Fran O'Sullivan: Fonterra must be a champion in China

Fonterra chairman Henry van der Heyden. File photo / Paul Estcourt

NZ dairy company Fonterra is at risk of being outclassed on its own home turf if it doesn't rapidly develop a strategy to launch high-quality New Zealand brands into the fast-growing Chinese markets.

It's hard to credit why Fonterra clings so assiduously to its strategy of shipping processed product to its customers in China for them to manufacture into their own brands, but shies away from the risky, but potentially rewarding step, of developing clearly-identified products here to capitalise on the huge Chinese demand for "safe" New Zealand-sourced food - particularly for infants.

Already two Chinese companies are moving into the space that Fonterra has yet to dare to occupy. Bright Dairy - which is the 51 per cent controlling shareholder of Synlait Milk - launched "Pure Canterbury" in Shanghai in mid-December. Shanghai Pengxin has reserved two brand names - "Nature Pure" and "Pure 100" - for the high-value products it ultimately plans to export from New Zealand after it completes its acquisition of the Crafar dairy farms.

Cans of Pure Canterbury infant formula - complete with their image of the snow-clad Southern Alps rising out of the fertile green Canterbury Plains - are now on the Shanghai supermarket shelves. But it is the Chinese-NZ joint venture that is promoting the NZ brand. Fonterra is not part of this space.

Fonterra's recently-appointed chief executive Theo Spierings will be acutely aware of these realities. Spierings is in the middle of a strategic review of the company and its China strategy. This is not expected to be published until next month. But he is known to view the burgeoning Chinese and Indian markets as the "gamechanger" for the company.

In China late last year, Spierings told Bloomberg TV that the local dairy market would increase in value by more than 10 per cent a year in the next few years and Fonterra plans to double sales by 2020. Fonterra would increase its sales through imports and also through expansion of local milk production via its three farms.

This was part of a fully-integrated model that Fonterra was applying within China to have control over its supply chain so it would not have the safety issues like the melamine disaster which resulted in its previous investment in Sanlu being wiped out.

Doubling sales by 2020 might sound ambitious enough. But as a straight mathematical progression it represents no more than continuing to maintain Fonterra's existing market share.

Meantime the company is stuck in defensive mode. Bleating about the $200 million (over three years) it may miss out on as a result of the Government's decision to expand the DIRA (Dairy Industry Restructuring Act) so that competitors will be able to access another 200 million litres of milk a year to feed their plants.

But not publicly alert at least to the distinct possibility that it will itself be able to negotiate very commercial terms indeed for these same rival customers if they have failed to stitch up alternative milk supplies by the time the obligation to supply expires after a three year period.

Personally I was disappointed to hear Fonterra chairman Henry van der Heyden stress the move to require more raw milk "to be handed over to increasingly foreign-owned dairy companies operating in New Zealand will impose nearly $200 million of additional costs over the next three years alone and work against our efforts to reduce the price of milk in New Zealand".

There is of course an element of bluster about this. Van der Heyden knows very well indeed that the Government wants Fonterra to morph into a major food player. The DIRA announcements - including giving the Commerce Commission a broader role in ensuring a transparent local market - is part of that.

But ramping up the possibility that Fonterra might not have the funds to provide cheaper milk, instead of simply meeting the competitive threats head-on by launching a much braver brand strategy was an under-whelming response.

So what is it that Fonterra doesn't get?

Maybe it's a lack of investment capital to underpin the difficult task of establishing a brand in a foreign market. (If so, it would be a simple measure to bring in private capital to launch a new food brands company).

Or fear by the co-operative's farmer shareholders of allowing private capital to team up with their company to develop additional and substantial added value manufacturing here.

Or is there a fear that valuable offshore customers will be upset if their supplier also competes against them in high-value market segments?

These issues will no doubt be part of the strategic review.

But fundamentally, it's my belief Fonterra's farmer shareholders don't want to be wrestled from their comfort zone.

It suits them (and there are strong commercial arguments for this stance) to continue to occupy their hard-won dominant position in the international commodity trade.

Problem is, as Dairy NZ notes, New Zealand dairy farmers "must anticipate that they will not remain the sole exporting nation with a competitive cost advantage based on extensive pastoral farming systems". The competitive cost advantage that Fonterra has long claimed in the pastoral farming space is increasingly under threat from the South American nations.

This external threat is understood.

But what about the new internal realities?

In mid-December, Synlait Milk chief executive John Penno joined NZ's diplomatic representatives in Shanghai for the official launch of Pure Canterbury on the domestic market by the company's 51 per cent Chinese shareholder Bright Dairy.

The Shanghai-listed company is currently ranked third largest dairy company in China, and last year had an operating revenue of $2.4 billion.

According to Penno, 900g cans retail from between $92 for stage one infant formula, to $84 for stage three infant formula. This is clearly significant when compared to formula on New Zealand supermarket shelves priced between $15 and $30.

But said Penno in a blurb for his local paper, "it typifies the value consumers in China are willing to pay for formula produced and packaged in New Zealand. It is little wonder that Bright Dairy is investing 20 million yuan on the advertising and promotion of Pure Canterbury over the next 12 months."

The most interesting metric Penno produced was the sales forecast by Bright Dairy. President Guo Benheng expects Pure Canterbury to achieve revenues of 3-4 billion yuan in the next three to five years through direct sales, e-commerce and traditional offline sales channels. On current exchange rates that is $570 million - $760 million revenue.

Fonterra was established as a "national champion". It's time it really got itself out there in the Chinese market.