Wednesday, March 6, 2013

The Sheep Industry Out Perform Fonterra. True Or False?

Sheep farmers receive 44% of the retail price of their products. So if a portion of lamb retails for $100 the farmer will receive $44.

The sheep industry is struggling with low profitability. The last 20 years has seen sheep farms converting to dairy because they offer a higher return.

Among sheep farmers, there seems to be an attitude that their meat companies are doing a poor job of marketing & selling lamb, both domestically and internationally.

There is a cockiness among dairy farmers around the returns the dairy industry are making. They seem to think the reason for the industries success is because they have an outstanding level of awesomeness and that the people running Fonterra posess superior business acumen, compared to the sheep industry.

I often hear both sheep and dairy farmers comment that, if the meat industry could just replicate Fonterra, then the industry would be a success.

Please take the time to listen to this 5 minute radio segment from The Framing Show. It's worth it.

Every Friday, dairy farmer Jason Uden & sheep farmer Jeremy Rookes discuss the topics of the week. There is no clearer example of the difference between sheep farmers and dairy farmers than these two.

Jason is a stereotypical dairy farmer, he has the high pitched voice with the Waikato dairy farmer accent. But the thing that stands out the most is his confidence that the reason for dairy farmers success, is their talent combined with Fonterra's superior performance.

Jeremy Rookes would sooner go broke than don the blue overalls and gumboots, which tend to be the dairy farmers uniform. Milking cows would go against his principles. Jeremy feels that the sheep farmers are doing all they can "on farm" and are being let down by the meat companies.

These two farmers pretty much represent the attitudes of their respective farming groups.

How does the sheep industry compare to Fonterra?

If we have a look at how the sheep industry compares to Fonterra in terms of providing value to the farm gate level. The percentage of retail price that the farmer retains is a good indication of how hard the Co-op is working for the farmer.

It's important to note that both the major meat processors/marketers and Fonterra are Co-ops. So their purpose is to return profits to the farmer shareholders.

Aaron Meikle (@AaronJMeikle) is the central South Island extension manager for Beef & Lamb NZ. We had a conversation via twitter, where Aaron produced the graph below.

That figure surprised me. Thats a high proportion. Apple, which is the most valuable company in the world receives around 40% of the final retail price of it's products. Apple is a company that develops groundbreaking products and has total control of its value chain and it keeps 40% of the retail price. (although electronics do have low margins)

So for a sheep farmer to keep 40% is a pretty impressive figure.

The above graph shows the type of lamb product mix that is exported. In the 1970's 85% of exports were frozen carcases which were processed off shore into retail cuts.
Today a majority of the processing is conducted in New Zealand and the lamb is processed into prepackaged branded frozen cuts. Which is obviously much more profitable.

How does Fonterra compare?

I can't find any official numbers which deal with the percentage of retail that dairy farmers retain, but we can get a pretty good indication.

At a $6.00/kgms payout a Fonterra supplier will receive around $0.50 per litre of milk. The supermarket is selling 1 litre of Anchor milk for $2.60. So, the farmers share works out to be 19%, which is less than half the return the sheep farmer is receiving.

They tell us that the domestic milk price is related to the export milk price, so it's safe to assume that the price of milk powder is similar to the price of milk. I would assume that the farmers share of the milk powder price would be similar.

While these figures are just an indication, it appears that the lamb processors are returning double what Fonterra is returning to it's farmers.

Whole milk powder is a base ingredient. The major food companies like Kraft and Nestle buy the milk powder and turn it into more processed retail products.

If we looked at a chocolate bar or a tin of infant formula and we calculated the portion of the final retail price that the farmer receives, I would guess it would be well below 10%. 

If we look at the graph above, I would liken Fonterra to the sheep industry selling frozen carcases in the 1970s.

The sheep industry are doing everything they are supposed to do, they have stopped exporting unprocessed carcases and are now producing branded retail products.

If we did as Jason Uden continually suggests on The Farming Show, and put Sir Henry Van der Hayden (former chairman of Fonterra) in charge of the meat industry. I don't think you will see any change to the fortunes of sheep farmers. Fonterra seems quite happy to continue supplying commodity products.

I would actually say, dairy farmers should get whoever runs the meat companies and get them to run Fonterra!

Imagine if Fonterra gave farmers 40% of the whole milk powder price. The payout would be $12.00/kgms! What would the payout be if Fonterra gave farmers 40% of the final price of a tin of formula!

So why then, is dairy farming more profitable than sheep farming?

I don't really know the answer to this, but we could look at it from two perspectives.

1. MIlk is just worth more than lamb

Lamb is the final product, it can't be made into anything else. Lamb chops stay as lamb chops. I suppose wool offers the ability to become a much more high value product, so there is potential there.

Milk is an ingredient in so many products and can be made into a much more high value item. The reports of a tin of infant formula selling for $80 in China is an example. 

2. A kg of dry matter can produce more milk than it can lamb/wool

Aaron pointed out to me that 30 kgdm (kg dry matter) will produce 1kg of meat/wool and you could assume that 15 kgdm will produce 1 kgms. 1 milk solid is worth $6.00 and 1kg of meat/wool is worth about $5.00-$6.00.

So a dairy farmer only needs half the grass to produce the same revenue. So dairy is twice as productive.


So to conclude, the dairy industry is more successful than the sheep industry in a large part because, milk is in demand and worth a lot of money. Combined with the fact that more milk can be produced from a hectare than meat/wool.

The assertion that the Fonterra leaders are doing a better job than their red meat counter parts does not withstand scrutiny.  In fact Fonterra could learn a lot from the meat companies.

For dairy farmers to sit there, smugly taking credit for the success of the industry, is like a home owner taking credit for the rise in the housing market.

Having said all that, theres no doubt that consolidation of the meat sector will have benefits. But this is more around the supply of lambs than the marketing and sale of lamb.

Sheep farmers should be proud of their industry. They are doing all the right things. 

Unfortunately for the red meat sector, Fonterra is at the bottom of the value chain, it has lots of room for improvement. All they need to do is move slightly higher up the scale and therefore receive more of the final price and dairy returns will be well and truly outstripping sheep.

A Real Story About Inflation

My Uncle was a cropping farmer in Zimbabwe. He purchased his first farm as a young man and worked it for couple of decades.

Robert Mugabe decided in 2000 to implement his "Land Distribution Policy".

The mob of "war veterans" arrived one morning and the beatings began.

My Uncle and his family fled to South Africa. They eventually immigrated to New Zealand.

Meanwhile the farm was distributed between Mugabe's loyal supporters.

But the bank had a problem. There was still a mortgage on the property.

The bank started sending my Uncle letters to his address in New Zealand demanding payment of missed loan payments.

He replied, how can I pay the loan when my farm has been confiscated? To which the bank replied pointing out the finer points of the loan documents.

Eventually my Uncle got out the currency converter and entered his sizable loan balance in Zimbabwe dollars and converted into NZD. 

The balance worked out to be a few hundred New Zealand dollars!

So he just paid it.

Since the backbone of Zimbabwe's economy was evicted from their land the country went into hyper inflation. The value of the Zimbabwe dollar dropped so much that a loan in the millions could be paid off with a few hundred NZ dollars.

While my Uncle lost his life's work when his farm was confiscated he still has his credit rating in tact.