Thursday, October 10, 2013

Fonterra & The Botulism Scare. What Actually Happened

Keith Woodford's blog is great. He doesn't post often but when he does its good.

His latest post is on the Fonterra botulism scare. Keith outlines the turn of events.

Here are the main points.

It all started back in May 2012 when some plastic came loose in a whey concentrate dryer at the Hautapu plant near Hamilton. The risk was that this plastic had got smashed up and possibly melted within the dryer, and then mixed with the whey.
The only way to find out for sure was to hydrate the whey powder (which is soluble) and then filter out any solids.  For reasons not clear, Fonterra chose to do this using equipment that had not been used recently.  Unfortunately the equipment had not been properly cleaned.
Once hydrated and then re-dried, the product passed the mandatory bacterial tests, but did have a level somewhat higher than typical. 
By this stage there should have been two orange flags but the Fonterra system recognised neither.  The first was that once the product had been reprocessed, then it should have been drafted away from human use and used for stock feed. The second orange flag was when the re-processed whey powder gave elevated but technically acceptable bacterial counts. Once again, this should have been enough to restrict its use to stock feed.
The next flag came in March 2013, when an Australian division of Fonterra re-tested some of the powder before using it as an ingredient. 
This time they found bacterial counts had further elevated. In all likelihood these levels were still below technically acceptable levels, but the fact that levels had risen in the powder would have been indicative of anaerobic bacteria being present. 
Fonterra saw this as an orange flag but it should have been a red flag. All products processed from the Hautapu plant using the same production system should have been immediately removed from the supply chain and placed under bond. Instead, Fonterra decided only to do further tests. 
Hindsight is wonderful. If in doubt leave it out.

Discriminating between sporogenes and botulinum is difficult. There is no quick laboratory test. Instead, it is necessary to culture the organisms and then feed them to mice. If the mice die then it is botulinum; if they don’t die it is sporogenes.
In this case, it would seem that some mice may have died but not enough to be sure. 
So AgResearch reported that it looked likely that there was botulinum present but they were still not sure. 
At this stage Fonterra did see a red flag. The Government was notified and there was a product recall.

If only Fonterra had seen the warning flags earlier on, then all of the damage could have been avoided. The products should have been removed from the supply chain before there was any risk of them getting anywhere near any consumers. If that had been done, then no public recall of products would have been needed.
Things got worse when Fonterra's representative went onto live TV and said that they had actually found the botulism toxin in infant formula! We now know that the actual harmful toxin was not present.

One of the interesting issues going forward will be whether legal action is now undertaken, and if so, as to who sues who.
Their unhappiness is not that Fonterra delivered them a product containing Clostridium botulinum. Indeed Fonterra did not deliver such a product. Their unhappiness will be that Fonterra so bungled the management of the scare that their infant formula market in China has been seriously damaged.

I was speaking with a food safety consultant recently. He has a client who manufactures and sells blackberry powder to the asian market.

His product has been stopped from entering into some asian countries. 

He was notified by his customer via an email in broken english explaining that they won't purchase anymore product because botulism was in New Zealand products.

This issue does not just affect dairy products.

I suppose this highlights the dangers of the food business. Reputations can be ruined so quickly. 

As a consumer, I often wonder how food can cost so much. Consumer may only think about the cost of land, inputs, wages, harvesting & delivery costs.

But the cost of testing food, storage costs while food awaits results and of course product that is discarded if test results are not conclusive, are all major costs that food companies must face and build into the price.

New Zealand has had such a good reputation as providing safe food, thats because its so easy to stuff up. Other countries have stuffed up.

Hopefully all businesses in New Zealand can learn from this. 

I get sick of hearing small business people complaining about the amount of regulation that they must pass in order to provide food to the public. Sure, it may be hard and tiresome, but the costs of getting it wrong are too great for our little country. 

Food safety is our competitive advantage, so we must protect it. 

Monday, October 7, 2013

On Farm Productivity Is Good, But The Big Money Is Made From Off Farm Productivity

Theres a lot of talk about productivity in New Zealand these days.

But are we focusing on the right areas?

The government has set a target of doubling the primary sectors export earnings from $32 Billion to $64 Billion by 2025.

Nobody doubts that this is a difficult ask.

New Zealands primary sector has a strong record of productivity gains.
The sheep industry alone has increase productivity (expressed as meat sold /ewe) by 80% over the last 25 years.

Thats 2.5% productivity gain every year. Any business analyst will agree that that is impressive.

But are sheep farmers any better off?

Despite 20 years of productivity gains sheep farmers recently experienced their lowest level of profitability, according to Beef & Lamb NZ data.

New Zealand farmers are very good at on farm production productivity, such as milk solids/ha or meat/ha or tons of grain/ha.

But its the off farm productivity that needs some serious work and that is where the big gains are available.

Rod Oram is a business journalist and he gave a very good example recently.

Fonterra has a total asset value of $4 billion.

One Fonterra plant manufactures infant formula for Pfizer, the pharmaceutical company.

Pfizer's infant formula business has an 8% share of the Chinese market.

Recently Pfizer sold that business to Nestle for $12 billion! Thats three times the size of Fonterra's entire business!

So, Fonterra supplies the milk, manufactures the milk into infant formula and packages the formula into tins.

Pfizer puts its branding on the tins and wholesales the formula to retailers. That part of the value chain, the branding and the wholesaling is worth $12 billion. 

Fonterra or New Zealand farmers receive a small portion of the value of the final product.

You could say, if Fonterra owned that formula brand which has an 8% market share and took the formula right through to the retailer. Then Fonterra would be worth its current $4 billion + $12 b to be worth $16 billion dollars!

I think you could say that the payout to farmers would also be three times its current rate. 

How does a $21/kgms payout sound?

We could put it another way, if Fonterra was just that one factory and all it did was produce infant formula for 8% of the Chinese market under its own brand. It would be worth three times what all of Fonterra is today.

New Zealand is very good at producing quality product, but not very good at keeping paid for it.

The graph below is from a Corileus report that they have made public. As you can see Fonterra is one of the largest dairy companies in the world from a volume perspective. Pfizer is way down the bottom by size. But Pfizer's dairy business makes a hell of a lot more money than Fonterra does from its products.

The graph below shows the profitability of the different dairy companies.

Fonterra is making a 4% return on Asset, while Nestle, Kraft, Danone which have their own retail brand products are making 14%-15%.

The nutritional dairy businesses which deal with infant formula etc are returning well over the 25% right up to 65% return on assets for BMS Nutritionals! 

These graphs are exciting, they show that Fonterra has plenty of room to increase profitability.

Fonterra have been saying that their "strategy refresh" will focus on increasing the value they receive for their products.

Last year Fonterra announced that they are launching their own branded infant formula into Asia. Which is a good start.

What will Fonterra look like in 10 years? Imagine if Fonterra is successful in growing the portion of its business that is branded. 

The increase in profitability is potentially huge. 

Some of the thoughts that are going through my head are:

  • How will a more profitable Fonterra affect land use change? If dairy returns are much greater than sheep/beef while Fonterra operates at the commodity level. How can other land uses compete with a payout of over $15/kgms?

  • Will the payout actually increase in line with profitability? You assume it would.

  • What will Fonterra shares be worth? Assuming greater profitability increases the dividend paid.

  • What will happen to land prices?

  • What environmental impacts will this have on New Zealand?

What ever your views of Fonterra or the dairy industry are, you can't deny that the future is bright for New Zealand dairy farmers and the flow on will benefit the whole NZ economy.

But the same challenges still exist for the industry such as public perception, environmental impact and staffing issues.