Actually, The $58K From 20 Cows Is Not That Easy

In my last post, How To Make $58,788 Per Year With 20 Cows. I talked about how a simple dairy can be set up for quite a small investment of just over $100,000 and the milk can be sold direct to the customer.

I hoped the post would encourage people to think differently about dairy farming and the possibilities available. 

It's certainly a good illustration of how profitable a business can be if it can retain the whole retail price.

Warning!

It's not quite that simple.

It's easy enough to buy a few cows and build a cheap dairy to process the milk. That's easy. There are plenty of experts who can design or build the components for you.

But the production of the milk is only a very small part of the equation.

There are many examples of farmers around New Zealand who have tried to process, market & retail their own farm products and either failed or simply decided to gave up, as it's just too hard.

There are a few who are successful, but they are a minority.

The skills required to produce milk or lamb are very different to those required to process the product and the skills to successfully market and retail the product are different again.

Processing Skills

The hygiene standards required to process a product are much greater than the average farmer has to deal with. I've heard of farmers complaining about the minimal and rudimentary hygiene standards insisted upon by Fonterra, they wouldn't cope with the requirements of many food producing businesses. 

There is no room for error!

Marketing Skills

You can spend $50,000 by putting one print ad per week in the Christchurch Press, and there is no guarantee it will help you sell a single bottle of milk. 

There are so many examples of marketing campaigns and product launches that fall flat or are simply not noticed.

All of the people behind these marketing efforts were convinced they would be successful.

Retail Skills

Customer service is hard work and unrelenting. Customers are demanding and often unsympathetic. They don't care the hours you work or the effort you put in. They care about them selves and if they feel your product is not good value or another product is better, they will switch.

You can give 100 customers in a row great service, but if you drop the ball on customer 101. They will let you know or worse, they won't let you know and instead tell their friends about it and tell facebook, twitter or that review site.

Farming Skills

There are approximately 11,000 dairy farmers in New Zealand. They all milk cows on grass the same way. They have over 100 years of collective knowledge to draw from. Combine this with farm advisors, fertiliser reps and accountants all available to give you information.

There is no excuse for a farmer to fail as they are surrounded by experience and knowledge.

There isnt really the same experience in the business world, as every product or business is different.

Who knows if your product is different and in demand by customers.

Microsoft were promoting tablet computers in the early 2000's and nobody bought them. Why did everybody want tablets when Apple made them?

Klondyke Fresh supply milk with no permeate in it, but do people really care?

Consistency

Maybe you have all the skills and your farm produce is much better than anything else on the market and maybe you're awesome at marketing and sales and maybe you have your processing sorted.

You might be fine for the first 6 months while its all still exciting. But what happens when you are sick or run off your feet for months on end or one of your staff leave. 

Can you maintain the standards? 

What happens when you (who does all the customer service duties) is sick for a week. Your husband, wife or son, who possess the people skills of a Tasmanian devil take over and rub 10% of your customers up the wrong way.

Happy Vally Dairies is an example of maintaing consistency.

The owners of a Southland dairy factory at the centre of a food recall say their business has been destroyed.

Frans and Jeanine Venekamp have decided to walk away from the factory after E.coli bacteria was detected in a sample of milk. 

The couple closed the 16-month-old business, Happy Valley Dairy Factory in Tuatapere, and laid off two staff yesterday.

The owners had gone away to the national cheese awards, when E.coli was detected in their milk. The NZFSA tried to call them but the contact number they had was not answered. They issued a full recall and alerted the media to ensure nobody drank the contaminated milk.

That day they got the most media attention of their lives, unfortunately for all the wrong reasons.

The brand was destroyed. 

The owners took their first break away from the business and one mistake by a negligent employee destroyed the entire business.

All the years of planning, the hundreds of thousands of dollars spent the hours worked, all destroyed by one person not washing their hands after going to the toilet or mud on someones boots getting inside the processing area.

If you had a choice, would you rather run 100 metres a day and get paid $100 or would rather complete a 100 metre obstacle course and get paid $500?

Thats how I think of it. 

Maybe its better to just get the tanker to pick up your milk every day and get paid $0.50/litre for your milk.

But there if definitely an opportunity to make $2.50/litre but you need to have the skills to complete the obstacle course and you need to be able to do it every day without fail.

If you can do that, then that just gives you the right to compete against the other brands.

You then have the opportunity to go up against the multi national food companies with marketing departments and legal teams and deep pockets.

Sounds like fun to me!

How Much Money Do Dairy Farmers Make-Part 2

How much money do dairy farmers really make?

Are they really that rich?

Do they really pay no tax?

One of my first posts was "how much money do dairy farmers make". It's one of my most popular posts too. The major source for this post is the google search, "how much money do dairy farmers make?".

I thought I'd go into a little more depth.

But first, what constitutes a dairy farmer? 

I'll just concentrate on owner operator farmers in this post as its simple and gives a good indication of dairy farm incomes.

Some quick facts:

76% of all herds are in the North Island

30% of all herds are based in the Waikato alone

The average herd size in the North Island is 325 cows and 596 cows in the South Island.

North Island farms are different to South Island farms, they tend to be smaller and owned by different types of farmers. So I'll look at two types of farmers. The first is your typical irrigated farm based in Canterbury and the second is your typical Waikato farm.

The Canterbury figures have been sourced from Brown Glasford and Co. The Waikato figures have come from Cooper Aitken Accountants based in Matamata (my old home town). The figures are from their 2011 farm survey for "owner operators".

Key points:

SI farms produce 60 kgms more per cow

Canterbury farms are nearly 3 times bigger than the waikato average.

Both regions have a similar income

Farm working expenses are higher in the Waikato. (Please note, this may be due in some part, to the data from different accountants being presented slightly differently)

Interest & Rent are the same amounts based on a per kgms at $1.48/kgms.

Farm surplus in Canterbury appears to be much higher

The total asset amount in Canterbury is a massive $14 Million dollars!

It appears on the surface that the combination of an extra 50 kgms/cow and economies of scale of the new modern Canterbury dairy farms results in greater profitability

The Waikato return seems unsustainably low, to the point where I am doubting the figures.

So back to the original question, how much money do dairy farmers make?

Personal drawings is one part of the answer. The drawings of both regions seem to be very similar at $80,000 to $90,000 per year.

I would think that if some one was running a business in town valued at over $5 million dollars, then they would be worth a package of over $100,000.

I read an article a year ago, where some accounting firm had worked out that an owner operator drawing $40,000/year is equivalent to a person in town earning $90,000/year. This article makes reference to these findings. 

Personal expenditure is about affordability, but Cooke says he often reminds farmers that drawings of $40,000, once everything else is paid, is equivalent to a town wage of around $90,000.

I assume this is because the farmer is able to claim or use the farm assets for personal use. For instance the farmer does not have to have a house mortgage as that expense will be included in the farm mortgage. (I know the personal residence is not tax deductible, but in real terms the house is included with the farm). Another area is vehicle use and fuel, if a car is used to get supplies for the farm then it is tax deductible. Its easy to buy some drench or pick up a few bolts on your way to the movies or dinner.

So there are tax advantages to being a farmer, but the same principles apply to any business owner not just farmers.

So if we assume that a farmer drawing $40,000/year is the same as a townie earning $90,000/year, then we could assume that a farmer drawing $90,000 is equivalent to townie earning over $190,000/year.

If you accept that logic (& you may not) then you could conclude that owner operator farmers are not doing too badly!

The remaining farm surplus of $726,614 for Canterbury farmers and $46,172 for the Waikato farmers will most likely go to the bank in the form of principle to pay down their loans. While this money doesn't end up in the farmers pocket, its still paying down debt.

The return on asset of 5% and just under 1% would suggest that farms make a very poor return. But the cashflow is only part of the profitability equation.

Capital gain is the other major aspect that determines how much money dairy farmers make.

I often hear that farm land has historically appreciated by an average of 10% per year for the last 30 years. This article written by the director of Gareth Morgan Investments says

The value of farmland has risen even faster (10.7 per cent a year) than housing over the past 20 years. That's a very healthy return given there's no tax to pay.
We're talking about a real after-tax return of something in the order of 7 per cent to 8 per cent a year.
A portfolio of world shares over much the same period would have yielded a real post-tax return of between 4 per cent and 5 per cent a year.

This article is a little more in depth and questions the true appreciation rate. But it does include this quote

Nartea and Basanta stated on Table 1 of their paper that the mean rate of
capital gain was 12.90% for dairy farms and 11.84% for farm real estate. The
period was 1966 to 1996.

So if a dairy farmers land is appreciating at a after tax rate of at least 8% (NZ has no capital gains tax) and is making a cash return of 5%, then the farmer is making a return of around 13%, which is quite reasonable. 

If your average Canterbury farm land is valued at $32,000/ha, then 270ha*32,000=$8,640,000 total land value. If this land appreciates by 8% then it gains $691,200 in one year!

Relying on capital gain is a risky proposition, but then again its worked for the past 30 years.


These figures are for owner operator farmers, these are the people who have "made it". They have either reached their goals of farm ownership through years of hard work and hard saving or they were able to inherit or "buy" into the family farm. The owner operator is becoming a rear breed in the South Island as the larger South Island farms are more likely to be in a corporate structure or some kind of syndicate. 

So to conclude, if I was sitting on an asset of over $5,000,000 and I was drawing in real terms, well over $150,000 per year and my business was paying off debt every year and my farm was increasing in value consistently. 

Then I would be pretty happy 

My Top Posts Of 2012

I've only been blogging since mid 2012 and I seem to have a reasonable number of followers now. I didn't realise that matters relating to dairy farming are relatively popular!

I had a quick look to see what were my most popular blog posts so far.


1.  The Mobile Milking System

It's not surprising that this post is the most popular, it just so different. It's about how we can milk cows with a cowshed that is mobile. It's a different concept that offers a range of farming possibilities. 

There will be a lot more posts about this in 2013.

2.  Sheep & Beef Farmers Can Diversify Into Dairy

This post was about how sheep and beef farmers can increase their profitability by milking a small herd of cows. The option to cheaply diversify into dairy is made possible by the mobile cowshed.

3.  What New Zealand Agriculture Can Learn From The iPhone

Here I had a brief look at the Apple business model. We find that Apple control every aspect of the value chain which helps them to maximise their profitability. I ask why do New Zealand agribusinesses not try an capture more of the value of their products.

4.  Horizons One Plan, Farmers Opportunity To Innovate

The changes to environmental policy has many farmers worried about how they will stay profitable. In this post I argue that all businesses have to adapt to changes in business conditions. I use small retailers as an example of how the successful ones have adapted to  big box stores and internet shopping.

I think farmers can adapt to the new environmental conditions and still be profitable.

5.  How much money do dairy farmers make?
This post was one of my first and it consistently gets visited every week mainly from google searches for "how much money do dairy farmers make". I have found it difficult to get a simple answer to that question and it appears lots of people are after the same information. I will write a more comprehensive post on dairy farmers income shortly.

I Tried To Resist But I've Been Seduced By Apple

Wow where has the last month gone? It's been a month since my last post!

I had planned to have a Christmas break where I could relax and write a heap of blog posts, but both the laptops in my household met an unfortunate end and the vomiting flu spread through the entire extended family over the Christmas break. 

My dear wife spent Christmas day & Boxing day in hospital due to the flu.

I received a copy of the Steve Jobs biography by Walter Issacson for Christmas and have thoroughly enjoyed reading it. It paints Steve Jobs as a manipulative control freak who was embarrassingly obnoxious & very difficult to work with. But at the same time a genius who understood design, he knew what he wanted and never compromised.

The book records how Steve was very hands on with product development, which I suspect is in contrast to many CEOs who will be much more hands off.

With the stories of Apple and Steve Jobs in my head I ventured out to purchase a new laptop. I was determined to buy a new Windows 8 touchscreen laptop. The idea of controlling the screen with your fingers like a tablet or smart phone appealed to me.

After feeling up the Windows 8 touchscreen ultrabooks that were on display, I wasn't totally happy with the models on display.

I looked up and the Apple display caught my eye, I said "no" to myself. "You're not changing over to mac", it will be a nightmare, compatibility issues with my current hard drives, I'll have to buy a new version of MS Office, my wife will have to learn new shortcuts for Archicad (her CAD program), it's not a touch screen and we all know that Apple products are so expensive and the accessories are a ripoff too.

I'll wonder over and have a quick look, I thought to my self.

Like all Apple products, they are so beautiful, so sleek and elegant. They felt sold and refined, the hinge on the mac books were firm and smooth. The track pad was just so easy to use and accurate and the keys had a wonderful feel to them. The whole package was so well designed.

I was losing the battle with my self. I started to justify why i should buy the mac book. When you start doing that you know its all over. 

Then I came across the display model that was for sale with $400 off! 

I couldn't resist, I walked out the store with my shiny new 13" Macbook Pro. I was expecting to suffer some serious buyers remorse when i got home, but I don't have any remorse. I'm totally chuffed with my purchase. I could have bought 2 windows 8 laptops for the price of my macbook Pro, but I have no regrets.

I was determined not to support Apple, because Steve Jobs style goes against what I believe in. The companies actions are often arrogant and they milk every last cent out of their customers.

But in the end I was won over by design.

They way things look are important, the small things matter. The trackpad is only slightly better, the back light keyboard is only slightly more appealing, the body feel slightly more robust and the internal components are just slightly better specs than the Windows 8 equivalents. But when you add all those small things up it equals a much better final product and I was prepared to pay more for it.

The Crafar Farms, Shanghai Pengxin & New Zealands Growth Strategy

Fonterra is investing heavily in farms in China (that is, if you call 6,500 cows in a big barn, a farm).

We New Zealanders think we are the experts in low cost profitable farming and we think we are spreading our farming knowledge around the world. We may be some of the best farmers in the world, but we are not the best at making the most money from our farming skills.

For a lesson on how to set up a truly integrated high value dairy business we need to look to Shanghai Pengxin. They have just completed the purchase of the 16 Crafar farms which total 7,892 hectares in the North Island.

Shanghai Pengxin now own the farms where the milk is produced, they are going to build a factory to process their milk, which they will sell into the Chinese super markets, that they also happen to own and they will do so using the trade marks "Nature Pure" and "Pure 100" which they have recently trade marked.

I have a big issue with this. This is not about the Chinese buying some of our farm land.

Shanghai Pengxin buying the Crafar farms is different to Shania Twain buying a hill country station or James Cameron buying a farm, its not the same as the Harvard Universities endowment fund buying farm land and its also different to the German investors buying dairy farms.

That's because these high profile international farm buyers are not planning to process their farm produce and sell it onto the international market using New Zealand's 100% Pure branding.

If Shanghai Pengxin were going to buy the farms and supply Fonterra or some other New Zealand milk processor then I wouldn't have a problem with it.

The government have a food and beverage project which is designed to increase the export value of New Zealand's food and beverage sector, which accounts for 53% of our exports. In a report called "Moving to the Centre" the goal of doubling the food and beverage sector is outlined. In order to achieve this goal  the food and beverage sector will need to earn an extra $40 billion dollars.

The Ministry of Business, Innovation & Employment has set up its Food Innovation Network which is designed to help the sector to develop new products in which they can export.

So it would appear that there is a strategy that the government is working to.

So I wonder how selling 7,800 hectares of dairy land to a foreign company, that will process that milk and market it to Chinese consumers using trademarks that allude to New Zealand's 100% Pure branding, is helping New Zealand double our exports?

It doesn't.

It's not like Shanghai Pengxin were going to partner with Fonterra or any other New Zealand exporter and help us access the Chinese market or anything.

You have to wonder what was being discussed by the two ministers in charge of this issue, Muarice Williamson and Jonathan Coleman.

For the record; I have a problem with any foreign company using the New Zealand brand. I'm unapologetically patriotic in this regard.

Meadow fresh is owned by the Australian company Goodman Fielder and sells UHT milk into China.

I'm not comfortable with that either. I'm not sure we can do anything about it though.

But this is not a anti Chinese issue. I just think we need to protect our "New Zealand" brand much like the French protect the region of Champagne.

I want to stress that I'm not anti Chinese, my wife and I began the process to adopt a child from China, but we decided to adopt from another Asian country as the wait times for China were very long. So as the farther of an Asian son I can say with certainty that I'm not racist.

Its acknowledged that Shanghai Pengxin is essentially part of the Chinese government, although its not officially written anywhere.

I think its important to note that the Chinese government is a communist regime and history gives us a clear picture of what communism is. They don't have elections, they control and censor the internet. Chinese citizens can't attend church unless it is a state sanctioned church and if you publicly disagree with the government you risk getting locked up on obscure chargers or you simply disappear. Many people under 35 have never heard of Tiananmen Square because it is censored out of history and it is thought that many cyber attacks on foreign governments and organisations originate from the Chinese government.

I think it is important to note these things about China, its not an indication of individual Chinese people. But their government is a less than desirable entity. Would you be happy living under that regime?

We seem to get all carried away with the massive opportunities that China offers. I'm happy to do business with the Chinese and I'm comfortable with us passing on our farming knowledge and genetics to their farmers, but we must not forget who we are dealing with.

The people who say that opposition to the Chinese purchase of the Crafar farms is a case of xenophobia are missing the point. Its not the land that is the issue. It's that a foreign firm is using our brand and creating a vertically integrated business out of it.

That is a poor strategy for New Zealand to take. I have only heard one person speak out about it and that is Rod Oram on Radio NZ.

What about Fisher & Paykel?

Fisher & Paykel are a iconic New Zealand whiteware manufacturer that has recently been sold to Haier, the Chinese whiteware maker.

I think it is sad that we have "lost" an iconic New Zealand brand and the dividends will now flow off shore, but it's very different to what Shanghai Pengxin are doing. 

The Fisher & Paykel brand relates to a range of whiteware the only people who benefited from that brand are the shareholders of Fisher & Paykel. Much of the manufacturing takes place in Thailand anyway.

The 100% Pure branding in which New Zealand promotes it self, can be used by any New Zealand company from tourism operators to clothing companies to food businesses. It is our identity and we need to collectively protect it. That means not ruining our environment and it also means protecting the misuse of our brand.

The precedent has now been set. It has been shown that the government of New Zealand is quite happy for foreign companies to set up in New Zealand, use our brand and compete directly with New Zealand businesses in the international market place. So its quite conceivable that a number of other Chinese companies can come in and do the same thing as Shanghai Pengxin. Before you know it, all the massive growth in China that the dairy industry are betting on may be met by Chinese firms based here in NZ. It may even be a multinational firm like Nestle who start marketing NZ milk in China next.

Its probably not a big deal having one company doing it, but how are we able to stop the next foreign company doing what Shanghai Pengxin have done? Or the next company. All new comers will simple point to Shanghai Pengxin and say "you let them do it, why not us".

Is it only a matter of time before international companies hungry for continued growth, identify the potential that "Brand New Zealand" has and act on it?

We risk becoming the low paid peasants in our own country, not because we don't own our own land but because we don't own our brand.

This is where strategic leadership from the government is required. But I doubt anything will change based on Muarice Williamson and Jonathan Coleman's attitude towards the Crafar farms.

High Fonterra Share Price, Not Good For Young Farmers

I had expressed earlier that I was not sure if investors would want to invest in Fonterra's units. I've been proven to be totally wrong, as the offer was well and truly over subscribed.

These are the thoughts that have been going through my mind over the last few days.

What will the Fonterra share price end up at, once shares begin trading later today? I'm worried the price will go higher.

A higher share price is great if you are an existing Fonterra supplier. They have already made a capital gain after Fonterra announced the issue price will be $5.50 per share, which is $1.00 higher than the current $4.52 price. A 300 cow farm doing average production of 350 kgms equates to a $102,900 capital gain.

Many share holders are happy and some are expecting an even higher price once the market begins trading.

I view the Fonterra share price as a barrier of entry into the dairy industry. The higher the share price the lower the cash return is for a farmer from the milk payout.

If farmers received a payout of $6.00/kgms and the share price was $4.52 then they make a higher return than if the share price is $5.50 per share, simply because they have to pay or borrow more money in order to receive the same payout of $6.

My concern is that the share price will eventually rise to around $7.00/share or higher. In this situation a farmer with 300 cows doing 350kgms, will need to buy shares at a value of $735,000 in order to receive a payout of $6.00. Compared to $474,600 when the share price was at $4.52. 

The reason I think this could happen is that different investors have different expectations in regard to returns. At the moment the share valuation at $5.50 with an estimated dividend of .32 cents/share equates to a 5.8% return.

I don't claim to be knowledgeable about how investment markets operate but I look around and I see that government bonds around the world are paying less than 2% return and New Zealand government bonds are trading at 2.85% for a 5 year term. Many company bonds are around 3%-4%.

I wonder if some of this international money may look for a home in the Fonterra shareholders fund. The concern is that these large international investors may deem Fonterra to be a low risk investment and therefore be happy to receive a return of 4.5% or lower, this would equate to a share price of $7.00 based on a .32 cent dividend.

Which leads me to ask, why is the price of the farmers market shares the same as the shares in the shareholders fund, that the outside investors trade? These are two totally different investments with different motives behind the purchase. 

Farmers buy shares because they have to, in order to have their milk picked up. The outside investors are looking for a return. One has voting rights another does not. The two purchasers have different motivations.

But the biggest difference between the two funds is the number of potential purchasers. The shareholders fund is open to any super fund, hedge fund, institutional investor or Mum and Dad investor around the world. The business models of these investors is different to a farmers business model and it concerns me that professional investors will be setting the share price based on their expectations and business needs. For instance, some large investors may just want to place cash into a safe place where they can simply beat the rate of inflation. If this happens then these investors have dictated the price that up and coming farmers need to pay for a share, which has the potential to alter the dynamics of the NZ dairy industry. 

I suppose what might happen is over the years, investors will see that Fonterra is a safe investment and then begin to bid the share price up over time. 

The result could be, dairy farming makes another move away from focusing on cash flow and instead relies on capital gain of the land and now the shares. An appreciation in the value of land and Fonterra shares just make it more difficult for the next generation to break through.

Maybe we will get a situation where existing Fonterra suppliers sit on their shares and the new young farmers supply Synliat, or Open Country Daries. Which would not be ideal for the industry over the long term.

I wonder what the share value will be in 12 months time?

That's just a few of my thoughts as I wait for the the cow bell to ring in 30 minutes time.

Less Farmer Appointed Fonterra Directors May Be A Good Thing

After the passing of Trading Among Farmers, there is now two parties involved with Fonterra. The farmer shareholders and the outside investors. It has been written about everywhere that farmers fear they will lose control of their Co-op. I completely understand that fear and I agree with them.
The argument is that farmers can not lose control because they have the voting rights. This seems a valid argument, but the farmers who are anti TAF point out that the influence of the outside investors will mean that decisions will be made that are not in the best interest of farmers but that of the investors. But surely, what is good for the investors is good for the farmers too. 

Farmers concerns are further raised when it appears there will be 3 directors appointed by the outside investors and 2 farmer appointed directors of the Fonterra Shareholders Fund management company. Fonterra are also conducting a governance review where one option is to reduce farmer elected Fonterra directors from 9 to 8 and decrease non farmer directors from 4 to 5.

We need to remember that Trading Among Farmers only passed by a narrow margin.

With all this going on we hear from the Wall Street Journal that Fonterra are in discussions with the Chinese who would like to buy $100 Million units in the new Fonterra fund. Fonterra are not commenting, which probably means its true. If this is the case it would be very poor judgement from the board to allow this to happen. Even before TAF has been implemented. Everyone knows that there are fears from farmers that they will lose control of their Co-op to outsiders. Even if this fear is unfounded, it is unwise for Fonterra to be talking to overseas buyers at this point in time, especially when so many New Zealand investors are going to miss out getting their hands on the Fonterra units.

This is the weakness of TAF which had been talked about. We now have two sides, the farmers and the investors, which is fine if they have the same goals.

But I feel the farmers goal is now to retain control, anything that comes out from the board in the future will be scrutinised by farmers from the perspective of "is this going to jeopardise our control of Fonterra". This attitude is a defensive inward looking view and is not ideal for growing Fonterra to be money machine for the farmers & investors.

I see future directors being elected purely for their "protect the farmers control" stance. Not because they are best at running Fonterra.

In this context, some farmers are: 

calling for a farmer-director majority on the board to be enshrined in the constitution and for farmer directors only to elect the chairman, who must be a farmer.

I can see why they want to do this, so farmers don't lose their co-op. But the question needs to be asked; do farmers have a place on the board of Fonterra? I mean what do farmers know about running the 3rd or 4th largest dairy company in the world? The chairman should be a person with experience at running a major organisation, not a farmer. 

I don't mean that in a derogatory way, its just that farming and running a multinational business are totally different things.

Boeing don't have pilots running the company and Methven don't have plumbers running the company just as Icebreaker don't have sheep farmers on its board.

I know Fonterra is a Co-op and that makes things a bit different because the farmer shareholders are in control.

The point I'm making is that, maybe the farmers control is holding them back. Maybe the people who appeal to farmers are not necessarily the best people to take Fonterra in to higher value branded products.

When election time arrives, I read the profiles in the farming magazines, which are there for farmers to decide who to vote for. They all basically say the same thing;  "I own a farm in XYZ province & I understand farming" or " I've been involved with the dairy trade for decades" or  "I have farming interests in South America & Timbuktu" & "I'll ensure we work to give you the highest payout we can" or "I will stick up for farmers and work to fix the "perception" problems of the dairy industry".

Which all sounds good to a farmer, but is has nothing to do with developing a high growth branded company.

So while TAF may get farmers upset and uncomfortable, maybe the input from the outside investors is going to be a good thing. 

The investors get their return from the dividend portion of the payout, at the moment that is not very high. They will want to see a higher margin business. Maybe we will see some exciting board appointments from the outside investors. Maybe these appointments will slowly begin to influence the board.

Maybe the inclusion of the outside investors will change things fundamentally and the farmers do have less influence on the board.

That could be just what Fonterra needs to move to the next level.

Maybe the farmers need to get out of their own way in order to see their co-op fly.

Of course, no Fonterra farmer shareholder is going to agree that sentiment.

Fonterra Shares Proving Popular

I have had my doubts about whether investors would be interested in the Fonterra shares/units/investment options.

But they are proving very popular. Homepaddock has some info here with an interesting comment from an accountant, and Stuff has a opinion peice that sums it up quite well too.

Fonterra Is A Price Taker

Following on from my post about how New Zealand agriculture can learn from Apple, I thought I'd look at some New Zealand companies that are doing well overseas. 

Geoff Ross is a former advertising executive who rose to prominence when he founded 42 Below, the Vodka company. He and his partners have gone on to invest and run other companies which they take public. The companies Geoff and co have invested in are Ecoya which makes candles and Moa Beer.
I think he is an interesting business person to study because he hasn't invented anything new or created a unique product. He has simply taken products which are already common place, but he creates brands that enable him to sell these products at a premium price.

42 Below is a brand of Vodka, which is hardly a new product but he promoted the brand in such a way that it appealed to their target market. He promoted it as a high value brand from New Zealand and took it global. He and his investors then sold it to Bacardi for over $100 MIllion.

So when I heard that The National Business Review were doing a question and answer session with Geoff Ross, I thought what a great opportunity to ask him about Fonterra.

I asked:

Geoff is saying you can be an ingredient business which is at the lower end of the value chain and be successful. But you should have a strong brand which creates loyalty. This branding allows you to have control over the price you receive for your product.

The Intel inside example and Gore-Tex are great examples of businesses that supply components to manufactures who create the final product.

Intel make the processors that go into most computers. Your PC laptop will likely have an Intel sticker on it. Prior to the 1990s Intel was just another component supplier, although a very good and innovative one. Anybody outside of the computer industry would not have heard of Intel. 

This quote is from the Intel Wikipedia page.

Intel embarked on a 10-year period of unprecedented growth as the primary (and most profitable) hardware supplier to the PC industry. By launching its Intel Inside marketing campaign in 1991, Intel was able to associate brand loyalty with consumer selection, so that by the end of the 1990s, its line of Pentium processors had become a household name.

Now consumers became aware of the processor in their PC and when they were buying their new computer, they would have the option to choose the brand of processor.

I remember buying my first computer in 1999. I actually researched which processor I should choose, AMD vs Intel.

Wouldn't it be great if consumers around the world actually knew and cared about where the milk came from to make the end product.  

Gore-Tex is another good example of ingredient branding. When you buy a new jacket you can get a Kathmandu Gore-Tex jacket or a Macpac Gore-Tex jacket. The Gore-Tex brand is quoted along side the jacket manufacturers brand. The Gore-Tex jackets are always much more expensive than the competing materials.

When I think about Fonterra, they have the powerful brand name, they also have a range of consumer brands. If we look at Anchor as an example. Anchor milk is a premium brand, it retails at the top end of the milk market. That's what it should be doing. But a vast majority of Fonterra's milk is sold as a commodity and the board of Fonterra seem to be quite happy with that fact.

Fonterra set up the Global Trade Event Auction, on which they sell their product to buyers. An auction is great when there is good demand for your product but it is not a strategy to maximise your products premium status or achieve a consistency in pricing. An auction is handing over control of your pricing to your buyers and it certainly does not go towards promoting your brand as a premium brand.

How many of the buyers (ie food companies) of Fonterra's milk, care about how it was produced? Do they care it was pasture based? Do they care that it has a very low carbon foot print?
I doubt it very much. The buyers are the food companies of the world and they will get milk where ever it is cheapest and whoever has a consistency of supply. That's why whenever the USA and Europe production increases the price New Zealand farmers receive drops. Simple supply and demand. 

The goal should be to have global consumers looking for the Nestle chocolate bars or the infant formula with the "NZ Inside" or "Fonterra Inside" or "Pasture Harmonies" label on the side of the packaging. 

Fonterra and New Zealand have such a unique branding opportunity and truly differentiated farming systems, that are not being promoted. The contrast between a New Zealand pastured based dairy farm compared to a housed factory farm in California is huge. The fact that New Zealand dairy products can be produced, processed and shipped 17,500km to the UK and still have half the carbon foot print of a UK produced product, is not being promoted. Our animal welfare standards are high. The average pet loving European house wife could be persuaded to pay more by simply showing her contrasting pictures of grazing cows, beneath snow capped mountains, and that of housed cows. But again that is not being promoted either.

If you look at the adverts at the top of this post and you applied that sort of design and creativity to New Zealand's low carbon, pasture based, animal friendly farming systems. You can see how the end consumer can be drawn to care about where the milk in their products comes from.

But we are just selling a basic product to the highest bidder via an auction. New Zealand milk is not considered any different to US milk or EU milk. Its just an ingredient and luckily for us there is demand for milk. Fonterra is successful simply because global demand is increasing, not because of some wonderful Fonterra strategy.

The future demand for milk is strong, so simple supply and demand will keep NZ farmers in the money. But there is a problem with this strategy.

Brazil can grow 30,000kgdm/ha/yr where New Zealand farmers can only grow 17,000kgdm/ha/yr. What happens in 20 years time when South America has adopted modern farming practices. 

Fonterra has the resources, the scale, the expertise and the people to execute a branding strategy to differentiate Fonterra's milk, just like Intel did in the 1990's. But they don't have the desire to. For 11 years they have been talking about "value add" but it's not really their goal. It's the sort of thing you're supposed to say in your annual report and you splash the phrase around in business plans and outlines of next years strategy.

When you look at companies that are based on being a premium product, the culture right from the top promotes the premium values. Apple had Steve Jobs and 42 Below had Geoff Ross. They promote the culture that permeates through the entire organisation.

The culture of the New Zealand dairy industry is "production" and that's what Fonterra's strategy is really about. That's why they are setting up mega industrial factory farms in China, to increase production. In the context of increased production, the global trade auction platform makes sense. But from a value perspective the auction system is an abomination.

Fonterra is going to be successful but they could be really successful. Fonterra's strategy is just lacking in aspiration and they will continue to perform below their potential. 

People will be able to counter the points I've made, but all I'll say is if Geoff Ross took control of Fonterra for 10 years. Who's strategy will provide the highest payout to farmers? Geoff Ross or the current management team? 

So I'm calling for Geoff Ross to be the next chairman of Fonterra. 

The Bare Bones, Scraping The Bottom Of The Barrel, Budget, 50 Cow Starter Farm

This post will seem crazy to the farmer who will someday inherit Mum & Dads farm or the farm owner or even the sharemilker milking 500 cows.

This post is to get people thinking about alternative ways in which they can get into dairy farming.

I want to talk about what I call the "bare bones, scraping the bottom of the barrel, budget, 50 cow starter farm". As the name states it's an attempt to milk cows with the lowest possible set up costs, and its a way for young people with no money to start building a herd.

Just like a standard dairy farm, you will need; 50 cows, a cowshed & some land. The way we acquire these three things will be slightly unconventional.

It's important to note that a sensible person would just go contract milking. So if you're not sensible or you can't get a contract milking position, then the "bare bones" system may work for you.

There are many reasons why this system won't work but as Geoff Ross said "Every Bastard Always Says No". To run this system the dairy company that you supply will need to amend their risk management programmes, which some seem happy to do.

The Cowshed
You need to be able to harvest the milk, and as the video below shows that a mobile cowshed does not need to be expensive and can be very basic. It also shows that tractors can be very small or is that a ride on lawnmower?

The cowshed in the video isn't the fastest way to milk cows. I would consider a single side herringbone or even a walk-through design rather than the design they have used. But either way this is a very simple structure that will allow you to get milk out of 50 cows and into a vat, which is all we are trying to do. You probably only want to do it once a day though.

Tanker Track
To supply a dairy company you need to have somewhere for the milk tanker to collect your milk. This usually consists of a purpose made gravel road made to the dairy companies specifications, which runs up to a farmers cowshed. The tanker parks onto a concrete pad where the farmers main collection vat is located.

You can build your own tanker track and put a concrete pad down, but that will cost money and if you are leasing land the land owner will probably not want a big tanker track on his property at the end of the lease.

Collection Vat
Your main vat does not need to be on the same bit of ground that you milk your cows on. It can be located in a number of areas. You could put your vat on the neighbouring dairy farmers tanker track (if you ask nicely), or on the sheep farmers track next to his wool shed or anywhere that a tanker can easily drive up to and collect your milk. Where the tanker collects your milk will depend on peoples individual situations. 

These collection areas are almost always made of concrete. But the MPI (Ministry of Primary Industries) food safety specifications say that these areas need to be made of an "impervious" material. MPI don't want a situation where waste milk and wash water are pooling or running into the surrounding area. There are a number of ways these requirements can be met with out using concrete. Having said that it might just be cheaper and easier just to build a concrete pad next to the track that you use as a tanker track and just remove the concrete at the end of your lease.

Your collection vat and vat wash facilities can be housed in a small shipping container and all waste water/milk runs into a plastic water tank and a cheap K-line style sprinkler system will enable you to spread the waste water. This type of set up will pass the regulations and allow you to move it when/if you move to a different block of land.

Cows
The cows will be your main cost and at the time of writing a fully recorded cow is worth about $1800-$2,000. So 50 cows will cost you $90,000-$100,000. 

But you don't need to spend this much money on cows. 

Lame Cows
Because you will be milking the cows in the paddock the cows do not have to walk to and from the cowshed. That means you can buy cows which have sore feet. I'm not talking about cows that should be culled for welfare reasons, but on every farm I have worked on we have had a few cows which seem to live in the sick paddock, close to the cowshed. They seem to have recovered from their sore feet issues, but after a week with the main herd they end up back in the lame paddock again. You should be able to buy these cows for $1,000.

Older Cows
A local stock agent told me that he has some clients who have larger herds (1,000-2000 cows). He said they have a practice of selling their older cows before they break down on the long walks which seem to go with large farms. These cows will do 400kgms/year but you must be careful they don't have a high somatic cell count. These cows can be bought for $1,100/cow. These cows will be living the life of riley, being milked once a day and not walking anywhere.

Empty Cows
In the autumn when the grass growth slows, farmers start to get rid of the stock they do not want to feed through the expensive winter months. Cows that have failed to get into calf in the late spring- early summer are often sent to the works for $500-$700/cow. You can buy these empty cows and milk them through the winter. If you milk these cows with the mobile system, where the cows lay in the paddock for 23.8 hours of the day waiting for you to park the cowshed next to them. You should have 50 fat, happy cows who are only too keen to conceive.
In the spring you simply put 2 bulls in with them and leave them there for a few months. The worst case scenario is that some of these cows don't get in calf. If some are still not in calf, then simply send them to the works and receive $500 for them. You will have received $1,700 for their milk over the past year (320kgms/cow@$5.50) so your total income from this cow will be $2,200. The farmers I know who have done this report having 20% that do not get in calf. 

Lease Cows
Leasing cows is also a good option as you don't have to stump up with the cash or borrow any money to buy your herd. Lease cows usually cost 10% of the purchase price of a cow. So in today's figures with cows worth $2,000 the yearly lease for a cow is about $200. You get to keep all the calves.

Here are three ways to buy a cheap herd of cows for half price. I would find a handful of farms that have a large number of cows, who have an absentee owner and a high turn over of staff (ie Crafer farms). This should not be hard to do, especially if you live in the South Island. These farms will have a high number of good cows that have had a hard life and will be lame from long walks or have not got into calf due to a combination of factors. If you can get first option on these cows before they go to the works etc you can have a consistent supply of half price replacement cows, which you can turn into great producing cows by inserting them into your mobile "living the life of riley" milking system.

Land
Your cows need to graze somewhere, you can buy land (too expensive) or lease land (good option).

If you lease land you pay market rates at a per Ha basis. Canterbury irrigated land is about $700-$1,000/ha, unirrigated land is about $300-$500/ha. Its difficult to find a lease block of land for 50 cows. You will need about 16-25 ha depending on if its irrigated or not. A small irrigated block of land for lease is very difficult to find. Other parts of NZ where irrigation is not required will have a much easier time.

I live in Rangiora, the surrounding farmland has been carved up into 4 Ha lifestyle blocks, which are purchased by townies with a dream of the country lifestyle. Many soon find out that their 700 square metre section in Christchurch was easier to care for than their 4 Hectares. Often these life-stylers end up spending money to have these blocks maintained.

Lifestyle blocks are an under utilized source of land that can be used to milk cows on. Because the cows will be milked with a mobile cowshed, you can move the herd from block to block. Depending on the type and amount of feed on each block it will take 50 cows 6-12 days to chew through a 3 ha block of land. Obviously you want the blocks of land to be quite close together.
You may not need to pay any lease on these blocks, if you agree to maintain it and look after it for the owners. You could also agree to supply them with milk and to keep their freezer filled with meat.

Show Me The Money

It's difficult to budget a system that is so experimental. But production of 330kgms/cow for a South Island herd milked once a day is realistic. Once a day milking generally shows a reduction in farm working expenses of 25%. 

If the farmer supplied a corporate dairy company they would not need to buy shares. This would reduce the set up costs by $74,580. If the cows were leased rather than purchased, then that would knock a further $50,000 off the set-up costs, which would leave you with a total setup bill of about $55,000. Which is quite good when you consider that the budget shows a profit of $32,000!

This system is all about just doing the basics, so there is no artificial insemination, or imported feed. Its just grass and milk.

This exercise is a bit mickey mouse, but it shows that there is the potential to make a profit from a small herd of 50 cows. I'd encourage young people with very little capital, to think how they could set up a small herd that would fit their circumstances.

A young couple could set-up a similar system. One partner could continue working in a job while the other milked the cows in the morning and did the farm work.

Or, you could just go contract milking!