Tatua result and forecast cast doubt on Fonterra’s strategy

Tatua’s amazing final payout of $9 a kilo of milk solids, trumping Fonterra’s $8.40 (admittedly after adjusting the milk price calculation) is just one element of an impressive performance by one of New Zealand’s most consistent performers.

 

The forecast of $6.50 for the current season compares with the recently adjusted $5.30 announced by Fonterra. It may not survive the vagaries of the season, but then neither may Fonterra’s significantly lower number.

 

Tatua also announced an increase of 10 in supplying dairy farms, rising from 109. Presumably the company won’t have any trouble filling this new requirement, because being selected as a Tatua supplier must be a bit like being picked as a permanent member of the All Blacks. The only problem is to qualify the farm has to be in a very small part of the Waikato within reach of the plant.

 

At a time when Fonterra’s sheer size casts doubts on its ability to add value to its product range, not least because its cooperative members expect maximum payouts, Tatua is a great example of a small niche company which has built its business on value added products.

 

It is not easy to be in Fonterra’s shoes: it must collect, convert into product and market the output of more than 10,000 dairy farms. Tatua in contrast has only a fraction of this number of farms and, if it needs more milk at any time, it can apply for an allocation under the provisions of DIRA. Synlait is an example of a well structured niche player in the South Island which has been successful because, not in spite of, its size.

 

But the suspicion remains, Fonterra’s scale may be both an advantage and a curse. It is very difficult to convince members they should be willing to forego payout in exchange for investment in brand building, but that may be just what the company should do, if it wants to compete with the big consumer goods companies like Danone and Nestle.

 

In the interest of ensuring above board milk pricing and the preservation of fair competition between dairy companies, Fonterra must calculate its milk price based on the milk price manual. This involves using a basket of commodity reference products such as whole milk powder and skim milk powder and their by-products, but excludes lower value products such as cheese. These price calculations are closely linked to Fonterra’s monthly global dairy trade auctions which have incidentally been dropping like a stone in recent months, since unrest in the Ukraine, resulting Russian trade embargos on European product, and a slowdown in China purchasing.

 

However the fact remains, Fonterra is heavily bound and constrained by commodity markets and their price structures. Fonterra claims with justification that it is a major world supplier of ingredients, not so much a branded goods marketer. But a report just released shows Fonterra to be lagging way behind its major consumer goods competitors in spite of its production capacity.

 

It has become axiomatic for the dairy industry to be held up as a model of how an agricultural industry should be in contrast to the meat industry. The cooperative nature of dairy, purely because a dairy farmer’s milk must be collected every day, has compared very favourably with the competitive nature of the meat industry. Higher payouts have merely served to confirm this viewpoint.

 

But it looks as if the dairy industry has its own particular problem which is how best to convert what it produces into something worth more than just a commodity.

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