Dialogue: Fonterra's response smacks of paralysis

It's time for the company's directors to show leadership, says TONY BALDWIN.

Like it or not, New Zealand's economic prospects are now closely tied to the performance of one company, Fonterra, the mega dairy co-op formed last year under special legislation which let it bypass normal checks by monopolies watchdog, the Commerce Commission.

If Fonterra does not succeed, we will all be worse off, not just dairy farmers.

Commercial director Mike Smith's resignation last week highlights some critical problems in Fonterra.

Strip away the fluff and it is clear that Fonterra's success depends on just a handful of men: CEO Craig Norgate; a few senior managers, selected by Mr Norgate; and a few gritty farmer politicians, led by John Roadley.

You'll find the prospects of many large businesses also depend, in reality, on the judgment of just a few men and women. So what's different about Fonterra?

The first is weak monitoring. Big companies need monitoring by many different analysts and institutions with access to good information. Telecom's business decisions are evaluated every week by thousands of highly experienced people all around the world. Many of those analysts also publish their views. They are certainly not always right, but problems are more likely to be spotted much sooner in a company that is monitored in this way than in one which is not.

Fonterra, not being a listed company, has virtually none of this external monitoring for shareholders.

Secondly, Fonterra's shareholders are largely powerless to respond promptly to weak performance. By contrast, shareholders in Telecom or Nestle (Fonterra's main rival) can sell their shares if they fail to perform.

All Fonterra's farmers can do is make political noises and campaign to change some of their directors once a year.

The result is that Fonterra's managers face much less commercial pressure from their shareholders than, for example, Telecom or Nestle.

Farmers' investment in Fonterra is, in effect, captured.

Fonterra's third big problem is that its directors are likely to be controlled by their chief executive. A strong chief executive in Fonterra can easily control the flow of information to the directors and effectively limit their ability to disagree with him.

A fourth key weakness is the deep culture of non-business practices. For years now, farmers in central Waikato and Taranaki have subsidised farmers in other parts of New Zealand. Payouts have been distorted. Unprofitable activities have been hidden. Rules have been twisted. Why? In essence, to protect political power bases within the industry. Many of the dairy co-ops have a strong culture of "Old Irish politics". No doubt this is still at work in Fonterra.

So what does all this amount to? To-be-expected teething problems, as claimed by Mr Roadley and the Prime Minister? (Curious that a Prime Minister, who does not sit at the board table, should seek to reassure private shareholders.)

No, Mr Smith's resignation should not be minimised as a minor event. His is the latest in a series of resignations which, put together, point strongly to some of Fonterra's underlying flaws.

It cannot afford to keep discarding the services of its best commercial minds. John Storey, Graham Fraser, Brian Allison and now Mr Smith all pushed aside because an inner cabal of farmer-politicians and top managers prefer to sweep their concerns under the carpet.

Even Mr Roadley acknowledged last year that Fonterra had some key issues to address, and he promised action after the merger was in the bag.

As reported by Fonterra's advisers last year, these must-do issues include:

* A radical change in management culture.

* A new discipline in governance by directors.

* New internal performance monitoring systems.

* Compulsory 4 per cent annual cost savings.

* Market-based pricing between business units.

* Differential payouts based on true costs.

* A separate corporate structure for the value-added businesses with tradeable shares.

* A larger proportion of independent directors appointed for their business expertise.

The acid test now is, do Fonterra's directors have the courage to make these changes? Given the four major flaws outlined above, chances are that the directors will wimp out.

Their response so far? Commission yet another consultant's report - hardly an encouraging sign. Nor is holding workshops for directors on how to govern. It all smacks of amateurism, procrastination and paralysis.

It is time for the directors to show if they can lead. The holes in Fonterra's structure are gaping. It will not work until they are properly filled.

* Tony Baldwin was leader, Producer Board Reform Team, 1999.