Situation and opportunities of dairy sector in Hungary and Latvia

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1 Situation ORIGINAL and SCIENTIFIC opportunities PAPER of dairy sector in Hungary and Latvia Situation and opportunities of dairy sector in Hungary and Latvia Agnese KRIEVIŅA 1,2, Tamás MIZIK 3 1 Latvia University of Agriculture, Department of Economics, Svētes 18, LV-3001 Jelgava, Latvia ( agnese@lvaei.lv) 2 Latvian State Institute of Agrarian Economics, Department of Agricultural Development and Economic Relations, Struktoru 14, LV-1039 Riga, Latvia 3 Corvinus University of Budapest, Department of Agricultural Economics and Rural Development, Fovam ter 8., H-1093 Budapest, Hungary Abstract Dairy sector is a special one in the EU, one of the last remained sensitive sectors. It has faced with dramatic changes in both Hungary and Latvia starting with the transition and followed by the EU accession. The aim of this paper is to give an overview of the dairy sector and an analysis based on structural, conduct and performance indicators. With the help of Structure-Conduct Performance, the main determining factors of dairy sectors can be identified and summarised in the frame of SWOT analysis. Key words: dairy sector, value added, Structure-Conduct Performance paradigm, SWOT Introduction Dairy sector has traditionally been one of the main agri-food sectors in both Hungary and Latvia. However, as in the country situated more on the north, milk production in relative terms is of more importance in Latvia than in Hungary. Dairy farming accounts for 22.0% of the total agricultural goods output at producer prices, and manufacture of dairy products constitutes 21.6% of the total value in food industry in Latvia (Eurostat database), what is the largest value among agricultural sectors and the second largest among food sectors. Dairy sector gives 7.9% of gross agricultural production value in Hungary (FAO database). Due to the support system of the Common Agricultural Policy (CAP), crop production has the highest share in agricultural output. However, Hungary is the 5th largest milk producer in the EU among the new Member States, Latvia is comparatively smaller producer obtaining about half of the Hungarian milk amount. Since joining the EU, the dairy sector is part of the EU single market and the CAP measures are applied in the sector, including milk quota system. Generally, milk quota limits the amount of milk produced, but, at the same time, it also determines the structural distribution of milk production in the EU, reducing the existing differences among the countries. Therefore, the abolishment of milk quota in 2015 determines the crucial need to ensure competitiveness as otherwise milk production at the existing level could be endangered in less competitive countries. The paper seeks to describe and estimate the state and performance of the dairy sector in Hungary and Latvia, as well as to evaluate its overall competitive position. The paper has been supported by the European Social Fund within the project Support for the implementation of doctoral studies at Latvia University of Agriculture, agreement No. 2009/0180/1DP/ /09/IPIA/VIAA/017, contract No /EF2.PD.29. Materials and methods The analysis is based on the Structure-Conduct Performance paradigm. This approach is much used in empirical studies in industrial organisation, though; it is not based on a formal theory, but hypotheses that market structure affects the market conduct of a firm, which in turn results in market performance. To Proceedings. 47th Croatian and 7th International Symposium on Agriculture. Opatija. Croatia ( ) Section 2. Agricultural Economics and Rural Sociology 193

2 Agnese KRIEVIŅA, Tamás MIZIK evaluate to the overall competitive position of the sector in both countries, a SWOT analysis has been used (an abbreviation for Strengths, Weaknesses, Opportunities and Threats). To have an overall and comparable picture, FAO database was used to show changes in cow population and milk yields. Structural, conduct and performance indicators were based on the latest reports on milk sector in Hungary and Latvia. In case of missing data, national statistics and expert studies were used. SWOT analysis required a detailed overview of the relevant literature and interviews with some key actors of the milk sector. Characteristics of milk sector Dairy sector is a special issue in the EU as milk production is regulated by quota system. The Health Check of the CAP resulted soft-landing by eliminating milk quotas by It causes decreasing quota prices and lower level of quota trade. However, raw milk prices have been and are still above the milk equivalent support price with huge changes in the recent years caused mostly by lower demand (European Commission 2009). Milk production is driven by two main factors: number of cows and yields. Clear trends can be identified on the EU markets: number of cows is decreasing continuously while average yields are getting higher. In the last 10 years cow population decreased by 13.5% in the EU-27, while yields increased by 12.9% (FAO database). However, there are huge differences among the member states starting from 32.6% (Slovakia) to only 3.4% (Cyprus) decrease. Figure 1. gives an overview of the changes in the two analysed countries. Cows, head Milk yields, kg/head Figure 1. Changes in number of cows and milk yields in Hungary and Latvia; Source: authors calculation based on FAO database As it can be seen from the figure above, cow population decreased more in Hungary than in Latvia. The Latvian value is around the above-mentioned EU-27 average (-17.1%), while the Hungarian one is closer to the Slovakian drop (-31.6%) according to the FAO database. On the other hand, both countries were able to increase their productivity by 19.4% (Hungary) and 21.4% (Latvia) th Croatian and 7th International Symposium on Agriculture

3 Situation and opportunities of dairy sector in Hungary and Latvia Results of Structure-Conduct Performance paradigm Structure analysis reveals that dairy sector is fragmented at primary and secondary level in Latvia (see table 1). Despite the considerable structural changes taking place in the sector over the past decade (Krieviņa, 2009), the average milk deliveries per farm in Latvia do not reach 50 t. It also needs to be mentioned that only about half of the dairy farms in Latvia are market participants and have milk quota, resulting that still a large proportion of milk produced does not enter the market (share of milk deliveries reach 75%) what could form milk base for processing. The large farm consumption at the existing milk production quantity also determines that milk quota is not fulfilled in Latvia (fulfilment rate 87%). Cooperation can bring the advantages of the largest farms to smaller operating members and there has been rapid development of cooperation in milk collection and marketing in Latvia since 2004, but still cooperatives collect only about 1/3 of the total milk deliveries in Latvia. Table 1. Structural, conduct and performance indicators of dairy sectors in Hungary and Latvia Hungary Latvia Structure Number of dairy farms, thsd Milk production per farm, t Milk deliveries per quota farm, t Share of farms with milk quota, % Share of milk deliveries, % Milk quota fulfilment rate, % Share of milk collected by cooperatives, % Number of processing enterprises Milk processed per enterprise, thsd.t Concentration in dairy processing, C Share of milk processed by cooperatives, % 5 6 Conduct and Performance Milk purchase price, EUR 100 kg Milk yield, t Share of raw milk exports, % Unit value of dairy products, EUR kg Milk processed per employee, t Share of dairy product exports, % Value added per AWU in dairy farming, EUR thsd Value added per employee in dairy processing, EUR thsd Source: author s calculation based on CSB of Latvia, Eurostat, FADN, DG Agri databases, Forgács (2009), Krieviņa (2009), Mizik et al. (2007) Transition and EU accession have caused dramatic changes in Hungary, too. As it was mentioned above, despite the huge decline in cow population, yields became significantly higher in the last couple of years resulting less decrease in milk production. Nevertheless, the low level of milk quota fulfilment rate (77%) reflects to some sectoral problems. Both milk production and delivery per farm are on a higher level in Hungary than in Latvia. The Hungarian production level is more concentrated with lower number of farms and higher level of production. What is a real problem is the weak market connection of the farms, only about one third of dairy farms have milk quota. Regarding processing, comparatively high concentration can be seen in Latvia as the concentration index (measured by the turnover of the ten largest dairies in the total turnover of all dairies) reaches 90%. However, the average size of the dairies in Latvia is small if it is compared to Hungary and to the leading milk processing plants in other EU countries. Dairies in Latvia produce wide range of products and therefore fragmentation exists at individual product level, too. Vertical integration only started to develop as cooperative dairies process about 6% of the total milk processed in Latvia. Though, in the near future, the share of milk processed by cooperatives could increase to 25% (new plant). Milk processing in Hungary is also more concentrated than milk production and has a strong regional profile (Forgács, 2009). The market share of the ten largest dairy processors is 81.5%. Similarly to Latvia, these plants produce a wide range of dairy products starting from milk, sour cream to yogurts and cottage cheese bars. Vertical cooperation in general is not so popular due to the forced cooperation during the socialism. Section 2. Agricultural Economics and Rural Sociology 195

4 Agnese KRIEVIŅA, Tamás MIZIK Nevertheless, it has to be taken account that some remarkable actions took place in last few years, e.g., when milk producers bought up the collapsed processing unit of Parmalat. Considering the fragmented dairy farming, Latvian milk producers receive one of the lowest milk prices in the EU, which arise from the low bargaining power and higher costs (transportation and milk quality costs). At the same time, also dairy processors are attracting comparatively low dairy product value from the market what results in low milk kg utilization efficiency, what along such processing inefficiencies as low labour productivity do not allow ensuring higher milk purchase price in Latvia. There have been high raw milk exports from Latvia to the neighbouring Lithuanian dairy industry, implemented mainly by the largest cooperatives due to better price conditions offered. The low milk purchase price, inefficient use of intermediate consumption, as well as large labour input determines very low value added per employee in Latvian dairy farming. The present competitiveness of the dairy farms on the market has been based on lower prices of some of the main production resources (Krieviņa, 2010), as well as supported by subsidies. However, considering the large differences in labour compensation levels between Latvia and the EU average level such competitiveness can not be sustainable. The inefficiencies in processing sector determine also low value added per employee in dairy processing, though so far it has been successful in ensuring net exporter position. Milk purchase prices are on a low level in Hungary, too. Therefore, export depends on the actual EUR/HUF exchange rate. The weaker the Hungarian currency is, the higher the export is. The major market of Hungarian raw milk is Italy, while Hungarian farms face with high competition of Slovakian and mostly Polish milk producers. On the other hand, dairy products can be sold on higher average price, which shows comparative advantage in processing to raw milk production. Higher level of efficiency measured by milk processed per employee and value added per AWU or employee in Hungary reflects to the high concentration and investments made by foreign companies in the dairy sector. Results of SWOT analysis The analysed counties face with several opportunities and challenges. The main aim was to identify three major factors in each quarter and compare them to each other. The next two tables summarise the main elements of the country specific SWOT analyses. Table 2. SWOT analysis of the Hungarian dairy sector Strengths Selected cow population Increasing yields Sufficient grazing basis Opportunities Increasing dairy markets Concentration and integration Cooperation Weaknesses Lack of cooperation Weak bargaining power Lower subsidies than in EU-15 Threats Import pressure strong competition Foreign food chains Black economy in dairy sector Table 3. SWOT analysis of the Latvian dairy sector Strengths Long-term traditions Still lower prices of some resources Sufficient grazing basis Opportunities Increasing dairy markets Concentration and integration High value-added products Weaknesses Small-scale production Low milk value and weak bargaining power Large labour input Threats Import pressure Increasing costs and lower subsidies High price volatility Conclusions EU accession brought both opportunities and threats to the dairy sector in the new member states, as well as the changing CAP also requires higher adaptability from dairy farmers. The elimination of milk quotas could th Croatian and 7th International Symposium on Agriculture

5 Situation and opportunities of dairy sector in Hungary and Latvia have significant effect on the Hungarian and Latvian export. The higher allowed production of the traditional export partners lowers their import need causing lower raw milk prices in the former exporting countries, as well as it puts further pressure caused by highly competitive import partners. The Structure- Conduct Performance paradigm helped to draw a detailed picture of the dairy sector in Hungary and Latvia and on this basis a SWOT analysis was carried out. Low-scale production in line with insufficient level of cooperation has undesired implication on raw milk production. It needs to be mentioned that primary sector is more concentrated in Hungary than in Latvia. Processing units are also bigger in Hungary, but more concentrated in Latvia. Conduct and performance indicators denote higher efficiency in Hungary measured by milk processed per employee and value added per AWU or employee. It is one of the results of previous investments into the dairy sector. In addition, Hungary seems to use its comparative advantages more as it exports more processed products than raw milk. Taking advantage of increasing dairy markets is the main opportunity of dairy sectors in both countries, which in its turn arise from the larger potential competitiveness, achieved through concentration and integration, as well as high value-added product orientation. On the other hand, import pressure seems to be the major challenge in both countries. References European Commission (2009): Dairy market situation Brussels, COM(2009) 385 Forgács Cs. (2009): An Assessment of the Competitiveness of the Dairy Food Chain in Hungary. Deliverable Report for Agripolicy. Available at: Krieviņa A. (2010) Evaluation of Resource Price Preferences and Resource Utilization Efficiency in Dairy Sector. in: Research for Rural Development. Proceedings of the 16th International Scientific Conference, Jelgava: LLU Krieviņa A. (2009): An Assessment of the Competitiveness of the Dairy Food Chain in Latvia. Deliverable Report for Agripolicy. Available at: Mizik T. Tunyoginé N. V. Varga, T. (editors) (2007): Price calculations in agriculture: theoretical foundations and current practice in Hungary /A mezőgazdasági árképzés elméleti alapjai és hazai gyakorlata/ AKI Agricultural Studies, No. 2., Budapest, p sa2012_0211 Section 2. Agricultural Economics and Rural Sociology 197