2. The evolution of the Dutch dairy industry

Dairy factories emerged when farmers recognised that they could realise scale economies when merging their supplies of milk to be processed centrally. In particular, the advent of centrifugal separation machines in the 1880s increased the level of scale economies substantially. This technology made it possible to produce butter on a continuous basis and with a much higher return for each litre of milk supplied compared with butter production at the farm. The scale advantages were further reinforced with the widespread adoption of steam-powered separator technologies around the turn of the century (Van Zanden, Reference Van Zanden1994).

Before the introduction of centrifugal separation technology, dairy products were made at the farm. In The Netherlands, the production of dairy products at farms concerned mainly butter and cheese. Geographically, dairy production concentrated in the west (Holland) and the north (Friesland) of the country, both areas with fertile grasslands. Part of the dairy production was exported to England (mainly butter from larger factories in Friesland) and to Germany, Belgium and France (mainly cheese from smaller factories in Holland) (Geluk, Reference Geluk1925; Van Bers, Reference Van Bers1994; Van Zanden, Reference Van Zanden1994).

In the sandy soils in the eastern and southern parts of The Netherlands, dairy products were produced at lower qualities by small factories for local markets. Cows were held mainly to fertilise the land. However, with the rapid fall of grain prices from 1870s onwardsFootnote ¹ and the advent of artificial fertiliser, farmers in the eastern and southern parts became more prone to engage in dairy production as a core activity. This explains why the spread of dairy factories from 1871 onwards did not only concern the traditional grassland area in the west and the north, but also involved the eastern and southern provinces (Van Zanden, Reference Van Zanden1994).

Although the advent of the dairy industry is made possible primarily by the invention of centrifugal separation technologies in the early 1870s, its rapid development should also be understood from a market perspective (Van Bers, Reference Van Bers1994; Van Zanden, Reference Van Zanden1994). Dutch butter exports to England dropped rapidly due to the competition of high-quality butter from Denmark and Normandy produced with the new separator technology. By contrast, the average quality of Dutch butter deteriorated due to fraud with ‘illegal’ addition of substances by both farmers and merchants. Hence, the key problem for private dairy factories was to effectively monitor the quality of the milk supplied by farmers.

The national government realised that in a vertically disintegrated dairy industry, the quality of Dutch dairy products would remain low. The advent of margarine butter by Dutch companies further reinforced the need for regulated quality to distinguish ‘real’ butter from margarine and to avoid that margarine was mixed with butter to reduce costs. A market-pull factor concerned increased inland consumption of dairy products due to rising income and changing consumption patterns. During the 1860s and 1870s, the percentage of household budgets spent on dairy products almost doubled (Van Zanden and Van Riel, Reference Van Zanden and Van Riel2004).

Lacking governmental institutions to regulate quality, farmers were advised to set up their own cooperatives in a report issued by a government committee for agricultureFootnote ² in 1886 (Roosen, Reference Roosen1993). In the Dutch context, the diffusion of cooperatives was further accelerated through learning from earlier successful practices in Denmark. Not much later, the cooperative form became dominant. As economic historians claim (Bijman, Reference Bijman2000; Henriksen Reference Henriksen1999; O'Grada, Reference O'Grada1977; Van Zanden Reference Van Zanden1994), farmers preferred to deliver their milk to cooperative factories to solve transactional problems. As in many other industries, the ambiguity regarding the quality of supply led to excessive monitoring costs (Ouchi, Reference Ouchi1979). Indeed, as mentioned before, illegal practices involving the addition of substances were a real concern. A second reason for farmers to join a cooperative has been to break the power of private factories, which enjoyed a spatial monopsony position (Van Zanden, Reference Van Zanden1994). The dependence of farmers on a local private factory followed from the high transportation costs, which severely limited the possibility to switch between factories. As a result, private factories were able to appropriate most of the returns of dairy products. The founding of a cooperative factory allowed farmers to make a better return on their milk supply, given the increased product quality and higher profit margins. As factory owners, farmers were able to reap the full benefits of milk processing, while, at the same token, production benefitted from more certainty regarding milk supply and its quality. As farmers’ incentives are better aligned in cooperative factories than in private factories, cooperatives are expected to survive longer than private factories. Our first hypothesis holds:

Hypothesis 1. Cooperative dairy factories survive longer than private dairy factories.

Though the advantages of cooperative milk processing became apparent to farmers throughout the 1880s and 1890s, private factories did not disappear and even continued to increase in absolute numbers. Some of these factories remained in business for many years. This suggests that private factories found ways to face the competition of cooperative factories. One common way has probably been to adjust prices for milk supplies upwards to levels paid by cooperatives. Thus, as suggested by O'Grada (Reference O'Grada1977, p. 295) in his study on Ireland, even though private factories had a de facto monopsony position, they can be expected to have paid acceptable prices under the threat of farmers setting up their own cooperatives or supplying their milk to nearby cooperatives. Put differently, the market was more or less ‘contestable’.

In this context, the co-existence of private and cooperative factories in the northern regions is worth discussing (Van Zanden, Reference Van Zanden1994). This phenomenon has also been noted in studies on Ireland (O'Grada, Reference O'Grada1977) and Denmark (Henriksen, Reference Henriksen1999). In the Dutch case, the co-existence of private and cooperative factories, however, has not been universal but restricted to the provinces north of the Rhine, where almost 30 per cent of all factories that ever existed were private (Willemsens and de Wit, Reference Willemsens and de Wit1995). In this grassland area with a tradition in dairy export, many merchants with experience in dairy trade started private factories in the early stage of the industry (Van Zanden, Reference Van Zanden1994). By contrast, in the sandy soils area of the southern provinces of Limburg and Northern Brabant, dairy production had always been for local consumption only. Here, private enterprise was reluctant to start commercial factories, leading to the relative dominance of the cooperative form. This tendency was further reinforced by the Catholic Church that played an important role in southern provinces in supporting farmers financially and administratively in setting up their cooperatives (Willemsens and de Wit, Reference Williamson1995). Indeed, out of all factories that ever started in Limburg and Northern Brabant, less than 10 per cent have been privately owned (Willemsens and de Wit, Reference Williamson1995).

One can expect that the continuing presence of private factories in the upper Rhine area is due to first-mover advantages of early entrants (O'Grada, Reference O'Grada1977). There are several reasons to expect that early entrants perform better than later entrants. First, following O'Grada (Reference O'Grada1977), having the first pick, early entrants were strategically well located in villages and towns with a tradition in milk and butter. Second, early entrants gained experience before local competition between factories took off. The continuing presence of private factories in grassland areas may thus be understandable from the fact that many early entrants were private factories combined with higher survival rates for any early entrant. Our second hypothesis holds:

Hypothesis 2. The earlier a dairy factory started, the longer it will survive.

3. Research design

To test the determinants of the survival of dairy factories, we will apply the Cox regression method (Audretsch and Mahmood, Reference Audretsch and Mahmood1994). We use Cox regressions because this method makes use of the contribution of censored cases. This is necessary because some factories still existed in 2005.

The data are taken from an encyclopaedia by Willemsens and de Wit (Reference Willemsens and de Wit1995) on 1,475 dairy factories in The Netherlands starting from the first dairy factories starting in 1871 until 1994.Footnote ³ We have updated the data to 2005 using the information of the Productschap Zuivel, which is the national association of dairy factories.Footnote ⁴ This leads to a total of 1,477 factories.

The data contain the entry and exit years for most factories. The entry year is the first year, in which a factory started producing dairy products commercially. The exit year is the last year of commercial production. For some factories, the entry year and/or exit year were unknown. In these cases, the factories were left out of the analysis. These missing data reduced the dataset from 1,477 companies to 1,141 companies. Most entry or exit data that are lacking concern data on private companies. This is probably caused by the fact that private companies were not members of regional associations, the records of which are well kept.

The data also contain information on the organisational structure of each factory, that is, whether it concerns a private or cooperative factory, or a factory that changed organisational form from private to cooperative or vice versa. Finally, the data contain the name of the province where the factory has been located, as a regional variable.