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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: emmsia@pacific.net.sg

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 Nestl 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 Nestl,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 Nestl, 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 VlagNestlSari Husada

East Java Nestl

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

Nestl - - 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 Nestl 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 Nio 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. Nestl 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).



35

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.



36

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. Nestl, 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.



37

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 pract

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