Briefing for the Incoming government on the dairy industry
Executive Summary
1. There is a tremendous amount at stake for New Zealand in the future of the dairy industry.
2. While NZ dairy farmers are widely regarded as the being the most efficient in the world, it is generally accepted that the industry now faces significant challenges. Farmers’ net incomes have declined significantly over the last decade and returns on investment are poor. Further, the industry continues to rely heavily on unbranded products whose prices are volatile and trending downwards.
3. In response to these challenges, dairy industry leaders have proposed establishing a “Mega co-operative” integrating most, if not all, of the processing co-operatives and the Dairy Board into a single company.
4. After negotiations with the industry leaders, the Government passed the Dairy Industry Restructuring Act (DIRA) in September 1999. The Act addresses the key public policy issues relating to the Mega co-op, including tax, quota and industry good issues and the removal of the single desk. The Act only comes into effect if the Mega co-operative is approved by farmers and authorised by the Commerce Commission by 1 September 2000.
5. If, however, the industry cannot agree on merger terms that are also acceptable to the Commerce Commission, the DIRA will not come into effect. If this happens there may well be demands on the Government to provide an exemption from the Commerce Commission process for the industry. We would strongly argue against any such exemption as it would expose farmers and domestic consumers to an entity with considerable market power, have a dangerous precedent effect for other industries and harm the domestic and international credibility of New Zealand’s competition policy.
6. Options if the DIRA does not come into effect include maintaining the status quo or revisiting specific elements of the DIRA. Maintaining the status quo, however, is not a viable option given the challenges facing the industry.
7. The most viable option in the absence of a Mega co-operative would be to move the industry to operate under general competition and governance law, based on the current industry structure of effectively two very large co-operatives. Such a step could offer significant advantages to farmers and the NZ economy if the industry was opened fully to competitive pressures. In particular, it would enable the industry to capture the benefits of vertical and horizontal integration while retaining the current advantages (such as benchmark competition) of having more than one major domestic processor.
8. This ‘two company’ option is likely to be a less risky strategy than the single Mega co-operative model, which effectively places all the industry’s eggs in one basket. The implications of this option for the Dairy Board and for the tax and quota elements of the DIRA would need to be worked through thoroughly.
Introduction
9. This briefing describes:
· the structure of the New Zealand dairy industry, its economic prospects and relevant international trends;
· historical and current roles of the New Zealand Dairy Board;
· the drivers of change in the New Zealand dairy industry;
· recent industry changes, and the current state of play on proposals for industry restructuring; and
· the industry’s options for change and the choices faced by the Government.
The Dairy Industry in New Zealand
10. There are approximately 14,700 dairy farmers, mainly in the Waikato and Taranaki areas, but with significant recent expansion in Southland.
11. Dairy farmers are currently grouped into:
· Three Main Co-operatives:
- New Zealand Dairy Group 58%;
- Kiwi 27.8%;
- Northland 8.6%;
· Five Smaller Co-operatives:
- Westland 2.5%;
- Tasman 1.5%;
- Tatua 0.8%;
- Marlborough 0.5%;
- Kaikoura 0.3%.
The percentages relate to shares in the Dairy Board and exclude supplies to smaller liquid-milk supply co-operatives that are not part of the Board structure.
12. NZDG and Kiwi dominate the domestic milk market. The only other North Island supplier is Northland (now merging with Kiwi and also involved in the mega merger). In the South Island there are other small producers but these largely sell under franchises. The liquid milk market is dominated by national or island-wide supply agreements with supermarkets and petrol stations. The dairy co-ops are the only significant producers of products such as cheese and yoghurt.
13. New Zealand dairy farmers have steadily expanded production through more efficient methods and farm aggregation, to maintain profits in the face of declining prices.
Overseas Trends
14. Huge retail chains dominate overseas markets. These chains require sophisticated management of their supply chains to minimise costs and to meet growing pressure from consumers on safety and environmental issues. Competition on the supply side is dominated by large domestic co-operatives and firms such as Nestle or Parmalat who expand mostly by buying into new countries.
15. Most of New Zealand’s dairy exports are general products that earn little or no brand premium but, apart from quota and similar markets, most profits internationally are in branded specialist products.
16. New Zealand represents a very small share of total world production and consumption of dairy products. Although New Zealand’s share of traded dairy products is higher, this does not translate into an ability to affect world prices.
The Dairy Board
17. The Dairy Board was originally responsible for co-ordinating overseas sales by a large number of small co-operatives serving strictly local collection areas. These small co-operatives were concerned to counter-balance the power held by the middlemen in overseas markets - effectively Britain. The Board was in a very strong position given its advantages in resources and information and the lack of a formal share structure to define its ownership.
18. The Dairy Board’s position is now weakened because of domestic consolidation. Domestic consolidation has created three major producers/shareholders. The continued exercise of the Board’s allocation powers for production of high-value products now clashes directly with the interests of each of those companies, creating potential conflicts for its directors. The Dairy Board Act prevents resolution of these clashes because no company can elect a majority of the Board or buy any other company’s shares without a full merger.
19. The Board’s role is also weakened by the greater range of overseas markets into which New Zealand’s dairy products are now sold. As a result, the uncertainty that was always present about whether the Board has any market power to influence prices is stronger than ever.
20. Further, the current legislation imposes weak governance on the Board, limits the Board’s access to capital, requires the Board to have multiple objectives (as both an exporter and regulator) and limits the scope for innovation in the industry.
21. In essence, the current legislative structure for the Board, rather than being a solution, may now be a problem in itself. It impedes the ability of the industry to adjust and compete in a much-changed international market.
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