NZ consumer loser in big merger plan

By JOHN SMALL*

The dairy manufacturing and marketing industry is seeking Government approval to create a farmer-owned, nationwide monopoly.

New mega-firm Global Dairy Company will export 93 per cent of our dairy production and supply more than 30 per cent of the global market. It's a very big deal in local terms.

Legislation is required to implement the merger and the Government is establishing a working group to consider the merits of the proposal. In essence, the industry is asking the Government to:

Approve the merger directly, without consulting the Commerce Commission.

Pass legislation dissolving the Dairy Board and handing its assets to GlobalCo.

Defer any Commerce Commission attention until a review after three years.

The merger plan arose from a McKinsey strategic study, at the end of which the consultants reported that although there was a very reasonable alternative (based on a duopoly), the "upside" was better for the monopoly plan. The consultants also "firmly" believed that the risks could be managed.

McKinsey said the main risk was performance management. The monopolist, not being in any danger of losing suppliers to a competitor, could become bloated and inefficient. The result would be high-cost production and lower returns to the farmers.

The applicants have predicted annual benefits to the economy of $300 million a year, and promised to have taken account of "the full range of issues that would stem from a merger, such as ensuring the interests of New Zealand consumers and milk suppliers are promoted."

This all sounds great, but the applicants' aversion to going before the Commerce Commission is sure to ring alarm bells. If the project is really so compelling, why do the normal checks and balances have to be avoided?

Some efficiency gains seem likely. The new company should be able to respond more quickly to demand, and reduce costs by rationalising production and investment schedules. This seems to be the main source of the $300 million in welfare gains. When the 1999 version of the mega-merger was provisionally rejected by the commission, the applicants claimed annual benefits of $229 million for a similar proposal. The commission's estimate was less than $100 million.

Offsetting these gains, the commission expressed concerns about the power of GlobalCo in domestic markets for milk and dairy products. In the wholesale milk markets, the new company will effectively be a monopolist and will be able to cut prices paid to local farmers.

The cooperative ownership structure of GlobalCo helps to alleviate this concern: since farmers are also owners, reductions in gate prices for milk can be offset by increases in the value of farmers' profit share.

Farmers voted for the amalgamations that brought the industry to its present level of concentration, and they will also get a veto right (by majority vote) over the current proposal. Thus, while a minority of farmers may oppose the merger, the "tyranny of the majority" is a fact of life in a democracy and not grounds for prohibiting it.

But the retail market issues are more problematic. It is obvious that the merged company will be dominant in the supply of dairy products. GlobalCo has undertaken to divest itself of Dairy Foods, which will become an independent retailer serving the New Zealand market, and sounds confident this will be sufficient. Divestment is not much help, of course, if GlobalCo is able to set the price at which Dairy Foods buys milk.

Somewhat ironically for such an export-oriented industry, the biggest impact on prices from the merger is likely to be in the domestic market. GlobalCo is unlikely to be able to increase prices above those achieved by the Dairy Board in export markets, because the board has always sold the entire national output into these markets.

In the local retail markets, however, the merger will replace two strong and competitive firms with a monopolist.

This is why the McKinsey plan is basically a bad idea. When McKinsey looked at the risks and decided they could be managed, they apparently didn't think of the community at large, only the business interests of farmers.

How can local consumers be protected while allowing the industry to determine its own destiny?

There are several possibilities, with the one proposed by the industry being the most "hands-off." Basically, the industry is saying, "Trust us and then have a look at the result in three years." Suppose the Government regarded this as being too weak; what other options are there?

The next step up could be for GlobalCo to offer an explicit undertaking about the level of prices over the next few years. Self-regulation of this form is available in other jurisdictions, though it seems not to be possible under present law. But since new legislation is required for the proposed merger, this approach seems feasible.

Moving further up the scale, some kind of wholesale access regime might be considered. This would oblige GlobalCo to supply local companies with product on terms that conformed with efficient pricing principles. This could have the advantage of stimulating the domestic retail market by allowing entrants to compete with Dairy Foods, though the cost of administering the access regime would need to be offset against such benefits.

Finally, some form of retail price controls could be implemented. This seems to be what the industry has in mind should the three-year review reveal serious problems. This option would do little to stimulate product or marketing innovation.

Though GlobalCo claims it is not going to be interested in trying to exploit size in a market as small as New Zealand's, lack of attention to consumers' interests is the plan's only obvious flaw.

The new GlobalCo boss, John Roadley, would be advised to get a proposal for consumer protection prepared quickly.

* Dr Small is a principal of the Network Economics Consulting Group and director of CRNEC, an Auckland University research group.