Tradable slaughter rights idea useful but may not be the answer

The Tradable Slaughter Rights concept, raised by me several weeks ago and promoted last week by Mike Petersen, was first proposed by Pappas, Carter, Evans and Koop in 1985. But its purpose was specifically to solve the problem of an industry that consisted of a lot of weak competitors with little innovation or variation in killing charges. The report identified excess costs between farmgate and shipside of $100 million or 8%.

Although the meat companies are not exactly making huge profits or enjoying strong balance sheets, it would be entirely false to accuse them of lack of innovation and high operating cost structures. What is still relevant is the issue of excess capacity, but the end result today is not too much cost, but too much procurement competition.

Of course surplus capacity produces too high an industry cost structure with too many overheads handling too little livestock. But the main problem for the industry as a whole is the volatility of farmer returns, when seasons swing wildly between grass and drought driven market conditions.

The TSR proposal, rejected by the industry 28 years ago, could have solved the industry’s capacity problems then, but it has some fish-hooks for the meat industry of today. PCEK also noted it had no mandate to propose solutions for the weakness of New Zealand’s international meat marketing. However it did note the two key challenges for the industry: to reduce the cost of delivery to its markets and develop products to satisfy changing consumer tastes.

A reading of the PCEK report shows the strategy’s main objective was to facilitate the reduction in the number of plants around the country. It was a plant specific rather than company-focused strategy which was designed to allow the closure of inefficient plants, financed by the sale of slaughter rights equivalent to the market share of each plant.

Although not explicitly stated in the report, the expectation was for a particular company to decide to sell its slaughter rights for a plant to a competitor. Although PCEK envisaged TSR transfer between plants in the same ownership, this already happens as a normal part of business decision making as shown by Alliance’s decision to close its Mataura sheep chain.

It is less clear how the TSR model would work under today’s very different farming environment and industry structure of multiple plant companies operating two or three shifts, supplemented by efficient single and two plant competitors. The livestock population has decreased and changed considerably since 1985. The biggest changes have been the massive reduction in sheep and lamb volumes and the increase in dairy farming, particularly in the bottom half of the South Island.

The attraction of tradable slaughter rights was its potential to minimise the exit costs for an individual company which would receive a sum of money from the purchaser equivalent to the market share processed through the plant in question. The retired plant and stockyards would then be demolished. The calculated TSR rate would desirably cover the costs of asset writeoff, redundancy and remediation for the vendor, while providing an economic return for the buyer.

After my initial enthusiasm for the concept of TSRs, I now struggle to see how it can be modified to suit the current industry problems. I understand the meat company group has considered among other things how TSRs could provide a solution to the issues of volatile prices, but have no knowledge of its conclusions.

In contrast to the situation in 1985, the meat industry is now efficient and it has very good international marketing networks; farmers generally receive a price for their stock which reflects market conditions, always recognising there is more volatility than is ideal. The exchange rate and international trading conditions are more important factors than the structure of the industry. Therefore overall improvements are more likely to be at the margins than the outcome of fundamental restructuring.

The MIE group’s five point wishlist consists of three structural items – one company with 80% of the stock, government backing for the restructure and farmer responsibility for restructuring costs with help from the banks – but solving the real problem can only come from achieving the other two items on the list, change in farmer supply culture combined with transparency and equality of procurement prices.

If the last two don’t change, it is likely the industry would revert to the same state in a few years. This is the hardest part, but it rests entirely in farmers’ hands. If all farmers refuse to deal on the spot market or to send stock to a company that applies differential pricing, the problem would go away.

It isn’t necessary for farmers to sign a contract or commit to fixed pricing; instead they should have a frank discussion with one or more processors, negotiate and agree mutual expectations of the relationship which both parties would stick to. Both parties must be prepared to terminate the relationship in case of default.

This won’t happen quickly, but the sooner the process starts the better.

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Tags: Alliance Group, livestock procurement, Mataura, Meat Industry Excellence Group, Mike Petersen, Pappas Carter Evans & Koop, slaughter capacity, Tradable Slaughter Rights