The ACCC says that a Murray Goulburn / Warrnambool Cheese & Butter merger (or takeover - depends which side you're on) will reduce competition and therefore the farm gate price for milk. Here at Xcheque we believe that the ACCC has got it 100% wrong and shows a complete misunderstanding by the ACCC of the role co-operatives play in a competitive market.
It is widely acknowledged that in the South Eastern Australia milk processing game co-operatives set the benchmark price that the other processors use as a reference point. Surely a strong co-operative presence in a competitive milk processing environment can only be good for the long term milk price. If an MG/WCB merger/ takeover results in a stronger MG then the farm gate milk price at the very least will not be eroded.
Last time we looked Fonterra had a strong presence in South West Victoria. UDP also source milk from this region and we have some fairly reliable mail that two second tier - but not insignificant processors - are looking to the South West for milk supply. How many are we up to? Five processors I think, plus National Foods.
Xcheque is not MG's official cheer squad (no cash for comments here!!) There may be good reasons to argue against an MG takeover (let's call it what it is) of WCB. However, reduced competition and therefore price paid for farm milk price, is not one of them.
By the way... When WCB tried to drop the milk price to 13 cents per litre late last year - was it in the best interest of their suppliers or their shareholders? Congratulations to the suppliers who voted with their feet - we found it incredible (despite the low milk prices) how many were so easy to forgive or forget a couple of months down the track. We also dispute WCB's claims that over the past 10 years they have paid a regular and significant premium above MG (more of that in a future blog).
Milk Processors, Co-operatives, Private Companies, Publically listed - they're all the same aren't they?
Well yes, they all buy milk from farmers and turn it into saleable product. We should state from the start that no ownership model is a guarantee to success - poorly run will give you a bad result regardless of the ownership structure. Plus competition is always good, or to refine that statement a tad - competition between two or more evenly matched and high performers is better.
It does need to be acknowledged that there are fundamental differences in how cooperatives and non cooperatives approach milk intake and farm gate pricing. Private processors are essentially sales driven. They source the milk they need at the times of the year to produce the products they can sell at a high enough margin to justify the capital they have invested in the processing business. Co-operatives on the other hand are essentially production driven. As the farmer owned processing facility their primary function is to process the milk that the farmer members choose to produce, when they chose to produce it. So there are the competing forces of the farmers producing milk when it is easiest (ie lowest cost of production) versus the value that can be created by having to direct milk to lower value bulk commodities.
Fundamentally the aim of the cooperative members is (or at least should be) to maximize the return on the capital invested in both the farm and the milk factory - whereas the publically listed and privately owned companies have a responsibility to maximize the returns on the capital invested in the processing business only. Cooperative suppliers may have to accept a lower price than that paid by some non cooperative processors, the quid pro quo is that while there is spare processing capacity there is usually no maximum or minimum they must adhere too. Nor are they obligated to produce milk to a certain shaped curve. When the cooperatives processing capabilities are at capacity their members can choose to limit production by some sort of agreed 'quota' system, or they can choose to invest in additional processing capacity.
At the very core of the issue co-operatives are the processing facility jointly owned by the farmer producers. As such then tend to be more focussed on taking all the milk that the members produce and extracting the most value that they can and sending back to suppliers all the profits that they can after all the bills have been paid, debt has been serviced and the necessary allowances are made for capital investments in the processing facility.
Paying the (tier 2) price
The ex Dairy Farmers Co-op suppliers now supplying National Foods (part of the Kirin Group) are starting to see firsthand the fundamental differences between supplying a cooperative versus a privately owned company. Recent events/announcements by National Foods across a number of their process sites that they will pay a two tier price for milk is sending a clear message that they will only source milk that they believe they can extract sufficient value from. Above this they are telling their farmer suppliers that the farm gate price needs to be substantially lower to warrant National Foods processing it. One example has been the announcement to suppliers of their Malanda milk processing plant on the Atherton Table lands in Far North Queensland. Suppliers were shocked by the recent announcement that National Foods would slash allocations for top tiered milk by 20 percent:
| Far Northern farmers milk public help | 13 April, 10 | ||
| Jennifer Eliot, The Cairns Post | |||
So co-operatives tend to perform two important roles in a healthy processing sector
1. The role of the price setter for other processors in that they return all the profits to the suppliers (they are after all the shareholders). Usually in the form of their milk price plus a return on their factory shares.
2. The role of building the processing capacity required by the farmer shareholders to process the milk that the farmer shareholders choose to produce and when they choose to produce it.
It is this commitment to build processing capacity that allows farmer shareholders to grow their business and continue to produce more milk. Look around and see who builds the spray dryers (the classic manufacturing processing facility driven by the need to process). More often than not it is the co-operatives that build these facilities. The downside is the process tends to be manufacturing driven. It has to be when in the middle of spring there is a couple of million litres of milk a day coming into your factory, there was yesterday and the day before that, there will be again tomorrow, the day after tomorrow, the day after that and so on.....This means that there very few things you can do with the milk and they are all commodities.
I've lost count of the number of indignant looks I've received from farmers over the years when, in response to the complaint that their cooperative is too focussed on commodities, I tell them that they are part of the problem. 'Well, you will insist on sending all this milk in the spring when it's easy to produce'. To which they provide the very reasonable response 'well, they don't pay us enough to produce milk when the grass doesn't grow', to which the factory manager is likely to make an equally reasonable reply 'we can?t extract enough value from the out of season milk to offer you anymore for it'. So round and round we go. Strangely enough we don't seem to enter into this circular discussion (it's not an argument - we're all far too reasonable for that) when commodity prices are high.
Balancing your private life
Private companies on the other hand generally are sales driven and they source the amount of milk they require to the supply curve that they require. If they can't extract sufficient value to justify capital investments from additional production then they don't source it. It the case of National Foods they have inherited a co-operative milk supply. Across their group of factories that stretch from one end of the east coast to the other (and then some), they now have more milk than they believe that is needed to run the Australian dairy business as profitably as possible. In isolated centres such as Malanda the situation is made worse by the distance to the next spare processing capacity.
Does Xcheque have a preferred ownership model for the milk processing sector? The short answer is no. The official Xcheque line (which despite appearances is not driven by the need to try and stay friends with everyone) is that a mix of well managed business which includes a strong cooperative presence is the best model for driving growth and value creation while still providing choice. As we said earlier, competition drives performance. Simply supplying any old cooperative or non cooperative is not the answer on its own. Poorly run privately owned businesses go broke relatively quickly. While (as a very astute businessman told me once), poorly run co-operatives don't go broke - the people supplying them do!!
In the next blog we'll start to discuss the strengths and weaknesses of the various ownership models in the context of the Australian processing sector.