Thursday, August 2, 2012

Why the Farm Gate Milk Price is Important

In my last post I talked about the Dairy Industry Restructuring Act (DIRA) and how Fonterra were compelled to sell competitors raw milk. These regulations were put in place because the government wanted to ensure that there was competition in the domestic market.

What has transpired over the last 11 years is the emergence of a number of large export based processors who are also buying regulated milk. I’m particularly referring to Synlait, Open Country Cheese, New Zealand Dairies (now defunct), Tatua , Westland Dairy Co-op and Miraka. These companies collect over 2 billion litres of milk from their own suppliers. Yet they are all eligible to receive regulated milk from Fonterra under DIRA.

The original provisions of DIRA were to compel Fonterra to supply 600 million litres of milk to independent competitors to ensure competition in the domestic market. There now is a very real possibility that there will not be enough DIRA milk left available for smaller processors who actually do supply the NZ market because the 600 million litre may be taken up by these large export based processors, who end up competing with Fonterra in international markets.

I feel pretty aggrieved that Fonterra has to supply regulated milk to companies that export their milk. But I feel it is really “on the nose” that these companies seem to be constantly campaigning to have the regulated price that they pay Fonterra reduced.

This year, Synlait, Open Country Cheese & Miraka have joined together and have made a number of combined submissions regarding DIRA and TAF. Their submissions claim that the farm gate price of milk that Fonterra charges competitors is too high. They claim that Fonterra are artificially elevating the price which puts independent competitors at a disadvantage. The main claim is that because Fonterra is a Co-op that they can increase the farm gate milk price paid to farmers and then reduce the dividend that farmers get to compensate.
The submissions are long and quite frankly a little bit complicated. There are counter submissions from Fonterra and other interested parties that all go into great detail and provide data to back up their various positions.

So is the farm gate milk price over priced? I don't know. 

But at the end of the day, you just need to watch what these companies do. Their actions give a fairly good indication if the farm gate price is too high.

      Why do the independent processors keep buying the milk?
      These companies are big, OCC is the 2nd largest processor in the country and they have a significant number of suppliers, who have left Fonterra to supply them. OCC are owned by the Talley family and Olam International from Singapore. Synlait is 51% owned by Chinese dairy giant Bright Dairy and has two driers, they own approximately 13 farms and have a sizeable supplier base too.

Both these companies have experienced boards of directors; they have in house accountants and chief financial officers. Make no mistake; they know exactly how much it costs to produce a litre of milk in NZ. If they could get it cheaper somewhere else they would. 
The fact that they still buy DIRA milk from Fonterra and they are buying larger quantities of it suggests that it’s not over priced.

Watch what they do, not what they say
Synlait are on one hand saying the DIRA milk is too expensive, but on the other hand they are attempting to sell 70% of their 13 or so dairy farms. Surely they wouldn’t get rid of their farms if they produced milk cheaper than the regulated DIRA milk, that they purchase?

It’s no coincidence that these three companies have corporate structures. They are owned by a small group of shareholders (compared to Fonterra’s 10,500 farmer shareholders). The whole purpose of these businesses is to make a profit for these shareholders and that’s fine, I applaud them.

It is in their best interests to have a low farm gate milk price, because that is one of their biggest expenses, if not their biggest expense. By consistently attacking the farm gate price that Fonterra pay their farmers and therefore charge for DIRA milk, they are signalling what their true intentions are. That’s for a lower farm gate milk price. This is no surprise, because that means the processor makes a bigger profit.

It raises a warning to the dairy farmers of NZ, if it was not for Fonterra being so well supported by the farmer suppliers of NZ, the percentage of the final retail price that farmers get will be much lower than what it is today. Because a corporate processor is in the business of making a profit for its shareholders and suppliers are not shareholders. Suppliers are a business expense, and corporates want to lower their expenses. The result being farmers missing out on the full value of the supply chain. 

We only need to look at the plight of many dairy farmers in the UK. The corporate supermarkets are making decisions best suited to its shareholders and reducing the amount paid to the milk processors. The milk processors which are also corporates are protecting their margins and reducing the amount paid to the farmers. As it turns out the farmers are being paid below cost. The farmers have lost total control of the value chain and are price takers. The same situation can be seen in many parts of the world. The Australian supermarkets using milk as a loss leader is another example which is a bit closer to home.

The farmers, who left Fonterra and now supply the corporate processors in New Zealand, need to open their eyes and see what the signals are. The constant lobbying of government and attacks on Fonterra’s farm gate milk price is an effort to lower the price that farmers get paid for their milk.

The irony is that it is only because the vast majority of NZ farmers stay with Fonterra that the suppliers of the corporate processors still have a comparable milk price.

To conclude, the shareholders and directors of the corporate processors are not bad people, I'm not suggesting that. It's just clear to me that all the lobbying and noise about the farm gate milk price by these processors, is simply an attempt to reduce the amount of money they pay for DIRA milk, which is clearly self serving.

New Zealand dairy farmers must ensure that Fonterra stays strong because a dairy industry dominated by corporate processors is sure to bring a erosion of the farmers share of the value chain.  

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