Fonterra and Tatua - Beasts of a different ilk

By LIAM DANN primary industries editor

Big is best - that was the battle cry that rallied farmers to support the creation of Fonterra.

Big wasn't looking too flash this week as farmers watched fleet-footed dairy minnow Tatua top Fonterra's payout by more than 50 per cent.

But Tatua's chairman, Alan Frampton, said that the comparison was unfair.

They were between different companies with different products and markets, he said.

That will be of little comfort to Waikato farmers who look across the fence to see their Tatua friends earning an average of $160,000 more this year.

It is unfair to compare a co-operative of 132 farmers with one of 12,600, but it highlights the challenge Fonterra faces to get the dairy sector back to its high of two years ago.

A cruel piece of American market manipulation last year means milk powder - Fonterra's main product - may never return to the record prices that it then enjoyed.

The United States Government cut the maximum domestic powder price from US$2200 a tonne ($3750) to about US$1800, creating a new glass ceiling for world prices. That, Fonterra must live with, World Trade Organisation negotiations aside.

The company is left with two seemingly conflicting ways to increase its margins. It can do things cheaper or it can do things smarter. And being smarter is not cheap.

Tatua's capital expenditure was proportionately 50 to 100 per cent higher than Fonterra's, Frampton said.

Developing and marketing high-tech, value-added products did not happen overnight.

He is seen as something of a visionary in the dairy sector and he identified the need to break out of the commodity cycle more than 20 years ago.

Tatua was formed in 1919, but it was in the 1970s that it headed off in its own direction.

It was then that Tatua decided to stay independent and stay small.

"That meant we had to do things the rest of the industry didn't want to do and that would be profitable," Frampton said.

The first step was a space age new product that had just been invented in the US - whipped cream in an aerosol can.

Tatua is now the sole Southern Hemisphere producer of aerosol cream.

It dominates the Australian market for the product and sells it throughout Asia and South America.

In the 1980s Frampton joined the Tatua board with the aim of taking the company further down the value-added road.

"I came with a strong view that the whole dairy industry should move as quickly as possible away from commodities."

Frampton saw an opportunity in the new field of complex protein ingredients and the company started to invest in the required people and facilities.

The number of uses for such products has exploded in recent years.

Now, when Japanese hospital patients are attached to a nutritional drip, it is protein molecules from Tatua's cows that are nourishing them.

Fonterra has similar businesses. In fact it generates $1 billion in revenue from value-added products that return similar margins to Tatua's. But spread across its volumes of milk, those margins are diluted.

Frampton can reel off many technical reasons why his company is different to Fonterra but it ultimately comes back to size.

"We've tried to develop a business to take advantage of being small," he said.

"Fonterra has to take advantage of being big."

And being big isn't all bad. Anyone who saw Jonah Lomu on a rugby field knows he took longer than most to get moving, but once he was rolling forward he could be an unstoppable force.

In some ways Fonterra, which produces close to 40 per cent of the world's traded dairy products - last season carefully picked up the ball.

To reduce supply and push up the world milk powder price it had to first sell down a massively overstocked inventory.

That the company managed to sell an additional 500,000 tonnes of product last year is a triumph in itself, said acting chief executive Jay Waldvogel.

They have caught the ball - this season they have run with it.

Fonterra will put the squeeze on supply and the world's milk powder price should rise.

It would have been a winning strategy if the Americans hadn't moved the goal posts.

If powder price goes higher than $US1800 per tonne it will be the trigger for the US to start dumping the enormous surplus - bought from its heavily subsidised farmers - onto the world market.

However, Fonterra chairman Henry van der Heyden is well aware that the commodity business now has limitations on price.

Fonterra did aim to grow the value-added part of its business, he said.

There have been suggestions that internal politics about direction might still be holding the company back from that, but that drew a sharp response.

"That's all nonsense," van der Heyden said.

He is adamant that Fonterra has a unified vision of what needs to be done.

It had a clear strategy with key themes that were well understood by everyone.

Theme one was to be low cost all the way down the supply chain, because commodities were still its core business.

The other themes all revolved around value-added products.

There was the specialised ingredients business that included high-tech companies like Pharmaceutical Lactose.

There were the joint ventures with partners like Nestle.

There was a fast-moving consumer goods company and another business based around food service.

Fonterra's annual research and development budget was almost $100 million.

In the past three years the value of the ingredients business had grown from 5.5 per cent of revenue to just under 10 per cent.

But there are some who worry that Fonterra might be pushing too hard.

Professor Bill Bailey, head of agribusiness at Massey University, said Fonterra should never put all its chips into the high-value game.

"If you are going to get on that treadmill then you better be prepared to stay on it," he said. "And you will have to run faster and faster."

In other words, that was a strategy that required New Zealand technology and talent to stay one step ahead of its competitors.

In a world where those competitors often had bigger resources, there was no guarantees that it was a sustainable position, ask our America's Cup team.

Bailey, a native American, said we shouldn't lose sight of how well the commodity business had served us in the past.

"New Zealand's natural competitive advantage is the fact that we are a low cost producer."

That did not mean New Zealand did not have some scientific advantages. But there would always be question marks about that.

That we could turn grass into dairy foods cheaper than any other country in the world was a fact - one that had contributed enormously to the nation's wealth.

"I believe there is case for even more emphasis being placed on the commodity business."

There are growth opportunities on the horizon for commodity products.

In China the per capita increase in consumption of dairy products has exceeded 10 per cent annually for the past three years.

The annual per capita consumption of dairy products in China is just 7kg, against the world average of 100kg.

Fonterra achieved record production volumes every month last season. On its peak production day, it received 66 million litres of milk.

This season looks like another record breaker.

"There is nothing surer than that one day 70 million litres will arrive at our door," said Waldvogel.

So milk production looked set to remain the key to New Zealand's prosperity for some time yet, and NZ could not afford to take big risks, said Bailey.

The way forward for Fonterra was not by focusing exclusively on one end of the market or the other.

Being involved in both gave the company a good hedge and limited its risks, he said.

"You might miss some of the highs but you also miss the lows."

Tatua did not have a choice. "Its strategy is exactly right for 132 farmers," he said.

Fonterra, in the short term at least, did not have much choice either.

In a couple of months milk production will be peaking.

A wave of it will flow from the country's farms and whatever the price, Fonterra must get rid of it all.