will not be met. There are medium – high benefits to the consumer of seeing liquid milk prices reduced to potentially around 70 ppl.

• there will be an on going decline in cow numbers across the Island and as a result Government objectives – green fields, brown cows - will not be met

• however, in the mid to long term, the JD would begin to loose critical mass and even in the situation of Option 2, the role of the JMMB in the domestic market could well be challenged

• and as we have stated under Option 1, further damaging, expensive and energy sapping legal cases should be avoided, not least because of the negative signals it sends out to customers on the Island and the mainland too, as well as other key industry stakeholders

Option 3 – A Totally "Free Market"

• Option 3 for the Jersey dairy sector is in its current state, a "short cut to disaster". The benefit to consumers is however high, milk is sourced at the lowest possible price, which might be in the region of between 45 – 65 ppl at the retail level

• however, the implication here is that all milk could be imported and in its current position, huge amounts of the local market would be lost in a very short space of time

• Farmers on Jersey would be exposed to the full force of EU and world market prices and would find it almost impossible to compete – many would be forced out of business

• there would be a significant fall out within the industry in terms of farmer numbers and the number of cows, and government objectives of - brown cows in green fields - will be tested to the very limit

• while consumers win, farmers lose out and the mid to long term sustainability of a dairy sector on Jersey is hugely compromised

• imports of liquid milk would dominate the market and over a period of time, extreme pressure from imports means that increasingly dairy farming on Jersey as it has been known becomes something of a "museum piece – this is the way we used to do it"

• even any possible advantage gained by the Government in terms of reduced subsidy to dairy farmers as they are forced to exit the sector would be negated by increased additional exposure to the running of the abattoir and the costs of increased payments to support better environmental practises

Option  4  -   An  Internally  "Free  –  er"  Market  with  Some  Import  Controls Removed

• Option 4 in effect produces the same end result as Option 3, only over a longer period of time. It does not position the dairy sector on Jersey to deal with the combination of imported liquid milk and the development of exports to the mainland – both of which we believe are the critical issues for the sector to deal with

• in the short term, it would probably produce a milk price war which is good for consumers but bad for dairy farmers and in the mid to long term might not even be that good for consumers either

• as the industry is forced to reconsolidate, it might be argued that it will eventually produce a "private monopoly" which would be ultimately challenged on a legal basis

• in reality, Option 4 for consumers produces a lower price for milk, but not the lowest. Over a period of time, cow numbers will be reduced putting Government objectives into some doubt. However, this decline will not be at the same rapid pace as seen in Options 2 and 3

• a fragmented industry, with no one single player being able to achieve a degree of critical mass will mean that the development of any exports business is put into severe doubt

• it might also be more difficult from a legal perspective to have a "semi free" market rather than a totally free one, not least in dealing with the question of if (and how) farmers not involved with the JMMB are regulated with milk licences

• something akin to a "half way house" scenario, Option 4 is most likely to produce a "slow route" to disaster rather than the "quick route" that would be produced under Option 3

Option 5 - The Development of a Farmer Controlled Business Option 5 is the most appropriate for the dairy sector in Jersey to consider:

• it provides a genuine long term solution for the industry but this is not to say it is without risk, and this is discussed later on – not least it requires a strong industry vision and leadership to "sell" the concept to the dairy sector and other key stakeholders on Jersey

• it is likely to address the concerns of organisations such as the JCRA

• a more competitive environment on the Island will see some consumer benefit in terms of milk price paid

• it is a proactive solution for the sector and avoids potentially further damaging internal legal action and/or having a solution and/or industry structure imposed on it externally

• it  deals  with  both  the  internal  and  external  issues  confronting  the  sector,  the development of exports and looking to produce a more efficient supply chain on the Island (i.e. more efficient farms and cows, a more efficient factory etc)

• the JD remaining a key player on the Island allows a degree of critical mass to be retained and cow numbers will be retained – having said this, Option 5 does not prevent farmers exiting the sector – and in the very short term, might even acerbate this

• it provides an opportunity to develop the new factory required and which is critical for exports, it also reduces the opportunity for asset stripping although a careful change over will be required here

• it needs to be achieved over a period of time in a controlled and managed fashion

• it represents something of a "new start" for the dairy sector and leaves behind much of the negative baggage of the past, despite some of the more positive changes of the last 2/3 years

• it has been achieved in other dairy producing countries – albeit it not without some pain

To pretend that this can all be achieved without some risk would be naive though. Some of the relevant  issues  here  are  discussed  below.  Essentially,  these  revolve  around  questions  over industry vision and leadership, the building of the new dairy processing plant and the creation of export markets as well as how assets are protected and transferred during a period of change. Not least, careful consideration needs to be given as to what time frame is required to achieve this sort of change in industry structure and the future role of Government support.

Implementation - Leadership is Critical

29. Industry leadership needs to recognise that change is inevitable and this is driven largely by the external factors surrounding the unsustainability of a monopoly milk buying system, milk imports and the development of competitive exports to the mainland UK. The best option is to be proactive and manage the change, rather than have it forced on the Jersey industry by external industry stakeholders.
30. A proactive stance is we feel far more likely to have a positive overall impact rather than adopting one of "looking to protect what we have for as long as we can". It is clear though that a realistic and planned timetable of change is required and this should probably be for between 2/3 years, but if it was possible to obtain further time, it should be taken. However, this programme of change should not be spun out and it is essential that any time available be made the very best use of.
31. The industry leadership also needs to sell the idea of controlled and managed proactive change to dairy farmers on the Island and provide the vision for the future that is credible with industry. The vision of a single united, strong, well equipped and market led co- operative as the best option needs to be sold to producers as it has been in other parts of the world in the run up to significant industry changes. The development of the Fonterra dairy organisation in New Zealand is a good example of this. While recognising that the scale of the New Zealand dairy sector is very different from that of Jersey, we believe that a number of similar analogies can be drawn vis a vis the development of the sector. Not least, Jersey should be looking to benchmark itself against the "best in class", which the New Zealand dairy sector undoubtedly is.

Key Lessons from the UK

32. In terms of what can be learnt from the process of de regulation in other parts of the UK, these can be summarised as follows:

• maintaining processing capacity is essential. This needs to be agreed and ensured at the outset

• this process takes time - unless it is well planned it could take at least 2/3 years to implement but to minimise time:

the industry needs to want the change and needs to convince the States of Jersey that it is a good idea to ensure that legislative changes are passed easily

the States needs to ensure that the JMMB is aware of what is desirable and feasible in setting up a new structure as this will save time going through the process of public consultation

the JMMB needs to put forward a sensible proposal for the new structure and one that is compliant with competition law etc.

How This Might Be Achieved In Jersey

33. There is a good deal of thinking to be done in Jersey before any major move is made in this direction, but a basic process could be as follows:

• the States of Jersey proposes a change from the JMMB to a FCB structure

• the JMMB puts forward a proposal and time frame

• the proposal goes out for consultation with key industry stakeholders

• the States of Jersey could then decide whether to change or not

• if the decision is "yes", this would require a change in legislation

34. Multiple challenges provided by this change in the industry will need the maximum time possible to ensure success. As stated we believe this should be achieved over a period of 2 – 3 years but if more time can be gained, then it should be used provided it is used constructively and not as part of a "spinning out process".

Government Support

35. Government should support the future development of the dairy sector in Jersey by providing assistance with:

• making a quick decision on the availability – once and for all – on the HDF site

• confirming on going support for dairy farmers as set out in past strategy documents

• granting a PPE for a specified period only to give the dairy sector at least some time to re adjust its structure and ensure that the new factory is built

• assisting with legal changes that might be required as part of the process of changing from a marketing board to a voluntary co operative

• providing  export  market  development  assistance  funded  by  the  Economic Development Department

• Government could (but only on a temporary basis) administer the licensing system to assist with the orderly transition within the Jersey dairy sector

The possibility of achieving what is a major change in the structure of the dairy sector on Jersey will be clearly enhanced by Government giving out clear, consistent and positive signals about the type, level and duration of support that the dairy sector can expect in the future.

36. We believe that the future structure of the industry in Jersey needs to look like this: Big Picture Issues –Short Term Priorities

• a FCB structure should be created which over arches the wider Jersey dairy sector and industry

• the JD is still the key and pivotal organisation in the sector

• the  factory  will  have  eventually  relocated  to  an  efficient  and  functional  (not automatically high tech) site

• after all commitments have been met there will not be much left over –if any at all - to pay out to farmers who want to exit the sector. The redevelopment of the factory has to come first as well as meeting other financial commitments. This might be unpopular, but is a harsh reality

• imported genetics are being used but as stated the full benefit of this will only be seen in the long term

• export development will have been developed to the mainland but probably not in short term. However, there is a need to keep trying in the short term gaining access to these markets is essential for future growth of the sector

• Government objectives of "brown cows in green fields" are still met and there will be the opportunity for reduction in a number of government subsidies as farming gets more efficient in the future

Tactical and More Operational Issues

• shorter supply chains and direct contact between producer and processor are the way forward: the JD contracts with farmers on a direct basis for the milk that it needs and wants, rather than the milk it is forced to accept

• the industry over a period of time becomes more customer facing, and less inward looking

• there will be a smaller, but more efficient farm base maybe no more than 15 - 20 farms at some stage in the future but this depends on market forces

• farmers are more efficient in the future, better managed and in less need of government support

• new industry entrants are required as they are more likely to enter an industry which has a sense of real purpose in it than they are in its current state. At the moment, the decision not to enter the sector is just about as easy as it could be

• there will be a small number of dairy farmers operating outside the JD structure in non competing markets

• farmers that want to exit the sector have a way out through payments made from the sale of Five Oaks, but not nearly as much as expected and might be limited to buying up quota @ 20 p a litre and seeing them not reissued

Change Mechanisms

37. We see the challenge as not being so much as to reduce production to what might be seen as a more optimum level. "Excess production" is still being incurred, which suggests that farmers on the Island should be persuaded and/or encouraged to reduce production. However, we see it very much more as a problem less of having the "wrong volume" of production but more of the "wrong type of production, at the wrong time".
38. The main option open to the JD to modify its current milk intake pattern is via strong seasonal price signals to farmers that reflect the real value of milk to the factory (and ultimately the farmer in terms of product return). Making changes to milk intake through demand price signalling is a difficult, but not impossible task.

39. It will be important to maintain production at above the level required for just liquid milk market in the short term. This is not to give the chance for the JD to it can export to UK mainland. If it does not happen in the medium term, the JD might have to bite the bullet

- and the industry goes into "contraction" mode of thinking.

3. BACKGROUND

1. The Way It Has Been

For hundreds of years, the Jersey cow and associated dairy sector have been inextricably linked to the Island of Jersey. The dairy value chain is still an important element of the overall make up of economic activity on the Island today. The Jersey Milk Marketing Board (JMMB) was first set up in 1955. Clearly since that time, much has changed both on and off the Island. In the mid 1950s, there were some 1,000 dairy holdings on the Island – today there are just 33. If the smaller size holdings are taken out of the equation, the reality is however, that there are only in the region of 25 working dairy farms on the Island per se.

Marketing boards, such as the JMMB, originally operated on a world wide basis – not just in the dairy sector – but in many other areas too – meat, fruits and vegetables and the cereals sector to name a few. They were formed in the UK, other European markets, New Zealand, Canada, Australia and South Africa and Israel, as well as other parts of the world. They were established for a number of reasons – not least to ensure adequate supplies of foods at what might be seen as "reasonable prices" to consumer (and to farmers too).

At that moment in time, this was the internationally accepted way of organising an agricultural sector, especially if it was involved in the export of agri food products.

However, the manner in which they were established was often in the favour of the primary producer. Based on our experience of working in a wide range of countries and agri food industries,[2] it is our experience that over a period of time, concerns were voiced that:

• they were often focused on meeting the needs of the producer - and not the consumer. For example in most cases, the selling price was set by the board concerned to reflect the local supply situation, rather than the international market reality. Produce was invariably "allocated" to customers rather than be subject to a wider sense of market demand and willingness to pay. Board structures often saw agri food industries ready to continue to operate as they had traditionally gone down rather than look to adopt new varietal  developments  and/or  new  methods  of  doing  business  with  customers.  In particular,  the  emergence  of  the  main  supermarkets  found  a  rigid  board  structure increasingly  inappropriate,  and  in  some  cases  difficult  to  deal  with.  This  has  been especially the case for the premium niche retailers operating in the UK such as Waitrose and Marks & Spencer who required a more flexible procurement and trading arrangement with their supply chain partners. Being able to deal with the major retailers in an effective and efficient manner has become a reality for all agri food producers who want to operate in the UK and other international food markets – they hold the balance of power in the supply chain and require high levels of customer service and attention – which has often been found wanting amongst national marketing boards

• they were anti competitive (in that they prevented individual producers and/or other exporters from operating in the market place) in their very nature – even if they did not intentionally set out to bethis situation resulted in a number of less than desirable situations arising, not least:

• individual farmers and groups of farmers mounting legal challenges to the jurisdiction of the board concerned, leading to lengthy, costly and energy sapping disputes within the industry

• distribution was often highly controlled amongst a strictly limited number of companies and which prevented true competition from taking place

• a loss in some cases of international market share against fierce competition

• a loss of competitiveness in the structure of primary production

• a lack of new products and/or services being introduced to the market based on huge faith on the existing status quo and existing products

• frustration from key international customers

• frustration from other key industry stakeholders, not least government

Around the world, the role of monopoly marketing boards has increasingly been seen as "not the way to do it (anymore)". This has been in response to pressure from across the whole value chain – from primary producers, from exporters and major customers in target markets. Governments around the world have also been forced to look carefully at:

• their role in terms of legal positioning vis a vis local and international law

• the overall cost of supporting their agricultural and primary food sectors per se (which might include direct or indirect support to a national marketing board)

• whether these types of organisations meet the needs of both their primary producers and the major customers that they service in international markets

Not least, pressure has also come from organisations such as the World Trade Organisation, the Cairns Group and the EU Commission who have seen them as being anti competitive in terms of the influence they might be able to exert in (distorting) trade in international agri food commodity markets. The Canadian Wheat Board is often cited as the worst case example of this.

In the period of the 1950s, the use of national marketing boards was regarded as an appropriate way of organising an agricultural industry, and met the legal requirements of the time. However, for  a  range  of  legal  and  commercial  reasons,  the  day  of  the  national  marketing  board  in agriculture and food seems to be well and truly over.

As a result of all these pressures, ranging from legal viability, the cost and type of support given to the agricultural sector per se by government organisations and then their ability to satisfy the range of commercial and technical demands made upon them by:

• primary producers

• intermediary organisations in the supply chain

• major end user customers

.national marketing boards have been disbanded in many countries around the world in countries and industries such as:

• New Zealand – fruit and dairy

• Ireland – dairy

• Israel – fruit

• Canada – wheat

• Cyprus – dairy and horticulture

• the UK – all major agricultural commodities, including milk

It is noted that in some countries and regions of the world, marketing boards have been retained and/or had their functions re organised – examples exist in North America in particular. The Dairy Farmers of Ontario is one of these organisations. A few small scale industries (such as the dairy sectors in Guernsey and the Isle of Man) also have in place similar arrangements as Jersey. However, it should be noted that in most cases, these structures are very much the exception rather than the rule. It should also be noted that over the last 20 years, none of these structures have actually been created.

None of this deregulation has happened easily - there has been pain experienced across the supply chain in the process. Primary producers have, in some cases, been less able to operate in an environment, which is less protected than in the past. Some have been forced out of business. Some would have been forced out of business anyway.

New processing and exporting operations have invariably emerged in a de regulated structure

– not least at times, flushed with the opportunity to do it "their way" and make good where the marketing board in the past has been perceived as letting them down. It has often not been easy as might have been expected.  Many have found that the transition from "protected farmer" to "entrepreneurial processors and marketer" is a very difficult one to make effectively.

Much of the success or otherwise of the deregulation process can be traced back to how this has been managed over the period of adjustment and any change in our view that might eventually be required in Jersey will need to take this into account. Certainly, change for the sake of change should be avoided, as should any dramatic short term change. Not least we feel that the industry is not in a robust enough state to withstand and sort of short, sharp shock to it.

Any change in the structure of the sector now or in the future will need a combination of:

• clear communication to the value chain as to what will happen, when and why

• strong industry leadership to manage this change and build a new vision of how the sector might look in the future

• a planned programme of change over a period of maybe 2 – 3 years: if more time can be gained it should be taken but not just to "spin the process out"

• time for those in the value chain to adjust and plan accordingly what their response is

However, the reality is that whatever internal structure emerges over a period of time needs to be able to face up to the external challenges that face the sector. These are the threat of what happens when (not if) imports of liquid milk come to the Island and the need to build exports to sustain growth of the dairy sector per se – both of these are discussed in more detail later on in this report.

Different country, different products, same process, same outcome ? What has happened elsewhere ?

In South Africa, when the fruit export sector was de regulated in the late 1990s, the industry structure went from one monopoly supplier, the national marketing board, dealing with all customers in all international markets (called Capespan International) to over 180 registered exporters of a full range of horticultural products.

5 years later, the structure had reverted to around 40 registered exporters, but with the top 5/6 players accounting for c. 80% of the exports. Capespan International is still the largest grower and exporter in the country and is seen by customers in particular – for which the demanding UK market for them is totally key – as being a leaner, meaner and more responsive organisation than it ever was in the past.

As a result, it now regarded as much more customer focused organisation and developed new markets in the US, Asia and other parts of Africa as well as developing joint ventures with other producing countries to give better all round seasonality of supply.

A major fruit and food company operating in Ireland and the UK has acquired a significant shareholding in the business, and it is now jointly owned by this company and SA based fruit producers.

2. The Way It Is Now

Back in the 1950s, supermarkets as we know them to day did not exist – consumers still purchased fresh foods on a daily basis from local corner shops, there was no internet shopping, no probiotic yoghurts and no big fuss made about "local sourcing" and "regional (and sub regional) provenance".

The entire situation regarding production and marketing in the international agricultural and food sector has changed out of all recognition. Markets have been gradually liberalised, and are fiercely competitive - and many, if not all, the agricultural marketing boards have been de regulated around the world. Markets for agricultural inputs and outputs have been gradually subjected to the huge forces of globalisation – and major international customers, primary producers and processors are invariably engaged in the search for partners in the supply chain which are seen as being "best of class". In many cases, the exact (geographic) location of these supply chain partners is becoming incidental.

Against this background - of highly competitive international food markets, de regulated markets and less protection for primary producers and a reduction – or in some cases a total removal of the monopoly powers marketing boards, the Jersey dairy sector has existed. It has been under constant pressure. The JMMB has remained in place. It has made some changes to the way it operates, but in many ways performing the same basic function as it did back in 1955.

It would appear that in effect, the Jersey dairy sector has been operating in isolation from the rest of the UK and other European markets for most of the last 25 years and more. It is understood why this has been the case in the past but we believe it is more important is to consider whether this can be the case in the future.

For example:

• there are no imports of liquid milk allowed on to the Island

• there have been no imports of genetics on to the Island

• the statutory marketing board has remained in place, through a combination of choice and because of the actual law in Jersey itself. Regardless of the reasons behind this, the reality is that the JMMB has remained in situ

• the main processing facility on the Island is now out of date and unlikely to meet the exacting technical demands of potential major retailers on the UK mainland

• there has, in effect, been a protected local market for liquid milk, but with a good degree of loyalty from key customers on the Island still evident

• there have been few exports to the mainland – the mini pots contract seems to be the only success here – and the loss of this business saw a significant reduction of the Island's production capacity. It was lost for a number of reasons – but not least because of the fact that the industry on Jersey could not compete against aggressive competition from the Irish dairy sector

• there has been ongoing decline in dairy farm numbers

• the dairy industry is heavily protected and subsidised in comparison to its counterparts on the mainland UK

The Jersey dairy industry still displays numerous large signs of being production driven – with a limited historical market focus – although under new management at the JD, this is beginning to change. We would be the first to acknowledge that the current management team has made strenuous efforts to improve the situation that they inherited several years ago.

Progress has clearly been made in areas such as reducing processing costs, reducing the staff numbers at the JD factory (always regrettable, but a fact of life if an efficient factory is to be run), the reduction of debt and the maintenance of liquid milk selling prices. However, it also clear that still much needs to be done and the external challenges to the business will not go away.

The situation that the current management of the JMMB and the JD find themselves in has much to do with the historical way in which the business has been run over many years. Mistakes might have been made, but there has been progress in the last 3 years. However, what cannot be denied is that due to the way the business was managed in the past, they are in effect "starting from a long way back".

3. The Way It Might Be

There are a whole plethora of challenges to the future of the dairy sector on Jersey that have to be faced up to in the next few years ahead – and in some cases the timespan is much shorter.

These include the following:

• a ruling likely on the status of the JMMB as a monopoly buyer and seller of milk on the Island in light of challenges to this position from individual farmers

• challenges that might be made on the import of liquid milk

• farmers will continue to exit the sector at least at the current/recent rate

• a leading UK and/or French retailer comes in to the market in Jersey – and changes the face of the industry

• there is an aspiration to export from the JD – but the physical infrastructure is not in place to meet customer demands on the mainland

• there is need for better genetics to survive – even if it takes 10 years to see the full benefit of this and the ban on imports on to the Island is challenged

• the JD factory is increasingly inappropriate for the customers it wants to serve

• it is inconceivable that this situation of operating in isolation of the UK and other EU markets will be allowed to continue, can continue - and/or is even desirable

• the States of Jersey wants to preserve "brown cows in green fields" and a sustainable industry on the Island. Support will be given to an industry which addresses its own key issues and looks as if it is prepared to continue moving forward

The Last Few Years v. the Previous 40.

The JMMB and JD has in the last few years begun to make progress on this front – but as mentioned earlier on – is "starting, in effect, from a long way back". This is not an implied criticism of the current management, but more of an indication of the way things have been run and managed in the past.

What it does not change is the fact that the JMMB and JD are still faced with a very difficult job in hand. They must face up to a range of external challenges to the business which cannot be dealt with in the same way that some of the internal challenges to the dairy sector in Jersey can (i.e. revert to a drawn out legal process)

• there are too many challenges to the Jersey dairy sector – with the implications being too significant in terms of impact – to carry on along the somewhat isolation route it has followed for too much longer

• many of the issues are inter linked – especially vis a vis imports of liquid milk, breeding material and the position of the JMMB as a monopoly player in the supply of milk on the Island – and there is a danger of a "domino effect" taking place. Dealing with just one of the issues and hoping that the others will "go away" is not likely to work

A Saving Grace – Time ?

Some of these factors still might take quite a long time to take full effect. There is therefore the advantage of having some time on the side of the industry – but this must be made full advantage of and not wasted if the industry is to successfully restructure as it will in inevitably be required to do so.

The time available might be as much as 2/3 - 5 years, depending on what might be the outcome of any legal decisions made in Jersey over the next few months on the status of the JMMB, as well as the potential threat from imported liquid milk – but this should not be abused. At this stage, the dairy industry in Jersey is not in a strong position to take any high risk options – and in our view, relatively low risk - but decisive action is required for the future.

4. THE JERSEY MILK MARKETING SCHEME

1. Background

We have already mentioned the background to the development of national agricultural and food sector marketing boards, which can be summarised as:

• 1950's – "the way to do it" – most agricultural producing countries had them across most sectors

• 1990s and on – "not the way to do it (anymore)" – most, if not all have disbanded them and/or altered their role – away from commercial trading, towards industry representation, promotion and R & D services etc. None of this change has been made without a degree of pain across the supply chain.

For example:

• the JMMB was formed some 50 years ago – but the world has changed a huge amount in the last 10 years, let alone 50, not least in the way that modern food retailers want to do business with their suppliers and the technical and commercial demands that they make on them. In Jersey, the number of dairy farmers has dropped from 1,000 down to just over 30

• a monopoly board structure is increasingly out of touch with a modern and efficient farming and food processing industry that has to compete against other internationally based farmers and processors – as well as (in some cases) for a share of the public purse too. Major retail and foodservice customers are looking for streamlined relationships with  progressively  minded  and  customer  focused  businesses  who  are  extremely responsive  to  market  demand  and  supply  as  well  as  the  process  of  new  product development and innovation, as well as high levels of commercial flexibility

• few other agri food sectors in the world have kept these structures. Dismantling them has been sometimes been painful and caused hardship in the short term but in the end, has invariably produced a more streamlined and efficient sector for those that "remain in play". A small number of marketing board type organisations still exist, some of the best known are in Canada, as an example, but they have been subject to review in terms of function and structure on a regular basis. Some small Island economies such as the Isle of Man and Guernsey have retained broadly similar structures to Jersey, but the "best in class" as found in New Zealand, the US, Denmark and Holland[3] have long since moved on in terms of industry structure and management. What is also clear is that in the last 10 – 20 years, none of these boards have actually been created

• how this is done is critical – do you go for the short sharp shock or programme of managed change ? Arguments can exist for both, but the Jersey dairy sector is not in robust health and might not cope with the "short, sharp shock"

• marketing boards are seen as an inefficient way of doing business – the rest of world in most (although we recognise, not all countries) is going to short supply chains and direct market messages from processors to farmers – the JMMB and the way it operates is not facilitating this - and indeed maybe even be blocking it. As an example, the way that the contracts between farmers and the JMMB operate is discussed in more detail in this section of the report. However, as a general comment, we believe they send out a mixed message and or in some cases, the wrong message to farmers

• UK mainland co operatives and plc's alike in the dairy sector are very aggressive in the purchase of milk, price setting and encouraging supply when they want it and perhaps even more importantly -  when they do not want it – they are not least strong on secondary balancing and processing

• the JMMB and by implication, the JD is very weak in this respect – they are forced to buy and then process whatever comes their way

• marketing boards tend not to be market focused - contracts usually favour farmers, not customers – from the business of farm gate and factory procurement through to dealing with the retailer

• the JMMB was formed in 1955 for the right reasons – but these are no longer applicable in the year 2006. This is not least because of the huge external threat that hangs over the industry in the form of the need to deal with the likelihood of liquid milk imports coming onto the Island and the need to develop exports to the UK mainland. It is also critical to take into account the legal challenges being mounted against the role of the JMMB and the need to demonstrate legal compliance to the likes of JCRA. The external challenges to the industry are essential to face up to if there is to be a sustainable dairy industry on the Island

• the JMMB is probably not sustainable in the future in its current form – and in any case it will be challenged by the JCRA

In terms of specific weaknesses in the way that the JMMB operates, the following are important to note:

2. Milk Price s

The milk price is the one area where the milk buyer can directly influence the supply of milk coming forward, to incentivise those aspects with enhanced market value, and to give the producer the market signals of where to change.

The JMMB contract lacks many of these aspects, though they do appear to be starting to change with their 2006-7 schedule.

3. Butterfat Bonus and Deductions

The JMMB pay an incentive for butterfat content of milk, of 0.5p per 0.2% above 5.4% (and from April 2007 the same level of deduction for milk with butterfat contents below this 5.4% level). This is 2.5p per 1%, or £2,500 per tonne of pure butterfat. But, the JD sell their wholesale bulk butter (with about 82% butterfat content) at £1,500 per tonne. Clearly, JD lose money on every extra kilo of extra butter produced.

In contrast, the leading UK dairy companies have aligned their farmer milk quality payments more in line with the falling cream and butter market values. The three major companies that supply liquid milk to mainland retailers pay as follows:

• Arla pay 0.5p per % over 3.70% butterfat milk, or £500 per tonne of butterfat

• Dairy Crest pay 1.70 per % up to 4.15% butterfat milk, and then no more

• Wiseman pay 1.5p per % over 3.5% butterfat milk, or £1500 per tonne of butterfat

In terms of the reaction from the supply chain, farmers can adjust the butterfat content of milk by changing their animal nutrition. The simplest modern methods allow this to happen without changing from say silage to hay diets. Feeding a pure palm oil supplement will raise butterfat percentage by 0.2 – 0.4 points (viz. from say 5.2% to 5.4% fat content or better). It works, because palm oil is a C16 fat, and this is also a constituent of cows butterfat output. This C16 fat can be incorporated in the dairy concentrate feed for a cost of £16 per tonne on the Island. The typical practical outcome is that farmer's feed cost will rise, which will earn a milk price bonus that will just about pay for it, but the JD will lose money on each extra kilo of fat sent to it to sell.

This is – in our opinion - the completely wrong market signal to give to dairy farmers.

4. Total Viable Bacteria Count (TVC)

This is important to a dairy supplying the liquid milk market, as it is a key influence upon prolonging the shelf life of milk for retailer and customer. This has only recently been introduced by JMMB. A clear comparison with the UK is not quite as easy, as most UK dairies use a slightly different hygiene measurement. The JMMB have a 0.5ppl bonus for the top band of 0-5,000 cells, and a penalty deduction of 0.8ppl for 50,000-100,000 cells, a spread of just 1.3ppl between top and bottom hygiene quality milk. Only 14 out of 33 Jersey milk producers averaged less than 5,000 TVC in the last milk year to 31.3.2006.

In contrast with the JMMB, leading UK milk companies operate as follows:

• Arla have a spread of +0.5 for the top to - 6ppl for the bottom quality band

• Dairy Crest have a spread of +0 to -15ppl for the bottom band, and

• Wiseman have a spread of +1ppl to – 5ppl for the bottom band

These are infinitely clearer market signals than those of the JMMB, that only top hygiene milk is wanted for liquid markets.

5. Somatic Cell Count

The average SCC in Jersey is 205,000 compared to 193,000 in the UK, with only 18 Jersey producers able to average less than 200,000 in the milk year to 31.3.2006. The JMMB and UK bonuses are directly comparable, though the levels at which the bonuses change are different

– see Table 1 on the following page.

Table 1 - Somatic Cell Count Payments

N/a – not applicable

The spread between top and bottom bands is just 1.5ppl for JMMB, but is still significantly tougher in most UK contracts – Dairy Crest is one of the gentler in this regard. Wiseman has a 10 ppl penalty for any milk over 400,000, and Dairy Crest has a 15 ppl penalty – and that is also the level above which milk should not legally be collected in EU countries.

6. Transport Costs

Most UK milk buyers have a fixed transport charge per collection ex farm, generally the same for all, and which encourages alternate day collection. This flat rate "stop charge" also means that the larger farms are not subsidising the collection costs for the smaller farms.

The JMMB has no such collection or stop charge.

7. Seasonality

Seasonal price bonuses have been used for very many years in the UK to try to encourage milk production in those months where supply is weakest. Conversely deductions are made when the peak milk supply has no valued market, or worse, no capacity to even process it.

Table 2 - Seasonality Payments

The JMMB has only reintroduced seasonal price differentials in Jersey. From the table above, the seasonal milk supply for Jersey is similar to the UK, but with a slightly higher summer peak, and a deeper mid winter trough.

However, the bonus and penalties on offer by the JMMB contract are very gentle in comparison to most of the UK milk buyers, and are probably insufficient to financially influence when farmers calve their cows and heifers.

Table 3 - Seasonality Pricing

Some of the major UK dairy companies also employ band pricing mechanisms to encourage a flat milk supply, and discourage a change to more seasonal calving patterns. This may be in addition to the sort of seasonal bonuses above (such as for supplies to Dairy Crest) or instead of (such as Milk Link with their "A and B" milk prices). The market message to UK farmers is very clear – your extra spring peak milk is unwanted, and has very little real value.

Implications for the Jersey Sector

The same is true for the market value of surplus milk sent to the JD, but the price consequence of sending extra unwanted peak spring milk to make the lowest value milk powder in Europe is not fed back to those producers who sold the milk.

All of the JMMB market price signals to producers are still in our view too weak, though we would recognise that under the current management they are changing and we understand that there are further plans to introduce more meaningful contract terms. Our concern is that this might be a case of too little, too late.

5. THE INDUSTRY RECOVERY PLAN

1. Introduction

The broad principles of the JMMB business plan for recovery are laid out by the JMMB in documents to support their application to the Minister for Economic Development for exemption under articles 12 and 18 of the Competition Law (Jersey) 2005.

The strategy is – on paper - relatively straightforward:

• to raise capital by getting planning permission for the current JD site at the Five Oaks Dairy

• to use some of this capital to build a new dairy complex at a site on HDF

• to use some of the money raised to repay some (or all) of the current bank borrowings

• to maintain the liquid milk business, but to change the product mix of the balancing milk supply from bulk butter and dried milk powder to catering pack butter and cheese

• to build an export market for high value milk products, mainly yoghurt

The increase in plant efficiencies, finishing the current loss making activities of milk powder and bulk butter, the savings in bank interest charges, and the new high value export markets will all contribute to a bigger planned divisible surplus of £1.23 million.

There is one further element of the strategy, which is to improve the Jersey cow genetic efficiency by semen imports, to reduce on farm production costs by £0.58 million, worth 4 ppl over 14.5million litres. However, this is not within the JMMB remit to deliver, and would involve a change in Jersey Law.

As is often the case – the theory of the strategy is relatively straightforward and to our mind makes a good deal of sense - but the actual implementation of it will prove to be more difficult.

2. The Five Oaks Dairy

The current dairy is 40 years old. It needs substantial investment in order to replace some of the very inefficient manufacturing equipment. The main dairy building has been added to over many years, resulting in an inefficient flow of raw materials, packaging, finished products, and refrigerated storage being all over the site. These are two of the primary causes of the plants current high operating costs. Not least, the buildings themselves are increasingly costly to maintain, with multiple old flat roofed buildings and inadequate drainage.

The dairy as it is currently, will not easily pass the sort of quality assurance inspection that the higher value market buyers (e.g. Waitrose, Marks and Spencer) would expect from their suppliers. In time, these standards are likely to be expected by most major retailers on the mainland.

The dairy site is currently designated as land for industrial use, but is actually surrounded by houses, and lies beside a countryside area of high amenity value to the east. It has been indicated to us that planning permission for housing on this site is highly likely, subject to all of the usual planning laws. Permission for a supermarket or retail park is unlikely.

The indicative value of such a site could be around £9 million, and so the first aspect of strategy would work. But it might be lower - depending on what the site is finally used for.

At this point, there is a danger that some disaffected dairy farmers could demand a poll to revoke the JMMB. Such a poll would need only 9 dairy farmers to call for such a meeting although it would need a majority of producers to go as far as to come to a decision to wind up the JMMB is passed in a general meeting. The net assets of the JMMB would then "be distributed in such manner as the registered producers in general meeting shall determine."

With planning consent, the JMMB net assets would be in the region of £6.5 million, after the pension deficit and redundancy costs are paid. That is a lot of cash to divide between 33 dairy farmers. While maybe good news for the 33 dairy farmers on the Island, it would be a severe hammer blow to the future development of the Island's dairy sector. It would also be a major threat to the stated intention of governments to have an Island with "brown cows in green fields". If the industry in Jersey is to move forward at all, this situation whereby the assets of the JMMB are sold off and divided amongst the 33 dairy farmers should be resisted.

Assuming that the above revocation does not happen, then the strategy is to relocate JD to the HDF site, where they have successfully gained full planning consent for the new factory. The proposed new dairy was costed at £6.25 million in 2004, plus the purchase price of the site of £0.75 million, a total of £7.0 million. This build estimate may well have risen by perhaps 10% by 2007, to £7.62 million.

The potential sale price of the Five Oaks current site is around £9 million, leaving perhaps £1.4 million for debt reduction. If there are cost overruns, further delays, unexpected costs (which would not be at all unusual), then there may be little –or indeed nothing left over left for debt reduction. And this assumes that the site at Five Oaks is sold for a relatively high value – if for whatever reason, it was sold at a slightly lower value, there maybe nil left over for any debt reduction.

The idea that the sale of the Five Oaks Site solves all of the problems of the JMMB and the JD seems somewhat fanciful. The interest saved on debt is not the major part of the recovery plan, but it does amount to £72,000 of planned cost saving. Although the sale at the HDF is agreed at the last site valuation of £750,000, there has been some disquiet about the sale on two grounds:

• there is a restrictive covenant from the original benefactor that the HDF site should be only used for education in farming practices

• there is concern from the States public accounts committee that the value is not wholly commercial

Both of these issues could, we believe, be circumvented by JMMB leasing the HDF site, rather than purchasing it, but they would still be operating physically very close to those watching its operation and performance. There is some dispute as to whether leasing would circumvent the restrictive covenant issue. To our mind though, the most important element of all this is:

• the HDF site is available

• the HDF site is suitable for a modern and efficient processing factory

• factory plans have been drawn up and site appraisal work carried out

• the JD desperately needs a new site especially if the export business to the mainland is to be built and we believe that this is critical for the future

• any further delay on a decision is not at all helpful as it will cause further delay to the development of exports, it will be a further drain on the confidence of the farming sector on the Island and will possibly act as a disincentive to JMMB and JD management

The site is fit for purpose, it is available and our advice is to sort out the remaining legal issues once and for all. Get on and build as soon as possible at the HDF site.

On both of the two issues above, there is alleged to be disagreement amongst those who will have to make the final decision on whether the sale goes ahead. Whilst there appears to be some sympathy for the JMMB, and that they have been led to this apparent "easy" solution to their quest for a new dairy site, the view now appears to be that it is unlikely to happen, at least in the short term.

As stated, we believe that on going delays in the search and identification of a new site for the JD will prove to be very damaging.

The JD is desperately searching for new markets and indeed these are critical to its future evolution and the future well being of the industry per se – the factory they operate from is not going to help them achieve this at all. It is inefficient, old fashioned, would not pass a stringent quality assurance inspection from a major mainland customer.

It produces the wrong combination of products at non-competitive prices. The JD has to move. And further delays to this situation will only make the current situation worse.

3. Other Site Options

Up until recently, it would appear that the JMMB had not developed any alternative plans for relocation, and had put all of their redevelopment plans - and costs - in the one basket of a new dairy at the HDF.

There are two other distinct possibilities for dairy redevelopment - sell part of the existing site, and reinvest in a smaller dairy on the current Five Oaks site. Or move to the dairy to another location altogether.

Planning permission for housing development on just the southerly part of the Five Oaks site is also very probable, and could release in excess of £4 million net for factory redevelopment on the rest of the site. This might be a little more if sensitive plans can be put forward for the small area further to the south of the above area now designated as industrial, which is currently scheduled as a "presumption against development" area.

There is at this stage no costing available for this option, but as complete refurbishment of old buildings often cost nearly as much as new build, there may be little difference to the new build estimate above apart from buying the site. This may leave no spare cash for the JD debt repayment part of the strategy, and the HSBC bank may well have a view on the desirability of this option, as they have the land as security for the loans currently made to JD.

It also does not get away from the fact that in our view, the Five Oaks factory is increasingly inappropriate  for  a  modern  and  efficient  food  processing  site  and  activity  per  se.  This  is regardless of whatever you might do there to re invest and bring up to the exacting technical standards required by a major retail customer on the mainland.

Planning for a new dairy in another location altogether, on a site of existing farm buildings is also a strong possibility, with planning for change of use from farming, to food processing being a straightforward planning decision - we are led to believe. This would allow the full release of capital from the Five Oaks site, and allow full development of a new dairy.

The dairy build plans are written, and so need only a little adjustment (and cost) to suit any new site. Planning for the new dairy site to be "leasehold" rather than purchased would also release capital, but at the expense of another large operating cost replacing the bank interest charges, but with no capital loan repayment as now. There is however no need for Jersey Milk to be a business with capital asset growth for its working capital. Buying the new site is also an option – and one that should be seriously considered. The overall costs between leasing and buying are probably over a period of time not that much different.

Leasing might be the less risky to the JD in the short term but buying out right might give more stability in the mid to long term. It also reduces the chance of a small number of farmers making a move for what might be seen as a "cash pile" resulting from the sale of the Five Oaks site.

In summary:

• the existing Five Oaks site is inappropriate – the wrong size, shape, outdated factory equipment,  in  the  middle  of  a  residential  area,  and  unlikely  to  give  new  mainland customers too much confidence (if any)

• its main advantage is the potential value of the land - estimated to be in the region of between £8 – 10 million

• other options are limited ..but the HDF option is still by far the "best bet" and this needs to be implemented as soon as possible

• the idea that there is going to be a lot of money (if any at all) "left over" to "pay out" to farmers who might want to take the opportunity to exit the industry is false. Once the site has been sold, some debt paid off and other considerations – there is probably going to be very little left over (if any) at all. It will need the Five Oaks site to be sold at maximum price and the new factory to be built totally in line with budget if there is any hope of this happening. Our experience is that a cautious view should be taken – selling Five Oaks at a low price and building at a cost of plus 10% on budget at least

• any factory built should be on a low risk basis – a flexible future development plan allowing for expansion in line with customer demand. Initially it should be built on the basis of known customer and market demand at the time – not on the basis of "jam tomorrow" – but it does need to allow for expansion

• renting or leasing the site on a long term lease might appear to be better than outright purchase and give more flexibility, but there are plenty of good businesses run on debt. If it was that the site was purchased outright. Not least, this gives the factory the chance to borrow in the future for further expansion that might be planned and/or needed

• any new factory should not automatically be state of the art, but primarily functional and efficient. It should be a "working factory" aimed at producing efficient dairy products

• the longer it takes to make a decision, the more difficult it will become to actually implement – there is a need to make a decision for all involved in the reasonably near future

An efficient factory on the Island is pre requisite for future success. Five Oaks does not give this. A move – sooner rather than later is required. HDF is by far the best option and this should be implemented as soon as is possible.

4. Better Genetics

This is one of the "hot topics" in the Jersey dairy sector. It produces extreme views on both sides – and which are passionately held. Unfortunately, there is no common middle ground which would make a decision on whether to allow imports of breeding materials (or not).

The Jersey dairy herd has been closed for approximately 200 years, with no imports of genetics. During the majority of this period, the Island was able to export surplus breeding stock to other countries, so providing a significant source of additional income. The Jersey breed is now the second largest breed of dairy cattle in the world, with substantial populations in many parts of the world, including New Zealand, the US, Denmark, the UK, as well as in many other countries. The success of the breed has meant that many countries have been able to develop their own selection programmes.

The use of imported genetics to guard against in - breeding within the Island population or to improve specific traits has been considered on several occasions, the most recent of which was in 2003. This followed the production of a very thorough report into this issue by Dr Maurice Bichard, entitled "Sustainable Development of the Island's Dairy Cattle".

This report made the following (clear) recommendations:

".the clear conclusion is that RJAHS should recognise that it cannot operate an internationally competitive closed breed improvement scheme for the Island's cattle. It would be of benefit to Island farmers and their customers if importation of Jersey breed semen (frozen) were permitted with due attention to the exclusion of disease. It is recommended that applications be made to the States to revoke the long-standing prohibition on such imports. Importation should preferably be under the control of individual herd owners, or failing that, of RJAHS. If importation is not to be allowed, then RJAHS should try to organise a new closed improvement scheme based upon the widespread use of selected young sires."

It is clear from the farmer interviews that there are still strong opinions both in favour of, and against, lifting the ban on imported genetics.

The view that the Island does not need the extra milk that is likely to result from the import of genetics is one that is hard to justify. This is because the imported genetics would enable farmers to either produce the same amount of milk from less cows (Option 1), or to maintain a similar number of cows producing a similar milk yield but using less feed (Option 2). There is particular merit to both of these options on Jersey because of the low value of cull cows and calves (Option 1), and because of the high cost of imported feed (Option 2).

The idea that the retention of the Island Jersey gene pool is of crucial importance can only be justified if there is a dairy industry on the Island, sufficient to justify the continuation of the Island breed. The lack of exports of livestock from the Island in recent years shows that dairy farmers in other countries currently place little value on the use of Jersey Island genetics. In the event that there are genes contained within the Island herd that may have value at a future date, there are ways of preserving them.

There are clearly sensible reasons for not importing live cattle of either sex onto the Island, in the event of lifting the ban; there is also an arguable case for not allowing the import of [4]frozen embryos. In the event that only frozen semen is to be permitted, it is important to realise that the improved efficiency resulting from using imported genetics will not show through immediately.

It is not possible to compare the Island Jerseys directly with the Jersey performance figures because the Island Jerseys do not participate in Interbull. However, it is still possible to measure the likely outcome of the use of imported genetics. These figures show that it would take approximately seven years for the additional initial investment in imported genetics to become cash positive overall for those farmers importing genetics, a summary of which is shown below for a 120 cow dairy herd[5].

Figure 1 - Summary of the Financial Benefits of Importing Semen (£)

80000 70000 60000 50000 40000 30000 20000 10000 0 -10000 -20000 -30000

£

Year

As Figure 1 shows, the lifting of the semen ban would take several years before the dairy farmers wishing to use the imported semen would benefit financially as a result[6]. In addition, based on the farmer interviews, it is also unlikely that all the farmers on the Island would use imported semen in the event that it was allowed, at least initially. This would further delay the financial benefits resulting for the farmers on the Island as a whole.

The individual circumstances of the farmers using imported semen would dictate whether they chose to produce higher yields per cow, or to produce a similar yield from less inputs. If they chose to maintain cow numbers and produce higher milk yields, then they would clearly require additional milk production licence litres (these are accounted for in the assumptions within the analysis shown above), and hence would depend on other farmers being willing to trade them.

It should also be borne in mind that the import of semen would provide greater choice for the Island's dairy farmers with regards to selecting for milk quality, in line with potential future changes in terms of requirements (including somatic cell counts, as well as butterfat and protein). This is another instance where the milk pricing needs to send a strong signal to the dairy farmers on the Island as to the composition of the milk that they are producing.

A further issue arising from the import of semen is that it should enable dairy farmers to select bulls with type traits, which would also potentially bring financial advantage through greater longevity, for instance.

5. Product Mix

This is the last element of the dairy industry plan for Jersey - the key points to note are as follows:

• the core part of this piece of the strategy is to supply Jersey with Jersey produced local milk, currently 9ml pa. There may well be brand loyalty to Jersey milk, but that could be tested if the price differential is too great between local milk, and the potential of imported milk

• the danger is a repeat of the jigger pot disaster, where the JD tried to sustain a high price for this specialised milk market, ignored the customers interests too much, and so lost the entire market to another (Irish) supplier who put the customer first. Their objective of reducing their wholesale price of milk, so that it could be retailed at around 70 – 72 ppl is entirely correct

• but it is also important to recognise that to maintain a given volume of wholesale milk supply to customers 365 days per year, there has to be a structural surplus of milk. This has to cover the peaks and troughs of ex-farm supply, of seasonally wet or dry or cold years for forage supply and milk production, and of product wastage. This suggests a minimum ex-farm production of 11.5 – 12 million litres per annum to satisfy the Jersey liquid and fresh product market

• the price aggressive liquid UK milk processors have removed their cost of disposal of this balancing milk by buying only 65% of their needs direct from farmers. They buy the rest from the milk co-operatives, who act as brokers, leaving the co-operatives with all of the secondary milk movement costs, and disposal of seasonal surplus at basement prices. This option is not available to the JD without importing liquid milk

• the consumer has (as in the UK) largely chosen to buy 1.5% fat content semi-skimmed milk, but the Jersey breed produces 5.2% fat milk on average. There is therefore an inevitable surplus of butterfat from any given sales volume of milk consumed, irrespective of cattle breed, but made worse for the Jersey breed

• SMP and butter are world traded low price commodity products. Jersey will never compete with the worlds' lowest cost, but high volume milk producers in New Zealand, Australia or Latin America, nor with the big volume processors on the cost of processing of these products

• EU butter prices have fallen consistently over recent years, from £2100 per tonne to £1700 per tonne now, and Jersey bulk butter has consistently earned £200 per tonne less than UK butter. Jersey SMP is of such poor quality (from the antique old drier) that it is only suitable for UK stock feed use, and earns £550 per tonne less than UK product

The strategy is therefore correct, to move away from commodity product that cannot compete with the UK on price, let alone the rest of the world.

However, it also that means that the JD must find a higher value market for these structural surplus products, in what is an aggressive international market place. The plan for the new dairy is for 14.5million litre capacity, which infers the need for a substantial market for products from 5 million litres of milk.

This is much easier said than done, of course, but it might be argued that one reasonable contract with a mainland retailer for say high quality yoghurts might be sufficient to account for this sort of volume of milk. However, there are lessons to be learnt from the jigger pots market experience which was lost in rapid fashion to the Irish dairy sector – not least having all eggs in one basket etc.

While highly encouraging progress has been achieved in recent months by the JD in developing a dialogue with major retailers on the mainland, this has yet to come to full commercial fruition. And it might take a further 12 – 24 months before any tangible success is really achieved.

The  basic  strategy  is  correct  –  but  as  often  the  case  in  these  situations,  the  timing  and implementation is proving to be more challenging.

6. PERFORMANCE OF THE DAIRY HERD

1. Financial

Jersey dairy farmers have a full farm costing service available (DICS), financed by the States and the JMMB, which allows a business performance comparison with each other. The chosen system uses "Earnings Before Tax, Interest, Depreciation, and Amortisation" or "EBITDA" as the measure of profitability. This is excellent for the detailed benchmarking purpose that it was intended for within Jersey, and produces very timely data. But it is curious in that while it does include leasing charges for purchasing machinery and capital items, but does not include depreciation or interest on borrowed money for those who buy, rather than lease equipment.

Promar International provides full farm management accounts (the FBA) for UK farmers, and select a subset of these who are specialist dairy farmers with minimal other farm enterprises. These provide full profit and loss accounts and balance sheet information, as well as technical analysis of all enterprise performance. In order to make the two data sets fully comparable, we have taken out the nominal "paper" expenses allowed for in the EBITDA calculation, actual rents and leasing costs, and the interest and depreciation charges shown in the FBA data.

We are now able to directly compare the "gross profit" before any resource costs for both Jersey and the UK specialist dairy farmers, and the direct overhead and variable costs, as shown in Table 4 below. Gross profit shows the farms management ability to efficiently produce milk, irrespective of how the farm is financed and resourced.

It should be pointed out that most of the farms in this FBA sample have black and white cows: there are just two Channel Island herds, which is about the normal UK herd breed make up. However, consumers buy milk, cheese, and other milk products irrespective of the breed of cow farmers use to provide the raw material.

Table 4 - Comparison of DICS and FBA data

This data clearly show the strengths and weaknesses of the average Jersey dairy farm:

• gross output is 20.7 ppl higher on average than the UK average

• direct subsidy income of 7.2 ppl is 4.5ppl greater than the UK average

• Jersey variable costs (feed, seed, fertiliser etc) are £71 per cow higher, though overhead costs (labour and machinery costs mainly) are very similar at just £19 per cow lower

• together, these total direct production costs are 11.9 ppl greater for Jersey dairy farms, when expressed per litre of milk produced

• profit before resource costs is therefore 9 ppl higher than the UK average, and this becomes 11.3 ppl for the top 25% of Jersey farms

The relevance of this large difference in milk production costs is that if Jersey retailers choose to import milk at some future date, and if they are able to in law, then it is from the UK that milk is likely to be sourced.

The simple data in Table 4 shows that total production costs are higher in Jersey than on the mainland by 11.9 pence per litre. Just where the differences lie is shown in Tables 5 and 6 below.

Table 5 - Dairy Herd Gross Margin from FBA and Jersey DICS data, 2005-6

The herd replacement charge for Jersey herds is not specifically calculated as in FBA, but the heifer rearing costs (of feed, forage, AI etc) are expressed within the variable costs of the dairy herd, so the net result is the same.

Table 6 - Overhead Cost Analysis

The key points to note are as follows:

• the major difference shown in the gross margin costs (also known as the variable costs) is the total feed and forage cost of milk production. These two alone amount to 10.7 ppl for Jersey, and 5.1ppl on the mainland. The key reasons are:

the higher price of concentrate feed at £203 per tonne

the higher usage of concentrate feed at 0.42 kg per litre of milk

the price and usage of seeds and fertiliser for forage crops, though tonnage and cost per tonne cannot be split apart as for concentrate feed cost

• some of the concentrate feed cost difference is inevitable, with the shipping cost of bagged feed, and the difficulty of importing cheaper alternative feeds. However, some of the higher cost may be a manufacturers' reaction to higher milk price and money available, and some to the inclusion of expensive C16 fat and other supplements

• the high usage of concentrate feed could be slightly lower, as shown by the top 25%, though this may be being hindered by the lower feed conversion efficiency of poorer genetic ability in the Island herd

• the higher concentrate usage will also be influenced by the lower grain content of later planted forage maize or corn crops after potatoes, resulting in bulk rather than high energy content, milk producing crops

• the overall stocking rate of Jersey animals is not really different to mainland Jersey stocking rate averages (shown in the dairy costing comparisons) so the much larger forage cost of the Island average is a function of the constant (and expensive) reseeding of crops and forages after early potatoes. Fertiliser price per tonne also reflects shipping costs

• there is a bigger range between the performance of the top 25% and the average in Jersey than on the mainland, suggesting that improvements can be made by many. This is particularly true of the concentrate feed use per litre, vet costs, and the forage costs per cow

• some of the overhead costs are known through the dairy industry costing, though not the full resource costs of interest charges and depreciation. The key differences shown are in:

higher wage costs

higher machinery and power running costs

rents

equipment leasing costs

rates (local property costs) on Jersey are significantly lower than UK

• the paid wage issue appears to be a function of business size: the average FBA herd has a wage bill of £27,065, but spread over 162 cows with 1.17 million litres of output. Similarly the top 25% have a £41,262 wage bill spread over 220 cows and 1.74 million litres of output. The top 25% Jersey figures have a wage bill of £35,475 spread over an output of 0.58 million litres, hence more than double the wage cost per litre

• the power and machinery are higher in the areas of repairs, fuel and electricity, and contracting costs. We understand that the unit cost of electricity and fuel is possibly lower than on the mainland. So part of this high cost per litre of milk sold is again scale of operation, with the relatively fixed cost of running the farmhouse and farm vehicles spread over more litres with the mainland farm businesses

• the contracting charges per vergee for most field operations certainly seem higher than the UK, where there is considerable competition (and much of it from marginal part time operations "borrowing dads tractor" etc). However, it is the use of contractors rather than the cost per operation alone that drives this total cost

• in general the increased use of a farm contractor's staff and machinery should reduce the farmers own wage, fuel, repair and depreciation charges in his business

• however,  the  Island  infrastructure  itself  adds  to  the  wage  and  machinery  costs  of producing milk on Jersey:

narrow and busy access lanes

small field sizes

the lack of piped water in those fields

the limited grazing area that the dairy cows can reach, so enforcing more mechanised storage feeding

repeated reseeding of secondary crops after early potato crops

All of the costs in a business can be changed to some extent. However, the fundamental issues of island infrastructure, rent competition for limited land, the limitations of the Island Jersey breed, and freight cost of imported goods will remain reasons for a higher cost of milk production on Jersey.

2. Technical

Having analysed the impact of the technical performance on the financial performance of the Jersey Island farms, it is also possible to compare more specific aspects of this performance to draw further lessons for the future.

The tables below show a comparison of the National Milk Records dairy herd performance and compare it to the performance of UK Jersey herds (see Table 7 -). They also review the DICS data converted into a dairy costings format, with the comparable UK figures for Channel Island herds (MDC and Promar) and Jersey only herds (Promar) in Table 8.

Table 7 - Comparison of NMR Dairy Herd Performance (2004-5)

Table 8 - Review of Available Dairy Costing Information[7]

3. Conclusions These are:

• in the UK, milk recording is entirely voluntary, costs around £12 – 15 per cow per annum, and only around half UK herds choose to use it. It is a self-selected group, and not a UK all herd average

• in Jersey, all cows in all herds are recorded and is subsidised by the State. As such, the Jersey data will include some herds that in the commercial UK situation may well choose not to milk record their dairy cows

• from the NMR data, it would appear that the Island Jerseys have a lower yield of 692 kg less, with poorer milk constituents, and 15% less total milk solids per lactation

• from the DICS information, the Island Jerseys have a lower yield of 856 less litres than Promar costed UK Jersey herds. The limited herd numbers shown by the MDC averages put Jersey and Guernsey breeds together

• the CEDAR research farm based at the University of Reading has some Island cows and mainland cows on trial. The Island Jerseys are 400kg live weight compared to 450kg LW for the mainland cows. Although the Island cows give less milk in this trial, there was no difference on milk versus feed efficiency per kg body weight

• feed usage per litre of milk is higher on Jersey, but the DICS data does include a small element of concentrates fed to the dairy heifers being reared

• the amount of milk produced from forage is lower on Jersey than in UK, although the corrected stocking rate appears to be very similar. The DICS quoted stocking rate is 2.6 vergees per cow, which equates to 2.16 cows per hectare. But, this includes the land used by heifer replacements, so the inferred stocking rate is 2.16 x 1.30 = 2.81to allow for a 25% island herd replacement rate with heifers at 2.25 years old

• feed cost per tonne is substantially higher on Jersey than the UK

• milk price is substantially higher on Jersey than in the UK

• margin over bought feed costs is higher in Jersey by £158 per cow, or 17%, and this reflects the higher milk price rather than any efficiency measures shown in breeding or management

4. Dairy Performance In Relation To Genetics

It is possible to make an assessment of whether the use of better genetics leads to improved cow performance on the Island at the moment. In order to preserve anonymity the analysis shown below does not show the underlying data. However, the trend line resulting from the analysis shows a clear relationship between genetic merit, in this case expressed as PIN, and performance, in this case expressed as Margin over Purchased Feed (MOPF per cow) for the herds on the Island where data is available. It should be noted that, unlike the convention in the UK, the MOPF within DICS excludes feed used by youngstock.

This analysis, albeit based on a small sample, does show a clear relationship between the genetic merit of the herds on the Island and their performance. Part of the reason might be accounted for by the fact that the facilities and/or management of the higher genetic merit herds are also superior. However, this is unlikely to account for other than part of the trend shown in the graph above. This trend is consistent with previous studies conducted in the UK using much larger populations of farmers.

Figure 2 - Analysis of MOPF per cow versus PIN- Jersey Island Herds

1400 1300 1200 1100 1000 900 800 700

-25 -20 -15 -10 -5 0 5 10 15 20 25 PIN

7. THE IMPACT OF LIQUID MILK IMPORTS

1. Background

This is a highly emotive issue on Jersey and has been for some time – and as such it needs to be handled with a degree of sensitivity. There are both plus and minus points regarding the situation which impact on the future structure of the industry and the desire that government has to see "brown cows in green fields". These are set out below.

However, despite the emotion surrounding the subject, the potential impacts of the import of liquid milk on to the Island are, in our opinion quite clear. What is also very clear is that in its current state, the Jersey dairy sector is in no real position to defend itself from severe competition, if it were that imports of liquid milk could not be resisted.

Again, this only serves to underpin the rationale that the Jersey dairy sector needs to take good advantage of any time it might have – and it does – to re organise its own industry.

As a summary, our view – would be as follows:

• the current situation has protected the industry – but is not likely to be sustainable in the future

• if  anybody  wanted  to  bring  milk  in  –  it  is  unlikely  that  a  legal  challenge  could  be maintained if taken to the EU – and it should not be assumed that this is not going to happen

• if liquid milk came in, it would be at much lower price than is currently supplied

• a major retailer coming on to the Island might well respect the importance of the local industry and not source from off shore to begin with – but in the mid to long term, they are unlikely to tolerate what they see as an inefficient dairy sector. Other retailers would certainly follow suit

• there is support for the industry from key retail customers on the Island, but only to a limit - if someone bought milk in cheaper, they would be forced to respond

• consumer loyalty will only go so far – not least with a high proportion of the current population coming from outside the Island now

• the farming sector would be put under severe pressure

• it is inconceivable that some farmers would not be forced out of production

• the dairy itself would loose a considerable amount of market share - as much a half over a period of time

• the industry would go into free fall - in its current state

• Government objectives of "brown cows in green fields" would be thrown into turmoil

To head this potentially disastrous situation off – the dairy sector needs to take advantage of the time it might have to get itself in shape – lower costs of milk production – get the factory efficient and shore up customer support

The more detailed "for" and "against" arguments are as follows:

2. Pros

These can be set out as being:

• Jersey currently consumes c. 9 million litres of liquid milk, and this would be a marginal volume for one of the UK's leading milk processors with spare capacity to supply

Case Study - Wisemans

Wisemans are currently building a liquid milk bottling plant at Bridgwater, Somerset, with 350 million litre capacity. This plant will buy 65% of its needs direct from farm, and contract to buy 35% from the co-operative milk brokers, who then have all of the secondary costs of dealing with seasonal over or under supply.

There are no other products, no milk product sold at below cost, and surplus cream from the semi-skimmed milk demand is simply sold off. This plant will distribute milk across the South and South West of England.

It plans to employ 350 – 400 people for the entire farm collection, processing, and distribution of that volume. Jerseys' entire liquid market is just one 25 tonne lorry a day from there to put on a ferry

• this combination of buying ex-farm cheaply at 19 ppl with this high level of processing efficiency can provide the consumer with the cheapest milk on the shelf (subject to the retailers margin) albeit primarily from black and white cows. This milk could be on a Jersey shop shelf at possibly around 65 ppl

• this route would also provide consumers with a larger range of milk bottle sizes than the JD from 0.5 pint up to the one litre, 4 pint, onto the 6 pint fridge door size. This would also use a range of modern plastic screw topped bottles, that are blow moulded on site as part of the milk bottling line, rather than using a wax carton[8]

3. Cons

These can be set out as being:

• if one retailer introduced much cheaper milk for sale, the others would have to follow for such a base household consumer necessity, and Jersey would very quickly have a small "milk price war". There would be very little time for the local Jersey dairy industry to adjust

• Jersey's higher milk price to farmers supplying the raw material at 33 ppl, combined with the higher cost processing of multiple products at the JD could not compete at this price

• as a consequence, Jerseys farmers and the JD would lose a large part of their market for more profitable liquid milk sales, and would have to fall back on the less profitable dairy product market, that they are not currently well equipped to supply. And this market is already saturated by large volume and international specialised suppliers

• the dairy farmers would see a fairly immediate price crash: there is insufficient equity left in JD to keep the milk price up by bank borrowing as happened after the crash of the Jersey dairy jigger pot market

• Jersey would therefore also have to import more of all other dairy products. It is conceivable that this could cause a problem for daily supplies delivered by sea, in a particularly bad winter storm – but to be fair, this, based on feedback gained in the project, is unlikely to happen on a regular basis

• there would be openings created for entrepreneur Jersey dairy farmers to supply smaller volume mainstream and niche dairy products to market. However, there would be little ability for any larger dairy to buy any milk that they produce, but eventually proves surplus to product sales and requirement

• the Jersey dairy herd numbers would fall to whatever market size Jersey milk could retain, perhaps 20 – 30% of the current 9 million litres – and which would need only as few as 500 – 600 dairy cows on the Island to produce

• this smaller Jersey cow population would be too small a genetic pool to prevent in- breeding and be sustainable. Jersey would have to import Jersey semen to maintain the breed. However, importing Jersey semen will mean importing semen from other breeds as well, so in time the fields may have Jersey crossbred beef rather than dairy cows. So why not import these as pure breeds and at least have an efficient beef breed?

• neither of these outcomes achieves the objective of maintaining the iconic breed of Jersey cows farmed in the small green grass fields of the Island

• the solution to this could be a Jersey herd kept on a farm museum basis for tourists – "this is how it used to be" – but is that desirable?

• there would be less farmer competition for land, so farmland rents will fall, and so allowing more land for Jersey Royal potatoes. However, potatoes already utilise around 50% of the available cropped land area, and further growth in cropping would change the balance between fertility building crops like grassland with stock, and fertility taking crops like potatoes. There would be a number of wide ranging environmental issues to address, for Jerseys' flora, fauna, and soils

• the secondary industries based around stock farming would become unsustainable, or dramatically smaller. For example the feed, seed, fertiliser and supply services, the veterinary services, the cattle breeding and AI business, and there should be very little need for an abattoir. The JD as it now is would probably not exist. There are very many Jersey people in this whole chain whom would no longer have employment as a result of importing milk and milk products

• there would be a different waste disposal problem for Jersey States with the bulky plastic milk bottles to deal with instead of the crushable wax cartons

8. OPTIMUM MILK PRODUCTION LEVELS

1. Introduction

Identifying or defining an optimal level of production for an essentially closed agricultural system such as the Jersey dairy industry is not a straightforward task. Defining an optimum level of production is essentially about identifying a level where supply and demand for Jersey dairy's products are in balance. Milk production's seasonal nature, combined with changes in consumer preferences and demand as well as fluctuating product prices mean that supply and demand levels for dairy products will vary over time. This means identification of a single optimum production level may be something of an academic exercise.

Understanding the supply and demand situation is essential for any dairy company. It is even more important though that companies are able to respond to these changes effectively and rapidly to ensure that supply closely fits market demand and that the company and industry maximise profitability. The supply and demand situation for the Jersey dairy industry has been evaluated based on three major areas:

• milk production or supply

• dairy product demand

• returns from different products

The following section explains these concepts in more detail. It also provides comment on the Jersey dairy industry's current supply and demand position.

2. Milk Production

Despite the technical advances in milk production over the last 50 years, milk remains a natural product, produced under system that is subject to variation. At the most basic level, this variation is expressed in the natural changing composition of the milk itself during the year. Unless cows are managed in highly intensive "factory like" farms, the volume of milk will also vary depending on the stage of lactation of the cows and the quality and volume of feed available.

An optimum production level needs to take into account these seasonal variations to produce enough raw milk to cover demand at all times. Figure 3 shows the natural variation in milk production in Jersey over the last 4 years.

Figure 3 - Jersey Dairy Raw Milk Supply

Raw Milk Intake by Week (2003 - 2006)

350,000 300,000 250,000 200,000 150,000 100,000

April Jul Oct Jan

High Average Low

The milk intake data indicates that the industry has a monthly peak to trough ratio of between 1.2 : 1 and 1.35 : 1. This compares relatively well with the UK and extremely well with countries like Ireland. Although these peak to trough ratios are relatively low, they still mean that at times of peak production (between May and June in particular) the Jersey dairy industry would be producing upto 35% more milk than was required.

This situation is not unique to Jersey, and is a situation faced by dairy companies all over the world. To minimise this cost, most dairy companies use a range of tools and incentives to try and minimise production of "buffer milk" by better matching their milk intake curves with the milk demand curves. In the past, the main method for dairy companies was to produce enough milk to cover the base level of demand for fresh dairy products, such milk and yoghurt. They would then convert  any  milk  produced  above  that  level  into  longer  life products such as cheese and SMP.

While this policy works well in theory, in practice the markets for products such as SMP, cheese and butter are becoming increasingly competitive and the profitability from these products is decreasing. In effect they are classic commodity products. In the future, it is expected that international producers such as Argentina and the Ukraine will be increasingly be important as key players in these markets. This is not least based on their low cost of production, along with other traditional suppliers such as New Zealand and Australia.

Figure 4 - the Global Dairy Cost Curve

60

50 Austria

Australia Denmark

40

Argentina Sweden

Hungary Ireland

30 Poland

20

NZ USA Brazi France GermanyU

10 l K

0 50 100 150 200 250 0 Milk Production (Million Tonnes) Source IFCN 2000

The UK is not well placed to compete in the international market – and has historically been at the wrong end of the cost curve – Jersey is in the same situation. Figure 4 shows more detail of how various countries are positioned in this respect. The further to the left one is, the more competitive you are deemed to be.

This decrease in profitability is forcing companies – and the JD is no exception here - to either:

• specialise in certain products - like liquid milks, cheese, fresh dairy or commodities to gain economies of scale and efficiency. These specialised dairy companies then use a variety of trading arrangements to either sell their surplus milk in times of excess, or outsource part of their milk requirements by buying in top-up volumes of milk when required

and/or

• develop differential pricing for milk at various times of the years - these prices need to be closely linked to the (real) market value of milk during different times of the year. When used effectively, these policies "flatten" milk intake curves and better match supply with demand

In reality, most dairy companies use a combination of both methods to minimise buffer milk production  and  match  supply  and  demand  as  closely  as  possible.  While  specialisation  and outsourcing of milk supply provide best-practice examples, they are not tools that the Jersey industry can easily use at the moment.

This is not least due to the historical development of the sector (i.e. no imports of liquid milk and the role of the JMMB as essentially a farmer facing organisation). The current import licensing system used on Jersey means that the JD is unable to either buy-in raw milk when required or sell (export) raw milk in times of surplus. Jersey's relatively isolated position along with high transport costs means that even without the current import licensing system, transporting volumes of milk to and from Jersey may not be economically feasible.

The only option open to the JD to modify its current milk intake pattern is via strong seasonal price signals to farmers that reflect the real value of milk to the factory (and ultimately, the farmer, in terms of product return). As we have said in Section 4 of this report, the price signals given to farmers by the JMMB are weak. Making changes to milk intake through demand price signalling is a difficult – but not impossible - task. In most situations, it requires extensive consultation and communication with farmers to implement. In the initial stages of use, relatively long implementation periods tend to be required. This is to allow farmers to change their businesses in response to the new price signals.

The impact of the above factors means that in the short term, the JD is likely to maintain its seasonal milk supply and therefore a requirement to convert seasonal buffer milk into long life products such as milk powders, butter or cheese etc.

3. Dairy Product Demand

As well as variation in production of raw milk, all dairy companies have to cope with variation in customer demand for the final product. However, this may not be a large issue on Jersey. Jersey's small population and the staple nature of most dairy products, means that milk and dairy product consumption on Jersey appears to be relatively stable –as it is in the mainland UK market. According to retail interviews carried out in this study, milk demand varies little from day to day. The only time milk demand really changes is when there are public holidays. Liquid milk dominates Jersey Dairy's consumer products business and accounts for around 63% of whole milk intake. In contrast "soft" dairy products[9] such as yoghurt, butter, cream fraiche and cream only account for 5.2% of whole milk intake.

Figure 5 below shows the average weekly consumer demand for liquid milk and soft dairy products over the last 2 years in Jersey.

Figure 5 - Jersey Liquid Milk and Soft Dairy Demand

Weekly Milk & Soft Dairy Demand (2004 - 2006)

200,000 190,000 180,000 170,000 160,000 150,000 140,000 130,000

120,000 110,000 100,000

April Jul Oct Jan

High Average Low

Although the variation in demand for dairy products may not be particularly great on a week to week day basis, as the sole supplier of fresh liquid milk on Jersey, the costs of not having sufficient stock to meet demand are particularly high. The need to satisfy liquid milk demand at all times, means that the JD has to run a larger than average buffer to ensure that there is always sufficient milk to cover possible variations in demand.

4. Matching Supply and Demand

An identification of the supply and demand situation at the JD can be made by matching the supply and demand curves together. To fully account for variation in supply, we have take the lowest weekly milk intake levels recorded over the last 4 years and then subtracted 10% from these low figures to create a worst case supply scenario. To allow for any variation in demand, we have taken the highest weekly level of demand recorded over the last 3 years and then added 10% to these figures to create a best case (i.e. the most sales) demand scenario.

Figure 6 - Jersey Dairy Supply and Demand

Worst Case: Jersey Dairy Supply & Demand

350,000 300,000 250,000 200,000 150,000

100,000 50,000 0

1 3 5 7 9 11 13 15 17 19 21 23 25 27 29 31 33 35 37 39 41 43 45 47 49 April Jul Oct Jan

Low Supply (-10%) High Supply Low Demand High Demand (+10%)

Combining the supply and demand curves for Jersey Dairy along with our "worst case" buffer levels clearly indicates that at all times of the year there is a significant gap between demand for liquid / soft dairy products and raw milk intake (as shown by the bars in the chart). This gap can be described as "excess" milk, but the real issue is, in our view, largely dependent on the returns that can be made from this excess milk.

5. Milk Returns

The dairy industry is essentially a refining business, taking in a single raw material and producing a range of products from the various fractions of the original input. The demand for the different final products and the prices paid for these products varies considerably (both at a single instant and over time). There is a wide range of gross profit[10] levels made on the core product lines currently produced at the JD. Premium yoghurt is the most profitable item while SMP is the least profitable and actually makes a loss.