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how Fonterra sets milk price
By Hugh de Lacy All the inquiries in the world won’t unravel the way Fonterra sets its milk price — short of the giant dairy cooperative opening its books to competitors and consumers, or letting them in on its pricesetting methodology. And given the fierce possessiveness with which Fonterra’s owner-suppliers regard their booming verticallyintegrated business, neither of those is about to happen any time soon. Which leaves the Nationalled coalition Government caught in the cross-fire between Fonterra and consumers outraged at the price they’re having to pay for milk in the supermarket, and rival limitedliability dairy companies bitching about the same price, albeit for different reasons. For consumers who grew up in a country where milk was so cheap they used to give it away in schools, the $2.50 or so a litre that the supermarkets are currently charging — which includes the supermarket’s margin and GST — is a nasty shock. For independent dairy companies like Synlait and Open Country, the price they’re paying for the 600 million litres of milk Fonterra is obliged each year to make available to them under the Dairy Industry Restructuring Act (DIRA) — and for the equivalent price they have to pay their own suppliers
to prevent them supplying Fonterra — is patently exorbitant. So consumers and competitors alike have leapt to the conclusion that Fonterra is ripping them all off. Groundless or otherwise, their suspicions have so far led to both the Ministry of Agriculture and Forestry (MAF) and the Commerce Commission conducting enquiries into the way Fonterra sets its milk price, and Parliament’s Commerce Select Committee — chaired by East Christchurch Labour MP Lianne Dalziel — threatening a third. The Commerce Commission findings had yet to be released at the time of writing, but the MAF inquiry, which Dalziel’s committee had called for this month, found no evidence of anti-competitive behaviour by Fonterra in setting its milk price. However Dalziel claimed MAF’s report left her none the wiser on how the price is actually set, and she reportedly added that she was “certainly leaning towards some further inquiry.” Whether that would yield any greater understanding of the process is problematic because Fonterra is “both a player and the umpire in the milk supply game,” Lincoln University Agribusiness Professor, Keith Woodford, told Canterbury Farming.
Fonterra’s role of industry price-setter was imposed on it in part by its own dominance of the nation’s milk production, and in part by the DIRA forcing it to make milk available to its competitors with the specific aim of reducing its industry dominance, now at 90% compared to 98% a decade ago. “Central to the formula by which Fonterra calculates its milk price are its capital and depreciation costs — highly commercially sensitive information which the company is understandably loathe to reveal to its competitors,” Woodford said. One company that would, for example, be delighted to get its hands on such information is Singapore-based agricultural investment multi-national Olam, which already owns about 25% of Open Country and is gunning for the struggling listed dairy farmer Farming Systems Uruguay. Short of getting a seat at the Fonterra board-table, Dalziel, the consumers and the competitors may have to settle for MAF’s and Fonterra’s word that their milk price is a genuine reflection of international prices minus its own costs of production, and is not inflated either by funds shifted over from the company’s operations dividend (previously called added-value), or by the way capital and depreciation costs are charged.
Woodford said there is, however, another element in the game, and that is Fonterra’s plan to change its shareholding basis — from one rigidly related to the amount of milk supplied, to one where farmer-suppliers may exchange among themselves ‘dry’ shares unconnected to milk supply. This change would require Parliament to amend the DIRA, which would offer Fonterra’s consumers and competitors alike the chance to get MPs tampering with Fonterra’s founding legislation. To sidestep the lobbyists in election year, the Government has, for the time being, consigned the question of DIRA amendment to the too-hard basket. “However, whenever the Government faces the issue of whether it will allow Fonterra’s farmers to trade Fonterra shares amongst each other, there will be two elements of opposition to it,” Woodford said. The first is “MAF objecting to the current proposals because
it isn’t satisfied that they are consistent with the DIRA’s intentions that farmers must always have easy entry and exit from Fonterra. “Secondly, the financial markets are wary of becoming involved in the share-trading scheme because of the absence of transparency in the way Fonterra sets its milk price. “The nub of the argument from competitors and consumer groups is that Fonterra allocates theoretical costs to its processing cost, rather than actual costs, and thereby raises the milk price for everyone. “A lack of transparency then fans the pre-existing suspicions,” Woodford said. How those suspicions are allayed while protecting the commercial sensitivities of Fonterra’s global operations, as well as creating the legislative framework for the farmer share trading operations that Fonterra wants, is going to be a challenge for whatever Government emerges from the November 26 elections.