Moratorium would solve meat industry’s capacity problem

Word has got out suggesting some processors are in favour of a moratorium on new capacity as the only means of sorting out the meat industry’s excess capacity problem. It also appears MIE is initially supportive of the proposal, although it would need to be sure it was in farmers’ best interests before endorsing it completely.

 

My understanding is the moratorium would specifically prevent any new plants or chains operating on beef and sheepmeat around the country. This is where the plan is different from the previously floated concept of tradable slaughter rights (TSR) which proposed to set maximum permitted slaughter volumes for each processor. TSRs were supposed to enable whole plants or even companies to be closed with the costs of closure being financed by the sum paid to the owner.

 

But using slaughter volumes based on a historical average as the determining factor presents two large problems. First there was disagreement between processors on how to calculate individual company slaughter rights and second the scheme would have reduced farm gate competition at farmers’ expense.

 

The proposed moratorium would have several benefits: it would facilitate meat industry reform by providing a starting point for rationalisation, it would protect existing ownership rights, involving a willing buyer and willing seller, and it would preserve farm gate competition. A further benefit of this solution would be to encourage innovation because it quite deliberately puts no restriction on the number of shifts, chain speed or productivity gains on each chain. It would issue a licence for every beef and mutton chain with no new plants or chains permitted during the life of the scheme.

 

So a casual observer might ask what a moratorium would actually achieve, but on closer analysis there is an element of subtlety about such a scheme which would not necessarily produce immediate results. However over time the outcome would be beneficial for the overall efficiency of the industry without the pain of a more radical approach. It is important to recognise the reality that any restructure has a human cost, as chain closures inevitably imply job losses.

 

The government would have to introduce regulation to allow the moratorium to occur in the first place. This gets back to the government’s stated position which is ‘bring us a solution which is supported by the majority of the sector and we will be prepared to intervene.’ The key question therefore is whether or not the moratorium proposal would gain support from the majority, both farmers and processors.

 

If MIE gets behind the concept which I understand it is seriously considering, this would mobilise the farmer side of the equation. It would also be helpful if Beef + Lamb NZ and Federated Farmers also supported it. That leaves the processors who have traditionally found it hard to agree about anything. Therefore it is highly likely the scheme could fail to gain a sufficient level of processor support.

 

This is where MIE’s role will be extremely important, assuming it does a thorough analysis of the concept and decides to throw its full weight behind it. It may then be able to exert influence on the cooperatives through those board members who are sympathetic to MIE’s goals which may be a tipping point in helping to get this scheme adopted.

 

Therefore the most important part of this exercise is to ensure a thorough and robust assessment of the potential benefits and negatives of the introduction of a moratorium. This I suspect is what the government would insist on seeing, before it would take the risk of regulating the meat industry.

 

The proponents of this capacity moratorium appear to have thought through the potential fishhooks associated with the scheme. Chain licenses are site specific and cannot be transferred between sites because it is essential to prevent a new plant or chain opening up where a chain has been closed. It is critical to prevent freeloaders taking advantage of another company’s investment in rationalising capacity. The Commerce Commission would have oversight of the licensing scheme through an annual review similar to the Fonterra milk price regime. Existing foreign ownership of meat companies would be protected, but new investment would be subject to OIO restrictions.

 

I understand the suggestion is the moratorium should last for 12 years, unless an agreed trigger point of capacity reduction were reached sooner than that. This will be a point of contention, but clearly there must be a period of certainty to encourage investment.

 

The experience of the 1990s with Trial Run Holdings is relevant here. This involved the industry contributing jointly to the closure of Weddel’s plants, ensuring the equipment was sold overseas to prevent it being used again in New Zealand,. Rationalisation could equally be achieved by a group of companies funding the closure and disposal of identified excess capacity.

 

But after the Weddel’s closure there was no mechanism in place to prevent the entry of new capacity, either plants or chains. The net result was barely two years of relative peace with enough livestock for all companies, after which the industry descended once again into a state of procurement competition caused by new capacity coming on stream.

 

This is the best plan I have seen for addressing the excess capacity issue, because there is no compulsion and no automatic lessening of competition which could attract the attention of the Commerce Commission. I am hopeful, if not optimistic, this will be the solution MIE will support and could herald a new era for the meat industry.

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Behaviour is the root cause of meat industry’s problems

I am not completely sure why we spend so much time and effort complaining about the meat industry or which problems we are trying to solve. However in the interests of encouraging progress and stimulating debate, I will try to define the problem: this appears to be that the meat processing and export sector is not profitable enough, whether in absolute terms or in comparison to dairy. Both may be true.

 

It is worth stating the unique challenges of the red meat sector up front. First, there is a market at both ends of the chain, procurement and sale of the products; second, New Zealand exports a higher percentage of its production than any other country which must travel further to reach its markets, not all of them equally buoyant; third, sheep and beef must be disassembled into multiple cuts of meat as well as many co-products, all of which are sold into a wide range of markets for variable returns; fourth the climate dictates when the grass will grow and livestock will be ready for slaughter; and last, but not least, the producer can choose when and where to send the livestock for slaughter except in a drought.

 

Statistics and financial reports show that only a minority of participants in the industry are making much if any consistent profit, whether farmers or processors. So the conclusion must be that everybody, except for a few good farmers or companies with a niche market, would be happier with a more profitable industry.

 

Everybody keeps blaming everybody else, but nothing seems to change, because individually the parties must attempt to survive at the expense of others. That is the fundamental reason for the state of the meat industry. It may seem obvious to outside observers that cooperation is the way to make progress, but the complex nature of the red meat industry poses a difficult dilemma. The answers are extremely hard to find; otherwise some genius would have found them already.

 

MIAG thought they had found the answer – merge the two cooperatives – and MIE, after promising not to make the same mistakes as MIAG, seem to be taking the same path. In 2008 Owen Poole, Alliance Group Chairman at the time, tried to achieve an industry grouping with 80% of processing capacity, as the minimum required to create a robust business model, but this foundered on lack of agreement between the larger processors.

 

When preparing the Red Meat Sector Strategy, Alasdair Macleod of Deloitte started out from the premise that Zespri and Fonterra were the models for the meat industry. But he soon realised that the meat industry’s characteristics and complexity made it different.

 

In the 1980s Pappas Carter proposed the concept of Tradable Slaughter Rights as the best way to bring about industry rationalisation; this was raised again last year as an option by me and with greater publicity by retiring Beef + Lamb NZ chairman Mike Petersen.

 

Three of the major processors, the cooperatives and ANZCO, with just over 60% market share took this idea to government, which rejected it, unless 80% of farmers and processors were in favour. While seductively attractive at first sight, on reflection TSRs only suit some players, because they will reduce farm gate competition, while protecting less efficient processors.

 

In any case it seems to be impossible to achieve the agreement of such a high percentage of either farmers or processors. There are still enough farmers who want to maintain their traditional livestock supply methods and stock agent relationships to make such uniform behaviour unachievable.

 

There are also quite a few highly efficient farmers out there who are profitable, based on high lambing and calving percentages, good pasture management, intelligent use of technology and constructive relationships with their processor of choice. Equally there are several privately owned, efficient and profitable processors who would be seriously disadvantaged by the introduction of tradable rights.

 

Farmer ownership is touted as the answer to the challenge of controlling the value chain, because in good times there should be bigger profits and farmer ownership would mean farmers would keep these higher profits, which is not necessarily true. It is often forgotten that meat companies, like all processing businesses, must invest in modernisation and new technology, or they will become steadily less competitive. Profits must be reinvested in maintenance, new plants, new technology and people, not just paid out to shareholders.

 

It will be interesting to see how the successful MIE backed board candidates find life on the boards of Alliance and Silver Fern Farms. The realities of the meat industry, especially cash flow, balance sheets and banking covenants, will concentrate their minds on these critical aspects at the expense of more idealistic ambitions.

 

Ownership carries risk. Therefore farmer ownership of both ends of the value chain entails double the risk of losses, when world markets collapse, unless payments to suppliers suffer correspondingly. The present exporters, both privately owned and cooperative, have the expertise to move between 85% and 90% of New Zealand produced red meat and co-products which is a far more complicated exercise than exporting 90% of dairy exports in the case of Fonterra.

 

Obviously processing over capacity contributes to loss of value in the industry, while it also affects behaviour – both forcing processors to pay more than is economically sensible for livestock and encouraging cash flow generating sale of inventory at less than optimum prices at certain times.

 

However it is wrong to blame the structure of the industry for lack of farming profitability. If there were a perfect balance between supply and demand (impossible to achieve in a seasonal industry), processors would pay a consistent price at all times, neither too much nor too little. Overall, farmers would still receive a fair, but possibly lower, average price for their livestock than under the present system.

 

It is the companies’ shareholders that lose from the present competitive environment with excess capacity and those shareholders may either be farmers or corporate owners. In the long run those companies losing the most money, which are by definition the least efficient, will have to go out of business.

 

The losers will be the shareholders and the banks, as well as the suppliers who have livestock at risk at the time of receivership. Merging the two cooperatives will involve a huge write-off of surplus assets with no guarantee of long term survival.

 

I am not trying to pretend that all is right with the present industry model with no improvements possible, but, judging by the reaction from the farmers who attended MIE meetings in the first half of 2013, I sense many of them have an unrealistic expectation of the potential improvements.

 

It also seems that farmers think it is all the fault of the processors and exporters and, if somebody waves a magic wand to merge the coops and enforce farmer ownership of the industry, it will all come right. But life isn’t like that!

 

For a start red meat does not have a premium position in global markets that guarantees all New Zealand production a top price. Those markets are there, but they are comparatively small; however meat exporters are adept at shifting all types of product into different markets at a whole range of price points. Occasionally they have too much inventory and prices drop which leads to accusations of weak selling.

 

When one combines that scenario with procurement competition, some farmers do well, but there is an impression of a dysfunctional industry. So the question is what can be done to correct it. The usual solutions proposed are rationalise capacity and move to single desk selling.

 

The first one costs money and is hard to achieve in a free market except through receivership or voluntary plant closure; the second one is naïve and will never work. Ultimately farmers must get on and do what they are best at, except they must use more logic and do it better.

 

Logic dictates that, unless farmers have very deep pockets, they cannot lead and pay for industry restructure; but what they can do is adopt farming practices which will lift them up the curve and bring in higher profits, by using the technology and information available from, among others, Farm IQ, Beef + Lamb NZ and Primary Growth Partnership investments.

 

The next piece of logic could equally be termed common sense. Work with your processor of choice to ensure that you are producing livestock to the required specification and delivery for which you receive a transparently fair price. If you aren’t happy with your relationship, either because your processor isn’t transparent, fails to accept stock when agreed, uses third parties for procurement or doesn’t convince you of their payment security, then change your processor.

 

The way farmers and processors behave in their dealings with each other will have the greatest impact on the future of the meat industry because greater trust will enable both parties to get on with what they are good at. Global market prices will fluctuate as they always have, but there remains solid demand and eventually profitability will improve.

Debt puts pressure on large meat companies to achieve solution

If there was ever a compelling reason for the meat companies to sort out the problems of procurement competition and excess capacity, the debt levels on the balance sheets of the big three at the end of last season provide one.

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%.

Meat Industry Excellence Group’s campaign warms up

The MIE organised farmer meeting in Feilding on Friday was attended by about 700 farmers which one speaker from the floor compared unfavourably with 2000 at the Drought Shout. However there is obviously an increasing level of support for substantial change to the meat industry’s operating method which results in volatile market returns.