MOVING MILK: THE FUTURE OF ORGANIC SUPPLY

KAREN RAUGUST

Every Dairy Manager wants to know: How long can it last?

For the first time ever, the organic dairy industry is dealing with an oversupply of milk. The spike comes courtesy of the large number of farmers who converted their herds to organic before stricter rules took effect on June 9, 2007. According to Mintel and the Cornucopia Institute, as many as 30,000 cows in the United States were in the transition pipeline as of October 2006, about to add 30% more capacity to the nation's herd of organic milk cows. That river arrived in the spring, and it's still flowing.

“The effect of the increased supply has meant we can maintain a continuous in-stock condition,” said Jeanne Norcross, spokeswoman for Spartan Stores. “In the year prior, we could not supply our customers on an ongoing basis and even had to limit orders being shipped. When we looked at adding another brand to our current assortment, we could not, because the manufacturer did not have the supply to support additional customers.”

What retailers need to know is that this is likely a short-term blip. The rush to conversion this past year was due to new, stricter standards that were part of the Arthur Harvey lawsuit. One outcome of the case was a 100% organic feed requirement for the entire one-year transition period, rather than 80% organic during the first nine months and 100% for the rest of the time. Facing significant increases in the cost of feed, many farmers decided to go organic sooner rather than later.

If anything, the white wave of milk swamped consumers, retailers and dairy processors. Through the second quarter of 2007, for example, Horizon Organic brought on 79 newly certified dairy farms to its network, three times the amount it added in the same period the previous year, according to Molly Keveney, director of communications.

Organic Valley has taken on more than 200 organic dairy farmers, raising its total from 749 to over 950, according to George Siemon, the co-op's chief executive officer.

“All the companies made a big push to get people in,” he said. He estimates that growth in organic dairy demand, which had been 20% to 25% per year, has slowed to a still-high 15% annually, while supply grew 30%.

“There's the problem,” he said. “Supply has gone beyond what the present moment can handle.”

This reversal of supply overtaking demand hasn't hurt the latter. Stores have plenty of milk to sell. Rick Moller, category director of natural and organic at distributor Tree of Life, says sales growth in dairy has been strong, with supermarket sales up between 18% and 20% over the last 12 months. In addition, there seems to be a lot more private-label dairy on the market, he noted, and the service level of some of the largest suppliers, including Organic Valley and Horizon, has risen dramatically.

“We've seen an 80% improvement in reduced out-of-stock on a year-over-year basis,” Moller said. “We're seeing solid fill rates compared to last year, when it was fairly ugly. That implies more product in the marketplace.”

The added supply has led to some price reductions. “The cost has declined slightly,” said Spartan's Norcross. “But what we are seeing is promotional offers from the manufacturers that were not given in the prior year.”

“[The oversupply] has put downward pressure on pricing in the marketplace,” Keveney agreed. “Competition is therefore getting more aggressive to use price as a lever to move milk volume.”

Conventional milk prices are also making organic milk more attractive to consumers. “The rising cost of the conventional dairy items may be helping some consumers make the jump to purchasing organics as the retail gaps become closer,” said Norcross. “Data we have seen is showing that as the retails have risen on regular milk the consumption has slowed, but organic milk has continued to grow.”

According to the U.S. Department of Agriculture's Economic Research Service, the national average price for organic milk in 2004 was $4.01 per half gallon, 98% higher than the $2.02 for conventional milk. But in the second quarter of 2007, the American Farm Bureau Federation Marketbasket Survey showed that a half gallon of regular organic milk was $2.65, 64% higher than regular conventional milk. And the latter rose 34 cents per gallon over the previous quarter, its largest-ever quarter-to-quarter increase.

The greater supply of milk is allowing manufacturers to expand their product lines. “The increase in organic milk supply will allow producers to better meet the continuously growing demand for organic dairy products with a broader offering of products in more accounts from more brands,” says Erik Drake, Stonyfield Farm's marketing director. “The increase in offerings will also help supermarkets integrate more organic products into mainline dairy sets as organic brands become more mainstream in awareness and sales volume, driving incremental growth in the different dairy categories.”

Stonyfield Farm and Organic Valley have worked together to encourage conversion by offering a transition fund, more staff to work with farmers, and educational events. Stonyfield expects to buy 48% more organic milk from Organic Valley in 2007 than it did in 2006.

Smeha Pasricha, an associate at the research firm Frost & Sullivan, said categories to watch include items touted for their health benefits, such as organic yogurt with inulin; probiotic kefir; and milk fortified with omega-3 fatty acids or DHA. There also are more low-fat and fat-free products, which are “really registering impressive sales,” Pasricha noted. In addition, the ice cream category is seeing growth through innovation in organic coatings and flavorings, which allows vendors to offer more variety.

Debbie Eddy, director of marketing at wholesale distributor United Natural Foods, says she's seeing more lactose-free and shelf-stable/aseptic products. She also notes that smaller suppliers, which had been having a hard time meeting demand for milk and butter, are now adding items such as organic yogurt. Other products that are expected to grow include sour cream, cottage cheese and other cheeses.

“The shortages made us narrow our business,” explained Siemon of Organic Valley. “We're building our business now with more diversity, such as sales in food service, ingredient sales and new products.”

Most industry experts expect supply and demand to balance out quickly. “Conversion is certainly going to slow down, simply because it will cost more,” said Eddy.

Keveney at Horizon Organic sees the oversupply as a short-term issue, too. “Demand in the organic milk industry continues to be robust, and supply is likely to tighten due to market dynamics and pressure from conventional dairy.”

On the other hand, farmers still seem to be interested in converting, and suppliers are still offering incentives.

“We're continuing to do what we've done for years, which is working to educate farmers about the organic opportunity,” Keveney added. “We're still expanding into new regions and recruiting new farmers. And now that the regulations have changed, more than ever we need to educate and provide support to farmers in their transition to organic.”

Datamonitor forecasts the value of the U.S. organic dairy food market will reach $4.5 billion in 2010, double the $2.25 billion in 2005.

“The organic market will continue to see growth ongoing as it has over the past few years,” Norcross predicted. “As more outlets make more additions to their current assortments, new items become available — and as the population has more concerns over what is being placed into the food supply, and the effect on their health and well-being, the supply will expand to meet the growing consumer needs.”

Good Advice

Product Proliferation

In 2007, through Aug. 15, 235 new organic dairy SKUs were launched in the United States, according to Datamonitor's Productscan Online. That compares to 178 in all of 2006, 230 in 2005, 157 in 2004, 269 in 2003 and 177 in 2002.

Some recent examples: