LB5229: Economics for A Sustainable World - Business Study Report Writing Assessment Answers

• Introduction to AUSTRALIAN DAIRY FARM GROUP and general business environment:

Australian Dairy Farm Group is considered as ASX’s only vertically integrated dairy company. The company has listed on ASX on 28th October 2014 as a milk farmer, processor, manufacturer and exporter of major dairy products. Actually it is the first milk producing firm to be listed on ASX.The code AHF has been issued to the group. The key products of the business are fresh milk, specialty milk, organic milk and other value added milk products. The produce high quality fresh milk and other dairy products and has the potential to meet the domestic consumption as well as export to other countries and vast market of China. At the beginning they entered in Australian dairy industry as farm owner and produce milk for sale to the milk processors. Gradually they become one of the leading and profitable suppliers of milk. Initially their major focus was one of the premier dairy regions of the country, South Western Victoria(Australian Food News, 2014).

The group has a supply management link with Fonterra, one of the major milk processor in the Victoria. Fonterra extensively support to increase the milk production by the farmers to supply across the world. Fonterra actively contribute to increase the productivity and value growth to the company. It helps to supply domestically and internationally especially to the Asian market to meet the growing demand for dairy products in emerging Asian market. ChAFTA, the tie-up between China and Australia through the removal of tariffs plays a huge role here. The key objective of ChAFTA is to remove the trade barriers and lay a solid foundation to improve Australia’s economic relationship with China. Market capitalization since listing to February 2016 has increased from $14.4 m to $50.0m. Since listing AHF has acquired four additional farms – among two adjacent properties are consolidated into single operational unit with one farm manager. As a business expansion plan, the company is looking forward to acquire additional farms.

AHF has recently acquired another milk specialist processor and dairy manufacturer Camper down Dairy Company. AHF has announced about the acquisition in December 2015 but completed in Q1 2016.The acquisition of Camper down Dairy Company has vast implications in the business growth and a real game changer. Camper down Dairy Company is a well-established dairy business with a history successful business growth and profit. The company already has a well-organized milk supply arrangements with many quality suppliers. CDC has a strong relation with dairy farmers and thus provides assurance of abundant supply of fresh milk. Moreover CDC is one among the two companies in Australia who has the CIQ (China Inspection Quarantine Certification) for rapid clearance of milk from Australia to China. After the announcement of binding contract with this company, the share price of AUSTRALIAN DAIRY FARM GROUP has increased by incredible 279% (Ryan Newman, 2015).

The security holders are from professional investors list across the world namely from Canada, New Zeeland, Singapore, Hong Kong and Australia. The company is presently located at Brucknell farm hub and Camper down dairy company is only 30 mins drive from this location.The management currently provides strong focus on the export strategy to China and other Asian countries – this would be the key driver of future growth. South Western Victoria has currently 7 dairy farms owned by Australian dairy.

The composition of customer base has evolved significantly over the years. The sales to Aussie Farmers Direct constitute 44.6% of total sales. Export growth has substantially increased due to emerging demand for Australian fresh milk in China.

The market structure in milk processing industry in Australia can be characterized by oligopoly. Oligopoly is characterized by few firms dominating in the industry with larger market share. Murray Goulburn (MG) is considered as one of the major rival accounting for approximately 37% of the national output of milk production (Dairy Australia, 2015).Oligopoly market is also subject to huge barriers to entry. CDC has obtained the China Inspection Quarantine Certification, the custom clearance needed to enter in Chinese market to sell fresh milk and Yoghurt. This CIQ acts as a material barrier for other sellers to enter in the market. Since the market is imperfectly competitive, Australian Dairy Farm Group faces downward sloping demand curve. It implies the company enjoys significant market power and has a substantial control over its price. In order to maximize profit, the firms operate at the point where marginal revenue equals to marginal cost. As an oligopoly firm, the company can earn positive economic profit both in the short run and in the long run. Since the firm is operating under imperfect competitive market, the price is greater than marginal cost. Neither the allocative efficiency nor the productive efficiency can be obtained in oligopoly.

The dairy products like milk, butter or Yoghurt are inelastic in demand due to less availability of substitutes. Inelastic demand implies the consumption is less responsive to price changes. If the firm wants to increase their total revenue, they can raise the price of the products. An increase in price will lead to reduce the consumption in a lesser magnitude thereby increase the total revenue. They can have a higher mark up over the marginal cost. Most importantly, the firms are very much interdependent to each other. While implementing any change in business strategy, each firm will consider the immediate response of their rivals.

1. Production costs and scale:

• importance of cost :

Cost of production plays a pivotal role in every business since it has a direct impact on the profitability. Any increase in cost of production would directly reduce the profit margin. Economic theory identifies various types of costs: fixed cost, variable cost, accounting cost, opportunity cost. Fixed cost is the cost that does not depend on the output produced. Fixed cost remains constant irrespective of the output produced. On the other hand variable cost is directly related to the output produced.

• Fixed cost and variable cost in dairy industry:

As far as the dairy farm industry is concerned, the overhead cost does not depend on the number of cows or the quantity of milk produced and sold by the farmers. The fixed cost in farming industry includes rent, lease, and government land, insurance, repayment for loan and other fixed financial obligations. Fixed costs are the business expense that are unavoidable and has to meet each year.

Feed cost is one of the largest variable cost for the farming industry. Other variable costs include, fodder, fertilizer, storage cost, transportation and truck load cost, labor cost, repair and maintenance cost various instruments used in the industry. Fertilizer is a key input to support pasture growth. Feed cost plays a crucial role in dairy farming. If the farmers tempted to reduce the feed cost by reducing some ingredients during the harder economic times, the milk income will reduce overtime through the reduction of milk production. Thus managing the cost of production is vital and definitely considered as challenging during the recent hard times of falling milk prices. As long as the price comes down below the average variable cost, the dairy farmers must continue the business operations even though they incur some loss. This is because they can recover some of the fixed cost by staying in the dairy business (Pepin R, 2009).

• Economies of scale and diseconomies of scale:

It is more likely that consolidation will continue in Australian dairy farm group – this would in turn increase the herd size and farmers would eventually obtain economies of scale. When the larger firms are able to achieve economies of scale, it would provide competitive advantage and stable profit. But cost disadvantages in terms of multiplant diseconomies of scale may also occur from managing multiple facilities in the same line of business.

• Macro business environment:

• importance of macroeconomic environment for business:

Macroeconomic environment is crucial for every business. Macroeconomic environment refers to the overall economic activity of the domestic economy. The historical trends of major economic indicators provide a broader perspective about the health of the economy. Macroeconomic environment is closely related to business cycle and the phases of business cycle directly influence the business growth. A favorable macroeconomic environment is essential for every business to grow because it determines the consumers’ ability and willingness to pay on one hand and firm’s ability to produce on the other. Let us examine the macroeconomic environment of Australia and analyze how far it is conducive for Australian dairy farm group.

• Current state of the economy:

Australia has shown significant economic prosperity during the last few years. The economy has shown a rapid pace of economic growth particularly after adjusting the economic liberalism with the process of globalization. Australia is blessed with the abundant supply of natural resources like copper, iron ore and many other precious minerals. The economy has enjoyed substantial comparative advantage in mining and agricultural products for a longer period of time. But the economic landscape of Australia’s economy has significantly changed. China’s economic slow -down and the continuous trend of falling global commodity prices have a massive impact on the mining and agriculture sector. As the price of iron ore and other resources are falling, mining industry realizes a drastic fall in their profits. Eventually the mining boom in Australia has come to an end. It has also lost the long standing glory of manufacturing production at the global level. Automobile production has come to a complete halt. As a consequence the economy has undergone a structural transformation and looking forward to diversified drivers of growth. From a mining and agro based economy, Australia has now gradually moving towards a service economy.

• The future of export growth:

China’s economic slow -down will have a little impact on Australia’s dairy industry. This is because milk is a normal good rather a necessity with huge nutritious value. Growing numbers of Chinese consumers have generated a keen preference and taste for Australian fresh milk. This is reflected in the increasing demand for Australian milk and dairy products from china as well as other developing Asian economies. Moreover the demand for milk is largely inelastic due to less availability of its substitutes. The export growth is expected to stay strong because of the depreciation of Australian dollar in the international foreign exchange market. Devaluation of AUD will make the Australian milk products cheaper to foreign countries and encourage the exports. Though RBA has kept the inflation target at 2-3% level, the actual inflation in Australia is lower than the target level. Lower inflation trend provides a strong signal of weak economy. Farmers across the industry are experiencing huge economic challenges because of the sharp fall in milk prices.

With the help of suitable fiscal and RBA’s monetary policy, the economy is expected to restore macroeconomic stability and operate at full employment level. Overall the macroeconomic environment is favorable for Australian dairy farm group to expand their business operations in 2016 and beyond (Wade M, 2016).

• Sustainability practice of the business

• Negative externality associated with dairy industry:

Livestock is a huge threat to the environment. Farming animals have a huge commercial value especially in an economy like Australia. It is also considered as a valuable source of food. Cows, sheep and other livestock in dairy industry are the private property with absolute ownership of the farmers. They have the right to use the grass for graze where no one can restrict them. Even if we assume a large pasture for grazing, the grass eaten by one farmer’s cow would definitely reduce the amount of grass available for other farmer’s cow. The consumption is rivalry but non excludable- every farmer has the right to use the commons. Without any property rights and restrictions, overgrazing will ultimately lead to deforestation and environmental degradation. Overgrazing eventually reduce the power to regenerate and destroy the common resource for all. Economic theory defines this as tragedy of commons and considers as market failure. Farmers have an economic incentive to own more cows as it provides sufficient economic gain to them. But if this trend continues, the economy will gradually worse off as market fails to allocate the resources efficiently.

Livestock farming significantly contributes to greenhouse gas emissions- methane emissions and nitrous oxide emissions are the primary contributors. Moreover, livestock farming leads to ecological imbalance that is harmful for humankind. It causes the loss of bio diversity, deforestation, land degradation and pollution.

• Animal Welfare:

Animal welfare is an issue of growing concern today. Animal welfare refers to the sensible, ethical and fair business practices that are positively concerned about their welfare. Dairy farming must aim to keep the animals free from hunger, thirst, pain, injury, mal nutrition – we must treat in the manner that causes the animal least suffering. But Australian dairy industry is treating cow and milk producing animals in a way that significantly affects the normal patterns of animal behavior. Farming animals are considered as the private property with absolute ownership of the farmers. When a common property resource is privatized, the issue of equity and efficiency will typically arise. But research study has observed that farming animals in Australia do not have any legal protection from inhuman and cruel practices.

• A drastic drop in milk price:

Australian dairy industry is currently facing huge economic challenges due to various reasons. The industry is in a state of huge crisis today. Leading milk processors like Fonterra and Murray Goulburn have reduced the raw milk price by 10%.NZ-based Fonterra is world’s leading milk exporter and Murray Goulburn is Australia’s biggest milk producer. Hence their decision on pricing has huge impact on the dairy industry. Dairy farmers are struggling because the price what they have received now have come down below the cost of production. They even look forward to break even this year (Wothington B & Fitzgerald, 2016).They are putting sincere efforts to cut their cost of production either by reducing the number of cows or using the home grown feed. Due to drastic drop in milk prices, farmers are losing thousands of dollars in every month. They have no other option but to sell the cows to meet up the mounting debts. The dairy farmers in Australia particularly in Victoria are incurring huge debt in every month. This debt burden ultimately leads to cruel husbandry business practices- according to ABC’s Four Corner’s report Australian farmers are slaughtering upto 700 cows every week. Moreover the farmers are expecting further price fall in the next year. Global market provides string indication that prices will further drop in the long run and there is no way that the dairy farmers can withstand the crisis. Due to lack of long term contract and mounting debt burden, the long term sustainability of the business becomes a growing concern today (Coletta F, 2016).

Conclusion:

Australian economy has undergone huge structural transformation as their mining boom came to an end. Australian Dairy Farm Group has a significant contribution to economic and social wellbeing of Australia. But the future outlook and the long term viability of the business are not much promising. The industry is experiencing numerous challenges that would affect the sustainability of the business in the long run. The industry is very much dependent on water availability but currently facing uncertainty on water policy.

Government can impose some legal restrictions in dairy industry to address the issue of animal welfare and environmental degradation. Initiative must be taken to make a gradual change in our diet – to a plant based or less resource intensive diet. Less the demand for animal food, lower will be consumption and production of livestock. Consumers must shift their demand from animal products to vegetation based diets. We can also convert our diet from dairy milk to soya milk because the soya milk has less carbon footprint and thus environmentally feasible. A major shift of consumer food preference will help to mitigate the climate change and internalize the market failure. Policy initiatives in terms of imposition of tax on meat and other livestock products are considered as a feasible option.

Some private policy initiatives can also serve the purpose. Nonprofit organizations can put sincere efforts to convince the community people about the environmental concern of the livestock production and the potential advantage of sustainable agriculture. Private individuals and the organizations can use the instruments that are less expensive than the conventional tools because they invest more on the activities and promise higher returns.

At the bottom line, the export growth of raw milk and other dairy products have a promising future because the demand in developing countries will continue to remain strong despite the volatility in prices (PWC, 2011).