Fonterra’s need to stay big cheese of the milk supply market about much more than pride – chairman

Fonterra is New Zealand's biggest business, with revenue in FY24 of $24 billion.

Gritty economic realities underpin why Fonterra needs to keep the lion’s share of the milk supply market in the $26 billion dairy industry, says chairman Peter McBride.

Fonterra’s critical mass and its balance sheet influence how risk assessors and risk pricers like bankers and credit rating agencies view not only the company but dairy farmers’ businesses, he said.

McBride was commenting on Fonterra’s slipping share of the milk supply market, raised as a concern at last week’s annual meeting of the dairy multi-national.

A farmer-owned co-operative, Fonterra is New Zealand’s biggest business. The export dairy industry is the largest sector in the country’s top economic contributor, agribusiness.

Farmer-shareholder watchdog, the Fonterra Co-operative Council, told the annual meeting it was concerned about the “further decline” in Fonterra’s share of milk supply, to 78.1% from the target 79%.

Council chairman John Stevenson told the Herald Fonterra was achieving excellent financial results and had several positive actions and measures under way to attract and retain milk supply, but “it is the trend that is concerning us”.

To those who might say that 23 years on from its creation under special enabling legislation, Fonterra is privileged to still have 78% of the milk supply market, McBride said the risk was there could be a “tipping point”.

He told the Herald he didn’t know what that point was and it was “all economic theory”, but if Fonterra lost its scale, “the risk management tools we can provide to farmers” would also be lost.

“It would put more risk into the market and that would be priced in. Things would become more transactional; you couldn’t hedge to the same extent, for example. If you look at other sectors, they operate on a more transactional basis. Meat companies can’t hedge and manage risk on behalf of farmers the way we can.”

When Fonterra was created in 2001 via an industry mega-merger, it had 96% of the market. However, the Dairy Industry Restructuring Act (Dira), which enabled its formation without needing Commerce Commission approval, was also designed to allow new milk processors to emerge. Fonterra has since lost milk to them and to general milk production shrinkage.

McBride said attracting and retaining milk supply was front and centre in Fonterra’s new business strategy and direction.

Peter McBride became Fonterra's chairman in 2020 after two years of disastrous financial results.

A capital restructure last year made it easier for farmers, particularly young ones, to buy into the co-operative to supply milk. Fonterra’s balance sheet strength of the past two years was also critical in countering competitor approaches to farmers, he said.

Not only did Fonterra need to keep performing well financially to pay the best milk price possible, it had to be at the top of its game in efficiencies and cost control. The latter two areas, which had a direct impact on the farmgate milk price, were also top priorities in the new business strategy.

McBride was frank that some milk loss was farmers reacting to Fonterra wiping $2b off their balance sheets with its disastrous losses in the 2018 and 2019 financial years.

As the dominant market player, Fonterra sets the industry’s base farmgate milk price. It’s a position that regularly exposes it to allegations from much smaller independents that it “games” the price. They pay a premium on this price for supply. The independents can also be attractive because they don’t require farmers to buy shares to supply.

Fonterra leaders have regularly cited the Dira as a curb on the company’s milk supply growth. Privately, industry leaders now suggest that was an excuse for weak performance before its turnaround from 2020.

The Dira, which reins in some of Fonterra’s market power – for example, it prevents it tactically pricing to attract milk and still obliges it to provide discounted milk to some companies – has been reviewed by the Beehive several times since 2001 and amendments have been made. It’s due for new scrutiny in 18 months.

Fonterra has lobbied in past years for the Dira to be abolished. McBride declined to discuss Fonterra’s likely position at the next review.

Council chairman John Stevenson said the Dira “has achieved what it was set out to do”.

“[The] Dira was set up to enable strong competition to establish within New Zealand and we’ve seen that happen. Plenty have come in and set up, and we consider there is now enough competition in the domestic market ...”

Stevenson said the council’s concern about milk supply was because farmers and rural communities depended on the co-op succeeding.

John Stevenson, chairman of the Fonterra Co-operative Council.

“If we don’t have milk, we don’t have a co-operative. If we’re inefficient, that feeds through not just to us as Fonterra farmers, but to all dairy farmers.”

To attract, retain and milk, Fonterra “needs to offer a really strong value proposition”, Stevenson said.

“They need to be competitive. They need to deliver ... to focus on efficiencies and deliver the strongest possible milk price they can alongside strong business performance.

“For me as a farmer, the co-operative is the lowest-risk option for my milk ... Fonterra needs to be able to tell that story and demonstrate that to other farmers.”

Andrea Fox joined the Herald as a senior business journalist in 2018 and specialises in writing about the $26b dairy industry, agribusiness, exporting and the logistics sector and supply chains.