Wednesday, August 8, 2012

Co-op vs Corporate

18 months ago I found myself feeding a baby at 2 am in the morning. This is when I first read James Parsons Nuffield report; SupplyChain Relationships and Value Chain Design. James is a director of Beef & Lamb NZ and I went to Lincoln with James but I doubt he remembers me.

I found myself at 3:30am last night feeding the latest arrival to our family, and I re-read James report again.

This paragraph jumped out at me.
While in the UK I was fascinated by one of the retailers’ latest trends. All the big retailers now employ ‘Agricultural Managers’ who are charged with building relationships with producers. They do this through developing producer groups, similar to the Waitrose model for lamb and are pitched to producers as being the ‘Collaborative Value Chain’ model covered in Section 2. I would liken it more to a wolf in sheep’s clothing. To lure these producers into the fold a carrot is dangled in the form of a price premium. Prices are calculated on a ‘cost of production plus model’, and benchmarking of individual producers’ costs and production is carried out by the Agricultural Manager. A focus on costs and benchmarking is a good thing on its own, and the producers are finding ways to improve, but here is the kicker: the retailer is gathering a huge amount of information it previously never had access to. As one Agricultural Manager stated proudly to me about a producer group: “I can tell you anything you want to know about the costs of production of any one of our 300 dairy farmers.”
That paragraph is very topical at the moment, as we watch the situation in the UK, where the dairy farmers are being squeezed by the supermarkets and processors. It’s an example of how the farmer has being relegated to the bottom of the value chain and has very little power to demand a fair price let alone a premium price.

I had a little crack at the independent processors in my last post, but I'm generally supportive of the independent milk processors in New Zealand. They have many advantages and are good for our economy. But we must be wary, because a dairy industry dominated by corporate processors will diminish the returns that dairy farmers receive.

Corporate vs Co-Op

The corporate model has a lot of advantages over a Co-op. A corporate is likely to be more innovative, faster moving, more efficient and statistically makes a higher return on capital than a Co-op. 

This Coriolis Research report showed that dairy Co-ops such as Fonterra, Murray Goulburn and Arla make around a 5% return on assets. Corporate dairy companies like Saputo, Kerry and Glanbia return about 10% and the dairy divisions of global conglomerates such as Nestle, Kraft and Danone make returns in the facility of 15-50%.

Corporates are started by driven entrepreneurs who have a vision or a unique solution to a problem. The entrepreneur and any other investors risk their capital in the venture but stand to make financial gains too. The whole reason for starting a new venture is to provide a new or better product or service, for this reason corporate structures are more innovative that Co-ops, in my opinion. They are faster moving, a corporate would not have taken 4 years to get a program like “trading among farmers” passed (yes, I know a corporate would not need a program like TAF). They would have researched the issue and then made a decision and then implement it. The Co-op has to bring a majority of shareholders with them. It’s often difficult to communicate complex business strategies to such a large group of small business people, but it is imperative that the Co-op has the support of its suppliers and going slow and making compromises is necessary to allow unity. This is a disadvantage in my opinion.

Successful companies often have a clear leader who is in control. They will have boards of directors, but generally speaking they call the shots. I’m thinking of Steve Jobs, Sam Morgan, Jeremy Moon, Geoff Ross are examples of this.

Co-ops tend to be more democratic as there is no real “founder” to lead the Co-op. Co-ops often start as a group of suppliers joining together. Leaders are generally elected and fired by the supplier shareholders. If we look at Fonterra they have 13 directors! Seems a lot to me? How on earth do they all decide an issue?

Cutting edge innovative products or strategies are often a little bit unconventional or have a higher element of risk to them (If they didn’t then they wouldn’t be innovative, because everybody would be doing it). I wonder if a board of 13 people who are answerable to their supplier shareholders is the best structure for innovation.

You don’t see entrepreneurs starting Co-ops. That’s mainly because the founding shareholders can’t sell a Co-op and get rich. Sam Morgan and his co-investors would not have profited from the sale of Trade Me to the tune of $700 million if they had set it up as a Co-op.

This is why I’m in favour of the Fonterra Co-op structure for the dairy industry of New Zealand. According to the NZ institute of economic research, every dollar of the milk payout, is equivalent to $270 dollars going to each New Zealander. So a payout that moves from 5$ to $7 adds an extra $540 to every New Zealander.

The co-op structure ensures that the profits from Fonterra are distributed to every shareholder farmer, who then distributes it throughout the community. The rural support companies receive some of that money, extra employment occurs, the local shops benefit etc etc.
If Fonterra was replaced by corporates there is no guarantee that the profits would be distributed to the farmer suppliers via the full milk payout and then further distributed throughout the New Zealand economy. The Co-op structure distributes that wealth so well. All profits of Fonterra are essentially passed down to the farmer via the dividend portion of the payout. The corporate structure has no mandate to pass any profit onto their suppliers; they will only pay as much as they have to for milk. Any profits would go into the bank accounts of the few shareholders and in the case of Open Country Dairies its Singapore’s Olam International Ltd and the Talley family. I don’t feel that the economic flow down is the same.

I have no problem with a corporate making money and making a return to its shareholders. But New Zealand farmers need to be aware of what their industry could look like if it is dominated by corporate processors and not Co-ops. Think the UK! Not all corporates operate ethically.

In short Co-ops are great for passing all the profits onto the shareholder farmers, this essentially keeps the farmer up the value chain. But Co-ops are not great at getting very far up the value chain. They tend not to own or produce the final consumer product, rather they supply the raw product or manufacture on behalf of the consumer brands.

Corporates can deliver greater innovation and growth; they create jobs and generate positive economic activity in their communities. But the direct financial rewards are confined to the shareholders and not passed down to suppliers.

How you feel about that, depends on whether you are a communist, socialist, conservative or a libertarian. 

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