Fonterra’s restructure more about poor strategy than milk price

When Fonterra was formed back in 2001, there was a great sense of optimism about the potential for a New Zealand dairy company to compete on a truly global scale. The industry’s infighting and parochialism would be a thing of the past and the clear intention was to use the greater efficiencies and scale to create a substantially better performing business model.


The big question 14 years down the track is whether that objective has even remotely been achieved. Fonterra is the world’s leading exporter of milk products and the fourth largest dairy processor, so achievement to date appears consistent with the objective. But for many observers there was another, more ambitious expectation: to establish an internationally competitive value added business to compare and compete with Nestle and Danone.


An examination of the dividend from Fonterra’s value added business unit, no greater today than it was 12 years ago with some peaks and troughs in between, confirms the failure to achieve this strategic intent. This begs the question why this is the case. Unfortunately this would have required a different shareholding structure and vision, far more capital and a much earlier start. It was never realistic.


Unlike the two international consumer food giants, Fonterra remains firmly exposed to exchange rates and global commodity cycles, apparently unable or unwilling to transition to a business model based on value added branded consumer products.


When global research group International Farm Comparison Network ranked Fonterra as the world’s leading dairy processor, then CEO Andrew Ferrier said “We may be processing more milk than anyone else, but at 2.7 per cent we still only account for a fraction of the total world milk market. The way we differentiate ourselves is through achieving the best quality, offering the most innovative dairy solutions and delivering product on time to meet our customers’ changing demands. This is our true strength.”


This straightforward statement of strategic intent seems consistent with the cooperative philosophy which dictates a mindset of maximising the milk payout to meet the demands of its farmer shareholders. However the tensions between the commodity and value added business models have never been resolved. Under Sir Henry van der Heyden’s chairmanship, the company tried to move to a dual structure with one part being open to external investment and listed on the NZX; this business unit would buy its raw material from the farmer owned milk processing unit for conversion into sophisticated value added ingredients and branded products.


History demonstrates Fonterra’s shareholders were totally against the concept of outside investment in their cooperative and much energy was expended on coming up with the parallel concepts of Trading Among Farmers and investment units for external investors which would set the share price for TAF.


Unfortunately this has proved singularly unsuccessful because the value of the investment units is dictated by the milk price and the dividend by the success of the value added part of the business. The current share and unit price are at a historical low because of the milk price, while the dividend has failed to rise contrary to expectation.


Fonterra has fallen between two stools because it has attempted to follow three business strategies: processor and marketer of commodity milk products, ingredients supplier to consumer goods and food service companies, and brand differentiated marketer. Each of these strategies requires a different set of skills and competencies. The commodity business needs operational and logistical excellence, high quality ingredients require product development and technological competence, and consumer goods demand world class marketing and brand building capability.


The recently announced management restructure, resulting in an initial reduction of 523 staff and savings of $60 million with more to follow, indicates an overhead structure that has blown out of control. Without any informed insight into how this has happened, the misguided attempt to follow three distinct strategies under a single company structure has inevitably necessitated an unsustainably large headcount. This excessive level of staffing has led to an equally excessive number of highly paid managers with 17 earning over $1 million and 4,000 or 22.5% of staff worldwide earning over $100,000.


These figures wouldn’t necessarily indicate inefficiency, provided they delivered value to both classes of shareholder. Current performance indicates this isn’t the case which is why McKinsey has been brought in to recommend structural improvements. The word from CEO Theo Spierings is the job cuts in finance, IT and HR will enable greater market investment in the international market with more customer interface.


Without having enough information to judge, the proposed solution gives no confidence the strategic review has addressed the underlying problems. The present company business model is clearly not working and must change, firstly to slow or reverse the defection of suppliers which has seen Fonterra’s share of milk production fall from 95% at merger to 86%, and secondly to resolve the conflict between farmer shareholder interests and capital requirements.


The inherent contradiction between cooperative ownership and investment outside the farm gate can only be properly resolved by separating the one from the other. If farmers want to hold an investment in research based ingredients and branded, value added production, this should be a separate investment decision in a separate vehicle.


The first step should be a decision by the Board to look seriously at whether TAF and the investment units are actually achieving the desired outcome; if not, as I would expect, the next step should be to establish Fonterra Processing and Fonterra Brands, as suggested several years ago by Professor Keith Woodford. Only then will the two parts of the business have the chance to grow without mixed market signals and conflicted shareholders.


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3 Responses to “Fonterra’s restructure more about poor strategy than milk price”

  1. Grant Says:

    Fonterra, like the prices, is just repeating a cycle without any attempting to address the pricing problem. McKinseys were the consultants used when Fonterra was formed from Global Dairy Co and were used 8 years ago when 1,000 staff were made redundant it a much less public restructure.

    Even in the Dairy Board era the issue was, and continues to be, that farmers are paid to produce low value milk (that is milk that must be expensively dried to remove water and then reconstituted to be useful). Until Fonterra farmers decide how to get paid from the success of overseas investment and production without producing more milk for expensive dehydration they will continue to be commodity price takers. What are they going to do when the Chinese market moves up to fresh milk?

  2. Rural round-up | Homepaddock Says:

    […] Fonterra’s restructure more about poor strategy than milk price – Allan Barber: […]

  3. Keith Woodford Says:

    Hello Allan
    We have similar views. However, my recollection in regard to the following comment is somewhat different:
    “Under Sir Henry van der Heyden’s chairmanship, the company tried to move to a dual structure with one part being open to external investment and listed on the NZX; this business unit would buy its raw material from the farmer owned milk processing unit for conversion into sophisticated value added ingredients and branded products.”

    My recollection is that there was to be just the one operational business unit, listed on the NZX, but with the co-op holding a controlling share. But there was no plan to have a separate ‘farmer owned milk processing unit’. In essence the co-op would have just been an ownership shell which controlled the NZX-listed entity but without operational activities.

    If there had been such a separate processing unit owned by farmers, and which produced commodities (raw milk, powders, and bulk cheeses; maybe even specialised ingredients but definitely not branded products owing to the high capital requirements for branding), then it could have worked. However, history has shown that setting a fair milk price in a monopolistic situation is more than a little complicated.

    In essence, TAF has all the same weaknesses that the Van der Heyden model had, but TAF has a few more frills around the outside. Those frills were enough to convince farmers that it was a good idea.
    Keith Woodford

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