Fonterra’s Auction System Destroys Milk Powder Price

Fonterra launched its new whole milk powder internet auction system in July claiming it would provide an objective market price and would be to the benefit of New Zealand’s dairy farmers. Unfortunately it appears to have had just the opposite effect, because prices at auction have fallen by up to US$1700 over the period.

Fonterra which claims to control 40% of world trade in dairy products now justifies the auction system by saying the market, not the company, sets the price. But when you realise the starting price for each monthly auction is 15% lower than the lowest price obtained in the month before, it doesn’t take too much imagination to work out that Fonterra is guilty of leading the market down by setting an artificial price cap. Because of the global credit crisis which has been an important factor, the incentive for buyers to bid up the price and buy large quantities is just not there when demand is sluggish. So they buy less than they normally would, allowing inventories to build confident in the knowledge that next month’s price will be cheaper!

The net effect of all this has been to see the price drop from as high as US$4300 in July to less than US$2600 in November, equivalent to a $3 per kilo loss in payout or at least $2 billion of farmer income.

Criticism of Fonterra’s auction system has been universal, with nobody being in favour apart from those customers who have picked up cheap inventory without effort outside a contracted supply agreement. Westland Dairy Cooperative which posted an all time record payout of $8.29 per kg of milk solids, compared with Fonterra’s $7.90 including 30 cents retained, reckons this season could see at least a $2 fall and blames Fonterra’s auction system for part of this. Dairy Australia  is also unhappy at what it sees as unnecessary price reductions because buyers have no incentive to buy at higher prices in the lead up period to the auction, preferring to wait for the auction to set the new price.

There are clearly two diametrically opposing views: Fonterra says its system provides transparency more quickly and prevents volatility, while its competitors reckon the company has become a laughing stock among global customers and has successfully destroyed the market price. Fonterra appears intent on sticking dogmatically to its auction strategy, defending it by reference to global credit crunch and tighter markets. How long before its shareholders really get serious and hold the board to account?

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2 Responses to “Fonterra’s Auction System Destroys Milk Powder Price”

  1. Simon Says:

    Apart from John Key holding a kitten on the steps of parliament, the Fonterra / San Lu milk powder scandal has been the only news about New Zealand to make the English papers in Japan. If the volume of headlines are anything to go by, food safety is to the Japanese what terrorism is to Americans.

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