Ubi ius, ibi officium – ‘privilege with responsibility’.

One bit of Latin every young farmer should be taught. What a great privilege it is to have such a key influence on human health, the environment and, in many cases, animal welfare. And it’s obviously a great responsibility too.

So it’s worth considering which farming systems discharge their duties admirably and which ones fall short? Which farming sector scores worst in terms of the environment? Worst in animal welfare?

I bet 99% of you answered ‘dairy’.

The dairy industry is having tough times. Dirty dairying still gets plenty of press. Animal welfare was a more recent body blow as a ‘Sunday’ exposé revealed the appalling treatment of bobby calves. Bobby calves are euphemistically called a ‘by-product’, but today they are of such little worth that they could more reasonably be considered a waste product.

The dairy industry solution is to stop the brutalising and ease the neglect, but in other respects the process remains largely the same. Annually allowing two million bobby calves a less distressing four or five days before they become dogfood, so that we might sip our lattes, still makes the average consumer queasy.

It’s also tough times business-wise down on the farm. The price for whole milk powder has more than halved from its 2013 highs, in US dollar terms. And the competition has never been hotter with the supermarket shelves full of soy, almond, rice and now coconut milk. Some of these alternatives are delicious, nutritious and make a damned fine latte.

Hawke’s Bay has not fallen victim to dairy’s economic malaise because the industry is such a small component of our economy. ASB’s Regional Economic Scoreboard ranks Hawke’s Bay 6th out of 16 regions, describing us as ‘perky’.

But we shouldn’t feel too smug. While Hawke’s Bay only makes up 1% of NZ’s dairy production, it is on the increase. The proposed CHB dam anticipates significantly more dairying. The cyclical problems of the dairy industry are sure to become our problems. So what are the big issues and how could they be remedied?

Too many strategies

For generations after WWII most rural producers had operated under state-sanctionedd producer boards – single desk monopolies. The prevailing view was that‘we need to work together’. This probably made sense for a nation of ‘cottage farmers’,but that is not how farming is today. When Fonterra was formed they secured a 96%market share with only Westland and Tatua opting to have a go independently. Since then Fonterra’s share has dropped about10%, indicating the ‘rebels’ have done abetter job in the eyes of the farmers.

In the early 1990s the NZ government paid Harvard business guru MichaelPorter to undertake a report on our export industries and how they might become more competitive. For awhile his writings were compulsory fodder for students of economics and commerce.

One of Porter’s enduring ideas was that there are only three broad business strategies – least cost, differentiated and niche. Each of these strategies has merit and may prosper.

The ‘least cost’ option is dominated by commodity producers or those that have natural cost advantages – like a Saudi Arabian oil producer. A differentiated producer is like Apple, with their IPad, IPhone and other cool devices. They don’t need to worry about cost so much as they appeal to consumers in other ways. Organics exemplifies the niche strategy; usually commanding less than 10% of market share, but securing a significant price premium from passionate devotees.

Fonterra’s problem is that it is trying to pursue all three of these strategies. Mostly it’s a ‘least cost’ producer and heavily exposed to the whole milk powder market. But it also produces differentiated products like anhydrous mild fat and it even does niche organics.

In theory a big company can create different business units, each focusing on one of the three strategies. But companies are driven by their culture and trying to create three different cultures is difficult. Usually it leads to unhelpful internal tensions.

In practice it’s easier to serve one master than three. “It’s been a distraction,” says Kevin Cooney, ASB’s Head of Agri Capital. He points out that Tatua have done a better job of differentiated products, which dominate their business. And Fonterra, some 20 times the size of Westland Dairy, have milk powder production costs that are almost identical. “They don’t show the economies of scale you’d expect,” says Cooney.

It’s just too hard to pursue three different strategies with excellence. Try telling an Apple executive to forget the gadgetry and work on making the cheapest phones and she’ll think you’re mad – it’s not in her DNA! Fonterra’s DNA is confused.

Pipfruit differentiates

The pipfruit industry is well on the way to finding a solution to this dilemma. Companies have evolved whose strategy is to exploit each of the three Porter strategies. Mr Apple and TaylorCorp have not invested heavily in new varieties, but continue to rely on being highly efficient (i.e. least cost) producers of commodity varieties – albeit some that have historically been dominated by NZ. This may be the highest risk strategy long term, but these operators have probably been the most successful over the last decade.

ENZA and my own Yummy have adopted a strongly differentiated approach with heavy investment in new ‘IP’ varieties; in ENZA’s case the global development of Jazz and Envy.

Bostock’s and Rockit have adopted a niche strategy, with organics and the tiny Rockit apple tubes. Innovation is great, but in any industry it’s not the domain of the biggest producers. For years when ENZA was a monopoly producer board they said there was no demand for organics. What they really meant was that the segment was too small to make a difference to its bottom line. This stance frustrated many, but it was exactly the right call for ENZA – niche was not their strategy.

For mainstream industries in New Zealand, the differentiated strategy is the best fit. Our costs of key inputs like labour, land, capital (interest rates) and shipping are high relative to our competitors.

What about dairy?

Perhaps one of the few exceptions to this is dairying. New Zealand’s benign climate and relatively abundant rainfall make it paradise for growing grass and milking cows.

You could make the case that our industry should be focused on a ‘least cost’ approach. We make up about a third of internationally traded dairy products so we’re forced to be fairly mainstream. Fonterra is mostly aligned to the ‘least cost’ strategy.

The downsides? Firstly you’re exposed to volatile global commodity prices. While they’ve been fairly high over the past decade, the price swings have been unusually violent.

The other problem with the least cost model is that it’s a bad fit with ‘Brand New Zealand’. A least cost operator will only be inclined to do the bare minimum in meeting, say environmental or animal welfare obligations. Does that sound like Fonterra to you?

Now don’t get irritated. If least cost is their strategy they are doing exactly the right thing from a business standpoint. It’s just not the right thing from a national perspective. It’s not what you want New Zealand to be. The hideously trite ‘Brand NZ’ is personified by other annoying clichés like ‘clean and green’ and ‘world leader’ in animal welfare. If you want to take the lead on such issues then a ‘least cost’ approach is incompatible.

Ian Proudfoot, KPMG’s head of agribusiness, has recently called on NZ primary producers to become ‘the Louis Vuitton of food’, targeting the 800 million richest people. He notes that we ‘must be deserving of the premium we need to achieve’. Given we’re not likely to win the price war, this advice is right on the money.

The future for Hawke’s Bay has to be a differentiated one. If dairy development here is to supply a ‘least cost’ Fonterra, then we’ll be on the wrong track. Fonterra’s fatal flaw right now is they’re too big to change, and have no intention to change. Fonterra have a gargantuan 13 person board of directors and despite their recent woes, all the standing candidates were just elected to another term. It’s a board of ‘right thinking’ peers with seemingly little tension.

This is a company that will give us more of the same. And given NZ is such an efficient dairy producer, more of the same might be good enough. The bumbling behemoth isn’t going to go away.

My advice? If you must consume dairy, buy it from a company with a differentiated strategy. One you think admirably represents the values our region should aspire to. It’s going to cost more, but it’s a price worth paying.

Paul Paynter is our resident iconoclast and cider maker. Sometimes he grows stuff at Yummyfruit.

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