John Roadley: The Merger Package
Preparing New Zealand For Success In A Globalised Dairy Market
Global Dairy Company
Speech to the Waikato Chamber of Commerce
Friday 2 February 2001
Thank you to the Hamilton business community for this opportunity to meet with you today. Today’s presentation is one we are taking to business groups right around New Zealand. We are proposing the biggest-ever changes to the partnership between dairy farmers and the Government. We need the goodwill of the community to achieve them. It’s fitting we are beginning this programme in Hamilton; in the Waikato. To this audience, some of the presentation will seem a bit fundamental. We’re determined that we have the same message for the business community right around the country.
I’ll start by quickly summarising the main features of the dairy industry. First, milk is highly perishable. Without processing or refrigeration, its value drops to zero overnight. That makes dairy farmers uniquely dependent on transport and processing networks that are prompt, efficient and totally reliable. That’s why farmers have preferred to own those networks on a co-operative basis. The industry has also been very fragmented. As late as 1960, we had more than ninety factories in New Zealand making butter and over a hundred making cheese. There was no way global markets could have been served by hundreds of tiny dairy factories.
That’s why – with Government help – the industry established the New Zealand Dairy Board – to provide the necessary scale to compete. It’s been successful. Every year, our industry has grown faster than the New Zealand economy as a whole. It’s made us the largest industry in New Zealand by far. We generate over 20 percent of New Zealand’s export receipts. We have succeeded in gaining a third of the world’s international dairy trade. But the market is changing, and we face new challenges.
While we have been successful in achieving a third of international dairy trade, the lion’s share of the global dairy business is currently not traded across borders. The part of the market that is accessible to us, is as small as six percent of world dairy production. Ninety-four percent of the market is largely inaccessible to us because of trade restrictions. The solid beachheads we’ve established in markets such as Sri Lanka, the Philippines, Chile and Venezuela are well known. But we still have less than four percent of the Asian market for branded dairy products, and less than two percent in South America.
The challenge for us is to move from that tiny slither to the main part of the pie, and to do it globally. Part of that will be continuing to work closely with the Government on international trade liberalisation. But far more immediately, we need to seek acquisitions and joint ventures with companies already operating in the inaccessible part of the market. And we need to continue to invest in leading-edge research and development, manufacturing technologies and brand development.
Let’s look at the environment we’re facing as we seek to do that. The dairy business – and the food business more generally – are both globalising. We used to have the local dairy company. We used to have the corner shop. That’s changing. Consumer tastes are converging. Transport and storage networks are global. Economies of scale continue to be sought – particularly in the very expensive areas of R&D and brand development. At the retail end, the change just in the last half-decade is extraordinary. Among the top 25 food retailers, there was just one major acquisition in 1995. That’s leapt to a dozen or more annually.
The French-based Carrefour, for example, now has more than 1,000 branches in 20 countries, and 50 of those operations are in Asia. It’s merging with Promodes – another big French retailer – for a move into Latin America. Ahold has 3,000 stores worldwide. It’s doubled in size since 1992. The Economist magazine predicts that these trends will continue until – ultimately – there will be just ten major food retail businesses in the world. Wal-Mart is tipped to be the first food company to turn over a trillion dollars.
At the same time as this retail consolidation is occurring, our competitors are consolidating too. Huge retailers want to deal with suppliers of similar size. The suppliers, in turn, need scale to have leverage with global customers. And the need for economies of scale is just as great for suppliers as for retailers.
Let’s look at just two examples. The first is Parmalat, a family-owned firm in Italy. In 1989, it had revenues of just US$690 million and was largely limited to its home base of Italy. Since then, it has made more than 80 acquisitions. By 1994, it had expanded into Europe, Latin America and the USA, and revenues had tripled to US$1.9 billion. By 1999, it had reached Asia and Australia and its revenues had reached US$6.5 billion – nearly ten times greater than just a decade earlier.
Another example is the French company Danone. In 1980, it already had a very strong presence in Europe and was starting to move into Mexico and Brazil. It had revenues of US$2.5 billion. By 1989, it had operations in India, China and Japan and revenues had trebled to US$7.5 billion. It continued to expand through the 1990s to have operations throughout the world, doubling revenues to US$13 billion in 1999.
Top dairy companies are becoming global by gobbling up expansion opportunities as fast as they can. In the five years to 1998, the revenues of the top 25 dairy companies had expanded by 30 percent, from US$78 billion to US$102 billion. Their share of the market continued to creep up, from 31 to 36 percent. They are progressively becoming more dominant. In New Zealand, we have to be part of this. And to be able to compete strategically against the top dairy companies in the world, we need a fully integrated structure.
In recent years, we have been consolidating quickly too. By 1996, Kiwi and the Dairy Group were processing 68 percent of the country’s total milk production. By 1998, that was up to over three-quarters. With Kiwi’s most recent acquisitions, it has now risen to 98 percent. That means that our existing structure is becoming redundant. That structure was about the Dairy Board ensuring our industry wasn’t fragmented. That always involved some costs, as the separate manufacturing and marketing arms interacted. But these were far outweighed when the alternative was dozens of tiny companies trying to compete on world markets. With the mergers of recent years, there is no longer the risk of fragmentation.
It means that the costs of our existing structure now outweigh the benefits. Three separate entities are involved in major decisions. We are not acting in a co-ordinated way as we seek assets offshore. The three-entity structure also creates delays in responding to day-to-day opportunities in the marketplace. And there is duplication with three boards, three CEOs, three HQs and so forth. It is not the best foundation for us to act fully strategically in this competitive, globalising industry. Our three organisations all agree that the merger is the only way forward. It will maintain our scale. But it will integrate our manufacturing and marketing arms to allow us to compete more strategically on world markets.
The merged company is known – for the time being – simply as Global Dairy Company. Approximately 98 percent of the nation’s milk supply would flow through it. The new company would incorporate the assets of the New Zealand Dairy Board. After one year, the export monopoly would be abolished, opening up the prospect of fierce competition. The company would be by far New Zealand’s largest, 100 percent owned and controlled by New Zealanders. It would start out with assets of $7.5 billion and 18,000 employees. It would have annual revenues of over $10 billion, from operations in 120 countries and territories around the world. On its own, it would generate over 20 percent of New Zealand’s export earnings and around seven percent of our GDP. Aside from the Government, it would be the biggest investor in research and development in New Zealand. It would be the number one training ground for New Zealanders seeking careers in international marketing and management.
The CEOs of the two companies and the Dairy Board have identified benefits for farmers of $310 million by the third year. These benefits include $70 million a year in revenue enhancement and productivity improvement from integrating manufacturing and marketing. There would be $120 million of benefits from harnessing synergies between different parts of the industry. And there would be cost savings of $120 million a year. This $310 million would go directly into farmers’ pockets – around 30 cents per kilogram of milk solids. But we argue that the benefits to New Zealand would go far beyond the $310 million for farmers.
Every country – particularly small countries – needs at least one company of truly global scale: Nokia in Finland; Philips in the Netherlands; Singapore Airlines. Companies such as these provide their countries with a global profile, international connections and marketing networks, the scale to invest in R&D, international career opportunities, and so forth. Having at least one company of global scale will open up opportunities that will help other New Zealand businesses grow.
Our 18,000 employees, for example, have opportunities to work in 120 countries. That experience then becomes available to other New Zealand businesses. Every nation needs a company like this and Global Dairy Company is New Zealand’s only shot at owning a company of truly global scale. Global Dairy Company would start out the 14th biggest dairy company in the world, and rank 440th in the Fortune 500. It would be only just big enough to compete successfully. We would start out equivalent to the second tier of global European or American dairy companies. From there, we’d have an opportunity to grow – through acquisitions and performance.
If the merger were to fail, we would disappear from this list.
The two companies would be equivalent to the third or fourth tier European or South American companies. They’d be around the same size as one of the smaller, domestic-focussed UK dairy companies – and 770th in the Fortune 500. From there, it would be very, very difficult to acquire companies to move up the ranking. We’d become acquisition targets ourselves. In the meantime, we would have had to carve-up the assets of the New Zealand Dairy Board, losing scale and value in the process. Our industry sees that as very much a second-best option.
While we see ourselves as only a medium-sized company – battling it out against larger competitors on the world stage – many New Zealanders see an enormous company. There are genuine issues relating to the domestic retail and wholesale markets for milk, and we have addressed them. The merger is not appropriately considered by the Commerce Commission. That Commission is rightly concerned with the domestic market. It can’t take the broader view of the international market necessary to consider the Merger Package in its entirety. That’s a view shared by leading economists and businesspeople.
Dr Roderick Deane says New Zealand’s competition policy needs to be re-thought to accommodate the problem of defining markets in international terms, not just domestic terms. Professor Lewis Evans of Victoria University argues that by forcing New Zealand firms to be small or medium-sized by our usual approach to mergers, we make it difficult for them to compete on world markets. He argues this potentially risks raising costs for New Zealand consumers. In our submission to the Government, we have argued that only it can consider these matters of national economic policy.
Only the Government – for example – can put a value on the benefits of New Zealanders owning and controlling the 14th largest dairy company in the world. At the same time, we have put together detailed proposals to address the interests of domestic consumers and suppliers. In the consumer market, we anticipate even more fierce competition than we have now. Already, any foreign company can market their dairy products here in New Zealand. That will continue.
We will also sell the Dairy Group’s 50 percent shareholding in New Zealand Dairy Foods to a competitor. It has the rights to market top brands such as Anchor, Fernleaf and Fresh ‘n’ Fruity in New Zealand – and will start out with 40 percent of the market. After the export monopoly goes, niche-market competitors will have a strong incentive to further develop their businesses in New Zealand, as a platform to start exporting. There will be stronger incentives for foreign competitors to enter the New Zealand market – on both the consumer and supplier side – and compete more strongly against us.
All this means we can expect New Zealand consumers to benefit from even-more intense competition than currently. There are also issues for our suppliers. Right now, there is very little scope for competition. Farmers in most parts of New Zealand have no real choice of dairy company. Each year they get a one-off number from their dairy company – and they make judgements based on that number. But 90 percent of the number is based on factors other than the performance of the company itself. The great rivalry between the Dairy Group and Kiwi accounts for just 10 percent.
With a fully-integrated industry, farmers will have much more information on the performance of their company. There will no longer be commercial or political reasons to withhold performance information. And the benchmark will not be between two New Zealand manufacturing companies. It will be against the performance of the world’s best, fully-integrated companies. What’s more, there will always be the possibility of one of those global companies entering the New Zealand market, buying milk from farmers, manufacturing product, and exporting it from New Zealand.
Other New Zealand companies could do the same. That will keep the new company far more on its toes than now. The Merger Package provides for rules to establish fair values for farmers wanting to enter or exit Global Dairy Company, should they want to supply a competitor. They will be able to get their capital out of our business and potentially put it in another.
There are also additional safeguards. A new Shareholder and Supplier Council will be elected by suppliers to represent their interests. It will appoint a Milk Ombudsman to settle any disputes. Finally – and this is important – we will continue to be under the day-to-day scrutiny of the Commerce Commission, just like any other New Zealand business. And if, after three years, the Commission is not satisfied with our performance it will have the ability to intervene, establish price controls and determine another method for establishing fair exit values for farmers.
We are working with the Government on the Merger Package, through a joint industry-Government working party. We recognise that the Merger is probably the biggest single item on the Government’s agenda right now. It will be the biggest and most important commercial deal in New Zealand’s history. It is understandable that Ministers will want a high degree of comfort before proceeding. We are committed to continuing to provide them with high-quality information, before they legislate and amend regulations.
We hope the working party process makes it possible to put a formal Amalgamation Proposal to shareholders in the next couple of months. We then require 75 percent support from the shareholders of both companies. Our objective continues to be 1 June for start-up day. That is the start of the 2001/2002 dairying season and therefore the most appropriate date, commercially, for the new company to start up. Time is of the essence.
While we have this debate in New Zealand, Nestle, Kraft and the rest of our competitors continue to grow and to consolidate. We want to compete with them for the benefit of our shareholders and all New Zealanders. We seek your goodwill towards the merger.
We look forward to working with you as a leading member of the New Zealand business community.