Fonterra’s sale of its consumer brands to an overseas owner marks the end of an era.
There was always a structural tension within the co-operative between the ideal business structure for ingredients versus consumer brands. Perhaps it was inevitable that there would be an eventual parting of the ways.
Whether or not the sale to French company Lactalis of the consumer-focused division for $4.2 billion is the best outcome for New Zealand is a moot point. My own preference would have been a public company headquartered in New Zealand, with Fonterra retaining a minority interest.
Despite knowing that change had to occur, with a co-operative not the natural owner of a consumer-products marketing company, I am uneasy. Retaining a minority interest in a consumer company would have kept Fonterra closer to consumer-market signals.
However, the potential large-scale investors, such as the public and private KiwiSaver companies, and perhaps ACC, did not see sufficient value to match the bid from French company Lactalis. In an open capital economy, it is dollars that count and the Kiwi investors did not front up.
So, if there is someone to blame, it is not Fonterra, but the broader New Zealand investor community.
I have written many times over the last 20 years about the tensions involved in Fonterra, as a co-operative, trying to span the void between marketing of long-life ingredients and short-life consumer goods.
In essence, an ingredients company is technology-based, underpinned by science, logistics and business-to business relationships. In contrast, consumer marketing is very much about understanding consumers and reacting quickly to evolving trends. The leadership and thinking-skills needed for these two types of business are very different.
Another fundamental difference between these two types of business is capital intensity. Also, a global consumer business needs considerable staff in each market.
Top-down decision-making does not work in a fast-moving consumer business. Head Office has to understand and respond quickly to the specific complexities of each market.
This is only possible if the key decision-makers are deeply involved in-market. Whizz-bang tours of a few days by executives and governance-board members do not cut the mustard.
I recall back in 2006 first talking with Fonterra directors about the merits of a two-company model, with the consumer-focused company majority funded by external capital. I and others sowed the seeds, but those seeds, if they ever sprouted, soon withered. Essentially, the directors and executives of those times thought they could do it all.
Perhaps they could have done it all, but they were misled by their own rhetoric as to how to go about it.
During those early years of Fonterra, particularly from around 2005 through to about 2015, I was doing a lot of international travelling. That included multiple trips both to China and across South America, building on my earlier in-country exposures to those cultures from way back in the 1970s. I kept seeing things that Fonterra was messing up in the market place.
Fonterra is a very different company now to what it was even five years ago. Its ingredient business is much more efficient than in the past. Under Chairman Peter McBride, the Board has decided to focus on the things it does best.
Within the broader public, there has been a lot of misunderstanding about Fonterra’s consumer business. In fact, most of the products sold by that business have not been using New Zealand milk.
Instead, Fonterra has been procuring the milk in the country of destination, then processing the milk in that country for consumer products, and then branding the products as being Fonterra, with this of course being totally legitimate.
The most important consumer markets for Fonterra have been Australia, using Australian milk, and that is where the global head of Fonterra’s consumer division is currently based.
There are two fundamental reasons for this off-shore milk production. The first is the challenge of perishable products, with short shelf-life, transported long distances across international borders. The second is that New Zealand’s supply of milk is highly seasonal whereas consumer demands for the perishable products are non-seasonal.
Seasonal production, with almost all dairy cows calving in spring and very few cows milking in winter, is a unique New Zealand system which works well but only for long-life products. Milk powders, butter, some cheeses, and infant formula, are the classic long-life examples.
Looking Forward
Now that divestment of the consumer business has been determined as the path ahead, there is no point in dwelling unduly on spilled milk. The big questions now are how can Fonterra maximise returns from specialised ingredients and food-service products.
Food-service is another part of the industry for which there is widespread misunderstanding by the general public. Food service requires Fonterra to work directly with in-country chefs from large companies using specialised ingredients and standardised food production systems. I recall some 15 years ago devouring trial products in Fonterra’s Shanghai food-development kitchen. Since then, the food service category has grown greatly.
Food service involves working close to the market but it is still a business-to-business operation. Increasingly, it refers to specialised products such as mozzarella cheese and bulk-whipped cream. Of course, it also includes butter, with New Zealand butter derived from grass-feed animals having a distinctive texture and colour.
To date, Fonterra has not done a good job of educating the commentariat, including some politicians, as to the differences between food service, specialised ingredients and commodities, and how each sits differently within the value chain.
Fonterra will always produce some commodities. This reflects the simple fact that seasonal production creates a flood of milk in October, November, and December, with this creating its own priority of getting the milk quickly to a shelf-stable state. Turning it into whole-milk-powder which is then sold in bulk is how this is done. Fonterra is a genuine global leader in milk powder.
Ironically, milk produced on New Zealand farms requires the addition of imported lactose to meet international commodity certification standards for whole milk powder. This means that New Zealand manufactured milk powder is not a pure New Zealand-sourced product. It contains an imported ingredient.
In passing, I note that Fonterra will continue to own the Anchor brand in China but not in New Zealand or elsewhere. That is another irony.
The ‘bottom line’ of what is happening in the New Zealand dairy industry is that dairy exports are going to remain New Zealand’s most important export category. Let there be no doubt about that. Within that framework, the specific products will continue to evolve.
*Keith Woodford was Professor of Farm Management and Agribusiness at Lincoln University for 15 years through to 2015. He is now Principal Consultant at AgriFood Systems Ltd. You can contact him directly here.