"We have seen extra capacity come online over the past five years, largely to deal with the wave of milk New Zealand has produced. If we see a slow-down in milk production growth, the risk is that processing plants could be operating at sub-optimal capacity utilisation."
The second implication is that processors will need to review their strategies for obtaining new or maintaining their existing milk supply.
There are at least three options for processors to maintain their milk base - protecting and defending the status quo milk supply, aggressively recruiting for new supply or expanding into new territory, or acquiring existing production assets with milk supply attached.
"Regardless of the supply strategy employed, processors will need to deliver more competitive returns to farmers to ensure supply stickiness, either by adding value to their product mix where possible and passing some gains through to farmers, or efficiently producing commodities at low cost," Ms Higgins says.
But both of these strategies come with risk.
"Value-add is easier said than done and requires exceptional execution. Not only does it require additional capital outlay, but it also requires long-term dedication from both the suppliers and the company to see returns come to fruition. Producing commodities at low cost is a possible strategy, but a tight rein on cost control is required and there is no guarantee of relief from global market volatility."
The final implication is greater competition at the farmgate, as milk supply slows and processors look to fill plants.
"We may see new pricing structures emerge and new, innovative products to support farmers to manage cash flow and capital in order to attract and retain milk supply."
Ms Higgins says the increased competition for milk is most likely to impact on Fonterra, Open Country Dairy and Westland, as the most exposed processors to adverse shifts in their existing supply base in relation to their current plant capacity.
Farmers in the Waikato, Southland and Canterbury regions are the most likely to benefit from increased competition, with three new plants in the pipeline over the next two years.
Key messages in the report:
A slow-down in milk production growth will have implications for the supply chain.
Capacity construction has run ahead of milk supply growth and appears to factor in
stronger milk supply growth than anticipated, leading to more cautious investment
in capacity over the next five years.
Companies and co-operatives will need to review their strategies for obtaining and
maintaining their milk base.
Farmers will likely benefit as increased competition for milk brings sharper pricing and a wider range of contractual options.
