Overview of the Summary of Submissions: Review of the Dairy Industry Restructuring (Raw Milk) Regulations
Clarifying industry concerns and the Regulations' intent
The following is a summary of 39 submissions and the feedback from nine consultation meetings on the Ministry of Agriculture and Forestry's public discussion document Review of the Dairy Industry Restructuring (Raw Milk) Regulations: Clarifying Industry Concerns and the Regulations' Intent (released 12 November 2007).
The objectives of the first stage of the review were to:
- clarify the intent of the Dairy Industry Restructuring (Raw Milk) Regulations (the Regulations), based on the purposes and intentions set out in the Dairy Industry Restructuring Act 2001 (the DIRA);
- canvas the full range of industry concerns about the current operation of the Regulations, so that these can be assessed against the Regulations' intent.
The discussion document sought feedback in four broad areas:
- regulatory objectives;
- access to milk;
- the regulated (default) price; and
- unregulated milk.
Additionally, submitters were asked to provide an overview of their main concerns in relation to the regulations and to raise any other issues not covered by the discussion document.
Overall, stakeholders' opinions on the Regulations often differed depending on whether they were sellers or buyers of regulated milk. The summary therefore distinguishes between Suppliers of Regulated Milk (being submissions from Fonterra and Fonterra suppliers) and Independent Processors (including small-medium independent processors, larger independent processors and food and beverage companies).
a) Regulatory objectives
The Regulations were developed in 2001 and aimed to:
- protect the position of those companies that previously bought raw milk from either Kiwi Cooperative or New Zealand Dairy Group (which merged to form Fonterra in 2001);
- protect domestic consumers (through providing raw milk to processors for the domestic market, such as New Zealand Dairy Foods, now Goodman Fielder New Zealand); and
- provide an entry pathway for new players into the milk processing industry.
The discussion document asked stakeholders if the objectives fit with their understanding of the Regulations or whether there were any other objectives that the Regulations should address. Stakeholders were also asked what objectives they considered most important.
Overall, the majority of stakeholders generally agreed with the original objectives of the Regulations. There were questions, however, as to whether the outcomes were currently meeting the intent of the Regulations.
As noted by several stakeholders, the Regulations are part of a wider package that was introduced under the Dairy Industry Restructuring Act 2001 (the DIRA), and need to be viewed in this context. To this end, the Regulations need to be consistent with the relevant policy principle as contained within the DIRA (that is, providing for the efficient operation of New Zealand dairy markets).
Importantly, both Suppliers of Regulated Milk and Independent Processors generally agree with the principle of promoting an efficient market and see this as important in framing the objectives of the Regulations.
Stakeholder opinions differ on how to best promote an efficient dairy market. The most common views include:
- ensuring a fair and efficient price for regulated milk, thus reducing or eliminating any subsidy that under priced regulated milk may create;
- maintaining the certainty of raw milk supply under the Regulations, thus ensuring an entrance pathway to the industry remains open and also allowing for the growth of Independent Processors;and
- establishing greater certainty for the raw milk price under the Regulations, enabling greater precision in pricing of final goods and reducing disputes and the various associated costs.
A number of Suppliers of Regulated Milk submitted that the regulations are no longer required due to new entrants changing the shape of the industry. Competition within the industry has increased since the Regulations have been in place, although this competition has not yet reached the threshold that would trigger the competition package contained within the DIRA to fall away.
Of those Suppliers of Regulated Milk who did see a (limited) role for the Regulations, a high importance was placed on the objective of protecting domestic consumers, and less importance was placed on protecting companies with historical (or recently commenced) purchasing arrangements, or providing an entrance pathway into the industry.
b) Access to milk
The discussion document asked stakeholders to outline their concerns on the certainty of access to regulated milk and on who should be able to access regulated milk.
Many Independent Processors considered certainty of access to milk as a major concern. Concerns can be classed under two broad types:
- Entrance pathway: Access to regulated milk is viewed by many as important tool for facilitating entrance into the industry. Multiple stakeholders considered that without access to regulated milk they would not have entered the market.
- Business models: Sourcing milk directly from farmers is not always viewed as a preferable option, depending on the business model adopted by a particular company. Some processors are too small to achieve the necessary economies of scale or scope to efficiently run their own collection network. Some business models are focused around investing downstream in fast moving consumer products. Without access to regulated milk, or access to other milk at commercially acceptable prices, investment would be required upstream to vertically integrate the supply chain.
Additionally, Independent Processors are also concerned about the:
- need for flexibility and evenness of supply, as fresh products need to be produced throughout the year;
- threat of Fonterra's "tactical pricing" and potential anti-competitive behaviour if Independent Processors attempt to increase supply through open entry/exit of farmers to/from Fonterra; and
- 20% rule (allowing Fonterra suppliers to supply up to 20% of milk solids to an independent processor) being impractical and difficult to utilise.
Most Independent Processors consider that the volume of regulated milk is too low, thereby reducing the certainty of access to regulated milk. Many Independent Processors advocate raising the amount of regulated milk to the maximum 5% of Fonterra Co-operative Limited's supply as permitted under the DIRA.
Independent Processors generally do not favour restrictions on access to regulated milk, whether the restrictions are via time, scale of company, or particular business model.
Of those that do favour restrictions on who should be able to access regulated milk, opinions are extremely varied and there are no clear themes. Suggestions include limiting access based on:
- processors reaching a critical mass (say 10M litres);
- processors supplying the domestic market; capping the number of new processors; and
- processors having their own direct supply of raw milk.
Other opinions from Independent Processors included doing away with the Regulations. The rationale for this is that those who access 'cheap' regulated milk have an unfair advantage against those who source milk entirely from their own supply.
Independent Processors do not favour imposing a time limit on access to regulated milk.
Submissions from Suppliers of Regulated Milk are split between those who oppose any access to regulated milk whatsoever and those that considered there should be some access to regulated milk, but with a variety of restrictions in place. Of those who favour restrictions, the most common restrictions put forward are limiting access so regulated milk is available only to processors who:
- supply the domestic market;
- do not have the scale to efficiently collect and manage the supply of raw milk; and
- do not have their own supply.
There is strong agreement among Suppliers of Regulated Milk that access to regulated milk should not continue indefinitely and that Independent Processors should be encouraged to compete for supply at the farm gate. Several submissions assert that access to regulated milk diminishes competition for milk at the farm gate, and therefore reduces farmers' payout.
c) The regulated (default) price
The discussion document sought opinions on the suitability of the price level of regulated milk, and on price certainty and the potential for price distortion.
The majority of Suppliers of Regulated Milk did not comment on all questions, however all commented on the price level of regulated milk. What appears as the most pressing concern is that they consider the price of regulated milk is too low.
The sale of 'cheap' regulated milk is seen as a direct subsidy to Fonterra's competitors, thus reducing the ability to gauge the performance of Independent Processors and reducing the payout afforded to Fonterra's suppliers. Reasons why submitters consider that regulated milk is cheap include views that:
- regulated milk being used to flatten supply curves;
- the transport component is unfair;
- the price does not include many risks faced by Fonterra and Fonterra suppliers; and
- Independent Processors prefer to access regulated milk rather than increase their own supply.
The majority of Suppliers of Regulated Milk submit that the price should be market level. Other suggestions included that the price of regulated milk should be the Fonterra payout, or the Fonterra payout plus a premium.
Independent Processors were generally less concerned about the price level, often submitting that the formula-derived price is in the right zone. Most submissions wanted the price to remain ‘fair' and ‘reasonable', and to ensure that there was a level playing field across the industry.
Many Independent Processors were concerned about any ambiguity or lack of clarity within the Regulations. Disputes caused by this are costly and reduce certainty for industry participants. Common vies from the submissions included the need for the Regulations to:
- give clarity to the pricing formula from the outset;
- give clarity on contract details for regulated milk; and
- protect the industry from anticompetitive behaviour.
An issue raised by most Independent Processors was the lack of certainty caused by the retrospective pricing regime. In particular, forecasting by Fonterra that they saw as conservative and sometimes inaccurate increases business risk to Independent Processors. Pricing decisions are difficult to make without accurate information on the price of raw milk, as this makes up a substantial percentage of input costs for many products.
Suppliers of Regulated Milk generally submitted that processors receive enough certainty, and in fact receive greater certainty than farmer suppliers. They consider that regulated milk already reduces business risk for processors through removing/reducing supply risk. Any move to increase price certainty, without a general increase in the price of regulated milk, would thereby increase this perceived subsidy.
d) Unregulated milk
The discussion document canvassed views on unregulated milk, in particular issues of price and views on factors that would lead to higher demand for unregulated milk.
Suppliers of Regulated Milk argue that unregulated milk more accurately reflects the costs of production throughout the year. Those who no longer agree there is a rationale for the Regulations submit that all milk should be unregulated.
Independent Processors generally agree that unregulated milk is priced at a level that makes it commercially unattractive, and therefore try to limit the amount purchased.
There are, however, some processors that do purchase unregulated milk. The most common reasons for purchasing unregulated milk include Independent Processors:
- under-forecasting demand and not being able to increase the amount of regulated milk to meet the extra demand;
- requiring milk outside the peak month and not being able to access it due to the 'October rule' (regulated milk required in a month by an Independent Processor cannot exceed by more than 10% the regulated milk required in October); and
- requiring milk in excess of the total individual amount allowed under the Regulations (including the growing demand for organic milk).
Most submissions agree that unregulated milk is for Fonterra to sell as it likes (within the bounds of competitive behaviour), although Independent Processors still want to retain access to unregulated milk.
Other submissions on unregulated milk include:
- all milk should be regulated; and
- 'unregulated milk' should be priced at a fixed premium over 'regulated milk'.
Overview of industry concerns
The most common concerns raised by Suppliers of Regulated Milk can be summarised as follows:
- Regulated milk is subsidising competitors because the price is too low.
- Regulated milk is being accessed by Independent Processors who have their own supply, increasing pressure on the total quantity available and being inconsistent with the original intent of the Regulations.
- Regulated milk should not be a long-term option for cheap milk.
- Suppliers should be competing for raw milk at the farm gate.Suppliers of Regulated Milk are faced with substantial supply risks and these risks are not factored into the regulated milk price.
The most common concerns raised by Independent Processors can be summarised as follows:
- Ensuring certainty and consistency of raw milk supply that will allow for business growth, especially for new entrants and those without own supply. To ensure adequate availability of regulated milk, many Independent Processors favour raising the total quantity available to 5% of Fonterra Co-operative Limited's milk supply.
- There is a general theme among smaller processors that they are more dependent on regulated milk and therefore should get priority access.
- Improving the certainty of regulated milk's final price. This includes addressing retrospective pricing and Fonterra's conservative forecasting. Maintaining a fair price across the industry so that companies are not put at a disadvantage (including against Fonterra Brands).
- The wording of the Regulations needs to give greater certainty and clarity, including the pricing formula and contract conditions for the supply of raw milk under the Regulations.
There were other concerns raised that had not been covered off specifically by the first discussion document. These include:
- the competition thresholds at which the Regulations expire;
- access to, and the quantity of, organic and other specialty milk under the Regulations;
- concern that the winter milk premium calculation does not pass on the full premium and needs to be amended to include the actual premium paid by Fonterra for winter milk;
- a view that the Regulations need to allow for more flexible supply of raw milk outside of the peak months; and concern that there is currently no incentive for Independent Processors to be accurate with their forecasted requirements of regulated milk.
Contact for Enquiries
Principal Advisor
MAF Policy
Sector Performance Policy
Ph: 04 894 0128
Fax: 04 894 0745
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