Proposed Dairy Mega Merger
Farmers are due to vote soon on what would be NZ's biggest business deal - the creation of a huge dairy mega co-operative made up of dairy giants Kiwi Co-operative Dairies (Kiwi), the NZ Dairy Group (NZDG), and the dairy industry's marketing arm, the NZ Dairy Board (NZDB). It's hoped the new company (tentatively called Global Dairy Company - GDC) will be up and running by September this year.
GDC would be the world's 14th biggest dairy company (accounting for 95% of the NZ industry) and NZ's only company of truly global scale. With estimated revenues of more than $US5 billion, GDC would be about one-third the size of the biggest, Swiss-based Nestle, and in the same league as French company Lactalis and British/Dutch giant Unilever.
The new co-operative would be responsible for around one-third of internationally-traded dairy products, more than 20% of NZ's total exports, and nearly 7% of the gross national product. In addition, the new company would hold a virtual monopoly on the purchase of raw milk from farmers, and the wholesale milk market. It could also affect every NZer, as spending on dairy foods represents 9.6% of an average household's daily food bill.
As a private company, GDC's success or failure would be in the hands of its shareholder farmers (note: the vast majority, but not all industry farmers, would be part of the GDC conglomerate), employees and management, and it would be the company's shareholders that would enjoy the fruits of its successes and bear the costs of its failures. This is a big change for an industry that has been tightly regulated for the last 50 years; so what lead to this momentous change?
Background
The dairy industry is NZ's largest exporter of merchandise products. In the year to June 2000 dairy exports were $4.8 billion, or 19.4% of total merchandise exports. The performance of the dairy industry has significant implications for the NZ economy as a whole. The industry has a number of separate (but related) components:
- about 14,000 dairy farmers, who produce milk and own all shares in dairy co-operatives (in proportion to their supply of milk to the co-operative);
- four dairy co-operatives (two major and two minor) who collect raw milk and process it into a variety of products and commodities, and who own all shares in the NZDB (in proportion to their supply of products to the Board);
- the NZ Dairy Board, which is the statutory single-desk exporter of dairy products, and which owns a number of offshore companies and joint ventures dealing with both NZ and non-NZ sourced dairy products (a single-desk exporter model, as the name implies, is based on one organisation having total control over the marketing and selling of export products);
- the wider food processing industry that uses dairy products and adds value to them; and
- dairy industry cluster companies, such as agritech, software, machinery, and advisory businesses.
The NZDB was established at a time when NZ had many small dairy co-operatives, very few of which had the scale or expertise to market internationally. Over the past 50 years, mergers have continued until the industry is now dominated by two very large co-operatives: NZDG currently owns 58% of NZDB, and Kiwi owns 38% of NZDB.
Globally, too, the industry is facing up to some big issues:
- Consolidation of customers and competitors: Internationally, retailers and manufacturers are consolidating to form immense businesses with increasing market power. This is tending to drive down producer returns (supporters of GDC would argue that one big producer company like GDC, has more clout than a number of smaller players, when negotiating with retailers/manufacturers).
- Market access: Most dairy products worldwide are sold in their domestic markets, rather than being exported. Because of trade restrictions NZ dairy products are effectively 'excluded' from around 95% of the world's dairy markets.
- Differentiating products: Commodity dairy products (e.g., milk powder, bulk casein, butter, etc.) are characterised by their cyclical nature (the usual demand and supply cycle is something along the lines of: demand for product, more production to meet demand, oversupply of supply, drop in demand, drop in prices, fewer supplies, rising product demand, etc., etc.) and falling returns over time (for commodities, generally, efficiency gains coupled with more countries producing these 'basic' goods, leads to lower prices and diminishing returns). The future success of the NZ dairy industry will depend upon its ability to create competitive advantage for its products on some basis other than commodity price.
- Growth strategy: The NZDB, NZDG and Kiwi are each investing in overseas dairy companies, particularly in Australia and South America (supporters of GDC would argue that one big company is better able to invest overseas).
- Single desk: concerns that the single-desk model (which has regulated the industry for the past 50 years or so) is out of date in today's world and is actually impeding the industry's development.
Generally, the industry believed that a merger of all NZ's major dairy assets was the best way to address these issues, by: being representative enough - of the industry - to bring about major reform, retaining advantages of size the industry has already achieved, and providing a large and stable financial platform to pursue aggressive offshore investment strategies. The question was how to go about it?
No Easy Path
In the 1998 Budget the former Government announced that all statutory producer boards, including the NZDB, should provide the Government with plans for deregulation. The dairy industry's response was to propose the so-called 'MergerCo', in which at least the two largest dairy co-operatives would merge allowing the operations of NZDB to be integrated into the new company.
In 1999 these proposals were put to the Commerce Commission (the main role of this government 'watchdog' is to ensure that market structures and market practices are consistent with competition). In August 1999 the Commission found that the detriments of the proposed merger significantly outweighed the benefits to the public, and posed 48 questions, which the industry avoided having to answer by withdrawing its application in September 1999.
Despite the failure of the initial merger application, NZDG and Kiwi continued private merger discussions for much of 2000. They developed a new merger proposal with the working name of the 'Global Dairy Company' (GDC). This new company was proposed again just before Christmas 2000, when the industry asked the Government to help it bypass the Commerce Commission (mainly because it was felt that the new proposals probably wouldn't gain Commerce Commission approval). The proposed merger package was discussed in Cabinet during January 2001.
On 9 April it was publicly announced that Cabinet approved the request to exempt the merger proposal from provisions of the Commerce Act (in other words, it wouldn't have to go to the Commerce Commission). The proposals were due to go to farmers to vote on 12 May, but, the vote has been delayed (at least partly because of disagreement over who would be the CEO of the new company). The vote is now expected to take place in June. To pass, the proposal needs the support of 75% of farmers.
Checks and Balances
In deciding to waive Commerce Commission approval, the Government had to balance a number of potential risks and benefits. These potential risks include:
- because GDC would have an effective monopoly in a number of important NZ markets, including the purchase of raw milk purchased from small farmers, it makes it all too easy to exclude potential competitors - even if GDC became quite inefficient;
- inefficiency and company 'smugness' could result from a major competitive advantage of GDC - that NZ farmers produce very low cost milk by global standards (this, potentially, could mean that GDC would be able to meet sales and profits targets largely through reducing returns to farmers, rather than through innovation and efficiency gains);
- creating GDC will, in effect, mean that the entire NZ dairy industry has "all its eggs in one basket" with only one strategy - GDC's (when evidence shows that the existence of a number of different strategies has benefited the industry in the past).
At the end of day, though, Cabinet decided the merger would produce greater net benefits than the current industry structure, polarised around two competing companies. But the industry didn't get all its own way, and Cabinet imposed a number of conditions in return for its waiver. These conditions included that:
- farmers are allowed to sell up to 20% of their milk to a rival company without being discriminated against by GDC;
- GDC is required to supply up to 400 million litres of raw milk a year to its NZ competitors at a fair price;
- the company is required to accept all milk offered to it (this would prevent GDC from manipulating its share price and payout for milk);
- sharemilkers, who make up 40% of the industry, are for the first time allowed to buy shares in
- GDC's share price must be the same at any time in any region, for both new entrants and exiting farmers;
- 50% of domestic Anchor flagship company NZ Dairy Foods must be sold (this is to ensure domestic competition);
- existing 'niche players' such as Tatua and Kapiti Cheeses are allowed to export freely (under the old system these companies had to apply to the NZDB to get an export permit);
- in 6 years, GDC is expected to lose its present monopoly access to NZ preferential tariff quota in markets for dairy products (perhaps not surprisingly GDC had requested that this access to the export quota should be maintained in perpetuity); and
- if the merger goes through, GDC will have to meet the full disciplines of the Commerce Act, which don't apply to the NZDB.
If farmers approve the merger, legislation will have go through the parliamentary system, including a full select committee process (which should take about 3 months).
Contact for Enquiries
The Ministry of Agriculture and Forestry
Pastoral House
25 The Terrace
PO Box 2526, Wellington
Tel: 0800 00 83 33
Fax: +64 4 894 0720
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