Expanding Opportunities for Milk Vending

Expanding Opportunities for Milk Vending The Multi-Channel Milk Vending Test October 2003 RESEARCH & CONSULTING FOR THE GLOBAL BEVERAGE INDUSTRY

Contents • Introduction/Background • Multi-Channel Vend Test Overview • Key Findings and Conclusions • Test Results • Financial Analysis • Milk’s Vending Opportunity

Beverage Immediate Consumption Growth Introduction/Background • Immediate consumption of beverages has grown at a rate more than 3X take-home in recent years • Consumers are on-the-go more than ever, and beverage brands are responding by being more widely available and in convenience packaging Growth of Immediate Consumption Beverages(1) 1997- 2002 5-Year CAGR Total Industry Volume(2) Per Capita Consumption CAGR = Compound Annual Growth Rate; (1) Non-alcoholic; (2) Millions of gallons Source: Beverage Marketing Corp.; IRI

Introduction/Background Milk’s Availability Disadvantage • Milk, however is significantly underrepresented in the immediate consumption channels (convenience, vending, down-the-street) • Lack of availability in these channels puts milk at a significant competitive disadvantage Estimated Retail Channel Shares 2002 Fruit Juice PET Water • Reasons Why • Milk’s perishability • Limited single-serve packaging • Limited product variety and lack of strong brands • Milk outspent by competitors – marketing, distribution, equipment Retail Channel Milk CSDs Take-Home 86% 45% 47% 70% Immediate Consumption 6% 30% 48% 17% Foodservice 8%25%5%13% Total 100% 100% 100% 100% (1) (1) (1) Includes fountain

Competitive Vending Presence Introduction/Background • Milk’s presence in vending, a key and rapidly growing immediate consumption channel, remains virtually non-existent • For competitive beverages, on the other hand, 3% to 12% of volume is sold through venders Vending’s Estimated Share of Volume % Volume Sold Thru Vending Growth Trend Soft Drinks 12% + Bottled Water 5% +++ Ready-To-Drink Tea 4% + Sports Drinks 4% ++ Fruit Beverages 3% +++ Milk <1% - Source: Beverage Marketing Corp.; Vending Times

Introduction/Background Foundation for Milk Vending • Recently, however, dairy industry innovations have provided the foundation for substantial vended milk opportunity • Consumers are increasingly on-the-go and eating more meals away from home; they expect products to be available wherever they are and whenever they want them • The dairy industry has recently been very innovative in terms of developing single-serve packaging and a broadened array of milk products that fit the vending channel (e.g. flavors, 16-ounce plastic) • Strong branding initiatives by processors, as well as national brand owners, have broadened the appeal of milk as a contemporary, competitive beverage Key Drivers of Vended Milk Opportunity

Introduction/Background Recent Milk Vending Initiatives • Recognizing vending’s potential, the milk industry set out to objectively test and understand the opportunity through a number of initiatives Milk Vending Tests/Initiatives • Upstate New York Secondary School Single-Serve Test • School Milk Vending Test • Local/Regional Dairy Council Initiatives • Multi-Channel Vend Test

Introduction/Background Key Learnings from Vending Initiatives • The highly successful School Milk Vending Test, along with anecdotal evidence from milk processors who have initiated school milk vending programs, showed that: • School milk Vending represents a profitable business opportunity for processors, vend operators and schools • Vending adds a new incremental sales channel for selling single-serve milk products • Vending satisfies consumer demand for milk in non-traditional settings/occasions • Vending serves as a low-cost marketing vehicle for milk brands

Vending Location Demographics • Location Type • Location Count • Location Share • Volume Share • Volume Index2 • Offices • 500,000 • 35.2% • 26.3% • 75 • Public Locations • 475,000 • 33.5% • 30.2% • 90 • Plants, Factories • 160,000 • 11.3% • 11.7% • 104 • Hospitals/Healthcare • 48,000 • 3.4% • 7.3% • 216 • Colleges/Universities • 34,000 • 2.4% • 10.7% • 447 • Schools • 20,000 • 1.4% • 2.4% • 172 • Government/Military • 13,000 • 0.9% • 4.1% • 451 • Other Locations • 170,000 • 12.0% • 7.3% • 60 • Total • 1,420,000 • 100.0% • 100.0% • 100 Introduction/Background • However, schools may represent only a very small portion of the total milk vending opportunity • There are over a million vending locations representing a significant cross-section of consumer segments Vending Industry Location Demographic Summary1 • [1]Vending Times, 2002 Census of the Industry • [2] Bachtelle and Associates’ location volume index calculations comparing location volume share versus location count share

Introduction/Background Adding to Our Fact Base • The Multi-Channel Milk Vending Test took the prior school vending analysis a few important steps further to determine: • Which locations, besides schools, are high-opportunity for milk vending? • What is the optimal product set for a milk vender? • What are the benefits of different types of milk venders? Ultimately, we can model an optimized total vending opportunity for milk processors

Introduction/Background Vending Locations Considerations • Due to the differences in the consumers and the location dynamics, we would not expect milk vending in other channels to look exactly like school milk vending School Milk Vending Milk Vending in Other Channels • Kids are the heaviest milk drinkers • Per capita milk consumption for adults is roughly half that of kids in traditional channels Consumer Realities • Often fewer beverage choices in schools • Students are “captive audience” 8 hours per day • Schools are densely populated: 700-3,000 students in our test schools • Heavy beverage vending available, plus options outside the locations • For Public and C&U variable and transient “population” (foot traffic) • Populations tended to be lower at B&I test locations vs. test schools Location Dynamics

Test Objectives Multi-Channel Vend Test Overview • The primary objective of the Multi-Channel Vend Test was to evaluate the opportunity and viability of milk vending in key, non-school channels • Building on and supplementing learnings from the school vending test • Developing detailed understanding of sales velocities, traffic requirements, demographic influences, etc. • Additional objectives were to understand and quantify the volume and economic potential for a processor’s total milk vending business

Vending Test Design Multi-Channel Vend Test Overview • 150 venders • Four markets – 2 in Southwest, Midwest, Southeast • Three channels • Business/Industry (Blue Collar/White Collar) • Colleges/University • Public (e.g. Retail, Neighborhood Centers, Clinics) • Selling milk only • 12-, 14- or 16-ounce plastic packages • Processor-owned local/regional brands and national brands (NesQuik, Hershey’s) • Range of flavors • Alternative Vending machine types

Market Selection Criteria Multi-Channel Vend Test Overview • The key criteria for market selection was the presence of large, “best-in-class” vend operator • Diverse, broad-market vending accounts/locations • Ability to sell in and physically place 50 milk venders • Good reputation, easy to work with, eager to participate • Additional market criteria included: • High market Product Develop Index (PDI) for flavored milk • Processor with broad line of plastic milk offerings • Geographic diversity

Other Variables Multi-Channel Vend Test Overview • Three vender types were tested: • Full vs. Limited product line venders were compared to see the impact of variety • Full = 10-15 varieties • Limited = 5-6 varieties Royal Live-Display Royal Closed-Front Dixie-Narco Glass Front

Test Location Cell Structure Multi-Channel Vend Test Overview • The 150 test machines included: • 90 glass front venders (identical to school test equipment) • 30 each of closed-front and live-display machine configurations

Cell Data Utilization Multi-Channel Vend Test Overview • The machine cell allocations allowed a variety of rather complex cell comparisons: Machine Type Comparison B&I Demographic Comparison (Blue vs. White Collar) Product Set Comparison (Full vs. Limited) Base Channel Comparison (B&I, C/U, Public)

Test Extension Methodology Multi-Channel Vend Test Overview • After the milk vending test was concluded, an additional smaller test was conducted to indicate the relative impact of including non-milk beverages in milk venders • The sample for the test extension was limited to a relatively small number of machines in only one market • Test Extension Structure: • One market – Columbus, Ohio • 18 machines, divided between three (3) cells – • Cell A: Milk Only (local processor brand and national brand products) • Cell B: Milk products plus expanded local processor items, including juice drinks, etc. • Cell C: Milk products plus variety of alternative beverages, i.e., juices, Gatorade, etc. • All glass front machines • 12 weeks, reported in four-week segments • All locations selected from Multi-Channel Milk Vending Test sites

Test Extension – Products Multi-Channel Vend Test Overview • Non-milk products included processor-manufactured juices and fruit drinks, as well as national brand juices/drinks, water and Gatorade

Test Extension – Qualifications Multi-Channel Vend Test Overview • There were a number of factors inherent in the test extension that limit the findings to use directionally, rather than quantitatively: • One market and small sample size • “Forced” vender placement in non-optimal locations • Location-specific variables/dynamics – e.g. operator ran promotion on other venders • Reported test data that did not match machine revenue amounts • In a larger test, these factors would be ‘smoothed’ out across the sample • Three valid ‘adjustments’ were made to the data to address the issues, giving enough confidence in the data to identify directional findings • “Seasonality adjustment” • Comparison with snack vender volume changes • Internal adjustment to match data to actual vender revenues

Project Timeline Multi-Channel Vend Test Overview • The comprehensive test was planned, executed and analyzed over a year-long period Multi-Channel Vending Test Timeline March 02 July 02 January 03 July 03 Test Planning and Set Up Test Execution Analysis and Reporting Test Extension Venders Installed

Key Findings and Conclusions • Demand exists for vended milk in all the channels tested • Business and Industry – blue and white collar • Public locations • Colleges and Universities • Milk vending can be a profitable business for both processors and independent vend operators across all channels tested • Within each channel, there are good and bad locations for venders • Success is largely driven by foot traffic/population at the location • Channel-specific milk vending profitability varies, based on different levels of foot traffic, seasonality (e.g. C/U may have reduced summer activity), availability of competitive products (e.g. B&I with or without an employee cafeteria) , product pricing and commission structure • However, venders in each channel can be profitable, and an efficient business model would likely include placing venders in appropriate locations across all the channels

Key Findings and Conclusions (cont’d) • B&I locations generally produced the highest per vender sales • Per capita consumption in B&I locations was even higher than in the school test – a surprising finding • This finding confirms that availability of single-serve product can be a driver of increased milk consumption for adults as well as kids • Per capita vended sales decline when other foodservice exists, however, total sales are often higher due to the larger location populations • Within B&I, higher per caps were realized in locations without employee cafeterias • Having a variety of brands and flavors drives increased sales • The test proved the importance of broad product variety, which may include a combination of more flavors, fat-levels and strong brands • The best total volume and profit opportunity is in mixed venders with milk and other beverages • In fact, including non-milk beverages may make vending locations viable where milk-dedicated vending would be unsupportable

Key Findings and Conclusions (cont’d) • Glass front venders, which clearly display and merchandise the milk products, deliver higher location and per capita sales volumes • However, alternative business approaches will make sense when equipment requirements and potential profitability are considered (e.g. glass front venders may not be appropriate for outdoor placements and are often more costly) • Working with independent vend operators to enter the milk vending business will be the more attractive option for most dairy processors, at least initially • Independent operators have existing required infrastructure as well as experience, if not with milk vending, with fresh food and other beverages • Independent operators will already have relationships and/or contracts with the most viable vending locations, whereas it may be difficult for a processor to secure milk vending locations • Additionally, independent operators are generally servicing multiple vending machines per stop/location; thus, unlike processors, who may require additional drive-time and higher costs for new milk vending accounts, servicing one additional vender for an independent operator adds negligible cost

Average Weekly Volume Over Time Wks 1-4 Wks 5-8 Wks 8-12 Test Results • Across all venders and locations, weekly sales averaged 78 units per vender • As expected, sales volumes were highest just following vender installation and declined over time Average Weekly Sales Per Vender By Period Average All Weeks = 77.6 Unit/Dollars Per Vender All machine types; all weeks Decline from weeks 1-4 -- -19% -23%

Comparative Volume Retention Levels Test Results • However, post-installation sales retention levels were relatively high – nearly 80% across all venders • In the School Milk Vending Test by comparison, base line period sales were 64% of installation period sales, also better than the estimated industry average of 50% to 60% Share of Installation Period Sales Retained Multi-Channel vs. School Test All machine types; all weeks

Alternative Channel Volumes Test Results • Vender unit sales were highest at Business & Industry locations – 96 units across all weeks • C&U and Public locations sold 10% and 20% less, respectively Average Weekly Unit Sales Per Location/Machine By Channel Units Per Week Per Vender Glass front venders only; All weeks

Range of Vender Sales Test Results • As with any test design that “forces” location distribution, some locations performed at significantly below-average levels, while others delivered very high unit sales volumes Range of Weekly Sales Per Vender By Channel Highest Median Lowest Glass front venders only; All weeks

Volume Less Poor Performers Test Results • Based on operator estimated sales requirements for retaining a vender location, when poor performing venders are eliminated from the mix (as would occur in “real life” situation) sales are significantly more robust Average Weekly Sales Per Vender Excluding Poor Performing Venders(1) All Venders Units Per Week Per Vender Excluding Poor Performing Venders (1) Venders with sales lower than the estimated requirement for profitability (14 of 22 public, 10 of 29 C&U, 14 of 22 B&I) Glass front venders only

Full-Line Milk Product Offerings All-Week Avg Baseline Test Results • Venders that carried broader product offerings significantly outsold those that offered only limited milk products Average Weekly Unit Sales and Per Caps Full vs. Limited Product Lines Units Per Week Per Vender Weekly Per Capita Sales (7+ varieties) (4 varieties) (7+ varieties) (4 varieties) B&I; Glass front venders only

Flavor Variety Analysis Test Results • Flavored milk accounted for 73% of unit sales across channels • Chocolate was the most popular flavor, with 47% of sales volume • The significant 11% from “other” comprised just 4 flavors Flavor Unit Sales(1) Shares Flavor Totals White: 27% Chocolate: 47% Strawberry: 15% Other: 11% Total 100% Significantly higher than 9% in school test (1) All Locations; all markets (2) Other flavors included Cookies ‘n’ Cream, Vanilla, Banana, Mocha

Brand Variety Analysis National Brands Processor-Owned Brands Test Results • Among the full product set venders, local/regional processor brands outsold national brands by slightly more than 2 to 1 • In B&I, the ratio was closer to 3 to 1 Processor vs. National Brand Unit Sales Shares By Location Share of Vender Sales Glass front venders only; All weeks

Alternative Vender Type Analysis Test Results • Glass front venders significantly outsold both closed front and live display equipment at B&I locations Relative Sales Volume by Vender Type Average Units Per Week Per Vender Performance Relative to Glass Front -33% -33% --- Baseline weeks 5-12; B&I locations only

Alternative Vender Type Analysis Test Results • Removing any volume variability associated with location population levels, glass front venders still outperformed the other test venders Relative Per Capita Volume(1) by Vender Type Average Units Per Week Per Vender Performance Relative to Glass Front -22% -24% --- Baseline weeks 5-12; B&I locations only

B&I Channel Analysis Average All Markets = 73.9 Test Results • Within the B&I channel (69 reporting blue collar and white collar locations) there were some variations in performance by market • The same trend occurred with per capita consumption per vender B&I Weekly Unit Sales Per Vender By Market Units Per Week Per Vender Per Capita Consumption 0.32 0.19 0.26 All machine types; all weeks

B&I Per Capita Consumption Test Results • Baseline per capita consumption at B&I locations was a healthy 0.25 units/week • Significantly higher than per caps realized in the school milk vending test B&I Per Capita Consumption Units Per Employee Per Week Per Capita Consumption in School Test 0.20 0.25 0.18 Glass front venders only

Blue Collar vs. White Collar B&I Test Results • Per capita vended milk consumption was slightly higher in blue collar vs. white collar locations B&I Per Capita Consumption Blue Collar vs. White Collar Units Per Employee Per Week Glass front venders only; Baseline Weeks 5-12 only

B&I Location Analysis Average Population 374 584 294 Average Location Per Capita Consumption 0.24 0.15 0.26 Test Results • In larger B&I locations with employee cafeterias, per capita vended milk sales were substantially lower than at locations without cafeterias • The larger populations at locations with cafeterias, however, drove higher total vended milk sales B&I Baseline Period Vender Sales Cafeteria vs. Non-Cafeteria Locations Weekly Sales Per Vender All machine types; All weeks

Mixed Beverage Venders – Sales Test Results • In the extended mixed-vender test, test venders with both milk and non-milk beverages outsold milk dedicated venders by 40% • Milk sales did decline, but much less than the reduced share of facings for milk (-33%) Mixed Beverage Vender Sales Change in Revenues with Addition of Non-Milk Products +40% Change in $ Sales with Non-Milk Addition -14% -21% -27% Note: Small sample size; results are directional only

Mixed Beverage Venders – Retention Rates Test Results • Milk’s retention rate in mixed venders was high – in fact milk sales recovered over time • This finding validates the notion that milk demand is resident, not just a reaction to new product availability Share of Installation Period Sales Retained Mixed Vender Test 105% 45%-50%

Vend Operators Response to Test Test Results • The participating vend operators, interviewed post-test, were quite positive • All of the vend operators were eager to evaluate this new vending opportunity; they expected to have mixed results between the various test channels • Each believes that milk is a viable product in the vend industry and will likely become a profitable component of their vending business at selected locations • In general, machine profitability is expected to increase by adding other non-milk products to the machines

Vend Operator Sell-In Issues Test Results • The vend operators cited some issues/hurdles related to selling-in milk vending in the various channels • Business/Industry • Availability of electrical outlets/adequate space • Moderate response by management to dedicated milk venders • College/University • Multiple levels of approvals required • Commissions expected • Exclusive soft drink company contracts in some locations • Public Locations • Security of equipment • Electrical outlets/adequate space availability

Best Practices Test Results • Full variety of milk product offerings • Placed next to snack and/or food machine(s) • No competitive milk nearby in same package (e.g. in cafeteria) • Prefer glass front vender (but site economics will dictate) • Milk and non-milk products, if possible Operator Perspective on “Best Practices” • Public locations with extended hours of access/ operation • e.g. retail, transportation, healthcare, etc. • B&I with 300+ population • Combination blue and white collar • Prefer location with limited access to lunch alternative within the immediate area • C/U locations with heavy foot traffic Operator Perspective on Key Locations

Financial Analysis Vender Procurement Options • There are a number of options for procuring milk vending machines, including purchase, lease and subsidized use Own Lease Subsidized Ownership • Owns and operates • From processor,brand owner, or machine manufacturer • Monthly payments to owner, or if processor-owned, lease cost can be amortized over COGS • Subsidized by brand owner • Subsidized by dairy industry association Operator • Owns and self-operates • Leases to operator • Supplies vender to operator to use free of charge • From brand owner • From machine manufacturer • Long-term lease or lease-to-own • Subsidized by brand owner • Subsidized by dairy industry association Processor • Leases to operator • Leases to processor to self-operate • Supplies vender to operator or processor to use free of charge • From machine manufacturer • Long-term lease or lease-to-own • n/a Brand Owner

Financial Analysis Hypothetical Milk Vending Economics • Hypothetical milk vending economics models have been derived for a number of possible milk vending scenarios, based on findings from the Multi-channel Milk Vending Test • The models also considered the type of vending machine (glass front vs. closed front), due to the differences in cost and sales velocity during the test Method of Vender Procurement Vender Operator Processor Self-Op Lease Vender Independent Operator Hypothetical Milk Vending Economics Models Processor Self-Op Purchase Vender Independent Operator

Financial Analysis Important Qualifications • Milk vending is emerging as a new channel for selling milk and is an additional means for milk to compete with other beverage types for away-from-home sales and consumption occasions • Because vending is not a traditional channel for milk, there are currently no well-established business models for the industry to follow or use to evaluate the vending opportunity • The hypothetical models presented here are derived from Multi-Channel Vend Test data and working with vend operators, processors and vending machine manufacturers to understand typical costs • Each processor’s and each operator’s costs will differ, perhaps significantly, depending on its capabilities/ competencies, product portfolio, local market dynamics, competitive circumstances, accounting practices, etc.

Expanding Opportunities for Milk Vending