Technology and Risk Management in a Changing Industry
In 2014, Veganuary launched in the UK. A month of post-Christmas veganism that individuals could sign up to online. That first year, 3,300 participants logged on share their meat-free, dairy-free experiences. By 2016, there were 23,000 people on board. In 2018, it was 168,000.Obviously, in the context of the global dairy sector those are still tiny numbers. But what is interesting is the growth trajectory: from fringe movement to accepted dietary choice, more and more people are rejecting animal products in their lives.
Bigger numbers can be found when you look at the global dairy alternatives market. It was worth approximately $8.51 billion in 2016 and is expected to grow at a CAGR of 12.5 percent so that, by 2023, it will be worth $19.45 billion.
That’s just a snapshot of one of the challenges facing the dairy sector. Dietary fads come and go, but current trends towards ‘clean eating’, wellness, environmentalism and so-called ‘authenticity’ have pushed dairy consumption to a new low, not just in the UK, but also across established Western markets.
In the US, the department for agriculture (USDA) tells us that 30 years ago Americans consumed about 247 pounds of milk each year; it was down to 154 pounds in 2016. The per capita consumption of fluid milk was down by 9.7 percent over the past five years. Even ice cream consumption is down 3.3 percent.
The dairy industry also struggles to offset this decline in its established markets. Other commodities often find it easier to engage with the growing middle class in China and elsewhere, targeting those with newly disposable incomes and aspirational lifestyles.
But dairy production doesn’t lend itself to international markets in quite the same way. First of all, there are the transport and logistics challenges of highly perishable goods. Then there are the cultural, wellness and lifestyle factors. For example, lactose intolerance is present in around 10 percent of the Western population. In Africa and Asia, it’s closer to 90 percent – making them unlikely candidates for growing demand.
Where this growing middle class may have an impact is in increasing the competition for key resources, like energy and certain feedstocks, which then introduce new levels of volatility to input costs that are already trending upwards.
Precise costs vary from country to country, region to region and even herd to herd, so sweeping generalizations are not helpful here. But the monthly dairy budgets produced by Robert Tigner of the University of Nebraska for the US Corn Belt (essentially, the I-29 corridor and most of Iowa) are a useful illustration.
He has shown that in March 2018, feed costs, including corn, soybean meal and cottonseed, rose by more than 40¢/cwt. He then went on to show that when the costs of labor and management returns were included in the calculations, freestall herds that produced 24,000 pounds of milk per cow had a budget surplus of 15¢/cwt. However, tie stall herds that produce 20,000 pounds per cow saw losses of $3.04/cwt.
The backdrop to all this is falling prices. In the US, milk prices famously bottomed out in 2016. The boom of 2014 was followed by a rapid drop in prices – from more than $25 per 100 pounds to $15.30 per 100 pounds. Overall milk receipts are expected to continue this downward trend throughout 2018.
Risks and hedges
The fact is that margins throughout the dairy supply chain are being squeezed by a startling number of interconnected factors. Patterns of demand are changing for a complex set of reasons. Various subsidy regimes compete with each other – and in certain cases are now under review, creating uncertainty.
The industry is subject to volatile prices in other commodities markets – from softs and ags to metals and energy. And, as this year is likely to prove, changing climate and weather patterns will have an immediate impact. Nobody thinks that heat waves, extensive wild fires and drought are good for farmers – and that includes water-intensive dairy farming.
Tariffs also increase uncertainty and price volatility in dairy markets. In July, trade tensions between the United States and China were behind a plunge in prices at the global dairy auction.
And so dairy companies face a complex matrix of risks that threaten profit margins wherever they sit in the supply chain. Not only is this damaging to the bottom line of the individual organization – sometimes to an irrevocable extent – it undermines the price stability that consumers want from what is still a key staple.
As risks and threats shift, so do prices. More and more dairy companies are finding that the market has moved before they have time to implement their hedging strategies, leaving them with unpredictable or unplanned exposures. The knock-on effect is that risk limits are breached but are not immediately detected, which forces companies to carry more risk and set aside more capital than is optimal for the business.
The hedging strategy that started as a means to manage fluctuating supply and demand and smooth earnings has – in many cases – become an instrument that does exactly the opposite.
Robots, AI and analytics
Technology can help. The dairy supply chain is as automated as any other commodity, and farms are no stranger to the latest developments in artificial intelligence and robotics. For example, more advanced establishments are using sensors to monitor and adjust the movements, diet, yield, health and well being of entire herds and individual animals.
Robotic milking systems and feed pushers support animal-led routines that lead to more efficient feeding regimes and output levels. Drones monitor cattle and crops, while automated misting fans and thermostat-controlled curtains keep cows comfortable throughout summer and winter.
These are just some of the examples of technology being deployed on the farm and they have an important role to play in optimizing yield while controlling costs.
But gathering data to optimize yield is only one aspect of the technology solution – albeit one that as in the examples above certainly grabs the attention. The other is gathering data to improve enterprise risk management. Less photogenic maybe, and one step removed from the animals themselves, but here the solution lies in specialist software and apps to take the place of generic office tools like the spreadsheets that still proliferate throughout the agricultural sector.
Spreadsheet culture is coming to the end of its useful life. As generic tools, they were never designed to provide the level of automation, predictive capabilities or error-resistant functions that effective risk management requires. Those limitations could remain hidden in less volatile times, but now they are horribly exposed – not least because they cannot readily accommodate the advances in analytics and automation made elsewhere in the supply chain.
This is what dairy organizations are starting to do. In one case, a US company wanted an effective way to monitor its profit margins from milk and processed milk products that would enable it to analyze costs and revenues on demand.
It did not have the instant visibility of its positions that would enable it to manage risk effectively or time markets better because it relied on manually pulling data in multiple formats and multiple sources. Spreadsheets for inventory, ERP for physicals, various direct brokers’ statements, market data from different feeds and websites, and information on derivatives in numerous formats were all brought together in a time-consuming, laborious process. Once complete, the organization would apply rules and adjustments to handle exceptions and to address any process issues and inaccuracies.
Inevitably, the company’s hedging strategy was compromised: decisions were delayed simply because too much time was spent on generating reports. By the time it could see its true exposure, the market had moved on. Potential opportunities quickly passed, obscured in a welter of data feeds and paperwork.
What’s more, its risk policies remained out of alignment with business-defined thresholds and breaches regularly occurred, particularly as analysis of gains and losses took so long to complete that market risks were not spotted – increasing overall risk still further.
By adopting new, modern technology, the organization could aggregate data from disparate sources, consolidating and automating contracts and inventory for butter, cheese, milk and other products with ease. The new system connects with market data providers. By aggregating, blending and analyzing inputs from all these data sources the dairy company developed a single, accurate, visual representation of its position – in real time.
With an up-to-date view of its actual position and exposures, the organization could configure its risk policies in line with business-set limits for contract prices, profit margins and hedge allocation percentages – as well as dynamic external conditions.
This particular organization’s challenges are not uncommon, and the solution is likely to become a fixture in the dairy business as farms recognize the inherent value of the data produced by more automated operations.
The most recent USDA farming census showed that the number of millennials among principle farmers has grown by more than two percent over the preceding five years. Not a huge increase, but still notable – and unexpected. However, if this cohort brings its tech savvy to the farmyard and the back office, we could see an even more rapid growth in tech-enabled dairy production.
Demographic change among the producers could, in the end, be as important as demographic change among their customers.