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Indonesia'sDairy Farming IndustrySWOT Analysis - 2005

Prepared for:

Directorate General of Livestock Services, Indonesia

Under a Research Project Funded by:

Dairy Australia

Prepared by:

Stanton, Emms & Sia391A Orchard Road, #12-01

Ngee Ann City Tower A,Singapore 238873

Tel: (+65) 6334 7030Fax: (+65) 6223 2010

E-mail: [email protected]

September 2005

Indonesia Dairy Farming Industry SWOT Analysis - 2005 Table of Contents

September 2005 i

Table of Contents

Page No.

1. Introduction and Indonesia in profile 11.1 Introduction 11.2 Envisaged use of this report 21.3 Indonesia in profile 3

1.3.1 Indonesia's population 31.3.2 Indonesia's recent economic performance and

future economic prospects 31.3.3 The Indonesian market for dairy products in

overview 4

2. The dairy farming industry in profile 82.1 The key organisations involved in the dairy farming

industry today 82.2 The development policy and macro management

environment in Indonesia today 92.3 The areas of activity and responsibility of organisations

involved in the dairy farming industry today 122.4 Milk production trends 132.5 Industry size and structure 142.6 Indonesia's national dairy herd in profile 152.7 Review of performance indicators for the dairy farming

industry 162.8 The market for local raw milk in overview 17

2.8.1 Raw milk usage today 172.8.2 Usage of local raw milk by Indonesia's milk

processing industry 19

3. Issues of importance to future industry development 223.1 Overview of major issues 223.2 The climate and its impact on the industry 24

3.2.1 Overview of rainfall patterns on Java Island 243.2.2 Practical problems arising from water supply to

dairy farmers on Java Island 253.2.3 Practical problems arising from feed supply to

dairy farmers on Java Island 283.3 Milk pricing 31

3.3.1 Milk price determination 313.3.2 Milk production costs 313.3.3 The structure of milk pricing and opportunities for

farmers 323.4 Investment planning, investment project activation and

financial reporting 383.4.1 Investment planning and investment project

activation 383.4.2 Financial reporting 41

Indonesia Dairy Farming Industry SWOT Analysis - 2005 Table of Contents

September 2005 ii

Page No.

3.5 Regulatory environment change 46

4. National SWOT analysis for the industry 514.1 Introduction 514.2 Opportunities and challenges arising from factors external

to the industry 514.2.1 Economic factors 514.2.2 Climate, geography and feed resources 534.2.3 Policy, legal and fiscal factors 544.2.4 Social and cultural factors 574.2.5 Technological and R&D factors 594.2.6 Factors in the dairy product supply chain 614.2.7 Commercial, government and aid funding factors 624.2.8 Factors in the local market and its characteristics 644.2.9 Factors in the milk processing industry, its

bargaining power and basis of competition 65

4.3 Internal strengths and weaknesses of the dairy farmingindustry 664.3.1 Industry strategy 664.3.2 Industry infrastructure and resources 674.3.3 Management of the industry 714.3.4 Technology and technical aspects 734.3.5 Dairy farming operations 764.3.6 Marketing and the supply chain 81

5. Conclusions and recommendations 835.1 The dairy farming industry is now operating in a new

regulatory environment 835.2 Overview of operational opportunities and challenges for

Indonesia's dairy farming industry 845.3 Recommendations to the Directorate General of Livestock

Services, Indonesia 85

Appendix: Canada's Indonesia Co-operative Development AssistanceProgram (INCODAP), Phase II

1. Program description 12. Expected outcomes 13. The co-operative modernisation and upgrading

component of the INCODAP II Program 34. Summary conclusion for the INCODAP II

program (1994 to 2004) 7

Foreign exchange note: All translations of Rupiah data into US$ have been made at the rateof Rp 9,000: US$1.00.

Indonesia's Dairy Farming Industry SWOT Analysis - 2005 Introduction and Indonesia in Profile

September 2005Stanton, Emms & Sia

1

1. Introduction and Indonesia in profile

1.1 Introduction

This report has been prepared for the Directorate General of Livestock Services (DGLS),Department of Agriculture Indonesia and Dairy Australia.

This study was commissioned as a result of discussions in Melbourne in March 2005 of theIndonesia Australia Working Group on Agriculture and Food Co-operation Taskforce onLivestock and Animal Products. Dairy Australia provided the funding for this study. Theopinions expressed in this report are not those of Dairy Australia or its management.

The main objective of the research was to produce a detailed SWOT (Strengths, Weaknesses,Opportunities and Threats) analysis that takes a view of the situation regarding thecommercial development of Indonesia's dairy farming industry in the post-1998 environmentfor trade in dairy products.

Many studies have been performed on the Indonesian dairy farming industry in the past butnone of these has considered the future strategic direction of the industry in a commercialenvironment similar to that existing in Indonesia today. Most of the past studies wereperformed by academics or government officials in an environment where:

! The now defunct Milk Ratio existed; and

! The main focus of industry strategists was on developing commodity suppliers for themilk processing industry rather than entrepreneurial farming businesses.

As scenarios in Indonesia are quite complex for small-holder farmers, the analysis providedin this report is detailed so that it establishes a baseline from which a realistic problemsolving analysis can be performed by the Indonesian government.

The research that supports the contents of this report included:

! Desk research;

! Interviews with government officials, co-operative and company management andacademics in Indonesia, Australia and Japan that are involved, or have been involved, atvarious levels with or in Indonesia's dairy farming industry; and

! Observations made within the industry, its supply chain and market.

Senior management from the DGLS assisted in some of the data collection, some surveys andsome of the interviews that were conducted as part of this study.

The organisations that have supplied information for this study include:

! The Department of Agriculture Indonesia and the Dinas Peternakan in West Java, CentralJava, East Java and North Sumatra;



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! The Provincial Governments of West Java, Central Java, East Java and North Sumatra;

! Biro Pusat Statistik Indonesia, the Ministry of Cooperatives and Small and Medium-SizedBusinesses, Indonesia and Badan Meteorologi and Geofisika, Indonesia;

! GKSI and its regional offices;

! The Industri Pegolahan Susu (IPS), PT Unilever Indonesia, PT Nestlé Indonesia, PTFriesche Vlag Indonesia, PT Ultra Jaya Milk Industry, PT Japfa Comfeed Indonesia, PTIndustri Susu Alam Murni, Carrefour Indonesia and PT Tetra Pak Indonesia;

! The Department of Primary Industries, State of Victoria (Kyabram), University ofMelbourne, Glenormiston (Institute of Land and Food Resources), Red Sky AgriculturePty Ltd, University of Queensland (Department of Economics), Universitas Diponegero,Heifer International, the Japan International Cooperation Agency (JICA) and theCanadian Co-operative Association (CCA); and

! The senior management of a number of co-operatives operating in the dairy farmingindustries of West Java, Central Java and East Java, Taurus Dairy Farms and CV CitaNasional. Individual dairy farmers operating in North Sumatra.

! The World Bank group, the Asian Development Bank and a number of international aidagencies, interviewed on a confidential basis.

1.2 Envisaged use of this report

This report is a strategic planning document that can be used by the Directorate General ofLivestock Production Services, Ministry of Agriculture Indonesia, to develop a new longterm and commercially based strategy for the dairy farming industry that is oriented around:

! Maximising on the external factors that provide business and income opportunities forsmall-holder dairy farmers and their co-operative organisations;

! Minimising the impact of external factors that threaten or challenge the small-holder dairyfarmers and their co-operative organisations;

! Improving and maximising on the future usage of the strengths of the dairy farmingindustry that exist today.

! Minimising or eliminating the existing weaknesses of the dairy farming industry that existtoday.

It is the main report in a series of three reports. The other two reports are titled:

! Central Java Dairy Farming Industry SWOT Analysis, which also includes an appendixtitled "First View" SWOT Analysis for KSU Andini Luhur, Central Java.

! Medan and Karo Highlands, North Sumatra - 2005: A Preliminary Review of the State ofthe Local Dairy Farming Industry and Milk Market.



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1.3 Indonesia in profile

1.3.1 Indonesia's population

Indonesia is South East Asia's most populous country. It has a population of around 220million people today. The population is currently growing at about 1.5% per annum and isexpected to grow to about 240 million by 2010.

Indonesia has a large number of persons under the age of 19 years (see Chart below).

Indonesia in 2004 - % of Population by Age Group

Source: Indonesian Government/ADB

Its young population is positive for future consumer market growth under circumstanceswhere the economy is growing and creating business opportunities and jobs. The personsunder the age of 19 years are tomorrow's large pool of new consumers. This is one reasonwhy consumer product companies, such as Unilever, have invested significant amounts intheir Indonesian businesses over the past 5 years.

1.3.2 Indonesia's recent economic performance and future economic prospects

Indonesia's GDP per-capita was reported at US$ 1,103 (market rate basis) in 2004. Thisequates to about US$ 3,400 when reported on a PPP (purchasing power parity) basis.

Since becoming the second Asian nation to be hit by the Asian currency and economic crisisin 1997/98, Indonesia emerged into a period of relatively stable moderate economic growth(see Table below).

Indonesia's Economic Growth - 2000 to 2004

2000 2001 2002 2003 2004

% GDP growth 4.8 3.3 3.7 4.1 4.8

Source: Indonesian Government and Asian Development Bank.

50 to 59 years7%

More than 60 years8%

40 to 49 years12%

30 to 39 years16% 20 to 29 years

19%

Under 19 years38%



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Indonesia's Other Economic Indicators - 1999 to 2003

1999 2000 2001 2002 2003

GDP per-capita in US$! Nominal 678 717 674 808 963! PPP basis * 2,899 3,056 3,198 3,334 3,490

Inflation rate (consumerprices) 20.5% 3.7% 11.5% 11.9% 2.0%

Rupiah: US$ 1.00 ** 7,085 9,595 10,400 8,940 8,465

*: Purchasing power parity basis. **: Year end rate.Source: Indonesian Government, Asian Development Bank and World Bank

Indonesia's future prospects have strengthened considerably since the election of newPresident in 2004. This event has increased international investor confidence in Indonesiawith a consequent increase in foreign direct investment.

There are now forecasts that the economy should grow at between 5.5% and 6.5% in 2005and between 6% and 6.5% in 2006, subject to the unknown impact of rising oil prices andrelated government policy on this matter. If this happens the economy will experience itsfastest rates of growth since the Asian currency and economic crisis of 1997/98.

Notwithstanding some concerns over an inflation rate of around 6.5% and some slowness inmaking some economic policy reforms, these forecast are positive for development of theconsumer market over the next 3 years or so.

1.3.3 The Indonesian market for dairy products in overview

Indonesia's market for dairy products is sizeable but fragmented due to the nature of itsconsumer market. The ex-factory value of the market was reported to be Rp 7,352.5 billion(US$ 820 million) in 2002 (see Chart below). Imports of retail packed dairy products in thesame year were negligible at Rp 160.5 billion (US$ 18 million) valued on a CNF basis.

Indonesian Production of Manufactured Dairy Products in 2002 - Rp 7,352.5 Billion

Source: Biro Pusat Statistik Survey (Latest Data, excludes farmer's market products)

Infant formula8%

Yoghurt and cultured milk

drinks5%

Other milk-based products

4%

Other milk-based powders

3%Dairy-based ice

cream5%

Liquid milk13%

Milk powder, not infant formula

49%

Sweetened condensed milk

13%



5

Indonesia's key milk processing businesses are well established and sizeable. They are able todefend their markets against imported retail packed dairy products because of:

! Their strong localised brands, which are well known to local consumers. Most importedbrands are not well known to Indonesian consumers and so have never developed anypreference amongst them.

! Their marketing and distribution strengths, including their advertising and promotional(A&P) campaigns. Spending on A&P campaigns is estimated at between 10% and 15% ofgross profit for the leading brands. In contrast, imported dairy products are rarelyadvertised or subject to promotion in the Indonesian retail channels; and

! Price competitiveness against imported retail packed dairy products in the market. In allcases, Indonesian-made dairy products are less expensive than competing imports (seeTable below).

Comparison of Retail Packed Dairy Product Ex-Factory Pricing of LocalProducts and CNF Pre-Import Duty Cost of Imported Products in 2002

Average Prices

Liquid milk (average prices):! Indonesian produced UHT milk Rp 3,877 per litre! Indonesian produced pasteurised milk:

" From milk processing industry Rp 3,853 per litre" From ice cream industry Rp 4,000 per litre

! Imported milk (full fat) Rp 7,020 per litre

Yoghurt (average prices):! Indonesian produced yoghurt Rp 3,563 per litre! Imported yoghurt Rp 15,480 per litre

Ice cream (average prices)! Indonesian produced ice cream Rp 21,742 per kg! Imported ice cream Rp 29,493 per kg

Note: Prices of Indonesian products are average ex-factory prices. Prices of imported products areaverage CNF prices before the addition of landing costs and import duties.Source: Biro Pusat Statistik Indonesia (Averages from import data and manufacturing industry survey)

The differences between the price of imported and local products increases significantly inthe modern retail channels, e.g. supermarkets and hypermarkets, because retailers demandhigher margins from imported brands. Some key points to note on this are as follows:

! The retailer's mark-up of imported milk products results in a situation where the retailprice of imported milk products can be between 2 and 4 times that of an equivalentIndonesian-made product.

! Discussions with upper income group Indonesians in a Jakarta supermarket revealed thatthey prefer reasonably priced and good quality local milk products, e.g. the Greenfieldsbrand, to high priced imported milk products.



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! Discussions with retail management indicate that expatriates who reside in Indonesiagenerally consume imported milk products. For this reason, the demand for imported milkproducts is a very small niche market, when compared to that for Indonesian-made milkproducts.

The structure of production output by Indonesia's milk processing industry is governed bysome realities that exist within the structure of the country's consumer markets, in particularthe ability of consumers to pay for products:

Accurate information on the structure of the consumer market does not exist. Trade sourcesestimate that:

! Indonesia's higher income group consumers number between 2 and 5 million persons,most of whom reside in Jakarta and neighbouring West Java.

These persons are a key target for higher priced products, such as pasteurised liquid milk,yoghurt, premium ice cream and higher quality infant formula and milk powders. Theyinclude expatriate families who are the main consumers of imported products.

! Indonesia's middle income group consumers number between 8 to 15 million persons whoreside in Jakarta and the other cities across Indonesia.

This group of persons is a target for all forms of dairy products, although demand forhigher priced products will not be very strong. Due to the level of their householdincomes, they do not have any specific demand for imported dairy products, althoughthey might occasionally treat themselves to items such as imported confectionery.

This group of consumers currently represents the core of the market for branded packagedfoods because they are volume consumers who frequently consume such foods, especiallythose made in Indonesia and marketed under trusted well known brands owned by Nestlé,Friesche Vlag, Ultra Jaya, Indomilk, etc.

Consumer surveys commissioned by Stanton, Emms & Sia on 500 housewives from thisgroup in 2004 indicate that they are becoming increasingly quality and health consciouswhen making decisions about food they purchase for their families, in particular for theirchildren.

! Indonesia's lower income group consumers who reside mainly in the country's cities andtowns number anywhere between 60 and 100 million persons.

These persons are a key target for household product manufacturers and for foodcompanies that supply shelf stable products, e.g. Unilever. The challenge in building amarket amongst these consumers is their inherent sensitivity towards product prices.

They only have limited demand for branded dairy products manufactured by Indonesia'smain milk processing businesses. The main branded dairy products that are consumed bythese consumers are:

! Sweetened condensed milk; and



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! The small packs of milk powders and infant formula, which are produced specificallyfor this area of the market.

These consumers are an important market for farmer's milk products because they residein areas close to dairy farming areas.

The balance of Indonesia's population, i.e. between 100 and 150 million persons, have verylow incomes and are not thought to represent a major market for any form of dairy products.

Indonesia's Dairy Farming Industry SWOT Analysis - 2005 The Dairy Farming Industry in Profile


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2. The dairy farming industry in profile

2.1 The key organisations involved in the dairy farming industry today

Indonesia has a number of different organisations involved in its dairy farming industry. Allof these organisations have impacts on the development trend of the industry, including on:

! Industry development policy as part of rural area economic development;

! Industry regulation;

! Industry investment and funding;

! Industry and business strategy; and

! Other matters such as technical development, breeding, health and hygiene, farmmanagement and farming skills, marketing and trade.

Four organisations have the most impact on dairy farming industry policy making anddevelopment strategy today (see Chart below)

The Key Dairy Farming Industry Policy Making Organisations

Department ofAgriculture

Provincial andMunicipal

Governnments

The Dairy FarmingIndustry (Co-ops and

Smaller HolderFarmers)

Ministry ofCooperativesand Small &

Medium SizedBusinesses

GKSI

Two other groups of organisations also have influence on dairy farming industrydevelopment through their active involvement with the sector on an operational basis:

! Foreign organisations, mainly aid and technical advice organisations that fund operationalimprovement and advice on future development for the industry. These are based in anumber of countries including Australia, Canada, Japan, the USA and some Europeancountries, e.g. the Netherlands.



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! The milk processing companies that operate in Indonesia. These commercial businessesrun milk treatment centres. They also play an important role in providing technicalservices, advice and even some funding to farmers that are members of co-ops that aresupplying raw milk to their businesses. These businesses include Nestlé, Sari Husada,Indomilk, Ultra Jaya Milk and Friesche Vlag (Friesland Coberco's Indonesian jointventure company).

The other government bodies that have a more limited impact of the dairy farming industryinclude the:

! The Ministry of Health (Food health matters);

! The Ministry of Trade (Trade in milk products);

! The Ministry of Industry (Commercial investment);

! The Interior Ministry (Government staffing); and

! The Ministry of Transmigration and Labour (Provides some cattle distribution andextension services).

The local cooperatives that interact with all of these organisations on behalf of theirmembers, the small-holder farmers, include:

! Dairy farming specific co-ops; and

! Broader based co-ops that contain a dairy farming business unit.

These co-ops are responsible for the operational management of the industry at a localisedlevel, inclusive of technical and financial aspects.

2.2 The development policy and macro management environment in Indonesia today

Macro management of, and policy development for, Indonesia's dairy farming industry isnow more fragmented and complex than it was prior to 1998. Having stated this, theinformation collection system, which covers only limited performance indicators for theindustry, is very similar to that which existed prior to 1998.

The complex situation that exists in 2005 has developed from the increased autonomy thatwas provided to provincial governments after 1998 and related changes in:

! The funding arrangements for rural area and agricultural industry development programs.Funding for such programs is complex and can be provided by central, provincial or localgovernments through a range of different budgetary channels and authorisations; and

! The lines of communication (and responsibility) between the various organisations,especially government departments, that are involved in policy setting and managing ruralarea development programs.



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The changes in funding arrangements have had a direct impact on the structure of lines ofcommunication that exist between:

! Government officials working in the rural areas and implementing rural area developmentpolicies through active local development programs, including extension services; and

! Government officials working in Jakarta that are developing and implementing nationalpolicies on rural area and rural industry development.

While there are many benefits from localisation of government functions through the policyof autonomy, the situation that has evolved in the livestock sector, may have weakened macromanagement of, and policy development for, the dairy farming industry. The evolution offunctions since 1998 has seen:

! A fragmentation of information flows between the various organisations that are involvedin the dairy farming industry; and

! Reduced strategic oversight of the dairy farming industry, such that no single organisationhas a clear understanding about the financial and non-financial performance of theindustry and its component co-ops and farms.

This situation is a challenge for future policy development covering the dairy farmingindustry because it does not provide policy makers with sufficient information on:

! The real issues that need to be addressed within the dairy farming industry throughgovernment policy and related development programs;

! Underperforming and problematic areas within dairy farming industry that need focuseddevelopment assistance through:

" Government funded development programs and extension services; or

" Aid funded development programs.

Taken together with the weaknesses in the performance indicators being used by theIndonesian government to evaluate the dairy farming industry prior to 1998, this has led topolicy activation that is:

! Rather fragmented and, in some cases, "hit and miss"; and

! Not focused on specific goals that are attainable for the dairy farming industry in future,specifically: "success stories that can be replicated on a national basis".

Examples of problems that arise from this situation exist in a range of areas, including:

! Aid program targeting and hand-over/follow up of terminated aid programs;

! Capital investment projects in the co-operative dairy farming sector;

! Breeding programs;



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! The import of milking cows;

! Education and training schemes for co-operatives and their farmer members, especially inview of the Indonesia's new co-operative laws, regulations and guidelines;

! Renewable energy projects, which are likely to become more relevant in view of changesin policy on energy subsidies and the trend in higher oil prices;

! Some aspects of the extension services that are supplied to dairy farmers, which havebeen undermined by funding constraints that have developed since 1998;

! Co-operative financing arrangements and the new demands of Bank Indonesia on banksinvolved in lending to all forms of businesses, including co-ops; and

! The changing climate and its impact on the viability of dairy farms run by small-holderfarmers.

The following chapters of this report provide more details on this study's findings on theabove matters.

No single organisation or individual is to blame for the complex situation that exists in policydevelopment and activation today. The underlying reason for the situation is rapid change inscenarios arising from:

! The autonomy policies and related changes in government funding and channels ofreporting;

! The new laws covering corporate and banking laws (covering loans to agriculturalbusinesses) that developed as a result of modernisation of Indonesian financial servicesindustry law since 1998;

! The freer market scenario for agricultural products that are produced by small-holderfarmers, including liberalisation of previously controlled markets; and

! The new food regulations, which have:

" Already changed / upgraded the quality requirements for ingredients, including rawmilk, that are used in Indonesian-made processed food and drinks, specifically onhygiene issues (bacteria content), food safety issue (approved ingredients) andcontaminants (agricultural residues, including drugs).

" Already identified milk and its products as a product sector for special attentionbecause these products are mainly consumed by infants, children and pregnantwomen.

" Legal provisions that will ultimately see more quality controls applied over farmingoperations that are involved in the production of products for human consumption,including inputs to processed foods, e.g. raw milk.



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Recognition of the changes that have occurred and that a more focused development strategyis needed will provide all government organisations with the opportunity to establish new andbetter co-ordinated policies and programs that facilitate the development of strongerdemocratic dairy farming co-operatives, which:

! Are able to compete more effectively in the quality-focused free market that exists todayand will continue to exist in future; and

! Maximise their member farmers' incomes through new market-oriented businessstrategies rather than the supply-focused strategies of the past.

2.3 The areas of activity and responsibility of organisations involved in the dairyfarming industry today

An overview of the key areas of activity and responsibilities of the main organisations thatare involved in dairy industry policy development and macro management is as follows:

Organisation Area of Activity / ResponsibilityDepartment of Agriculture,including the DirectorateGeneral of LivestockServices (DGLS)

Policy development and implementation for the sector andother direct involvement in veterinary services, sanitationand breeding activities; and development of small-scalemilk processing units in targeted rural areas.

Ministry of Cooperativesand SMEs

Cooperative regulation. Funding of co-operativedevelopment projects. Importing of cattle for use by thedairy farming industry.

Provincial governments,including the DinasPeternakan.

Investment approvals for dairy farming businesses in thearea they govern. Implementation of localiseddevelopment programs and the provision of extensionservices.

GKSI (Association ofIndonesian MilkCooperatives)

Representing cooperative members' interests at nationallevel in milk trade, including negotiating milk price withmajor buyers. Coordination of other activities, e.g. AI,feed supply and technical assistance. The operation ofmilk treatment centres on Java Island.



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2.4 Milk production trends

Indonesia's dairy farmers produced 535.9 million litres of milk in 2004, up from 498 millionlitres in 2000 (see Table below).

Liquid Milk Production in Indonesia - 2000 to 2004

2000 2001 2002 2003 * 2004Tonnes Tonnes Tonnes Tonnes Tonnes

Production 498,009 479,950 493,370 514,170 535,850

% change +14.2 % (3.6%) + 2.8 % + 4.2 % +4.2 %

*: Provisional figure.Source: Directorate General of Livestock Services, Department of Agriculture and GKSI Jakarta

Java Island continues to be the main dairy farming area in Indonesia. It accounted for 97% ofthe nation's milk production in 2004, down slightly from 99% in 2000 due mainly to areported increase in milk production in Aceh in 2003 and 2004.

The Chart below provides an overview of the long-term trends in milk production in WestJava, East Java, Central Java and other areas of Indonesia over the period from 1996 to 2004.

Milk Production in Indonesia in Tonnes - 1996 to 2004

Source: Directorate General of Livestock Services, Department of Agriculture (Provisional for 2004)

The two regions with the most dynamic production activity are:

! West Java, where production has bounced back from the collapse in production thatoccurred during the crisis period of 1998. The provisional figures that have been releasedfor 2004 suggest that West Java has once again become Indonesia's largest producer ofliquid milk.

! East Java, where there has been a gradual increase in milk production over the periodfrom 1996 to 2004.

0

50,000

100,000

150,000

200,000

250,000

300,000

1996 1997 1998 1999 2000 2001 2002 2003 2004

Tonn

es

West JavaEast JavaCentral JavaOther areas



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2.5 Industry size and structure

In 2002, Indonesia had 417 dairy farming organisations (reported as "farms" in official datareleases) comprising of co-operatives and private businesses, up from 342 dairy farmingorganisations in 1999. The industry is highly fragmented:

! The bulk of its component organisations are co-operatives owned by smallholder dairyfarmers.

! The number of farmers in the industry is very high at 92,526 persons in 2004, up 80,931persons in 1999.

An overview of the development trends in the numbers of dairy farming organisations anddairy farmers over the period from 1999 to 2004 is provided in the Table below.

Trends in Dairy Farming Industry Development - 1999 to 2004

1999 2000 2001 2002 2003 2004

Farms:

! Number offarms 342 348 422 417 NA NA

! % change +0.9% + 1.8% + 21.3% ( 1.2%) - -

Farmers:

! Number offarmers 80,931 87,484 88,856 95,597 93,896 92,526

! % change + 0.8% + 8.1% + 1.6% + 7.6% (1.8%) (1.5%)

NA: Data not yet availableSource: Directorate General of Livestock Services, Department of Agriculture and GKSI Jakarta

Based on the above data, the number of new farming organisations being established mayhave peaked in 2001. Additionally, the data for farmers indicates that the number of newfarmers entering the industry may have also peaked in 2002. No information is available onthe reasons for these trends.

No details are available on the financial performance of the dairy farming industry becausethere is no single agency collating, or a system to enable easy collection of, such data. Itshould be noted that:

! Copies of the annual reports of a number of dairy farming co-operatives were collected aspart of this study.

! These annual reports could not, however, be used to develop any form of financial profileof any section of the industry. This occurred because there is no standard reportingsystem being used to prepare the financial statements of dairy farming co-operativesoperating in Indonesia today.



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The Table below provides an overview of the number of dairy farming organisations(primary dairy co-operatives) that have operated in the major dairy farming areas in the mostrecent years for which data is available.

Number of Primary Dairy Co-operatives by Province - 1996 to 2002

1996 1997 1998 1999 2000 2001 2002Units Units Units Units Units Units Units

East Java 185 185 181 185 187 139 150West Java 45 44 43 44 46 148 136Jakarta 28 28 28 27 28 70 72Central Java 75 75 74 74 75 48 48North Sumatra 5 5 5 5 5 4 4Yogjakarta 7 7 7 7 7 3 3

Total no. offarms 345 344 339 342 348 422 417

Source: Directorate of Farming, Department of Agriculture

2.6 Indonesia's national dairy herd in profile

Indonesia's milk cow population was reported at 379,632 cows in 2004, up from 341,000 in2000 (see Table below).

Indonesia Dairy Cattle Population (Milking Cow Only) - 2000 to 2004

2000 2001 2002 2003 * 2004Head Head Head Head Head

National herd 341,000 346,998 358,386 368,470 379,632

% change + 2.7% + 1.8% + 3.3% +2.8% +3.0%

*: Provisional figure.Source: Directorate General of Livestock Services, Department of Agriculture and GKSI Jakarta

Average growth in the numbers of milk cows in the national herd was low at about 1.7% perannum over the period between 1996 and 2004. The Chart below provides an overview of thelonger term trend in milking cow herd development in Indonesia



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Milking Cow Population in Indonesia - 1996 to 2004

Source: Directorate General of Livestock Services, Department of Agriculture and GKSI Jakarta

This period saw:

! The decline of West Java's milking cow population in the period of the economic crisisfollowed by a gradual rebound in the size of the province's milking cow herd from 1999onwards.

! A gradual increase in the milking cow populations in East Java and Central Java.

! Relatively static herds of milk cows in other parts of Indonesia.

2.7 Review of performance indicators for the dairy farming industry

As mentioned earlier in this section, there is no financial data readily available for theindustry so performance is generally reviewed based on the range of non-financial data that iscollected for the industry.

The Table below provides an overview of national performance indicators based on availabledata.

National Performance Indicators for Indonesia's Dairy Farming Industry - 2000 to 2004

2000 2001 2002 2003 * 2004

Litres of milk permilking cow per annum 1,460 1,383 1,376 1,395 1,411

Number of milking cowsper farmer (average) 3.9 3.9 3.7 3.9 4.1

Litres of milk per farmerper annum 5,692 5,401 5,161 5,476 5,791

*: Based on provisional data.Source: Averages based on data provided by the Dept of Agriculture and GKSI Jakarta

0

20,000

40,000

60,000

80,000

100,000

120,000

140,000

160,000

1996 1997 1998 1999 2000 2001 2002 2003 2004

Hea

d of

Milk

ing

Cow

s

East JavaCentral JavaWest JavaOther areas



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The above averages are underpinned by differences in performance in the different areas ofIndonesia. In particular, average annual production of milk per milking cow variessignificantly from province to province (see Table below).

Average Annual Production of Milk Per Milking Cow - 1996 to 2004(Major Production Areas Only)

Source: Based on data supplied by the Dept of Agriculture, Indonesia

Based on the data supplied by the Department of Agriculture, productivity improvements arebeing seen in West Java and East Java. In contrast, productivity in Central Java has notincreased but has remained similar over the period from 1996 to 2004. A supplementaryreport covering Central Java provides more information about the low level productionstatistics that are being reported for this province.

2.8 The market for local raw milk in overview

2.8.1 Raw milk usage today

Raw milk is used in a number of different ways in Indonesia (see Chart below). The mainuses are as follows:

Raw Milk Usage in Indonesia in 2004

Source: Estimates from DGLS, GKSI and trade sources

0

500

1,000

1,500

2,000

2,500

3,000

1996 1997 1998 1999 2000 2001 2002 2003 2004

Litre

s pe

r milk

ing

cow

West Java East JavaCentral Java

Calf feed5%

On-farm processed

5%

Direct consumption

10%Used by the milk

processing industry

80%



18

! It is sold as an ingredient to the country's large milk processing industry. This representsabout 80% of raw milk sales in 2004. The farms involved in this activity are principallyingredient (raw milk) suppliers to this industry. The sales transactions are arranged:

" Centrally through GKSI; or

" By a non-GKSI co-operative that has negotiated a supply contract with a milkprocessing business.

This area of the dairy farmers' business is the base upon which the industry in West Javaand East Java has been developed. Some key points to note on this are as follows:

" There is generally a very high level of reliance on the milk processing industry as acustomer for raw milk in these areas.

" This high level of reliance arises because of longstanding government policy thatpromoted developing links between dairy farmers and milk processors that are notpart of the farmers' organisations, rather than developing independent market orientedco-ops that include their own milk processing capabilities.

Today, this government policy revolves around the concept of PIR ("Pola Inti Rakyat"or "Program Inti Rakyat") systems, known in English as "Small-holder NucleusFarming Scheme", under which business relationships are encouraged between a largecorporation (as the buyer) and a group of small-holder farmers (as the supplier).

! It is used by localised co-operatives to produce their own end products, e.g. liquid milkand yoghurt, for sale into local markets. This represents about 10% of raw milk sales in2004. The farms that are involved in this activity:

" Are located in areas that are too distant from milk processing factories to becomeinvolved in sale transactions with them; or

" Are producing:

- Poor quality raw milk that does not meet the requirements of the milk processingfactories; or

- Quantities of raw milk that are surplus to the requirements of the milk processingfactories. Local trade sources comment that situation arises for two reasons:

♦ In some cases, the production of raw milk that cannot comply with thepurchasing criteria of the milk processing industry, especially on productquality; and.

♦ In other cases, because the capacity of some raw milk processing plants is notsufficient to cope with such a high volume of supply. Additionally, demandfor liquid milk and yoghurt is still at a developing stage in Indonesia, so somebusinesses do not yet find it commercially viable to invest in new productioncapacity for this surplus raw milk.



19

Having stated this, the IPS has confirmed that its members have the capacity toabsorb all high quality raw milk that is supplied by Indonesia's dairy farming co-operatives.

! It is used as part of the feed rations for calves that are being fattened up on the farms. Thisrepresents about 5% of raw milk sales in 2004.

The farms that are involved in this activity appear to be marginal dairy farms that haveproblems selling their milk to users. In some parts of Central Java, calf rearing hasbecome an important part of the business of small-holder farmers that keep dairy cows.Such farmers routinely use their raw milk to feed their calves.

2.8.2 Usage of local raw milk by Indonesia's milk processing industry

Unfortunately, due to a lack of centralised records on sales by co-operatives that are notmembers of GKSI, it is not possible to identify, with any accuracy, the total amount of locallyproduced raw milk that is being purchased by the milk processing industry.

Estimates obtained from trade source for a study performed in 2002 indicated that just over90% of liquid milk produced on Java Island was sold to milk processing industry in 2000. Ashighlighted earlier, this percentage has declined because raw milk production output hasgrown at a faster pace than demand from the milk processors. While the industry hasperformed well on a volume basis, the weaknesses in product quality has undermined thesaleability of the additional raw milk supply that has developed since 1998.

It is evident that raw milk produced by Indonesian farmers is an important input for the milkprocessing industry. Sales by GKSI member co-operatives to the industry amounted to376,600 tonnes of unprocessed raw milk valued at Rp 654.9 billion in 2002, up from 313,085tonnes valued at Rp 305.3 billion in 1998. Over this period, GKSI sales to the industryincreased at about 4% per annum and then flattened out in 2003 and 2004 (see Chart below).

GKSI Sales of Raw Milk to the Milk Processing Industry - 1997 to 2004

Source: GKSI

0

50,000

100,000

150,000

200,000

250,000

300,000

350,000

400,000

450,000

1997 1998 1999 2000 2001 2002 2003 2004

Tonn

es



20

Discussions with the management of co-operatives (as part of this study) indicated that someco-ops, which are not members of GKSI, are also selling raw milk to the milk processingindustry. This situation is arising for two reasons:

! Better returns from direct sales transactions with milk processing companies; and

! In some areas, e.g. Central Java, co-op management unhappiness with GKSI as anintermediary between their operations and the milk processing companies. This situationwas reported to be one reason why a change in GKSI Central Java management occurredat a general meeting of its members in early June 2005.

In some areas, local trade sources have indicated that:

! There is a developing trend towards more co-ops selling directly to milk processors.

! Direct sales transactions may now an increasing proportion of raw milk sales to the milkprocessing industry.

Unfortunately, no data is readily available to support this reported development.

In 2004, about 65% of national raw milk production was being sold by GKSI co-operatives tothe milk processing industry. As a result, although this organisation has some problems, itssales function is a highly valuable asset to its member co-ops and their own member farmers.

The Table below provides details of the provinces from which each of the major milkprocessing companies are sourcing raw milk.

Source of Raw Milk for Major Milk Processing Companies

Province CompanyWest Java Indomilk

Ultra JayaFriesche VlagDiamond

Central Java IndomilkFriesche VlagNestléSari Husada

East Java Nestlé

Source: GKSI



21

The Table below provides details of the amount of local raw milk produced by GKSI memberco-operatives that is being purchased by the milk processing companies in 2004.

Raw Milk Purchased from GKSI Java by the Milk Processing Companies in 2004

Company Name West Java/Jakarta

CentralJava/DIY

EastJava

Total forJava Island

%Share

Tonnes Tonnes Tonnes Tonnes

Nestlé - - 183,017 183,017 47.0Friesche Vlag (FVI) 36,616 28,855 7,093 72,564 18.7FI (Foremost Indonesia) 34,133 3,327 - 37,460 9.6Indomilk 17,579 - 11,093 28,672 7.4Ultra Jaya 24,619 - - 24,619 6.3Indolakto 17,808 - - 17,808 4.7Sari Husada - 16,506 - 16,506 4.2Others - 4,484 3,873 8,357 2.1

Total 130,755 53,172 205,076 389,003 100.0

% of province's supply* 51.9% 59.4% 86.1% 65.2%

Important note: This data does not include milk delivered by non-GKSI members. *: Provisional estimate.Source: GKSI Jakarta

The structure of demand for raw milk in 2004, as detailed above, is very similar to that whichexisted in 2000 when the top three users were also Nestlé Indonesia, Friesche Vlag/ForemostIndonesia and Indomilk/Indolakto.

Indonesia's Dairy Farming Industry SWOT Analysis - 2005 Issues of Importance to Future Industry Development


22

3. Issues of importance to future industry development

3.1 Overview of major issues

There are a number of major issues that have been identified as very important to the longterm success or failure of Indonesia's dairy farming industry:

! Identified by customers, i.e. the milk processing industry and the retail industry:

" Milk quality and characteristics as an ingredient for use by the milk processingindustry. A spokesman for the IPS stated that: "Good quality milk produced byIndonesian farmers is a competitive input to Indonesian-made processed milkproducts, but poor quality milk is not".

" The opportunity cost of poor quality milk and "cost of quality" to buyers, sellers andproducers of raw milk.

" Developing the co-operatives and dairy farmers as quality-oriented and customerfocused businesses.

" Product and packaging integrity in modern retailing channels.

" Product costs to customers, which must be competitive in the market.

! Identified by technical advisors and technicians involved in industry development:

" The ability of the industry to respond to the climate and related water and feed supplyconstraints.

" Feed availability, especially in the dry season, and feed cost versus sales value of milkproduced.

" Dairy farms operating in marginal areas where water and feed resources are limitedand so limit the success of dairy farming operations.

" Low productivity and small herd sizes.

" The commitment of the dairy farmers towards using clean milk productiontechniques, including those who have received training in this aspect of theiroperations.

" Problematic breeding programs and herd management systems (including herdrecording systems) and their commercial impact on local dairy farmers.

! Identified by cooperatives and dairy farmers:

" Milk prices as paid by customers, especially the milk processors. (Note: This situationarises because many co-operatives are not producing raw milk that is high enough inquality to qualify for higher prices, e.g. bonuses and incentives, that are available toproducers of good quality raw milk).



23

" The profitability of co-operatives and dairy farms. (Note: This situation arises for anumber of reasons, including co-ops that are too small to be efficient businesses, highoverhead costs, poor financial management and a related failure to collect amountsdue from members, loss making divisions within co-operatives, and poor qualitycontrol, which actually results in penalties being incurred for supplying poor qualitymilk. The dairy farms are also inefficient because of their very small herds, lowproductivity per worker and the inability to maximise milk production per cowthrough a good feeding regime).

" The poor performance of local bred and imported dairy cows. (Note: The poorperformance of cows arises mainly from failures in feeding regimes, husbandry andhandling, which arise from weaknesses in dairy farming operations as well as somesupport functions, e.g. cattle procurement activities and on-farm breeding practicesthat are not properly monitored by veterinarians).

" The lack of opportunities to sell raw milk to the milk processing industry in areaswhere milk processing businesses do not have factories, e.g. Central Java. (Note: Thissituation arises because it is not commercially viable for milk processing businessesto invest in areas with weak dairy farms and weak markets for milk products. It alsoarises because the government's focus on developing PIR systems that support milkprocessors have limited entrepreneurial activity amongst co-operatives. Co-ops are,as a result, unable to / unwilling to consider alternative business strategies involvingthe development of their own brands and marketing channels).

" Disloyalty amongst dairy farmers who are members of co-operatives. (Note: Thissituation arises because co-op members are disappointed in the financial returns thatthey are receiving from their co-ops. The underlying problem is weak co-opmanagement who cannot manage the co-op's business in a profitable manner and paythe farmers a good milk price and an annual dividend out of the co-op's net profits).

! Identified by this study:

" Investment planning and activation of investment projects.

" Financial management skills within the industry.

" Financial reporting at the level of whole industry and individual co-operatives.

" Performance reviews, exceptions reporting and industry development activities.

" The development of co-operatives in line with international co-operative principlesand best practice within Indonesia's new laws and regulations governing co-operatives. The opportunity to restructure the dairy farming co-ops in this manner hasexisted since President Habibie started the process of regulatory change in 1998 whenhe announced that: "co-operatives would be the responsibility of society, notgovernment".

" Other changes in Indonesia's regulatory environment, in particular:

- The new laws and regulations governing co-operatives.



24

- The new food regulations, which now incorporate some aspects of CODEX.

- The new Bank Indonesia regulations covering lending by the banks and otherfinancial institutions, including agricultural businesses and co-operatives.

The following sections of this chapter consider the following three issues in more detail aspart of the national SWOT analysis.

! The climate and its impact on the industry.

! Milk pricing.

! Investment planning, investment project activation and financial reporting.

! Regulatory environment change.

All of these issues are interrelated in terms of their impact on the industry in the past and theirrelevance to managing development of the industry and its strategic direction in future.

3.2 The climate and its impact on the dairy farming industry

3.2.1 Overview of rainfall patterns on Java Island

Indonesia's main dairy farming areas on Java Island are impacted upon by a dry season thatlasts from June to September in most years. In years with poor rainfall, the dry season canextend from May to October (see Table below).

Rainfall Patterns for Java Island (Averages)

Jakarta (WesternJava)

Semarang(Central Java)

Yogjakarta(Central Java)

Surabaya (EastJava)

Rainfall Dayswith rain




Jan 304 19 379 NA 358 NA 327 17Feb 300 16 307 NA 390 NA 275 18Mar 210 15 226 NA 294 NA 283 19Apr 148 10 193 NA 209 NA 181 15May 110 9 132 NA 53 NA 159 13Jun 96 8 96 NA 52 NA 101 11Jul 67 6 44 NA 43 NA 22 7Aug 42 4 65 NA 9 NA 15 3Sept 69 5 90 NA 5 NA 17 4Oct 111 9 170 NA 144 NA 47 5Nov 142 12 241 NA 248 NA 105 12Dec 201 13 292 NA 341 NA 219 23

NA: Not readily available.Source: BMG Indonesia (2002)



25

Although the above Table indicates rainfall does occur in the period from May to October,rainfall at this time of the year is generally unreliable. Some points to note are as follows:

! In some years in central and eastern areas, there is no rainfall in the period from June toSeptember and this has negative impacts on the volume of water in the region's rivers.

! In the last El Niño year, the dry season extended until the middle of November in CentralJava, with major negative impacts on the region's livestock industry.

Essentially, Indonesia's main dairy farming area is located in a climatic zone where 80% ofrainfall occurs in 6 months of the year.

While Java is located in the equatorial region, the dairy farms in its upland dairy farmingareas are not impacted upon as negatively by heat and humidity as lowland dairy farms in thetropics. Foreign technical advisors and technicians working in the industry comment that, forthis reason, the upland dairy farms operating on Java Island have good opportunities tosurvive and thrive using a Friesian-Holstein (FH) milking herd, if:

! They are well managed; and

! Can deal with the negative impacts of the dry season, for example:

" Water shortages; and

" Feed shortages, including the tendency of farmers to use inappropriate quality feedingregimes when feeding Friesian-Holstein (FH) milking cows.

Unfortunately, this does not always happen because the industry does not manage the impactof the dry season in a manner that maximises milk production during this season. The resultis that:

! Milk production on co-operative member farms plunges in some areas of Java; and

! Dairy herds come under significant stress from poor quality watering and feeding regimesthat can, in the worst cases, ultimately lead to the death of valuable stock.

Some areas of Java Island have severe to cronic problems with feed and water availabilitythat may categorise them as marginal for dairy farming. (Note: No formal study has beenperformed to consider this possibility). This situation exists in some parts of Central Java. Forexample, in the Boyolali area which has already seen some dairy farming businesses evolvingout of dairy farming and into calf rearing/meat cattle farming and/or non-farming businessactivities.

3.2.2 Practical problems arising from water supply to dairy farmers on Java Island

It is well known that sufficient all year round supplies of clean water are very important tothe success of dairy farming and milk collection activities. Water is required:

! For the herd, especially for larger breeds of milking cattle, e.g. FH cows, which are heavyusers of water in Indonesia's hot climatic conditions; and



26

! For use in:

" The animal shed, where there should be a supply of clean water and equipment to heatwater so the farmer can maintain a clean milk production environment in whichbacteria counts (TPCs) are kept low; and

" The milk collection centre (MCC) where clean water and equipment to heat water isvery important to maintain a clean environment and low bacteria counts (TPCs).

Technical advisors stress that heated water is vital for maintaining a clean environment atboth farms and milk collection centres. Nestlé Indonesia has advised that the existence anduse of hot water systems are a mandatory part of their contractual conditions with the co-operatives that supply them with raw milk.

Insufficient and/or poor quality water supplies, and access to hot water supplies are majorproblems in some parts of Java Island. This situation results in:

! Poor quality health amongst dairy cows, which in the worst cases has led to the death ofvaluable milking stock.

! Poor quality milk being produced on-farm.

! Poor quality post-farmgate handling of milk in the milk collection centres. Data receivedfrom the Dinas Peternakan West Java revealed that well equipped co-operatives candeliver raw milk with bacteria (TPC) counts of around 1,000,000/ml or lower. Incontrast, the TPCs at poorly equipped co-operatives are routinely measured at levels inexcess of 20,000,000/ml.

The main impacts on the dairy farmers and their co-operatives are financial, although noaccurate details are available on this because of weak financial recording and reporting by theindustry as a whole. At a micro level, i.e. farm and co-operative level, the actual losses oropportunity losses (costs) of this situation are as follows:

! Loss of a productive cow, which has to be replaced either by the farmer through a loanscheme or by a donor, if cows are being donated to farmer by the government or aidagency. In rare cases, there may be some form of co-operative insurance scheme thatcovers the loss.

! Loss of on-going milk sales income in the period between the death of the cow anddelivery of a new milking cow.

! Opportunity losses for the farmer and the co-operative arising from a failure to take theincentive payments for higher quality milk, i.e. milk with lower bacteria (TPC) counts.Several studies have been conducted on this over the past 5 years.

One of them conducted in 2003 by the Department of Primary Industries, Victoria,Australia estimate the losses incurred by two (2) large milk collection centres that werenot operating in a clean milk production and handling environment to be:

! Rp 1,080 million (US$ 120,000) per annum in West Java; and



27

! Rp 2,424 million (US$ 270,000) per annum in East Java.

Trade sources advise that large opportunity losses are also being made in some parts ofCentral Java where shortages of clean water in the dry season causes major problems formilk quality.

Overall, this situation arises because of:

! A lack of investment in ensuring sufficient water supplies in all of the dairy farming areasand in water resource management and planning in those areas;

! A preference for using of "heavy water use" Friesian-Holsteins rather than more droughttolerant stock, e.g. Frisian Sahiwal and other crosses (Note: No study has ever beenperformed into the impact of this preference on dairy farming operations in the drier areasof Indonesia); and

! Dairy farms being established in marginal areas, e.g. some parts of Central Java, wherewater shortages are reported to be a perennial problem.

! A lack of co-ordinated planning for government investments in milk collection centresthat have been constructed with no electricity supplies for hot water or appropriate milkchilling facilities. (Note: Discussions with government officials and the management ofcommercial farms indicate that this situation is solvable through the use of alternativetechnologies, e.g. solar water heaters (used by a commercial farm) and micro biogaspower plants (used by small rural area businesses, including co-ops).

If actual losses and opportunity losses, incurred as a result of water problems could beextrapolated against the whole industry and its milk collection centres, the total loss is likelyto be very large. Water problems are known to exist across the whole of Java Island in the dryseason. Discussions with government officials and business management in the industryrevealed that there is no data or estimate on the economic/financial impact of this situation.

This situation exists despite the fact that the industry is increasingly being offered incentivepayments for cleaner milk. While clear pricing signals are being provided to the dairyfarming industry, the farmers and co-operatives, are not fully able to use clean milkproduction and collection techniques because of the weaknesses that exist in the water andpower supplies to the industry.

Ultimately, the impact of both forms of losses impact negatively on the organisations thatprovide credit and development assistance to the industry:

! The government, whose financial and other resources are not being maximised upon bythe dairy farming industry;

! Other credit providers, including co-operatives and banks, that may suffer bad loans andunpaid doubtful loans from within the dairy farming industry; and

! Donors, e.g. aid agencies and technical service providers whose programs and resourcesare not maximised upon by the dairy farming industry.



28

3.2.3 Practical problems arising from feed supply to dairy farmers on Java Island

It is well known that for dairy farms to be successful profitable entities, there must be:

! Productive and adaptive forage species in the dairy farming area;

! Farm management systems that ensure adequate year-round feed supplies;

! Feed that is of appropriate nutritive quality for the breed of dairy cattle being used by thefarm; and

! Available credit to fund the growing of feed, if this is part of the farm's activities.

In practice, the dry season places constraints on the natural feed resources in most parts ofJava Island. As the dry season lasts up to 6 months and can have a dramatic effect on feedavailability, efficient and productive dairy farms can only exist with some form of feedmanagement program that deals with the deficit in natural feed supply in the dry season.

Technical advisors comment that this program should ideally be underpinned by acomprehensive audit of feed resources in each of the dairy farming areas. The goals of thisaudit would be to identify:

! Better forage species, e.g. legumes, that can be grown in the vicinity of the dairy farms,e.g. close enough for efficient on-foot collection by individual farmers;

! Land that is not being effectively used in the vicinity of the dairy farms, includingmarginal lands, which could be used for the production of forage, including nutritioussilage (conserved wet season "feed crops") for use during the dry season;

! Unutilised agricultural waste products (including the identity of their nutritional benefits)that could be used in feed for dairy cattle; and

! Determine the optimal dairy cattle herd size for each farming area based on availablehome grown feed supply and an assessment of the cost effectiveness of feed that will berequired to operate the herd during the dry season.

Such audits are not yet part of government policy, whether at a national, provincial or locallevel. None of the areas in West Java, Central Java or North Sumatra that were visited as partof this study had ever been covered by such an audit.

Unfortunately, in many areas of Java Island there is no system in place to guarantee costeffective feed supplies to all dairy farmers in the dry season. Although Indonesia's overallmilking cow herd and dairy farming community has grown substantially since 1998, little orno investment has been made in feed management systems aside from some aid-fundedactivities, e.g. feed workshops run by the Australian State of Victoria's Department ofPrimary Industries.



29

Aside from the inherent weaknesses that exist in tropical forages, e.g. high fibre/low nutrientcontent, many farmers also face the following types of problems:

! Dry season feed that is particularly low in nutrients. Providing a balanced diet can meanusing more concentrates, which are high cost.

! Access only to lower quality roughage, e.g. rice straw, which is usually the only roughageavailable during the dry season. (Note: Interestingly, in some parts of Central Java co-opmanagement reported that their herds see an improvement in yield in the dry seasonbecause the cows are consuming more dry matter than in the wet season. Discussionswith these respondents discovered that they were not using this information to develop afeed regime that also maximised milk yield during the wet season).

! Technical problems in producing silage for use in the dry season. Although training onsilage production has been provided to selected co-ops and farms, discussions with anumber of managers revealed that the outcome of this training has been variable. Someco-ops and dairy farms that were involved in the training programs have not beensuccessful in adding silage to their feeding regimes.

! Farmers with their own land in more drought prone areas having to "buy in" feed for theircattle. Such feed can be high cost, depending on the quantities of feed that are available intheir area. Feed shortages generally result in higher feed prices because of market forcesand so can reduce the profitability of farms in these areas during the dry season.

! Challenges arising from the industry's preference for a breed of cows, i.e. Friesian-Holsteins, that may not the best for use in Java's dry season conditions.

The preference for large cows, especially Friesian-Holsteins, is a significant risk to apoorly equipped industry because they need a good quality and consistent feed regime toproduce milk.

Under the dry season circumstances in more marginal (drier) and lowland areas, it mightbe better to use crossbreeds, e.g. Frisian Sahiwal. (Note: No technical study has beenperformed to assess the usefulness of cross breeds).

Unfortunately, making a change to this entrenched breed preference is likely to be achallenge because industry sources and foreign technical advisors report that the dairyfarmers prefer Frisian male progeny. These cattle are reported to be are more valuablethan non-Frisian bulls/steers in the beef cattle market.

! An inability amongst smallholder farmers to manage larger herds of cattle because of feedshortages and the time it takes to collect feed from neighbouring areas. Technical advisorscomment that:

" In some cases, there is no local source of feed and no delivery system for feed fromother areas where it is available.

Under these circumstances, farmers may have to walk up to 10 kilometres per day tocollect feed for their cattle during the dry season.



30

This situation reduces the amount of time that smallholder farmers have for husbandryand so limits their ability to manage a herd larger than 2 to 4 animals, e.g. 2 milkingcows.

" Family-run farms with larger herds, e.g. 5 or 6 milking cows, 2 dry cows and a smallnumber of immature animals can only exist in areas where there is a secure feedsource in close proximity to the farms.

The main impacts of poor feeding regimes on the dairy farmers and their co-operatives arefinancial, although no accurate details are available on this because of weak financialrecording and reporting by the industry as a whole.

Overall, the dry season can have the following financial effects on smallholder farmers andtheir co-operatives:

! Reduced sales volumes of milk.

! Reduced returns from sales of milk because of poorer milk quality/characteristics and aninability to maximise returns from milk price incentive schemes.

! Higher business costs, including feed and veterinary costs;

! Lower profits; and

! Cash flow problems.

In worst cases, poor feeding regimes in the dry season can also lead to the death of cows inthe farmers' herds. This event has a consequent negative future impact on farm operations andprofitability.

In addition to this, the dry season also has negative psychological impacts on the dairyfarmers, which can lead to demoralised farmers who are no longer interested in dairyfarming. Industry sources comment that this situation is most acute in areas where the dryseason is most severe.

As no one is monitoring the financial performance of the dairy farming industry as a whole,the full extent of the cost of the dry season in terms of lower business profits or losses is notknown or understood. Ultimately, the lack of investment in a feed management program thatimproves dry season feed quality, impacts negatively on the organisations that provide creditand development assistance to the industry, including:

! The government, whose financial and other resources are not being maximised upon bythe dairy farming industry;

! Agricultural credit providers that suffer bad and doubtful debts from within the dairyfarming industry; and

! Donors, e.g. aid agencies and technical service providers, that expect their efforts todeliver real benefits to the industry and its farmers.



31

3.3 Milk pricing

3.3.1 Milk price determination

Many farmers and co-operatives in Indonesia consider that the milk price obtained frombuyers is a function of their own business costs. The buyer should compensate them for theiroperating costs and provide them with a price that makes their operations profitable.

This viewpoint contradicts that fact that the milk price paid to co-ops and farmers is beingdetermined by the market, i.e. the various customers that operate in the market and theirdemand specifications.

In practice, price determination is made by buyers who consider a range of different factorswhen buying their ingredients. These factors can include milk quality, milk characteristics,service from supplier, freight costs and milk that is being offered by competing suppliers.Overall, the most cost effective producer of the highest quality product will always win thesale.

Since 2004, the determination of milk quality has also been underpinned by Indonesia's newfood regulations that have incorporated some aspects of CODEX on matters such as thecontents of pesticide residues, animal drug residues and bacteria content.

As the products manufactured by the milk processors have to comply with these new laws,the laws also apply to all of their input and ingredient suppliers, including Indonesia's dairyfarmers. This situation has recently been reflected in the milk pricing schemes that determinethe actual price that is received by co-ops.

3.3.2 Milk production costs

Due to the lack of on-farm accounting and meaningful financial data, performance indicatorsand financial management at farm level, it is difficult to obtain reliable information on thecost of producing raw milk in Indonesia. As a result, the cost of milk is usually an estimatebased on known inputs, e.g. feed, and other costs, e.g. labour and extension service costs.

In addition to this, farms that receive donated cows or equipment and/or free extensionservices do not account for the costs of these assets (depreciation over their useful life) orservices (manpower and related input costs) in their raw milk cost. As a result, this situationmay distort some estimates of raw milk production costs being quoted in Indonesia.

Technical advisors working in the industry are concerned that bought-in feed costs, lowproductivity and other areas of inefficiency may mean that many farms are unable to make aprofit from the milk that they are producing and selling.

Overall, although some co-operatives do have information on milk production costs in theirarea, no one has a clear and accurate understanding of milk production costs because ofweaknesses in the industry's financial recording and reporting.



32

3.3.3 The structure of milk pricing and opportunities for farmers

Today, Indonesia dairy farmers have the opportunity to earn a range of different prices fortheir products. The milk pricing structure, which now includes incentives and penalties, hasbeen evolving since the mid-1980s, when the first technical specifications were introduced onfat content.

An example of the development in basis of payments for raw milk is provided in the Tablebelow, which highlights the rapid change in demands on milk specifications (characteristicsand quality) since 1998, in particular since 2004.

Basis of Payments for Fresh Milk - 1978 to 2004

Year / Parameter/Criteria Applied ExplanationPeriod Fat SNF TS TPC Antibiotic

Content1978 to 83 - - - - - Payment for milk based only on

volume delivered in litres.

1984 to 87 Yes - - - - Minimum standard fat content of3%, plus or minus 1% incurs abonus or penalty of Rp 5 perkilogram.

1988 to 97 Yes Yes - - - Price based on per gram of fat andper gram of SNF (solids-not-fat).

1998 toApril2004

Yes Yes Yes Yes - Price based on per gram of fat, pergram of SNF and:

! TS (Total solids) of aminimum of 11%, with abonus or penalty of Rp 5 perkilogram paid for +/- TS of0.1%.

! TPC (bacteria) count ofbetween 20 and 30 million,with:

" A bonus available for TPCcounts below 20 million;and

" A penalty imposed forTPC counts above 30million.

Continued …



33

Basis of Payments for Fresh Milk - 1978 to 2004 (Continued)


ContentMay 2004 Yes Yes Yes Yes - Price based on per gram of fat, per

gram of SNF and:

! Milk with TS (Total solids) ofless than 11% being rejected.

! Milk with TS of more than11% attracting a bonus.




June 2004 Yes Yes Yes Yes - Price based on per gram of fat, pergram of SNF and:


! Milk with TS of between 11%and 11.2% attracting a penalty.

! Milk with TS of more than11.3% attracting a bonus.




Continued …



34

Basis of Payments for Fresh Milk - 1978 to 2004


ContentStartingAugust2004

Yes Yes Yes Yes Yes Price based on per gram of fat, pergram of SNF and:


! Milk with TS of between 11%and 11.2% attracting a penalty.

! Milk with TS of more than11.3% attracting a bonus.




! Penalty for antibiotic content.If milk is found positive forantibiotic content, a penalty ofRp 200 per kilogram will belevied.

Source: GKSI (Supplied in August 2005)

It should be noted that:

! These raw milk specifications have been introduced to ensure that milk being consumedin Indonesia conforms to standards that are acceptable for processing into branded milkproducts for sale locally and, as relevant, in the export markets.

! The parameters that have been established by GKSI (as detailed above) differ from themore stringent parameters that have been established by the larger milk processingcompanies. In some cases, penalties for high bacteria counts are activated at lower TPC(bacteria) counts, e.g. about 3,000,000/ml, instead of the TPC count of more lenient15,000,000/ml detailed in the Table above. (Note: In Australia, the quality standardsrequired of dairy farmers are even more stringent than those detailed above. Penaltiesstart to be levied on dairy farmers if the TPC in their raw milk exceeds 200,000/ml.Additionally, TPC levels must be less than 50,000/ml for the raw milk to qualify aspremium milk).



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The actual milk prices reported as being paid in May/June 2005 range from a high of Rp1,800 per litre to a low of Rp 1,300 per litre on Java Island, a difference of 38% whichdepends on the farmer meeting measurable quality standards (see overview in Table below).

Example of Raw Milk Pricing Scale Used on Java Island

Price Per Litre

Total Solid Content (TS):! 11.3 to 11.9 1,550! Above 12 1,700! Above 13 1,800

Note: Other co-operatives have a system that is based on a range of different TS(bacteria) count values in raw milk that is delivered to their depot.Source: KSU Andini Luhur, Central Java (Effective 28 May 2005)

Such pricing structures also exist for the dairy farming co-operatives in their salestransactions with the milk processors (see Table below).

Example of Pricing Scale Paid to Dairy Farming Co-operatives

Price Per Litre

For higher quality milk with high total solid(TS) content and low TP (bacteria) count 2,050

For lower quality milk with low total solid (TS)content and high TP (bacteria) count 1,800

Source: KSU Andini Luhur (PT Indomilk pricing)

This situation exists as part of efforts by major users of Indonesian milk to encourageindividual dairy farmers and their co-ops to upgrade their own production standards to meetthe higher standards that are now being required to compete in Indonesia's market for brandeddairy products.

Under the 2 examples detailed above, farmers can make 16% more, if they produce higherquality milk, and the co-operatives, 14% more, if they supply higher quality milk. In essence,both farmers and co-ops are able to determine their own profits through applying betterquality management and production procedures and processes.

As TPC (bacteria count) and TS (total solid content) levels vary significantly (see Tablebelow), the practical impact of these incentive schemes is variable profitability amongst dairyfarming co-operatives.



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Average production and milk quality of GKSI Jabar membersJanuary to March 2005

Production Fat SNF TS TPC TempCooperatives

1 KPSBU Lembang 2,924,960 4.24 8.17 12.40 2.84 5.052 Karya Utama Sejahtera 771,480 3.74 7.90 11.63 7.99 8.233 Cisurupan 379,857 3.47 8.23 11.70 26.18 8.274 Bayongbong 586,645 3.74 7.80 11.55 44.09 6.935 Cilawu 153,257 3.64 7.79 11.43 89.27 6.036 Tani Mukti Ciwidey 94,425 2.18 4.84 7.02 27.12 0.007 Dewi Sri Kuningan 78,083 3.94 7.83 11.78 8.42 6.338 Sinar Jaya, Ujung Berung 95,480 3.62 7.78 11.39 11.12 6.079 Tandangsari 900,293 3.88 7.93 11.81 2.14 5.57

10 Ciparay 112,036 3.70 7.86 11.56 5.99 0.0011 Cipanas, Cianjur 32,367 2.47 5.43 7.90 4.96 0.0012 KPS Gunung Gede 88,929 3.68 7.90 11.58 0.00 0.0013 Gemah Ripah 93,383 3.74 7.98 11.72 0.00 0.0014 Makmur, Selabintana 96,766 3.55 7.94 11.33 0.00 0.0015 Bakti, Sukaraja I 21,044 3.59 7.97 11.56 0.00 0.0016 Cipta Karya, Samarang 0 0.00 0.00 0.00 0.00 0.0017 KPBS Pangalengan 2,534,672 3.91 5.12 11.61 10.67 0.0018 Mitrayasa, Pager Ageung 74,978 2.35 5.01 7.36 8.44 0.0019 Balebat, Banjaran 24,785 3.64 7.78 11.42 0.00 0.0020 Giri Tani, Bogor 87,033 2.21 5.14 7.34 0.00 0.0021 Sarwa Mukti, Cisarua 350,791 2.35 5.29 7.64 8.36 2.0322 Pasir Jambu 249,353 3.57 7.94 11.51 33.17 3.8023 Puspa Mekar 0 0.00 0.00 0.00 0.00 0.0024 KPS Bogor 269,102 2.53 5.27 7.80 2.66 0.00

10,019,719 3.69 7.88 11.56 20.68 6.48

January

Notes: Fat: % of volume; SNF (Solid Non-Fat): % of volume; TS (Total Solids): % of volume;TPC: Bacteria in millions per ml; and Temp: ° C

Source: DGLS West Java

Based on the above information, the most successful co-ops in West Java in terms of meetingmilk processor demands for high TS content and low TPC levels in the early part of 2005would be KPSBU Lembang and Tandangsari.

Indonesia's market for liquid milk is underpinned by the following other factors that impacton the price that is received by individual farmers and co-operatives:

! A number of different businesses have demand for their milk, e.g. Nestlé, Indomilk,UltraJaya Milk, etc., which is competitively priced when compared to the market entryprice of imported dairy ingredients when they are reconstituted into consumer products.

As buyers, these businesses are generally stronger when it comes to bargaining powerthan their suppliers, e.g. the dairy farming co-operatives. These buyers are able to dictatethe prices that they are prepared to pay for local milk.

Notwithstanding this bargaining power, the prices paid have increased significantly sincethe mid-1990s, with a large increase occurring after the milk market was liberalised inFebruary 1998 (see Table below). Trade sources comment that average pricing hasstabilised at just over Rp 1,700 per litre since 2002.



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Average Milk Prices Per Litre Paid by the Milk Processing Industry- 1997 to 2003

1997 1998 1999 2000 2001 2002 2003

Price inRupiah 705 975 1,275 1,299 1,686 1,739 1,725

% change - +38.3% +30.8% +1.9% + 29.8% + 3.1% ( 0.8%)

Source: Department of Agriculture, Indonesia

! Entrepreneurial co-ops that produce their own finished dairy products, e.g. milk andyoghurt, for sale to their local area markets. These activities are occurring, or are plannedto start, in a number of areas of Java Island.

These co-ops are exploring the prospects that supplying finished products direct toconsumers may provide them with a better margin/profit than working with a milkprocessor solely as an ingredient supplier.

! Farmers that operate in areas, e.g. Central Java, that are distant from major milkprocessing factories that continue to insist in supplying such factories. These farmers arelikely to receive a lower price for their milk because of:

" Freight/distribution costs to transport their milk to the milk processing factory;" Product degradation due to unstable temperature control in longer milk supply chains;

and" Competition from farmers who are physically closer to the milk processing factories.

Opportunities are being provided to dairy farmers and co-operatives to improve their milkquality through the dairy farming industry upgrading programs that are being run in variousparts of Indonesia by the Directorate General of Livestock Services and a number of foreignorganisations. JICA/Japanese Government, Dairy Australia/State Government of Victoria,Heifer International and Friesland Coberco group/Netherlands Government have beeninvolved in, and funding, such programs.

These programs make a very positive contribution towards farmers' opportunities to improvetheir profits and return on capital invested in their farms. They generally focus on the qualityproblems that are undermining pricing, i.e. poor milk quality and characteristics.

Comments from various sources, including Indonesian government and foreign aid agencyofficials and technicians, involved in these programs indicate that:

! While some farmers that attend these training courses do consistently implement betterhusbandry practices and clean milk production techniques, many are reported to revert totheir old practices after a few months of using the upgraded practices; and

! Farmers that do revert to old practices generally operate in areas that do not have quality-related incentives built into the prices that they are paid for their raw milk.



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This industry trait now underpins a growing belief in some areas of the industry, its supplychain and extension services that more price-driven incentive schemes will be needed as partof efforts to further upgrade the dairy farming industry in future.

A key challenge for industry strategists lies in motivating dairy farmers to consistently applyhigh standards of clean milk production so they can obtain higher prices for their milk.Unfortunately, this is not easy in an environment where the cool chain does not always workto the benefit of farmers that do practice clean milk production (see following section).

3.4 Investment planning, investment project activation and financial reporting

3.4.1 Investment planning and investment project activation

It is well known that for investment projects to be successful in any industry they must bewell planned and activated in a manner that is fully consistent with the goals and objectivesthat have been established for making the investment. In broad terms, investments are madeto provide some form of the benefit to the investor:

! In the case of a commercial investment this would usually be a financial benefit, e.g.greater profits, a larger market and/or higher market share, and better returns on totalinvestment.

! In the case of investments by governments or aid donors, the benefits would, for example,be:

" The knowledge that the donation has done some good in the recipient community, e.g.new economic development has been stimulated; and

" Improved goodwill with the recipient community.

This study has identified a number of cases where problems have occurred with investmentprojects in the dairy farming industry because assets were purchased or constructed that wereinappropriate or insufficient to make the development projects successful and provide newopportunities for Indonesia's dairy farming community. No detailed investigation has beenperformed into the reasons for these problems as this was outside the scope of this study.

The respondents to this study provided the following examples of projects that have not yetprovided any substantial financial benefits to the dairy farmers:

! A sweetened condensed milk factory located in Boyolali in Central Java and constructedat a cost of Rp 35 billion (close to US$ 400,000) that is not operating. One localrespondent commented that the factory was not operating because of problems with itswaste treatment facility.

At the time of the last field trip conducted as part of this study, this production facilitywas being tested with the objective of commissioning it for commercial operations in thenear future.



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! The establishment of a milk collection centre (MCC) without water heating equipmentclose to the Barusampeu dairy colony in Kabupaten Bandung, West Java.

This has resulted in a situation where high bacteria (TPC) levels undermine the ability ofthe co-op and dairy farmers to earn high prices for their raw milk under a milk qualitylinked pricing scheme.

One Australian technical advisor commented that this MCC's opportunity losses probablyamount to millions of Rupiah every month, e.g. up to Rp 45 million (about US$ 5,000)per month based on his information about the MCC's likely processing capacity.

! Milk pasteurisation equipment costing Rp 400 million (about US$ 45,000) installed atKSU Andini Luhur in Kabupaten Semarang, Central Java that is not operating because acomplete set of spare parts was not delivered together with the equipment.

Additionally, this equipment was purchased without other facilities and equipment thatwould be required to facilitate operation of a pasteurised milk business, e.g. an automaticcup sealer, sterilising and cooling rooms, an electricity generator, etc. The co-op'smanagement estimate that a further:

- Rp 500 million (about US$ 55,000) will need to be spent on a spare parts inventory;and

- Rp 1.5 billion (about US$ 170,000) will need to be invested in the other assets andfacilities to make the pasteurised milk business fully operational.

! The failures of businesses and dairy colonies, which are blamed on problems with theperformance of milking cows that were supplied under procurement programs funded bythe Ministry of Co-operatives and SMEs. A number of these failures were known by therespondents to this study, including:

" A milk processing joint venture company that was established in the Semarang areaprior to 2000.

" Two dairy colonies in West Java:

- One, a breeding colony in the Kuningan area, which was reported to have resultedin the collapse of a co-operative:

- The other, a milking colony in the Bandung area, which was reported to be havingproblems at the time of the last field trip undertaken for this study.

Discussions with local government officials indicated that:

- Problems arose because of the quality of the milking cows that were distributed tothese dairy colonies, in particular the state of their health, their ability to producemilk and some reproductive issues.



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- The farmers at the colony in the Bandung area were reported to have originallyrejected the cows that were delivered to them. They were visibly poor qualitycows when first delivered to them.

- The herd from the failed Kuningan dairy colony was distributed to small-holderfarmers in the area. Unfortunately, the distributed cows died, which led to thecollapse of the farmers' co-op.

- No formal investigation had been done to identify the exact reasons for theproblems that were experienced by these dairy colonies. In view of the fact thatdairy colonies are part of the government's development policy for the dairyfarming industry, it would be advisable for these failures to be fully investigatedso that planned dairy colonies do not experience problems in future.

In addition to these projects, there have been several failed investment projects in NorthSumatra, including investments made under the Colombo Plan, by GKSI and by variousgovernment agencies in the period prior to 2000.

All of these examples indicate the possibility that there are significant weaknesses ininvestment planning and investment project activation. In the areas affected by the examples,the problems have undermined the performance of Indonesia's dairy farming industry. Ifthese examples are indicative of a nation-wide problem, then these weaknesses in investmentproject management may be having severe impacts on the industry as a whole.

As investigation of this matter is not within the scope of this study, no conclusion can bemade as to the cause or causes of the problems that have been reported by respondents to thisstudy. The respondents to this study, however, identified the ultimate impact or effect ofthese problems as follows:

! Failure of milk processing plants due to insufficient milk supply in Semarang, CentralJava;

! The failure, and near failure, of innovative farming concepts, e.g. the dairy colonies, inWest Java;

! Failure to develop a milk processing plant that could have been the focal point for dairyfarming industry development in the highlands of Northern Sumatra.

! Failure to establish a fully equipped milk collection centre and system at the Barusampeu,Kabupaten Bandung in West Java;

! Slow development of opportunities to provide the dairy farmers in the Boyolali area ofCentral Java with a new market for their milk through a fully operational sweetenedcondensed milk factory.

! Slow development of opportunities to establish a fully operational pasteurised milkproducts facility and chilled distribution system in Kabupaten Semarang, Central Java,that could provide an opportunity to develop a new market for chilled dairy products inthe region's key cities.



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If the financial impact of these examples of poor investment management could be computedthey are likely to be sizeable:

! Actual losses have definitely been incurred by a range of entities involved in theseinvestment projects, including the government, other providers of funds and credit to theindustry, the co-operatives and the dairy farmers.

! Lost opportunities have definitely occurred due to the inability of dairy farmers and theirco-operatives to take new opportunities that were envisaged when initial decisions weretaken to invest in these failed or defective projects.

Overall, these problematic investment projects were not planned or activated in a manner thathas provided the full envisaged benefits to the dairy farming community in the areas wherethese projects were implemented. Had these investment projects been planned effectively andactivated in a commercial manner, Indonesia would now have a broader based market for itsdairy farmers milk, which could be supported by direct links between the farmers and endconsumers.

3.4.2 Financial reporting

As mentioned earlier in this report, very little financial information is available on theperformance of Indonesia's dairy farming industry and performance is generally reviewedbased on non-financial data that is collected from the industry.

The Table below provides an overview of average milk incomes per cow in West Java,Central Java and East Java based on a notional Rp 1,350 per litre, which is the lowest pricethat is reported to be paid to dairy farmers in these provinces. As mentioned earlier in thisreport, farmers that produce higher quality milk can earn up to Rp 1,800 per litre.

Notional Average Milk Income Per Milking Cow in West, Central and East Java in 2004

West Java Central Java East Java

Average annual productionof milk per cow 2,176 litres 647 litres 1,504 litres

Lowest milk price reportedas paid to Javanese farmers Rp 1,350 per litre Rp 1,350 per litre Rp 1,350 per litre

Average annual milk salesrevenue per cow Rp 2,937,600 Rp 873,450 Rp 2,030,400

Source: Based on information supplied by the Directorate General of Livestock Services and GKSI Jakarta

The above Table highlights that even at the lowest price being paid to Javanese dairy farmers,the average sales revenue per cow is significantly higher in West and East Java than it is inCentral Java. Follow up on the situation in Central Java discovered that dairy farming in thatregion is often a side-line business for farmers who are also involved in calf rearing (raw milkis used to feed the calves) and the production of various cash crops. As a result, the earningsfrom the sale of milk is likely to be lower than in West and East Java.



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A review of the available data on Central Java highlights that the largest dairy farming areasin Central Java are also significantly less productive when it comes to raw milk for the"human food" supply chain than those in West Java (see Table below).

Comparison of "Human Food" Milk Production Output and Notional Average Revenue forMajor Dairy Farming Areas in West and Central Java

% of ProvincesTotal Output

Average LitresPer Cow

Lowest MilkPrice Paid *

Average Annual MilkSales Revenue in Rp

West Java (2004) 100.0 2,176 1,350 2,937,600! Bandung 45.2 2,406 1,350 3,248,100! Garut 24.1 2,442 1,350 3,296,700! Kuningan 6.9 2,641 1,350 3,565,350! Sumedang 5.5 2,414 1,350 3,258,900

Central Java (2002) 100.0 691 1,350 932,850! Boyolali 38.4 482 1,350 650,700! Semarang 31.0 898 1,350 1,212,300! Klaten 9.4 959 1,350 1,294,650! Salatiga City 5.4 1,152 1,350 1,555,200

*: As reported per litre price paid to dairy farmers, assumed as lowest possible income in all areas for this comparison.Source: Based on information supplied by the Directorate General of Livestock Services and GKSI

Based on the available data:

! The dairy farmers in Boyolali, Central Java's main dairy farming area, are earningsignificantly less per cow from sales into the "human food" supply chain than those inBandung, which is West Java's main dairy farming area.

! Even when compared based on the lowest milk price being paid on Java Island today,Bandung farmers are being paid close to 5 times more per cow than their counterparts inBoyolali.

! This large difference arises because of poor productivity of raw milk for the "humanfood" supply chain being reported in the Boyolali area when compared to West Java dairyfarming operations. Other raw milk is being used as calf feed.

The weaknesses in Central Java and its likely financial impact on the industry in this provinceaffect not only the Boyolali farmers but also farmers in other areas of this province. Incontrast, the farmers across West Java are significantly more productive and so likely to havemore profitable operations.

Based on the fact that farmers in all of these provinces operate in fairly similar climateconditions and have similar sized farms, the very low revenue figure in Central Java mayindicate that the dairy farming component of farms in this area are making low profits or areloss making. This situation could explain why many farmers are reported to view dairyfarming as a sideline rather than a mainstream business activity. Unfortunately, thisconclusion cannot be verified because there is insufficient data available on industry salesand costs to accurately conclude on this matter.



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The lack of financial data about Indonesia's dairy farming industry is a considerableweakness because it is not possible for any single entity, e.g. government department, tomake an accurate assessment of:

! The profitability (or otherwise) of the industry and its constituent regions and businesses,the co-operatives and individual dairy farms;

! The financial status, in particular the economic viability, of the industry in the variousrural areas of Indonesia;

! The financial (economic) return on government funding and other aid to the industry interms of economic benefit to the industry, e.g. business generated by the investment inspecific rural areas of Indonesia.

! The areas of the industry that are efficient and inefficient to more effectively directgovernment development efforts, aid and government funded extension services toproblematic areas of the industry.

! Future needs of the industry in various parts of Indonesia in terms of new investment, aidor extension service intervention, e.g. identifying exceptions that need strategic or tacticalintervention by a government agency, aid agency or contracted-in technicians to improveindustry performance, e.g. higher incomes for smallholder farmers.

This situation arises because Indonesian law covering accounting and financial recording andreporting has historically been very weak. Discussions with officials from the Canadian Co-operative Association (CCA), which has been running a co-operative upgrading program inIndonesia since 1994 (see the appendix to this report), revealed that:

! Many managers of co-operatives do not fully understand the reporting requirements thatexist in Indonesia's co-operative laws and regulations. Some management teams considertheir co-ops are too small to prepare formal reports to their members, or lack thecommitment to do so on a regular basis.

! There are often weaknesses in co-operative accounting records that make it difficult forthe co-op's managers to produce appropriate annual reports, i.e. that comply withinternational accounting standards. In addition to this, many co-ops also suffer fromweaknesses in internal controls over their financial transactions. This exists because ofmore general weaknesses in financial management.

! Indonesia law does not require co-operatives to carry out independent audits on theirbooks of account or annual financial statements. Having stated this, the CCA's studieshave found that a sizeable number of dairy farming co-ops have appointed independentauditors.

! There are a lack of stringent auditing standards to guide the independent audit of co-opfinancial statements in Indonesia.

! The release of annual reports and financial statements is often delayed so timelyinformation is not always provided to co-op members.



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Unfortunately, the legal system left by the Dutch at the time of independence was not asdetailed as those left by the British and the USA in the other ASEAN countries. Whengovernment information systems were first set up in Indonesia, the existing laws providedonly a limited basis for government departments to access financial information about localbusinesses, especially those in the agricultural sector.

Corporate law in Indonesia was strengthened significantly in the late 1990s although thisactivity has focused mainly on banks and commercial businesses that are listed on the Jakartaor Surabaya Stock Exchanges, e.g. PT Indofood Sukses Makmur Tbk, PT Ultrajaya MilkIndustry & Trading Company Tbk, PT Japfa Comfeed Indonesia Tbk and alike.

While Indonesia's co-operative law covering some financial aspects of co-ops' operations,e.g. loans, was also strengthened as part of this upgrading of corporate law, the new legalprovisions did not add significantly to the basic legal requirements on financial recording,reporting and auditing that were included in the original laws.

The basic requirements of co-operative law in force in Indonesia today are that:

! The co-operative's appointed manager should:

" Maintain orderly accounting and inventory records.

" Prepare management reports for consideration by the co-operative's members. Thesereports should cover:

- The co-operative's financial affairs; and

- The performance of the manager's responsibilities as are assigned to him by theco-operative's members.

" Prepare a written annual report that contains, as a minimum, a balance sheet andincome and expenditure statement that reflects the co-operative's financial results forthe year.

! A public accountant can be appointed to perform an audit of the co-operative's financialstatements. As mentioned earlier, this does not appear to be a compulsory requirement.

The legislation reviewed as part of this study does not provide any detailed guidance on whatshould be included in the management reports, the annual report (income and expenditureaccount and balance sheet) or establish any formal standards on the disclosure content of thefinancial statements.

A limited scope survey of co-operatives conducted by the Directorate General of LivestockServices, in conjunction with this study, confirmed that agricultural co-operatives operatingin the dairy farming industry today:

! Do maintain accounting records; and

! Are preparing some form of annual report for their members.



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A follow-up review of the contents of the recent annual reports of a number of co-operativesinvolved in dairy farming industry by Stanton, Emms & Sia's senior management found that:

! Co-ops are complying to various extents with the legal requirements for annual reportsand financial statements.

! The annual reports being prepared by co-ops do provide a base from which new financialinformation about the performance of the dairy farming industry could be developed.

Unfortunately, the financial and other operational information that is available from the co-ops:

! Is not easy to collect as there is no centralised repository for the annual reports; and

! Does not facilitate easy collation because of non-standard formats that are being used inthe preparation of co-op annual reports.

While these challenges exist, they should be relatively easy to rectify to establish a base fromwhich improved access to financial information can be obtained about the dairy farmingsector and its performance as a key part of rural area industry.

There are just over 200 dairy farming co-operatives operating in Indonesia today and itappears that most of them are likely to be preparing some form of annual report, includingfinancial statements for their members. If collected by the government, these annual reportscould form the basis of a new information system about the nation's dairy farming industry.

As co-operatives are essentially a form of public companies owned by a large number ofpersons, it is very important that the Indonesian government ensure that there is a high levelof transparency over the activities of co-ops in future. Co-ops are a very important part of therural economy. To improve the base of information that is provided by the co-ops in theirannual reports and financial statements, it would be advisable for the Department ofAgriculture to:

! Develop a new guideline covering the financial and non-financial information content ofthe annual report and financial statements of farming co-ops; and

! Lobby the Ministry of Law for some type of legal provision in future co-operative lawsthat:

" Compels co-ops to prepare their annual report and financial statements in astandardised manner, e.g. in accordance with the Department of Agricultureguidelines.

" Provides the Department of Agriculture with full access to co-op annual reports andfinancial statements for the purposes of policy making, macro management andstrategic decision-making on agricultural industry development projects.

With these guidelines and provisions in place, the Department of Agriculture Indonesia willbe a much better position to monitor the dairy farming industry performance and developrelated development policies and programs than it has been in the past.



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3.5 Regulatory environment change

The broad structure of the dairy farming industry, including most of its co-operatives anddairy farms, was established in the period prior to the 1998 crisis. Although some co-opshave been upgraded under the CCA (Canada funded) program into entities that closelycomply with international co-operative principles and best practices, there have been fewchanges to the way in which:

! The whole industry operates; or

! The broad policies around which the industry operates.

Discussions with government officials, co-operative managers, company management andindividual dairy farmers indicates that most of the dairy farming industry is stranded in thepast. This includes co-ops and dairy farms that have developed since 1998.

The 1998 crisis resulted in a number of regulatory environment changes that have had, or willhave, significant impacts on the dairy farming industry in future. These changes include:

! The well known liberalisation of the milk market and scrapping of the milk ratio, whichsaw a free market develop for milk and dairy products in Indonesia.

! The introduction of the new policy towards co-operatives under which as PresidentHabibie stated: "co-operatives would be the responsibility of society, not government".

! The introduction of a range of new laws and regulations that provided a new basis for theestablishment of new co-operatives and restructuring of existing co-operatives in closecompliance with international co-operative principles and best practices. (Note: It isreported that the laws and regulations governing co-ops in Indonesia are still evolving atthe date of writing).

! The introduction of new banking and financial service industry regulations by BankIndonesia covering loans/credit facilities to agricultural businesses, including co-ops, andrelated matters such as the duty of the lender to:

" Perform credit and background checks on the borrower before approving loans;" Undertake regular reviews of loan recoverability;" Obtain security for loans; and" Manage loans to ensure their recoverability from the borrower.

! The introduction of the first in a set of new food regulations that are based on CODEX.

! The gradual change in government policy towards subsidised energy supplies inIndonesia, which resulted in a major change in fuel prices during the course of this study.

! The implementation of the ASEAN Free Trade Area covering the trade in ASEAN-content dairy products. This has provided duty free access to Indonesia's market for mostASEAN-content dairy products since January 2004.



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! The recent entry of Indonesia into a formal process to harmonise ASEAN foodregulations by 2008.

It should be noted that a detailed review of these new policies and regulations was not withinthe scope of these regulations, however, discussions were held on their broad content andpotential future impact with key respondents.

In addition to these internal changes, discussions with international financial institutions andaid agencies have discovered that there have also been some negative changes in attitudestowards Indonesia as a potential recipient of international loans and aid donations. The fear ofcorruption and failed aid programs as a result of corruption and mismanagement has broughtabout this change since 1998.

Discussions with a range of government officials and co-operative managers revealed that:

! While all were aware of the liberalisation of the milk market in 1998 and its impact, mostwere not aware of:

" The changes in the other policies and laws listed above; or

" The implications that these changed policies and laws would have on the dairyfarming industry in future.

The speed at which these changes were made, the compartmentalised nature of theIndonesian government and weak communication channels between the differentministries and departments within the government appear to be key reasons for thedevelopment of this situation.

! Co-operatives were seeing the impact of the implementation of the new food regulations,for example, on animal drug residue in raw milk, but most thought this was a newrequirement of the milk processors, rather than a regulatory change.

! Some co-operatives are operating with very limited access to credit but their managersdid not realise that their inability to obtain more credit arose from new Bank Indonesiapolicies than from problematic bankers.

Overall, this situation is unfortunate for the small-holder dairy farmers because most of thechanges made by the Indonesian government to its policies and laws have not beenappropriately considered in:

! Dairy farming industry development strategy since 1998, especially since 2000 when thenew structure of the government and the autonomy policy had stabilised; and

! The individual business strategies of most of the co-ops that operate in the dairy farmingindustry.

The top-line implication of these changes in Indonesia government policy, laws andregulations are summarised in the Table below.



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Area of Policy orRegulatory Change

Implications for the Dairy Farming Industry

Milk market liberalisation The industry operates in a new market environment inwhich entrepreneurial activities can be developed bydairy farming co-ops and their members without therestrictions of the past.

"Co-ops as the responsibilityof society, not government"(President Habibie).

Government involvement in Bapak/Anak(Father/Child) relationships will be eliminated so thatco-ops become independent organisations that aremanaged by their members for their members. Thisswitches the responsibility for the success of co-operative industries from the government to co-opmembers and their appointed management teams, as isthe case in most other parts of the world. In essence,co-ops shift from being rural area development toolsof the government to businesses that are owned,operated and managed by their members.

New co-op laws andregulations that are beingbrought into line withinternational co-operativeprinciples and best practices.

This allows co-ops to be established in a manner thatis fully compliant with international co-operativeprinciples and best practices. Indonesia currently hasthree broad types of co-ops:

! Old style top-down managed co-ops, whichgenerally do not comply with the Indonesiangovernment's new policies and laws.

! Intermediate co-ops that have been adopting someof Indonesia's new co-op laws and regulations aspart of a transitional process.

! New style co-op's that are owned, operated andmanaged by their member farmers throughdemocratic processes.

Bank Indonesia's newregulations over lending toagricultural businesses,including co-operatives.

Co-operatives that obtain their credit facilities andloans from banks and other financial institution willsee an increase in demand for information about theirfinancial status and monitorship of their accounts bytheir bankers. Co-ops will need to improve theirfinancial management skills, reporting and recordingto meet with the demands of their bankers as theydevelop in future. Co-ops that are currently insolventor technical insolvent (having severe cash flowproblems) could be forced into bankruptcy if they areunable to negotiate new facilities under the banks'new terms and conditions.



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The new food regulations, asintroduced in late 2004, plusany future provisions that areplanned.

These regulations are already having an impact onsuppliers of raw milk to the milk processing industry.As the branded milk products of this industry have tocomply with the new regulations so does any inputs oringredients that are incorporated in these products.

If the new food regulations are properly implementedacross the whole industry in future, all dairy farmersin Indonesia will have to operate in a manner andenvironment that reduces bacteria content, antibioticcontent and other residues in their products that enterthe human food supply chain.

The change in thegovernment's energysubsidies.

This situation will raise the operating costs of co-operatives with energy intensive operations. As themarket for liquid milk is generally price sensitive, itcould be difficult for cost increases to passed onto theconsumer on an immediate basis without damaging(reducing) demand for liquid milk. (Note: Themanagement of some dairy farming businesses havealready been assessing how available renewableenergy sources / alternative technologies might beable to assist in dealing with their energy crisis).

The ASEAN Free Trade Areaand the follow-upharmonisation of ASEANregion food regulations.

Indonesia's dairy farmers now operate in a regionalmarket in which there is now close to free trade inASEAN-made dairy products. Thailand and Malaysiaare already exporting milk products to Indonesia.Indonesia is also exporting some milk products tomost of the ASEAN countries.

Harmonisation of the ASEAN food regulations by thetarget date of 2008 is likely to create a true free tradearea for ASEAN-content milk products in the region.This situation will see dairy farmers and milkproducers in Indonesia having to comply with exactlythe same regulations as their counterparts inSingapore, Malaysia, Thailand and the other ASEANcountries.

The AFTA process will lead to the establishment ofthe ASEAN Economic Community by 2020 or earlier,which in terms of internal trade will exhibitsimilarities to the European Union and NAFTA.



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The negative attitudes ofsome international financialinstitutions and aid agenciestowards providing assistanceto Indonesia.

This situation may limit the ability of the dairyfarming industry to attract new internationalassistance, unless a new environment can bedeveloped that can meet with the due diligence criteriaand the specific program goals of the internationalfinancial institutions and aid agencies. The key lenderand donor demands are for:

! Better, and more responsible, programmanagement by all Indonesian organisations thatare involved in their programs; and

! Importantly, higher levels of transparency,monitorship and financial control by allIndonesian organisations that are involved in theirprograms.

Dealing with this matter in a constructive manner islikely to be crucial to any future development programto assist the dairy farming industry to evolve within itsnew operating environment over the next 5 to 10years.

Indonesia's dairy farming industry is now operating in a new regulatory environment that hasdeveloped by its government. This is having direct impacts on the business environment inwhich the farmers and their co-ops operate. In view of this, it is very important that a newstrategic plan be developed for the dairy farming industry to ensure that:

! A firm operational foundation is developed for the industry that is fully in line with thenew policies, laws and regulations as they develop in future.

! The industry continues to be a vibrant part of the rural economy, in particular inIndonesia's uplands, in future.

Indonesia's Dairy Farming Industry SWOT Analysis - 2005 National SWOT Analysis for the Industry


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4. National SWOT analysis for the industry

4.1 Introduction

The matters that are highlighted in this SWOT analysis have been identified specifically fromdiscussions with respondents from:

! The Indonesian government (including national, provincial and local level departmentsand agencies) and Indonesia-based financial institutions, co-operatives, businesses, farmsand academic institutions; and

! Foreign organisations, agencies and experts that have been involved in developmentprograms in Indonesia's rural areas and agricultural industries.

4.2 Opportunities and challenges arising from factors external to the industry

4.2.1 Economic factors

Indicators of Opportunities Indicators of Challenges! Indonesia's economic growth is improving.

There are now forecasts that the economy willgrow by between 6% and 7% per annum overthe next 3 years (subject to any negativeimpact of rising oil prices). This will havepositive impacts on demand for dairy productsacross all income groups, especially in urbanareas.

! The new "autonomy" policies that have beenintroduced should stimulate economic growthon a provincial / localised basis acrossIndonesia providing local taxes/localgovernment charges do not deter such growth.Such growth will improve consumer marketconditions on localised basis with positiveimpacts on demand for dairy products.

! The new President's policies are orientedtowards stimulating new economic growth ina more stable Indonesia. Foreign investors arestarting to take notice of Indonesia again.Foreign direct investment in internationallycompetitive business sectors is now beingforecast to see a substantial increase for thefirst time since the economic crash of 1998.

! Since the 1998 economic crash, much ofIndonesia's economic growth has beenstimulated by local investment. Thisdevelopment is significantly "healthier" thanthe pre-1998 scenario of high level reliance oninward investment from foreign investors.

! Significant disparities in householdincomes between rich and poor and urbanand rural areas across Indonesia. Themiddle and upper income groups representless than 10% of the population in 2005.

! The rate of unemployment andunderemployment is still too high acrossthe whole of Indonesia. Positively, therates are expected to decline because newjobs and business opportunities will becreated as the economy grows in future.

! Although declining, the rate of inflation isstill impacting negatively on the consumermarket, especially the middle to lowerincome groups. Most analysts expect thenew President's policies to moderateinflation over the next 3 years.

! The value of the Rupiah on worldmarkets, which has both positive andnegative impacts on Indonesia's economyand consumer markets.

Increasing confidence in Indonesia as aforeign investment destination andeconomic growth over the next 5 yearswill see the Rupiah's value strengthenagainst major currencies such as the US$and Euro. This will have a complex rangeof impacts on Indonesia's dairy industryand market.



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Indicators of Opportunities Indicators of ChallengesSince 1998, there has been a significantbroadening of economic activity involvingsmall and medium sized businesses, whichare now an important source of jobs, bothformal and informal, for Indonesians. This"economic engine" will continue to be veryimportant in future because of its positivebenefits on household incomes andconsumer demand.

! Indonesia has two broad economies and costof livings, one in the urban areas, the otherin the rural areas. Depending on the city, theretail pricing of foodstuffs can besignificantly higher than in the rural areas.

This provides well-organised dairy farmingbusinesses, e.g. entrepreneurial co-operatives, with the opportunity to segmenttheir market around the different demandtraits that exist across Indonesia.

! Future economic development under the"autonomy" policies of the government willcreate a number of different urban areamarkets across Indonesia. The vibrancy ofeach city economy will underpin thedevelopment of its food and drink marketopportunities, including issues such as theprice that is acceptable to consumers andprofits earned from the market.

! Competition from China and othercountries in South East Asia for foreigndirect investment although weakening,because of the new President's policies, isstill a challenge for economic developmentand related job creation in Indonesia.

! Small dairy farms in areas that are veryclose to urban areas may only remain inexistence in future if their owners cannotfind other sources of income, e.g. jobs infactories or service industries or morediversified farming oriented around marketgardening. (Note: There is alreadyevidence that this is happening in someparts of Java).

! Rising world oil prices and their impact onthe Indonesia economy. The relatedchanges in government policy coveringsubsidised energy and its impact on therural economy, inclusive of rural areabusinesses.

! The economics of tropical dairy farmingare underpinned by natural constraints, e.g.climatic, environmental, a milk yieldceiling and feed characteristics, quality,cost and availability, when compared topasture-based dairy farms operating ontemperate grasslands.



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4.2.2 Climate, geography and feed resources

Indicators of Opportunities Indicators of Challenges! Indonesia has highlands with

temperatures averaging in the mid-20°C,compared to the mid-30°C in thelowlands. Accessible highlands existacross Indonesia, although only those inJava and Sumatra are located close tomajor consumer markets.

! Outside Java Island, grazing landconstraints are less severe. In the otherislands, livestock farming ranges fromtethered grazing and semi-intensivefarming in Sumatra to free grazing in anextensive system in some easternislands.

! Where extensive dryland farming ispossible, cattle farming is more viable.In these areas, the % of farmers'incomes from livestock is double that inareas where intensive farming ispractised, especially where wetland(rice) farming dominates.

! Indonesia is reported to have a widerange of local feed plants, includinggrasses, legumes, leguminous trees andshrubs, although these are not wellutilised in formal feed production andfeeding programs. Many of these plantsare reported to be resistant to localpests.

! Indonesia has extensive agri-wasteproducts that are derived from theprocessing on agricultural products, e.g.rice straw, corn stover, banana stems,pineapple waste, cassava tops, palm-oilwaste, etc., that can be used ascomponents in cattle feed rations. InJava, additional waste products alsoexist, e.g. soybean waste and brewingwaste, which is already used in dairycattle feed.

! The FAO Grassland & Pasture CropStudy (1999) reported that Indonesia'shighlands perform better in feedproduction yield during the dry seasonthan any other part of Indonesia.

! Indonesia's more general tropical environmentin its lowland areas is challenging for cattlefarming.

! Nationally, Indonesia is affected by wet anddry seasons. Livestock farmers identifyperiodic water shortages in various areasacross Indonesia as a challenge to theiroperations:

" Java's dry season is June to September." Eastern Indonesia has a longer dry season,

which is up to 9 months long in someareas.

" Periodic droughts, e.g. every 3 to 5 years,are a problem in Eastern Indonesia, similarto Australia.

These conditions have negative impacts on:

" Water availability for cattle rearing; and" Local feed crop production output.

! Java Island has a shortage of grazing landbecause of its high population density, landusage and topography. This causes itslivestock farms to be intensive.

! Productive land is rarely allocated by small-holder farmers for fodder production. Thesefarmers usually grow fodder crops in marginalareas of land, e.g. field edges, steep slopes,etc., and on productive land that has beendesignated as fallow land.

! Fodder availability for cattle that graze undertrees during the dry season is often limitedbecause of green matter does not grow whenthe ground is covered in dry leaf litter and seedpods. Feed costs can be high during the dryseason.

! Indonesia's hot and humid climate createsinherent risks for quality / integrity of dairyproducts at all stages in the supply chain fromfarm to consumer. Inappropriate processing,storage and handling of dairy products in thisenvironment can result in significant healthrisks for consumers.



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4.2.3 Policy, legal and fiscal factors

Indicators of Opportunities Indicators of Challenges! The Indonesia government's policies

towards economic development have afocus on rural economic development andthe development of more viablebusinesses, including dairy farms, in therural areas.

Rural economic development is viewed asvital to a stable Indonesia in future underwhich the rural areas play a key role infood security for Indonesians.

! Since 1998, Indonesian government policyhas favoured freer private sectordevelopment of a wide range of industrieswithin the country's economy.

The "autonomy" policies have added tothis by establishing potential for newzones of economic and industrial growththat are being "promoted" by provincialand other local governments acrossIndonesia. Some of these governments arefocused on maximising the use of localcompetitive advantages to boost economicdevelopment in their areas. Thisdevelopment provides opportunities forbusinesses, including co-operatives ownedby farmers, to develop more viablebusinesses in the provinces.

! Indonesia's law covering co-operativesprovides a basic framework for theestablishment of modern co-operativebusinesses that are owned, managed andoperated by groups of small-holderfarmers.

! Dairy farming is an accepted part ofIndonesia's rural industry, although it isnot underpinned by strong businessstrategies and management skills. Thissituation exists because of weaknesses infarmer education and training and theextension services.

! Indonesia's government policy on ruraleconomic development has someweaknesses in terms of projectimplementation in the rural areas. Aidagency management and private sectormanagement comment that these weaknessesare often underpinned by:

" Incomplete planning of projects that areto be implemented in rural areas.

" Short term views and budgeting;" Demands for "quick fixes"." Corruption." A lack of longer term consistency in the

composition of Indonesian developmentteams due to changes in key personnel.

" Disagreements between the variousgovernment departments and localagencies that can be involved indevelopment projects.

! Corruption and its general negative impacton small businesses. This is now starting tobe dealt with by the new President under hisanti-corruption stance and related policiesand regulations.

! Local taxes and government charges aredeveloping as a result of the "autonomy"policies. These disadvantage smallbusinesses because of the additional coststhat they add to operating such businesses.Such taxes can be a significant burden tofarms that operate at a low level ofprofitability.

! Indonesia's co-operative legal framework isnot complete because it does not providesmallholder farmers with guidance on howthe legal provisions in the law should workin practice.

! The ownership of farmland in Indonesia isnot always officially registered through anyform of title deed. This situation does notfacilitate the granting of loans to farmers thatare secured by way of a mortgage over thefarmers' land. Commercial banks aretherefore reluctant to make large loans tofarmers.



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Indicators of Opportunities Indicators of Challenges! Indonesia's new food regulations, the

related regulatory upgrading programbased on CODEX, and industryreaction to the new provisions onbacterial content and agriculturalresidues should stimulate animprovement in the quality ofIndonesian milk products in future(Also see indicators of challenges).

! Industrial democracy is alreadyworking in Indonesia. In early June2005, the members of GKSI in CentralJava voted to install a newmanagement at the organisation toreplace a team that was not running itin a manner that was bringing benefitto its member co-ops.

! Most of Indonesia's new policies, lawsand regulations, if appropriatelyfactored into future developmentstrategy in a practical manner, shouldlead to:

" A better managed and moreefficient dairy farming industry;

" More entrepreneurial andprofitable dairy farming co-operatives;

" Better quality raw milk and milkproducts;

" A stronger commercial foundationfor the dairy farming industry tocompete within the free marketconditions that will exist all acrossthe ASEAN region in future; and

" Improved compliance withIndonesia's food regulations and, inthe near future, with the ASEANharmonised food regulations.

! Macro management of the dairy farmingindustry is shared by a number of ministries,departments and agencies. This situation doesnot facilitate efficient management of theimplementation, monitorship or performanceevaluation of key development projectsundertaken in the industry.

! Indonesia's new food regulations enacted in2004 are based on some parts of CODEX.Provisions on bacteria content and agriculturalresidues will be a challenge for small-holderdairy farmers (Also see indicators ofopportunities).

! Policy covering dairy farming industrydevelopment does not provide enough emphasison the maximisation of small farmers' incomes.

Policy focus is oriented towards expandingdairy farming and the production of milk ratherthan on development of profitable farms andco-operatives. As a result:

" There is no evaluation of the financialperformance of the industry, its componentparts or development projects that arefunded for the industry.

" Weaknesses exist in productive assets,including cows (poor quality), plant andequipment (poorly planned or incompletesupply), that are supplied by governmentagencies;

" No breeding program exists to develop andtest a crossbred milking cow with high milkproduction and tolerance to dry seasonconditions.

" PIR (networked) systems tie farmers tostronger profit-oriented businesses and maynot be maximising farmers' incomes in amanner that an efficient and well managedco-op might.

" There is limited evaluation of the impact ofeducation and training schemes onsmallholder dairy farmers' incomes.

Continued …..



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Indicators of Opportunities Indicators of Challenges" Development projects are not

established at a level that can beafforded by the co-ops and theirmembers. In some cases, equipmentpurchased is too sophisticated for the co-ops or maintenance costs too expensivefor co-ops to operate the equipment onan on-going basis.

" No activities exist to review theappropriateness of the performance ofthe Frisian-Holstein breed versus otherbreeds/crossbred cows on co-op farms inthe dry season.



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4.2.4 Social and cultural factors

Indicators of Opportunities Indicators of Challenges! Indonesia's population is continuing to

grow. Based on forecast economic growthtrends, the population will also becomemore urbanised in future. Both of thesetrends are positive for suppliers of food anddrinks that are distributed for sale in theurban areas.

! About 28% of Indonesia's population isyounger than 15 years today. By 2015,about 25% of Indonesians will be aged 15years or younger. This scenario is verypositive for consumer market developmentunder conditions where the economy is alsogrowing.

! The basic trend seen in the diet of middleincome group Indonesians residing in thekey urban areas has been towards:

" Diet modernisation;" Higher consumption of retail packed

processed food and drinks; and" Demands for better quality products,

inclusive of packaging.

This trend has impacted on all persons thatcan afford to purchase these products andinvolves a range of dairy products.

With Indonesia's economy moving into ahigher growth mode, this trend will continuein future with larger numbers of consumersinvolved in the market for retail packedprocessed food and drinks.

! Although per capita consumption is verylow, liquid dairy milk is quite well known toIndonesians, especially consumers on JavaIsland.

! Amongst the middle and upper incomegroups, liquid milk has demand and isregarded as a healthy and nutritious foodproduct even amongst lower income groupsin areas where liquid milk is available fromstreet-side hawkers.

! Increasing demands for higher qualityproducts, including packaging, can be achallenge for small businesses that areproducing lower quality products, if theyare targeting the higher income groups.

! Demand for dairy products other thancondensed milk and milk powder is stillvery weak and underdeveloped inIndonesia today.

! Weak education amongst small-holderfarmers does not facilitate the developmentof viable businesses amongst thiscommunity. As a result, most of thesefarmers are mainly producers ofcommodities for industrial customers andnot businessmen with direct access toconsumers.



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Indicators of Opportunities Indicators of Challenges! Children are reported to be key consumers

of liquid milk in households that purchasethe product. Consumption of the product isencouraged by parents, especially motherswho are key purchasers of liquid milk.

! As household incomes increase there is a"natural" increase in demand for healthierand more nutritious products. In Indonesia,these demand traits incorporate liquid milk,milk powders and drinking yoghurt orcultured milk drinks. This demand trait alsoextends to packaging, which must behygienic.

! As Indonesia's economy grows, itsconsumer market will develop a wide rangeof segments for food and drink processors totarget. These segments will range from thelower income to higher income groups.Each segment will have its own demands onvalue, including its reaction to price andproduct quality.

! Although there is currently a trend ofmigration to Jakarta and other Java Islandcities, successful implementation ofeconomic development policies under thegovernment's autonomy legislation shouldsee provincial cities also involved in suchmigration in future.

! Cattle (and buffalo) farming, but notorganised dairy farming, has some traditionsin parts of Indonesia, e.g. Madura, WestJava, Bali and some parts of Sumatra andSulawesi.



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4.2.5 Technological and R&D factors

Indicators of Opportunities Indicators of Challenges! Technology, including enhanced

extension services, exists to increasethe efficiency of small-holder farmersif they can take advantage of acommercially oriented co-operative.

The benefits of upgrading farmingtechnology, including governmentprovided extension services, to a levelappropriate to market-orientedsmallholder farmer co-op operationscan have positive benefits on:

" Production output;" Feeding;" Herd health, including breeding;" Milk yield and post farmgate

activities;" Processing and packaging;" Distribution; and" Product marketing.

! Technology, R&D abilities andenhanced extension services that aremore appropriate to Indonesia'senvironment may exist in other warmclimate areas of the world, includingQueensland, Australia. These provideopportunities to invest in a shift awayfrom past methodologies that revolvearound tailoring Developed Worldtemperate climate technologies to theless advanced Indonesian dairy farmingenvironment.

! Weaknesses exist in technology used by smallholder farmers in Indonesia, includingextension services supplied.

! Local investment in feed technology mainlyrevolves around the mass production ofcompound feed for the poultry industry.Production of such feed for other livestock isnot a major activity and, in some cases, onlyservice demand from integrated livestockfarming operations linked to large feedmills.Compound feeds are reported to be tooexpensive for most small-holder farmers to usein their farming operations.

! Aside from the large feedmills that are modernoperations, most of Indonesia's animal feed isproduced by a transient and informal feedindustry. Feed industry trade sources refer tothe players in this area of the industry as"backyard producers", which mainly use"trash", e.g. waste inputs, in their feeds.

! There has been little investment commerciallyoriented R&D activities and technology todevelop Indonesia's indigenous feed resources.The large businesses that produce compoundfeed mainly use local soybeans, corn, fishmealand cassava inputs and imported inputs,including soybeans, corn and soybean meal, intheir feed.

! Broadly, feed technology usage is in its infancyoutside Indonesia's large scale producers ofcompound feed. This situation underpins thelower quality of feed being used by small-holder farmers.

! Small scale producers of animal feed may notbe competitive with larger businesses that areable to take full advantage of productioneconomies of scale, unless they are:

" In-house operations; or" Have a localised market that provides them

with lower distribution costs.



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Indicators of Opportunities Indicators of Challenges! The FAO, IDF and other organisations,

such as ACIAR, have funded manytechnical studies into appropriatetechnologies for small-holder farmers andco-ops owned by them in the DevelopingWorld. Some studies have been publishedas technical manuals for use by co-ops thatare owned by smallholder farmers.

The focus of these studies has been on highquality-low cost technologies for smallscale dairy farming operations that processbetween 5,000 and 10,000 litres of milk perday. The technologies covered by thesestudies include:

" Milk quality;" Milk collection systems;" Milk cooling and cooling systems;" Milk separation;" Pasteurisation;" Packaging;" Storage and transportation;" Refrigeration." Production of liquid milk." Production of longer shelf life

fermented products, e.g. flavoureddrinking yoghurt (Lassi) and cupped(eating) yoghurt.

! The general preference for investing in amodern dairy processing business that useshigh cost production equipment andpackaging systems imported from theDeveloped West rather than equipment thatis affordable to smallholder farmers, e.g.stainless steel equipment, homogenisersand UHT processing systems.

Such investments are likely to be too highin terms of investment capital and too lowin terms of commercial returns oninvestment capital to be viable for a smallholder farmer co-operative under themarket conditions that exist in Indonesiatoday. In practice, the use of high costequipment may only be viable with thesmallholder sector of the industry if it isgifted to the farmers or their co-ops by thegovernment or any aid agency.

! Milk processing facilities for processingliquid milk of less than 5,000 litres per dayare not readily available.

! UHT processing and packaging systems aregenerally too costly for small dairybusinesses to operate.

! Technicians advise that there are significanthealth risks to smallholder farmersproducing sterilised liquid milk rather thanpasteurised products.

! Many of the dairy farming co-operativesand their member farmers are unlikely to beable to comply with the technicalrequirements of Indonesia's new foodregulations, in particular:

" Some of the additional provisions thatplanned for the near future, which areCODEX-based;

" Any upgraded provisions that might berequired as ASEAN upgrades itsregional regulations under the on-goingharmonisation process.



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4.2.6 Factors in the dairy product supply chain

Indicators of Opportunities Indicators of Challenges! Indonesia's future consumer market development

scenarios indicate that segmented distributionchannels will continue to exist in future withdifferent channels existing to the:

" Lower income groups, who will be serviced bytraditional channels, e.g. hawker stalls andhome delivery, and some modern discountretail outlets, e.g. some types of localhypermarkets and minimart chains supplyingbasic packaged products.

" Middle and upper income groups, who will bemainly serviced by modern retail outlets,including chains of hypermarkets, supermarketsand convenience stores focused on supplyingbranded products.

! The modern retailers are strengthening theirpresence across Indonesia. Currently, these outletsaccount for less than 25% of Indonesia's retail salesof food and drink. This provides food supplierswith:

" Better access to the developing middle incomegroups in the major cities; and

" Larger retail display space than in the past forchilled and ambient temperature dairy products.

! Some major retailers are now active in directprocurement from manufacturers and agrifoodproducers. These products include retailer labelproducts that are produced for the retailers on acontract manufacturing basis.

! The foreign investors in supermarkets andhypermarkets are stimulating change in the qualityof the shopping environment for middle and upperincome group shoppers. This is upgrading thedemands of these shoppers on the quality ofproducts that are carried by these types of retailoutlets.

! Milk pricing incentive schemes have beenintroduced by most milk processors to reward dairyfarming co-ops and farmers who supply betterquality milk with a higher price for their raw milk.

! Weaknesses exist in the chilledproduct distribution channels acrossIndonesia that threaten the integrityof short shelf life dairy products.This creates barriers for pasteurisedproducts that have to be distributedover long distances, includingimported products.

! The traditional retailers that controlwell over 75% of Indonesia's retailsales of food and drinks are smallhighly localised family runshops/stalls that are not equipped tohandle perishable products such aschilled dairy products.

! The major retailers, especiallythose with foreign shareholders,have implemented internationalstandard procurement andmerchandising practices inIndonesia. These practices are achallenge for businesses that arenot quality-oriented and able tosupport their products insupermarkets and hypermarketsthat service the middle to upperincome groups. (Note: Discussionswith some of the foreign investedretailers now operating inIndonesia revealed that they haveprograms that will assist localfarmers to supply them with theirproduce on a direct basis throughcommercial and quality-orientedsupply arrangements).

! Trade sources comment thatinformal road tolls that are levied insome rural areas of Indonesia addto the cost of distributing productsfrom farms to their markets in theurban areas.



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4.2.7 Commercial investment and aid funding factors

Indicators of Opportunities Indicators of Challenges! Indonesia's larger corporate

investors and foreigninvestors have no majorinterest in investing in dairyfarming in Indonesia. Anybusinesses that are interestedwould prefer to invest in acost effective and efficientintegrated operation underwhich they can:

" Manage costs effectively;" Control production and

product quality along thewhole supply chain fromfarm to retailers.

" Profit from selling a highquality brand under apremium level brandtargeted at the higherincome groups.

This scenario providesopportunities to developindependent market-orienteddairy farming co-operatives infuture.

! The primary focus ofbusinesses that are involved inIndonesia's dairy productmarket is in the profitableproduction of high qualitybranded dairy products forIndonesia's growing middleand upper income groups.

! Foreign aid has long beenavailable to Indonesia's dairyfarming industry, however,most of the aid programs havenot led to the establishment ofany "consumer market"oriented co-operatives that areowned, managed and operatedby a group of small-holderfarmers.

! Apart from a small number of commercial farms that areowned by corporations, most of Indonesia's dairy farmsare operated by small-holder farmers who have verylimited access to funds for investment in their farms. Inaddition to this, it is also reported that the dairy farmingco-operatives also have major constraints over thefinances.

! Indonesia's larger corporate investors have a high levelfocus on the Java market, which includes:

" The country's most vibrant consumer markets,especially Jakarta; and

" Is home to close to 60% of Indonesia's population.

This impacts on investment strategy as these businessesprefer to manufacture close to their Java markets and"export" their products to other areas of Indonesia. Thisundermines the investment prospects outside Java Islandand arises because being close to Java consumersprovides distribution economies of scale that would notexist for larger businesses operating in other parts ofIndonesia.

! There is a history of failed joint ventures betweenforeign businesses and co-operative enterprises inIndonesia. The senior management of one majorinternational dairy company advised that they had triedto develop two joint ventures over the past 10 years.Both efforts failed because of a lack of commitmentfrom the Indonesian joint venture partner. Afterinvestigation, it was concluded that obtaining areasonable return from the proposed investments wouldbe very difficult because inherent weaknesses in thedairy farming industry as a strategic supply base for anynew commercial ventures.

! International financial institutions and some aid agencieshave become increasingly wary about committing fundsto Indonesia. This situation arises because of:

" A fear of becoming involved in corrupt practices,which could be very embarrassing for suchorganisations under the current anti-corruption drive;

" Project failures in the past as a result of corruptionand/or bad project management in Indonesia; and

" The past history of bad and doubtful debts whenlending to Indonesian agricultural developmentprojects, especially in the livestock sector.



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Indicators of Opportunities Indicators of Challenges! The government has established

various agricultural creditschemes that can be utilised bythe dairy farming co-ops and theirmembers. (Note: Discussions withthe management of a number ofbanks in Indonesia indicate thatthe co-operative sector is highlyproblematic because the prospectof incurring a bad debt is veryhigh. The ADB have reported thatin some of its livestock programsin Indonesia well over 75% of allloans provided to Indonesianbusinesses become irretrievablebad debts).

! In many cases, foreign aid programs have involveddeveloping farms that are based on a temperateclimate dairy farming model and based ontechnology that has largely proved too advanced andtoo expensive for small-farmer co-operatives toinvest in and profit from in Indonesia's currentmarket environment.

! The results of past aid projects have not beensustained in terms of long-term survival of farmingbusinesses that are viable in the commercial world.The focus of these activities has been on improvingtechnology and farming processes rather than on abroader goal of developing viable dairy farmingbusinesses.

! Some sectors of Indonesia's farming community,including some dairy farmers, are aid dependent andhave significant reliance on the government toprovide an environment in which they can surviveoutside a commercially oriented marketenvironment. This situation does not facilitatedevelopment of viable commercial farms.

! Financial institution reaction to Bank Indonesia'snew regulations over enhancing credit controlprocedures over loans and credit facilities willreduce the availability of loans and credit facilities toco-ops that have:

" Weak financial management;" Poor levels of responsibility towards repaying

their loans and credit facilities; and" Poor financial performance and credit histories.

(Note: This situation could result in cash flowproblems for weaker co-operatives and theireventual bankruptcy over the next 3 years or so).



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4.2.8 Factors in the local market and its characteristics

Indicators of Opportunities Indicators of Challenges! Indonesia has a sizeable

market for some dairyproducts that is centredmainly in the urban areas ofJava Island. The mainproducts being consumed interms of LME volumes are:

" Sweetened condensedmilk, which includesfilled products, a lowervalue commodity item.

" Retail packed milkpowder.

" Infant formula andfollow-on milkpowders.

" Liquid milk, bothbranded milks andfarmers' milk.

" Cultured milk drinks.

The main target for highervalue dairy products is thecountry's relatively smallpopulation of middle andupper income groups, whichrepresent less than 10% ofIndonesia's population.(Note: This is a sizeabletarget market of about 22million persons in 2005).

! Overall, Indonesia's demandfor dairy products hasbounced back from thelarge decline in demand thatoccurred in 1998. Growth inconsumption shouldcontinue as householdincomes and consumerconfidence continues toimprove on the back offorecast growth in theeconomy over the next 3years.

! The size of Indonesian demand potential is often over-estimated because it is extrapolated based on totalpopulation size, which in reality contains large numbers oflower income consumers who do not represent a viabletarget for most dairy products.

! Demand for some dairy products is weak because they aretoo expensive to develop a broad based market or have nostrategic "fit" in local food culture. These products include:

" Drinking yoghurt." Dairy based ice cream (branded)." Cupped (eating) yoghurt." Cream." Cheese of all types." Butter." Ghee (Minyak Sapi).

! The most viable area of Indonesia's dairy product market,i.e. the middle and upper income group segments, revolvearound demands for branded higher quality products,which are produced by commercial businesses and notfarmers co-operatives. Higher quality products includeproducts that are hygienically packed and healthy toconsume in terms of their contents. These characteristicsare considered very important by middle income groupmothers that buy dairy products for their children.

! The middle and upper income group consumers aredeveloping strong preferences towards shopping for muchof their household food in modern higher qualitysupermarkets and hypermarkets that focus on supplying thequality branded products that these consumers demand.

! The school milk programs that have been run in Indonesiahave not assisted in developing a more viable smallholderdairy farming industry. As in other countries, most of theschool milk programs have an aid orientation that does notpromote the development of commercial businesses thatare viable into the long term. Trade sources comment that:

" The school milk programs being run in Indonesia tendto promote a level of temporary aid dependency forany farmers that have been involved.

" School milk programs in other countries create aiddependency that can spill over into major argumentsbetween the farmers and government when the farmersmilk cannot be sold, e.g. during school holidays.



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4.2.9 Factors in the milk processing industry, its bargaining power and basis ofcompetition

Indicators ofOpportunities

Indicators of Challenges

! The milk processorsthat are major users oflocally produced rawmilk have access tosizeable growingmarkets for theirbranded products.

! The milk processingindustry is involved insome generic milkdrinking campaigns toincrease milkconsumption acrossIndonesia. Companiessuch as UltraJayaMilk, Indomilk,Greenfields and AlamMurni have beenworking together withTetraPak, Indonesia'shealth and educationdepartments, somelocal governmentsand local clinics torun these campaigns.

These promotions areaimed at educatingmothers, school agechildren and thegeneral public aboutthe benefits ofconsuming health andnutritious milk. Themain campaign hasbeen focused inchildren. In someparts of Indonesia,such campaigns havealso been aimed atwomen, especiallypregnant women, andthe elderly as part ofimproving babyhealth and reducingthe risk ofosteoporosis.

! The milk processing businesses, Nestlé, Friesland, UltraJaya,Indomilk, Diamond and Greenfields, that supply the most viablearea of the Indonesian market for dairy products are powerfulprofit-oriented local and foreign invested businesses that aresupported by:

" Strong brands that have built positive reputations in themarket, in particular the important middle to upper incomegroup market segments.

" Access to funds for new investment in productive assets, e.g.factories and equipment.

" Mass production facilities that are more cost effective andefficient than smaller operations.

" Strong distribution capabilities that allow their brandedproducts to access all target customers across Indonesia.

" Strong business and marketing strategies supported bymarketing campaigns that support their brands in the marketand build defences against competition from existing andnew businesses.

" Active R&D capabilities, some of which are part ofinternational resources, e.g. Nestlé and Friesland Coberco.

These businesses have strong bargaining power over theirsuppliers. In a liberalised raw milk / ingredient market situationthey can choose where they source their raw milk /ingredientsfrom and will generally buy the lowest cost highest quality inputsthat are available to them.

Additionally, their brands, marketing strategy and distributionstrengths provide significant barriers to expansion by existingplayers in the industry or the entry of new brands, includingimports into the Indonesian market.

! One local business known as PT Greenfields Indonesia hasestablished a modern standalone integrated dairy farming andmilk processing operation in Malang, East Java, based on a herdof dairy cows imported from Western Australia. This business iscompeting actively with the older branded milk businesses butdoes not buy any raw milk from local small holder farmers.(Note: Strategically, the other milk processing businessesoperating in Indonesia have no significant interest in investing indairy farming. Additionally, Greenfield's quality-focusedoperation is not designed to assist small-holder milk suppliers).



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4.3 Strengths and weaknesses arising from factors within the industry

4.3.1 Industry strategy

Industry Macro Management and Strategic Planning

Strengths Weaknesses! Industry

management hassuccessfullyincreased the size ofIndonesia's dairyfarming herd andmilk productionoutput since the mid-1990s. Today,Indonesia has:

" One of thelargest dairyfarmingindustries inSouth East Asia;and

" The onlyindustry that hasseen significantproductiongrowth in anenvironment oflow tradebarriers toimports. At thelevel of entryprice, theindustry iscompetitive inthe face ofcompetition fromimports.

! The Indonesiangovernment is fullycommitted tostimulating dairyfarming developmentalthough a variety ofweaknesses exist inimplementation of itsdevelopmentstrategy.

! No evaluation of the real impact of industry development strategysince the mid-1990s has been performed. Unfortunately, whileindustry size and milk production output has increased, farmers'operations are still inefficient (small herd sizes) and problematic(quality and productivity issues) in many parts of Indonesia.

! No strategic overview exists on what is happening within thewhole of the dairy farming industry, in particular on:

" The financial state of the industry and the economicreturns/benefits of the investments that are being made by thegovernment and others in the industry; and

" The on-going impact of programs that are designed toimprove the farmer's productivity and financial returns fromtheir farms.

" Activities at co-operatives and on individual farms that areoperational or improvement benchmarks for co-operatives andfarms.

! Industry management and development strategists are mainlyusing non-financial performance indicators to assess whetherindustry development plans are meeting their goals and objectives.These indicators do not consider whether the dairy farms aredeveloping into more viable businesses that are increasingfarmers' incomes.

! Strategic planning for the industry and the activation of such plansis often undermined by weak investment planning and investmentproject activation (Refer to previous analysis of challenges).

! Management teams and industry strategists involved in dairyfarming industry development frequently misidentify the largepotential that exists for milk consumption in Indonesia as anindustry strength rather than an opportunity that is external to thisindustry. This error has led to inappropriate strategic analysisbecause to take this opportunity, the industry must improve itsproduct quality and develop strengths in marketing, somethingupon which there has been little strategic focus.

! The centralised information systems that exist to support macromanagement of the dairy farming industry are not comprehensiveenough and do not contain vital information on the performance ofthe industry, its component parts, and its supply chain.



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4.3.2 Industry infrastructure and resources

Organisational Issues

Strengths Weaknesses! The dairy farming industry is generally

organised around farmer owned co-operatives to take benefit from economiesof scale in sales and marketing, operationsand procurement (see weaknesses).

! Commercial dairy farms generally operatein an integrated manner, which includestheir own farm and milk and dairy productprocessing units. Examples include FajarTaurus and Greenfields.

Some, but not all, of these farms also buyraw milk from smallholder farmers toaugment their own production. Thesebusinesses:

" Have proactive and modern business,marketing and distribution strategies;

" Produce their own branded "consumerready" products, e.g. retail packedliquid milk, yoghurt, cheese, etc;

" Are active in the retail market,especially supermarkets andhypermarkets; and

" Are actively competing with importedproducts and the products of the largerIndonesian milk processing businesses,e.g. Ultra Jaya, Nestlé, etc., on the basisof product quality and value-for-moneybranded products.

! Most dairy farms operating in Indonesiatoday are too small to be independentbusinesses.

! Many co-operatives are small in size andoverburdened with overhead costs andinterest charges because of large loans andcredit facilities. This situation reducesprofitability of their members' farmsbecause these costs have to be covered byco-op's sales revenue.

Farmers, who are members of such co-ops,receive lower returns from them in terms offarm-gate pricing. Additionally, co-opfunds are often insufficient for payment ofany form of annual dividend to co-opmembers.

! Some dairy farmers are part of multipurpose co-operatives that may not operateto the benefit of their dairy farmingbusiness unit. In some cases, profitabledairy farming units are subsidising otherdivisions that are not profitable. (Note: Thisproblem is well known in some parts ofJava, e.g. East Java, and strategies arebeing put in place to avoid this problem infuture).



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Financial Resources

Strengths Weaknesses! The Indonesian government has established

a range of different credit facilities that areavailable to dairy farming co-operatives.(Note: Unfortunately, it is reported thatstrategic management of these facilities hassome weaknesses because some investmentprojects are not fully funded and this hasled to the purchase of productive assets forthe dairy farming industry that areunderutilised or dormant [see analysis ofchallenges and weaknesses]).

! Aid agencies have been providing funding(including donated livestock and otherproductive assets) and free technical adviceto various co-ops operating in Indonesia formany years (see analysis of challenges)

Unfortunately, while benefits havedefinitely accrued to the industry, there isno clear information on the extent to whichthese donations and other aid activities haveassisted in establishing sustainable, moreefficient and successful operations at all co-ops and farms that have been beneficiariesof the aid.

! Small-holder farmers generally havelimited access to funds to invest in theirherd and the productive assets, e.g. land(for feed) and equipment, that is required torun an efficient and profitable dairy farmingoperation.

! Internal generation of financial resourcesby the dairy farming co-operatives anddairy farmers is weak because ofinefficiencies in their operations (farms aretoo small) and corresponding weakprofitability.

! Some credit facilities being provided tofarmers by feed lot companies do notprovide the farmers with opportunities tomaximise their incomes from sales of meatcattle.

! Weaknesses exist in financial managementwithin the industry. Many co-ops arereported to have financial problems,although no clear information is availableon the extent of these problems on anationwide basis.

These weaknesses are undermining theviability of some credit schemes becauseof:

" The build up of bad and doubtful debtsin the co-operative sector; and

" Lender reluctance to continue fundingco-ops and farms that have defaulted onrepayment of their loans.



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Locational Strengths and Weaknesses

Strengths Weaknesses! Most dairy farms operate in the cooler

highlands of Indonesia where exotic dairycows, e.g. Frisian-Holstein and Jerseys,have good prospects for high volume milkproduction under conditions of:

" Good farm management andhusbandry; and

" Good feeding practices, especiallyduring the dry season.

Unfortunately, a range of weaknesses atvarious levels in the industry and its supplychain undermine this locational strength formany of Indonesia's dairy farmers so theyfail to realise high productivity from theirdairy cows.

! The main dairy farming areas on JavaIsland are in close proximity to the largeand more prosperous urban areas, e.g.Jakarta and Surabaya. Additionally, theKaro highlands in North Sumatra are veryclose to Medan city. Being "just down theroad" from major markets is a key strengthfor co-ops that have well managed chilledmilk operations.

! Although the dairy farms operate in thehighlands, many have not been establishedin a manner that can deal with the negativeimpacts of Java Island's dry season on:

" Feed availability/feed quality; and

" Water resources for dairy farming andthe milk collection centres.

! Most dairy farms operating outside theprovinces of West Java and East Java, e.g.Central Java, operate in an area where nomajor milk processing business has afactory. (Note: This could provide dairyfarmers in these areas with the opportunityto establish a market-oriented co-op withits own product range, brand anddistribution channels over the next 10years).

! There is insufficient focus on developingWest Java dairy co-operatives into market-oriented businesses that are able to exploitthe Jakarta conurbation market for highervalue chilled dairy products, which hasIndonesia's best long term prospects for allforms of consumer products. (Note: Thisarises because of the Indonesiangovernment's longstanding policy ofdeveloping PIR (networked) systems thatare tied in closely to third party owned milkprocessing factories).



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Feed Resources and Feeding Regimes

Strengths Weaknesses! Dairy farms that operate in areas of West

Java and East Java where there is:

" Sufficient natural feed in closeproximity to them on a year roundbasis; or

" They have access to stored fodder orsilage during the dry season can operatemore efficiently and profitably with alarger herd than farmers with feedconstraints.

! Some dairy farms that operate in Indonesiaare able to deal with the challenges offeeding in the dry season through a goodfeeding management regime and feedproduction and stocking-up during the wetseason. Examples of these farms exist inboth the co-operative farming sector andcommercial farming sector, e.g. TaurusFarms.

! Shortages of land for feed production are amajor problem for dairy farmers operatingin most areas of Java Island. Feed is:

" Grown on marginal land not used bythe farmers; or

" Bought-in from feed suppliers,especially during the dry season whenthe farmers cannot grow feed crops ontheir own land or collect it locally.

! The feeding practices of many dairyfarmers on Java Island, especially duringthe long dry season, are not alwaysappropriate for Frisians, the preferred breedof dairy cattle. Crossbreeds with dry seasontolerance do not form a major part ofIndonesia's dairy farming herd.

! Weaknesses are evident in nutritionmanagement on many small holder farms inJava Island. These weaknesses areaccentuated by shortages of nutritious cattlefeed during the dry season. (Note: Nutritionmanagement on commercial farms and atsome better managed co-ops allows thesebusinesses to operate consistently andprofitably throughout the whole year).

! Some concerns exist over pesticide residuesin on-farm produced feed because ofweaknesses in farmer education about theuse of pesticides.



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4.3.3 Management of the industry

Business Strategy for the Industry

Strengths Weaknesses! Increased milk production over the past 5

years has forced the management of someco-ops, e.g. in Central Java, to "thinkoutside the box" to deal with milk that issurplus to the demand of the milkprocessors. Some of them are:

" Investing in new equipment to assistin developing new dairy marketopportunities.

" Negotiating contracts directly withother milk processors, which isreportedly yielding better prices thanthose offered by the GKSI network.

" Developing new direct business forchilled dairy products, mainly liquidmilk, in the urban areas close to theirfarming area.

! Some farms have reacted well to milkquality improvement programs and areconsistently able to earn a higher pricefor their raw milk under milk priceincentive schemes. Examples of thesefarms exist at KPSBU Lembang,Tandangsari and KPS Bogor in WestJava, where it is reported that milkquality is higher than amongst themembers of other co-ops in neighbouringareas.

! Co-operative dairy farms with largerherds of up to 6 milking cows and 6 othercattle are reported to exist in thehighlands of West Java and East Javawhere good feed management exists atboth macro (industry) and micro (farm)levels during the dry season.

! In North Sumatra, dairy farmers have asmall market oriented business thatrevolves around basic processing(boiling) of their raw milk for sale tolocal households, food service outlets andinstitutions such as schools and hospitals.

! The main business strategy that has beenpromoted by the government andimplemented by the co-operativeorganisations has not facilitated thedevelopment of entrepreneurial businesses inthe co-operative sector. The strategy is gearedtowards organising a co-operative and findinga corporate business partner with sharedbusiness objectives, e.g. a milk processingbusiness. This strategy limits the co-ops andfarmers' abilities to maximise their incomesand develop into larger businesses that havedirect sales links to the consumer market.

! Many dairy farmers in West Java sell off theirherd's male progeny as immature cattle ratherthan fattening them up for ultimate sale to themeat markets. These farmers are notmaximising on their income potential but arepart of the feeder cattle supply chain thatinvolves feed lot businesses in various partsof Indonesia. (Note: It is more common inNorth Sumatra for bull calves to be fattenedup for sale when they are 2 years old).

! Most dairy farms in Indonesia have smallherds which undermines efficiency across thewhole dairy farming industry. Althoughprograms have existed for many years toincrease herd sizes, most of these have notbeen very successful, e.g. because ofproblems with:

" Feed supply and feeding regimes;

" Farm management issues, e.g. animalhealth and/or breeding raising fromweaknesses in education and training aswell as in farmer commitment to highquality farm management;

" Dairy cattle, which have been poorlyhandled at some stage in the channel fromsupplier to dairy farmer; and

" Investment project management andactivation of projects involving thedistribution of cattle to dairy farmers.



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Business Management of the Dairy Farming Industry

Strengths Weaknesses! Integrated commercial

farming businesses aregenerally wellmanaged and soprovide somebenchmarks for theoperation of dairyfarming co-operativesand dairy farms inIndonesia. Examples ofbusinesses that arerelevant to co-operatives owned bysmall-holder dairyfarms are TaurusFarms and YummyFood Utama, both ofwhich rank as smallerprivately ownedbusinesses.

! Some entrepreneurialco-operatives haverealised that it ispossible to improvetheir profitability andthe financial returns totheir members bydeveloping:

" Direct saleschannels to themilk processingindustry, i.e.without theinvolvement of theGKSI network;and/or

" New consumermarkets for milkthat is not requiredby the milkprocessingindustry, e.g. directsales of liquid milkand, in some cases,yoghurt in urbanareas close to thedairy farms.

! The focus of most co-operatives operating dairy farmingbusiness units is on selling what their members produce ratherthan focusing on what is being demanded by the market. Thissituation undermines business profitability because many co-opsare not taking full benefit from:

" The milk pricing incentive schemes by maintaining highquality milk supplies that have characteristics demanded bythe milk processors:

" The opportunities that exist to produce products that can besold directly to their local consumer market.

! Many co-operatives operating in Indonesia have not developedgood markets for the raw milk that cannot be sold to the milkprocessing industry. This situation arises because themanagement of these co-ops have a high level of reliance onchannels that were originally developed when the Milk Ratiomarket regulation system was in force.

! The dairy farming industry does not always learn from some ofthe benchmarks that exist in Indonesia, for example:

" The JICA funded industry improvement projects in Cikoleand Bunikasih in West Java;

" Taurus Dairy Farm's herd management and feeding systems;

" Friesland Coberco group/the Dutch Government's milkquality improvement intervention at KPSBU Lembang.

" The various dairy farming quality improvement programsrun by the State of Victoria's (Australia) Department ofPrimary Industries.

" CCA (Canada) co-operative development program's successat KPSBU Lembang.

! Industry managers/strategists have no clear definition on whatconstitutes a profitable dairy farming co-operative in terms of:

" Number of farmers;" Herd size; and" Milk production output.

This situation arises because of weaknesses in the financial andnon-financial recording and reporting and macro-levelmonitorship and performance assessment of the industry and itscomponent parts.



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4.3.4 Technology and technical aspects

Technical Areas of OperationsStrengths Weaknesses

! Farmers and co-ops that havebeen trained in clean milkproduction and handlingpractices that have appropriatefacilities, e.g. chilled storageand transport facilities, andcommitment towards low TPClevels are able to operate moreprofitable businesses.

! Past studies into the impact offrequent extension service visitsto Javanese dairy farms foundthat the farmers reactedpositively to such visits with aconsequent impact on theproductivity and earningscapacity of their farms. Areaswhere improvements werereported are in feeding andnutrition, animal health,reproduction, milk quality andgeneral dairy farm managementand husbandry techniques.(Note: Foreign technicaladvisors involved in the sectorsee a direct correlation betweendairy farm success and thefrequency and number ofextension visits all over JavaIsland. This will only develop asa permanent strength for theindustry in the long term, ifIndonesian extension serviceproviders take over the activitiesand responsibility for them fromthe foreign technical advisorsthat are currently involved inproviding such services to theindustry).

! Indonesia's dairy farms have been developed aroundfarmers who have little or no previous experience inlivestock farm management and husbandry. Althoughthese farmers do usually attend initial trainingschemes, many do not attend follow-up sessions.(Note: In some cases, this happens because no follow-up training sessions are provided by the extensionservices in the farmer's home area).

! Weaknesses continue to exist in the small holderfarmers' ability to manage hygiene and animal health intheir operational environment. This underpins thevariable incidence of Mastitis, other cattle diseases,incorrect drug application, high calf mortality andreproductive problems. (Note: This weakness isunderpinned by a lack of resources for veterinary staffand weaknesses in farmer and co-op staff [extensionworker] education and training schemes, in particularactive evaluation of impact on the schemes and follow-up checks on performance benefits of the training).

! Weak commitment towards clean milk production andhandling exists amongst trained farmers and co-opworkers despite the existence of pricing schemes thatare related to low TPCs. (Note: Some respondentsblame this on the lack of appropriate facilities in co-ops and related farmer despondency with their co-opmanagement. (Farmer's viewpoint: Why should Iproduce good quality milk on the farm if handling atthe milk collection centre increases TPC levels with theresultant negative impact on milk pricing to the co-op'smembers?).

! Variability is reported in the technical strengths of thedifferent co-operatives that are operating in the dairyfarming industry. This has an impact on operationalmatters including breeding, animal health, farmertechnical expertise, feed production, milk quality (TPClevels and product characteristics) and farmprofitability.

! Some dairy farming co-operatives do not havesufficient assets, e.g. production and distributionequipment, to maximise their profits. (Note: Thissituation is sometimes outside the control of the co-opbecause of errors that were made by governmentdepartments in planning and activating investmentprojects).



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Strengths Weaknesses! A range of technical and technical

improvement benchmarks existthroughout Indonesia. Many of thesebenchmarks have been established as aresult of some level of input fromforeign aid programs (also seeweaknesses). These benchmarks cover:

" Herd recording standards andpractice.

" On-farm hygiene and clean milkproduction standards and methods.

" Milk collection scheme hygiene." Extension worker training scheme

and in-the-field capabilities." Low and sustainable TPC counts." Milk handling and equipment

sanitation and maintenance." Quality awareness amongst dairy

farmers and co-op workers." QC systems for milk collection." Feeding systems." Fodder (silage) production." Reproductive health and breeding

management.

Examples of some of these benchmarkscited by respondents to this study existin:

" The KPSBU Lembang MilkCollection Scheme, a project whichwas funded by the DutchGovernment with input fromFriesland Coberco through itsIndonesia joint venture.

" The JICA Dairy TechnologyImprovement Projects, whichare/have been funded in variousparts of Java, e.g. Cikole andBunikasih in West Java.

" The various programs have beenfunded by Australia, including dairyfarming industry strategic planning,feed and clean milk productionworkshops and training programs.

" Taurus Dairy Farms in West Java, aprivate sector farm.

! The preferred breed, i.e. Frisians, may not bethe best breed for dairy farmers to maximisetheir incomes from milk sales in future.Challenges exist because of the dry seasonand also in the structure of the milk pricingincentive schemes, which focus on totalsolids rather than liquid milk supply. Sometechnical advisors believe this breedpreference should be reviewed to enablefarmers to improve their returns from theirmilk supply.

! Knowledge dissemination from thefragmented range of technical and technicalimprovement benchmarks is not widespreadin Indonesia so learning is also limited withinthe context of the whole industry. Havingstated this, JICA has extended their programto other parts of Java but the past projectsthat they have exited now suffer fromchallenges in sustainability because of a lackof strategic policy direction/funding.

! Indonesia's focus in recent years on boostingthe quantity of milk production output wasnot established with the objective of ensuringthat all new milk produced was a highquality product that would be acceptable to:

" The milk processing industry as a user ofthe milk as an ingredient; or

" The middle income consumer of farmer'smilk products.

! While high technical standards andcapabilities do exist on certain farms and insome areas of Indonesia, the quality oftechnical standards and capabilities that existon a broad basis are not wholly appropriatefor an industry that is producing a perishableproduct for sale into the human food chain.This weaknesses underpins a range ofproblems that exist in:

" Farm, milk processing and supply chainhygiene.

" Herd management and husbandry." Animal health and nutrition." Extension services for small holder

farmers." Milk quality." Farm productivity and profitability.



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Strengths Weaknesses! Indonesia has a large number of

extension workers and many ofits dairy farmers have receiveddetailed technical training inmatters that are important to theiroperations. Unfortunately, thesestrengths are being underminedby the highly fragmented natureof the dairy farming industry(many small farms) and theconsequent lack of time andresources, including budget, thatare available to the extensionservice providers.

! PT Greenfields unique integratedstandalone operation may alsoprovide some technicalimprovement benchmarksalthough some may not beappropriate to small-holderfarmers as this business operateswith high capital costs that mightbe a challenge to immaturebusinesses run by small farmercontrolled co-operatives.Greenfields has invested in anexotic (imported) dairy herd andmodern processing andpackaging equipment andpackaging formats. It is reportedto be funded by Japfa Comfeed,one of Indonesia's largest animalfeed businesses. (Note: Thismethod of operations does notprovide any benefit toIndonesia's small-holder dairyfarmers because Greenfields hasno demands for their raw milk.This situation arises because thiscompany operates to very highquality specifications. Havingstated this, the operation doesprovide jobs for rural residents).

! Extension service providers have a large numberof potential "clients" to service because of thesmall sizes of the dairy farms and herds that existin Indonesia today. This situation has led to arelatively high cost of ensuring high technical andquality standards exist on each farm whenmeasured on a per animal basis or per farm basis.This situation is a challenge for the budgets ofextension service providers and for the efficientprovision of services and handling emergencysituations.

! JICA funded projects focus on dairy technologyimprovement in a small farm environment. Whilethe technical and quality standards and methodsbeing transferred from Japan to Indonesia underthe JICA funded projects are high, the Japanesehome model of small farms is not an efficientdevelopment model because of the impact of farmsize on the full range of milk production costs.Japanese farm-gate prices are amongst the highestin the world at Rp 3,983 (US$ 0.46 in 2003) perlitre, with a consequent impact being very highretail prices in the Japanese market.

! Expensive imported equipment is often viewed asthe best way to support a dairy farming operationin Indonesia. Unfortunately, the capital cost ofthis equipment, related maintenance costs and, inthe case of packaging machines, the cost ofpackaging inputs, are usually too high for small-holder farmers and their co-operatives to operatein a profitable manner in developing countries.

! The cost of extension services that have beensupplied under aid agency projects is not alwayscosted into the farmers' milk production costs,unless the services are provided by a co-op orprivate sector company that is charging for theservices via deduction from amounts due for saleof milk. When an aid project has been terminatedby the donor, e.g. some of the JICA programs,these services and their costs are "taken over" bythe government.

! Milk hygiene, which is underpinned by lenientstandards (despite incentive schemes) that willaccept TPC levels of between 1 and 14.9million/ml depending on area in which the co-opoperates.



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Strengths Weaknesses! Incentive schemes that are based on milk solid

content rather than liquid milk, which may runcontrary to the use of Frisians rather thanbreeds/crossbreeds that produce milk containinghigher levels of milk solids.

! Indonesia's longstanding reliance on foreign aid andtechnical advisors for the periodic provision of aidfunded technical development services for the dairyfarming industry.

4.3.5 Dairy farming operations

Farm ManagementStrengths Weaknesses

! Some farmers in areas wheredairy farming is a marginalactivity because of constraintson water and feed resources,e.g. some parts of Central Java,are shifting away from dairyfarming towards lessproblematic businesses, e.g.livestock production and non-farming businesses.

! There is too much reliance on the government andaid agencies in some areas of the dairy farmingindustry to solve the industry's problems. Thissituation has existed for several decades and hasundermined the development of entrepreneurialbusinesses that can compete effectively in themarket.

! Many dairy farmers continue to operate farms thatare too small in terms of herd size to be efficient,profitable and viable businesses.

! Farm management training does not involve trainingin business skills that are need to developentrepreneurial farming businesses in the co-operative sector. In contrast, there are a smallnumber of commercial integrated dairy farms thatoperate in Indonesia.

! The dairy farmers have a focus on quantity ratherthan quality, as a result they fail to obtain higher"per litre" prices for their milk. Many farmers andco-operatives are not reacting to the pricing signalsthat are now being clearly provided to them by themilk quality payment incentive schemes.

! Herd recording and reporting is generally weak onmost dairy farms in Indonesia. This weaknessundermines the efficient and effective managementof co-ops and also extension services providersbecause of failures to identify:

" Areas for improvement in the dairy herd;" Animal health problems in the herd; and." Weaknesses in reproductive performance of the

herd.



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Strengths Weaknesses! Farmer loyalty to dairy farming co-operatives in

some areas of Indonesia, e.g. Central Java, is weakbecause:

" The farmers are unhappy with the performanceof their co-ops in terms of financial returns, i.e.milk price (which can be undermined by poorco-op management) and annual dividends(which are rarely paid).

" In some areas, profitable dairy farming businessunits subsidise other unprofitable business unitswithin the co-operative organisation, e.g. thegeneral store.

! The co-operative sector includes small co-ops thatare over burdened with high administration costsand so are not efficient or profitable operations.



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Husbandry and On-Farm Practices

Strengths Weaknesses! Commercial dairy farms

generally have good qualityherd recording andmonitorship systems, e.g.Taurus Dairy Farms. Thesesystems support herdmanagement, the AI program,feed procurement planningand feeding regimes. Suchsystems provide "bestpractice" benchmarks orexamples for the dairyfarming co-operatives.

! Indonesia dairy farming herd sizes are too small to beviable independent businesses. Increasing the herd sizecan be problematic in areas where there are severe foodshortages in the dry season which require the farmer towalk many kilometres to collect feed materials for hisanimals.

! Indonesian farmers have problems in farming effectivelywith high yielding imported breeds, in particularFrisians. The Frisian is preferred not for its milkproduction but for its male progeny, which bring a highprice in the market. (Note: In many cases, this preferenceis not being maximised upon by many farmers becausethey sell immature bulls rather than fattened up bulls tothe market).

! The business model being used in Indonesia focusessolely on milk production and does not allow small-holder farmers to maximise their income from fattenedup bull calves, which are bred on their farm, into market-ready steers/bulls.

! The uptake of learning from small-holder farmers'training schemes is variable despite in the introductionincentive payment schemes that provide opportunities toearn high milk prices.

It is quite common for small-holder farmers who haveparticipated in clean milk production training schemesare reported to revert to their "unclean" practices a fewmonths after attending the training scheme. (Note: Thistype of activity is not always identified and rectified dueto a lack of consistent follow-up and monitoring of theimpact of training schemes).



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Milk Production

Strengths Weaknesses! Some well run dairy farms in West Java

and East Java produce in excess of 3,000litres of milk per cow per annum.

! Most of the milking cows used onIndonesian dairy farms are high yieldFrisians. (Note: Unfortunately, yields fromthese cows are generally low on small-holder farms because of problems arisingfrom farming / feeding practices and in thesupply system for cows and weaknesses inbreeding programs in some areas ofIndonesia).

! Milk production is inherently low andvariable in Indonesia despite:

" Dairy farming being an activity that isusually conducted in the coolerhighlands.

" Many years of dairy farming activityand improvement interventions bytechnicians from the government, theco-operative sector, the milk processingindustry and foreign aid and technicaladvisory organisations.

! The official records indicate Central Javahas very low productivity per cow(Average: 647 litres per cow in 2004) whencompared to West Java (Average: 2,176litres) and East Java (Average: 1,504 litres).

Milk production output per cow also variesbetween co-operatives and between farms.

! Milk contamination is high in most areas ofIndonesia's small holder dairy farmingindustry, unless there is direct interventionby milk processing business, e.g. FriescheVlag's involvement at KPSBU Lembang(Note: This situation exists despite manyyears of foreign aid and technical providersactivities in training the farmers and co-opstaff in clean milk production andhandling).

! Although technology and best practiceshave been transferred to the dairy farmingindustry and this activity is continuing tooccur, many small-holder farmers areunable (or unwilling) to adopt technologyand best practices.

! Dairy farming co-operatives (and theirmembers as a group) may be loosingmillions of Rupiah per month because ofpoor milk quality. This is the cost of nottaking the opportunities that are available tothem in the quality-driven milk pricingschemes that are now being used by themilk processing industry.



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Milk Collection and Distribution

Strengths Weaknesses! The GKSI network forms a strong milk

collection foundation for the dairy farmingindustry's business with the milk processingindustry.

! Many co-operatives that are involved indairy farming do not control the sales anddistribution of their milk. This situation hasimplications on milk quality andcharacteristics in the distribution channelsand on co-op profitability.

! Many farms in Indonesia do not have on-farm chilled storage facilities for their rawmilk, hence bacteria (TPC) levels start tobuild up immediately after milking and inthe period until the product enters chilledstorage at their local milk collection centre.

! Profitable and efficient operation of dairyco-operatives is often undermined byinsufficient investment in productive assets.In the case of distribution, limitedinvestment in assets for the chilleddistribution network, e.g. chillers,transportation equipment.

! In some areas of Indonesia, the dairyfarmers have to rely on independent parties(know as "Lopers") to deliver their rawmilk to the milk collection centres. Thesepersons, who distribute via motorcycles, arereported to be a source of milkcontamination in some parts of CentralJava.



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4.2.6 Marketing and the supply chain

Marketing Strategy and the Marketing Mix

Strengths Weaknesses! Some of the smaller commercially run

operations, e.g. Greenfields, Fajar Taurusand Yummy Food Utama have moresophisticated marketing strategies that areoriented around brands which are supportedin the market by:

" Quality products that are packaged forthe target market;

" Competitively priced products;" A range of different products." Distribution in a range of different

channels including the growing modernchannels, e.g. supermarkets andhypermarkets;

" Advertising and promotionalcampaigns to support brand andproduct awareness amongst consumers.

" Elements of service to retailers and thetargeted consumers.

These businesses have business andmarketing strategies that allow them to takeadvantage from the developing trends in theconsumer market, in particular segments inwhich it is possible to make higher margins,e.g. higher quality chilled products. Thesebusinesses are competing in markets inwhich there are larger players, e.g. UltraJaya, Indomilk and Friesche Vlag.

! A small number of dairy farming co-operatives that have raw milk that is surplusto the requirements of the milk processingindustry have developed business andmarketing strategies to develop newconsumer markets for their milk and otherdairy products, e.g. yoghurt.

! Most dairy farming co-operatives operatingin Indonesia do not have a marketingstrategy. They merely act as suppliers of acommodity to the milk processing industry,usually through the GKSI network.

! There is generally a high level focus onmilk price within the co-operative sector.This focus often ignores other aspects ofthe marketing mix for raw milk:

" Milk quality and other demands of themilk processors for co-ops that are nottaking advantage of the milk priceincentive schemes.

" Service to customers, whether buyersfrom the milk processing industry orend consumers. These customers have adifferent perception about theimportance of quality.

The co-ops and farmers do not appear tounderstand that the demands of the milkprocessors for quality products are beingdictated to the milk processors byIndonesian middle income consumers.These end consumers are increasinglybecoming quality, health and nutritionconscious, a developing trait that willbecome more important in future.

! Promotional activities are not conducted bydairy farming co-operatives. Such activitieshave becoming more important inmarketing products to the middle to upperincome group area of the market.



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The Dairy Products Supply Chain and Market

Strengths Weaknesses! Many of Indonesia's dairy farmers are an

integrated part of their country's dairyproducts supply chain. Through the GKSInetwork and direct links of their co-operatives they are "supply partners" to themajor milk processors.

! The dairy farming industry is currently aprice competitive supplier of raw milk as aningredient to locally processed milk, whencompared to the factory entry price of milkpowders, e.g. CNF, plus landing costs andimport duties. (Important note: The IPSadvise that raw milk supplied by the localco-operatives must be a good qualityproduct for it to be a competitive input totheir products).

! Small-holder farmers produce the bulk ofliquid milk that is consumed in Indonesiatoday.

! Long term and high level reliance on themilk processing industry as a customer forlocal raw milk has not stimulated thedevelopment of entrepreneurial farmingbusinesses that can expand into other areasof the market.

! Many dairy farmers and their co-operativesare not customer-oriented businesses and soare not consistently meeting the milkprocessors demands on raw milk quality(low TPCs) and milk characteristics.

! Most dairy farming co-operatives haveweak bargaining power in their marketsbecause they do not have direct access tothe consumers.

! Most dairy farming co-operatives that haveretail packed milk and other dairy productsare supplying products that are lower endand so not able to take advantages from thegrowing middle income group that isbecoming more quality and healthconscious. (Note: The milk processingbusinesses and a small number ofintegrated commercial farming operationsare satisfying middle income consumerdemands)

! Most dairy farming co-operative productswould have difficulty accessing thesupermarket and hypermarket networks thatare developing in Indonesia's key urbanareas due to packaging, product quality andsupply chain weaknesses. (Note: in 2002,PT Industri Susu Alam Murni appointed PTWickasana Overseas International, a majorIndonesian distribution business, to dealwith this weaknesses in its West Java andJakarta markets).

Indonesia's Dairy Farming Industry SWOT Analysis - 2005 Conclusion and Recommendations


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5. Conclusion and recommendations

5.1 The dairy farming industry is now operating in a new regulatory environment

The regulatory environment in which Indonesia's dairy farming co-operatives and farmsoperate is complex and has been in a constant state of change since 2000. This situation hasbeen evolving because of the implementation of new policies, laws, regulations andguidelines that are strategically important to the dairy farming industry. These new lawsinclude:

! New food laws and regulations, which have significantly raised the quality standards thatare to be applied to foods of all types that are produced in Indonesia, including raw milkand processed milk and dairy products. These laws will eventually bring Indonesia foodlaw into close alignment with international standards and best practices as laid down byCODEX. Ultimately, compliance will also be required with an ASEAN regionalDirective, which is currently being worked upon by ASEAN appointed working groups.

! New co-operative laws, regulations and guidelines, which require that co-operatives beoperated in a democratic and commercial manner by their members broadly in line withinternational co-operative principles and best practices. The laws and regulations weredeveloped and promulgated after a new era for co-operatives started when PresidentHabibie announced that in future "co-operatives would be the responsibility of society,not government".

! New banking industry laws and regulations that require financial institutions to protectthe recoverability of the loans they make to businesses, including co-operatives, throughcredit assessment, rating and management processes that are in line with internationalstandards and best practices for banks and financial institutions.

Currently, these new laws and regulations only have limited impact on the dairy farms, butthey are already evidenced by:

! Increased demands on the quality of raw milk by the IPS and GKSI, whose brandedproducts have to comply with the new food regulations.

! Changes in the management of GKSI and dairy farming co-operatives in some provinces,as a result of "one man - one vote" process at the organisations' annual general meetings.

! A developing reluctance on the part of commercial financial institutions to extend creditto agricultural co-operatives that have a poor history of repaying their loans and servicingtheir other credit facilities.

Over the past 5 years, the co-operative industry has been slowly shifting from its past as asocial development project towards a future as a commercial industry that can provide morebenefits to Indonesia's rural economy and the small-holder farmers. These new laws,regulations and guidelines are strategically important in this process. They will ultimatelyimpact on almost all aspects of dairy farming co-ops, including production and productstandards, business management and operations, and funding.



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Unfortunately, this study has found that many dairy farming co-operatives and dairy farmsare still operating in the same manner as they were prior to 1998, i.e. when their industry wasprotected by the now defunct Milk Ratio legislation. This situation is a significant challengeto future development because there is currently insufficient focus on upgrading the industryand its component co-ops and farms so that they can:

! Comply fully with the new regulatory environments that are developing for theirproducts, businesses, finances and management; and

! Evolve into dairy farming co-operatives that focus on maximising the incomes of theirmember farmers through businesses that are:

" Focused on their markets;

" Efficiently and effectively managed; and

" Commercially oriented, profitable and viable into the long term.

5.2 Overview of operational opportunities and challenges for Indonesia's dairyfarming industry

The future opportunities for Indonesia's dairy farming co-operatives and their memberfarmers are generally positive, providing that their products can meet with the future qualitydemands of:

! The milk processors;

! End consumers of milk and dairy products.

Full compliance with the new food regulations (mentioned above) should facilitate theproduction of better quality milk by Indonesia's dairy farming co-operatives and theirmember farmers.

Senior officials at the IPS have confirmed that their industry can absorb all Indonesianproduced liquid milk providing that it is high quality and competitively (reasonably)priced. GKSI is also positive that new developments within its own organisation will boostusage of the farmers' raw milk in future.

In addition to these opinions, the more general market scenarios for milk and milk products,under circumstances where the Indonesia economy is growing, are very positive for:

! Increased consumption of milk and milk products by urban area consumers on anationwide basis, especially in the larger cities with more dynamic economies;

! An expansion of the milk products market into further segments revolving arounddifferent brands, products, brands, packaging types and sizes, and price; and.

! Continued dominance of Indonesian brands and locally produced liquid milk products inthe market over the next 5 to 10 years.



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While these positive aspects exist, there are also a range of operational challenges to beconsidered in any future development plan for the industry that covers the next 5 to 10 years.Many of these challenges exist because most co-operatives and the industry support functionshave not been in a position to update their strategies to take into account:

! The impact of the autonomy policies that were introduced after 1998;

! The free milk market environment that has existed in Indonesia since 1998; and

! The above-mentioned changes in the regulatory environment.

These operational challenges undermine investment prospects in the dairy farming industryover the short to medium term. The current level of weaknesses in the industry (as a strategicsupply partner) would be a significant risk to the investment plans of both local and foreigninvestors who would be seeking a commercial return from their investment.

5.3 Recommendations to the Directorate General of Livestock Services, Indonesia

Discussions with senior officials and managers in government, co-operative and industryassociations, co-operatives, academia and the private sector in Indonesia indicate that thedairy farming industry may now have lost its strategic direction because of:

! The rapid change that the industry has undergone since 1998 and its inability to evolvesufficiently to deal with the changes in its regulatory and business environment; and

! The lack of focused and co-ordinated macro management and policy development andimplementation for the industry.

This loss of strategic direction could worsen in the short to medium term if something is notdone about it in the near future. Any delay in dealing with the challenges that face the dairyfarming industry could result in negative impacts on its businesses and the rural economy.

There is a general belief amongst senior officials and management of the IPS, GKSI, DinasPeternakan and some co-operatives and commercial farming businesses that developmentpolicy for the industry should be improved and better co-ordinated, preferably at the level ofcentral government:

! By a single department, e.g. the Directorate General of Livestock Services (DGLS); and

! In full consultation with:

" All relevant ministries and departments in central, provincial and local governments;and

" All co-operative and private sector organisations that have an interest in the dairyfarming industry and its future strategic direction.

In view of this, it is recommended that the DGLS start immediate discussions with allinterested parties on the development of a new 10-year strategic development plan forIndonesia's dairy farming industry.



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The main objectives of this 10-year development plan should be to:

! Maximise small-holder farmers' incomes through viable dairy farming operations,including promoting the on-farm fattening up of bull calves that are bred on the farm.

! Restructuring the dairy farming co-operatives so they fully comply with Indonesian co-operative law and operate in a manner that is profitable for their member farmers and inaccordance with international co-operative principles and best practices.

! Focus on facilitating the development of a small number of modern market-oriented co-operatives, based on the smaller co-ops that are owned, operated and managed by theirmembers in Denmark, Iceland, Australia and New Zealand. Such co-ops would:

" Be well managed as viable commercial operations.

" Comply with Indonesia's future food regulations and the ASEAN region harmonisedfood regulations when they come into force.

" Meet the purchasing criteria of the IPS (milk processing industry) as trusted strategicsupply partners for that industry in future.

" Have the opportunity to develop their own products, brands, distribution channels andmarkets, if this opportunity is found to be commercially feasible by their managementteams.

" Become real commercial success stories for the dairy farming industry that bringeconomic benefit to small-holder dairy farmers and the rural economy.

" Be new development benchmarks for replication at a later date in other parts ofIndonesia.

" Be able to develop into independent commercial operations rather than operate in themanner of a social development program that has to be constantly subsidised bygovernment funding or foreign aid.

This 10-year period could be split into two periods:

! The first 5 years is a development period in which efforts are focused on facilitating thedevelopment of a small number of strong market-oriented co-operatives.

It is very important that this activity in this period be highly focused rather than spreadtoo thinly, as has occurred in Indonesia in the past. Additionally, any targets fordevelopment should be appropriately screened to ensure that they are viable for inclusionin such a development program. Points for consideration in this process would include:

" Evidence of a clear understanding of co-operative democracy and a willingness tomake an initial legal commitment to developing a democratic co-op in line withinternational co-operative principles and best practices. (Note: According to CCA[Canada] officials, making this change can be very difficult in Indonesia, especiallyamongst the traditionally run old-style co-operatives).



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" Evidence of existing entrepreneurial activity and successful independent marketdevelopment efforts by the co-op and/or its dairy farmers. (Note: This study has foundthat very few co-ops operate in this manner, although their member farmers may bevery entrepreneurial when it comes to making decisions about which crop, product orother income source is more profitable for their own farming operations).

" The willingness of the co-op and its member farmers to invest their own time andother resources, i.e. reinvested cash, into a new co-operative business venture with along term goal. (Note: This study has found that short term views and decision-making are more prevalent than longer term views and strategic planning in the dairyfarming industry).

" Evidence of a clear understanding amongst participating co-ops or members that theultimate goal of the development program will be a commercial co-operative that hasbeen weaned off government and aid funding as quickly as is possible during the 5year development period, e.g. at some stage between the 3rd and 5th year of the period.

" A willingness on the part of the co-op or farmers group and their members to:

- Provide full access to information about the co-op's or farming group's operations,including financial and non-financial performance indicators.

- Undergo a co-operative business development review, similar to that which hasbeen undertaken by the CCA (Canada) on a number of different co-ops inIndonesia between 1994 and 2004.

- Participate actively in a commercially-oriented feasibility study that will be firststep in the 10-year development process.

- Enter into agreements that will form the basis of the development assistancepackage that is offered to any co-operatives that are accepted for participation inthe 10-year development process. This agreement will set out conditions uponwhich the assistance will be provided, including on very important matters such asthe requirement to provide information to the development program managers.

! The second 5 years would be a period in which the dairy farming industry couldconsolidate and grow around its new base, which has a strong commercial orientation asdeveloped over the first 5-year period. This would be facilitated by limited involvementof government agencies, e.g. mainly in technical aspects of the industry's operations.

From a practical viewpoint, the initial discussions on the recommended 10-year plan shouldprobably revolve around:

! The establishment of a new fully co-ordinated dairy farming industry training and skillsupgrading program, which can bring about the practical and tangible commercially-oriented changes that are required by the industry;

! New fully co-ordinated development policies to support this industry training andupgrading program; and



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! Establishing an agreement between all interested parties, especially those in the Indonesiagovernment, on what they would contribute to the new plan in terms of:

" Resources to facilitate training and industry upgrading;

" Funding for the 10-year development program.

This study indicates that establishing a meaningful agreement between the variousgovernment departments on the above will be challenging because of the way in which thegovernment is structured and budgets are established. This challenge will need to beovercome on a speedy basis if there is to be no delay in launching a viable new developmentplan for Indonesia's dairy farming industry.

In view of the level of weaknesses that currently exist within the dairy farming industry, it isrecommended that the development of the 10-year plan and supporting policies andagreements between the various interested parties focuses on the following modules.

1. Dairy farm management and animal husbandry;

2. Fodder development and feeding practices;

3. Clean milk production and handling;

4. Milk quality and testing;

5. Co-operative leadership training, including relationships with co-op members, e.g.members' meetings and annual report preparation;

6. Business and financial management and control for co-operatives;

7. Marketing and distribution of the co-op's products;

8. Training the trainers (because of changes in Indonesia's regulatory environment);

9. Renewable and alternative energy systems for rural area industries; and

10. The new food regulations and their future impact on dairy farming businesses and theircustomers.

11. Co-operative members' rights and the duties and responsibilities of co-op management.

12. Independent audits and their benefits to co-op members.

Aside from the above recommendations, the other matters that should be discussed byinterested government departments and other stakeholders, as part of developing this newplan, are as follows:

! Successfully managing and funding a 10-year development program under the constraintsthat exist in the Indonesian government's own fragmented budgeting, reporting and inter-departmental communications systems.



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! Effectively managing the offers of foreign aid and technical assistance as part of the 10-year development plan. As foreign involvement in dairy farming industry developmenthas been rather fragmented in the past, a plan will have to be developed so that the inputof aid agencies in future is more focused in line with the goals of the new 10-yeardevelopment plan.

! The dry season and its impact on dairy farming, including access to water and feedresources.

! Maximising farmers' incomes by encouraging the practice of fattening-up bull calves bornfrom their own herd. A study of the impact of this activity on small-holder farmer'sincomes should be conducted to measure its potential on small dairy farms with differentherd sizes.

! The impact of changes in national government policy on energy subsidies and its impacton rural area industries and relevance to the new dairy farming industry as it expands.

! The importance of milk quality throughout the whole milk supply chain from farm to endconsumer and its relevance to the new dairy farming industry as it expands. Developingand motivating quality consciousness amongst the farmers should also be considered.

! The role of women (farmers' wives) in milking cows and the benefit that women (who arenormally more quality conscious than men) could have on small-holder dairy farms in amarket environment that will become increasingly quality conscious in future.

! Developing a new set of performance indicators for Indonesia's dairy farming industry forinclusion in a national and provincial databases that can support improved governmentpolicy setting and decision-making for more focused government involvement in theindustry in future. The new performance indicators should include both financial and non-financial indicators so that economic impact of development efforts can be betterunderstood in future. Collecting the data from the field and managing the database.

! Maximising herd sizes on farms run by husband and wife teams. A study should beconsidered into identifying the maximum number of cows that can feasibly be managedby a husband and wife team in various parts of Indonesia.

! Indonesia' new food regulations, co-operative business regulations and Bank Indonesiaregulations and their long term impact on the dairy farming industry.

! Maximising milk production per cow through managed feeding regimes. A feed resourcesaudit and study on the financial impact of concentrate usage on small-holder farmershould also be considered in various parts of Indonesia.

! Reviewing the success and failures of farmers' groups (kelompoks) and dairy coloniesand, as relevant, considering new development policies on these matters.

! Maximising the shelf life of pasteurised products through the production of longer shelflife pasteurised fermented milk products similar to Lassi / yoghurt, including using localfruits as flavours.

Canada's Indonesia Co-operative Development Assistance Program, Phase II Appendix

© Canadian Co-operative Association1

Canada's Indonesia Co-operative Development Assistance Program, Phase II

1. Program Description

The Indonesia Co-operative Development Assistance Program, Phase II (INCODAP II) is a$13.5 million project which began in 1994. This bilateral program, funded by the CanadianInternational Development Agency, was executed by the Canadian Co-operative Association(CCA) and implemented with a variety of Indonesian partners. The project was implementedin two distinct sub-phases:

! The Initial Phase, which ran from 1994 -1999; and

! The Extension Phase, which ran from April 2000 to March 2004.

The Canadian Co-operative Association (CCA) is the national umbrella organization ofEnglish speaking co-operatives; it consists of 32 member organizations representing finance,insurance, agri-business, wholesale and retail, housing, health and service sectors.

INCODAP II is a partnership for a “movement-to-movement” program of co-operativedevelopment between the co-operatives of Canada and Indonesia. There was no governmentministry in direct partnership in the INCODAP program; the State Ministry of Co-operativesand Small and Medium Enterprises acted solely as a witness to the agreement.

The partnership was directly with the co-op movement, with the following two organisationsacting as representatives of the Indonesian co-operative movement for two different periodsof time:

! DEKOPIN, the Co-operative Council of Indonesia (1994-2000); and

! LSP2I, the Institute for Indonesian Co-operative Development Studies (2000-2004).

2. Expected Outcomes

2.1 The Initial Phase

The project purpose, in its initial phase (1994-2000), was to increase the capacity of fivesecondary and national organizations (DEKOPIN, the Co-operative Council; GKSI, theUnion of Dairy co-operatives; KAI, Co-operative Insurance of Indonesia; CUCO, CreditUnion Co-ordination of Indonesia; and FORMASI, an NGO Forum for co-operativedevelopment).

The principal focus of the project was institutional capacity-building, with the objective ofstrengthening co-operatives as private-sector entities to facilitate mature trade relationshipsbetween Indonesia and Canada.

2.2 The Extension Phase

Upon completion of INCODAP II (1994-2000), there were sufficient resources remaining tosupport a three-year (2000-2003) extension. The project time frame was further extended (atno additional costs) to March 31, 2004.



For the Extension period (2000-2004), the project goal was broadened to recognize thecontribution and relevance of co-operatives in programming initiatives directed towards thesmall and medium enterprise sectors of the economy.

The project purpose was also modified to focus on the establishment of economically viableagricultural and financial co-operatives at the primary level, in accordance with internationalco-operative principles. It was expected that these primary level co-ops would be able toserve as a model for future co-operative development in Indonesia.

The expected outcome was 15 co-operatives that are economically viable, self-reliant andresponsive to members’ operational needs. The targeted 15 co-operatives included 6 dairyco-ops, 4 financial co-ops and 5 agricultural co-ops. Within this new framework, INCODAPbecame more closely aligned with the overall development theme of poverty alleviation inthe period from 2000 to 2004.

3. The Co-operative Modernisation and Upgrading Component of the INCODAP IIProgram

3.1 The Initial Phase (1994 to 2000)

The Initial Phase of the project had a principal focus on trade facilitation and businessdevelopment for co-operatives.

Over time, as general economic conditions in Indonesia steadily worsened, and the economyvirtually collapsed in 1998, the thrust of the project moved more towards the strengthening ofco-operative governance in the people-based movement. This reflected the emergingopportunities for a more member-responsive, bottom-up development approach fordeveloping co-operatives in Indonesia, an approach that was more consistent withinternational co-operative business standards and best practices.

A risk abatement strategy, based on important assumptions (e.g. that the economy wouldremain stable) was developed and implemented, but in the face of the 1998 financial crisisand subsequent events, it was close to impossible for those measures to have had a mitigatingeffect. Many businesses, including co-operatives, collapsed over the crisis period, and otherco-operatives were consolidated in an effort to ensure that they survived into the longer term.

On a more positive note, the modern era of Indonesian co-operative development reallybegan with President Habibie’s declaration that henceforth co-operatives would be theresponsibility of society, not government, and allowing the registration of new, non-KUD(government sponsored village level co-ops), forms of co-operatives.

During the period from 1994 to 2000, the main dairy farming industry focus was onproviding assistance and advice to GKSI to strengthen its ability to function as the industry'snational co-operative organisation. This objective developed from the preliminary conceptualphase of INCODAP, which ran from 1990 to 1991 and had a primary focus on developmentof co-operative dairy farming in Indonesia.

To facilitate this, INCODAP II included a GKSI sub-project, which was the largest singlecomponent of the program in terms of funding, technical assistance and technology transfer.



The activities undertaken in the dairy farming industry between 1994 and 2000 included:

! The provision of advice and assistance to GKSI in the areas of:

- Developing a new vision and mission for the organisation;- Master plan development for the organisation;- Reorganisation of the organisation, which involved restructuring the Java Island

organisation into three decentralised service organisations covering West, Central andEast Java.

- Business development; and- Cattle breeding, including genetic improvement using frozen semen imported from

Canada.

! Sub programs covering:

- Milk quality improvement;- Milk processing and marketing development;- The feasibility of cattle rearing;- Feeding management;- Dairy cattle productivity improvement;- Extension training;- Industry statistical database development and reporting; and- AI management and the use of imported frozen semen.

As the Initial Phase of the program developed, the activities with GKSI were "narroweddown" to focus on two key development areas:

! A farm level extension program, including women and youth development initiatives; and

! A genetic improvement program using frozen semen imported from Canada.

3.2 The Extension Phase (2000 to 2004)

3.2.1 The new focus of the program

The focus of INCODAP II shifted away from the provision of capacity building assistanceand advice to Indonesia's national co-operative organisations and institutions to:

! Facilitating the establishment of economically viable agricultural and financial co-operatives at the primary level, in accordance with international co-operative principles;and

! Encouraging the development of a policy and regulatory environment that is based oninternational co-operative principles and best practices.

As a result of this, the programs involvement with GKSI was limited to the farm levelextension and genetic improvement programs, which were started during the Initial Period ofthe INCODAP II program.



3.2.2 Facilitating the establishment of new style co-operative organisations

Fifteen (15) co-operatives / farmers groups were selected for participation in this pilotdevelopment program. Due to organisational and conceptual difficulties two of the farmersgroups were unable to participate in the program after 2001. The dairy co-operatives thatwere selected are as follows:

! Kop Susu Warga Mulya;

! KUTT Suka Makmur;

! KUD Sinar Jaya;

! Kan Jabung;

! KPSBU Lembang; and

! KUD Dewi Sri Bahagia.

The objective of the development activities being undertaken with these co-ops were to:

! Establish economically viable agricultural and financial co-operatives at the primarylevel, which adhere to international co-operative principles and best practices; and

! Develop some practical models (benchmarks) for future co-operative development inIndonesia.

The single project outcome sought by the project was:

"15 operational co-operatives that are economicallyviable, self-reliant and responsive to their members’needs".

This part of the program was supported by the CCA’s Development Ladder Assessment(DLA) tool. The primary co-operative development program introduced as part of theExtension Phase of INCODAP II Extension in April 2000, was based on the four majorcomponents of the DLA tool:

1. Vision:

This is defined as a co-operative organisation’s ability to articulate and generatecommitment to its mission, goals, objectives, members, approach and desired level ofimpact. It is a term that encompasses equity and commitment to social justice.

2. Capacity:

This is defined as a co-operative organisation’s ability to structure itself; to developsystems for planning; to implement and evaluate its activities; and to recruit, train andretain staff.



3. Resources:

This is defined as a co-operative organisation’s ability to earn or raise sufficient revenueto cover expenses, to manage finances, to maintain capital and to ensure accountability.

4. External Relationships, also referred to as "Networking":

This is defined as a co-operative organisation’s ability to develop and maintain productiverelationships with relevant organizations in order to advance an institution’s vision toaccess information, resources and also to advocate policy change.

These 4 components of the DLA were closely linked to a set of performance indicators atboth development program output and outcome levels. These indicators facilitatedmonitorship and evaluation of development performance of each of the participating co-operatives.

The CCA's management consider that these four components represent the main healthyfeatures of a co-operative enterprise and a balance of both the social and enterprise dimensionof co-operatives. Interpretation of the development program results was therefore linked toknowledge/understanding of the DLA components, indicators and methodology for theapplication of the DLA.

Operationally, the program involved the development of specific organisational developmentprograms for each industry in which the participating co-ops/farmers groups were involved.This included a program tailored for the dairy farming co-operatives. On a generic basis,these programs included:

! Structured education and training schemes;

! Technical interventions, where deemed necessary;

! Ad hoc advice and assistance on challenges faced by the participating organisations;

! Exposure programs; and.

! Limited capital support, where deemed necessary.

Aside from CCA, the organisations that were involved included LSP2I (the Institute forIndonesian Co-operative Development Studies) and a number of key Indonesian universities.

The primary areas of focus for the education and training activities under each component ofthe Development Ladder Assessment (DLA) tool are as follows:

! Under "Vision":

- Strategic planning;- Business planning;- Communication with co-operative members;- Commitment to social development;- Dispute resolution;



- Effective leadership/management of Board and Committees;- Gender (womens' issues); and- Youth

! Under "Capacity":

- Qualified personnel, management and staff;- Staff development;- Operating systems; and- Services and markets.

! Under "Resources":

- Capitalisation (adequacy);- Growth (in profitability and net worth); and- Assets.

! Under "External Relationships (Networking)":

- Relationship with the government and regulators;- Involvement in Apex (National Co-operative) organisations), and relationship with

these organisations;- Mentor/partner relationships.

The DLA was essentially used to

! Identify gaps (weaknesses) in organisational strategy, knowledge, infrastructure, abilitiesand resources relevant to international co-operative principles and best practices; and

! Facilitate positive organisational change through training, advice and, in some cases,intervention, so that the participating co-ops and farmers groups move closer to becoming

- Economically viable businesses;- Self-reliant organisations; and- Co-operative organisations that are responsive to their members’ needs.

The participating co-operatives and farmers groups were involved the Canadian governmentfunded CCA DLA-driven development program from mid 2000 until March 2004. Duringthis time, the performance of the program at each organisation was formally evaluated on asemi-annual basis.

3.2.3 Encouraging the development of a new policy and regulatory environment forco-operatives

Since President Habibie's landmark declaration that henceforth co-operatives would be theresponsibility of society, not government, one of the goals of the INCODAP advisoryprogram was to assist Indonesian organisations that wish to restructure their country's co-operative industries and organisations around international co-operative principles and bestpractices.



The program assisted The Institute of Co-operative Development Studies (LSP2I) with thisprocess of change through a range of activities designed to:

! Develop a broader based awareness of international co-operative principles and bestpractices; and

! Actively encourage Indonesian co-operatives to adopt such principles and best practices.

This part of the program:

! Consisted of national level workshops covering the broad range of critical strategic issuesfor the future development of co-operatives in Indonesia.

! Brought together key Universities in Indonesia to address the need for standardising theteaching curriculum of co-operative economics and to shift the balance, from governmentdefining co-operative thought, to the universities as centres for co-operative learning.

! Raised the level of debate over the form and content of Indonesia co-operative law andregulations when compared to the state of international co-operative principles and bestpractices.

! Engaged a range of different parties, including University academics, leaders from the co-op movement, government officials and Islamic scholars in discussions on theInternational Co-operative Identity Statement (ICIS) and the Islamic economic system.Under this, strategies for actualising economic justice through co-operatives in thecapitalistic environment were reviewed, and the discussions led to the conclusion thatthere are no conflicting values between the Islamic system and the concept of co-operative identity in Indonesia.

! Established a research project that was undertaken in collaboration with Indonesianuniversities. This project field tested INCODAP's primary co-operative development tool,the Development Ladder Assessment (DLA). This research concluded that the DLA wasvalid for use in the Indonesian context and agreed to promote it as a standard tool toassess levels of co-operative development throughout Indonesia.

! Stimulated spin-off benefits in terms of broadening Indonesian knowledge of:

- The workings of co-operatives that comply with of international co-operativeprinciples and best practices; and

- The benefits of such co-ops to Indonesia's economy, its society and, importantly, toindividuals and families that are active members of such co-operatives.

4. Summary conclusion for the INCODAP II program (1994 to 2004)

The evaluations that have been performed on the actual outcomes of this program, whencompared to its goals, indicate that there have been significant steps taken in the developmentof the co-operative movement in Indonesia, particularly in Indonesia's credit union systemand dairy industries.



Strengthening apex, secondary and primary level co-operatives has enabled memberhouseholds, mostly small entrepreneurs and farmers, to increase their standard of living byimproving their access to credit, savings and better livelihoods through co-ordinated co-operatively-based economic activity. The more open enabling environment in Indonesia isnow adequate, if not yet ideal, for co-operatives to develop as autonomous, member-controlled enterprises based on international co-operative principles and best practices.

The CCA's Development Ladder Assessment (DLA) tool has helped to define benchmarksfor sound, democratically managed, financially healthy co-operative enterprises in Indonesia.Viable model (benchmark) co-operatives have been developed in three sectors, credit union,dairy and agricultural. These can serve as benchmarks for development of co-operatives andother small and medium enterprises in Indonesia in the future.

While the dairy co-operatives involved in the INCODAP program were initially the mostresistant to organisational change and the democratisation of their organisations, over thecourse of the program, their "traditional" top-down philosophy and management styles werereplaced with:

! More openness towards co-operative members, including women and youth; and

! Greater clarity of roles and responsibilities of stakeholders within the organisations,including the board, operational management and members' committees.

The efforts of some of the dairy farming co-operatives that were involved in the INCODAPExtension Phase program have demonstrated that it is now possible, through education,training and technical assistance, to establish co-operatives in Indonesia that are:

! Governed along the more democratic systems of governance as envisioned byinternational co-operative principles and best practices;

! Co-operative organisations that are responsive to their members’ needs.

! Self-reliant organisations; and

! Economically viable businesses.

Indonesia's Dairy Farming Industry SWOT Analysis - 2005foodandbeverage.biz/images/Indonesia_Dairy_Farming_Report_2005... · Indonesia's Dairy Farming Industry SWOT Analysis - 2005

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