David Hargreaves says Fonterra needs to undergo a massive overhaul otherwise the consequences could be quite drastic

David Hargreaves says Fonterra needs to undergo a massive overhaul otherwise the consequences could be quite drastic

By David Hargreaves

I think it is now time to stop just hoping that Fonterra 'comes right'.

As we look at it today, things at the co-operative seem very 'wrong' and it's long past the time that meaningful attempts need to be made to fix what is in my view a very broken model.

I'm not a farmer, so, I don't understand that perspective and so happily lay myself open to the criticism that might be forthcoming from such quarters.

But I know a bit about business and what works. Fonterra is not working as a business. Its model is flawed. It needs to change or else the consequences for the dairy industry and the economy could be quite dire.

Essentially Fonterra is trying to be all things to all people. 

On the one hand it's attempting to play with the big boys and girls out in the wide world, producing value-added products that make a buck.

On the other it's dutifully trying to satisfy farmers with a good price for their milk.

It's never managed to do both properly.

If the milk price is low then its operating margins (because the milk price is a key input cost) are better and it can make a better profit on the valued added goods.

But if the milk price goes up, the farmers are happier, but the profitability in the value added business gets squeezed because the milk's costing so much for Fonterra to effectively buy.

Disastrous result

This year's disastrous result shows that after years of trying to handle this double-edged sword, Fonterra has failed.

I commend anybody who can to get their hands on a recent piece of research done by First NZ Capital's Head of Institutional Research Arie Dekker, which was reviewed here by interest.co.nz's Guy Trafford.

Dekker's report, issued before the latest strife around Fonterra emerged, attempts to start the debate about the necessary changes and decisions Fonterra will have to make. 

In a nutshell Dekker reckons that Fonterra needs to either;

  • simplify its business, go back to basics reducing the business back and exiting non-core businesses to focus on key areas of strength that he believe would likely centre around ingredients processing out of the NZ milk pool or;
  • to undergo a structural separation, with the NZ processing business remaining under co-op control, while perhaps the offshore value-added businesses are spun out into a separate vehicle, which crucially would have access to outside capital. 

I like the separation idea. 

It would allow a greater source of capital to be put into the businesses currently under the one Fonterra umbrella and would help to remove the essential conflict that exists at the moment.

And if you don't think conflict exists, consider the release that the Fonterra Shareholders Council put out, expressing "absolute disappointment" in Fonterra's latest announcement.

Do the shareholders get it?

I'm certainly not going to argue that they are entitled to be something rather stronger even than 'disappointed' by what's happened. But I have a horrible feeling that even within this disappointment they feel, they don't really 'get it'. 

Fonterra's keeping more capital for itself right now because the business has blown out its debt levels. How badly we may or may not find out when the results are issued on September 13. I'm not holding my breath for us to get a clear picture because I've got to say, the Fonterra financial statements are generally about as transparent as the milk they handle. 

Without any clear indication of just how bad a position the company has got itself into this year we can but wonder whether there may be some problems with those debt levels getting too high. Whether there's some element of compulsion about Fonterra holding more capital back, or it's just decided to do so to be prudent, Fonterra as a commercial business has decided it really needs to do this.

As I read the Shareholders' Council's comments, I get a sense that they are questioning whether Fonterra really does need to hold on to extra money that they presumably feel should be in shareholders' pockets.

Well, if you look at the circumstances of the financial year having ended a week-and-a-half ago, and Fonterra suddenly calling a trading halt on the NZX and ASX on Wednesday while it discussed the annual accounts, you have to consider that something fairly serious has come up. And it required extra cash being held on to. 

Fonterra's a multibillion dollar business, with big multibillion dollar debts and credit ratings and all the bells and whistles. If it has decided to hold extra cash, it probably needs to.

But this just highlights the essential problem. Fonterra's trying to run an international value added business whilst the farmers want top dollar for their milk. Conflict.

Solutions need to be found

This issue has got to be tackled head on and as soon as possible.

A radical rethink is needed urgently, I think, with the best solution involving some sort of separation, which allows the value-added part of the business to access outside capital.

On top of all Fonterra's problems is the fact that organisationally it's in a huge state of flux, if not disarray. CEO Theo Spierings has said he's going but a replacement has yet to be named. John Wilson has stood down as Chairman due to ill health and his replacement John Monaghan has barely had time to warm his seat.

I confess to not knowing Monaghan at all and so I'm not in a position to judge the job he might do in steering the ship through these turbulent waters. But what I would say is that as someone who has been on the board already for 10 years he would not seem to be ideally placed to bring fresh ideas to the table.

The unfortunate thing about Wilson standing down the way he did is that the opportunity for a careful hand over to perhaps a new director from outside of Fonterra was passed up.

I really think now was the time to inject fresh ideas from outside of Fonterra into the organisation.

I think Monaghan would do the country a big service if he caretakered Fonterra for long enough to bring in some more outside knowledge - some fresh eyes - to really look at what's needed to right the badly listing ship.

The situation at Fonterra has been allowed to drift on for far, far too long. 

Everybody involved, and that means Fonterra as a business, and the shareholders, need to appreciate that the situation is getting untenable. Without firm decisive action the consequences for our economy might be quite dire indeed.

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Depressingly, I think so much is wrong in Nz, in both the private sector and government

Depressingly, I think so much is wrong in Nz, in both the private sector and government

Depressingly, I think so much is wrong in Nz, in both the private sector and government

Depressingly, I think so much is wrong in Nz, in both the private sector and government

Depressingly, I think so much is wrong in Nz, in both the private sector and government

Fivefold depressing sounds awful... at least its Friday night though Fritz.

Sorry, but as you're probably aware, the site has been experiencing a few issues today. These are probably what's behind Fritz's comment x 5.

I know Gareth. It was actually me that highlighted it in David's 90 seconds 9.00am.. Just having some fun and Fritz is a good guy so will understand my jest.. Have a good weekend and thanks again for an entertaining week.

Ha ha

Fonterror when I was associated with them was throwing money around like there was no tomorrow...

I thought they should have remained a main stay of New Zealand as a large coop....they could not really lose....

Perhaps the chickens are coming home to roost.......

Try hard, wannabees in charge, not Business men concentrating on their main objective. A fair return on their Farmers money, not blowing it.........over seas..

Well all the fat cats in their ivory tower building their in house grand empires to thrust up their own self interest and remuneration. Great grandiose schemes to squander other people’s money. Where have we been before. The hungry lion, Fletchers? Energyco, oh dear, who remembers that one.. Lovely monopolies. No need to stay with core functions, what the hell, fling it out there. Who cares.Great government cronies. Absolutely no accountability. Man Mr Key, your government wanted to be a corporate just like them. Who suffers? Cui bono. Stand up Shane Jones, wish we had more like you with some backbone to speak forth.

Join the 150;000 employee Cargill multinational
That’s the answer for Fonterra but the management & the farmer co-op are too proud to admit they drastically
need outside worldly wise assistance and Cargill being the first largest private corporation in the USA even larger than Koch has all the skill set & experience to transform NZ Dairy forever into the future
I know Cargill & I know Fonterra it’s time to bite the bullet and form an alliance
Major Key Players Analysis:
Some of the key players profiled in the Global Dairy Blends Market: Galloway Company (U.S.), Kerry Group plc (Ireland), Cargill Inc. (U.S.), Fonterra Co-operative (New Zealand), Royal Frieslandcampina N.V. (The Netherlands), AAK Foodservice (U.S.), Cape Food Ingredients (South Africa), Agropur Cooperative (Canada), Afp Advanced Food Products LLC (U.S.), Dohler GmbH (Germany), and others.

Basically agree, certainly on the need for drastic overhaul. My one obvious point of disagreement is on the issue of value added. Just because Fonterra repeat their spin over and over that value add is what they are growing does not make it true. Statistics from them point to the percentage of value add being static and the biggest statistical give away is the very low dividend paid when the milkprice was lowest.
I don't know the answer to Fonterras woes but an effective start point would be to ditch the spin and get to the facts as hard to find and unpalatable as they may be.

The Beingmate fiasco should be analysed seriously. Publicly. The NZ/Chinese accountants who aided the review of their books prior to purchase should be taken to the cleaners. Plus those Fonterra appointed board members who did not appear to have any idea of what was going on.

It is as simple as being the cost of business in China

All part of the cunning masterplan.

Policy of paying dividends when you have debt is totally flawed, so not paying them is a good move.
Best to get rid of all debt first.
Unfortunately it is the size of the debt, not common sense, which has forced them to see sense and cut dividends.
This policy of borrowing money merely to pay dividends pervades a lot of large companies, unfortunately.
Including Mercury, Genesis, Meridian....xc

Zombie companies they call 'em.

I have a couple of friends who have worked in the value added side of Fontera over the last several years and they saw many high value opportunities with new product development killed off because money was constantly pulled out of that side of the business to prop up the payout to farmers. Which underlines the need for more autonomy or an outright spin out like FP healthcare did and look how succesful that has been.

I think you've put your finger on a key issue. The business is owned by indebted farmers, who have a total focus on maximising short-term returns. Whereas to develop brands and hi-end products, you need a long-term focus and investment in the future. These have clearly been incompatible goals.

One only has to look at how successful Synlait and A2 Milk are to see that Fonterra is effectively being run into the ground. Seperate them, and at least give the value add side of the business a chance of success. More than just capital is required though - a change in management and organisational culture is also critical.

I agree, leave Fonterra selling commodities and sell the rest.
But offer the rest as a going concern, a publicly listed company.

We know whose hands they will end up in.

If they handled a sale as badly as other efforts yes..to you know who...
But a sophitsticated seller may do fancy things, share classes etc..not that Im a share holder or property investor.
The rest would be worth a few bob and the effort.

Agreed, it probably needs some serious oversight as the lust for short term profits is highly likely to see a relatively lowball offer win the day.

Oh, and if farmers could stop getting themselves into ridiculous debt positions that would be brilliant, then there could be less impetus to drain the cooperative of badly needed capital, capital that could be used for longterm investment....

Now that is lateral thinking....
Its all their fault, probably including the GFC...

everyone and that includes farmers in particular have over-stretched themselves on debt IMHO assuming grow for ever. So much for great business acumen of the right.

I agree, as a society we have racked up debt and sold assets to survive, if we didnt sell them directly we pillaged them.
As a result we dont have a culture of innovation in order to survive.
It equates to us still being colonial, relying on the mother country or its substitute, our government.

I was floored several months ago by my brother in law explaining why he is now a former dairy farmer...he blamed it on the gfc...funny I thought it was due to the unsustainable debt he took on when the banks sweet talked him 4 years earlier...

....and the promise of a glorious future in dairying promoted by the government agencies.
Another round of think big....
Farmers need to understand that innovation never originates from government or their agencies, mostly its blood sweat and tears by individuals
Think about the entrepreneurs of the internet.

Not his fault at all then 4th Estate ?

It's been broken for years. You know that when you go to Australia and buy 2 litres of milk for half the price of New Zealand.

Hard to accept low payouts when land prices doubled between 2002 and 2014


Also noting on the graph the switch in 2008 where farmers started producing more from the same land. I pick this is the combination of Feedpads, PKE (amongst other feeds) and 'system creep' Whether they were spending a dollar to make a dollar is another question.