Where to now for Australian Dairy Co-operatives?

A couple of weeks ago the Xcheque blog touched on the question of co-operatives and competition.  That article questioned the efficiency and commercial effectiveness fertiliser supply sector - from a farmer's perspective at least ("Fertiliser prices on the nose" Dr Jon Hauser, Xcheque.com, 9 December 2009).  This week we move the discussion to Australian dairy processing sector where we hold no such concerns over competition but we do fear for the future of co-operatives.

Murray Goulburn's recent milk price step up has prompted a similar response by the other processors and Fonterra in particular has stepped up strongly to regain a milk price advantage.  It seems unlikely that Fonterra's New Zealand shareholders would be keen to give any more money to their Australian cousins than they have to - especially given the NZ milk payment system which is traditionally very tardy in the release of cash.  We would therefore contend that these early step ups by the private processors are simply tactical ploys to encourage transfer of farmers and increase in milk supply.

Don't get us wrong, this competition and release of cash is good for farmers and the industry in general.  Milk price is still below the cost of production for most farmers and the past 12 months has put a big dent in their overdraft and other available funds.  What we are questioning in our blog this week is whether the milk price today has any bearing on the final price paid and also whether the erosion of co-operative supply is good for the long term milk price for all farmers.

Since Deregulation the Australian dairy co-operative sector has lost three major players - first Bonlac, then Warrnambool Cheese and Butter, and more recently Dairy Farmers.  Arguably Tatura has also gone with the capital being controlled by Bega.  Australia has gone from 80 - 90% of the milk in the hands of farmer co-operatives, to 30 - 40%.  That is a dramatic change and we can't help wondering what the future impact will be.

We have noted on many occasions that the milk price in south east Australia is pretty much determined by Murray Goulburn - by far the largest pure dairy co-operative.  MG have a clear mandate to return to their farmer members the highest possible milk price.  With that goes the requirement for a reasonable return on capital invested but milk price clearly takes precedence - as evidenced by the reduction in equity and the break-even profit performance of Murray Goulburn in the 08/09 financial year.  The tension at Board level between farmer Directors and management must have been immense but in the end a balanced outcome was achieved.

Private and publicly listed processors on the other hand have a primary commitment to maximising profit return and shareholder value.  With milk as the major input they have a vested interest in the lowest possible milk price.  In the absence of an effective competing co-operative, only external demand and competition for supply will push this milk price higher. When milk is 60 - 70% of your input cost, dropping milk price is always going to be the easy option for improving the bottom line. 

The contrasting behaviour between Murray Goulburn and that of the Warrnambool Cheese Board and Management in 08/09 brings this difference into stark relief.  We must be fair and remind everyone that Warrnambool paid a significant premium to their farmers in the year but that appears to have been a mistake.  WCB Management and Board's attempt to correct the situation (and their profit position) met with disaster and the exit of CEO and Chairman of the Board.  

Believe it or not we are not spokesmen for Murray Goulburn or co-operatives and we have given them a whack or two along the way.  We also believe that private and stock exchange listed processors are an important part of the industry mix.  It is a sad fact that in the past many co-operatives have been 'not for anyone's profit'.  Furthermore, we think the NZ processing sector has gone too far the other way in being dominated by one large cooperative processor who shall remain nameless but whose initials are Fonterra (where's the effective competition?).  We will however speak for farmers and the growth of the Australian industry on this issue.  We firmly believe that further erosion of the strength of MG in particular and the concept of co-operatives in general would spell disaster for the Australian export industry and the equity of farm balance sheets.  Call it religion if you like but that is our view.

In the interests of brevity here are a few more salient points to think about:

• Co-operatives tend to be the processor that build the capacity to handle peak season production
• Co-operatives tend not to restrict supply by quota and generally encourage growth.  Price is more often the signal for supply increase or decrease
• The capital base of farms supplying the processors is roughly 4 - 5 times the capital requirements of the processors.  Think about this - the effect on the economy in general is much more significant if farms are not profitable when compared with processors.
• Competition drives innovation and improvement - to survive in this environment both co-operatives and private processors must keep up or move over.
• Pursuit of profit is not a bad thing if it comes from market and product innovation (rather than milk price).  Small / medium private processors tend to excel in this area because they can put more focus on these new opportunities.

With regard to milk pricing this season:

• We live in volatile times and the GFC caught everyone unawares
• MG has borne the brunt of farmer disfavour by leading the way with a milk price step down and then a low opening price.
• We believe that MG have done a poor job of explaining why they opened up as low they did and what was the risk and opportunity for a final milk price.  It looks like they have paid dearly for this in loss of supply.  (see also our article "What Value Milk Price Transparency" Dr Jon Hauser, 23 December 2009).
• In many case farmer exits and transfers were understandable due to immediate cash flow pressure and concerns over whether MG would pay a competitive milk price for the current season

That said we are genuinely concerned that suppliers have moved to another processor with false expectations of receiving a significant milk price premium above MG.  In so doing they have actually undermined their future milk price.  Furthermore, they are rewarding companies that have done nothing more than ride on MG's coat tails.  We contend that one or two of those processors would not be around today if MG had not taken the lead on lowering milk price.

We respect completely the decision of individual farmers to change processors.  There are lots of reasons why this happens and needs to happen, not the least of which is financial.   Before making the decision however:

1. Look at the processors milk price payment history and how this relates to your milk supply curve
2. Ask not what the price is today but what commitment does the processor give for the milk price at the end of the season
3. Consider whether this is a decision for today or tomorrow and whether this is for you or the next generation.