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Current as of 26/09/16 08:39AM NZST

Fran O'Sullivan: Fonterra raring to shake supply shackles

Growing competition in NZ dairy market means time is right to adopt growth focus.
Theo Spierings and his team at Fonterra are driven by a "value" philosophy. Photo / Jason Oxenham
Theo Spierings and his team at Fonterra are driven by a "value" philosophy. Photo / Jason Oxenham

Fonterra is pushing hard for the Government to remove the obligation on it to accept milk supplies from all comers even when it doesn't make commercial sense to do so.

The dairy co-operative has a point.

If there was ever a time to change the legislative regime that governs Fonterra so that it can concentrate on high-value growth instead of over-investing in stainless steel - this is it.

There is a plus to this scenario which Fonterra does not talk about.

That is within an environment where dairy farm prices are set to move sideways - instead of appreciating so farm investors once again see the potential to score lucrative, untaxed capital gains - putative dairy farmers will be forced to be focused on cash flows.

Not simply riding on the coat tails of the industry behemoth and its existing farmer shareholders and suppliers.

There is upside for the entire economy if "farming for capital gains" finally goes out the window.

The Reserve Bank should be getting in Cabinet Ministers' ears on this one given the economic fragility caused by the enormous dairy sector debt.

Fonterra is not saying a great deal in public.

But behind scenes it is marshalling its arguments as to why it should no longer be required to accept all new milk offered, particularly where it impacts on the co-operative's processing investment decisions.

Legislation was introduced in 2001 when the merger of two dominant NZ dairy companies created a dominant player: Fonterra.

The Dairy Industry Restructuring Act (DIRA) was set up to address market dominance (Fonterra collected 96 per cent of NZ's raw milk at that stage).

But there is now considerable competition in the NZ market. Particularly when it comes to the emergence of foreign processing companies which can buy milk directly from suppliers. Under the current situation Fonterra is still obliged to sell specific volumes of raw milk at close to cost price to these larger processors who predominantly export to Asia and are the NZ dairy company's offshore competitors.

The legislation is now under review.

Fonterra has issued a DIRA-101 explainer on its website which sets out its arguments. Arguably its business is analogous with any other which manufactures perishable goods. Milk is a perishable product. A bit like newsmedia products.

Fail to collect milk and process it in a timely fashion and it expires as consumers opt for fresh and safer product.

No one buys a two-day-old newspaper nor - increasingly - will they pay good cash to penetrate online newsmedia paywalls if the product is out of date.

But the fundamental difference is that Fonterra's options to make sensible manufacturing investment decisions are bound by legislation. It has to keep on investing in stainless steel - if sufficient new suppliers roll up - even if its investment budget is better spent elsewhere.

This is an important time for NZ's dairy industry.

The lengthy dairy commodity slump has decimated farmer revenues. The pressure is on Fonterra to be nimble and agile and skew its products to customer demands and preferences.

This is so it can stay ahead of the curve and gain a larger share of high-value market segments on international markets.

Within Fonterra's new corporate HQ on Fanshawe St in Auckland several teams in the Disrupt programme are now going through an accelerator process to develop new products and services. This is exciting culture-changing stuff and another step towards the "value" emphasis which now drives Fonterra CEO Theo Spierings and his executive team.

The Government is also considering phasing down Fonterra's obligation to make specific milk volumes available to competitors.

Goodman Fielder is one of those. It has a domestic customer-facing business making top cheese brands and Meadow Fresh milk which compete domestically against Fonterra's brands in the retail market.

Analyst Tony Baldwin has proposed a wholesale milk market be established, potentially mirrored on some early initiatives used to set up the wholesale electricity market in New Zealand.

It's a difficult situation as Goodman Fielder is effectively the outlier as the other major processing players like Yashili and Yili are highly capitalised Chinese export companies. But there is little Government appetite for radical reform in this area; long-term contracts are a better option.

Under the current regulations, independent processors cease to be eligible for regulated milk from Fonterra once their own supply has reached 30 million litres for three consecutive seasons.

Five independent processors are close to that threshold.

And under the DIRA's sunset provisions, when Fonterra's share of liquid milk drops to 80 per cent of all milk solids the obligation to provide supply to competitors goes.

That threshold was achieved in 2014/2015 in the South Island. The pro-competition provisions will expire no later than May 31, 2018 unless the DIRA is amended before then.

Problem is the Government proposals suggest moving the goal posts to 75 per cent in either the North or South Islands - or after five years, which is anticipated to be the end of the 2021/2022 season (which ever comes first).

Shifting goal posts might have helped NZ's men in the Olympic sevens - but when it comes to business it just doesn't make sense.

- NZ Herald

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Head of Business for NZME

Fran O'Sullivan has written a weekly column for the Business Herald since its inception in April 1997. In her early journalistic career she was a political journalist in Wellington and subsequently an investigative journalist who broke many major business stories including the first articles that led to the Winebox Inquiry in both NBR and the Sydney Morning Herald. She has specific expertise in relation to China where she has been a frequent visitor since the late 1990s. She is a former Editor of the National Business Review; has twice been awarded Qantas Journalist of the Year and is a multiple winner of the Westpac Financial Journalism Supreme Award.

Read more by Fran O'Sullivan

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