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Retailers pressure dairy industry with new plants

Walmart, others gain more control over private label milk with vertical integration

Walmart’s foray into fluid milk processing is shaking up the dairy industry as the company prepares to begin operations from its first dairy plant early next year.

The company announced plans last year for the new bottling plant, a 250,000-square-foot facility in Fort Wayne, Ind., that will reportedly supply 600 of the company’s stores with 100 million gallons of private label milk per year.

While traditional supermarket operators around the country, such as Kroger Co., Publix Super Markets and H-E-B, have long operated their own milk bottling plants and other dairy-processing facilities, the move is a first for Walmart. As reported in a recent article in the Wall Street Journal, Walmart’s investment in dairy processing follows Kroger’s opening of a fully automated milk plant in Colorado and Albertsons’ debut this summer of a new, versatile milk bottling facility in Pennsylvania. Kroger now supplies 100% of its own fluid milk to all of its stores, the article said.

“Retailers have almost always operated very efficient plants,” said Jerry Dryer, editor of the weekly newsletter Dairy & Food Market Analyst. “This is another round of them spending money on new plants, and new plant capacity, which will presumably be state of the art.”

Many of the bottling companies that have long supplied retailers with branded and private label milk “have been a little lax” in terms of investing in their facilities, he said, given that milk has been suffering from weakening demand and under pricing pressure.

“Because demand is going down, there is already excess plant capacity in the industry,” said Dryer. The new, high-efficiency retailer-owned facilities, he said, “are just going to force the hand of traditional processors a little bit sooner.”

By operating their own dairy processing facilities, retailers gain the opportunity to exert more control over their supply and their costs, giving them a competitive advantage, said Dryer.

Mike McCully, owner of dairy consulting firm The McCully Group, agreed.

“The fluid milk case on a gross margin basis is one of the most profitable areas of the grocery store, so having more control over what goes in there probably gives them more control over their overall margin structure,” he said.

Walmart’s move into vertically integrated dairy processing comes as the company has been flexing its pricing muscle in the marketplace to compete against discounters such as Aldi, Lidl, and dollar stores.

McCully also said Walmart’s investment could spur other retailers, such as Target and Costco, to look into the milk-processing business as well.

And, he noted, the industry has been speculating that Walmart will likely open a second milk processing facility elsewhere in the country if the first one produces the expected results.

That’s all bad news for traditional dairy processing companies, such as Dean Foods, which has said the Walmart opening will impact its business, but has not yet said to what degree.

Dean Foods, for its part, has been emphasizing to its retail customers the importance of having branded milk in the category to drive additional sales and margins, the company said in a recent conference call with analysts. The company sells both private label and branded milk to its retail customers.

For retailers that choose to take their dairy processing in-house, the margins might not be as great on private label milk once they factor in the cost of their plants, Dean Foods executives said in the call.

The challenge for dairy processors, however, is that consumers tend to view milk as a commodity, said McCully.

“Companies have tried with varying degrees of success to brand it, but in the minds of consumers, milk is milk,” he said. “It can be very hard to extract a premium for that white gallon jug.”

Private label fluid milk captured about 64% of the market share in the first quarter, said Dryer, citing IRI data.

“Twenty years when I started tracking this, it was about a 50-50 proposition,” he said. “Private label just keeps chipping away.”

Walmart’s move into milk processing could also reflect a trend toward more vertical integration among the big-box retailers, McCully noted, citing Costco’s plans to build a $300 million chicken-processing facility in Freemont, Neb.

That plant, which began construction earlier this year, will be able to process 2 million chickens a week when it opens in 2019, according to local reports.

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