Back to the future

By PHILIPPA STEVENSON, agricultural editor

The success of the New Zealand dairy industry may boil down to something as fundamental as milk.

Victoria University Economics Professor Lewis Evans, the executive director of the Institute for the Study of Competition and Regulation, has done several studies of the dairy industry.

In New Zealand, the meat industry is one of the few that comes close to dairying's scale but it has no companies to match the $12 billion Fonterra cooperative, the country's biggest company by far, and twice the size of the next biggest, Telecom.

The meat industry as whole, says Professor Evans, has performed well by delivering value-added meat and services across the world. But the sector is typified by companies failing, rising, succeeding, and failing again.

The dairy industry, cooperative from the grass roots, had opted for a single export marketer "that naturally led to a concentration in decision-making; so [the success of the industry] has been single desk selling," he says.

But while other industries have tried monopolistic selling with mixed results, Professor Evans suggests the reason the cooperative arrangement worked so well in dairying is because of the homogenous nature of the product it processes - milk.

"There are examples in the US of cooperatives forming in vegetables but even though they have a common operation, different vegetables have different characteristics, sometimes they come on stream at different times, and that has led to the breakdown of those cooperative arrangements," he says.

WestpacTrust chief economist Adrian Orr also cites the industry's base product as a fundamental reason for its success - but more because of what the industry has done with it.

"There have been some less than successful [other] industry models," he says, "but probably more importantly there is the ability for value added and further processing, and wider marketing to go on within the dairy space, relative to, say, the meat and timber space.

"The dairy industry has been, among the pastoral industries, the best at boosting productivity on core [commodity] products ... and they've also been better at doing better things - creating new products, new markets and new uses for the protein."

New Zealand has moved on ("though never enough") from just producing tasty and mild cheddar, while internationally the dairy industry has gone into areas such as plastics, chemicals, and bio-technology, he says.

Such high-tech products, though, are a long way from where it all began.

In the 1840s, European settlers milking two or three cows began to produce more milk than their friends, neighbours and small communities could consume. Even the smallest communities had a dairy company. The first butter shipment was exported to Australia in 1847 and the first cooperative, the Otago Peninsula Cheese Factory, was established in 1871. The industry's export potential was realised 11 years later in 1882 when the ship SS Dunedin sailed from Port Chalmers to London carrying the first refrigerated cargo of meat and butter.

Farmers and investors responded. By 1900 there were 152 proprietary dairy companies, and 111 cooperatives.

The Department of Agriculture report for 1900 showed 178 creameries, 88 cheese factories and 442 private dairies (365 butter, 77 cheese).

The numbers continued to rise until the 1930s when regulations were brought in defining areas of cream supply for butter factories.

The Dairy Produce Control Board, established in 1923 and later to become the Dairy Board, exclusively handled zoning from 1936. It was no easy task. Twice it lost lawsuits but its zoning powers were viewed as an important element of quasi-judicial control in the cut-throat industry and a way to secure amalgamations among less economic companies.

Slowly company mergers occurred, often against strong local loyalties.

In the 20 years to 1965, there were 45 amalgamations involving 112 dairy companies and 145 factories, 50 of which were closed.

In 1960 there were 107 butter factories with an average output of 1943 tons. By 1970 their number had dropped to 67 factories with an average production of 3474 tons.

Cheese factories went a similar course: from 160 factories averaging 583 tons in 1960, to 84 in 1970 producing an average of 1169 tons.

The merger juggernaut that has this year left just one major cooperative, Fonterra, and two small ones, Tatua and Westland, continued through the decades. In 1975 there were 75 companies, by 1988, just 22, in 1994 they were down to 15, and last year four remained.

"The New Zealand Dairy Board and the local dairy cooperative have been as much a part of New Zealand life as the cheese segments and the Marmite sandwiches that have been lunchbox staples for generations of New Zealand schoolchildren," Adrian Orr wrote in July in an introduction to a study of change in the dairy industry by Professor Evans and fellow Victoria University Professor Neil Quigley.

In the study, which looked at the move from the Dairy Board single seller model to deregulation and Fonterra, Mr Orr asked why the change was desirable or necessary.

There was nothing more inevitable, he said, than the fact that the New Zealand dairy industry's competitive advance would fade away as the sources of that advantage - our relatively low production costs - were replicated or bettered by our competitors.

The challenge today is to lever as much value as possible from that advantage for as long as it may last, while continuing to seek out new advantages for the future.

He told the Herald that forming Fonterra was a good step but only one step along a path.

"If you truly want to shift agriculture out of that commodity-based side - or just doing the same thing better - it is about the research and development, the innovation, being exposed to foreign ideas, demands, international knowledge. That is where Fonterra really has to get itself exposed, and quickly."

The goals have already been defined. Swiss-based Nestle and New Zealand's Dairy Board were around the same size in the 1950s. Today Nestle is a multinational with turnover from dairying alone of more than $31 billion.

In those terms, Fonterra, with turnover of $12 billion, is just getting started.