Keith Woodford wants Fonterra to get rid of the spin, communicate with its shareholders and other stakeholders with transparency, through good times and bad

Keith Woodford wants Fonterra to get rid of the spin, communicate with its shareholders and other stakeholders with transparency, through good times and bad

By Keith Woodford*

Within the coming week, Fonterra will release its six-month accounts. There should be plenty of good news there, including profit guidance for the whole year of more than $800 million. The key issue is how will Fonterra spin that story?

Drivers of profit

The key reason profit will be strong this year is that milk powders have low value. The investor market has taken some time to understand this inverse relationship between milk-powder prices and profit. This relationship exists because the farm-gate price of milk, which farmers get paid, is a cost to Fonterra itself. But milk powder is just part of the story. 

Owing to quirks in the way that the milk price is calculated, using five so-called reference products, the profit will also be raised because commodity cheese – which is not a reference product – has been more profitable than the reference products.

The latest figures I have seen indicate that Fonterra is producing about 18% more cheese this year than last. The net earnings from commodity cheese, relative to the alternative of producing milk powders (whole and skim) and/or butter plus anhydrous milk fat, will go to profit.

Sorting out the components

Analysts need information on at least eight profit streams if they are to interpret the true meaning of the headline figure.

The first of these is the earnings from toll processing of milk into the five reference products. These earnings are calculated from formulae that assume Fonterra is an efficient processor, and include both assumed operating costs plus assumed cost of capital. I expect these payments will amount this year to about $2.8 billion, from which Fonterra will have to deduct its actual processing costs.

The second earning streams will be from commodity sales of cheese and other commodities, outside of the five reference products, minus the value of the milk therein if it had been used for reference commodity products.

This net figure for non-reference commodities can be either positive or negative. In 2013/14 it was negative and this is why Fonterra had to underpay farmers in relation to the calculated milk price; otherwise they would have had a cash flow problem. But this year it will be strongly positive.

The third profit stream is from New Zealand consumer operations. This should be positive, given that it comes from selling consumer products to New Zealanders in an environment where there is little competition. Fonterra never separates out these returns for outside scrutiny.

The fourth income stream is from Australia and this has been negative in recent years. This is because Fonterra has been uncompetitive in Australia relative to competitors. To get supply, it has had to purchase milk from its Australian farmers at considerably higher prices than are paid to New Zealand farmers.

This year, Fonterra has exited from its Australian yoghurt and custards business. It still sells milk to Woolworths at what can only be a low margin. This milk then sells for AUD $1 per litre as Woolworths’ house brand. The upside of the Woolworths contract is the quid pro quo that Fonterra’s ‘Mainland’ cheese is now back on the Woolworths supermarket shelves.

The fifth stream is specialist ingredients for specific clients. These ingredients earn a margin over basic commodity products.

The sixth stream is food-service products. Essentially these are ingredients which go to manufacturers of final consumer goods. In all likelihood, this is one of Fonterra’s goldmines. The boundary between this stream and the ingredients stream can be opaque. 

The seventh stream is Fonterra’s own consumer products sold outside New Zealand and Australia. The key brands are Anchor and Anmum, although not all Anchor products are from Fonterra. This is because Fonterra sold off some of the brand rights some years back. This stream also includes products sold by Fonterra’s subsidiary companies such as Soprole in Chile.

The eighth stream is Fonterra’s farm operations in China. Last year they made a net loss prior to any deductions for interest of $44 million. Where are those numbers going this year?

And then there are two big cash costs to take account of. The first is corporate overheads – including salaries for the reportedly 1500 staff operating from Fonterra’s new Auckland headquarters. And then there is Fonterra’s cost of debt on about $7.5 billion. There is also a book cost for depreciation and any asset write-offs.

Sorting through the fog

In past years, I have never been able to separate out all of the above with any confidence. That simply illustrates that Fonterra’s annual reports are largely good news stories of spin and obfuscation. 

Of course Fonterra will claim that providing information on all of the above is commercially sensitive. Well, Fonterra’s competitors will be able to work out from their own numbers as to where Fonterra sits in the segments that are relevant to them. But the rest of us are largely left in the dark. Hence, no-one, except perhaps a few in senior management, gets the overall picture.

In relation to the company balance sheet, Fonterra always highlights their debt-to-debt-plus-equity ratio. The current spin is that it will come back to between 45% and 50% this year. But what is often lost in translation is that the only debt that is included here is debt that incurs interest.

Part of the reason that debt-to-debt-plus-equity will improve this year is that Fonterra has been moving its non-milk and service suppliers to 91-day payment terms. This delayed payment reduces the debt on which Fonterra pays interest and shifts an equivalent amount to liabilities which don’t incur debt. So yes, the so-called debt-to-debt-pus equity ratio will improve, but in part this is at the cost of their non-milk and service suppliers.

In the latest July 2015 accounts, Fonterra had total liabilities of $11.656 billion and net equity of $6.569 billion. I have never seen Fonterra refer to those two figures together.

In previous times, Fonterra has been able to get away with obfuscation. Fonterra used to earn huge respect from its sheer size, and farmers were generally happy with the returns they were receiving. But Fonterra has spent that goodwill.

Farmer disappointment

Most of the farmers I talk to remain fiercely loyal to co-operative principles but are deeply disappointed by Fonterra’s performance.

At the last AGM, a majority of shareholders voted for a reduction in the size of the Governance Board. Farmers tell me they voted this way, not because of fundamental belief that a small Board is necessarily better, but because they wanted to send a message of dissatisfaction.

Quite simply, the public relations spin has been found wanting on too many occasions and the fundamental trust has now gone.

Over the last few years, Fonterra has come up short too many times. First there was the San Lu investment debacle and the subsequent melamine scandal. Then there was the botulism scare. Then the wheels fell off the China farms operation. Somewhere along the line Fonterra missed the early opportunities to invest in UHT manufacture. They also missed, and are still missing, the A2 opportunities which are now turning into a threat.  And the price guidance to farmers over the last five years has been consistently woeful, with a failure to communicate the extent of uncertainties, and updates unnecessarily delayed. 

Community relations

In regard to the broader community, the delayed payments to non-milk and service suppliers have left many a sour taste. In essence, it has been bully-boy tactics. And more broadly, much of the nation has now turned against Fonterra and our largest export industry.

Back in 2014, following the release of reports on the botulism scare, there was a breath of fresh air with independent director Sir Ralph Norris recognising the fundamental flaws of corporate culture that needed to be addressed. In contrast, other leaders provided defensive spin about everything being under control. Well, in late 2015 Sir Ralph resigned, for whatever reasons, and the old PR machine seems to be back in control.

There are good things going on at Fonterra. Recent innovations include the mozzarella factory at Clandeboye and the sliced-cheese processing at Eltham. Fonterra tells us that they can now manufacture enough cheese for 300 million pizzas and 3 billion hamburgers. To me, those numbers look like PR spin, rather than solid figures like tonnes of cheese or kg of milksolids.

Getting rid of the spin

Within the last week, Fonterra’s chief of spin-doctoring and related matters has resigned. We can only surmise as to the ‘personal reasons’ that led to this outcome. But in reality it does not matter who is in charge of the spin-doctoring. Corporate culture is determined at the very top. 

So how can Fonterra address this?

A good starting point would be to cut out all the spin when the interim profit figure is announced next week. Just tell it as it is, with total transparency as to the good and the bad, the strengths and the weaknesses. 

Keith Woodford is Honorary Professor of Agri-Food Systems at Lincoln University. He combines this with project and consulting work in agri-food systems. His archived writings are available at

We welcome your help to improve our coverage of this issue. Any examples or experiences to relate? Any links to other news, data or research to shed more light on this? Any insight or views on what might happen next or what should happen next? Any errors to correct?

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Interestingly a significant part of how we feel and react to stories about an organisation are what the commentators refer to as the "optics" of a situation.
Part of the problem is that Fonterra is unable to put anyone in front of a camera who:

Does not earn over a million a year

Does not have a foreign accent

Has any kind of rapport with the New Zealand at large
This is a problem that isnt going to help anyone manage what happens next.

Businesses may be private enterprises, co-operatives, public companies or whatever else, but they exist in social and environmental frameworks, as well as in the political and the economic arenas. They are parts of a society and the total environment in which we live. It is imperative that all businesses learn to answer to these larger social and environmental considerations. This has been, and will be, harder for some businesses to learn than others.

Spin, pr, obfuscation, no longer cuts it. This is to privilege the business – its economic priorities and its self-serving objectives - above all other audiences and the public in which it lives (even future generations which stand to inherit what a business and its sector leaves), and such self-privilege is to treat these others with contempt. This, I emphasise, is not to disparage farmers or managers, nor is it to risk true commercial competitiveness. It is a matter of renewing the traditional corporate culture. The requirements for active, upfront, social and environmental communication and responsibility are the facts of the new framework or business operation.

In particular, when a company like Fonterra is of such importance to New Zealand, it should learn that it does not answer to a closed circle of executives, politicians, bankers, farmers and customers. Sustainability, a key issue here, is no mere handy catchword. It is the essence of continuing and future social and environmental provision and sustenance. And it depends on honest communication, and frank and responsive, inclusive relationships. Not what a company thinks sounds good, what it thinks will get difficult questions out of the way.

The low payout and risk of longer term lower average is a problem on 2 fronts. Of huge risk and concern to all dairy farmers is the dairy boom is over and that mean land prices are falling. This is effectively evaporating their equity in to thin air as farm prices fall back to profitable levels. It needs to fall by 40% over the next 1-2 years to be viable. This has not been addressed yet, but it will be a shock to all dairy farmers, especially those who plan to sell their farms and retire

They will not like it as many have got into the game for capital gain primarily and were willing to mortgage themselves to the hilt to do it. And many who were once well established have risked everything to buy the neighbouring property with 100% finance. Not such a smart idea now but hind sight is a great thing.

How much pressure do you think (CFO) Lukas Paravicini is under to resign right now? I wonder....

I dont think his interview on Paul Henry this morning helped either his or Fonterra's cause....

One has to wonder about the abilities of the executive team. It's kinda like a certain sports team we all know - individually, look great on paper, but as a team abysmal failures....

Not the first time i have heard NZ management styles compared to a national sport.
And that was refering to another goverment pseudo company.

Unbelievable. Their PR is incredible. Literally. Heard the interview. Paul pushed him hard. Mr Paravacini was completely confusing.

I invoiced you on the 1st March, and your terms state you will pay me 60 days from the 31st of March - in plain English, that is not 60 days payment terms. Mr Paravicini might be able to speak five languages.... Does he think we're all idiots? ... I can speak a bunch of words from more than five languages and make just as much sense....

All it needs is for some of these alleged emails to find their way into the public arena and he might be looking for alternative employment. Trying to be cute with his language to skirt around the issue is just plain dumb.

Thoroughly excellent article......great read .

Excellent article.
Fonterra seems to create needless complexity. Perhaps they like that.
Simple question would be - If it is profitable, why have a $7.5 debt timebomb ?

It all comes back to the fallacy that "bigger is better". It really never is. Big conglomerates, cooperatives and other organisations (e.g. the EU) generally all succumb to the same self-destructive forces:
1) The management/executive are often the product of ego and power seeking personalities who are completely unsuited to running large businesses;
2) The management/executive become divorced from the realities and expectations of their shareholders and their markets and tend to pursue their own dreams based on their own beliefs;
3) The management/executive in essence have very little, if any, "skin in the game". They are paid large sums irrespective of performance and are essentially rewarded when things turn to custard, by walking into other high paying management roles. Essentially, they just need to keep up appearances and re-invent the Emperor's Clothes...simple really.
4) Interests are not aligned. If the executives feel their positions are under threat, whose interests do you think they will protect - theirs or the interests of the members/shareholders? Answer: the former every time.

Very accurate Ludwig, an additional mechanism thrown into the mix is McKinsey

You are getting close.
Or maybe as a nation we enthuse over peformance rather than experience...the superstar syndrome.
The other view is that we flatten the tall poppies, encouraging mediocrity rather than excellence.
Who knows

I think it is a bit more simple. Everyone argues you need to pay the big bucks to get someone good to run the company. But the reality is, the CEO is just another employee. They are not a business owner or more importantly a business creator. They are just the person that got promoted into a role they probably weren't made for.

Promotion to incompetence is another path.
Dare we look at the American experiences for General Motors and Apple versus Hewlett Packard and.Ford for that matter.

Daniel Kahneman (relatively well known psychologist) researched this topic and found that the influence that a good CEO had on company performance was barely greater than chance. How this then determines the lofty pay packets, and why we as a society accept that CEO's get paid so much, I have no idea. Time we started calling them out.

A lot of them don't actually know the business they run - I mean the actual day to day running's. You just have to watch an episode of the undercover boss, to see how out of touch most CEO's are with their companies. Most of them are there to network and hook up plum exec jobs for mates.

Well thats a relief,
That leaves culture which has been refered to today. I dont know them myself but presumeably they are like one of the types copied out of Wiki

Deal and Kennedy Edit
Deal and Kennedy (1982)[6] defined organizational culture as the way things get done around here.

Deal and Kennedy created a model of culture that is based on 4 different types of organizations. They each focus on how quickly the organization receives feedback, the way members are rewarded, and the level of risks taken:[18]

Work-hard, play-hard culture: This has rapid feedback/reward and low risk resulting in: Stress coming from quantity of work rather than uncertainty. High-speed action leading to high-speed recreation. Examples: Restaurants, software companies.[18]
Tough-guy macho culture: This has rapid feedback/reward and high risk, resulting in the following: Stress coming from high risk and potential loss/gain of reward. Focus on the present rather than the longer-term future. Examples: police, surgeons, sports.[18]
Process culture: This has slow feedback/reward and low risk, resulting in the following: Low stress, plodding work, comfort and security. Stress that comes from internal politics and stupidity of the system. Development of bureaucracies and other ways of maintaining the status quo. Focus on security of the past and of the future. Examples: banks, insurance companies.[6][18]
Bet-the-company culture: This has slow feedback/reward and high risk, resulting in the following: Stress coming from high risk and delay before knowing if actions have paid off. The long view is taken, but then much work is put into making sure things happen as planned. Examples: aircraft manufacturers, oil companies.

I can remember going down to the large herds conference in 2006 or 2007 in Dunedin.The key note speaker was a large local farmer who ripped into Fonterra for there PR spin,excessive salaries,blubber fat staffing and the fact that could go bang.Nothing has changed it has got so much worse

What is this fascination with European managers - are Kiwis just blinded by Spivs?
For example - John Key - we see him as a successful, worldly guy and he could tell us that "dairy has a great future " and we would believe him. Emperor / clothes.

Time for NZ to look inward.

p/s - Any contractor knows that if you get asked to extend the invoice payment date its time to cut and run.

Im in no way competent to be asking these questions or anwering them but as NZ ers we have a vested interest.
Smalltown, you ask the question that should be put to the shareholders
What pushes their buttons?

To ask suppliers/contractors etc to wait 61 to 90 days for payment for services rendered is ridiculous. And to ask for most suppliers/contractors to take a 10% reduction to previously agreed payment rates is also ridiculous.

I'd think the 10% reduction could start with the numbers of and salaries of the 4000 Fonterra staff making more than $100,000 per year.

None of the ones I've seen fronting for the company and making more than 1 million dollars give any confidence at all. Not tall poppy stuff - just common sense and fairness to farmers and shareholders.

It's all you get from Fonterra is spin.
Will be interesting what comes from the DIRA review Fonterra asking not to be required to accept all milk supply and asking to drop marginal area's. There goes Northland reaches of the east coast, any Westland supply.

If Fonterra's farmers knew what has been going on at their Princes St HO in recent years, they would have been in there to lynch some of their exective team. The behaviours and activities pursued by key members of the team would not be tolerated in a well functioning organisation that takes the word accountability seriously. An organisation that has a culture which tolerates illegal and immoral behaviour and deals with these same problems by either sweeping them under the carpet or moving the culprits out quietly with glowing references deserves to have its day of reckoning.

Keith what interest rate is Fonterra paying on the debt since their credit rating has been dropped?

No helmet,
Last year Fonterra paid finance costs on interest bearing debt of $557 million on opening debt of $4.898 billion and closing debt of 7.560 billion. But not all of the 'finance costs' are included as 'interest'.
Costs specifically assigned as interest were $414 million.
The effect of a lowered credit rating with be relatively minor. It will depend on the conditions for specific debt instruments. The general lowering of interest rates should have a larger effect, but once again it depends on the currency the debts are held in.
Keith Woodford

Can you elaborate on " not all finance costs are included " where are these cost accounted for and how much ?
Wouldn't the auditors comment on this sought of issue ?

All of the finance costs are included. So there is nothing there for the auditors to get excited about.
The point I was trying to make was that the 'interest' of $414 million was not the total cost of finance ($557 million). The additional $143 million were finance costs associated with derivative instruments which - in the arcane world of finance - are not called 'interest'.
Keith Woodford

Keith, I have enjoyed reading your recent articles on this topic.
I think though, it is time for the media commentators to put the blowtorch onto the Fonterra Directors, rather than only the Management.
I feel it is at that level that poor decisions (or worse no decisions!) are being taken, simply due to lack of relevant global experience!.. the majority of the Directors are not competent enough to run our largest company.. Ralph Norris' departure should have sounded alarm bells..

""It's actually a win-win. It's helping grow the industry and create more demand for New Zealand milk," farmer and Fonterra director Ian Farrelly said.
And with 11,000 Kiwi cows already docked in China those in the industry are confident there's room for more without creating competition for New Zealand farmers and milk products."

I am no Einstein but when I first heard of the above I went "Duh" and since then the market has said the same. I would suggest some of these directors stick to milking cows.

Frustrated Insider
Both the Board and the management include some very skilled people. And some - but not all - of the farmer elected Board Members did have a lot of international experience prior to joining the board.
However, the Chair and the CEO are the only people who can really drive change. And it is therefore they who have to take overall responsibility, and hence be accountable, for both the culture and the outcomes.
And there has been an organisational culture problem within Fonterra for a long time.
Next week's figures from Fonterra should, on the surface, be strong. The problem, in terms of a sustainable future, is what lies underneath.
Fonterra has got itself into a position where there is now no easy path forward.
But it is indeed time for some fresh thinking with some fresh leaders.
Keith Woodford

One thing I've been wondering is how the 'breakeven' payout figure is calculated. Does it assume a 'standard' proportion of mortgage debt, or no debt, or what? This could skew the result markedly. And what happens when land values fall, such as we are now being told is running at 20% from the end of last year? I note though, that only 16% (by volume or value?) of the sales relate to dairy. That seems a very thin statistical sample from which to be making the bald statements in the media of today. Or have I missed something?

Dairy NZ quoted $5.40 breakeven is for the " average dairy farm " what ever that is . It covers all cash cost including debt serving