Lotz discusses how Arla is tackling flat European markets

Lotz discusses how Arla is tackling flat European markets

Scandinavian dairy giant Arla Foods is growing apace outside Europe. In contrast, it is facing sluggish consumer sentiment and a highly promotional environment within Europe, where the company remains focused on growing ahead of the dairy category while also expanding its milk supply in the region. In part one of this two-part interview, Arla chief financial officer Frederik Lotz spoke to just-food about the group's priorities in core European markets.

Earlier this month, Arla Foods booked a bumper set of full-year results. Growth was driven by expansion in dynamic emerging markets for dairy, which drove a headline-grabbing 16.6% rise in group revenue.

Arla's sales grew 35% in Russia and 60% in China, highlighting booming demand for dairy in these countries. The Scandinavian company is focused on expanding in the priority markets of China, Russia, the Middle East and Africa. Nevertheless, Europe - where the company generates more than 70% of its revenues - remains core.

Arla's top-line performance in Europe lacks some of the momentum it sees elsewhere in the world. The company admits revenue growth in these mature markets is constrained by a highly promotional and price sensitive environment, which is shaped by weak consumer sentiment and intense competitive pressures.

The group booked an increase in organic sales in the region of 3.5%, well ahead of the flat market. According to Arla CFO Frederik Lotz this expansion can be attributed to market share growth.

"Overall we do see market share growth. In the UK, for example, we have seen for the past few years our added-value spread business like Lurpak has been eating into our competitive territory, taking market share. We have seen similar development in Germany. We are seeing growth over and above a European market that is virtually flat so the 3.5% growth that we do see in Europe organically is a token of that market share development," Lotz tells just food.

Arla is expanding its share of sales in Europe by strengthening its brands, which include Castello, Lurpak and Anchor. The company is applying the familiar formula of investing in marketing and innovation to keep its brands at the forefront and influence purchasing decisions.

"The market is not expanding. We have a number of strong brand - like Lurpak - that really we see growing through innovation, such as the introduction of Lurpak Lightest. It is innovation like that that brings value to the consumer and makes them willing to pay that extra margin to get something that is really second to none in terms of quality and taste."

Arla has indicated it hopes to generate 10% of total revenue from new products. Over the last 12 months, Arla has introduced a variety of new products that it hopes address specific needs. These range from organic brand Arla Bio, which was rolled out in Germany last September, to expanding its range of Lactofree milk and the introduction of a flavoured milk brand, Wing-Co., in the UK in 2013.

Lotz says the company is "significantly stepping up" its efforts around NPD because innovation is essential to position the company as a "value player" in Europe.

"Over a period of four or five years, 2012-17, we aim to double our spend on innovation overall. We believe that the payback - and the need for that - is an integral part of being a value player in the market. There really is a demand and a need also to continuously innovate in the face of the consumer that increasingly is looking for new inspiration, whether it is in cooking, a special occasion or everyday."

As part of that strategy, Arla is opening a new research and development site in Denmark. The facility, which will be located near an existing site in the Danish city of Aarhus, will see an investment of DKK270m. Construction is slated to start in the spring and is expected to be completed by the third quarter of 2016.

Lotz says: "We will be opening in Denmark, what we believe at that time will be the leading global innovation centre for dairy products. So we are significantly investing in that area. We believe that [European] markets can be preserved, but the markets remain highly competitive."

A major driving force behind the competitive nature of European dairy markets is the strong uptake of private label in the category, which results in pricing pressure, Lotz suggests. However, Arla believes it can defend its brands against the incursion of lower-priced retailer brands while also working with retailers to meet this need.

"There is still a lot of pressure from discount private label in Europe in general. We also very much operate in private label and embrace that market. But it does bring a pricing pressure into the competitive market that we see," Lotz explains.

Arla has been able to grow sales of both private label and branded items but private-label sales are growing at a faster pace for Arla in Europe, he continues. Lotz expects growth of private-label sales to continue to accelerate.

"We had growth in both areas [last year]. We continue to see an over-proportion of growth in private label because that is really where the consumer is. Not only in dairy products but in general we do see across categories in the supermarket - a general trend towards private label. We are following that trend. There is more growth in private label. But we do still see significant pockets of growth in our branded business. We believe that part of our successful relationship with retailers like Tesco or Asda is that through strong global brands we can really bring value to the category overall and help lift the value of dairy."

Arla has set a margin target for profits to stand at 3% of sales and the company achieved this in 2013. But will growing sales of cheaper private-label products stand in the way of Arla's margin targets?

"No we don't think so. Our response to that is twofold. One of course is that the company strives to take out costs. So we would be merging plants, shutting down plants, increasingly building larger facilities. Last Fall we opened the largest global fresh milk dairy just outside London in Aylesbury. These initiatives allow us to set new standards for what you can produce high-quality products for. That is one response. The other is we are significantly stepping up our efforts and investments in innovation, marketing, branding."

In addition, Lotz stresses the price Arla pays its owner farmers - its "performance price" - is one of the key measures of the co-operative's financial health. This, he suggests, relates more to the trends on the global stage than the pricing pressure dairy processors are experiencing within Europe.

Lotz explains: "Increasingly the price for dairy products is not being set in Europe. Increasingly the price is being set outside Europe. There is structurally a global demand for dairy products that is growing faster than supply, [sending] global milk prices to record levels. Really, it's primarily driven by what is going on in China and Asia."

As such, one of Arla's key missions is to secure greater supplies of milk from European farmers. To this end, Arla has completed a series of mergers and acquisitions in the region in recent years - including the combinations with Milk Link in the UK and with Milch-Union Hocheifel in Germany.

Lotz observes: "We a lot over the last two or three years. In 2010 we had a turnover of EUR3.5bn. Three years on in 2013 we are a EUR10bn company. A lot of that comes from those mergers. When it comes to the UK we feel very good about our position. The merger with Milk Link in 2012 gave us a very strong foothold on the cheese market, we are now clear number one overall. When it comes to Germany I think that you may see more action I think this year or next year. There is still a market that needs to be consolidated there.

"But we also need to get more milk. The demand that we see outside Europe really requires us to find more milk. As you translate the mergers and acquisitions that we make in Europe - Germany and the UK - in many ways it's not only to take out cost it is also to find the milk that we believe we can convert into highly value-added dairy products to be exported outside Europe, at very good profit."

As Arla drives market share gains and expands in private label in the flat European markets, it is also rapidly expanding in key non-European markets. For more on what this will mean for the group - and the impact it will have on Arla's margin structure - click here for part two of the just-food interview.