The new rules will stifle much-needed competition, the commission says in a draft report on improving the competitiveness of New Zealand’s so-called “frontier firms.”
The Dairy Industry Restructuring Act (DIRA), which allowed the creation of the giant farmer-owned cooperative in 2001, was amended in July to give Fonterra the right to refuse re-entry by dairy farmers who have left but want to return.
In a report into how to fix NZ’s mediocre productivity, the commission says the softer regulation will increase Fonterra’s power to deter departures in the first place, which will stifle development in the industry.
“Such power risks causing detrimental effects on competition, new entry and innovation in dairy processing, yet these are needed more than ever in the face of environmental limits to further expansion of land under dairy,” the report said.
Previously, every farmer in NZ could freely exit to supply another processor and retain the right to return to Fonterra at any time. This created competition for the cooperative as farmers could redirect their supply to a better-performing processor.
Fonterra has failed to live up to lofty expectations of 15% revenue growth per year by moving into high-value exports.
Instead it has grown less than 2.5% per year, and continues to concentrate on commodity staples such as milk powder. The cooperative will release its quarterly earnings on Friday, where it will report progress on its retreat from the previous leadership’s push to own more of the global raw milk pool and instead concentrate on adding value to NZ-produced milk.
By contrast, industry newcomers The a2 Milk Company and Synlait Milk have been successful with their focus on high-value export brands.
Competition for milk at the farmgate has been gradually increasing, with Fonterra now collecting 81% of the nation’s milk, down from 96%.
The Productivity Commission wants the primary sector to focus more on “value-add” exports, as increasing the output of commodity products is putting pressure on the environment.
“Dairy expansion has reached its environmental limits in terms of pressures on water quality, availability of water, biodiversity, natural landscapes and greenhouse gas emissions,” the report said.
“The likelihood is that the industry has reached peak co’ and the limits of its social licence, and must now grow value rather than volume.”
With processors like a2 and Tatua Cooperative adding value, the commission is anxious to see more, but is concerned the changes to DIRA in July have “put a brake on the emergence of other innovative new entrants.”
The new rules for Fonterra don’t kick in until 2023, but farmers considering shifting their supply to a smaller processor may be thinking twice about whether they’ll be able to swap back on good terms.
Rival processor Synlait voiced this concern in a submission on the DIRA amendment bill, warning the removal of open entry “will be used as a heavy stick by Fonterra.”
“This would be a deterrent to suppliers leaving Fonterra and moving to independent processors, thereby restricting further growth by current independent processors and making it more difficult for new processors to start up,” it said in the submission.
The Productivity Commission shares this view and says waiting four or six years for the next DIRA review was too long. Instead, the amendment should be reversed immediately.
“Given its challenges, the dairy sector needs more health competition and innovation, not less,” the commission said.