Dialogue: Full ahead for exports

SIR WILLIAM BIRCH* considers the benefits of the dairy merger and laments the lack of scrutiny.

The Government's decision to support the dairy merger with legislation that bypasses consideration by the Commerce Commission is controversial and will be debated for some time.

But the two companies have made welcome progress in addressing competition concerns compared with the proposal I considered as a minister and on which the commission gave an interim negative ruling.

The industry is now committed to rules that make it easy for farmers to become, or cease to be, supplying shareholders and for them to obtain (or pay) full fair value for their shares.

This will require the valuer to also determine a milk price that will be disclosed to suppliers. An independent valuer will find this a challenge.

In the context of a deregulated market, free entry and exit and a transparent milk price mean that Global Dairy will want to do all it can to avoid any systematic overstatement or understatement of its share value.

A share value that's too high will encourage farmers to switch to competitors, while one that's too low will encourage unwanted entry.

And the process for determining fair value of Global Dairy's shares will promote accountability by requiring much greater disclosure of projected financial performance than is typical of many listed companies.

As well, Global Dairy will be obliged to supply milk to competing companies serving the domestic market on the basis of the price it pays for raw milk. More importantly, Global Dairy will be subject to the full rigours of the Commerce Act after its establishment.

It would have been beneficial if the proposal had been subjected to the Commerce Commission process, as it would have closely examined the competition issues and thus improved the outcome for the whole economy.

The industry's current merger proposal supported, where appropriate, by legislation to give effect to the merged entity's commitments and a clear policy statement by the Government, would probably have gone a long way to addressing the concerns raised by the Commerce Commission in its consideration of the earlier merger proposal. It's a pity we'll never know for sure.

Referring the proposal to the Commerce Commission would also have strengthened the credibility of New Zealand's competition framework.

Bypassing the commission will not necessarily undermine that framework, however, if the unique features of the dairy industry that are problematic from a policy perspective are appreciated.

Where necessary, governments over the past 15 years have intervened legislatively to restructure and modify the regulatory regimes of a wide range of sectors - transport, post, fisheries, electricity and telecommunications are a few examples.

The dairy industry has an unusual semi-integrated structure shaped by legislation stemming from the 1930s.

The Dairy Board sells products provided almost exclusively by two competing shareholders that own almost all its shares.

This is a highly confining context for competition between the two dominant shareholders.

They are sometimes encouraged to make decisions that merely shift costs to others or to pass up opportunities that would benefit all dairy farmers.

Many smaller processors in New Zealand are able to penetrate niche markets with dairy products such as ice-cream, but have been frustrated by the export licensing requirements of the Dairy Board.

I saw that first hand as the Minister of Finance in my interactions with the industry on its earlier merger proposal.

These weaknesses, which are acknowledged openly by the industry's leaders, are intolerable for a sector that accounts for more than 20 per cent of our exports. A continuation of the status quo is simply not an option.

The choices for change are therefore stark - either split the industry in two by breaking up or selling the Dairy Board, or complete the integration of manufacturing and distribution by allowing a merger.

The former is really a vote for the status quo for a considerable time to come. It would pose significant transitional problems and could only be undertaken in the short term against the wishes of dairy farmers - an unlikely scenario.

The future of the dairy industry has been debated for several years and issues have been well aired by many well-informed commentators.

Realistically, no change at this time would be a recipe for continuing uncertainty and a further loss of competitiveness. Even greater losses of global market share would result.

The Government's announcement gives shareholders of the two main dairy companies the opportunity to take the short step to complete the rationalisation of the industry's current semi-integrated structure. Global Dairy will have the opportunity to prove whether resulting economies of scale and scope enable it to enhance the value of existing investments in brands, intellectual property, and marketing infrastructure.

And if Global Dairy can hit the ground running, remain efficient, flexible, competitive and responsive to market needs, it is more likely to retain its suppliers.

To its credit, the dairy industry has briefed political parties on its proposals and cross-party support will ensure the durability of any reforms. I understand that the National Party has discussed improvements to address competition issues which the industry has taken on board. Parliament will have a further opportunity to review and, if necessary, improve the legislation.

On balance, therefore, the proposed legislation will provide much needed certainty for the industry and a platform for it to quicken its pace.

* Sir William Birch was Minister of Finance in the National Party-led Government between 1993 and 1999.