Matthew Hooton: Leadership needed to fix Fonterra

Fonterra was sold with the idea that bigger is better, and that scale would help it deal with overseas customers. Photo / File

Nearly two decades ago, dairy industry leaders promised Fonterra would be New Zealand's Nokia. That may be the one promise they have kept.

Almost everything else promised to dairy farmers, Prime Minister Helen Clark, Parliament and New Zealand turned out to be bogus.

At the heart of the argument why Clark should overrule the Commerce Commission and legislate for Fonterra was vertical and horizontal integration.

Fonterra was formed not just by merging Craig Norgate's Kiwi Co-operative Dairies and Henry van der Heyden's New Zealand Dairy Group, but by integrating their joint subsidiary, the New Zealand Dairy Board, into the new structure.

This vertical integration, everyone was assured, was necessary so that one organisation could control the whole value chain from farm to consumer or, as Norgate put it irreverently, from tit to tongue. It would ensure farmers captured the maximum share of the real value of dairy products to the consumer.

Eventually, vertical integration would mean price signals could flow all the way from yoghurt consumers in China back to New Zealand farmers and the research effort behind them. Individual farmers could even be paid more for milk that had more of the most valuable proteins. All this was essential for a so-called value-add strategy.

Horizontal integration — code for maintaining something close to the Dairy Board's export monopoly — would ensure the new entity had sufficient scale to deal with the world's major supermarket chains, which were undergoing a similar consolidation process as dairy co-ops in New Zealand and abroad.

There just wouldn't be space on shelves for products from smaller entities, we were told.

Back then, no one had any insight into how online shopping might disrupt those assumptions.

The reason I recall this type of rhetoric so well is because I wrote a lot of it as part of the team lobbying politicians and farmers to back the deal.

In six months, Clark's Government, Jenny Shipley's Opposition, Parliament and a sufficient majority of dairy farmers bought it.

Those who were more sceptical — including officials at Treasury and MAF; politicians Michael Cullen, Bill English, John Luxton and Damien O'Connor; policy analyst Tony Baldwin; and journalist Andrea Fox, now at the Herald — were in the minority.

For a company as large as Fonterra, all generalisations are inadequate. Roughly, though, Fonterra and its support organisations remain among the world's best at pastoral and bovine science; near-exemplary at milk collection and processing; very good at ingredients and food services; disastrous at establishing joint ventures; not even a material player with fast-moving consumer goods (FMCG); and absolutely world class at lobbying and farmer PR.

The problem, as the critics said at the time, is that by and large, New Zealand has put all its milk in one pail — in a company with inadequate governance and capital to match its aspirations.

Contrary to some sneers in the wider business community, Fonterra's directors are far from bumpkins. In fact, they have always been some of New Zealand's most successful businesspeople, having built some of the world's largest and most financially successful farming businesses.

Prime Minister Jacinda Ardern and agriculture minister Damien O'Connor. Photo / File

Beyond their agribusiness skills, they can talk the language of international marketing as well as anyone. But the suggestion that they have sufficient insights to successfully govern a global FMCG business is as unfair as expecting Nestlé directors in Switzerland to know anything about herd productivity.

Moreover, when appointing non-farmer directors and chief executives, their primary focus seems to be getting people they feel comfortable with and who will fit into the existing culture.

From Norgate, to Andrew Ferrier, to Theo Spierings, being chief executive of Fonterra is a lonely job, with no globally significant businesspeople on the board to report to and from whom to seek insight and advice.

When assessing management proposals, directors can only draw on their New Zealand-centric experiences and tend to rely on external consultants such as McKinsey, whose obligations are to their own partners to maximise billings. This in turn leads to bureaucracy and senior management becoming highly process-focused, and the in-house politics that comes with it.

In contrast, leaner, more fleet-footed and less political New Zealand dairy companies have boomed over the last two decades, most notably the new giant a2, but also much smaller export players, down to Pic's Peanut Butter.

Most dairy farmers will continue to want the protection of a co-op. Milk is highly perishable and turns almost immediately from an asset to an environmental and economic liability if not picked up within a few hours.

But if so, they need to forget any fantasies that a company drawing its governance and capital from such a limited pool can ever do much more than collect their milk, remove the water, put the residual powder in 50kg bags and sell them at auction.

That would be fine were dairy not still such a major part of the New Zealand economy and were Fonterra not surrounded by legislation that still effectively locks most of it into one structure.

Parliament remains a stakeholder.

Paradoxically, fixing Fonterra involves removing some of its ongoing legislative constraints. It should no longer be required by law to collect milk from new entrants or those who want to expand — which only leads to overproduction, including at the peak — nor to sell raw product to its competitors.

It should be set on its path to being a completely normal company. That requires tough decisions and bold leadership from Jacinda Ardern, Grant Robertson and Damien O'Connor, or perhaps Simon Bridges, Paul Goldsmith and Todd Muller.

And it will require tough decisions and bold leadership from more dairy farmers. If they want to play it safe as commodity price-takers, the co-op will always be there for them.

But if they ever want the returns expected by shareholders of a2 or even Pic's, they will need to abandon that safety blanket and take a risk with something new, less conservative and less constrained.

• Matthew Hooton is managing director of PR and corporate affairs firm Exceltium.