Home' Greymouth Star : September 1st 2015 Contents Greymouth Star
4 - Tuesday, September 1, 2015
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uLetters to the editor
891 - Arnulf defeats the Vikings from
Scandinavia at the battle of Louvain in
1531 - War breaks out in Switzerland
between Zurich and Catholic forest cantons.
1542 - Holy Roman Empire’s campaign
against the Turks in Hungary fails.
1858 - The East India Company ’s
government of India ends with the British
Crown taking over its territories and duties.
1923 - Coalmine explosion and fire at
Bellbird Colliery, at Newcastle, New South
Wales, kills 21. The Great Kanto Earthquake
shakes the Tokyo metropolitan area, killing
more than 142,000 people.
1939 - Germany invades Poland,
leading to start of World War Two.
1951 - Australia signs the Anzus
treaty, a mutual defence pact, with the
United States and New Zealand.
1961 - United Nations breaks off
relations with Katanga government,
and heavy fighting in Elizabethville
and Jadotville results from UN attempt to
arrest members of government.
1974 - Anastasio Somoza is elected President
1983 - A Korean Air Lines Boeing 747 is
shot down by a Soviet fighter after the airliner
entered Soviet airspace; 269 die.
uWest Coast yesteryear
uToday in history
Engelbert Humperdinck, German composer
(1854-1921); Edgar Rice Burroughs, US
author (1875-1950); Yvonne De Carlo,
Canadian-born actress (1922-2007); Rocky
Marciano, US boxer (1923-1969); Lily Tomlin,
US actress-comedienne (1939-); Barry Gibb,
British-born singer of the Bee Gees (1946-);
Dr Phil McGraw, US talk show host (1950-);
Nicu Ceausescu, Romanian politician (1951-
1996); Gloria Estefan, US singer
(1957-); Stephen Kernahan,
Australian footballer (1963-); Craig
McLachlan, Australian actor (1965-
); J D Fortune, Canadian singer,
former frontman for INXS (1973-);
Natalie Bassingthwaighte, Australian
singer of the Rogue Traders (1975-);
Marcos Ambrose, Australian race car
“ With history being made all the time, every
day now seems to be the first anniversary of
something awful. ” — Anonymous.
“ You hypocrites! You know how to interpret
the appearance of earth and sky, but why do
you not know how to interpret the present
time?” — Luke 12:56
The old Ngahere
Church — perhaps
the oldest on the
West Coast — is to be restored to its former
glory as a relic of the province’s past. Its owner,
Mr E Matthews has had the aged building
moved on to his property near the new church
and plans to restore it.
The church has an association with the
Coast ’s pioneering days and was first erected
at Notown, believed to be in the year 1865.
Its construction was the inspiration of the late
Patrick J Gillen, a pioneer Grey Valley farmer.
Following negotiations with Bishop Viard, of
Wellington, Mr Gillen was permitted to have
It was erected by Arnott and Seabrook, of
Greymouth, for the meagre sum (today) of
£240 and the first Mass was celebrated by the
Rev Father Royer in 1866. In later years, when
the need for the church was not so great, it
was moved to the then-bustling sawmilling
township of Ngahere.
The Grey Hospital Board is to explore
avenues which could improve the emergency
telephone ser vice here. This move has been
sparked off by the criticism directed at the
ser vice yesterday when a man died on a
Runanga footpath on Saturday after another
man had spent 15 minutes fruitlessly on the
telephone trying to get help.
Mr R B Gibbens, of Taylor ville, told the Star
yesterday that when he rang the emergency
number,111, the operator asked if he had rung
a doctor and then eventually put him through
to the hospital. The hospital operator in turn
asked if he had phoned any doctors, but did
not send an ambulance.
uFood for thought
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Created in 2001, Fonterra was heralded as a “breakthrough idea” meant to help New
Zealand “catch the knowledge wave”. Fourteen years on, there has been no economic
transformation, writes TONY BALDWIN.
onterra is “potentially better
than an oil well,” founding
chairman John Roadley
boasted in 2002.
“ White gold” was another
Over many decades, New Zealand
has invested massively in raw milk as a
pathway to economic prosperity. It is why
Fonterra was formed.
But with the collapse of international
dairy commodity prices, and Fonterra’s
recent announcement of low payouts for
the 2014-16 seasons, the oil and gold
metaphors do not seem so apt.
This was not supposed to happen.
Created in 2001 by special legislation
overriding the Commerce Act, Fonterra
was heralded by industry leaders and
key advisers as an “icon of economic
transformation”, a “ breakthrough
idea”, “ helping New Zealand catch the
knowledge wave”, and “moving us up the
As a near-monopoly dairy processor
collecting 96% of all raw milk in New
Zealand, the vision was that by 2011
Fonterra would generate $19 billion of
new revenue using milk proteins and
enzymes to make pharmaceuticals, health
foods, specialised ingredients and high-
margin consumer foods.
It would also deliver efficiency gains of
at least $300 million.
Outcome versus vision
Fourteen years on, Fonterra is doing
fundamentally the same things it did in
2001. It still collects the lion’s share of
the raw milk in New Zealand and turns
it into mainly milk powder, cheese and
butter, which it still sells in relatively basic
form, in more than 100 countries.
It still has a patchwork of overseas
businesses and partnerships in higher-
value market segments, but these remain
a relatively small proportion of its
overall earnings, which has not grown
significantly for many years. Fonterra’s
growth and return rates are well short of
So what has changed since 2001? In a
nutshell: Volume and China.
Raw milk production in New Zealand
has increased 58%. More cows (up 33%),
more milk per cow (up 21% on average),
more land used for dairying (up 22%),
more investment in milk processing plant,
more on-farm plant and equipment, more
water for irrigation, more waste, more
cow genetics, more pasture management,
and of course more borrowing. Dairy debt
almost trebled over the past decade to
reach $32b last year.
In short, New Zealand dairy farming
has become considerably more intensive
and production of low-value commodities
and ingredients, especially milk powder,
But while volumes have increased, so
have costs. For a long time, New Zealand
was the cheapest producer of raw milk
in the world. In the past decade or so,
New Zealand has lost that ranking to
Argentina and the State of Victoria, with
California reported to be running close.
On the demand side, the big change has
been China. Demand for protein from its
burgeoning urban middle class has risen
rapidly. In 2013, China’s dairy imports
increased by 50%. In the same year, New
Zealand supplied over 70% of China’s
total dairy imports. The 2008 Free Trade
Agreement with China has been crucial.
Fonterra is still confined largely to
segments of dairy business that deliver a
return on assets of no more than about
5% to 8%. Put plainly, it is still a “ bottom
In the China dairy market, milk powder
has been key: 90% of all dairy exports to
China in 2014 were milk powders and
products derived directly from powders.
Some 34% of New Zealand’s total dairy
exports by value were shipped to China as
Professor Keith Woodford of Lincoln
University opined last month that
“ without China and without dairy, then
New Zealand would indeed be in long-
term trouble”. However, Prof Woodford
remains “very confident that in the longer
run, China will come to the rescue and
that our dairy industry will flourish”.
India is another strong source of
potential demand growth.
However, Europe and the United
States have the capacity to increase
their dairy exports to a degree that can
readily dwarf any increases coming out of
New Zealand. As economic consulting
firm Infometrics highlighted last year:
“Northern Hemisphere dairy producers
still pose a significant competitive threat
over the medium-term”, particularly with
the abolition of milk production quotas in
Europe from April this year.
North America is perhaps an even
stronger medium term threat. Canada, in
particular, has the potential to massively
increase dairy production based on cheap
International prices for dairy
commodities are likely to remain
inherently volatile and Fonterra’s
prospects of winning the race for market
share are not assured.
Certainly, there have been other
changes and gains since 2001, but from
a big picture perspective, Fonterra is still
confined largely to segments of dairy
business that deliver a return on assets of
no more than about 5% to 8%.
Put plainly, it is still a “ bottom
feeder”. There has been no economic
transformation, only intensification.
How have dairy farmers and others
For many dairy farmers during much of
Fonterra’s 14 years, returns on assets and
equity from farming operations have been
poor. Analysts say that few farms cover
their full economic costs (which include
land, labour and capital) from farming.
The Ministry of Primary Industries’
model dairy farms show accounting
surpluses on farm assets of less than 4.5%
on average for 2008 to 2013. Profits and
surpluses for reinvestment were highly
Last year, industry consultant Peter
Fraser and two colleagues surmised
in a paper that farmers accept these
uneconomic outcomes as part of “building
a stake” in the industry and accumulating
assets that will, in due course, deliver
untaxed capital gains. From this
perspective, farmers see their income as
sufficient if cash flows cover farm costs,
drawings and debt, but not necessarily
their labour or equity.
As former Reser ve Bank Governor
Allan Bollard obser ved back in 2006:
“It has become increasingly hard to try
to rationalise prices paid for land using
estimates of the future flow of income
from the land.”
In 2012, the Ministry for Primary
Industries estimated that the top 10% of
dairy farms needed a break-even payout of
$4.79; the bottom 10%, $6.96. Dairy NZ
says the average break-even milk price
Fonterra’s revised estimate for 2015 of
$3.85 will cause real pain for most farms.
From a Fonterra shareholder perspective,
results for the last several years have also
been poor. Dividend yield has varied from
1.3% to 8.6% with an average of 5.8% .
During this time, the share price has been
as high as $8 but is now trading about $5.
In terms of local competition, Fonterra
is still dominant in the domestic raw
milk markets. Only three key competitors
have emerged in the past 14 years: Open
Country, Synlait and New Zealand
Dairies. Together they account for about
12% of milk collected in New Zealand.
In the domestic market, Fonterra is
still governed by detailed regulations and
rules that set the price it pays farmers for
raw milk and the price Fonterra charges
other processors for raw milk supply.
The Commerce Commission is currently
reviewing the state of competition in the
What does ‘higher value’ mean?
“ Moving up the value chain” is hardly
a new vision for New Zealand dairy.
Industry leaders have been repeating the
same mantra for at least the past 25 years.
In 1989, then chairman of the Dairy
Board, Sir Dryden Spring, set the goal
of lifting the proportion of valued added
products “as close to 100% as we can get
as soon as possible”.
What does it mean?
Some dairy products have higher
margins between sales price and cost.
Some have a higher value per kilogram.
For example, in 2012, blue vein cheese,
infant formula, condensed milk, and
caseins were all worth more than $US9.50
per kg. By contrast, cheese, milk powder
and butter were worth less than $4 per
Some of the steps in a product reaching
its point of sale to consumers are more
valuable than other steps. For example,
according to management consulting firm
Coriolis, manufacturing infant formula
typically earns about 30% on assets, but
making its milk powder ingredients earns
only about 9%.
Around the world, dairy co-operatives
focus mainly on the low-value steps
of processing raw milk and selling the
commodity ingredients they manufacture
from it. According to Coriolis, this
activity earns returns of no more than 1%
to 8% on assets and 1% to 4% on sales.
Prices for those dairy commodities also
tend to be relatively volatile.
By contrast, publicly listed dairy
companies like Nestle, Danone and Kraft
make and sell dairy products with much
higher margins — 15% or more. Prices
for these products tend to be much less
volatile. The companies’ business risks are
spread much more widely. For Nestle and
Danone, dairy has become a smaller part
of their diversified global food businesses.
Like is its co-operative peers around the
world, Fonterra’s business is dominated
by the low-value end. It has some useful
medium-margin positions in Asia, Africa
and the Middle East in nutritional
products and food ser vices, but these are
relatively niche. Fonterra’s revenue from
its higher value consumer business has
been essentially flat for many years.
Contrary to industry claims in 2001,
forming Fonterra did not create “critical
mass” to achieve its value-adding
vision. As British consultant Promar
International noted in its 2001 report for
the Ministry of Agriculture and Fisheries,
the minimum efficient scale of production
for global food companies, whose core
activity includes the production of milk
and dairy products, was a total asset base
in excess of $67b and revenue of $111b.
Fonterra’s revenue then was $10b. After
14 years, it is still only $22b.
Why has it not worked?
Fonterra was supposed to be the
breakthrough that would make it possible
to move New Zealand dairy revenues up
the value chain. Why has it not worked?
Six factors stand out.
First and foremost, successful consumer-
end businesses are designed and driven
by what consumers like and don’t like,
and how much they are prepared to pay.
By contrast, Fonterra is driven strongly
by its producers. Increasing volumes and
holding market share take precedence
over moving up the value cur ve.
Reinforcing this volume and production
focus, legislation requires Fonterra to take
all milk supplied by any New Zealand
dairy farmer, whether it is wanted or
not, and no matter how distant from
Fonterra’s milk payout makes up 80-90%
of a dairy farmer’s income, so unless he
or she has resources and skills to increase
income from other sources, dairy farmers
perceive that they can only grow their
earnings by increasing milk volumes.
2. Misunderstanding strengths and
The second factor is an apparently deep
misunderstanding by Fonterra of its
strengths and weaknesses. In Fonterra’s
strategic outlook, covering every step in
the supply chain — from farm vat to retail
consumer — gives it a major advantage
over its competitors. It boasted in 2007:
“ We do it all. We can take this expertise
and apply all or part of it in any market.”
However expertise in commodities
manufacturing and distribution does not
give any special competitive advantage
in downstream markets. They are quite
different businesses, requiring quite
different resources and skills.
Further, consumer dairy markets are
already relatively full and the existing
players — like Nestle, Danone, Kraft and
others — are well established.
For Fonterra, trying to move deeper
into those higher margin segments
would only make sense if it was likely
to earn returns that fully reflected the
considerably higher risks it would face. In
its current configuration, there is no basis
for concluding that Fonterra is likely to
3. Confused roles and objectives
The third key factor contributing to
Fonterra’s apparent inability to get more
of its business into high-value segments is
confusion and tension in Fonterra’s roles
Fonterra tries to be many things to
Fonterra’s key co-operative goal
of maximising the milk price paid
to supplier-members pulls it in one
direction. But its corporate goal of
growing dividends and share value pulls it
in another direction.
Fonterra is also an international investor,
using shareholders’ capital to invest in
overseas milk supply and downstream
businesses from which it aims to deliver a
return on capital.
Thus Fonterra has described itself
as a “dairy farmers’ co-operative, a
multinational marketing company, and an
international capital investor”.
Compounding this chameleon self-
conception, Fonterra’s statements of vision
and strategy tend to embrace all parts of
the value chain.
The result is a muddle.
4. Capital constrained
Building a successful higher-value dairy
business in overseas markets is extremely
capital intensive. But Fonterra is capital
It can raise equity from only two
sources: its 10,500 farmer-shareholders,
who have limited capacity; or retaining
part of its profits, but this is also difficult
given farmer pressure for maximum
payouts. This was noted by credit rating
agency Standard and Poor’s, in its
December 2014 report on Fonterra.
Trading Among Farmers (TAF) and the
Fonterra Shareholders’ Fund (FSF), which
were introduced as a package in 2012, did
not deliver any additional capital. Since
TAF, there has been virtually no new
equity capital put into Fonterra.
TAF and FSF did two things: They
removed the risk that Fonterra’s balance
sheet could be drained by having to buy
back a large volume of farmers’ shares
(called “redemption risk”); and they
improved “price discovery” of Fonterra’s
shares, although the volatile nature
of FSF ’s share price since TAF was
introduced raises questions about the
price discovery objective.
Fonterra is now using capital to provide
interest-free loans to its supplier-
shareholders to help them through the
As a substitute for lack of capital,
Fonterra used offshore joint ventures to
grow new business. However it is not
clear that the gains they deliver fully
reflect the complexity, risks and costs that
5. Capital into stainless steel
The fifth key factor contributing to
Fonterra’s apparent failure to move more
of its business up the value chain is
that the capital Fonterra does have has
been channelled mainly into plant and
equipment for processing raw milk in
New Zealand, which dominates Fonterra’s
Reflecting the infrastructure-intensive
nature of Fonterra’s operations, growth in
capital expenditure has been greater than
growth in selling and marketing expenses.
Allan Bollard, now Secretary General
of Apec, alluded to this issue in a speech
in Wellington this year when he said:
“There is something about the way returns
between Fonterra and farmers go that isn’t
cycling into future capital expansion. You
have to look at governance and incentives
in the dairy industry.”
6. Weak governance
Weak governance and limited capacity
to execute are the sixth key factor
contributing to the apparent failure to
realise Fonterra’s value-adding vision.
Fonterra has 13 directors: Nine dairy
farmers elected by supplier-shareholders
and four independents appointed by the
other nine. So the board’s expertise is
unavoidably and heavily weighted towards
milk production and processing.
A wider range of talent is required to
successfully grow higher value businesses.
Inadequate information disclosure
and weak monitoring are important
related problems. Having the Fonterra
Shareholders’ Fund has improved things
to some degree, but external monitoring
of New Zealand’s largest company is still
Highly-fragmented ownership by
10,500 farmer-shareholders makes
robust and well-directed shareholder
monitoring almost impossible. Fonterra’s
Shareholders’ Council is more akin to a
members’ consultation group.
Among many examples of deficient
disclosure, Fonterra’s current reporting
does not enable its New Zealand
processing business to be monitored on
a standalone basis, which substantially
weakens any measurement of its efficiency
against the regulated farm gate milk
price. Forecasting Fonterra’s results has
also been difficult due poor disclosure
of underlying performance drivers and
Options for change
Put simply, Fonterra’s strategy is at
odds with its structure. This was clear
when Fonterra was formed. From a big
picture perspective, it has two choices:
Change its structure to enable its
strategy or change its strategy to reflect
Real structural change has proven too
difficult. The 1999 proposal for a single
national dairy co-operative had its
consumer business separated into a listed
company with a large amount of non-
farmer equity capital injected. But this
was unacceptable to most industry leaders.
In 2007, Fonterra’s board really pushed
the boat out with a proposal to float
Fonterra as a whole, like Kerry, an Irish
dairy co-operative that morphed into a
successful international food business.
This was way too much for Fonterra’s
conser vative membership.
Other options have been considered,
including the idea of merging with dairy
co-operatives in other countries. But this
would not address Fonterra’s underlying
In the past year or so, several new
advocates have surfaced in favour of
separating Fonterra’s food ser vices
and consumer business, including Prof
Woodford at Lincoln University.
However, among supplier-shareholders,
Fonterra’s status as a co-operative,
100%-controlled by its farmers, is
sacrosanct. There is a deep-seated distrust
of any structure that might allow non-
suppliers to share in potential gains from
As progressive former industry leaders
like John Storey and Graham Fraser can
attest, farmer politics gives no quarter to
those seeking to apply a more progressive
approach to these covenants of co-
In short, industry politics continues to
preclude any major change to Fonterra’s
Where to from here?
Despite its fundamental weaknesses,
Fonterra’s vision is still to earn more from
higher value market segments. By 2025 it
wants total sales to come 21% more from
consumer and foodser vices, 10% more
from overseas partnerships, 15% less from
ingredients and 6% less from the global
dairy auction market.
If you keep saying something and
use more seductive words and pictures,
perhaps you can persuade yourself that a
wish can become a reality. However, 14
years on, Fonterra is further away from its
core goal than when it was formed.
Rather than dabble with indifferent
results in so many parts of the value
chain, Fonterra should concentrate on
the things it is good at and dispense with
the rest. This may mean paring back to
commodities and related ingredients.
It certainly means Fonterra turning
itself into a very efficient low-overhead
As well, Fonterra should only purchase
and process volumes of raw milk that
make economic sense. To this end,
Fonterra should reduce its market share
to below the statutory thresholds that
require it to collect all raw milk wherever
it is produced.
It should also put in place mechanisms
to signal the value of raw milk, regularly
during the season. The value of Fonterra’s
processing should also be signalled
separately from the price of raw milk.
In reality, Fonterra was not a
“ breakthrough idea”. It did not “catch the
knowledge wave”. Raw milk is not “white
gold” or “better than an oil well”.
As Bill English told Parliament in 2001,
forming Fonterra was, underneath the
flannel, the “product of a political deal
between the Government and the dairy
industry”. It was a defensive compromise
to break an impasse. The industry agreed
to lose the Dairy Board’s statutory “single
exporter” powers on condition that the
Government replaced it with special
legislation enabling the formation of
In short, the statutory monopsony was
swapped for a commercial near-monopoly
with special rules.
It was a paradoxical deal: The industry
believed it would continue a highly
dominant dairy exporter; deregulation
supporters hoped it would lead to
contestability and significant innovation.
Fourteen years on, it looks like the
industry was right.
Tony Baldwin is an industry
commentator and was leader of the
Government project team responsible
for facilitating the deregulation of New
Zealand’s nine producer boards in 1999.
— New Zealand Herald
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