An organic milk war turns sour

(Fortune) -- Mark Retzloff, a pioneer of the $16.7 billion organic food industry and president of Aurora Organic Dairy, lobbied for years for strict government regulation of organics. He got what he wanted - and then some.

Two months after Aurora, a Colorado-based company that makes store-brand organic milk for big retailers like Wal-Mart (Charts, Fortune 500), Costco, Target (Charts, Fortune 500) and Safeway, settled U.S. Department of Agriculture allegations that its milk didn't meet national organic standards, the war of words between Retzloff and his foes shows no sign of abating.

Aurora president Mark Retzloff says charges that the company's products violated organics standards are unfair - and has threatened to sue critics.

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Retzloff is threatening to sue critics who claim that Aurora committed consumer fraud. Much to its adversaries' dismay, Aurora didn't pay any fines when it settled with the USDA.

"We don't think we did anything wrong," says Retzloff.

But critics counter that Aurora is hardly a victim - and scoff at Aurora's efforts to silence them. "We don't know of any scandal in the history of the organic industry that approaches the magnitude of this one," says Mark Kastel, co-founder of The Cornucopia Institute, an advocacy group that filed complaints against Aurora that led to the USDA action this spring.

"These were serious violations," continues Kastel. "The scale was tremendous. And they were willful."

Yes, passions are running high in the lucrative organic milk business. Both Marks - Retzloff and Kastel - say they want an organic food industry that benefits consumers, farmers and the environment. But they can't agree on what the industry should look like.

Retzloff wants the business to get big, fast, in order to capitalize on economies of scale, bring down prices and spread the environmental benefits of organic farming far and wide. "Organic milk shouldn't cost so much that only elites can afford it," he says.

Kastel, meanwhile, is arguing for new standards that would better protect small-scale, family farmers - many of whom started the organic movement in the 1960s. "It's cheaper to produce milk on big farms," he concedes, and "nothing in the organic law says you can't produce milk in Colorado and ship it to Portland, Maine, stupid as that is. But environmentally, it's a sellout."

In theory, there should be enough business for everyone. Organic dairy is expected to be a $3.5 billion business by 2010, according to J.P. Morgan. Of that, $1.8 billion will come from organic milk sales, double today's level.

Retzloff, a big and bald 59 year-old, has made a lot of money in organics. He helped start two natural supermarket chains and co-founded Horizon Organic Dairy, which created the first national brand of organic milk before it was acquired by Dean Foods (Charts, Fortune 500).

"I was an environmental activist as a student at the University of Michigan in the 1960s," he told me last week at the Natural Products East Expo in Baltimore. "Ever since then, I've been a huge advocate of changing the way we do agriculture in the U.S., one acre at a time."

In 2003, Retzloff and Marc Peperzak, one of his partners at Horizon, started Aurora with backing from Harvard University's endowment, among others. They saw a business opportunity in selling store brands of organic milk. While store brands of conventional milk account for more than 50% of milk sales, store brands (like Safeway's (Charts, Fortune 500) O-Organic) register less than 10% of organic milk sales.

Aurora has done well. Annual sales this year will top $100 million. The firm owns and operates farms in Colorado and Texas, as well as its own processing facilities.

Last spring, though, the USDA cited 14 "willful violations" of organic standards and threatened to revoke Aurora's organic certification. Among other things, the USDA said that Aurora cows did not get sufficient access to pasture and that cows fed conventional grain were introduced too quickly into the organic herd.

Aurora settled the USDA charges in August. Without admitting any wrongdoing, the company agreed, among other steps, to reduce the size of its herd at a farm in Plattsville, Colorado, from 4,200 to 1,000 cows.

Retzloff says current rules are too vague about how much access to pasture is required, and that other violations were either trivial or committed by a supplier, which the company no longer uses. "People are saying you're not putting your cows out to pasture," he says. "Well, we are. Just not the way you'd like us to."

While Retzloff feels victimized by the USDA charges, others say the company got a mere slap on the wrist.

The Federation of Organic Dairy Farmers, a.k.a. FOOD Farmers, says the agreement between USDA and Aurora sets an "unacceptable precedent" because "major, multiple violations occurring over several years" did not lead to any penalty. For his part, Cornucopia's Mark Kastel calls the consent agreement "a sweetheart deal."

It's not clear whether this war of words is a struggle for the soul of the organic milk industry, a battle for market share, or both. Don't be surprised if it finds its way into a courtroom before long.