Cooperative model not ideal for all business types

Cooperatives emerged in the 19th century as an important business structure designed to protect the interests of a group of members, based on the principle of equitable distribution of benefits related to use or supply. The first New Zealand cooperative was formed in 1871 by eight cheese making settlers on the Otago Peninsula; by 1890 40% of dairy factories were cooperatives and by 1925 there were about 500, of which only three remained after the formation of Fonterra in 2001.

 

The cooperative model has continued to flourish throughout the world and in New Zealand and in 2017 the top 40 cooperatives represented 16% of this country’s GDP. Fonterra’s turnover outstripped the rest by a wide margin, its revenue equal to the combined turnover of the other companies making up the top 10. The rest of this group consisted of retail grocery groups Foodstuffs North and South Island, Zespri, Farmlands, Silver Fern Farms, Alliance, Southern Cross, Market Gardeners and Mitre 10, while next came fertiliser companies Ballance and Ravensdown, Westland Milk Products and Rabobank.

 

This list gives a good idea of the industry types best suited to the cooperative model: agricultural production (dairy, meat and horticulture), agricultural inputs (fertiliser and farm supplies), financial services (health insurance and rural banking) and retail (grocery and hardware). From small beginnings, cooperatives have expanded to much larger groups of buyers and suppliers to take advantage of scale.

 

Recent trends suggest the dairy and red meat sector supplier-based as distinct from purchaser-based cooperatives may struggle to realise this advantage.  This appears to be due to highly capital intensive operations, a failure to retain or generate sufficient capital for reinvestment, returning too high a proportion of the product margin to members and decisions to step outside their core business activity which have ultimately proved to be an unwise use of scarce capital.

 

None of this contradicts the intended benefits of the cooperative model or the validity of its primary objective which is to ensure an equitable distribution of profits to members based on use or supply. However the problems facing Fonterra and Westland suggest the cooperative model may no longer be the best fit for the dairy industry, founded and conducted on cooperative principles for nearly 150 years. Equally the red meat industry has experienced difficulties, AFFCO converting from a cooperative with no shareholder funds in 1994 to a listed then privately owned company, SFF having no option but to sell half the company to a Chinese investor and Alliance still surviving as the only 100% cooperative, although its return on assets remains disappointing.

 

The stronger performance of privately owned companies in both dairy and meat industries during the past decade, if not longer, has put further pressure on the cooperative side of the industry. Lower or barely competitive product payments, combined with the need to buy shares in a cooperative, have made it attractive for suppliers to choose one of the growing number of private processors. Cooperatives work best for those farmers who have already ‘shared up’ and farm in a region where the cooperative is the main or only option, particularly when a guarantee of processing capacity is critical.

 

Competition from newer, more efficient processors means there is a danger of the large cooperatives becoming processors of last resort which then necessitates paying over the odds for livestock, as the only means of filling up available capacity. The exception to this is during drought or peak livestock flows, normally in the autumn and in the South Island, which may partly explain why lamb prices there are as much as 50 cents and prime beef 30 cents a kilo below North Island schedules.

 

Milk payouts are a very obvious way of measuring processing and marketing gaps between dairy companies which doesn’t provide very good reading for cooperatives Fonterra and, more particularly, Westland. The smaller Tatua traditionally makes a superior payout which clearly has much to do with its relative size and specialised focus.  However dairy farmers have less flexibility than sheep and beef farmers in choosing their processor and have little option but to remain for a minimum of a season.

 

To my certain knowledge, the meat industry paid too much for livestock throughout the 1990s and 2000s relative to the market return, because of an excess of capacity. SFF’s attempt to extricate itself from low end commodities and create added value was compromised by high debt, ageing and inefficient capacity, and procurement competition. The substantial investment by Shanghai Maling rescued the business and removed the crippling debt, but the 2018 result provides no evidence of an improvement in operating performance.

 

SFF and Alliance have closed capacity in recent years, but the annual maintenance bill and capital expenditure needed to ensure the competitiveness of the remaining capacity remain substantial. Both companies have placed great emphasis on moving up the value chain to try to capture a greater share of the final product price. But the cost of doing this, at the same time as spending scarce dollars on plant maintenance and upgrades is significant.

 

In conclusion it appears supplier owned cooperatives may not be the best structure for large scale commodity processing and international marketing. There is an inherent tension between essential investment in operations, product development and brand development on the one hand and competitive payments to the shareholder suppliers on the other. Fonterra, Westland, Alliance and SFF have all found it tough to satisfy both priorities and two of these cooperatives have already chosen an outside investment solution.

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