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Dairy Industry Position On Commerce Commission


Media Statement
Saturday 20 January 2001


DAIRY INDUSTRY POSITION ON COMMERCE COMMISSION EXPLAINED

Limitations in the Commerce Act meant the Commerce Commission could take only “a partial and uncertain” view of the dairy industry’s Merger Package, according to the industry’s submission to the Government posted to shareholders and industry stakeholders today. The 11-page submission was requested by the Minister of Agriculture.

John Roadley, chairman-designate of the proposed Global Dairy Company, said the industry was committed to being open as it worked with the Government on the legislative and regulatory implications of the Merger Package.

“We want our shareholders to know what we are saying to the Government on their behalf and we appreciate the Minister agreeing to that approach,” Mr Roadley said.

“The issues our submission addresses are complex. But it presents a comprehensive and compelling case that the Government is the guardian of the wider public interest and that only the Government can ensure the Merger Package produces the intended benefits to New Zealand.

“In contrast, the Commerce Act has a narrow competition law mandate. This would force the Commerce Commission to undervalue most of the benefits the merger will bring to New Zealand.

“Those benefits include having the world’s 14th largest dairy company 100 percent owned and controlled by New Zealand dairy farmers. It would employ 18,000 people in 120 countries, and have revenues of over $10 billion from more than $7.5 billion in assets.
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“The merger would give New Zealand its only company of truly global scale, responsible for over a third of the world’s international exports, over 20 percent of New Zealand’s exports and nearly seven percent of our national income.

“The company would be the biggest investor in research and development in New Zealand, aside from the Government, and be the number one training ground for New Zealanders seeking careers in international marketing and management.

“Only the Government can consider these issues relating to national economic policy and the industry’s position in international markets.

“The Commerce Commission’s legislation means it would have to take the normal domestic approach to its analysis of the merger. It would compare the new company with the New Zealand market and other New Zealand manufacturers, rather than with its competitors offshore.

“If we want to share in the benefits of the global economy, we must have global scale companies. A Commerce Commission review focuses on the small New Zealand economy.

“It is almost certain this approach would lead the Commission to recommend breaking up the industry, which would result in New Zealand companies underselling each other on world markets. That is not in anyone’s interest but the huge multinationals which would get cheap dairy products which they would sell to their customers at a profit.”

Mr Roadley said the industry recognised there were issues for domestic consumers and suppliers of dairy products. These were addressed by the Merger Package, the industry continuing to be under the scrutiny of the Commerce Commission, and the major review by the Commerce Commission in three years.

“On the domestic retail market, we anticipate even more fierce competition following the sale to a competitor of the New Zealand Dairy Group’s 50 percent share in New Zealand Dairy Foods, a company that markets well known brands including Anchor, Fernleaf and Fresh ‘n’ Fruity.
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“Suppliers’ interests will be promoted through their ownership of the company and fair value exit and entry provisions, factors the Commerce Commission’s competition-based analysis is unable to consider.

“Other measures to promote the interests of consumers and suppliers include the prospect of competition from overseas competitors, a Shareholder and Supplier Council, a Milk Ombudsman and the ability for the Commerce Commission to introduce price controls after three years.”

Mr Roadley said the industry would continue to work in partnership with the Government as it considered the Merger Package. This would involve supplying any additional information that the Government required.

END

Embargoed Until 0100 Saturday 20 January 2001

5 January 2001

GLOBAL DAIRY CO
C/- New Zealand Dairy Group and Kiwi
Co-operative Dairies
Level 9
115 Queen Street
Auckland

The Honourable Jim Sutton
Minister of Agriculture
Parliament Buildings
WELLINGTON


Dear Minister
Thank you for your letter of 22 December 2000.
We have addressed below the specific question raised in your letter, but in order to place the issues in their proper context we have also provided a broader overview of the industry and the impact of industry reform on the national interest. There may well be matters on which you require further information or analysis and we will respond to any further requests as quickly as we can.
The different elements of the dairy industry's proposal are designed as a package. That package is intended to operate not just in the interests of the dairy industry but to satisfy broader public policy tests and serve the overall national interest. Because there are wider issues at stake, we believe it is appropriate for the Government to assume overall responsibility, and to ask the question, “what is in the national interest, and does the package achieve that?” The subsidiary question is, what role, if any, will the Commerce Commission play.
This letter summarises why we believe the Government has that primary role, and why the Commission is best placed to monitor and implement those policy decisions, in the manner set out in the package.
1. THE DAIRY INDUSTRY AND NEW ZEALAND'S NATIONAL INTEREST
More than any other sector, the dairy industry's performance profoundly affects the economic and social viability of New Zealand communities. It accounts for over 20% of New Zealand's exports and around 7% of GDP. Over the last 5 years, dairy products have contributed a large proportion of New Zealand's overall export growth, and the dairy industry has been a major engine of growth in the economy throughout the 1990s. The industry is New Zealand owned and controlled with most of the industry stakeholders and employees living in New Zealand's regions and rural communities.
The dairy industry is a driver of innovation in New Zealand, both in terms of product development and also pastoral and agricultural research. The industry spends over $120m a year on research and development, and has specific targets relating to new product development and customisation, cost reduction, breakthrough technology and bio-science. The dairy industry is the largest funder of research in New Zealand, apart from Government, working closely with Universities Crown, Research Institutes and other entities. This commitment has a substantial impact on the ability of New Zealand to develop and retain the intellectual capital of its outstanding scientific minds.
The scale and scope of the dairy industry's activities have required the dairy industry to develop and retain managers capable of creating and implementing business strategies on a global scale. Few other industries require or permit the level of commitment to acquiring and enhancing these skills.
The New Zealand dairy industry has an overwhelming export focus:
 it exports over 95% of manufactured dairy products;
 Put another way, domestic New Zealand dairy consumption is relatively unimportant to the viability of the dairy industry and therefore of the economy as a whole; and
 New Zealand is a major and growing player in the international dairy market, selling about one third of the world's internationally traded dairy produce (under 20% a decade ago).
The efficient development of this industry is in the national interest. The proposed package serves that national interest because:
 It creates a streamlined company with sufficient scale to be a major player in international markets. The proposal eliminates a grossly inefficient artificial separation between manufacturing and marketing, with an associated complex process for allocating customer orders. It is the least option for enhancing industry performance.
 The downside risks are managed by the fact that fair value entry and exit and the elimination of the export monopoly will introduce the discipline of potential new processors (which are themselves likely to be big global players) to enter the New Zealand market. New marketers could be formed by groups of current suppliers. Some existing international marketers could expand their activities here. The new market structure will also create an opportunity for niche players to thrive. Divestment of a major industry asset in New Zealand will secure competition in consumer markets.
 The Commerce Commission will have an ongoing role which will ensure that the outcomes will be as anticipated. The Government will retain its ability to intervene, should that be called for in future.
2. THE STRUCTURE OF THE INDUSTRY AND THE PROCESS OF INDUSTRY REFORM
The industry's achievements result from the drive and commitment of the people who have worked and made investments in the industry over several generations. This drive and commitment has been harnessed by unique ownership and legislative arrangements which have allowed all participants to combine in a single structure.
In 1998 the then Government asked the industry to assess whether that structure would continue to best serve the country's and the industry's interests. The industry has looked at its old structures and decided that they no longer serve it well for future development or growth. After nearly three years' analysis and consultation, the industry has responded with the current package of reforms.
That package is dependent on Government policy and action:
 The industry's present structure is entrenched in legislation, and is dependant on that legislation for its strength, efficiency and unity. This is fundamental to the reform process: the industry is now united in a structure which Government introduced and maintained over several generations but which has now become a source of unnecessary cost. The Government alone can restructure the industry so as to avoid that cost or dismantle that unity.
 The industry seeks removal of the current heavy handed regulation of export control, but seeks to avoid the dismantling of the industry's unity which has been achieved under that control.
 Only the Government can make an overall assessment of whether the industry's package is in the national interest and only the Government can implement the light handed regulation to replace the current heavy handed export controls.
The proposed package, and Government's role in it, is entirely consistent with precedent established recently in the electricity and telecommunications industries where the Commerce Commission's role was as implementer of Government policy. The Commission did not design or approve that policy. In those cases the Commerce Commission had previously been given exclusive jurisdiction, but that was seen to be too narrow, or too limited in the available tools. The Government itself reassessed and redesigned the role of the Commission on more pragmatic lines.
In those two industries, the historical pure Commerce Act/competition law approach had led to impasse and years of litigation in one case and distortion of Government policy by lines companies in the electricity market, in the other. In the lines company case the value resulting from this distortion passed to the mainly foreign owners.
The key reason the industry does not believe the Commerce Commission is the right body to deal with the proposal is that Government can and should continue to be involved in the process of reform described above and in designing the best changes to the regulatory regime. The Commerce Commission cannot take part in that process and would be forced to make a partial and uncertain decision on the basis of its assessment of what the regulatory environment may look like and how the industry will evolve within it. On the other hand, if the Government makes its policy assessment and participates in the design of the new regime, initial review by the Commerce Commission becomes superfluous and is an unnecessary imposition on the industry. However, its ongoing monitoring of the regulatory regime designed by government and industry would be an effective safeguard, and would be consistent with other industries.
3. THE ROLE OF THE COMMERCE COMMISSION
The Commerce Commission is not well placed to formulate dairy industry restructuring policy. This is because:
 National Economic Policy: Questions of economic policy and the position of New Zealand's major industry in international markets are involved. These issues are unavoidable and inevitably more the responsibility of the Government than a Commerce Commission. The narrower, albeit important domestically, issue of the application of local market principles are clearly the responsibility of the Commission. Those issues are dealt with as part of the package;
 Farmers value control: Analysis of the restructure in competition terms ("choice") is unimportant to suppliers of raw milk who depend daily on reliable performance of their dairy company. They have seen disastrous results of well intentioned policies providing "choice" in some other countries. Their real protection is provided by their control over the co-operative ("voice"). The industry would not achieve widespread farmer support for a restructure unless it incorporates and strengthens this supplier "voice";
 International Markets: The Commerce Act was designed to enhance economic well being in New Zealand by encouraging competition in domestic, not international markets. The dairy industry exists primarily to participate in international markets. As New Zealand’s economic well being is dependent on the industry remaining a dominant player in international markets, the industry’s structure must be designed to provide it with the best chance to prosper in those markets. The domestic market is but a part of the picture; and
 Limited tools available to the Commission: The Commerce Commission's mandate, expertise and experience to assess the unique national economic and international market issues involved in the dairy industry is limited. It has limited tools to mitigate the risk of large mergers.
We will discuss each of these issues in more detail below.
3.1 National Economic Policy is the Responsibility of Government: implementation of competition policy is the responsibility of the Commerce Commission
The Government forged unity between dairy companies, and ensured continuing New Zealand ownership of the industry, as a matter of national economic policy which has evolved over the last 70 years: Government members in the House referred in 1932 to:
"… a relentless search for efficiency not on the farm alone, but in marketing and other co-operative organizations. To take the dairy industry as an illustration, we are well advanced in having excellent co-operative dairy factories - the best in the world. But how much of the advantage is lost through over-lapping and competition in collecting cream and milk, and through the co-operatives marketing in competition with one another."
To avoid that loss, the Government introduced the predecessor to the Dairy Board. That fundamental step has been augmented and developed ever since. It is incorporated in a number of statutes, including the current exemption from the Commerce Act set out in the Dairy Board Act 1961, allowing transactions between the New Zealand Dairy Board and the co-operative dairy companies.
However, the mechanisms used to achieve that policy of industry unity were developed prior to consolidation of the manufacturing dairy companies. Previously many small co-operatives manufactured products which were sold by the Dairy Board. Now 96% of all production comes from just two companies. As a result, the multi-company structure which has brought about a united industry is now a source of substantial unnecessary cost and has become an impediment to rapid, competitive industry wide action in response to the needs of customers and the challenges of competitors.
Those mechanisms need to be simplified, and the old checks and balances in the Dairy Board Act replaced with a more flexible structure which responds to current and future needs.
The Commerce Commission has the different focus of implementation of competition policy. This difference is well illustrated by differences between Government objectives and Commission guidelines.
For example, the Government's objectives may include:
 creating employment within New Zealand;
 increasing the country's international competitiveness;
 fostering an environment which encourages innovation and the adding of value within New Zealand; and
 maintaining a degree of control and economic sovereignty within New Zealand;
 regional development.
In contrast, provisions of the Commerce Act, and Courts' decisions on the effect of those provisions, have resulted in a set of guidelines, published by the Commission, on how it should assess the public benefits of mergers:
 In general terms, the creation of jobs or retention of jobs is not an efficiency improvement or a net economic gain and would therefore fall outside the definition of the public benefits (see Paragraph 8.1 Guidelines to the Analysis of Public Benefits and Detriments in the Context of the Commerce Act, Revision December 1997);
 Efficiency should be counted but international competitiveness should not be separately taken into account (see Paragraph 4 of the Guidelines);
 The Guidelines suggest:
- value added with neutral efficiency gain is not a benefit; and
- value added in New Zealand is not a benefit as compared with value added offshore.
(See Paragraph 8.4 of the Guidelines);
 If there is no efficiency change, the Commission does not consider that benefits to consumers or to producers are a public benefit. (See paragraph 5 of the Guidelines). This analytical framework would force the Commission not to recognise the fact that the benefit of efficiency gains would pass to foreign consumers;
 Location and control of the resulting entity is not an issue for specific consideration (see Paragraph 8.5 of the Guidelines).
This focus of the Commerce Act results in a process of analysis which undervalues issues such as:
 the benefits of having a world scale dairy business headquartered in New Zealand. These benefits include development of world class management skills, the multiplier effect of service and product firms supplying Global Dairy Company and a New Zealand focus on intellectual property development and retention;
 retention of efficiency gains in New Zealand. For example, efficiency gains may result from restructure, but those gains may be seized by offshore customers of, or foreign investors in, the industry if the restructure is aimed at efficiency alone, without regard to wider national interests;
 the avoidance of continued head office drift away from New Zealand, with the implications for both sovereignty and economic welfare of the nation;
 The benefits of scale in developing and maintaining management excellence. That issue was placed before the Commission in 1999. Constrained by the need for a conservative approach tied to efficiency, the Commission concluded that New Zealanders "… lack experience in managing such large undertakings …". (That is in itself a very surprising conclusion in view of the evident experience of the dairy industry management). On that basis, it concluded that the required efficiencies would not be achieved by "NewCo". The Commission felt this was a factor in its not authorising a world scale firm: but the absence of that world scale firm would deprive us of the chance to develop those very skills. That would condemn New Zealand to a vicious circle of insufficient skills, coupled with insufficient opportunity to develop them; and
 the desire of farmers to continue to own and control their industry and thus their economic future. This also has the effect of securing the ownership of the industry in New Zealand hands. This ownership motivation may be intangible, but in an industry which is largely owned by individual farmers and their families, it is a major factor for Government consideration.
The Government's broad based consideration of the national interest elements of the proposal is required, not the Commerce Commission's narrow efficiency/competition based analysis of just one aspect of that proposal, namely the merger.
In essence, we are saying that a balance must be struck by the Government between competition for its own sake, the undesirable and unintended consequences of competition, and other national goals which competition alone cannot deliver.
3.2 Co-operatives and farmer control
Milk is produced on a daily basis, is perishable and is bulky. Milk production is uncontrollable in the short term by the farmer who is thus totally dependent on the performance of the dairy company. The dairy farmer is unique as the only producer who must produce every day, who must have production collected every day, and who is exposed to the cost and pollution of dumping production if the contracted dairy company fails to collect for any reason or dispute whatsoever.
Because the supplier's milk collection needs are always immediate, the supplier cannot switch between dairy companies to solve a service problem or to achieve greater efficiencies or returns. Furthermore, there would simply not be the transport or processing facilities available from other companies mid-season.
Thus, the business of dairy farming is totally dependent on the behaviour, competence and performance of the local dairy company. This dependence is unique to the dairy industry, but is a standard problem around the world, and has led to a common solution around the world: the dairy co-operative.
This key issue has been recognised, increasingly, by the Commerce Commission. While continuing to recognise the theoretical possibility of competitive constraint through switching of shareholders/suppliers to alternative co-operatives, the Commission has consistently, and with increasing forcefulness over the last 10 years, reached the conclusion that, in practice, such competition does really not exist. The co-operative structure gives shareholders/suppliers control of the direction and actions of co-operatives and as a result switching has no practical role as a competitive constraint.
This point is emphasised by the United States' approach to competition and co-operatives. The Sherman Act is subject to an exception under the Capper Volstead Act, which provides that the Sherman Act should not apply to co-operatives. US commentary emphasises that shareholders/suppliers in co-operatives do not require the same protection from their own organisation.
There are two consequences of the role of the co-operative in the dairy industry:
 The industry's package is the result of extensive discussion and sometimes differing views. The agreement which has been reached was dependent on the role of the co-operative in the restructure, and the strengthening of the co-operative model through the Supplier and Shareholder Council and the Milk Ombudsman. I do not believe the shareholders will pass the necessary resolutions if this "voice" is in any way jeopardised, even if the jeopardy results in more hypothetical "choice" through competition.
 Competition analysis is not reliable if it does not have the co-operative at its centre. Adapting the "choice" model of investor owned firms will not do: a choice between an investor owned firm and a co-operative is not an equal choice.
We ask the Government to consider the proposal based on these realities, and not assume that structure and dynamics of other markets can be transformed without modification to the dairy industry.
3.3 International Markets
New Zealand may be a small participant in a global sense, but it has established a significant position for itself through its unified marketing structure.
The international dairy markets are undergoing significant change:
 There are constant changes in key consumer trends worldwide, including growth in liquid milk, cultured dairy products, and cheeses consumption, decline in butter consumption, increasing out-of-home and prepared meal consumption and increasing emphasis on nutrition, health and wellbeing.
 Supermarket chains and the other customers are consolidating on a global basis, thereby strenthening international purchasing power. The result of this activity is that suppliers are competing for business of powerful global retail companies.
 Many of the international dairy suppliers who compete with the New Zealand Dairy Industry have grown their business significantly in recent years, (through merger and acquisitions) to respond to the imbalance in market power, eg:
- Parmalat has made many acquisitions around the world, notably including Australia;
- Nestlé have acquired Klim;
- Formation of Dairy Farmers of America - the largest dairy co-operative in the world;
- Dean Foods (USA) spent US$1.1 billion in 1998 on acquisitions. Having gained strength by acquisition in the US, Dean Foods is now acquiring dairy interests in Portugal, Mexico and Latin America;
- The MD Foods/Klover merger representing 90% of the domestic market in Denmark. The subsequent merger with Arla of Sweden resulted in one of the largest dairy companies in the world, with almost total dominance in its domestic markets; and
- Frieslan/Coberco have merged in the Netherlands, producing the dominant domestic company. The other main Netherlands dairy company has combined with a German co-operative to produce Campina Melkunie.
 The New Zealand dairy industry competes in world markets which are characterised by protection through export subsidies, import tariffs and support price mechanisms which effectively depress the world market price.
 The industry is effectively excluded from the world's richest markets by tariffs, and is forced to do business in markets where access is relatively unrestricted, but tariffs, on average, are still around 30%, and returns are lower. Last financial year the industry paid NZ$524 million in tariffs, an average of $37,800 for each New Zealand dairy farm.
 Further, virtually every country, but with the notable exception of New Zealand, has price support mechanisms for their local milk. In other words, almost all dairy industries in the world have a Government assisted local market to support their industries. In Australia, for example, the Government is providing A$1.74 billion to assist Australian dairy farmers during the current transition period.
To meet these challenges, the New Zealand dairy industry needs to develop closer integration between marketing and manufacturing in New Zealand to allow fast, flexible responses to the demands of customers. The dairy industry's viability, efficiency and contribution to New Zealand's national interest must be assessed in that international context.
But the Commerce Act is designed for the domestic market: its long title is "An act to promote competition in markets in New Zealand …" This focus would lead to the normal domestic approach to the merger part of the package. The starting point would be a comparison of the size of the Global Dairy Co with the New Zealand market, and with the other manufacturers in New Zealand. The Commission has already shown a preference for two smaller companies.
Professor Lewis Evans argues that to force New Zealand firms to be small by New Zealand standards through the normal approach to mergers is likely to make it difficult for those firms to compete in other countries, and may even raise costs for New Zealand consumers. (See The ISCR Competition and Regulation Times, Issue 3). Not pursuing the Global Dairy Co strategy, and fragmenting the present unified dairy industry structure would condemn New Zealand to the margins of world commerce and trade. It would mean that in a world of large dairy industry firms, the scale of the largest New Zealand owned participant will be defined by reference to the small New Zealand domestic market. This approach has specifically been rejected by smaller EU countries which do not wish to see their economies dominated by German and French firms because of their domestic competition policies.
The application of the Commerce Act's domestic focus to the international business of the New Zealand dairy industry would force the industry to take one of two sub-optimal routes:
 maintain the world class international marketing scale of the New Zealand Dairy Board but suffer the artificialities and costs of regulated export controls and the inefficiencies of the current ownership and product transfer system; or
 break up the New Zealand Dairy Board/New Zealand Dairy Group/Kiwi unity in deference to a domestically focussed analysis. This would lead to a massive loss of value to New Zealand. Two competing co-operatives would be too small to capture the attention of the very large retail players emerging around the world, but too big to be effective with players. We would lose the industry's best chance of competing on world markets. Moreover, the breakup would inevitably lead to:
 Division of the industry.
 Both would have an international expansion strategy.
 Both parts would be capital constrained.
 Both would seek, first, joint venture partners offshore, and then offshore capital.
 As a result, there would eventually be overseas control of one or both of the companies.
If New Zealand also removed export controls as part of this second route it would allow large scale international dairy companies to enter the small New Zealand market. Those large companies would use their international scale and strategies (scale and strategies denied to New Zealand companies) to undermine the position of the relatively small New Zealand companies. This would result in New Zealand losing the strength which has been achieved to date in the international marketplace, with a resulting reduction in returns to New Zealand. It would also result in the breakdown of co-operative control and ownership of the industry, as the foreign investor owned firms followed their normal pattern of seeking to impose contracted milk supply.
3.4 Commerce Commission Process and Mitigation Tools
The Commission has only a one time look at mergers. On that look it must create two scenarios, one for the outcome of the merger and one (sometimes with variations) if the merger does not occur.
This process is a flawed one for developing national economic policy:
 The merger analysis is driven by the commercial motives and decisions of the two companies involved, not by a broader national perspective.
 The non-merger analysis is an unprovable hypothesis. With no superior ability to project what the participants, their competitors or the Government might do in the future, the Commission inevitably projects a future which does not happen. This is not a criticism of the Commission but a reflection on the process.
 The process forces the Commission to adopt a "virtual legislation programme" on which it bases its decisions. Parliament's role is imagined, and then locked into the Commission's decision. This is illustrated by the 1999 draft determination where the Commission's non-merger scenarios included an assumption that the export restriction would be removed by Parliament even if the merger did not proceed. Incorporation of that assumption into the Commission's analysis was a factor in concluding that the "Merge Co" should not be approved. By this process, the Commission's view of a Parliamentary decision, not the decision of Parliament itself, determined (or at least significantly influenced) the industry's attempts at restructure.
The result of these factors is that the Commission adopts an extremely cautious approach before accepting benefits of merger, and is wary of the potential detriments: it has no ability to rectify the position if its projections are wrong.
This is fundamentally different from a Governmental review. The Government can aim for the best outcome, in the knowledge that unforeseen outcomes, unfavourable events or other changes not contemplated when the original decision was taken can readily be addressed and rectified by the Government or Parliament at a later stage.
The Commerce Commission has only one tool to mitigate the risks of a large firm created by merger: it can accept an undertaking to divest. This mitigation is structural, in that divestment happens once and thereafter the Commission leaves the structure of the market to implement the desired efficiency outcomes. Implicitly, that leads to the "small country, small company" vicious circle described above.
The Commission has no power to participate further. The Commerce Act prevents the Commission from accepting undertakings by firms to behave in a manner which would enhance or protect competition. As the Commission observed, the contractual commitments offered by the industry in 1999 could not form part of the divestment undertaking, they cannot be accepted as such, and are simply matters to which the Commission can give such weight it considers appropriate.
Again, this is fundamentally different from the Government's position. The Government has available a wide range of devices to enforce economic performance and tailor economic structures to achieve outcomes. It has knowledge and control of its own legislative and regulatory programme. Those tools would not be available if only the Commerce Commission were involved. The package proposed by the industry has proposed use of a wide range of tools to protect domestic consumers, protect milk suppliers and monitor the anticipated gains: virtually none of these would be available to the Commission.
4. CONCLUSION
The boards of New Zealand Dairy Group and Kiwi have put together a package which responds to the Government's wish to see reform of the industry and which incorporates their own vision for the best future of the industry. They believe the package is in the best interests of the country, and addresses all issues, including competition. They are confident that their shareholders will support that package, including the regulatory constraints it would impose.
The proposal does not create a precedent but follows the general approach adopted by the Government of tailoring economic principles to the circumstances of each particular industry.
The Government, and not the Commerce Commission, is the appropriate judge of the benefits of the proposed restructure. The Government is the appropriate guardian of the public interest and the Government alone has the tools to ensure the implementation of all aspects of that re-structure deliver the anticipated benefits.


Yours faithfully

John Roadley Henry Van der Heyden Greg Gent
Chair Chair
New Zealand Dairy Board and Chair Designate New Zealand Dairy Group Kiwi Co-operative Dairies Limited
Global Dairy Company



SUMMARY OF CORRESPONDENCE WITH GOVERNMENT
Embargoed Until 0100 Saturday 20 January 2001

John Roadley, Greg Gent, Henry van der Heyden, John Spencer and Craig Norgate met with the Minister of Agriculture shortly before Christmas to brief him on the Merger Package and the necessary legislative and regulatory measures. This established a consultation process on the detail of the Amalgamation Proposal.

The Minister wrote to the Industry on 22 December requesting more information on the Merger Package. On 5 January, the Industry responded in a letter that has been released publicly with the Minister’s consent. Key points from that letter are:


 The international market place is changing rapidly. Globally, international dairy companies are merging into huge competitors. Our customers are combining to acquire buyer power. Critical mass is crucial if New Zealand is to both maintain and grow its position in an increasingly competitive global environment.

 Our industry’s strength comes from its unity and existing global scale provided by Government legislation dating back to the 1930s. There has been a solid partnership between the Government and farmers, which has been rewritten over the years in response to changes in the world economy and New Zealand’s place in it. That partnership and our structure now needs to be reviewed, to ensure that the new company and wider regulatory framework builds on our strengths and remedies the weaknesses of our existing structure.

 The Government has the required mandate, processes and experience to ensure that the package as a whole, including the merger, will produce the intended benefits over time.

 We believe the Government should authorise the merger of Kiwi Dairies and the New Zealand Dairy Group without the merger proposal being subject to Commerce Commission authorisation approval, for several reasons.

 The Commerce Commission process involves an analysis of the merger proposal in competition terms. This analysis is based on “choice” between competitors and the idea that by being able to choose between production companies, suppliers will be protected from anti-competitive behaviour. This analysis does not take into account the value that farmers place on their "voice" in controlling their industry.

 The importance of recognising the value of the co-operative structure cannot be understated. As a result of this co-operative structure, the new company will be owned and controlled by New Zealand dairy farmers - there will be no opportunity for people outside the company to take control of the industry. It is our view, given the international trend of mergers to create critical mass, the creation of one large scale company is the only way to retain ownership of our industry by New Zealand farmers, also ensuring that investments off-shore provide returns to the New Zealand economy.

 Further, when the Commerce Commission decides whether or not to authorise a merger it must weigh the expected benefits of the merger against the possible detriments. While the Government is able to give appropriate national policy weighting to objectives like the creation of employment, regional development and increasing the country’s international competitiveness, the Commerce Commission’s focus on efficiency limits its ability to consider the broad range of issues.

 The focus of the Commerce Act results in a process of analysis which undervalues issues such as:

 The benefits of having a world scale dairy business headquartered in New Zealand;
 The value of retaining efficiency gains in New Zealand;
 The avoidance of continued head office drift away from New Zealand;
 The benefits of scale in developing and maintaining management excellence in New Zealand; and
 The desire of farmers to continue to own and control their industry and thus their economic future.
 The ability of the Commerce Commission to assess the unique national economic issues involved in dairy industry reform is limited by both its mandate and its processes which are designed to deal with the important but narrower issue of the application of local market principles.

 The process followed by the Commerce Commission when assessing mergers involves a one off analysis based on a series of hypothetical assumptions about the way Parliament, industry participants, their competitors and the Government may act in the future.

 This process results in the Commission adopting a cautious approach before accepting the benefits of a merger and being wary of potential detriments. If the assumptions made by the Commission prove to be wrong in the future there is no way to rectify those assumptions and hence opportunities can be lost for no good reason.

 Unlike the limited tools available to the Commerce Commission, the Government has the ability to aim for the best outcome for New Zealand with the knowledge that any unforeseen problems can be dealt with by the Government or Parliament at a later stage through the legislative and regulatory processes that are under its control.

 Finally, the analysis undertaken by the Commerce Commission under the Commerce Act would lead to the normal domestic approach being taken to the merger part of the package. The starting point of this analysis would be a comparison of the size of the Global Dairy Co with the New Zealand market, and with other manufacturers in New Zealand.

 We believe that this approach would lead to the industry being forced to take one of two sub-optimal routes in the future which would both have the potential to result in overseas control of all or a part of our dairy industry. The issues dealt with by the Commerce Commission are important issues. It should be remembered that the reform package does deal with the types of competition issues that the Commerce Commission will be concerned with.

 Not only does the reform package incorporate the divestment of the New Zealand Dairy Group’s 50 percent shareholding in New Zealand Dairy Foods, it also incorporates a wide range of other devices to protect domestic consumers and milk suppliers. Only the Government has the ability to take these additional protections into account when assessing the merger and to make these tools available.

 It is for these key reasons that we asserted in our letter to the Government that, “[t]he Government, and not the Commerce Commission, is the appropriate judge of the benefits of the proposed restructure. The Government is the appropriate guardian of the public interest and the Government alone has the tools to ensure the implementation of all aspects of that re-structure deliver the anticipated benefits.”


ENDS


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