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904M76 ARLA AND MD FOODS — THE MERGER DECISION (A) Pankaj Shandilya prepared this case under the supervision of Professor W. Glenn Rowe solely to provide material for class discussion. The authors do not intend to illustrate either effective or ineffective handling of a managerial situation. The authors may have disguised certain names and other identifying information to protect confidentiality. Ivey Management Services prohibits any form of reproduction, storage or transmittal without its written permission. This material is not covered under authorization from CanCopy or any reproduction rights organization. To order copies or request permission to reproduce materials, contact Ivey Publishing, Ivey Management Services, c/o Richard Ivey School of Business, The University of Western Ontario, London, Ontario, Canada, N6A 3K7; phone (519) 661-3208; fax (519) 661-3882; e-mail [email protected]. Copyright © 2004, Ivey Management Services Version: (A) 2005-06-23

Society must accept that it is possible to create companies with sufficient strength to compete on an equal footing with the best in the community we have chosen to be part of, i.e., companies at the top of the European league. A small country must be capable of creating large companies.

Knud Erik Jensen, chairman, MD Foods.

Arla cannot achieve better results in the long run, simply by cutting costs. Arla is too big to be a niche company and too small to compete alone in an open EU market. Our potential lies in the increased refinement and partnerships with other companies.

Lars Lamberg, chairman, Arla. In October 1999, Jens Bigum, managing director of MD Foods, was sitting alone in his office in Århus and was happy that his long-standing dream of merging two of the leading Danish co-operative dairy companies had been realized in the past year. This merger was the largest in MD Foods history, and it meant that it now controlled 90 per cent of the Danish market as well as having a strong international presence. Still, he wondered if this achievement was sufficient to counter the rapidly changing global market, one in which MD Foods wanted to be a leader. He also wondered if MD Foods was ready for another merger, this time with the Swedish company Arla.

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Around the same time, in Stockholm, the president of Arla, Åke Modig, was pondering his company’s future. Arla, the largest Swedish dairy company, had attained the 65 per cent maximum quota (regulated by Swedish government) for weighed-in milk. The management realized that Arla needed to grow to improve profitability and to remain a market leader. Hence, partnerships and strategic alliances were considered important routes for future growth. Was a cross-border merger with MD Foods the best solution for Arla? A merger between MD Foods and Arla would create Europe’s largest dairy company, with 18,000 co-operative owners, 19,000 employees and a total milk volume of seven billion kilograms, including 800 million kilograms in the United Kingdom. Current partnerships between the two companies included Functional Foods (within the joint venture Scandairy) as well as some vending machine products (within AM Foods). After three years, these joint ventures were showing positive results. Could the two companies extend the success of their joint ventures to a merged company? Would their owners, i.e., the milk-producing farmers (also called members) of Sweden and Denmark, accept the merger proposal? Would the competition commissions in the European Union (EU) countries, where they had a substantial market share, react favorably to this merger proposal? The companies needed to perform a much more comprehensive examination of the legal and tax aspects of the merger than had been done prior to the joint ventures. Besides the size of the two companies, the differences in the organizations’ cultures and the fact that Sweden and Denmark had different currencies and languages posed formidable challenges. Last but not least, throughout the world, a cross-border merger of two co-operatives was unprecedented. HISTORY MD Foods In 1882, the world’s first co-operative dairy, Hjedding Mejeri (Dairy), was founded. By 1945, there were 1,650 other co-operative dairies in Denmark, and soon thereafter, it became clear that there would be incredible benefits to having a single nationwide dairy association. However, it was not until 1970 that this single dairy association was realized and Mejeriselskabet Danmark (MD — The Dairy Company Denmark) was formed. During the 1980s, MD expanded greatly through mergers and acquisitions, and in 1988, it adopted the name of MD Foods. In 1989, MD Foods International A/S was founded with the aim of buying production plants abroad, and in 1990, the company made its first purchase with the acquisition of Leeds (UK)-based Associated Fresh Foods, which also operated in Settle and Newcastle. Further regional acquisitions followed in 1992, with

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Oakthorpe dairy in North London and in 1993, with Bamber Bridge dairy in the North West. MD Foods now exported to more than 60 countries outside Europe, and 22 per cent of its turnover was from non-EU countries. Additionally, the company had diversified, through its subsidiaries, into packaging (Danapak), fruit juices (Rynkeby Foods), financing and investment (Medani A/S) and insurance (MD Insurance Company). Arla Arla’s history traced back to 1915 when a company known as “The Milk Centre” was founded. During the next few years, a number of dairy co-operatives joined the company through larger mergers. In the beginning of the 1970s, the idea arose that the company should have a new common name, and in 1975, The Milk Centre changed its name to Arla, after Sweden’s first dairy association — Arla Mejeri Forening (Arla Dairy Association). Arla Mejeri Forening traced back to May 1881 when it was founded on a Swedish farm called Stora Arla Gard (Large Early Farm). The name change to Arla was also considered appropriate because Arla means “early” in Swedish, and farmers’ activities usually take place early in the mornings. By the time Sweden joined the EU in 1995, Arla had developed into the largest foodstuffs company in Sweden. It had also established itself in some European countries. THE PAST 15 MONTHS A detailed report of the two companies values, activities, initiatives and performance in the past 15 months is presented below. MD FOODS The Company The soul of MD Foods was deeply rooted in the traditions of Danish agriculture. Although far from being heavy, stolid or lacking in dynamism, MD Foods was a down-to-earth company. It was a proactive and flexible organization, having, for example, the ability to anticipate developments in Europe and adjust accordingly. Unlike most traditional agricultural companies, it succeeded in keeping pace with the times. To prepare MD Foods for future challenges, an extensive assessment of future demands for information technology (IT) was carried out in 1997/98. As suggested by the assessment, the company centralized many functions and

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increased staff to serve customers in a better way. Furthermore, the company’s complexity required that data transmission and processing be optimized. Considerable investments in extension of capacity and structural rationalization were also carried out. All investments were rooted in a long-term strategic plan, intended to maximize competitiveness and production efficiency. Respect for the retailer and consumer was key in all activities at MD Foods. Management believed that any company that is dependent on selling its products must be constantly aware of developments in the market. Management also believed that the consumer is a judge and will determine at the point of sale whether the product is successful or not. MD Foods focused on building brand awareness in the market, where an increasing share of the milk was sold as a branded product. Although this strategy increased marketing costs, it was seen as essential to sustain growth rates. The presentation of MD Foods was aimed at enhancing the group’s image as a farmer- controlled, integrated company. Some of the specific campaigns to promote the brand strategy included: • “The Fresh Milk” Project: This project reduced the time from milking to the

retailer from three days to one. MD Foods received a higher profile while fulfilling a strong wish from the retail trade for increased focus on freshness and natural raw materials.

• The Danish soccer team was used to market the “Fresh Milk” concept. • An extensive campaign was launched to provide consumers with greater

insight into the origin and processing of liquid milk. A new MD Foods label was introduced, featuring a cow symbolizing the company’s roots in Danish agriculture.

For MD Foods, being responsible to society meant more than just following the letter of the law. Within areas such as environment, health, nutrition and animal welfare, it played a leading role in setting the agenda. It was committed also to providing children with a better understanding of where milk came from through initiatives such as visitor centres in its plants. As a co-operative, its corporate culture was in tune with public debate. A lack of formality and extensive use of “open door” policies were part of the company’s daily life from its earliest days. During work on the company’s image, a number of values were found, and summed up in three words, “Respect for milk.” The level of production of various products for 1998/99 is shown in Exhibit 1. The organization chart is shown in Exhibit 2.

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Market Report and Performance The financial crises in Russia and South East Asia resulted in a massive supply of cheese and other dairy products being channelled into the largest markets of MD Foods, causing significant pressure on price. Price pressure and competition for market share was also evident in Germany, the company’s largest export market. In Germany, the company adopted the strategy of defending market share while, to the greatest extent possible, it avoided becoming involved in a price war. The strategy largely succeeded, in spite of a long period of expansion during which exported volumes began to stagnate. The strategy was successful for two reasons: the range of specialty cheese in general was less price-sensitive than bulk products and the company’s strong emphasis on marketing. In Denmark, the first six months of the 1998/99 financial year were dominated by the intense battle, fought on price, for market share. This battle led to the merger of MD Foods and Kløver midway into the financial year. The merger not only increased the possibilities of rationalization, but also strengthened the business position of MD Foods in the Danish market and was met with considerable understanding and support from employees. Management knew that the merger of two such large groups would not have been possible without strong commitment throughout the organization. The company also took steps towards bringing large production areas together into a few modern plants, in order to maintain competitiveness with Europe’s strongest players. During the 1998/99 financial year, MD Foods realized its largest ever investment budget, one in which the construction of a dairy in Taulov with a capacity of 25,000 tonnes of cheese played a major part. Other structural projects were initiated or implemented. These investments imposed some financial strain on the company and required significant management resources. Milk prices declined 3.3 per cent for the first time in many years during 1998/99, but still, MD Foods maintained its target of new product development. Approximately 250 new products — or product varieties — were developed in the year. These product developments took place either in partnership with individual retail chains, within MD Foods itself or in co-operation with large customers in the European food industry. A brief report of the various divisions in the 1998/99 financial year follows. The Home Market Division This division experienced its worst results in years, due to the strong competition in the Danish market in the first half. The expected benefits in production, distribution, organization and combined product ranges, from the Kløver-MD

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merger, would be realized over the next three years. The merger enabled MD Foods to strengthen its range of strong branded products and to increase supply to meet customer demands in a dynamic and innovative manner. Following the merger, MD Foods also took over product sales from the French Danone group. However, in the future, competition from foreign dairy companies was expected to increase in line with the wishes of retail chains for increased competition. The structural developments within the retail sector continued with the formation of large purchasing associations. Approximately 80 per cent of sales in the Danish retail sector were now accounted for by three chains: FDB, Supergros and Danish Supermarkets. The Europe Division This division had an unsatisfactory year in terms of sales and earnings and failed to achieve its customary volume growth of five per cent to six per cent. Sales were affected by the collapse of cheese exports to Russia. Sales of bulk products were particularly hit in most European markets. The downturn was accentuated by rising competition between European retail chains, resulting in demands for lower prices from suppliers. Production facilities were also insufficiently exploited, resulting in poor economies of scale. On a brighter note, the Europe division received the Supply Chain Efficiency Award from logistics Europe/KPMG for “efficient logistics in production and inbound logistics from packaging and additive suppliers.” The U.K. Division This division showed significant advances in terms of results and volumes sold. Locally produced products increased to a level of approximately 850 million litres liquid milk, and sales of Danish produced goods rose to 46,000 tonnes. The market continued to be characterized by upheavals on both the supply and sales sides. For example, the Irish dairy industry withdrew from the liquid milk market. Significant events took place in the retail sector. The Marks & Spencer chain was in trouble, and speculations arose about the company’s future. Tesco expanded on the European continent, and Wal-Mart made major inroads in Europe by acquiring Asda in the United Kingdom. These events marked the beginning of renewed consolidation, not only in the United Kingdom but also across Europe. Against this backdrop, targeted efforts by MD Foods to produce high-quality products to meet the retail chains’ demands seemed likely to benefit the company.

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The U.K. division rationalized and developed its technical skills with the introduction of equipment to enhance milk quality. The substantial logistics challenge of distributing a very large volume was met with regard to cost and accuracy. On the organization side, a restructuring program was implemented, and the marketing and sales functions were strengthened. The Overseas Division This division focused strongly on internationalization. The broad product range of MD Foods and the brand image of its Lurpak butter were valuable assets in the competition with large international suppliers. The position of MD Foods in overseas markets was supported by ongoing rationalization of the subsidiaries and servicing key customers from Denmark. With exports to more than 60 countries outside Europe, sales were inevitably affected by the financial crises in some regions. The Belgian dioxin scandal impacted the export of food products from the EU for a considerable period. Growth in the MD Foods subsidiary in Saudi Arabia, Danya Foods, stemmed exclusively from the product areas given the highest priority. The company strategically focused on a limited number of production areas. Despite adverse market conditions, development of value-added products contributed to the financial advances for the division. MD Foods Ingredients This division showed good progress in volumes with total sales of 196,000 tonnes, the largest volume ever processed and sold in a year by Ingredients. The company also maintained reasonable earnings from speciality and retail products. During the year, the basis was laid for further growth in South America. A letter of intent was signed with Argentina’s largest dairy company, SanCor, for a joint venture for production and sale of milk proteins. This venture seemed likely to strengthen the division’s position among global market leaders within value-added milk proteins. The Transport Division The amalgamation of milk collection routes following the MD-Kløver merger was the division’s biggest task during the year. The amalgamation proceeded at a pace

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that exceeded the capacity of the organization and placed considerable strain on all involved. The merger also involved significant one-off costs for upgrading Kløver milk’s tankers and training Kløver’s drivers. From now on, all liquid milk would be Fresh Milk collected at night. Subsequently, an average rise in hourly wages of DKK10 was envisaged. During the year, it was possible to compensate for increased costs with increased efficiency. Consequently, wage costs per litre of milk were reduced by øre 0.13 per litre. THE GLOBAL MARKET REPORT The MD Foods group turnover with market breakdown is presented in Exhibit 3, and highlights of the market report from various countries are presented in the following table.

Europe Germany • MD Foods Deutschland launched its largest-ever marketing campaign.

Individual brands, such as Buko and Höhlenkäse, were gathered under the umbrella brand “MD.”

• TV commercials, in-store activities and Internet advertising established the MD Foods name and values in the minds of the German consumers. The objective was to create a strong cohesion between the MD Foods product range and to facilitate the launch of new products under the well-established name.

• A more customer- and market-oriented organization structure was introduced. Sweden

• MD Foods maintained its position in a market characterized by imports of cheap firm cheese from Europe.

• Advances within the focus areas, feta and mould cheese, were sustained. Price increases and continued advances for specialty cheese contributed to satisfactory operating profits.

Norway

• MD Foods was the largest supplier of imported cheese in a market where cheese imports from EU were subjected to quotas.

• A sales partnership with the private dairy company, Synnøve Finden Mejerier, enabled increased distribution.

Holland and Belgium

• Value-added products showed increased growth. • Exports to Belgium doubled.

Poland

• Western retail chains expanded into Poland but stringent restrictions curbed imports.

• In connection with the Kløver merger, MD Foods acquired a 50 per cent stake in the local dairy, Lindals Foods, which produced firm cheese.

Spain

• Products such as havarti, cream cheese, mozzarella and Danablu achieved 15 per cent growth.

• Business with large chains and industrial customers was increased. Italy

• Added-value products maintained growth. • The development of a national agent network enhanced distribution.

France

• The subsidiary in Lyon was now two years old. • Sales to retail trade showed positive development.

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Greece

• Six per cent rise in sales of cheese and butter. MD Foods was one of the largest suppliers of imported products in Greece, where imports accounted for 25 per cent of the total consumption.

• Lurpak butter strengthened its position and captured more than 20 per cent of the Greek market.

Russia

• The Russian market hit rock-bottom due to the devaluation of the ruble. The credit-based distribution system collapsed completely. Imports of cheese were only 10 per cent of the previous year’s levels.

• The large Russian middle class cut back on the consumption of imported products.

The Middle East Saudi Arabia

• Subsidiary Danya Foods showed satisfactory growth in turnover and volume. • Considerable sums were invested in new production equipment, and new

storage facilities were opened in Jeddah. Gulf States • Business relations with key customers were strengthened. Lebanon

• Deep economic crises led to increased duties and hence sales were affected.

The Caspian Countries

• The Russian crisis spread to countries around the Caspian Sea. MD Foods maintained sales of feta in brick packs in Azerbaijan under the Three Cows brand.

Americas United States

• Launch of locally produced cheese encountered considerable difficulties as record-high U.S. milk prices lowered competitiveness for locally produced cheese.

• A new strategy where efforts were directed at key customers and new products, coupled with a high dollar rate, led to satisfactory results.

Canada

• Strengthened position as a respected supplier of specialty cheese for the retail trade.

• Successful distribution developed in Quebec. • Collaboration with Amalgamated Dairies Ltd. progressed satisfactorily, and new

joint initiatives were planned for the coming year. Brazil

• Brazil’s retail sector underwent extensive structural reorganization. Increased competition in key areas continued to demand innovation.

Argentina

• Relations with a leading supermarket chain strengthened with the signing of a number of national supply agreements.

Asia Korea

• General economic downturn meant that MD Foods Korea failed to increase sales. However, a focus on reducing costs led to slightly positive numbers.

South East Asia

• Lurpak butter strengthened its position as the leading butter brand in Hong Kong’s retail market.

• The goal for the future was to expand distribution within all markets. Japan

• For the first time in decades, Japan’s cheese imports declined. • Danish cheese exports to Japan remained stable.

The outlook for the MD Foods subsidiaries was generally good. The exception was the Danapak group, which only achieved a positive result by selling off the Cardboard division. Key figures for the entire MD group for 1994/95 to 1998/99 are presented in Exhibit 4.

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ARLA The Company VISION: Since 1988, the vision has been “to create a large Nordic dairy association.” MISSION: “Arla shall develop, produce and market milk-based foodstuffs for the well-being and culinary pleasure of European consumers, using Sweden as a base. The aim is to create a long-term profitable market for the Arla member’s milk production.” VALUES: “Arla economic association is a farmer-owned co-operative which supports agricultural values. Every single Arla member is an important link in the chain from COW TO CONSUMER.” Arla wanted to be the best channel for refining co-operative members’ milk and to generate profitability at the primary production level. It ranked high in the European transfer price league, but deteriorating profitability of milk production continued to promote structural changes. Over the previous few years, many Swedish farmers had quit milk production, due to both the need to invest in modern facilities and uncertainty regarding the EU’s future milk policy. There was a great need for increased strength to cope with establishments abroad, to cope with challenges in the domestic market and to cut costs. Although the manufacturing costs had fallen, the sales and marketing costs were increasing to a greater extent, due to deliberate investments in modern brand name products. There was a high level of consumer confidence in Arla products and brand names. This confidence was based on Swedish milk, which was produced in a natural manner from animals that were kept in good living conditions. At Arla, quality was ensured in vital areas such as animal health and the environment. Arla planned to continue to be a market-oriented organization by prioritizing customers to an even greater extent and expanding the customer service package. Recent investments had been made to improve delivery reliability and customer service. First steps were also taken for a four-year investment program of SEK2,400 million when the board approved a record investment budget of SEK720 million ahead of the 1999/2000 budget year. The research and development level stood at almost 1 per cent of the turnover, and active product development was placing high demands on the entire chain. The key figures are shown in Exhibit 5 and the organization chart is shown in Exhibit 6.

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Market Report and Performance In the past year, the management at Arla had once again been reminded that events outside Sweden had consequences on profitability. Overall, the Swedish dairy market was reporting weak or no growth, and the Swedish retail trade was becoming increasingly Nordic. Even though milk consumption continued to fall, Arla’s figures were reasonably good, and Arla managed to meet its projected goals. Contributing factors to the success included Arla’s position as market leader in Sweden, coupled with its strong brand names and the confidence built up amongst consumers and the retail trade by Arla’s staff and members. The Swedish cheese market was uneasy throughout the year. The Russian crisis generated a cheese surplus, resulting in price cuts, unstable pricing levels and increased cheese imports into Sweden. The risk of continued pricing pressure on the EU’s cheese market in 1999/2000 was considerable. However, Arla maintained a stable pricing level for its quality cheese by reinforcing its Swedish identity. A brief summary of the performance of the various divisions/subsidiaries in the 1998/99 financial year is presented below. Arla Medlemmar (Members) For this division, the value chain started at the farm and employed a number of different tools to ensure both animal welfare and quality controls. Started in July 1998, the Arla Quality movement operated from a consumer perspective and was an important indication of Arla members’ dedication to consumers. Arla’s 1998/99 weighed-in total of 2.1 billion kg (see Exhibit 7) was the highest achieved since Sweden joined the EU in 1995, and corresponded to 65.2 per cent of Sweden’s weighed-in milk. The results of the milk analyses improved due to stringent deductions and the introduction of supplementary payments for milk with low cell counts. The concentration level of milk, however, continued to fall, primarily as a result of lower fat content (see Exhibit 8), which meant a transfer price that was down SEK0.016 from 1997/98. Arla was actively involved in the “Swedish milk know-how network” with the aim of working with the industry in setting up models and tools designed to promote animal welfare and quality control practices. A number of projects focusing on animal health care were being implemented, and agreement was reached on a new breeding objective that placed greater emphasis on achieving cows with greater longevity and high fertility levels.

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Arla Dairy Arla reinforced its role as an innovator through several new products and recipe ideas. The previous year’s cold summer resulted in poorer sales performances by fermented milk and yogurt products, and milk consumption continued to fall by one per cent to two per cent. However, cream and other cooking products performed strongly. The butter and margarine market reported an overall declining trend. Evolving consumer habits further created new demands on liquid milk. Consumers were eating out more often, were eating alone more often and were placing greater emphasis on convenience. Consumers wanted quick cooking that tasted good and involved natural, raw materials — all factors that were starting points for Arla’s development of new ideas and suggestions for home cooking. Finally, there was a strong demand for recipes, as was evident from the number of hits on the home page and the popularity of the recipe book. Arla Cheese and Butter This division manufactured cheese, butter, margarine and powdered milk for the Swedish and export markets. A brand name program designed to make it easier for the consumer to identify Arla’s range of cheeses made progress. Arla Cheese and Butter division had 1,200 employees. The division invested in staff training and new systems with the aim of improving service, ensuring more consistent quality and improving safety. Investments were also made in cheese stores and a cheese-cutting centre in Götene. These investments totalled SEK450 million and were designed to boost Arla’s competitiveness. Five production plants worked on an environmental management system with the aim of achieving ISO 14001 certification before the end of the year. The division had successfully reduced butter and margarine wastage over the past year. A new combined transportation system was introduced in collaboration with Arla Dairy, using rail and road traffic. Delivery reliability for cheese improved while the already high level of reliability for butter and margarine was maintained. Arla Research and Development The division conducted research and development with Arla’s other companies in order to meet Arla’s need for new products in the short and long term. Other important spheres of activity included analyses and consultation. The division had a total of 104 employees. Investments in product development yielded

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considerable dividends and several innovative research projects were conducted with substantial success. Functional foods (foods that provide health benefits beyond basic nutrition) was a growing market and one of the R&D department’s most important research spheres. Over the past year, Arla had developed and obtained patents for a new strain of lactobacilli, which was tested and shown to be effective against a variety of complaints. The R&D department also engaged in extensive developmental work in the field of new functional foods, in partnership with MD Foods and under the umbrella of the jointly owned company, Scandairy. This venture resulted in the launch of a healthy margarine, Gul Gaio, which is rich in omega-3 fatty acids. Whey, the liquid byproduct of cheese-making, underwent successful development work at the division. Desalinated whey powder was used for ice cream and baby food and drinks based on whey protein were used in the hospitals sector. Arla R&D had a broad international network with universities and institutions. The company was involved in a variety of EU projects, the NordFood project and a range of research programs. The division was very active in Arla’s environmental adaptation work and was involved in collecting facts and analysing them for the environmental report. Arla R&D was also active in the ISO 14000 certification work. Arla Export Arla’s cheese, butter, margarine and fresh products exports were grouped within a single company to gain greater emphasis in the marketplace. The total value of Arla group’s exports was SEK1.56 billion, with Arla Export accounting for SEK983 million. Arla’s export volumes fell during the financial year, as a result of the crises in Russia and Asia, but increased product refinement, coupled with new launches, prevented the value of the exports from falling to the same degree as the volume of exports.

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THE GLOBAL MARKET REPORT A brief report of Arla’s foreign subsidiaries is presented below: Finland • Arla became the third biggest supplier of dairy products in Finland.

Turnover increased over the year by almost 10 per cent. • Arla successfully reinforced its position as the leading player in the low-

fat cheese sector. • Local competition was intense in the fresh produce sector, and Arla’s

turnover on these products fell slightly to 7,000 tonnes. Germany

• Arla International Deutschland, established in 1997/98, increased its turnover by almost 60 per cent.

Norway

• The Norwegian operations, run through the subsidiary Arla Norge (Norway) A/S, strengthened its position by establishing a nationwide sales team.

• A number of yogurt products, together with consumer butter, were successfully launched in the previous year.

• Restrictions in trade quotas for cheeses led to reduced sales in Norway, but the turnover of products exported from Sweden increased by nine per cent in 1998/99.

• Arla acquired a Norwegian dairy in Disenå from Kraft G.F. in a move that would give it a strong foothold in Norway. In July 1999, Arla and Tine Norske Meierier (Tine Norwegian Dairies) signed a partnership agreement whereby cheese production would be subcontracted to Tine from Arla for the Norwegian market.

Estonia

• Several fresh product items were launched in the Estonian market and, coupled with the positive performance reported by cheese sales, helped to boost turnover by eight per cent.

• Arla Eesti (Arla Estonia) established a partnership with Dagab Baltic A/S in the Estonian market to distribute products to Latvia.

United Kingdom

• Arla entered into a partnership with MD Foods UK plc, whereby MD Foods would be responsible for the sale and distribution of Arla’s products in the United Kingdom.

Greece

• Sales volumes increased, and Arla worked in a partnership with J. Mazarakis & Sons. Greece became Arla’s second largest export market after Finland.

Denmark

• Arla worked up the Danish grocery retail trade using its own sales team. • Arla retained its volumes in the Danish market and increased turnover,

in spite of the intense competition. Russia

• Arla lost two-thirds of its sales volumes, primarily in the cheese sector.

Overall Arla’s performance over the past year had been satisfactory. A five-year summary of key data is shown is Exhibit 9. THE CHANGING EXTERNAL ENVIRONMENT The market-related developments posed considerable and similar strategic challenges for MD Foods and Arla. The challenges contained the following main elements:

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Marked Developments in the European Union (EU) and Home Markets Both Denmark and Sweden were members of the EU. Consequently, MD Foods and Arla operated in markets where goods could move freely over international borders. Furthermore, it was expected that the EU would reduce intervention prices in 2006 by 15 per cent after several Eastern European countries became members. With the obligation to sell all the milk each co-operative’s members produced, both companies’ sales needed to be oriented towards increased exports via international expansion. Liberalizing of the Global Dairy Business Continued With the General Agreement on Tariffs and Trade (GATT), considerable liberalization of the global dairy products business was expected. Consequently, European dairies faced reduction in the level of domestic market protection, a lowering of export subsidies and an increase in imports. The result would be an increased supply, falling prices and increased price pressure on the EU’s milk producers. Change in Consumer Demands Globally, a series of consumer trends were visible. An increasingly larger proportion of the world’s population was including milk and/or yogurt in their breakfasts. Unfortunately, there seemed to be a trend towards a number of people skipping breakfast. Other than at breakfast, milk was under increased pressure from substitutes, such as soft drinks. Another global consumer trend was fast food, which was replacing lunch and dinner meals. Consumers were looking for more homogeneous and differentiated products. They were looking for low-fat products, simple products for daily use and luxurious products for weekends and celebrations. Products were needed for children, middle-aged consumers and those inclined to organic foods. At the same time, there was an increasing interest towards animal welfare, ethics, security and origin. On one side, these trends reduced consumption of the traditional dairy products, but on the other side, there were huge possibilities for the development and marketing of new dairy products. Overall, the diverse consumer trends posed a series of new challenges for the dairy industry — challenges requiring huge investments in technology, research and marketing.

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Customers were Concentrating their Purchases In northern Europe, it was expected that cross-border activities of retail chains would increase. Some chains would, due to considerable homogeneity between the northern European consumers, see the entire Northern Europe area as a large single market. In most European countries, less than five retailers would control the main part of the retail trade, as retail shops consolidated (Exhibit 10 shows the change in market share for retail shops from 1991 to 1998.). Large retailers exerted considerable pressure on suppliers and were demanding changes in quality, product development, logistics, marketing and price. At the same time, retailers were rationalizing their vendor circle and the supply of milk, cheese and butter needed to occur in larger quantities. Lastly, the largest American, German, French and English retail chains were establishing themselves in new markets throughout the world. As an example, in September 1999, the French retail giants, Carrefour and Promodès, confirmed a merger, which would turn the two groups into the world’s second largest retailer with an estimated turnover of DKK400 billion in 1999. (Wal-Mart, the world’s largest retailer, had a turnover of DKK1,000 billion.) Other retailers had shown interest in merging with Carrefour and Promodès, and share prices in the retail sector had risen following the merger. This trend suggested that the markets expected more mergers to occur. Fortunately, these challenges presented new business opportunities for the strongest vendors. European Dairy Companies were Becoming Larger The dairy industry was dominated by a few large, international companies, which could be separated into two distinct groups. The first comprised stock-exchange- listed or privatized companies, such as Nestle, Danone, Kraft etc. All of them had huge resources and were clever in product development and marketing. These capabilities gave them a leadership position in many markets and product categories. The second group was the large co-operative dairies in Holland, France and Germany. These co-operatives were looking to strengthen themselves for the future through mergers with complementary dairies. In August 1999, the final formalities for the formation of North West Germany’s new and large dairy group, Nordmilch AG, were completed. This merger made the group Germany’s largest dairy company. The new company distributed 4.4 billion kg milk, had 12,800 milk producers and had a turnover of DKK18 billion. The Dutch dairy company

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Campina Melkunie was also showing an inclination for cross-border co-operation. The current state of European dairy companies is presented in Exhibit 11. THE DECISION Both Bigum and Modig knew that they were soon going to meet their respective company’s board of representatives, to whom they had to make a recommendation. Due to the co-operative nature of the two companies, any other form of alliance (acquisition, etc.) was ruled out. But, was it the right time and were the companies ready for a merger? Did they need it? What about the investments the two had made in building their brand names? What name would the new company have? How would it be organized? Where would its headquarters be? These were some of the questions that remained unanswered.

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Exhibit 1

MD FOODS LEVEL OF PRODUCTION 1998/99

Use of Milk (in tonnes)

Cheese 1,830,326 Butter and Spreads 86,815 Liquid Milk 1,561,198 Ingredients 1,471,093 Other 105,929 Total Volume 5,055,361

Group Production (by product)

Cheese (tonnes) 248,918 Butter and Spreads (tonnes) 98,583 Liquid Milk (1.000 kg/litres) 1,662,747 Ingredients (tonnes) 211,724

Source: Company files 1998/99.

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Exhibit 2

MD FOODS GROUP ORGANIZATION CHART (April 10, 1999)

MD Foods (parent company)

Europe Division

United Kingdom Division

Overseas Division

Home Market Division

MD Foods Ingredients

Transport Division

Dairy Companies Other Group Companies

Foreign sales companies in: MD Foods Ingredients Danapak • Canada • Germany AM Production MD Insurance Co. Ltd. • Italy • Sweden AM Foods MD Foods International Group • Norway

• United States MD Foods Ingredients foreign sales companies in: MD-Holding

• France • Japan • Poland • United Kingdom Rynkeby Foods • Greece • United States • Germany Lindals Sp. Poland Biolac Gmbh Source: Company files 1998/99.

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Exhibit 3

MD FOODS GROUP TURNOVER Market Break Down

Country %

1. EU Countries 78 Denmark 36 United Kingdom 21 Germany 9 Holland 2 Italy 2 Sweden 2 Greece 2 Spain 1 France 1

2. Middle East 8 Saudi Arabia 4 Other 4

3. Asia 5 4. Central/South America 4 5. North America 2 6. Other 3

Other Europe 2 Africa 1

Source: Company files 1998/99.

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Exhibit 4

MD FOODS PAST FIVE YEARS SUMMARY PARENT COMPANY 1994/95 1995/96 1996/97 1997/98 1998/991

Result (DKK million) Net result 503 583 627 556 589 Supplementary payments 444 568 580 492 505 Consolidation 59 15 47 64 65 Interest on personal accounts 0 0 0 0 19

Financing (DKK million) Equity 2,122 2,569 2,669 2,645 3,380 Safety fund 297 298 311 314 384

Raw materials purchased Raw milk received in tonnes 2,966,195 3,007,294 3,165,428 3,219,935 4,095,567 No. of suppliers 9,461 8,919 8,714 8,180 9,479 Average supply per supplier (kg) 307,835 328,664 353,425 385,994 415,626

GROUP Result

Turnover DKK million 21,022 23,141 23,771 25,381 Of which abroad 13,087 15,033 15,138 16,177 % abroad 62 65 64 64

Financing (DKK million) Balance sum 12,488 12,268 12,967 14,329 Fixed assets 6,101 6,396 6,612 7,414 Gross investments 1,198 1,017 1,395 1,380 Equity2 3,129 3,090 2,912 3,493

Equity ratio In % 25 25 22 24

Employees No. of person years 12,782 13,122 13,218 13,604

Source: Company files 1998/99.

11998/99 comprises of 53 weeks. 2Group equity includes minority interests.

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Exhibit 5

ARLA KEY FIGURES

Milk weighed-in 2,144 million kg Annual tonnage per supplier 254 tonnes Members (June 99) 8,432 Milk payments SEK6.32 billion Average producer price SEK2.951/kg Turnover SEK13.34 billion Profits before tax 144 million Equity/assets ratio 40.7% Operating costs SEK6.85 billion Investments SEK373 million Average number of employees 5,602

Source: Company files 1998/99.

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Exhibit 6

ARLA ORGANIZATION CHART

Source: Company files 1998/99.

Medipharm Frödinge Dairy

Arla R&D

Semper Foods

Arla Cheese &

Butter

Arla Dairy Arla Export Arla Medlemmar

5,602 Employees

Development Division

GROUP MANAGEMENT INCLUDING

THE BOARD

Elected auditors Authorized public accountants

Association meeting 145 assembly delegates

Administrative council

48 members

39 regional councils 344 elected representatives,

145 of whom are assembly delegates

8,432 members in 39 regions, 8,210 of who are active milk

suppliers

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Exhibit 7

ARLA MEDLEMMAR (MEMBER) 1995/96 to 1998/99

Year 1995/96 1996/97 1997/98 1998/99 Membership costs, SEK million 461 474 467 469 No. of full-time employees 151 134 127 116 Milk weighed-in, kg million 2,042 2,118 2,112 2,144 No. milk suppliers(June) 9,667 9,117 8,727 8,210

Source: Company files 1998/99.

Exhibit 8

TRANSFER PRICE 1994/95 to 1998/99

Year 1995/96 1996/97 1997/98 1998/99

Fat content % 4.27 4.30 4.28 4.22 Protein content % 3.32 3.33 3.31 3.30 Av. Transfer price, SEK/kg 2.974 3.046 2.967 2.951

Source: Company files1998/99.

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Exhibit 9

ARLA FIVE YEAR SUMMARY 1994/95 to 1998/99

1994/95 1995/96 1996/97 1997/98 1998/99

Milk weighted in (millions of kg) 2,134.0 2,042.0 2,118.0 2,112.0 2,144.0 Milk producers (June) 10,437.0 9,667.0 9,177.0 8,727.0 8,210.0 Average transfer price (öre/kg)1 292.2 297.4 304.6 296.7 295.1 Milk payments (in SEK millions) 6,235.0 6,075.0 6,450.0 6,266.0 6,328.0 Net sales (in SEK millions) 12,367.0 12,773.0 13,298.0 13,128.0 13,340.0 annual change % 5.8 3.3 4.1 -1.3 1.6 Operating expenses (excl. milk payments) (in SEK millions) 6,092.0 6,422.0 6,768.0 6,754.0 6,861.0 Total assets (in SEK millions) 5,520.0 5,569.0 5,492.0 5,680.0 6,221.0 Equity/assets ratio 38.4 40.6 42.2 42.4 40.7 Cash flow from current year's operations (in SEK millions) 137.0 109.0 401.0 606.0 297.0 No. of full-time employees 6,043.0 6,020.0 5,659.0 5,621.0 5,612.0 Net turnover/full-time employees (in SEK millions) 2.1 2.1 2.4 2.3 2.4

Source: Company files 1998/99.

1100 öre = SEK1

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Exhibit 10

FIVE LARGEST RETAIL CHAINS DEVELOPMENT IN MARKET SHARE FROM 1991 – 1998

Source: Presentation by MD Foods management to its board of representatives.

France Denmark Sweden England Germany

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