Dairy merger benefits cited in application

By Brian Fallow

WELLINGTON - The economic benefits of the proposed dairy industry mega-merger outweigh the detriments by as much as $200 million a year, according to the New Zealand Institute of Economic Research.

The institute's report accompanies the application to the Commerce Commission to approve the merger of the Dairy Board and the processor co-operatives.

The commission can authorise such a merger if it is persuaded the efficiency gains of the merger exceed the efficiency losses from the lessening of competition.

To minimise those losses a key part of the proposal is that the merged company would divest an integrated town milk and consumer products business, selling liquid milk, butter, cheese, yoghurt and the like in the domestic market. That is likely to be either Kiwi's Mainland operation or the New Zealand Dairy Group's Dairy Foods business.

As for the loss of competition at the farm gate, the applicants argue 95 per cent of dairy farmers have no effective choice now who they sell their milk to. In addition the continuing farmer ownership of the merged company would constrain any temptation to profiteer.

The institute said the most pessimistic estimate of the potential economic losses from reduced competition would be between $7.5 million and $30 million a year.

By contrast it quantifies the annual benefits from a merger at $210 million, compared with the status quo.

It puts a value of $40 million a year on eliminating the "artificial" separation between production and marketing. The present structure bundles the milk price up with returns on investments in processing and marketing, which scrambles market signals.

In addition it requires complicated annual negotiations between the board and the co-ops, involving significant numbers of staff.

A second area of savings is from corporate overheads $35 million from the co-ops and $40 million from the board.

Further gains of $23 million would come from processing efficiencies a better match of milk supply and processing plant and from deferring some capital expenditure ($14 million).

The institute also predicts about $20 million a year from the adoption of best practice among the participating co-ops.

Another $9 million would come from a greater emphasis on reducing on-farm costs, as research in that area is encouraged by removal of concerns about free-riding.

Other savings have been edited from the public version of the report, including lower debt servicing and insurance costs.

The institute also compares the proposed merger with another alternative scenario in which the industry ends up as two vertically integrated companies based on NZ Dairy Group and Kiwi, each with its own international marketing operation. The overall annual savings in that case would be slightly larger, about $229 million.

"Our overall conclusions for New Zealand are consistent with research results overseas which have also found there is more to lose from preventing aggregation to an efficient scale than from any possible exercise of market power," the institute said.

The commission expects to make its decision by September 13.