David Hargreaves says Fonterra's still failing to balance the commodity cycles - and that's bad for New Zealand

By David Hargreaves

It may seem harsh in the extreme to be critical of Fonterra at a time when it's just ramped up the forecast milk price for the end of the current season and for the coming season as well.

For me though, the announcement squeezed in between those two bits of good news that the dividend might be more than halved this year means they've given us the milk, but taken away the cookies. There's no 'sweetener'.

Yes, the Fonterra directors can say (and already have) that the overall return to farmers this year is going to be better than last year. And look, that's absolutely fantastic.

But with Fonterra having paid a much higher milk price last year than the year before - and having maintained the dividend at 40c last year - I guess I had hoped it was at last getting a better handle on the juggling act between paying the market price for milk and being able to make good profits through adding value to milk products.

Does it matter? Aren't things fine and dandy as long as the milk prices stay up?

Yes, well, that's the exact point. Find and dandy as long as the milk prices stay up. Not so if they don't.

Look, Fonterra is a curious business. It takes the milk from the farmers and then pays them the highest price it can based on what it believes it can fetch on the open markets for commodity products such as milk powder that are made from the milk.

So, in attempting to reward the farmers it's actually facing the possibility that in times of rising milk prices, well, it's input costs go up considerably.

That's where the value-added products, which are not included in the milk price calculation, become so important. 

What the country needs is for Fonterra to be able to make good profits on value added products when the milk price is up.

Otherwise we are just completely hooked into the commodity cycle. We are hostage to the good or bad fortunes of the global milk markets.

As I've said probably plenty of times before, I was opposed to the creation of Fonterra, effectively a single mega dairy company that was entrusted with the wellbeing of the country's dairy industry - and therefore a very big part of our economy.

And the simple reason for that opposition was the sense that if the people running the mega dairy company don't get the strategy right they put the whole dairy industry - and therefore a very big part of our economy - at risk.

We've got to attempt to break out of the boom and bust commodity cycles as much as we possibly can. 

Now yes, commodity prices will always go up and down - but that's the trick really, isn't it. It's being able to balance things. The only true way to balance out the ups and downs is by adding value. That's what the global economy is all about now.

I'll be very interested to see if the upcoming review of the Dairy Industry Restructuring Act 2001 comes up with anything substantive. 

Two questions posed in the review's terms of reference are of particular interest to me in respect of the export market, namely:

Where/by whom are the benefits of the sector’s performance being captured and the costs/risks incurred? What is the extent and distribution of the benefits and costs/risks across the dairy industry supply chain and the wider economy?

What, and how strong, are the existing incentives and disincentives for the dairy industry to transition to higher value New Zealand based dairy production and processing that global consumers seek out for a premium? What, and how strong, are the incentives and disincentives for organics and alternative dairy production methods and product manufacturing? What is the role of government in strengthening these incentives and/or reducing/removing the disincentives?

I think the second question is particularly pertinent and the fact is I reckon we are still a long way off having the right incentives.

I don't pretend I've got a whole bunch of answers, but I do know that the latest announcements from Fonterra suggest it's no closer to finding it's own answers.

If Fonterra for all its talk, and unnecessarily flashy head office buildings, and ridiculous wages paid, can't genuinely move beyond being a straight commodity dealer then we are always going to be fully exposed to the commodity cycles. And worse - other countries will work on that value added thing and they will do it better and we will get left behind.

Is it time to consider a whole new approach to the industry? And should that include Fonterra as a single dairy industry flagship?