A tale of two industries
ONCE UPON a time there were two dairy industries, on opposite sides of a big ditch, that were very similar. They produced about the same amount of milk, they made similar products and the farmers got paid a similar amount ….then everything changed. Comparisons are often made between the New Zealand and Australian dairy industries about prices, farmgate prices and various aspects of the industries — and depending on the cycle, which has the better structure. It’s a rivalry a little like the Bledisloe Cup in Rugby — and depending on your measure of success — almost as one-sided. As chart 1 shows if success is measured in terms of industry size and output — the Kiwis have scored all the tries. While Australia’s output has stalled, New Zealand’s milk output has more than doubled since the mid-90s. Fuelled by favourable production conditions, a tax structure that favours investment in land, access to growth markets and a dominant farmerowned cooperative, Kiwi farmers have responded enthusiastically, expanding and intensifying — and increasing debt-load. Fonterra was established back in 2001 — with the aim of moving what was already an important industry further down the value chain towards the consumer. The critical mass offered by Fonterra — which was given a free-kick by the government’s competition watch dog, the Commerce Commission — was meant to make Kiwi farmers price-setters rather than price takers in global markets. In return, the act establishing Fonterra required transparency in farmgate price-setting, and some provisions to reduce barriers to entry to new players and competitors, to reign in the co-op’s market power. Many Kiwi farmers have no other option but Fonterra when it comes to supplying milk so the regulations are meant to ensure there is adequate contestability and efficiency. The New Zealand Commerce Commission reviews Fonterra’s farmgate price calculation each year, which is based on sale revenue from reference products minus operating costs and an allowance for capital recovery. It is on this basis that Fonterra’s revenue is divided between farmer payouts and dividend, as well as returns to unit holders in the Fonterra Shareholders Fund. It’s a level of transparency and oversight that many farmers on this side of the Tasman may envy — although it’s not without its critics. Taking a helicopter view of the New Zealand dairy industry’s development over the last couple of decades, a few things stand out. First and foremost it has always viewed itself as a global player and its tiny domestic market has seen to that. It is still strongly supply-driven — most of the post-farmgate capital has gone into stainless steel rather than innovative high value products. In terms of the operating environment, the industry has enjoyed significant government support — in the formation of Fonterra, in pursuing market access and supporting investment in the sector. Community support hasn’t been so steadfast. Alongside the industry’s growth and intensification have grown vocal and persistent concerns about environmental impact. The industry’s significant economic contributions have not been sufficient — or perhaps, shared widely enough — to shield it from criticism when it comes to the pollution of waterways and threatening its “100 per cent Pure” reputation. Back on this side of the ditch, dairy farmers generally command sympathy and respect from the community — but mostly because the industry is perceived to be “doing it tough” most of the time. The industry has received plenty of government attention also, but mostly in the form of overlapping inquiries and short-term responses to crises. The Australian processing sector is less cooperative in nature and much less concentrated. In southern regions where most farmers have lots of choices to make when it comes to supplying milk. Competition for milk supplies has been a key pre-occupation for local dairy companies trying to fill capacity in the production-constrained environment and “pick the winners” in terms of product and market mix in view of their inability to compete on cost. In attitude and actuality, the Australian dairy industry is much less a global player than it was — accounting for around 6 per cent of global trade compared to a peak of around 17 per cent in the early 2000s. That said, a virtually open market for imports and with around 75 per cent of milk production converted into tradeable products — the industry is not immune from international markets, despite the increasing share of milk consumed at home. Nevertheless, the mechanics of the domestic marketplace — which is tough and getting tougher — and more particularly supermarket power is an increasing focus for an industry that is withdrawing from the world. The recent Senate Inquiry has called for a lot more involvement from our own competition watchdog in the way the industry and domestic market works, although it appears to have dismissed the need for greater price transparency. It’s unclear that a more consistent approach to industry structure and regulation would have produced a similar outcome for the two industries — much is clouded by climatic conditions that have certainly favoured the Kiwis over the past couple of decades. Although it’s interesting to observe how these divergent pathways have evolved, and how dissimilar the two industries have become, it makes less and less sense to compare them! Still Chart 2 shows how it stacks up for the coming season. What’s the reason for the gap this year? A more bullish outlook from Kiwi dairy companies, and superior conversion efficiency; or does it reflect waning leverage and value capture on this side of the Tasman? It’s this gap and whether it is sustained that is likely to decide who is declared the “winner”, although profitable and sustainable growth in a supportive community should be the goal for both industries.