Fonterra's plan to cut staff will help lift its fortunes, but the giant co-op faces more profound challenges than headcount as it enters what analysts say is a time of structural change in the world's dairy markets.
Milk prices have tanked, and look likely to fall further before any improvement, and Fonterra's earnings are under pressure.
"They are in quite a big bind and I don't think the milk market is going to let them out easily," says one dairy analyst.
Unlike its overseas competitors, Fonterra is outwardly focused, exporting about 95 per cent of its production.
Other dairy-producing countries have tended to focus on feeding their own populations, viewing exports as an add-on.
That's quickly changing as other producers get more serious about the export trade, particularly given the so-called "protein deficit" facing the world and the likely increase in demand from emerging economies.
When dairy prices started to fall sharply last year, analysts saw it as a cyclical downturn. Now they are not so sure, and suggest the playing field has changed.
"To me, there are components of cyclical oversupply, but there are some worrying factors when you look at the overall position of the dairy market," says Ian Proudfoot, KPMG's head of agribusiness. He says the key changes are China's focus on production for domestic consumption and the removal of production quotas in the European Union (EU) on April 1 this year.
"I have always said that changes in the EU quota system will have a material impact on the markets we target - the high, premium end - and I believe Ireland, France, Denmark and the Netherlands are obviously targeting similar markets." In the United States, meanwhile, farmers are chasing a bigger share of the export market, says Proudfoot.
ANZ rural economist Con Williams agrees that the market is likely to face structural change over the next three to five years.
"Looking at the current supply/demand imbalance, we don't think the current market is solely supply driven, or solely demand driven," he says. "We think that there is a structural element from increased European competition and more subdued demand from China."
As well as increasing competition, the industry's entire cost structure has changed. A higher US dollar and a lower cost of capital - thanks to near-zero interest rates around the world after the global financial crisis - combined with lower feed and energy prices, have lowered costs considerably, Williams says.
Proudfoot, in the latest edition of KPMG's Agribusiness Agenda, says over-capacity in New Zealand dairy processing is being viewed as a real risk to the industry. The big challenge, he says, is whether New Zealand can do a better job of adding value to its growing milk supply.
The price paid to dairy farmers has been on a rollercoaster for the past few seasons.
In 2013-14 the farmgate milk price hit a record of $8.40 a kg of milksolids. The following season it was just $4.40/kg. For this season Fonterra has forecast $5.25/kg, but a cut to the low $4 range looks likely when the board meets to consider the forecast on Friday next week.
For farmers and investors alike, the real bone of contention has been that Fonterra's dividend has not helped to partially offset low milk prices. While there is little farmers, or their co-op, can do about volatile commodity markets, there has been an expectation that the dividend Fonterra earns on its manufacturing operations would help out when milk prices are down. That hope has not been borne out.
When the company announced the results for its first half-year in March, executives revealed a dividend in the 20c-30c range, down from 25c-35c a share, and had their work cut out explaining why it had fallen.
The Fonterra share price should be going through the roof at the moment.
In theory, while low milk prices aren't welcomed by farmers, they should help Fonterra's manufacturing side, because they represent a lower input cost, but things haven't turned out that way. "The Fonterra share price should be going through the roof at the moment, because their input costs are falling with the lower GlobalDairyTrade price," says Matt Goodson, managing director of Salt Funds Management.
In the background is the Dairy Industry Restructuring Act, which enables Fonterra to function as a near monopoly but has clauses to allow an element of competition.
The legislation allowed for the formation of Fonterra by permitting the 2001 merger of Kiwi Co-operative Dairies, the NZ Co-operative Dairy Co and the NZ Dairy Board.
When Fonterra began, its market share was 96 per cent of NZ milk production. Under the act, a review of the rules is triggered if the co-op's market share falls under 80 per cent in either island. It is now 86 per cent.
To maintain that share, Fonterra has made it easier for non-shareholding suppliers to climb aboard through the "MyMilk" programme, and built extra capacity to make sure it can handle the milk.
"Farmers lose sight of the fact that [the act] is competition law at its most peculiar," says Federated Farmers' policy adviser Ann Thompson. "It allows Fonterra to do a whole lot of things, and requires Fonterra to do whole lot of things that, under good old commercial law, it might not be able to do."
While the act gives Fonterra many privileges, it comes at a price. The co-op must accept milk from suppliers with shares, wherever they are - from prime Waikato dairy country to the Northland backblocks.
In recent seasons that has created big problems because good growing conditions have created a tsunami of milk - product that can't be turned away. That meant hundreds of millions of dollars had to be spent on "stainless steel" to handle the inflow.
The Commerce Commission is looking at the regulations and calling for submissions on whether the current arrangement is helping or hindering the industry's efficient operation. The Government wants the commission's report by next March.
The essence of Fonterra's strategy is that New Zealand cannot produce enough milk domestically to compete on the world stage, so the co-op has to get involved in "milk pools" overseas.
To Jacqueline Rowarth, professor of agribusiness at the University of Waikato, this "world domination" strategy is a big mistake.
"That strategy is like swimming in a rip," she says. "They have not re-adjusted their landing place and they are battling against that rip and getting further and further away from the shore." Fonterra's share of internationally traded dairy product has plunged from 42 per cent in 2007 to 26 per cent today.
As Rowarth sees it, not enough is made of the superior quality of New Zealand's product, from cows fed mostly on pasture. "A certain proportion of world consumers would pay a premium for that, and all we are doing is putting it on a platform and saying: 'who wants it?'"
That platform, GlobalDairyTrade (GDT), is also attracting flak, with some farmers suggesting GDT auctions should be suspended while the market settles. At today's prices, whole milk power is selling on GDT at about half the cost of production.
Critics like to compare Fonterra - unfavourably - with the successful but tiny co-op Tatua. But that criticism overlooks the fact that Tatua operates deep in the heart of prime Waikato dairy country, with most of its suppliers close to its processing facilities. While Tatua focuses on high end, niche products, Fonterra's sheer size means it doesn't have the same luxury.
About 35 per cent of Fonterra's production leaves NZ as whole milk powder - close to its raw form, thus opening up the co-op to criticism that it doesn't do enough to add value.
Not that New Zealand's worried dairy farmers are alone. Their European counterparts are also increasingly nervous as prices drop. Only this week, FrieslandCampina - once headed by Fonterra boss Theo Spierings - announced another cut in its milk price.
Three Fonterra directors are up for re-election at the next annual meeting - chairman John Wilson, Blue Read and Nicola Shadbolt. Such is the discontent that there are doubts whether Wilson will survive the farmers' vote.
The departure of one of New Zealand's most accomplished businesspeople, Sir Ralph Norris, has been viewed with some consternation. Norris is to step down from the Fonterra board after the co-op's annual meeting on November 25 to pursue other commitments.
The ANZ's Williams says Fonterra could do a better job of communicating with farmers and investors . "I think particularly in the current environment - for budget and business planning purposes - there is a need for more regular updates, month to month forecasts, both in terms of the likely milk price and dividends," he says. A lack of transparency is also a common complaint among sharemarket analysts. "For me," says KPMG's Proudfoot, "the key is what 'Dairy 2.0' should be looking like, rather than continuing to do what we have done previously, which was obviously to focus on powder." He believes more could be done to export liquid milk.
"The challenge for us is how we start to think about how we get the value for that product that we should be capturing. A lot has been done in that space, but have we done enough? I think where we are at the moment suggests that we could have done more."
• Can Fonterra handle increasing international competition?
• What can NZ do to add more value to milk exports?
• Is the legislation that created Fonterra now helping or hindering?
• What can be done to boost dividends?
• Is "world domination" still the right strategy?
Farmers still committed to the co-op way
Dairy co-operatives have been part of New Zealand's history since 1871, when the country's first cheese company was created on the Otago Peninsula.
By the 1930s, more than 400 separate dairy co-ops were operating throughout the country, says the Dairy Companies of NZ website.
The 1930s to the 1960s saw the beginnings of industry consolidation as transport and refrigeration technology improved. By the 1960s, 400 co-ops had become 168 and numbers continued to shrink through mergers and acquisitions.
In 2001, the two big co-ops that remained - Kiwi Co-op and NZ Co-operative Dairy - joined with the Dairy Board to form Fonterra.
There is a sense that time is running out to achieve the promise that is Fonterra.
For Stu Taylor, who farms in the Rangitikei, "Fonterra carries the hopes and dreams of five generations of New Zealand dairy farmers.
"The Fonterra co-op has the potential to be the success story of New Zealand."
But he says Fonterra has to strike an "uneasy balance" between the needs of Fonterra, the company, and the needs of Fonterra, the co-op.
"Fonterra has the opportunity to be the great New Zealand success, but every time there is a failure like Sanlu [the Chinese melamine scandal] or the botulism scare, the high quality brand that is Fonterra gets eroded.
"There is a sense that time is running out to achieve the promise that is Fonterra, and major change is required.
"The change in the employment structure is welcome and it is good to see that Fonterra is making the changes required to move to higher returning ingredients-based business."
Lance Gillespie, who farms at Apiti, near Feilding, says farmers are disappointed the Fonterra dividend has not compensated for lower milk prices.
"I guess it's a reflection of them not producing the right goods at the right time, out of the right factory, to create the right returns for co-op members." Gillespie notes that some farmers have opted to sell their Fonterra shares and join other dairy companies.
"There are a number who have jumped ship but I don't think that they will be any better off at the end of the day."
He also observes that Fonterra staff were out in force to help farmers during the recent floods in the central North Island - a sign the co-operative spirit remains alive and well. "I'm definitely a co-op man and I'm keen to stick with them," Gillespie says.