OPENING SALVO

The rain poured, the sun shone, the grass grew and GDP rose 1.1% in the March quarter.

That a wet summer drove New Zealand’s fastest growth in five years again underlines Fonterra’s central importance to New Zealand’s economic destiny.

Since being founded in 2001, Fonterra has performed adequately.  Dairy exports have grown nearly 10% a year, second only to kiwifruit among primary industries.

But the performance has been well below that promised.

Swashbuckling
Fonterra started out with a hiss and a roar under the swashbuckling Craig Norgate.

In six months, five major initiatives were launched.

Fonterra became the largest exporter of skimmilk powder out of the US, under a deal with Dairy America.  It announced a North and South American joint venture with Nestle, including consumer products.  Acquisitions made it number one for cheese in Mexico. It JVed with Arla in the EU butter market.  It took its first step into India with Britannia, a national distributor partly owned by Danone.  In China, negotiations were finalised with San Lu but for some reason the deal took years to consummate.

Mr Norgate’s approach proved too aggressive for his new chairman. Sir Henry van der Heyden replaced him with Andrew Ferrier, with a brief to consolidate what had been achieved and build internal culture.  Mr Ferrier delivered stability and successfully navigated through the commodity price boom but his more passive approach lasted too long.

Navel gazing
Fonterra then spent six years navel-gazing over its capital structure.

Initially, the co-op managed its redemption risk through its capital notes market on the NZX.  Farmers paid cash to enter the co-op but received capital notes on departure, which they could on-sell.

For largely political reason, but also to save a fraction of a percent in servicing costs as part of a disastrous debt restructuring, Sir Henry’s board scrapped the capital notes market in 2006, deciding just to borrow to pay departing shareholders.

The board recognised the dangers of that decision but wasn’t able to make decisions on a new method of managing redemption risk before the word crisis began to be thrown around in 2009.

Pressure from its bankers prompted the further three-year debate on Trading Among Farmers (TAF).  This week’s shaky vote in favour of TAF is a step forward after Sir Henry’s step back six years ago when he abolished the capital notes scheme.

Whatever the history, the TAF vote means Fonterra can again talk to foreign partners and consider new initiatives under new chief executive Theo Spiering’s Strategy Refresh.

Three Vs
Mr Spiering’s strategy is about Volume, Value and Velocity and is an important recommitment to the original Fonterra strategy put on hold while Sir Henry and his team dealt with other matters.

“Value” includes the usual glib promises of breakthroughs in nutraceuticals, and appeals to NZTE bureaucrats, but “volume” is the more interesting issue.

As Mr Spierings argues, global milk demand will grow by over 100 billion litres by 2020 but New Zealand production will increase by only five billion litres.

Fonterra can never deliver its promise if its primary business continues to be the export of New Zealand production.

Even if nutraceuticals double revenues per kilogram of milksolids, and even if the industry overcomes the environmental movement to double domestic production, Fonterra would only end up four times bigger than it is now.

Relative to its international competitors, it would move from being a biggish player to a small one and would lose market power.

Moreover, four-fold growth over the next decade would represent abject failure to seize the opportunities Fonterra was set up to exploit.

In the period the company has been debating a replacement for the capital notes scheme, Facebook, for example, has grown 75-fold. 

During the time of the TAF debate, the company Fonterra said it would emulate as a national champion, Finland’s Nokia, has boomed and then been supplanted first by Blackberry and now Apple.

If technology companies are not the best case studies right now, in the time Fonterra has existed China’s Mengniu Dairy Company has grown 250-fold from its base in Inner Mongolia, increasing revenues from around NZ$10 million to over $2.5 billion this year.

Despite the free-trade agreement with China, Fonterra has not grown its China business to that extent and hasn’t even aspired to.

Fonterra can only capture such opportunities by massively increasing its own offshore procurement, and transforming itself into a proper international food business rather than being a mere exporter of domestic production from the most isolated country on earth.

The “velocity” element of Fonterra’s Strategy Refresh is therefore the most important – building the ability to move quickly to capture opportunities in China, India, Brazil, Indonesia, Russia and elsewhere rather than focusing primarily on getting the politics right in Te Awamutu.

Fonterra will shortly indicate how aspirational it is when it makes its decision on Sir Henry’s successor as chairman.  Now it has resolved its redemption risk issues, there are no excuses left.

Mr Spierings will be hoping he gets a boss with a good understanding of the difference between governance and management, who lets him get on with making Fonterra all that it promises to be.

Disclosure: Matthew Hooton led the communications project for the creation of Fonterra and his company Exceltium has recently completed a project for the Fonterra Shareholders' Council. These views are his own.