Arla will use the joint venture with China's Mengniu Dairy Company to produce milk powder in consumers packs for the Chinese market. The venture will begin on 1 October this year.
Arla said the deal made sense because consumer milk powder was one of its core businesses and China has the world's largest market for these products.
"At the same time it is important for us to replace bulk production with several added value products for the benefit of our co-operative members," said Peder Tuborgh, Arla Foods chief executive.
Production for the Chinese joint venture will take place both in Arla's European factories and in China.
Arla last week announced it would cut 44 out of 325 staff and stop production of a number of products at its Akafa factory in Denmark by the end of 2005. The group said the factory would then focus on producing more retail packed, full-cream milk powder, especially for the Asian market.
Increased cost pressures have hit Arla in recent weeks, and the firm said recently that European Union's cuts in agricultural export subsidies would harm earnings from butter exports this year.
The group is therefore hoping that the deal in China can play an important role in relieving profit margins.
And Mengniu, its new partner, certainly looks strong. The group was founded in 1999 just north of Beijing, but is already China's biggest and fastest growing dairy firm with a listing on the Hong Kong stock exchange.
Mengniu will keep a marginal controlling stake (51 per cent) in the joint venture. The deal looks rather similar to those already seen in China's brewing industry where foreign firms agree to share technical expertise in exchange for market penetration.
"We have the necessary know-how with regard to added value milk powder products and our partner has an excellent distribution and sales network which makes for a good match," said Jais Valeur, sales director for Arla Foods Ingredients.
The milk sector in China has grown by an estimated 188 per cent over the last five years, according to market research group Euromonitor, with sales of UHT and long-life milk far outstripping those of fresh milk.
And China has the lowest per capita consumption of milk in the world - an estimated two litres per year - revealing strong potential for growth.