Allan Barber wonders if Fonterra's lock on large scale supply is inhibiting competitors who need volume to make the most of higher value product opportunities

When Fonterra was established in 2001 it had over 12,000 suppliers and 95% of national milk collections, while New Zealand had about five million dairy cows. After hitting peak cow numbers in 2014/15, this has gradually decreased each year and sits at 4.67 million at the end of the 2022/23 season. At the time of Fonterra’s formation under the Dairy Industry Restructuring Act (2001) there were more than 13,500 herds in the country which have now reduced to about 10,800, although average herd size has increased by 200 and production per cow has risen by 25% over the same period.

During the last 20 years Fonterra has seen its share of milk collection fall to below 80% as a result of the number of new entrants to the industry, driven substantially by the opportunity to produce added value products for discerning overseas, especially Chinese, customers. Opportunities for infant formula and nutritional products have attracted new entrants keen to satisfy these new export markets.

While dairy companies’ success in opening up these new markets is undeniable, there remain questions about the most efficient structure of the New Zealand dairy sector and whether Fonterra has entirely achieved what was envisaged when it was formed. In 2001 only Tatua and Westland chose to remain outside the new cooperative, believing they could operate better from outside the tent.

Tatua has continued to prosper, regularly paying its 102 cooperative suppliers more, occasionally much more, than Fonterra, although this is largely due to its small scale, restricted operating area, and specialised range of high value dairy based products for retail and food service. It has found its market niche and is consistently good at what it does. Conversely Westland suppliers realised after a few years they would have done better by joining Fonterra, but by then it was too late and Fonterra indicated their lack of enthusiasm for milk collections on the West Coast. In 2019 Westland’s cooperative suppliers voted overwhelmingly to accept a takeover offer from Mongolia based Yili Group. Yili also owns Oceania Dairy in South Canterbury which began operations in 2013 and combined with Westland represents about 4% of the dairy industry’s turnover.

Open Country Dairy was formed 20 years ago, originally named Open Country Cheese, and is now New Zealand’s second biggest dairy company with about 10-11% of milk volumes and more than 1,000 suppliers. It exports over 300,000 tonnes of dairy products to more than 50 countries from plants in Waikato, Taranaki and Southland. The business model is totally different to Fonterra’s, as the company is part of the Talley’s Group and pays its suppliers a competitive price up front on a regular settlement programme. For many suppliers this compares very favourably with Fonterra’s staged payout schedule with regular announcements of changes to the final season’s milk price.

In addition, Fonterra shareholders are obliged to own shares in proportion to supply, although the recent constitutional change makes this easier than it was. When Open Country started operating, Fonterra shareholders were able to cash in some of their shares and take a better and faster milk payout from OCD. With the recent change in shares to a quarter of their previous requirement, the advantage no longer exists for new entrants to sign up suppliers. The only recourse is to copy the meat industry and pay a premium for supply which must be earned from efficiency and added value.

The other large players in the sector are large multinational corporates, Danone and Nestle, which source further-processed product from the primary processors, and Goodman Fielder which is guaranteed 250,000 million litres annually under DIRA, so it can provide meaningful domestic competition for Fonterra through well-known brands, Meadow Fresh, Puhoi Valley, Yoplait and Tararua.

There are several smaller companies competing for suppliers and milk volumes in different parts of the country, the best known being Synlait with 250 suppliers and A2 Corporation which have come up against a number of obstacles since their high profile earlier days. A2 still owns 20% of Synlait, although its purchase of 75% of Mataura Valley Milk has signalled its strategic objective to reduce its dependence on Synlait for product. Synlait has plants in Canterbury and North Waikato and its largest shareholder is Chinese company Bright Dairy which owns 39%.

[Update: An earlier version referenced Miraka. However this contained in error. Our apologies.]

In contrast Olam Dairy, Tokoroa, which is part of Olam Food Ingredients, 51.4% owned by Singapore government investment company Temasek and 14.5% by Mitsubishi Corporation. Olam commissioned its dryers late last year with supply from farmers in South Waikato who are attracted by its philosophy of paying a competitive price, building partnerships and investing in the community. According to milk supply General Manager, Paul Johnson, Olam generates more income through its added value product range and parent company’s supply chain logistics which it shares with its suppliers. It is going ahead with its stage two development, having confidence in its ability to move up the value chain as well as secure enough committed suppliers.

One dairy company executive described the industry as “dysfunctional” with razor thin margins because the structure provides little opportunity for large-scale competition. The industry has all the characteristics of a “monopsony” (similar to a monopoly) because Fonterra effectively controls the market as the major buyer of goods offered by many sellers. When Fonterra was established by merging the two main farmer-owned cooperatives, New Zealand Dairy Group and Kiwi Dairies, with the single desk seller NZ Dairy Board, the goal was to have a strong farmer-owned dairy export champion, while allowing all other companies freedom to export.

In retrospect this seems to have given Fonterra virtual carte blanche to be the dominant buyer, while restricting the ability of new operators to expand and grow profitably beyond a certain limited extent. Those that have started up must focus on the higher value products, but securing adequate supply to generate economies of scale is difficult.

This may be both what the Commerce Commission intended and a majority of farmers wanted, but it does not necessarily guarantee the best commercial outcomes.

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