Fonterra/Nestlé joint venture: A change of balance in Chile

Nestlé SA and Co-operative Group announced in late November plans to establish a joint venture for chilled and liquid dairy products in Chile. The joint venture will involve the manufacturing, retailing and distribution of liquid milks, yoghurts, desserts, fruit juices, cheese, cream, butter and margarine in Chile. It is being submitted to the Chilean antitrust authorities and remains subject to regulatory approval.

A part of Dairy Partners Americas (DPA)

The two companies will each hold 50% of the new company, which will be called DPA Chile. It will be part of the Dairy Partners Americas (DPA) alliance, which was established between Nestlé and Fonterra in 2002, under which a number of local joint ventures have been launched in Latin America.

Fonterra’s dairy ingredients and export business in Chile – Prolesur – will remain outside DPA Chile. Other parts of Nestlé’s dairy business in Chile, including milk powder, condensed milk and export products, will also remain outside the auspices of DPA Chile.

Industry insiders suggest that this new venture should provide new growth possibilities in a market that is becoming increasingly added value-oriented. Fonterra and Nestlé are positioned in complementary dairy categories and therefore are in a privileged position to achieve economies of scale through both commercial and production agreements.

Market background

Health innovation drives demand for drinking milk products in Chile

Drinking milk should see retail growth of 5% in current value terms to reach CLP380 billion for the whole of 2010, with fortified and functional milk having been the primary drivers of growth. The category has also become more segmented in recent years, and 2010 has also seen new product launches custom designed for different health needs.

For example, Nestlé launched a new Svelty line of powder milk for different health issues, such as Calcilock (for stronger bones), Digestión (with fibre to aid digestion) and Corazón, designed to promote heart health thanks to its omega-3 fatty acid content. Meanwhile, as consumer awareness of lactose intolerance has risen, lactose-free milk has also made inroads in the category, thanks in large part to new product launches and redesigned packaging from Soprole.

Functional yoghurt goes from strength to strength

Other functional drinking yoghurt put in a strong retail performance, posting growth of 12% in current value terms. The category remains in its infancy in Chile, meaning it has still been gaining new supporters throughout 2010. In general, functional yoghurts have performed better than standard varieties in large part because many Chileans suffer digestive problems due to poor dietary habits. Many functional yoghurt products are expressly promoted as a way to alleviate such problems.

Staple status constrains value added opportunities for cheese

Cheese is predicted to see retail current value and volume increases of 4% in 2010, with retail value sales surpassing CLP340 billion. Despite attempts to innovate and introduce new products, Chilean tastes in cheese remain rather traditional, especially with regard to hard cheese. The category has seen attempts to innovate and introduce a wider variety of products, but nearly 90% of hard cheese sales were accounted for by mild yellow varieties such as Mantecoso, Chanco and Gouda. According to industry sources, most hard cheese is consumed with bread at breakfast or tea time, or used to make empanadas. Consequently, it is viewed as something of a basic staple for these uses and most consumers are not willing to pay a premium for something more sophisticated.

Competitive environment

Fonterra Co-operative Group and Nestlé continued to lead the dairy category in 2009, accounting for 23% and 21%, respectively, of retail value sales.

Fonterra led the yoghurt category, accounting for 44% of total sales in 2009. The company was followed by Nestlé, which commanded a 17% retail value share the same year. Two multinational brands were the most popular in Chile – Soprole (Fonterra) and Nestlé. While Soprole managed to maintain its share, the Nestlé brand fell behind in terms of innovation and did not perform as well.

Fonterra took second position in cheese, accounting for 17% of retail value sales in 2009. This represented a 0.4 percentage point increase on the previous year as Fonterra continued to take share from smaller producers thanks to its significant economies of scale. The share of private label remained close to negligible, accounting for less than 1% of sales in 2009.

Nestlé’s core strength within Chilean dairy products lies in drinking milk products, a category in which it is the clear leader. The company accounted for around 38% of total retail value sales in 2009, but also saw its share decline by nearly two percentage points from 2008. The main reason for this was its decision to withdraw the Nestlé brand from liquid milk in order to focus on powder milk, where its brands have a stronger presence and greater local consumer recognition.

Market implications

Economies of scale resulting from the merging yoghurt, cheese and drinking milk production facilities could lead to a decline in dairy manufacturing costs. Given the importance of both companies to the Chilean dairy market, the newly-formed venture – assuming it receives regulatory approval – might result in the greater affordability and more widespread retail distribution of added-value drinking milk and yoghurt products in Chile.

Overall, such a development could also accelerate the expansion of the dairy consumer base into lower-income groups and improve current volume growth projections over the medium term. According to Euromonitor International’s latest estimates, Chilean dairy products are forecast to grow by 10% in retail volume terms between 2010 and 2015.

As for the broader implications on the competitive environment of the Chilean dairy market, the newly-formed joint venture is likely to put smaller local players under even greater strain. Local manufacturers should adjust to this new scenario by stepping up co-operation agreements or even mergers in order to maintain competitiveness against the combined forces of Nestlé and Fonterra over the medium term. Alternatively, smaller Chilean manufacturers could ensure survival through greater specialisation in high growth niches, which could include the introduction of organic, functional or locally-flavoured dairy lines targeting premium consumers in urban areas.