The Crafar Farms, Shanghai Pengxin & New Zealands Growth Strategy

Fonterra is investing heavily in farms in China (that is, if you call 6,500 cows in a big barn, a farm).

We New Zealanders think we are the experts in low cost profitable farming and we think we are spreading our farming knowledge around the world. We may be some of the best farmers in the world, but we are not the best at making the most money from our farming skills.

For a lesson on how to set up a truly integrated high value dairy business we need to look to Shanghai Pengxin. They have just completed the purchase of the 16 Crafar farms which total 7,892 hectares in the North Island.

Shanghai Pengxin now own the farms where the milk is produced, they are going to build a factory to process their milk, which they will sell into the Chinese super markets, that they also happen to own and they will do so using the trade marks "Nature Pure" and "Pure 100" which they have recently trade marked.

I have a big issue with this. This is not about the Chinese buying some of our farm land.

Shanghai Pengxin buying the Crafar farms is different to Shania Twain buying a hill country station or James Cameron buying a farm, its not the same as the Harvard Universities endowment fund buying farm land and its also different to the German investors buying dairy farms.

That's because these high profile international farm buyers are not planning to process their farm produce and sell it onto the international market using New Zealand's 100% Pure branding.

If Shanghai Pengxin were going to buy the farms and supply Fonterra or some other New Zealand milk processor then I wouldn't have a problem with it.

The government have a food and beverage project which is designed to increase the export value of New Zealand's food and beverage sector, which accounts for 53% of our exports. In a report called "Moving to the Centre" the goal of doubling the food and beverage sector is outlined. In order to achieve this goal  the food and beverage sector will need to earn an extra $40 billion dollars.

The Ministry of Business, Innovation & Employment has set up its Food Innovation Network which is designed to help the sector to develop new products in which they can export.

So it would appear that there is a strategy that the government is working to.

So I wonder how selling 7,800 hectares of dairy land to a foreign company, that will process that milk and market it to Chinese consumers using trademarks that allude to New Zealand's 100% Pure branding, is helping New Zealand double our exports?

It doesn't.

It's not like Shanghai Pengxin were going to partner with Fonterra or any other New Zealand exporter and help us access the Chinese market or anything.

You have to wonder what was being discussed by the two ministers in charge of this issue, Muarice Williamson and Jonathan Coleman.

For the record; I have a problem with any foreign company using the New Zealand brand. I'm unapologetically patriotic in this regard.

Meadow fresh is owned by the Australian company Goodman Fielder and sells UHT milk into China.

I'm not comfortable with that either. I'm not sure we can do anything about it though.

But this is not a anti Chinese issue. I just think we need to protect our "New Zealand" brand much like the French protect the region of Champagne.

I want to stress that I'm not anti Chinese, my wife and I began the process to adopt a child from China, but we decided to adopt from another Asian country as the wait times for China were very long. So as the farther of an Asian son I can say with certainty that I'm not racist.

Its acknowledged that Shanghai Pengxin is essentially part of the Chinese government, although its not officially written anywhere.

I think its important to note that the Chinese government is a communist regime and history gives us a clear picture of what communism is. They don't have elections, they control and censor the internet. Chinese citizens can't attend church unless it is a state sanctioned church and if you publicly disagree with the government you risk getting locked up on obscure chargers or you simply disappear. Many people under 35 have never heard of Tiananmen Square because it is censored out of history and it is thought that many cyber attacks on foreign governments and organisations originate from the Chinese government.

I think it is important to note these things about China, its not an indication of individual Chinese people. But their government is a less than desirable entity. Would you be happy living under that regime?

We seem to get all carried away with the massive opportunities that China offers. I'm happy to do business with the Chinese and I'm comfortable with us passing on our farming knowledge and genetics to their farmers, but we must not forget who we are dealing with.

The people who say that opposition to the Chinese purchase of the Crafar farms is a case of xenophobia are missing the point. Its not the land that is the issue. It's that a foreign firm is using our brand and creating a vertically integrated business out of it.

That is a poor strategy for New Zealand to take. I have only heard one person speak out about it and that is Rod Oram on Radio NZ.

What about Fisher & Paykel?

Fisher & Paykel are a iconic New Zealand whiteware manufacturer that has recently been sold to Haier, the Chinese whiteware maker.

I think it is sad that we have "lost" an iconic New Zealand brand and the dividends will now flow off shore, but it's very different to what Shanghai Pengxin are doing. 

The Fisher & Paykel brand relates to a range of whiteware the only people who benefited from that brand are the shareholders of Fisher & Paykel. Much of the manufacturing takes place in Thailand anyway.

The 100% Pure branding in which New Zealand promotes it self, can be used by any New Zealand company from tourism operators to clothing companies to food businesses. It is our identity and we need to collectively protect it. That means not ruining our environment and it also means protecting the misuse of our brand.

The precedent has now been set. It has been shown that the government of New Zealand is quite happy for foreign companies to set up in New Zealand, use our brand and compete directly with New Zealand businesses in the international market place. So its quite conceivable that a number of other Chinese companies can come in and do the same thing as Shanghai Pengxin. Before you know it, all the massive growth in China that the dairy industry are betting on may be met by Chinese firms based here in NZ. It may even be a multinational firm like Nestle who start marketing NZ milk in China next.

Its probably not a big deal having one company doing it, but how are we able to stop the next foreign company doing what Shanghai Pengxin have done? Or the next company. All new comers will simple point to Shanghai Pengxin and say "you let them do it, why not us".

Is it only a matter of time before international companies hungry for continued growth, identify the potential that "Brand New Zealand" has and act on it?

We risk becoming the low paid peasants in our own country, not because we don't own our own land but because we don't own our brand.

This is where strategic leadership from the government is required. But I doubt anything will change based on Muarice Williamson and Jonathan Coleman's attitude towards the Crafar farms.

High Fonterra Share Price, Not Good For Young Farmers

I had expressed earlier that I was not sure if investors would want to invest in Fonterra's units. I've been proven to be totally wrong, as the offer was well and truly over subscribed.

These are the thoughts that have been going through my mind over the last few days.

What will the Fonterra share price end up at, once shares begin trading later today? I'm worried the price will go higher.

A higher share price is great if you are an existing Fonterra supplier. They have already made a capital gain after Fonterra announced the issue price will be $5.50 per share, which is $1.00 higher than the current $4.52 price. A 300 cow farm doing average production of 350 kgms equates to a $102,900 capital gain.

Many share holders are happy and some are expecting an even higher price once the market begins trading.

I view the Fonterra share price as a barrier of entry into the dairy industry. The higher the share price the lower the cash return is for a farmer from the milk payout.

If farmers received a payout of $6.00/kgms and the share price was $4.52 then they make a higher return than if the share price is $5.50 per share, simply because they have to pay or borrow more money in order to receive the same payout of $6.

My concern is that the share price will eventually rise to around $7.00/share or higher. In this situation a farmer with 300 cows doing 350kgms, will need to buy shares at a value of $735,000 in order to receive a payout of $6.00. Compared to $474,600 when the share price was at $4.52. 

The reason I think this could happen is that different investors have different expectations in regard to returns. At the moment the share valuation at $5.50 with an estimated dividend of .32 cents/share equates to a 5.8% return.

I don't claim to be knowledgeable about how investment markets operate but I look around and I see that government bonds around the world are paying less than 2% return and New Zealand government bonds are trading at 2.85% for a 5 year term. Many company bonds are around 3%-4%.

I wonder if some of this international money may look for a home in the Fonterra shareholders fund. The concern is that these large international investors may deem Fonterra to be a low risk investment and therefore be happy to receive a return of 4.5% or lower, this would equate to a share price of $7.00 based on a .32 cent dividend.

Which leads me to ask, why is the price of the farmers market shares the same as the shares in the shareholders fund, that the outside investors trade? These are two totally different investments with different motives behind the purchase. 

Farmers buy shares because they have to, in order to have their milk picked up. The outside investors are looking for a return. One has voting rights another does not. The two purchasers have different motivations.

But the biggest difference between the two funds is the number of potential purchasers. The shareholders fund is open to any super fund, hedge fund, institutional investor or Mum and Dad investor around the world. The business models of these investors is different to a farmers business model and it concerns me that professional investors will be setting the share price based on their expectations and business needs. For instance, some large investors may just want to place cash into a safe place where they can simply beat the rate of inflation. If this happens then these investors have dictated the price that up and coming farmers need to pay for a share, which has the potential to alter the dynamics of the NZ dairy industry. 

I suppose what might happen is over the years, investors will see that Fonterra is a safe investment and then begin to bid the share price up over time. 

The result could be, dairy farming makes another move away from focusing on cash flow and instead relies on capital gain of the land and now the shares. An appreciation in the value of land and Fonterra shares just make it more difficult for the next generation to break through.

Maybe we will get a situation where existing Fonterra suppliers sit on their shares and the new young farmers supply Synliat, or Open Country Daries. Which would not be ideal for the industry over the long term.

I wonder what the share value will be in 12 months time?

That's just a few of my thoughts as I wait for the the cow bell to ring in 30 minutes time.

Less Farmer Appointed Fonterra Directors May Be A Good Thing

After the passing of Trading Among Farmers, there is now two parties involved with Fonterra. The farmer shareholders and the outside investors. It has been written about everywhere that farmers fear they will lose control of their Co-op. I completely understand that fear and I agree with them.
The argument is that farmers can not lose control because they have the voting rights. This seems a valid argument, but the farmers who are anti TAF point out that the influence of the outside investors will mean that decisions will be made that are not in the best interest of farmers but that of the investors. But surely, what is good for the investors is good for the farmers too. 

Farmers concerns are further raised when it appears there will be 3 directors appointed by the outside investors and 2 farmer appointed directors of the Fonterra Shareholders Fund management company. Fonterra are also conducting a governance review where one option is to reduce farmer elected Fonterra directors from 9 to 8 and decrease non farmer directors from 4 to 5.

We need to remember that Trading Among Farmers only passed by a narrow margin.

With all this going on we hear from the Wall Street Journal that Fonterra are in discussions with the Chinese who would like to buy $100 Million units in the new Fonterra fund. Fonterra are not commenting, which probably means its true. If this is the case it would be very poor judgement from the board to allow this to happen. Even before TAF has been implemented. Everyone knows that there are fears from farmers that they will lose control of their Co-op to outsiders. Even if this fear is unfounded, it is unwise for Fonterra to be talking to overseas buyers at this point in time, especially when so many New Zealand investors are going to miss out getting their hands on the Fonterra units.

This is the weakness of TAF which had been talked about. We now have two sides, the farmers and the investors, which is fine if they have the same goals.

But I feel the farmers goal is now to retain control, anything that comes out from the board in the future will be scrutinised by farmers from the perspective of "is this going to jeopardise our control of Fonterra". This attitude is a defensive inward looking view and is not ideal for growing Fonterra to be money machine for the farmers & investors.

I see future directors being elected purely for their "protect the farmers control" stance. Not because they are best at running Fonterra.

In this context, some farmers are: 

calling for a farmer-director majority on the board to be enshrined in the constitution and for farmer directors only to elect the chairman, who must be a farmer.

I can see why they want to do this, so farmers don't lose their co-op. But the question needs to be asked; do farmers have a place on the board of Fonterra? I mean what do farmers know about running the 3rd or 4th largest dairy company in the world? The chairman should be a person with experience at running a major organisation, not a farmer. 

I don't mean that in a derogatory way, its just that farming and running a multinational business are totally different things.

Boeing don't have pilots running the company and Methven don't have plumbers running the company just as Icebreaker don't have sheep farmers on its board.

I know Fonterra is a Co-op and that makes things a bit different because the farmer shareholders are in control.

The point I'm making is that, maybe the farmers control is holding them back. Maybe the people who appeal to farmers are not necessarily the best people to take Fonterra in to higher value branded products.

When election time arrives, I read the profiles in the farming magazines, which are there for farmers to decide who to vote for. They all basically say the same thing;  "I own a farm in XYZ province & I understand farming" or " I've been involved with the dairy trade for decades" or  "I have farming interests in South America & Timbuktu" & "I'll ensure we work to give you the highest payout we can" or "I will stick up for farmers and work to fix the "perception" problems of the dairy industry".

Which all sounds good to a farmer, but is has nothing to do with developing a high growth branded company.

So while TAF may get farmers upset and uncomfortable, maybe the input from the outside investors is going to be a good thing. 

The investors get their return from the dividend portion of the payout, at the moment that is not very high. They will want to see a higher margin business. Maybe we will see some exciting board appointments from the outside investors. Maybe these appointments will slowly begin to influence the board.

Maybe the inclusion of the outside investors will change things fundamentally and the farmers do have less influence on the board.

That could be just what Fonterra needs to move to the next level.

Maybe the farmers need to get out of their own way in order to see their co-op fly.

Of course, no Fonterra farmer shareholder is going to agree that sentiment.

Fonterra Shares Proving Popular

I have had my doubts about whether investors would be interested in the Fonterra shares/units/investment options.

But they are proving very popular. Homepaddock has some info here with an interesting comment from an accountant, and Stuff has a opinion peice that sums it up quite well too.

Fonterra Is A Price Taker

Following on from my post about how New Zealand agriculture can learn from Apple, I thought I'd look at some New Zealand companies that are doing well overseas. 

Geoff Ross is a former advertising executive who rose to prominence when he founded 42 Below, the Vodka company. He and his partners have gone on to invest and run other companies which they take public. The companies Geoff and co have invested in are Ecoya which makes candles and Moa Beer.
I think he is an interesting business person to study because he hasn't invented anything new or created a unique product. He has simply taken products which are already common place, but he creates brands that enable him to sell these products at a premium price.

42 Below is a brand of Vodka, which is hardly a new product but he promoted the brand in such a way that it appealed to their target market. He promoted it as a high value brand from New Zealand and took it global. He and his investors then sold it to Bacardi for over $100 MIllion.

So when I heard that The National Business Review were doing a question and answer session with Geoff Ross, I thought what a great opportunity to ask him about Fonterra.

I asked:

Geoff is saying you can be an ingredient business which is at the lower end of the value chain and be successful. But you should have a strong brand which creates loyalty. This branding allows you to have control over the price you receive for your product.

The Intel inside example and Gore-Tex are great examples of businesses that supply components to manufactures who create the final product.

Intel make the processors that go into most computers. Your PC laptop will likely have an Intel sticker on it. Prior to the 1990s Intel was just another component supplier, although a very good and innovative one. Anybody outside of the computer industry would not have heard of Intel. 

This quote is from the Intel Wikipedia page.

Intel embarked on a 10-year period of unprecedented growth as the primary (and most profitable) hardware supplier to the PC industry. By launching its Intel Inside marketing campaign in 1991, Intel was able to associate brand loyalty with consumer selection, so that by the end of the 1990s, its line of Pentium processors had become a household name.

Now consumers became aware of the processor in their PC and when they were buying their new computer, they would have the option to choose the brand of processor.

I remember buying my first computer in 1999. I actually researched which processor I should choose, AMD vs Intel.

Wouldn't it be great if consumers around the world actually knew and cared about where the milk came from to make the end product.  

Gore-Tex is another good example of ingredient branding. When you buy a new jacket you can get a Kathmandu Gore-Tex jacket or a Macpac Gore-Tex jacket. The Gore-Tex brand is quoted along side the jacket manufacturers brand. The Gore-Tex jackets are always much more expensive than the competing materials.

When I think about Fonterra, they have the powerful brand name, they also have a range of consumer brands. If we look at Anchor as an example. Anchor milk is a premium brand, it retails at the top end of the milk market. That's what it should be doing. But a vast majority of Fonterra's milk is sold as a commodity and the board of Fonterra seem to be quite happy with that fact.

Fonterra set up the Global Trade Event Auction, on which they sell their product to buyers. An auction is great when there is good demand for your product but it is not a strategy to maximise your products premium status or achieve a consistency in pricing. An auction is handing over control of your pricing to your buyers and it certainly does not go towards promoting your brand as a premium brand.

How many of the buyers (ie food companies) of Fonterra's milk, care about how it was produced? Do they care it was pasture based? Do they care that it has a very low carbon foot print?
I doubt it very much. The buyers are the food companies of the world and they will get milk where ever it is cheapest and whoever has a consistency of supply. That's why whenever the USA and Europe production increases the price New Zealand farmers receive drops. Simple supply and demand. 

The goal should be to have global consumers looking for the Nestle chocolate bars or the infant formula with the "NZ Inside" or "Fonterra Inside" or "Pasture Harmonies" label on the side of the packaging. 

Fonterra and New Zealand have such a unique branding opportunity and truly differentiated farming systems, that are not being promoted. The contrast between a New Zealand pastured based dairy farm compared to a housed factory farm in California is huge. The fact that New Zealand dairy products can be produced, processed and shipped 17,500km to the UK and still have half the carbon foot print of a UK produced product, is not being promoted. Our animal welfare standards are high. The average pet loving European house wife could be persuaded to pay more by simply showing her contrasting pictures of grazing cows, beneath snow capped mountains, and that of housed cows. But again that is not being promoted either.

If you look at the adverts at the top of this post and you applied that sort of design and creativity to New Zealand's low carbon, pasture based, animal friendly farming systems. You can see how the end consumer can be drawn to care about where the milk in their products comes from.

But we are just selling a basic product to the highest bidder via an auction. New Zealand milk is not considered any different to US milk or EU milk. Its just an ingredient and luckily for us there is demand for milk. Fonterra is successful simply because global demand is increasing, not because of some wonderful Fonterra strategy.

The future demand for milk is strong, so simple supply and demand will keep NZ farmers in the money. But there is a problem with this strategy.

Brazil can grow 30,000kgdm/ha/yr where New Zealand farmers can only grow 17,000kgdm/ha/yr. What happens in 20 years time when South America has adopted modern farming practices. 

Fonterra has the resources, the scale, the expertise and the people to execute a branding strategy to differentiate Fonterra's milk, just like Intel did in the 1990's. But they don't have the desire to. For 11 years they have been talking about "value add" but it's not really their goal. It's the sort of thing you're supposed to say in your annual report and you splash the phrase around in business plans and outlines of next years strategy.

When you look at companies that are based on being a premium product, the culture right from the top promotes the premium values. Apple had Steve Jobs and 42 Below had Geoff Ross. They promote the culture that permeates through the entire organisation.

The culture of the New Zealand dairy industry is "production" and that's what Fonterra's strategy is really about. That's why they are setting up mega industrial factory farms in China, to increase production. In the context of increased production, the global trade auction platform makes sense. But from a value perspective the auction system is an abomination.

Fonterra is going to be successful but they could be really successful. Fonterra's strategy is just lacking in aspiration and they will continue to perform below their potential. 

People will be able to counter the points I've made, but all I'll say is if Geoff Ross took control of Fonterra for 10 years. Who's strategy will provide the highest payout to farmers? Geoff Ross or the current management team? 

So I'm calling for Geoff Ross to be the next chairman of Fonterra. 

The Bare Bones, Scraping The Bottom Of The Barrel, Budget, 50 Cow Starter Farm

This post will seem crazy to the farmer who will someday inherit Mum & Dads farm or the farm owner or even the sharemilker milking 500 cows.

This post is to get people thinking about alternative ways in which they can get into dairy farming.

I want to talk about what I call the "bare bones, scraping the bottom of the barrel, budget, 50 cow starter farm". As the name states it's an attempt to milk cows with the lowest possible set up costs, and its a way for young people with no money to start building a herd.

Just like a standard dairy farm, you will need; 50 cows, a cowshed & some land. The way we acquire these three things will be slightly unconventional.

It's important to note that a sensible person would just go contract milking. So if you're not sensible or you can't get a contract milking position, then the "bare bones" system may work for you.

There are many reasons why this system won't work but as Geoff Ross said "Every Bastard Always Says No". To run this system the dairy company that you supply will need to amend their risk management programmes, which some seem happy to do.

The Cowshed
You need to be able to harvest the milk, and as the video below shows that a mobile cowshed does not need to be expensive and can be very basic. It also shows that tractors can be very small or is that a ride on lawnmower?

The cowshed in the video isn't the fastest way to milk cows. I would consider a single side herringbone or even a walk-through design rather than the design they have used. But either way this is a very simple structure that will allow you to get milk out of 50 cows and into a vat, which is all we are trying to do. You probably only want to do it once a day though.

Tanker Track
To supply a dairy company you need to have somewhere for the milk tanker to collect your milk. This usually consists of a purpose made gravel road made to the dairy companies specifications, which runs up to a farmers cowshed. The tanker parks onto a concrete pad where the farmers main collection vat is located.

You can build your own tanker track and put a concrete pad down, but that will cost money and if you are leasing land the land owner will probably not want a big tanker track on his property at the end of the lease.

Collection Vat
Your main vat does not need to be on the same bit of ground that you milk your cows on. It can be located in a number of areas. You could put your vat on the neighbouring dairy farmers tanker track (if you ask nicely), or on the sheep farmers track next to his wool shed or anywhere that a tanker can easily drive up to and collect your milk. Where the tanker collects your milk will depend on peoples individual situations. 

These collection areas are almost always made of concrete. But the MPI (Ministry of Primary Industries) food safety specifications say that these areas need to be made of an "impervious" material. MPI don't want a situation where waste milk and wash water are pooling or running into the surrounding area. There are a number of ways these requirements can be met with out using concrete. Having said that it might just be cheaper and easier just to build a concrete pad next to the track that you use as a tanker track and just remove the concrete at the end of your lease.

Your collection vat and vat wash facilities can be housed in a small shipping container and all waste water/milk runs into a plastic water tank and a cheap K-line style sprinkler system will enable you to spread the waste water. This type of set up will pass the regulations and allow you to move it when/if you move to a different block of land.

Cows
The cows will be your main cost and at the time of writing a fully recorded cow is worth about $1800-$2,000. So 50 cows will cost you $90,000-$100,000. 

But you don't need to spend this much money on cows. 

Lame Cows
Because you will be milking the cows in the paddock the cows do not have to walk to and from the cowshed. That means you can buy cows which have sore feet. I'm not talking about cows that should be culled for welfare reasons, but on every farm I have worked on we have had a few cows which seem to live in the sick paddock, close to the cowshed. They seem to have recovered from their sore feet issues, but after a week with the main herd they end up back in the lame paddock again. You should be able to buy these cows for $1,000.

Older Cows
A local stock agent told me that he has some clients who have larger herds (1,000-2000 cows). He said they have a practice of selling their older cows before they break down on the long walks which seem to go with large farms. These cows will do 400kgms/year but you must be careful they don't have a high somatic cell count. These cows can be bought for $1,100/cow. These cows will be living the life of riley, being milked once a day and not walking anywhere.

Empty Cows
In the autumn when the grass growth slows, farmers start to get rid of the stock they do not want to feed through the expensive winter months. Cows that have failed to get into calf in the late spring- early summer are often sent to the works for $500-$700/cow. You can buy these empty cows and milk them through the winter. If you milk these cows with the mobile system, where the cows lay in the paddock for 23.8 hours of the day waiting for you to park the cowshed next to them. You should have 50 fat, happy cows who are only too keen to conceive.
In the spring you simply put 2 bulls in with them and leave them there for a few months. The worst case scenario is that some of these cows don't get in calf. If some are still not in calf, then simply send them to the works and receive $500 for them. You will have received $1,700 for their milk over the past year (320kgms/cow@$5.50) so your total income from this cow will be $2,200. The farmers I know who have done this report having 20% that do not get in calf. 

Lease Cows
Leasing cows is also a good option as you don't have to stump up with the cash or borrow any money to buy your herd. Lease cows usually cost 10% of the purchase price of a cow. So in today's figures with cows worth $2,000 the yearly lease for a cow is about $200. You get to keep all the calves.

Here are three ways to buy a cheap herd of cows for half price. I would find a handful of farms that have a large number of cows, who have an absentee owner and a high turn over of staff (ie Crafer farms). This should not be hard to do, especially if you live in the South Island. These farms will have a high number of good cows that have had a hard life and will be lame from long walks or have not got into calf due to a combination of factors. If you can get first option on these cows before they go to the works etc you can have a consistent supply of half price replacement cows, which you can turn into great producing cows by inserting them into your mobile "living the life of riley" milking system.

Land
Your cows need to graze somewhere, you can buy land (too expensive) or lease land (good option).

If you lease land you pay market rates at a per Ha basis. Canterbury irrigated land is about $700-$1,000/ha, unirrigated land is about $300-$500/ha. Its difficult to find a lease block of land for 50 cows. You will need about 16-25 ha depending on if its irrigated or not. A small irrigated block of land for lease is very difficult to find. Other parts of NZ where irrigation is not required will have a much easier time.

I live in Rangiora, the surrounding farmland has been carved up into 4 Ha lifestyle blocks, which are purchased by townies with a dream of the country lifestyle. Many soon find out that their 700 square metre section in Christchurch was easier to care for than their 4 Hectares. Often these life-stylers end up spending money to have these blocks maintained.

Lifestyle blocks are an under utilized source of land that can be used to milk cows on. Because the cows will be milked with a mobile cowshed, you can move the herd from block to block. Depending on the type and amount of feed on each block it will take 50 cows 6-12 days to chew through a 3 ha block of land. Obviously you want the blocks of land to be quite close together.
You may not need to pay any lease on these blocks, if you agree to maintain it and look after it for the owners. You could also agree to supply them with milk and to keep their freezer filled with meat.

Show Me The Money

It's difficult to budget a system that is so experimental. But production of 330kgms/cow for a South Island herd milked once a day is realistic. Once a day milking generally shows a reduction in farm working expenses of 25%. 

If the farmer supplied a corporate dairy company they would not need to buy shares. This would reduce the set up costs by $74,580. If the cows were leased rather than purchased, then that would knock a further $50,000 off the set-up costs, which would leave you with a total setup bill of about $55,000. Which is quite good when you consider that the budget shows a profit of $32,000!

This system is all about just doing the basics, so there is no artificial insemination, or imported feed. Its just grass and milk.

This exercise is a bit mickey mouse, but it shows that there is the potential to make a profit from a small herd of 50 cows. I'd encourage young people with very little capital, to think how they could set up a small herd that would fit their circumstances.

A young couple could set-up a similar system. One partner could continue working in a job while the other milked the cows in the morning and did the farm work.

Or, you could just go contract milking!

Fonterras Trading Among Farmers Launches, But I Still Don't Understand It

I've blogged about TAF before here and here. We now have a bit more information on how it will play out in practice. But to be fair, I still don't really understand it and this view has been expressed by many observers in the media and the industry. It is not fully understood and some of the reason for this is Fonterra themselves don't know exactly how the governance will work, as they are still undertaking a review.

My thoughts;

Will farmers sell some of their shares into the fund?
I think they will, there are lots of farmers who have very high debt levels, the drop in the forecast payout is making many farm budgets drop into the red. I think many of these farmers would sell 25% of their shares into the fund and use the proceeds to pay off debt.

The dividend portion of the shares is estimated to return net 4.2%-5%, farmers will be paying 7%-8% interest on their debt, so they make a greater return by reducing their debt. 

Farmers can only sell 25% of their shares
I think this is because farmer shareholders want to retain control. From my perspective, I felt the ability for a farmer to supply Fonterra without having to buy shares is an advantage of TAF. Lets say I was planning to milk 100 cows with a mobile cowshed. In order to supply Fonterra I will need to buy about $170,000 worth of shares @$4.52/share. Thats $170,000 that I will have to borrow from the bank. If I retained these shares I would receive the full farm gate milk price plus the dividend component of .32 cents/share. On current forecasts that would be a total payout of $5.25. My interest bill on the shares will be 170k @7%/38000kgms = .31 cents/share. The dividend component pays the interest of the shares.

If I could sell my shares into the fund then I would not have to borrow $170,000, but I would only receive $4.93/kgms. From a cash flow perspective the two options are the same. But I would have to forfeit any capital gain on the shares.

I would be prepared to accept that in order to not have to borrow the $170,000, because as a farmer starting out. I don't have the ability to borrow lots of money as I don't have any land to offer as security. By not having to buy shares I reduce the amount I have to borrow by 50%.

At the moment, I would buy shares for $170,000 and sell 25% for $42,500 and only need to borrow $127,500. Which is better than not selling any at all.

Well at least, thats how I interpret TAF to be. I'm not sure if I understand it peoperly though.

Sharemilkers buying shares
Willy Leferink from Federated Farmers said;

Many sharemilkers will be thrilled at the prospect of buying Fund units because units are convertible to shares, should a unit holder go farming in their own right.

It is an innovative means to build and broaden someone’s capital towards the ultimate goal of farm ownership.

If a sharemilker can make 15% on their money, why would they buy Fonterra shares that return 3%-5%. They would be better off to invest in cows.

Are these shares just like bonds?
These shares will probably sell like hotcakes. But I still can't see why an investor would want to buy shares instead of a Fonterra bond. Fonterra Bonds are yielding about 7% gross, which is the same as the estimated return these share will return. These shares have no voting rights and your capital is not secured like it is with a bond. Then investors also have to consider that the farmers (who have control and voting rights) benefit from a lower dividend and a higher milk price, which is 180 degrees opposite to what an outside investor would want. 
On the other hand they have the upside potential of Fonterra increasing its profitability and therefore increasing the dividend amount, which theoretically increases the total value of the shares as well. 

Fonterra consistently say that Trading Among Farmers is not about bringing in new capital, but about reducing redemption risk.

This whole trading among farmers is a ballsy move. I'm not a conservative person and I love change and the excitement of something new, but man, TAF is a complicated, long winded way of solving a problem (redemption risk) that wasn't even a big problem in the first place (in my opinion).

The inclusion of outside investors is common in corporates, but in a co-op I can only see it causing more tension. We've got tension among farmer suppliers and the directors and now they have added another party to the mix whose goals are at odds with the farmers. There are lots of other ways Fonterra could deal with farmers withdrawing or cashing up shares, without such fundamental and structural change.

Farmers are right to be a bit wary of this.

I hope it goes really well and Fonterra get held up as an example to the world.

What New Zealand Agriculture Can Learn From The iPhone

I've never owned an Apple product. I was tempted to buy a Macbook Pro recently, but the temptation evaporated when I saw the price tag. Now that the new Windows 8 ultrabooks with touch screens are here, my next laptop will definitely not be a mac.

This got me thinking about Apple and why they are so successfully. 

It goes without saying, Apple is a hugely successful company. When people analyse Apples success, they talk about Apples design focus, their pursuit of perfection, the innovative thinking, the drive to make technology simple or the Steve Jobs factor. All these factors explain why they have great products and such brand loyalty, but it doesn't explain why Apple is the most valuable company in the world.

This graph shows that if you consider an iPad a computer then Apple has 25% of the US computer market. Which is a huge percentage. But if market share was the key to financial success then HP and Dell would be just about as profitable as Apple. The fact is Apple makes just about as much profit as Microsoft, HP, Dell, Google & Facebook combined. 

The reason Apple is so profitable is that Apple have total control of their value chain. This means they control the design, manufacture, distribution, retail and after sales service of their products. This doesn't mean that they do all of these things themselves, but they certainly control it.

For the past 8 years I have been involved in the retail sector and I know a bit about the margins on electronics. On average a retailer will make a margin of 8%-10% on products such as televisions, computers & home theatres etc. Generally a manufacturer will have a recommended retail price that they expect retailers to follow, but the retailer is free to sell the item for whatever they like.

The next time you visit your local appliance retailer you will see that the computer section is filled with "Sale" or "Reduced" signs all over the PCs. A quick glance over to the Apple display and you will see no such thing. I have never seen an Apple product on sale at a discount. This is because Apple set the retail price of its products and the retailer can not sell it for anything other than that price, secondly Apple only gives retailers a 3% margin on its products. So the latest 32gb wi-fi iPad retails for $879.00, the retailer will get $26.37 including GST.

Why would a retailer stock Apple products if they only make a 3% margin?  Because Apple products bring customers too their stores. Apple can treat retailers like this because their brand is so strong and their products are popular. The retailer can try and make their money by selling you an extended warranty (never buy an extended warranty), the protective case, the charger or docking station. The accessories have healthy margins.

To become an authorised Apple reseller you have to jump through hoops, once you are approved, you are then fortunate enough to be totally controlled by Apple.

My point is Apple have total control of the retailers and they apply this same control to every aspect of their supply chain.

Samsung have been putting in a good effort to compete with Apple in the smartphone and tablet markets. Samsungs Galaxy S 3 smartphone sales are matching Apples iPhone sales, but total sales are not even half the story.

This research paper called: Capturing Value in Global Networks: Apple’s iPad and iPhone, is quite interesting.

The report outlines Apples supply chain and details where the money from Apple products end up.

Who captures the financial value?

Like the iPod, the iPad and the iPhone are big money makers for Apple. While other companies are thrilled to be part of the supply chain for these highly successful products, their benefit in dollar terms pales in comparison to Apple’s.

They go on to say 

In the case of the iPad, Apple keeps about 30% of the sales price of its low-end $499 16GB, Wi-Fi only model (and more if the unit is sold through Apple’s retail outlets or online store). We estimate that Apple keeps a healthier 58% of the sales price of the iPhone 4. In both cases, these are far greater than the amounts received by any other firms in the supply chain.

Apple publicly acknowledge that they make an overall margin of 40% on its products. This is an average across all their products. What this figure means is if a product retails for $1,000, Apple receives $400. 40% is high for consumer electronics company. Samsung has an average margin of around 16%-20%.

Assuming these averages are correct, Samsung needs to sell twice as many products as Apple does in order to make the same amount of money.

So how does Apple actually make these large margins?

Its because they control the whole process of their product. Apple design the products, they design and create the software, they source the components and have the products assembled in China. 
You can be sure that Apple will not pay more than they have to. 

An excerpt from the reports says:

we estimate that only $10 or less in direct labor wages that go into an iPhone or iPad is paid to China workers.

(the estimated factory costs of an iPhone or iPad), the portion retained in China's economy is a tiny fraction....

 Apple are in control of the distribution of their products. This means they can control when every market receives shipments and this can be tied into their marketing and product release strategy. 
Compare this to the launch of Windows 8, because Microsoft generally don't make hardware (ignore the Surface) they are reliant on other manufacturers like HP, Toshiba and Sony to get their Windows 8 products to market. A quick wonder around Harvey Norman and Noel Leeming last week showed a distinct lack of Windows 8 touch screen laptops available in the week Windows 8 was launched. This would never happen with an Apple product launch. They keep it all in house and control all the releases.

But the biggest factor to their profitability is they control the retailing of their products. As discussed earlier they don't give up much margin to their authorised resellers, but the strategy of setting up their Apple destination stores has meant that they retain all of the margin that may have gone to a retailer. The Apple stores are hugely successful. In this interview with the Harvard Business Review. Ron Johnson, who was the VP of Apples retail division says;

Look at the Apple Stores, which have annual sales averaging $40 million per store in a category that in 2000 everyone said would move entirely to the internet. Today the Apple Stores are the highest performing stores in the history of retailing.

 In keeping with all other aspects of their business, they don't pay their staff more they have to either.
Apple also have their on-line store which is popular, they make it easy for customers to download their software from their on-line store therefore retaining the margin on software as well.

Whether a customer buys an iPad from a reseller, and Apple store or Apples on-line store. The fact remains Apple retains almost all of the retail margin.

Then there are the little things that people don't think about. Apple has designed its products to get the maximum amount of money out of its loyal customers. Take the battery replacement for your iPhone as an example. The iPhone is designed so that you can't open it, you have to send it away to Apple and have them replace the battery for you. Of course that will cost you $145, compared to $39.00 for a replacement battery for a Samsung Galaxy S3 where you just open the back cover and do it your self.
Then there are the accessories like the standard Apple mouse which costs $82, and that's not even wireless. The standard Microsoft mouse costs $25.
Then there is Apple Care which is Apples extended warranty program. An Apple care plan for an iPhone will cost you $132 and extends your warranty for an extra year to a total of two years. Which is another great way to extract more money out of their loyal fans.

Finally we get to the most obvious part of the supply chain, which is the retail price. Apple products are always the most expensive when compared to a comparable product. The iPhone 5 32gb model retails for $1199, the comparable Samsung Galaxy S3 retails for $1049. The iPhone 5 is 14% more expensive.

Samsung can probably build a Galaxy S3 for the same price as Apple can have the iPhone 5 built. They may even be able to do it cheaper as Samsung supply a significant amount of the components for the iPhone. But Samsung have to pay a margin to a retailer (8%) and then they also have a product that retails for 14% less than the iPhone. If you add these two figures up you get 22%, which is about the difference between Apples 40% margin and Samsung's 20% margin.

Even if the retail price of the iPhone 5 & Galaxy S3 were the same, the design of the supply chain dramatically increases the profitability of the iPhone, because Apple have more control of  the entire supply chain.

Apple can operate a supply chain in this manner because of the power of their brand. Samsung don't have the brand power to force retailers to sell you product for next to no margin, they can't also ask customers to pay the premium that Apple can. 

Samsung is a very broad brand, they do lots of things from supplying components to other brands, through to an entire range of household electronics and of course smartphones and tablets. 
Apple just do computers (iPhone & iPad are computers) and they make sure they do it very well and they own and control the entire process, from design through to the after sales servicing. They have designed the entire process to make them the most amount of money possible.


New Zealand's agricultural sector could do well to study Apples business model and supply chain design. I'm really struggling to think of a major NZ agribusiness that even attempts a vertical supply chain.

Fonterra is New Zealand's economic saviour, but Fonterra is a commodity supplier. It is equivalent to a Korean company that supplies a component to Apples iPad or iPhone and receives less than 7% of the final retail price.
The red meat sector is in the same, farmers are relegated down the value chain and as a result receive only a small fraction of the retail price.
Australian dairy farmers are at the mercy of the supermarkets because they don't control their supply chain. The same is true for our UK dairy farming friends too.

Is it possible for New Zealand's agricultural sector to have a vertical supply chain?

Why does Fonterra stay as a commodity supplier to the world? 

How can sheep/beef farmers control their value chain?

The answers to these questions are complex and the solutions are not easy. If it was easy it would have happened long ago. But if it can be done, it has the potential to really boost the New Zealand economy.

Steve Jobs picture from www.uproxx.com