Tuesday, July 31, 2012

The Dairy Industry Restructuring Act

The Dairy Industry Restructuring Act (DIRA) has been getting a lot of attention lately, from the discussion on the price of milk through to Trading Among Farmers. That’s because the diary industry restructuring act is the foundation piece of legislation that allowed Fonterra to be formed.
I have one major issue with it, but first some background.

Prior to Fonterra or before 2001, the dairy industry was made up of a number of dairy Co-operatives spread across the country. These Co-ops supplied both domestic and export dairy products.
But all milk that was exported had to go through the NZ Dairy Board, who controlled all the marketing and distribution of NZ milk into export markets. So an individual NZ company could not negotiate deals directly with customers in a foreign country (Craig Norgate gave it a crack though).

Fonterra was formed when the two largest Co-ops, Kiwi and NZ Dairy Co-op merged with the marketing board and most of NZ other small Co-ops. Fonterra now accounted for over 95% of all milk collected in NZ. The DIRA was passed to allow this merger to take place. It now meant that anybody or company can export milk out of NZ independently.

But the government were concerned that this merger would create a monopoly player in the domestic market, who could exploit that position and NZ consumers could end up being over charged for their dairy products. So provisions were made in DIRA that required Fonterra to supply 600 million litres of milk to competitors. This would allow competitors to buy milk from Fonterra at “the farm gate” price, who could then process the milk and compete in the domestic market. Therefore ensuring there was plenty of competition.

In the 10 years following the formation of Fonterra, we have seen plenty of milk processors in the NZ market, producing all types of dairy products from milk to yogurt etc.

If we look at liquid milk as an example, most of the milk in the brands we see in the super market is purchased from Fonterra under DIRA. Meadow fresh which is based in Christchurch and owned by Goodman Feilder, simply gets the milk delivered to its factory by Fonterra tankers, where it is processed and put into a Meadow Fresh bottle. Fonterra’s Anchor brand competes directly with Meadow Fresh as they are both aimed at the same price point. Both brands contain exactly the same milk. The supermarket home brands price there milk at a cheaper rate. There are also a few smaller processors like Klondyke and Al & Sons. So it is clear that there is competition in the New Zealand market.

Further proof of the existence of competition is there is nothing to stop any dairy farmer in NZ from pasteurising their cow’s milk and selling it to the NZ consumer. Many farmers have done it in the past. Likewise, there is nothing stopping any start-up company from creating any dairy product and selling it. They simply call Fonterra and tell them how much milk they want and where they want it. So there is competition in the domestic market.

We have also seen export based dairy companies come onto the scene in the last 10 years. Synlait, Open Country Cheese are two early examples. These companies are export based businesses and as far as I’m aware they don’t provide any product to the domestic market and if they do it will be a tiny fraction of their total business.

These two companies are entitled to DIRA milk from Fonterra as well, even though they have their own suppliers and in Synlait’s case they process milk from their own 15,000 cows as well as their own suppliers.

Now both these two independent companies have at every opportunity argued for the reduction of the “farm gate” price of milk that they pay Fonterra. There are endless submissions to government and a healthy amount of lobbying of government ministers takes place. These two processors among others jumped into the recent “milk price” debate that raged, as consumers complained about the rising cost of milk.

They claim that Fonterra are artificially raising the “farm gate” milk price because their processing division essentially accepts a lower return on investment than a normal competitor would. The recent claim is that the farm gate milk price is 40-50c/kgms higher than it should be, and that a normal competitor would not or could not pay this price and still make a suitable return.
This is where the “war of words” between these companies and Fonterra is focussed.

I don’t believe the farm gate price is over inflated, in fact I believe that it is actually quite a cheap method of acquiring milk.

I’ll comment on the “farm Gate” milk price at a later date.

But my main concern is, why does DIRA allow an export based company buy DIRA milk from Fonterra. The main concern of regulators back in 2001 was that Fonterra would have a monopoly in the domestic market and stifle domestic competition. So the provisions within DIRA that we discussed above, were designed to allow this domestic competition.
We now have a situation where these two companies are taking “cheap milk” from Fonterra processing it and then essentially competing with Fonterra in international markets. If one wanted to get all sensational about it we could put it like this; the NZ government has legislation that allows 2 foreign owned companies to come in and buy cheap milk from Fonterra and then compete against Fonterra internationally. From a NZ Inc perspective it makes no sense!

There has been a huge public response to Shanghai Pengxin buying the Crafar farms. Shanghai Pengxin have stated that they will build a processing plant to process their milk, but it is entirely possible that they would be eligible to buy DIRA milk as well, which I find to be totally backward thinking, as Fonterra and its farmer shareholders should be making the margin from the final processed milk not a foreign owned company.

I believe that a simple amendment needs to be made to DIRA, that DIRA milk is only available if it is destined for the NZ domestic market. There does not need to be competition for raw milk destined for international markets. The Commerce Commission and the NZ government only need to worry about competition in the NZ domestic market.

The Government of NZ has no greater task than to support our export sector and protect the businesses that earn our foreign money, Open Country and Synlait are included in this group.  I have no problem with companies competing with Fonterra, that’s healthy. But if an independent company wants to export dairy products then they should get their own milk supply.Both Synlait & Open Country have their own suppliers anyway.

I can’t think of an example anywhere, where a company is required by legislation to supply product to competitors.

1 comment:

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