Dairy industry rises to the mourning after

By PHILIPPA STEVENSON

The dairy industry's failure to bring about its mega-merger has left it with a mega-problem - what to do next.

The companies whose union would have precipitated the near full integration of manufacturing and marketing have alluded to new paths: Kiwi Dairies' Plan B and New Zealand Dairy Group's Project Eagle.

But an insider said little work had in fact been done on either plan. A range of industry people and observers believe the reason is simple and what is known as "Tina" - There Is No Alternative.

Or at least, they say, no alternative that will leave New Zealand dairy farmers in control of their destiny, though there are plenty of options that will consign the industry to a slow demise and ensure farmers become the commodity price-takers of multinationals.

All through the 10 months of merger negotiations the strong suggestions were that, if they failed, then one company - if not both - would immediately court an Australian partner or two.

It sounded a logical idea. But now the prospect has dawned, devilish detail is clouding what might have seemed a simple picture. Trying to cut through a range of complex issues surrounding an industry still regulated by single-seller legislation will be one big headache.

Since the mega co-op was first suggested five years ago, and especially since it was promoted last year, little effort has been put into studying other options. Certainly none has been sold to the farmer shareholders who have repeatedly given overwhelming support to the single-company concept.

Even companies that adamantly did not want to be included, such as Waikato's Tatua, have backed the idea. Chairman Alan Frampton said last week that the mega co-op was the inevitable end of years of mergers which whittled down the number of cooperatives from hundreds to seven.

The message has been consistent from the industry's other elected leaders, its top management teams, their consultants and independent observers.

In January's annual state-of-the-industry address, Dairy Board chairman Graham Fraser spelled out to a large farmer audience the reasons for the mega co-op.

"We have evolved to the position where we need formal integration of manufacturing and marketing. Our present structure has become slow and unwieldy. It is not conducive to the type of business we wish to be."

He added that there would be significant cost savings from the mega co-op but "my plea to you would be to keep your eye on the larger picture." The world scene was one in which competitors were getting bigger and rapidly occupying the space New Zealand wished to be in.

The unwieldy structure arises from years of amalgamations of provincial companies that have made Kiwi and Dairy Group unequal giants. Their opposing influence on the Dairy Board has destroyed the cosy arrangement that once existed between a plethora of small manufacturers and the marketer.

The companies' desire to maximise profit from their manufacturing operations frequently conflicts with market demands identified by the board.

Where other industries' market-led companies streamline manufacturing, the dairy industry still has two or more plants turning out products that any one factory has the capacity to make.

The industry changed the way the board pays companies for products in an effort to align it more closely with market requirements. It did not work.

In another attempt to resolve the issue, Kiwi and Dairy Group entered an export marketing joint venture. But Dairy Group's takeover of the South Island Dairy Co-op last year gave it a more powerful 58 per cent of the industry - too dominating a size for Kiwi (then 27 per cent) and the venture died before it had lived.

Kiwi put its efforts into the mega co-op and into merging with Northland. Chairman John Young told suppliers his board felt "that a new mega cooperative has the potential to deliver the vision of an industry that acts as one, has cooperative principles as its cornerstone and a structure that is market-led and customer-driven."

Then-Dairy Group chairman Doug Leeder had promoted the mega co-op since he was chairman of the Bay Milk co-op, one of four companies that came up with the concept in 1995 and have all since merged into the big two.

The Dairy Board backed the mega co-op proposal last May after then-chairman John Storey quoted studies by an industry team supported by analysis from international business consultants McKinsey and Co and the Boston Consulting Group. The studies showed the co-op was the industry's best option.

Mr Storey outlined the earnings capacity of the new structure with figures that were met with disbelief. Today's $8 billion business would be earning about $40 billion in 10 years, he said.

The study team had explored 32 other structural options but it had all come down to just one, the mega co-op, Mr Storey said.

Despite changes to the head of the board and Dairy Group, the promotion of the mega co-op continued.

Last Friday, the hard sell was thwarted by the companies' failure to merge. The big question now has to be how the same industry leaders will champion other options, and what they could possibly be.

Immediately, of course, the industry staggers on in its present form with all export marketing controlled by the Dairy Board.

The legislation passed last year that would have deregulated it from September 1 depended on the merger succeeding and gaining Commerce Commission approval. Without that, the legislation will lapse.

In last year's application to the commission, the industry claimed in its case for the mega co-op that "the status quo is not expected to be sustainable in the longer term."

The report maintains that without a merger the remaining smaller companies are likely to join either Kiwi or Dairy Group, with the latter's influence likely to be greatest.

"As one cooperative comes to have controlling influence over export marketing, it would have an incentive to extract for itself the rents that are available from the exercise of market power by a single New Zealand entity overseas.

"Just as a voluntary joint venture in export marketing between two partners of unequal size would be unlikely to be stable, so too, over time, would the legislated single-desk seller tend to become unstable.

"The minority cooperative is likely to find its self-interest will be best pursued by acting independently ... seek the removal of the single-desk seller, and possibly may seek partnership with one of the multinationals in the sector."

However, the report concludes that "others in the industry may have incentives in the opposing direction. The result may well be legislative stalemate for an extended period."

Former Dairy Board chief executive Murray Gough, now a Kiwi director, put it another way in a recent speech. Neither company was likely to succeed on its own as a global, value-added business without losing control to external interests, he said.

"Even if that were not the case, the prospect of valuing and then separating the ownership of one or the other in the Dairy Board, dividing up the intellectual property in the Dairy Research Institute, vying for the best executives, and then aggressively competing with each other in the marketplace, and on payout, is horrific and destructive."

Managing consultant Brian Shaw, of PA Consulting, which has just done a study of the Australasian dairy industry, said if Dairy Group and Kiwi could go their separate ways "they would take an industry that is collectively number 12 in the world to being individually 26 and 37 [respectively]."

To regain critical mass, partnerships, particularly in Australia, could be contemplated. But none of the companies across the Tasman was "terribly attractive" and all were compromised by their own merger proposal difficulties and the imminent deregulation of their industry, he said.

"Each of those [Australian companies] on their own is quite small, so they are not doing that much for you. They would have to look much wider than just Australia."

And there were the difficulties of forming partnerships while exports from New Zealand remained the board's prerogative.

"You could develop some product that is really great but you would have to make it all in the offshore location. You cannot actually get the synergy out of it by making it here and there and around the world.

"Structurally, it is difficult for them just to go off and form partnerships. All these things point to the fact they should be having another go at trying to merge."