The Status Quo Leads to Peasantry

  • John Luxton
Food, Fibre, Biosecurity and Border Control

HAWERA

Currently there is an advertisement on TV which says " Without revolutionary thinking nothing of magnitude is ever achieved". I agree. There is another well know saying "that today's revolutionary thinker is tomorrows conservative.

This year you mark the fiftieth anniversary of Massey Dairy Conferences. Fifty years ago people had revolutionary thoughts.

In 1948 few would have thought that some day food and petrol would no longer be rationed, that you should be able to buy a beer at five past six, wash and dry clothes or watch the All Black on the other side of the world at the push of a button.

Some may have thought of selling dairy products to other than the British Government, but few if any would have thought all the dairy factories in the southern North Island would merge into one in Hawera.

Today such thought is reality so how about a bit of revolutionary or visionary thinking about the dairy industry. I want to question how we can improve dairy farmers incomes and enhance their assets.

The last fifty years has taught us that change is inevitable. Technology and globalisation mean that capital, information, people and skills are highly mobile. To prosper we need both as a country and as an industry to attract those important ingredients. Governments no longer contain them as of right but economic performance can.

The dairy industry with it current risks simply cannot afford to stand still. If we as farmers don't want to be peasants, I believe that as an industry we need to look forward towards the next fifty years and prepare our industry to be more able to maximise opportunities and to convert them into cash in your bank accounts, in more ways than by lowering processing costs. We need to ensure that we build a profitable future from the current base to enhance the interests of all dairy farmers.

The Problem
In 1972, when I began dairy farming, I received over $6/kg ms in 1998 dollars. Now I receive around $3.50. At the present level of commodity sales, this may halve again over the next 25 years. Quite simply, dairy farmers continue to be commodity traders. Farmers, on their side of the gate, have doubled their average herd size to almost 200, increased production per cow, cows per acre, spent more capital and produced at record levels in response. Fluid milk production in the 1996-7 season reached a record level of 11,500,000 tonnes, around double what it was 20 years ago.

Much of this increase has been on the back of a transfer of existing dairy farmers assets to new farmers who have not met the real costs of entry and then been subsidised to produce marginal product by existing farmers.

While farmers continually work to improve on their side of the farm gate, the performance and current structure of those who service the farmer and provide monopoly marketing services on the other side of the farm gate, needs to be further addressed.

To me, any export industry that gets asked to take a 20% drop in income when the trade weighted index drops around 20%, is not delivering as well as it could. Over the years we have heard rhetoric that payout would be higher, if only the dollar was lower.

On the 14 October 1997, Sir Dryden Spring said in his Dairy Boards AGM speech,

"We achieved a record sales volume of close to 1.3 million tonnes of product; an increase on the previous year of 258,000 tonnes. To put this increase in perspective, our total branded consumer sales are around 260,000 tonnes and it has taken us over 15 years of concerted effort to reach that volume" (page 3).

That is just 20% of production being sold as branded consumer sales.

Under your current structure and arrangements originally set up in 1926, after 70 years of concerted effort you now have only 20% of you product sold as consumer branded product. If you are to prosper, we now need to make changes more quickly to capture a higher return for the other 80% which is currently sold as commodity or to other organisations to add and capture value through to the consumer.

The status quo leads to peasantry because it traps you in the commodity market , which will continue to decline. All commodity prices decline over time. Unfortunately politicians cannot legislate for a higher price in the commodity market as commodity prices are set by who is prepared to sell for the least price. Milk solid price per kilo has decline further than beef per kilo prices at farmgate over the last 50 years or so.

As owners and operators of medium to large businesses you need to have sufficient information on performance so that you can make sound business decisions about where and how you want to invest your capital, time and effort.

Currently you have little information and are outlawed by the current Dairy Board Act from making normal business choices. You have little ability to make decisions about your own investments off farm.

You have no way to know whether the next dollar invested by coercion in an offshore subsidiary, the Board, or your local dairy company is going to give as good a return than if you used your money to reduce you overdraft or mortgage. And of course you are outlawed from having that choice anyway.

But there are some things we do know.

The current industry structure is determined by Parliament and not the market place. It requires the will of Parliament and politicians to agree to make changes to your structure which a normal corporate could make at a general meeting. We have two bills before parliament at the moment that in a commercial rather than political industry would be dealt with at an AGM

It restricts innovation by allowing only the good ideas of one marketeer out of New Zealand, and by outlawing the competition needed to encourage innovation. Currently around 80% of your product is sold as a commodity or to someone else to add and capture value.

It limits capital investment which, if unlimited, could add much more value to the New Zealand dairy industry and the economy. Rapid growth requires substantial levels of investment in infrastructure, support services, marketing research and technology.

Yarrow's, a Taranaki institution is a classic case of outside capital adding value to your industry, and here in new Zealand, largely because it uses less dairy product than the 30% licensing threshold. They can therefore get on with the job without political interference. There is huge potential to grow our industry with others capital, skills technology and market access.

Capital constraints are not exclusive to the dairy industry. Demutualisation is sweeping across the insurance industry in an attempt to attract new capital and to grow rapidly in a very competitive market.

The industry lacks transparent, market-driven performance indicators. While comparisons can be made between manufacturing co-operatives, the Dairy Board, which contributes the bulk of farm payout, has no competitive benchmark organisations.

The incentives can be perverse. While farmers are the owners and chief source of capital, this isn't properly recognised. Current payment systems encourages extra production. Ownership needs to be better identified with a tradeable asset or share. Much, if not a majority, of a dairy farmer's wealth is now off the farm, but largely invisible, unavailable, inaccessible and not managed with adequate accountability. It does not allow you as business people to redirect your own capital to where you might get a better return. It simply takes it away from you prior to your final payout.

While they may own the industry, farmers themselves have little direct control. Apart from trying to voice concern at Dairy Company meetings, they have no way to influence management. In most industries the option of redirecting your investment is a very strong way of ensuring accountability on a daily basis.

Management does not have an ownership stake. Normal business incentives do not fully operate. As farmers, you might behave differently if you did not have an ownership stake in your business, or had less external competitive pressures.

Your biggest competitors market a range of products from milk chocolate to coffee through their marketing infrastructure. Is your asset underutilised?

Why can't you sell an apple or kiwifruit through your structure to the same supermarket you sell cheese to? It is like running two separate trucks to deliver toothpaste and mouthwash to the same supermarket. Why do we require vertical segregation by agricultural product line from this country when it doesn't make economic sense?

It creates very big risks when the industry gets it wrong, for example this year's forward exchange decision, and the decision to hold on to stocks when prices were very high a couple of years ago. You totally underwrite those risks, and simply receive a lower payout once the cost has been deducted. The main way you have to control your current risk is to sell the farm.

The Vision:
To have a constructive debate on how to solve these problems we need to know what we want to achieve. What is the vision? What is my revolutionary thinking. I want a dairy industry:

where your hard work counts, and is rewarded;
where you have control over your capital and earn a good return from it;
where your standards of living improve, not decline;
that encourages innovation and attracts capital so that we can capture the maximum value from the consumer in the international market place;
that is focused on commercial performance and not distracted by politics;
that is market driven and has the right incentives;
where you don't underwrite all the risks;
where you don't just take a residue payment after everyone else has subtracted their costs and profits;
that is out of the commodity trap and provides more value added jobs within New Zealand;
that your sons and daughters will want to join to build on your efforts.
So how can we get such an industry?

A possible solution:
So how do we improve things? How do we build from our current base to improve the business of dairy? I am pleased there has been debate on future structures over the last year and different models have been suggested. In the last budget the government announced that it was giving the producer boards the opportunity to develop planes to enable the respective sectors to capture more value for the farmer and grower without the handicap of politicians in Wellington. You as Dairy farmers need to take that opportunity.

It is important with any change that if at all possible we maintain the existing marketing infrastructure and support services. I don't want the current marketing, infrastructure and support services broken up for the sake of it. Such a change could result in New Zealand losing marketing opportunities in the short term until the industry adapted to the significantly different export marketing structure. Rather I wish to see the current statutory single seller handicap removed to get the industry responding to the market not central government politics.

Any structure, if it is to succeed commercially, must be market driven. As the Dairy Board's Operations manager, Mr David Pilkington, said last recently in the NZ Herald, "No matter what the industry evolves to it has to become much more commercial. We have driven down the cost side but the natural evolution of where we are going is the real world of commercial principles" ( NZ Herald 4 March page E7). I agree 100%.

When we talk about structure it is important to remember that structures are a means to an end, not the end themselves. Dairy farmers should not be subservient to structures. Rather it is the structure that should be the servant of its owner - the dairy farmer. Can dairy farmer say that this is the case currently?

So where does this lead us? The dairy structure involves three aspects; Government regulatory structure; ownership/control structures; and the internal dairy industry procurement structure (e.g., the cost model). I will look at each briefly in turn.

Government Regulation

In the budget the Government has asked the dairy industry to come up with a process to remove the current political framework which constrains it.

The Board as a corporate would have no statutory functions or hindrances.

It should operate on purely commercial principles, driven by the market place, paying a dividend to shareholders for the use of their capital.

Remove the requirement of the Corporation to purchase all export product.

Other people with good ideas, technology, capital and trade relationships would no longer be outlawed from investing in, and adding value to, New Zealand's dairy produce. Nor should they require a licence.

There should be commercial incentives, not compulsion to supply.
Ownership/Control

my own view would be to reduce dairy company shareholdings in the new Corporations to 51%. This would ensure initial majority indirect farmer control. However, the dairy companies may ultimately want to sell down their shares if it made sense to do so.

The other 49% would be put directly into the hands of dairy farmers. These would be floated on the stock exchange and could be freely traded. This would be in a similar manner to the successful Telstra float in Australia recently, West Farmers or that of Kerry Dairies of Ireland a decade ago.

The Dairy Companies could possibly be structured in a similar manner, if that is what farmers wanted.

If farmers decided to keep their shares, they would of course, collectively control 100% of their current industry assets. However, farmers themselves would make their own decisions on much of their own off - farm capital. They would be able to spread their risk.

Additional equity could be raised from outside the industry.

Farmers would receive 3 revenue income streams; a payment for their milk product, a dividend from their shares in their local processor, and a dividend from their shares in the new Dairy Corporation.

Any capital gain from land or shares in beyond farm gate assets could be realised separately.
This would enable farmers to own as much of their current industry assets as they chose to, while giving them options on where they invest their capital and how they wish to receive income. It also allows them to benefit from alternative sources of capital, ideas and trade relationships.

This would also enable top management of the various companies to be offered a stake in the company that they manage, therefore giving them added incentive to perform, rather than just be salaried employees.

Internal industry structure
The cost model is already being changed to be more market orientated, to reduce the huge incentive to produce commodities, and to reduce the cost of carrying large stocks.

Anchor General products Manager, Ross Townsend said recently in the NZ Herald that the present system where dairy companies were paid according to industry agreed standard cost models encouraged 'feral' behaviour.

"There is the opportunity for dairy a company position being taken, not an industry one," he said.

The present system also did not deal well with dairy company innovation and was not representative of best commercial practice he said. But the new payment system, which will be progressively introduced from June 1 would move returns much closer to market reality rather than the present cross-subsidisation of different milk products.

Mr Townsend said that the current approach had led to "the wrong plant being built for the wrong reason." He said "None was catastrophic but we needed to develop a set of tactics which were less obstructive than what goes on now and which would put more money in farmers' pockets."

With the new payment system products will be divided into 10 commodity groups for which a free alongside-ship price will be paid to dairy companies.

But a mere 6 percent were in the innovative product category where companies would be able to negotiate joint venture profit sharing arrangement with the Board.

"If we are serious about innovation this level is a message all on its own," Mr Townsend said.

From what Mr Townsend says, the new model is progress in the right direction. But I would suggest that the commercial marketing company needs to have an independence from its processing suppliers to act on the basis of the market for its shareholders, rather than its processors. This is perhaps the key difference from the current proposal before the industry

Any new internal industry structure should be set up as an umbrella organisation which would allow takeovers of processing facilities to occur in return for new shares issued to farmers or other owners. Alternatively, processing companies may prefer to sell product through the Corporate on a commission or other form and retain their independence.

Conclusion:
You as dairy farmers need to consider all your options. This is a rough outline of a structure to which the dairy industry could evolve quite quickly. This model enables farmers to build a profitable future from the current base. It will free up the existing Board from existing constraints and allow it to utilise its recognised skills and expertise to grow and harness new opportunities.

I believe that the timetable for change needs to be sooner rather than later. Each year that goes past is another year of falling behind.

As Sir Dryden Spring says it has taken over 15 years of concerted effort to get total branded consumer sales to the same level that volume increased by last year, that is just 20%. And as Ross Townsend says of having a mere 6 percent in the innovative product category under the new payment system, "If we are serious about innovation this level is a message all on its own."

For those of you who want to retain a "single seller", I would suggest the best and most profitable single seller isn't one forced by politicians but one based on commercial performance. One based on innovation, value added, "a brand" that is highly desired by consumers who are prepared to pay a premium.

Unfortunately politicians cant legislate for higher commodity prices as the price decline of commodities over the years shows. The current statute and its single seller is a major handicap weighing down the dairy industry's prospects, keeping us low cost commodity producers.

If we are to prosper, we now need to make changes so that we can quickly capture a higher return of the 80% of product which is currently sold as commodity or to other manufactures to add value.

I want to congratulate the Board on their efforts to now focus on the future without the handicap of central government politics. I know that like me they want to work towards a stronger and more profitable industry for the benefit of New Zealand's 15,000 dairy farmers.

The status quo leads to peasantry. I believe that the dairy industry has a rosy future if it addresses the challenges and opportunities that it faces. The choice is yours.