DAIRY SUPPLY CHAIN IN UKRAINE: BOTTLENECKS AND DIRECTIONS FOR DEVELOPMENT

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1 DAIRY SUPPLY CHAIN IN UKRAINE: BOTTLENECKS AND DIRECTIONS FOR DEVELOPMENT OLEG NIVIEVSKYI, INNA ILIENKO AND MARIA RYZHKOVA ABSTRACT The global demand for dairy products today is much larger than supply and Ukrainian producers have a real chance to occupy substantial niche of this global dairy market. However the trade restrictions laid on Ukrainian dairy products on behalf of Russian Federation made it especially clear, that Ukrainian dairy sector should not only increase the quality of dairy products but also should optimize all supply chains to achieve considerable advantages on the local and global market. This paper examines the major bottlenecks in the dairy sector and summarizes the main results of the recent empirical studies done on the dairy sector revealing some prospects for the development of the entire dairy supply chain in Ukraine. Keywords: Dairy Supply Chain, Ukraine 1 INTRODUCTION The process of globalization has brought far-reaching impacts on the structure and sourcing of production, as well as the nature of market opportunities and competitive pressures for producers around the world. The challenges for production companies are shifting from internal efficiency to supply chain efficiency. The efficiency of all supply chain units and interaction between them defines the competitiveness of the whole dairy sector. Topicality of the research is especially relevant in the light of joining Ukraine WTO. In this paper we discuss the major bottlenecks in the dairy sector known in the literature and expressed by the sector players in a course of interviews. Also we summarize the main results of the recent empirical studies done on the dairy sector of Ukraine. These pieces of information allow us to reveal some prospects for the development of the entire dairy supply chain. Department of Agricultural Economics and Rural Development, University of Göttingen, Germany. oniviev@igwdg.de. Association Ukrainian Agribusiness Club, Ukraine. Institute for Economic Research and Policy Consulting, Ukraine

2 2 Poster Paper presented at IAMO Forum 2008 In the following we present the facts about the dairy supply chain in Ukraine and pick up the major weak points. Then we present the results of the recent empirical studies revealing the nature of interaction within and between the different components of the supply chain. Section 4 concludes the paper. 2 THE PROFILE OF THE DAIRY SECTOR: SOME FACTS AND PROBLEMS Ukraine annually produces about 14 m tons of raw milk. Figure 1 shows the spatial distribution of the sector. Figure 1 Dairy sector map, 2005 Source: Nivievskyi et al (2008) One may notice that milk producing farms are mostly concentrated in the North-Central-West part of Ukraine and dairy plants seem to follow the same pattern. According to the official statistics Ukraine had 440 dairy plants and about 5000 milk producing farms in However, these farms produce less than 40% of national raw milk volume (see Table 1).

3 Poster Paper presented at IAMO Forum About half of the total raw milk supply is processed by the dairy industry being one of the most dynamically developing and export revenues generating sectors in Ukraine s food processing sector (see Figures 2 and 3). Table 1 Characteristics of raw milk production in Ukraine ( ) Cows in milk, mill. head: Dairy farms Households Total Yield, t/cow: Dairy farms Households Total Fluid Milk, mill. t: Dairy farms Households Total Source: State Statistic Committee of Ukraine Figure 2 Dairy Production/Export ratio Figure 3 Dairy Export from Ukraine thd.t Domestic Consumption Exports Imports mln USD Butter Cheese Dry Whole Milk Powder Nonfat Dry Milk Source: Nivievskyi et al (2008) Source: Nivievskyi et al (2008) The major problems with the dairy farming, processing and logistics could be summarised as the following 1 : 1 The majority of problems are discussed at length in Nivievskyi and von Cramon-Taubadel, 2008, Nivievskyi and Strubenhoff, 2006; von Cramon-Taubadel and Nivievskyi, 2008; von Cramon et al But some were collected in the course of interviews with market player

4 4 Poster Paper presented at IAMO Forum 2008 The prevalence of households in the total raw milk supply poses a significant challenge for the future development of the sector and the entire dairy value chain. Households cannot capture economies of scale in production, and they make it much more difficult to capture economies of scale up- and -downstream from dairy farming. This adds costs to the value chain, making it less competitive on the world arena. However, for the generally underemployed members of rural areas the subsistence production of milk having sometimes a great deal of income. There is a pronounced seasonal pattern of raw milk production by households and dairy farms. This adds up problems and costs to dairy processors strategies. Ukrainian raw milk quality standards are far from Western standards. It increases the costs and limits the export possibilities for the dairies. Productivity of cows per lactation is very low in Ukraine by Western standards (see Table 1). The average productivity in Germany, for example, is in the range 6-7 tons/year; in Israel it is about t/cow. On the other hand there is evidence that some dairy farms in Ukraine are able to reach Western yield levels. Feed production for dairy cows on Ukrainian farms generally takes place on a very extensive basis increasing the feed costs. Lack of investments in dairy farming mainly due to taxation of inputs (seeds, agrochemicals, machinery etc) via tariff and tariff import barriers, excessive regulation (e.g. certification), a lack of a market for farm land, a lack of market and marketing information and infrastructure, and a glaring shortage of human capital. Logistics or infrastructure (milk collection, storing and distribution) is underdeveloped and rather expensive, e.g. according to market operators information, it is times more than even in Russia. The export possibilities for the dairies are limited mostly to the Former Soviet republics. In EU, for example, Ukraine exports the dairy products for non-human consumption. To export to EU, Ukraine should receive the so-called third country status and this is mainly the task of the Ukrainian government.

5 Poster Paper presented at IAMO Forum RECENT EMPIRICAL FINDINGS ABOUT THE SECTOR Von Cramon-Taubadel and Nivievskyi (2008) by examining the competitiveness of the Ukrainian agriculture found that only 20% of dairy farms produced milk competitively in These 20% of all dairy farms produced about 49% of the total production volume. Then analyzing the determinants of competitiveness using econometric methods they found that the impact of productivity (milk yields) on competitiveness has the strongest positive impact. One additional ton of milk per cow and year increases competitiveness by over 50 times as much as increasing the herd size by one cow does. Labour intensity negatively correlates with the competitiveness suggesting the level of capital on the farms. Also they confirmed that it is important to keep arable land per animal equivalent as low as possible to increase competitiveness. Finally, total subsidies received by farms 1 are found to have a negative impact on competitiveness. From the policy making point of view these results suggest termination of the current subsidy mechanism for the dairy farming of Ukraine to improve the sector s competitiveness. Instead, the developing of technology promotion (e.g. avoid taxation of inputs and excessive regulation procedures, etc) and human capacity building policies would have a positive impact on productivity, herd size and labor-to-capital ratios thus improving the competitiveness. In the other paper Nivievskyi et al (2008) investigated the determinants of the productivity growth of the dairy farms using spatial econometrics techniques. In particular the total factor productivity index was decomposed in several components to capture the different sources of productivity growth. Special attention was paid to the identification of the spill-over effects among the dairy farms and agglomeration effects in the sector. The findings basically are similar to those in the study covered above. They found that subsidies do not lead to technological progress, on the contrary, the correlation between the technical progress and the amount of subsidies was found to be strongly negative. This again suggests the termination of the current subsidy mechanisms for the dairy farming of Ukraine. The other interesting finding is that there are significant spill-over effects in the sector. The biggest spill-over effect is identified for how dairy farms make their technological progress. Essentially they do it by just looking over the fence and coping what their neighbours do. The same pattern is observed for other components of the total productivity growth. More over this spill over effect turned 1 i.e. premiums for the milk supplied to dairy processors

6 6 Poster Paper presented at IAMO Forum 2008 out to be much stronger than a certain individual effects. This reflects a rather high degree of interaction between the dairy farms which under the right policy might bring the cumulative positive effect into the sector. Also Nivievskyi et al (2008) confirmed that there are agglomeration effects in the sector. The locations near to dairy plant that have been modernized have a positive impact on productivity growth, mainly via technological progress. That means that processors requiring a dependable supply of high quality raw milk, provide farms with investment help (equipment, prefinancing etc). From the policy making point of view this finding calls for the investment aids, but it is not necessarily means outlays from the budget. First of all taxation of inputs (seeds, agrochemicals, machinery etc) via tariff and tariff import barriers, excessive regulation (e.g. certification) has to be eliminated. That should not cost too much to the budget, but is supposed to have a positive effect on the whole dairy sector. CONCLUSIONS AND DIRECTIONS FOR FUTHER RESEARCH In this paper we discuss the major bottlenecks that hamper the development of the dairy sector and the whole dairy supply chain in Ukraine. High share of households and pronounces seasonal pattern in the raw milk supply, low productivity, extensive feed production, taxation of inputs, excessive regulations, a lack of a market for farm land, a lack of market and marketing information and infrastructure, a glaring shortage of human capital, low milk quality standards, limited export excess to EU markets all these problems limit the competitiveness of the entire dairy sector in Ukraine. The recent empirical studies essentially confirmed these observations econometrically, and added some additional insights. First, the current subsidy mechanism for the dairy farming of Ukraine proved to have the negative impact on the sector s competitiveness, thus requiring termination. Second, there are significant spill-over effects in the dairy farming sector. Essentially the dairy farmers operate by just looking over the fence and coping what their neighbours do. And such behaviour turned out to be much stronger than a certain individual effects. This reflects a rather high degree of interaction between the dairy farms which under the right policy might bring the cumulative positive effect into the sector. Lastly, there are agglomeration effects in the dairy sector. The investment activities on the plants have positive impact on productivity growth of the nearby dairy farms, mainly via technological progress. This finding calls for the policy steps that facilitate investments into the sector.

7 Poster Paper presented at IAMO Forum A further research step would be to study the determinants of the dairy farming competitiveness by adding the spatial dependence to the picture. The other important moment missing so far is the actual valuing the chain, i.e. to study what value added is produced at each stage in the value chain. REFERENCES LISCHKA, G. (2004). Farm Management Challenges in Ukrainian Agriculture. In: VON CRAMON-TAUBADEL, S., S. DEMYANENKO & A. KUHN (eds.): Ukrainian Agriculture Crisis and Recovery. Shaker, Aachen. NIVYEVSKIY, O. AND VON CRAMON TAUBADEL, S., (2008): The Determinants of the Dairy Farming Competitiveness in Ukraine. To be presented at the XIIth Congress of the European Association of Agricultural Economics August 2008, Ghent - Belgium. NIVYEVSKIY, O., STRUBENHOFF, H. (2006): Barriers to Investment in the Agriculture and Food Sector in Ukraine. IER Policy Paper, < NIVYEVSKIY, O., VON CRAMON TAUBADEL, S., AND BRÜMMER, B. (2008): Subsidies and Technology Change of Ukrainian Dairy Farms: Spatial Dependence in the Components of Productivity Growth. Presented at the Vth North American Productivity Workshop June 2008, New-York - USA. VON CRAMON TAUBADEL, S., NIVYEVSKIY, O. (2008): Ukraine: Agricultural Competitiveness. Forthcoming as a World Bank Policy Note. VON CRAMON-TAUBADEL, S., NIVYEVSKIY, O., VON DER MALSBURG, E., MOVCHAN, V. (2008): Distortions to Agricultural Incentives in Ukraine. in ANDERSON, K. AND J. SWINNEN (EDS.) (2008), Distortions to Agricultural Incentives in Europe s Transition Economics, Washington DC: World Bank