Producer Board Reform

Thank you for the opportunity to talk to you today.

I want to talk about producer board reform, right now, far the biggest set of innovations on the public agenda.

In the next few months, every dairy farmer, every kiwifruit grower, and quite possibly every apple and pear grower in the country, will be voting on new industry proposals.

All of those boards have huge communication programmes in hand, to place farmers in a position to exercise an informed vote on issues of critical importance.

The commercial proposals in every case have been developed by the industry concerned. But their proposals inevitably imply changes in the regulatory environment.

So all the industries are coming to Government for changes in the legislation regulating their industry, to let them implement more commercial programmes in future.

Dairy legislation came into the House last week. Kiwifruit and Apple and Pear Board legislation should be introduced this week.

The Government has advocated producer board reform for some time. There is a serious downward trend long-term in commodity prices worldwide.

It affects all commodities. Real petroleum prices have, for example, fallen by around 65% since 1980. Commodity food prices fell 45% in the same period.

The fall in agricultural commodity prices since 1980 is 38% in real terms. That puts ever-increasing pressure on agricultural producers.

If we don't find an effective antidote, the ongoing decline in commodity prices will, slowly and very painfully, impact adversely on many of our rural communities.

That's why the Government asked producer boards last year to put forward long-term plans by November, to improve the prospects otherwise facing rural producers.

All of the boards responded. They have all, at a rapidly increasing rate, developed their individual industry proposals to put before their own producers.

The Government, while we place great emphasis on the need to solve the problem, is not in the business of dictating commercial answers to any rural industry.

The commercial future of an industry is a matter for the people in that industry. It's their money which is at risk on the consequences of action or inaction.

Each industry has done its own homework, and come up with its own individual recipe for a better future.

Essentially, what we are seeing is the transformation of statutory monopolies into commercial monopolies, but with safeguards built in, to protect both minority producer interests and the interests of the New Zealand consumer.

Each industry is taking a slightly different route.

Milk for example, is a very perishable product. Dairy farmers have always felt vulnerable about that. They fear it might let an independent processor exploit them unfairly.

They require processing companies to be cooperatives owned by their own milk suppliers, with daily pickup guaranteed as a built-in part of their ownership rights.

To make sure that the cooperative system cannot be eroded, shares are held on a 1:1 ratio with volume supplied, and only suppliers are able to hold them.

Consequently, suppliers are the only source of capital available to the industry. Its modernisation and expansion are limited to what dairy farmers themselves can afford.

To get critical mass, the supplier-owned cooperatives are compelled by statute to do all their overseas marketing through the single desk of the New Zealand Dairy Board.

In the last year or two, however, the dairy industry, inspired by the Government and its own opportunities, has made a big investment in independent studies of its own potential.

The studies conclude that present annual turnover of $8 billion or so can, by adopting the right strategies, be expanded five-fold to something like $40 billion a year.

That's a mind-blowing prospect. Very clearly, it will require a lot more investment than anything which could ever be achieved by dairy farmers acting entirely alone.

Even if farmers had the necessary funds, you don't get that kind of growth using captured capital. Captured capital leads to soft decisions, and you can't drive successful growth on that scale off soft decisions.

The need to persuade outside suppliers of capital is an absolutely critical discipline on the quality of investment proposals, when you are playing with that kind of money.

The aim of the industry's new proposal is to get critical mass, innovation, commercial discipline and the huge investment they need, without any sacrifice of dairy farmer autonomy.

To achieve that, it wants to merge the cooperatives processing 95% of the total milk supply into one single MegaCo-op, to be owned by its own farmer suppliers.

The current shares in cooperative processors would be swapped for shares in the MegaCo-op. It would own the processing companies. The Dairy Board would convert to a commercial company owned 100% by the MegaCo-op.

Instead of the present statutory monopoly, you would have something very close to a huge commercial monopoly-something quite intolerable under any form of law the Government could contemplate in New Zealand.

So before it can have any hope of becoming a starter, the industry has had to refine its plan to deal with the competition issues raised by the Commerce Act, for independent adjudication by the Commerce Commission.

The industry has proposed to the Commission that at least 40% of the domestic market in New Zealand should be divested to an independent competing processor.

The company would be created by divesting to it some of present facilities and brands. It would contract with the MegaCo-op for its processed milk supply.

Work is going on right now to try to write a contract capable of ensuring its independence from the MegaCo-op which supplies its processed milk.

Equally important, if a farmer wants to exit from the MegaCo-op, he has to be able to do so on a basis that gives him fair value for his share of the assets of the MegaCo-op and the quota earnings of the industry.

Protection of minority grower rights is fundamental.

The industry is proposing to the Commerce Commission that it will protect minority rights by creating:

1. A single unbundled commodity price for milk

2. A new 'Q' share to distribute dividends based on quota, not linked to milk volume, and freely tradeable among MegaCo-op suppliers

3. A new 'A' share to distribute dividends all other activities, tradeable among suppliers, but linked more flexibly to supply than the present 1:1 ratio.

Whether those protections for the consumer and for minority rights are sufficient under the Commerce Act is a matter for the Commerce Commission.

Without its authorisation, the plan dies. The industry has to go back to square one, and start again.

That's just one of the four separate hurdles this proposal has to jump, before it can be implemented.

First, the cooperatives have to agree to join the MegaCo-op. That requires a 75% majority of the producers supplying each cooperative.

Secondly, the industry has asked the Government to pass a dairy industry restructuring bill, which sets the regulatory environment for the reformed dairy structure.

They want the Dairy Board Act 1961 repealed from 1 September 2000, conditional on the amalgamation of the co-ops into the MegaCo-op, and Commerce Commission authorisation, by that date..

If the amalgamation doesn't happen, whether because the Commerce Commission refuses to authorise it, or because the co-ops decide not to amalgamate, or because dairy farmers finally vote no, then the Bill dies.

The legislation spends six weeks in a select committee for submissions. If the House doesn't pass the Bill, the reform is not implemented. The industry goes back to square one.

Finally, about October or November, dairy farmers throughout New Zealand will vote on a constitution for the MegaCo-op to ratify all this.

Unless 75% of them vote yes, again, that ends the proposal.

Labour complains that the Government is rushing this legislation. Rubbish. It's the industry which has set the timetable, not us.

They want the money it can make. I can understand that. The Government would be blameworthy if it ignored relevant commercial factors.

But the plain fact is, there are checks, safeguards and balances coming out our ears at every step and stage of this process.

This proposal is going to be tested very severely by the cooperatives, the Commerce Commission, the House and all dairy farmers nationwide.

Conditional on those approvals, certain quota rights assigned currently to the dairy board in the EU, US, Canada and Japan will, under the legislation, pass to the MegaCo-op for 6½ years, then become contestable in 25% chunks over the ensuing four years.

The dairy board has invested a lot in those markets. That transition will permit them to recoup their investment before those particular quota rights become contestable.

The kiwifruit industry has a different set of problems, so it has come forward with a different set of answers.

There is no MegaCo-op proposal. Kiwifruit has a supply chain of orchard management, pack houses, coolers transport and insurance.

About five major groupings are already deeply involved in the packhouse/cooler/transport/insurance chain, under a variety of ownership.

One is a listed company, a couple are private companies, there are cooperatives.

The people involved are generally growers, though not all growers.

So kiwifruit has a different starting point. The five groupings already compete from orchard to shipside. They are not merging. Nobody wants them to.

The kiwifruit industry proposes that growers will, directly and indirectly, put directors on the board of Kiwifruit New Zealand. It will be the regulatory body and watchdog of the industry.

Kiwifruit New Zealand will delegate all commercial and marketing tasks to a commercial company, Zespri.

Zespri will be owned by growers, and freely tradeable among growers, but unlike dairying, they will not be linked to the volume of fruit a grower supplies. Unlike dairying, Zespri will for the time being retain its present single export desk.

Fruit purchase, presently governed by regulations, will become a contract with Zespri. Contracts will become more diversified, to reflect differences in supply, volume, fruit features, quality and reliability, as you would normally expect, in a sensible commercially oriented industry.

Volume, characteristics and so on, will reflect what the market wants.

The price will be unbundled in the new system, with separate payments for the fruit, and for the shareholding dividend based on returns from marketing investments.

Though shares will be tradeable only among growers, prices can therefore be expected to reflect future value. That will put real grower pressure on, if Zespri's commercial performance shows any sign of inadequacy.

Obviously, single-desk operations always involve some risk to shareholders. Four counter-measures have been set in place to keep any risks to manageable levels:

1. There are some very strong information disclosure requirements for full reporting, no cross subsidies, and full information on costs relative to revenues.

Where information is commercially sensitive, it will go only to Kiwifruit New Zealand, the new board. That's what gives the board its power as watchdog.

2. Discrimination between growers is outlawed, except on strictly commercial grounds. If two suppliers have the same volume, fruit quality, fruit type, cost and reliability, they can expect the same price.

3. A non-diversification rule will be set in place to ensure that single-desk revenues and captured grower capital cannot be used by Zespri to fund diversification into new ventures.

4. Other protections are,. In particular, requirements of the Companies Act providing, in the constitution, certain minimum shareholder rights which cannot be changed.

The apple and pear board has undertaken overseas diversifications in the past using such capital, and they were very costly for growers.

If they want to do that in the future, then it must be via a separate company which is staked with voluntary capital.

I understand that Kiwifruit New Zealand aims to do exactly that. There will be a prospectus out within weeks, seeking capital for Kiwifruit International, to provide equity to market foreign fruit in overseas markets.

Proposals for the apple and pear industry are, generally speaking, very similar to the restructuring plan put forward by the kiwifruit people. Their grower-owned commercial and marketing company is called ENZA.

There are just two big differences from kiwifruit.

1. The Apple and Pear Marketing Board has a very large onshore investment in cool stores. It considered selling, but in the upshot, opted deliberately to keep all of them.

A single-desk marketing operation is placed in a very dominant position if it also owns most of the cool stores. It controls the onshore flow of fruit.

So three things have been agreed to mitigate that:

a) The Board has to put those onshore assets into a separate subsidiary.

b) The subsidiary must be run at arm's length from ENZA, as if it were separately owned, with a lot of transparency.

c) As for kiwifruit, ENZA takes legal ownership at the ship, not the coolstore. The onshore chain will be fully contestable from 1 October 2000.

2. There is a difference in the way the two industries under their single desk arrangements go about granting export permits to other companies.

For apples and pears, the new board will appoint an independent licensing body to grant export permits, but such exporters will be required to export on a basis the board regards as complementary to ENZA.

For kiwifruit, the new regulatory board, Kiwifruit New Zealand, makes the decision, and it will require "collaborative marketing" with Zespri. Approved exporters will export, as it were, in joint ventures with Zespri.

The Government has taken quite a lot of stick in the past for encouraging producer boards to think more constructively about the future. All kinds of nefarious motives have been attributed to us.

In fact, all we want is more wealth for agricultural producers, rural communities and the nation. Once that sunk in, agricultural industries have found themselves able to think much more freely and flexibly about the future.

All of these industries have moved a long way since November. They deserve the credit. They have made their own decisions, and they are working flat out for progress.

I take my hat off to them. They have done their home work, all of them, more intensely than at any time in the past.

Obviously, the Government, in fairness to New Zealand consumers and minority interests, has to set the regulatory framework. We have been quite upfront about that, and our sincerity has been recognised by producers.

But within the bounds of good public policy, if I can facilitate the achievement of their goals, then I have no hesitation in giving my commitment to do so where I can.

Rural industries face a huge transformation as they move into the competitive world of the new millennium. I want to see them succeed, and so should every New Zealander. They are a key part of our living standard.