SPEECH TO DAIRY SECTION - FEDERATED FARMER

Introduction:
New Zealand farmers are great at growing grass. In fact we are the best and cheapest in the world at it.

In the last 100 years New Zealand has demonstrated two traditional areas of clear comparative advantage over the rest of the world. Firstly, growing grass and converting it into products to sell at the farm gate. Our geography, our climate, our science, our husbandry and our hard work mean that as farmers we have been the best.

The second, of course, is on the rugby field with the All Blacks.

But today both farmers and the All Blacks are having to adapt to the changing business environment. Like the All Blacks we have to keep up with the changes taking place around the globe. We have to continue to enhance, improve, innovate, and invest so that we can successfully continue to compete. We have to be able to adapt quickly to maximise our potential.

The All Blacks know that they must have good competition in order to remain competitive. But what about the dairy industry?

Today I challenge you to think about your industry. I want to challenge you to think about your profits and standards of living and to consider whether the current structure is delivering the best return to you and your family from all your assets and efforts. Is it constraining innovation and not allowing new investment to add real value and allow you to move out of commodity trading?

In the modern world, I don't think anyone could argue with the fact that farmers should see themselves as business people. Farming isn't a hobby. As business people, I feel there are a few key questions that you need to be asking yourselves about your futures. All these questions concern your ability to maximise your incomes over the longer term.

You have just been told to take a $50,000 drop in cash income over two years. You are told that commodity prices and the value of the dollar are the reason. There is no doubt that these two factors are of significance, but are they the only reason that your standards of living are continuing to decline? Or is it the fact most of your product is still sold as a bulk commodity? In products with real market differentiation there is now such thing as a fall in commodity price

I seriously question whether the current structure of the industry is delivering for dairy farmers and their families. (Slide of questions)

Is the statutory protection of the Dairy Board in your interest?

Is the dairy industry structure giving you a fair return for your efforts and assets?

Can your industry access sufficient capital to maximise its potential?

Do you have the flexibility to cope with the risks and uncertainties that the future holds?

Can you free up sufficient amounts of your funds and time to allow for the kinds of innovation and improvements that will let you get ahead?

Is the Government providing you and the Board with the kind of freedom that you need to achieve success?
If we are the best dairy farmers in the world, why do we seem to have to work harder, buy more cows and more land, just to maintain our standard of living. Why are other parts of the New Zealand economy, that don't have a natural comparative advantage, making greater progress than dairy in the international marketplace?

The world is changing with the globalisation of the marketplace. With this change the choices of capital, people, and technology are greater than ever. If the environment is not right, these move elsewhere. This is part of the risk facing the dairy industry at present.

OTHER INDUSTRIES: PERFORMANCE
Manufacturing and service industries:
As Minister of Commerce, I believe that there are other sectors of the New Zealand economy that are in a strong position to meet the kinds of challenges that we face. I have been privileged to witness a revolution in the manufacturing and commercial sectors of this country over the past decade. Lobby groups used to come to me and say that their industries would die if tariffs were reduced. Now those same industries ask me to open new factories to export their products into world markets.

Clothing, plastics, whiteware, cars, even gumboots, and other industries have progressed a long way since the farmers of New Zealand, and Federated Farmers in particular, successfully sought the removal of statutory protection and political interference from these manufacturing, input and service provider industries.

Farmers have been very keen to expose former protective parts of the New Zealand economy to the global market place, and rightly so, because they know that is the best way to make progress and improve industry performance.

Like the All Blacks, they know they need competition to remain competitive and beat the best in the world. Federated Farmers pushed hard because they knew that Kiwi ingenuity, if given the chance, would find better ways of doing things than political interventions. (Slide Graph tariff levels)

It's no surprise that suddenly we find new investment has occurred in these industries, exports have hit record levels, and New Zealand and it's products are world leaders. We now have cutting edge technology from industries that a decade ago couldn't survive without 50% tariff protection, subsidies, or import licensing restrictions.

Today's Budget signals a zero tariff for motor vehicles and ultimately for all imported goods. Yet exports of motor vehicle components and other elaborately transformed goods are at record levels in the face of no protection from Government (Slide ETMs)

Former Government sectors
Over the same time, again with a strong push from farmers, we have opened up previously protected parts of the public sector to competition. Farmers again knew that protecting these areas would only continue to deliver poor results.

They didn't believe the line, given by some, that the public sector should not be exposed to competition because that might make them unviable, standards might fall and they would be worse performers if competition was allowed.

Air New Zealand, TVNZ, Telecom, ECNZ, NZ Post and many other parts of the public sector were corporatised and the protective market mechanisms that restricted trade all but eliminated. Capital from other than the taxpayer was provided and innovation encouraged by increasing competition.

I don't need to tell this audience about the gains that have resulted from this. The range of goods and services has increased dramatically, while costs have decreased. Investment and innovation have skyrocketed and operating deficits that used to be borne by the tax payer have turned into profits for the companies and corporations involved.

These business's have every pressure to remain focussed and to perform for their owners. Something perhaps not so apparent in current dairy industry structures.

Telecommunications
Do you remember when 25,000 people worked for the Government in the area of telecommunications and it could take you two years to have your phone connected?

(Slide Telecom)

Today Telecom and around half a dozen other telecommunications companies employ about 9,000 people to operate the system. Several hundred new companies have sprung up to service them and they are now competing so vigorously that many have been able to expand offshore.

The original asset has increased in value over 3 fold for Telecom's owners.

Today we have one of the most modern telecommunications systems in the world with significant infrastructural development which everyone can benefit from. In fact the Swiss based World Economic Forum publication, the Global Competitiveness Report, in 1996 again ranked New Zealand first in the world overall in its annual survey of how telecommunications infrastructure meets business requirements.

The industry as a whole now employs more people than the old public sector. And services and infrastructure, including those in rural areas, have improved dramatically. A growing export sector has developed. Perhaps this is a useful analogy of what might happen in a freed up dairy sector.

Other primary industries:
Forestry
The forestry industry has also made huge gains by allowing the capital and competition of others to come in to the old state run forests and getting Government out of it. (Slide forestry stats)

Forestry now makes a large contribution to our economy, acting as a large employer in many of the smaller towns of this country. This has resulted from companies being freed up to invest and innovate in what was previously a commodity driven industry. With the entry of new companies such as Juken Nisho and International Paper, access has been gained almost overnight to large amounts of investment, technology, expertise and international distribution channels including in previously impenetrable markets such as Japan. This could never have been achieved by the New Zealand forestry industry trying to go it alone.

Fishing
New Zealand's fishing industry is another that has made spectacular progress, growing from about $6.5 million in exports in 1965 to $1.2 billion in 1996. (Slide Fishing Stats).

The industry got a major boost when individually tradeable property rights were established - these enabled fishers to benefit from their investment and to put the fishery on a more sustainable basis. Today, New Zealand fishing companies are seen as being at the cutting edge of niche marketing and adding value. Many different companies provide a diverse range of products to markets around the world, including live and fresh fish and live lobsters to highly discerning markets in Asia.

What do these industries share in common?
All these industries have benefited from getting Government out of the way and allowing resourceful groups of Kiwis to get on with the job of creating wealth. A real ownership interest has been established.

Competition has created the right incentives, it has allowed investment and it has forced innovation. Innovation and profits, rather than politics, have been the key focus. New Zealand as a whole has benefited from these developments.

On the other hand, I do not believe that monopolies generally benefit New Zealand even though they continue to exist in some areas. I received a letter from a kiwifruit exporter just last week, not complaining about the Board itself but making the following general comments:

``The area of my concerns is best described as the suboptimal behaviour by a monopoly. No person or organisation can make the right decisions all of the time. A competitive business who makes a poor decision usually has that fact quickly highlighted by poor or relative performance in the marketplace in comparison to competitors who have made a different decision. In these situations, for commercial survival reasons, the organisation which has made the bad decision is forced to recognise its decision and correct it.

The exporter goes on to say:

``Similarly where an organisation has clearly made a very good decision, the other organisations or participants in the industry usually copy or follow suit realising the benefit of that good idea or decision for the whole industry. Because monopolies are not working in parallel with similar organisations they do not have the benefit of being able to copy better decisions being made by another organisation. Nor the opportunity to have any poor decision made highlighted by relative performance.''

I have always had a healthy scepticism of monopoly providers of service, because in the end the farmer pays the costs one way or the other.

Interestingly, the most successful industries in the world today are those that are totally exposed to a competitive environment, be they the emerging industries of South East Asia or the New Zealand sectors that I spoke about earlier or other new sectors in NZ such as computer software, yachting, or wine making.

THE DAIRY SECTOR
So where does the New Zealand dairy industry fit into all this?

I look at the industry and believe it can take due credit for what it has been able to achieve in improving processing efficiency within this country and in being able to dispose of milk into a world market against mainly subsidised competitors.

The Board was set up in the 1920's when information was more scarce and the market didn't operate as it does today. The world had been at war. It gave producers some sense of control over their destiny.

In 1961, the Dairy Board, following on from the organisations that came before it, was given statutory recognition under the Dairy Board Act, an Act which has been amended some 15 times through to the most recent amendment in 1996. Each of those has seen much lobbying and a change in direction as the Dairy Board has evolved. There is no doubt the Board has been a competitive lobbier of Governments.

Today, while the Board may be seen as a single desk seller of New Zealand dairy exports, it is anything but a dominant player in the international market place. It is actually one of many competitors.

For example, Nestle is 15 times the Board's size (although the two organisations were founded about the same time) while Kraft General Foods is about 10 times bigger. There are at least 20 or 30 other major competitors in the market.

"And other competition, such as Australia, is growing rapidly," the Boards Corporate Profile tells us on page 9. This is, incidentally, without New Zealand's statutory restrictions and I might add with a healthy dose of international investment!

Where the Board does have a monopoly is in the provision of marketing services to New Zealand's 14,000 dairy farmers. Simply if the Board doesn't do it, or licence it, it doesn't happen. They are expected to have all the great ideas, and you are expected to have all the capital.

For example, yesterday I received a letter on my desk from a frustrated potential exporter of your product. It says, and I quote;

Product Bundling: Our company was unable to pursue a very lucrative supply contract with a consortium in Hong Kong because a condition was that milk powder had to be part of the supply arrangement. The contract as I understand it went to Denmark. Bundling of dairy products is important to small customers in Asia and is impossible under our present regulations.

In examining a JV with an overseas source of technology it was found that a NZ dairy product exported by the NZDB was priced 25% higher in NZ than it could be obtained in Europe. Clearly the strategy is to prevent NZ companies being competitive.

An application for a licence for an analog cheese has been declined on the basis that it is cheaper and is not compatible with NZDB strategy.

Our company had the opportunity because of personal relationships to export frozen cream to Saudi Arabia. This was made impossible by the NZDB on the basis that they supported the market even though there was no intention on the part of the perspective customer to buy from the NZDB.
As I say, if the Board doesn't do it, or doesn't licence it, it doesn't happen. It's saying to this businessman risking his money, we don't want you to add value to New Zealand dairy farmers' milk.

Having a monopoly provider of marketing services puts you in a very different position to many of your competitors offshore who have a much greater degree of freedom in deciding what they will produce and who they will market their products through. This I believe is the major difference between the dairy industry and the other New Zealand industries I have described earlier.

I would suggest that if you are worried about competition in the market place of a weak seller undercutting New Zealand produce, it is very likely to be happening now between the many current players. But then the commodity price is always determined this way.

I question whether the current structure of the industry is capable of realising the full potential for dairy farmers and their families. How much better off could you be in a more competitive environment that allowed for more innovation and improved marketing and investment choices? Do you want to take the risk of keeping the status quo at all costs?

Why do some farmers clamour to force competition on all their service providers, but not with the most important one, the provision of their own marketing services? Where can we make progress to improve the profits and standards of living of our dairy farmers and their families?

Return on Dairy Assets
In effect we have a situation today where dairy farmers indirectly comprise the Board's shareholders and the Board's performance is reflected in your land values as well as in the value of your pay out. I have tried to obtain some information from the Board and other sources that would let me know how well it is performing on your behalf. Quite frankly the real information on performance is not available.

Both farm size and herd size have been increasing in recent years. The question we need to ask is whether farmers incomes have increased at the same rate. The evidence would suggest otherwise. (slides farm size/herd size)

The Economic Survey of Factory Supply Dairy Farmers of 495 dairy farmers tells us that for 1995/6 average assets were $1,516,846, liabilities$365,592 with owners equity being $1,151,251. For the last two years return on farmers equity was 2.8% and -.08% respectively. Sharemilkers haven't fared as well. (Slide returns)

A rough indicator of the overall return achieved by farmers on all assets is provided by the level of average dairy company total payout (per kilogram of milk solids). This has fluctuated somewhat in real terms. This to me is not an indicator of increasing returns or of increasing value added. (Slide dairy payout)

I was particularly interested in questions surrounding the average capital invested by farmers beyond the farm gate in the dairy industry over the last 5 years. From the 1996 Board annual report each of New Zealand 14700 farmers own about $100,000 of the Capital & Reserves of $1.458 billion. They each share about $240,000 of total assets. And, according to the conservative accounting policies of the Board, these assets are undervalued. In addition, each farmer also has around $100,000 invested in his local co-operative. Beyond this, however, it has been very difficult to obtain any idea on what the return on this capital has been.

This total off-farm investment is significant. At, say, around $300,000 per farmer, it equates to about 10 new HiLux's, 20 new kitchens, about 30 years worth of boarding schooling, or a pretty good house on the shores of Lake Taupo.

There has also been a strong feeling in the dairy sector that this sector is doing well, at least when compared to sheep and beef farming. These farmers have been through some tough times, especially as they faced the need to restructure their processing industries in the face of overcapacity.

There is growing evidence, however, that sheep and beef farmers are operating in a sector that has moved quickly to increase efficiency and add value. In fact over the last 45 years the farmgate price of a kilogram of milksolids has fallen by twice the amount as the farm gate price of beef. But then all undifferentiated commodities fall and will continue to fall in price as they are produced more efficiently.

Good information is critical to you as businesspeople if you are to make appropriate investment decisions and manage your financial risks. You must ask yourselves whether, under current circumstances, you are disadvantaged compared to businesspeople in other sectors of the New Zealand economy. Not only are you required to invest massively in areas where you, as individuals, have limited expertise, but you also have to have complete trust that you are investing in the best alternative. You have no other choice.

Because of both the vertical and horizontal cross subsidisation, your investment has been in the name of the common good - often to the benefit of the retiring sheep or beef farmer

In these circumstances, we all need to ask ourselves whether the return we get as farmers from the Dairy Board and dairy factories is as good as we could have achieved from investing in a proprietary company, which at present we are not at liberty to do.

I suspect that if I had invested the amount of money that I have invested in dairy factories and the Dairy Board in the 25 years I have been farming in Nestle shares, the return on my capital in terms of both dividends and asset growth would have been considerably larger.

And I don't know about my audience, but my involvement in dairying is to earn the best possible return on my total investment. Every dollar has to do better over time than leaving it in the bank.

Risks
But what are some of the risks of the status quo?

I believe the risks for dairy farmers of not questioning their current structure are great. Farmers have to take individual risks at farm level. Risks at the processing level, which is now becomming more concentrated. Risks by having a monopoly provider of marketing services. And external risks which are really beyond your control.

These risks are heightened by lack of quality information made available to you on your assets and investment. As dairy farmers you receive a residual payment after all other costs have been taken into account. You are actually underwriting all the commercial, financial and any other risks of the industry.

Innovation Risks
Aside from the lack of information and accountability under current structures, there is also a strong risk that we in the dairy industry are being discouraged from undertaking the kinds of innovation that we need to secure our futures.

I am told that Tatua has more PhD biochemists on staff than the next door neighbour, the New Zealand Dairy Group, fifty times their size. The current cost model has a strong bias towards large scale commodity processing. Innovation is not encouraged despite some of the rhetoric from within the industry.

Despite some specialised products returning very high prices, the cost model sometimes only returns half of that to the manufacturing company. The reason always given is that the Board helped develop the products but the payout system is still rather arbitrary.

We need to ask ourselves whether the current cost-based model employed in our industry acts as an effective brake on innovation. Mr Robin Manson, Chairman of Tasman Milk Products said in a recent issue of the magazine ``Exporter'', that his company is ideally placed to benefit from any change in the industry payment system that rewards innovation.

Income from specialised products is currently used to cross subsidise the commodity and therefore the return on new, often riskier, investment is reduced. The investment levels required to get out of commodities, which cost about $2-3/kg of milksolids to process, and get into specialist areas is often $20-30/kg. This is where New Zealand fails to invest under the current rules.

Some might say that it is an indictment on the politicians in the industry that they have allowed this situation to continue for so long. But some of us were trying to change it 10 years ago.

As well as taking risks in terms of product innovation, it seems to me that we are also taking risks in terms of allowing for innovative marketing practices. It is just too much to ask one organisation to have all the good ideas in an industry as large as the New Zealand dairy industry.

Allowing for competition in the area of marketing would, in my view, provide for a more differentiated and sophisticated approach in this area. Look at the innovation of the Kapiti Cheeses and ask why this hasn't happened across the industry.

Dairy Industry Freeing Up
We in the dairy industry are no different to other sectors of the New Zealand economy. We are quite wrong to believe that we can get a better return by hanging on to statutory controls on who can invest in the dairy industry's processing and marketing facilities and by limiting competition in the most vital parts of our industry.

What would happen if we freed things up a little? What would happen if we allowed investment in the New Zealand dairy industry on the same basis that we have seen in such sectors as telecommunications and forestry?

I believe that the value of both our on and off farm assets would increase in much the same way as the value of shares in companies such as Telecom or Air New Zealand. This would be achieved through greater efficiency, innovation and product differentiation.

I believe that there are many in the Dairy Board who now accept that the Board's days as a statutory monopoly are limited. Whatever the perceived political support, this is what a Government may have to do for international political reasons or domestic political reasons, for example, to form a coalition.

But this need not spell the end of the Dairy Board if it proves that it has the continued capability to compete as a marketeer of dairy products. I would imagine that there will be many employees in the Board who will feel both relieved and stimulated when they are freed up to operate in the same manner as their competitors. In their heart of hearts, I think they realise that their current monopoly position is more a curse than a blessing.

A Set of Proposals
So where should we go from here to improve your standards of living? My vision, and it is a personal view, is that the status quo is not an option. The risks are too high.

We need to evolve our industry structure to one where farmers have a true ownership interest. Such a structure would not need statutory protection and the Board would be freed from this imposition. So here's a possible plan:

Corporatise all the commercial assets of the board into a company, the New Zealand Dairy Corporation, under the Companies Act.

This company should operate on purely commercial principles, making transparent profits and paying a dividend to shareholders.

The new company could ultimately list on the stock exchange. The large company shareholding would ensure control as long as farmers wanted it.

Allow investors other than farmers to own a proportion of share capital.

Remove the requirement of the Board/Corporation to purchase all export product, but perhaps allow it to retain a real advantage by allocating it the quota market premiums.

Retain a small licensing authority to licence exports, monitor marketing activities, and assist Government, if required, with market access issues.

Require the new Corporation to apply for an export licence like any other exporter.
This is a rough outline of a structure to which the dairy industry could evolve quite quickly.

It would allow farmers to receive three income streams from their assets and efforts: first from their on farm milk production; secondly from their substantial capital invested beyond the farm gate in their processing factories; and thirdly through dividends from their shares in a provider of marketing services.

This would give farmers greater accountability, a more transparent return on their assets, the right market signals in terms of production levels, and a more portable and transparent "superannuation scheme".

It would give the Dairy Board and its 6500 employees the freedom to operate without statutory constraints. It would mean greater responsiveness to the market and less distraction on political issues. It would mean that they wouldn't have to sell surplus production at a loss. And it would provide them with real incentives to lower costs and sharpen marketing focus.

It would force market signals through to farmers - something currently not happening under the current payout system which subsidises entry and then subsidises new milk production, at existing farmers cost.

Government role would be in its only legitimate area in the industry, that of international trade access and lowering internal cost in the New Zealand economy.

Transition issues are important to move to such a model. It would be important to move to this in a carefully managed way over say perhaps a 2-3 year time period. Although some may think this is too slow, this would give any new corporate structure plenty of time to make the shift from political and production driven, to this new environment of being profit driven.

Conclusion
My call today is for New Zealand dairy farmers to wake up to the very serious risks inherent in the current approach of not allowing real investment or competition into the most vital parts of the dairy industry.

I believe we need to free things up to encourage innovation and allow new investment to add real value and move out of commodity trading. As your chairman Mark Masters said in the Dairy Exporter after his recent trip to Asia,

"There are more potential markets in South East Asia to be tapped but it will need capital. The amount of capital required will depend on the rate of growth that NZ dairy farmers desire. Buying an existing brand takes a large amount of capital but it is one way we can add value quickly."

I invite Federated Farmers to show some leadership and motivate farmers to call for the freeing up of the dairy industry - New Zealand's largest exporter - so that it can really live up to it's growth potential in the long term. This will allow dairy farmers as businessmen to maximise their incomes over the same period.

I know that some may feel threatened by these proposals. But we just have to look at the growth of other New Zealand sectors without the constraints that are applied in the dairy sector. The status quo is not a runner. We as New Zealand dairy farmers will have to wake up or we will be left behind.

Thankyou