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"Taking on the World" - Craig Norgate Speech

"Taking on the World"

Craig Norgate Chief Executive Officer

Dexcel Ruakura Dairy Farmers' Conference

Waikato Convention Centre
Claudelands Showgrounds
Hamilton New Zealand

10.00 am Wednesday 15 May 2002

Peter Jensen; Fonterra Shareholders and Staff; Ladies and Gentlemen:

I'm very appreciative of this opportunity to give the keynote address to what is probably the best-attended and most important conference on the New Zealand industry calendar. And it's good to be in the Waikato, which is the traditional heartland of the New Zealand dairy industry, the largest centre of activity for Fonterra in this country and the headquarters of our manufacturing operation. I hope that Fonterra continues to have a strong presence at this conference in the years ahead. Today is just the start.

Your theme this year is "Taking On The World". In one sense, that's what the New Zealand dairy industry has been doing since its foundation and - in particular - over the last twenty years. In another sense, last year's industry merger was about getting our own house in order, so that we could lift the business to the next level of performance.

Because of that, Fonterra can be described as both a new company and an old company. We have inherited a very strong platform, from each of our three legacy companies, which has been built up by dairy farmers over the generations. We start with 20,000 staff, and with customers and consumers in 140 countries, in all corners of the world. At the same time, we start something completely new.

Our first six months in business were as challenging as any major international merger, and it those first six months that are most dangerous in any merger process. We have faced three key challenges through that period.

First, we needed to ensure that it was business-as-usual for a company upon which many of you rely for your livelihoods, and which is responsible for more than twenty percent of New Zealand's exports and seven percent of its GDP. We had a responsibility not to drop the ball in any respect and by and large we haven't - despite facing record peak milk production in the spring, a record production season, and record sales and shipment volumes, in a market that has been particularly difficult through the latter part of the season.

The second challenge was launching a series of initiatives, which only became possible to finalise with the merger behind us and which were consistent with our 1998 Industry Strategy. We've reported on each of these, as they have developed.

Our 50:50 alliance with Nestlé is the best known, and - in broad terms - it will see us combine our manufacturing expertise with its marketing grunt to benefit both companies' shareholders. Beyond the Nestlé initiative, we have joint ventured with Arla in the UK, to bring our Anchor brand and its Lurpak brand together into a single, stronger entity. We've signed a skimmilk-powder export deal with Dairy America, to make New Zealand dairy farmers the largest exporter of that category out of the United States. We're becoming the first to commercially manufacture Milk Protein Concentrates in the United States, with our partners, Dairy Farmers of America. We've made two major acquisitions in Mexico, to secure the leading position in its cheese and spreads markets. And we've taken our first step into India with our Joint Venture with Britannia, a bakery business with a national distribution network, which is now moving into the dairy category.

All of the initiatives have been made a lot easier - and, in some cases, were only possible - because of the creation of Fonterra, which gave our industry a stable, long-term structural base.

The third challenge, however, is the most demanding and in the long term the most important: establishing a new business, retaining key talent, and building a new culture for the business that is distinctively Fonterra. We have been in the unusual position of being both a large, established business and a start-up, both at the same time. By and large, shareholders have been very supportive and very understanding through that period, and we appreciate it.

The first phase of the merger process is now drawing to a close. The major decisions of the merger process are now behind us. The structure we have put in place builds on where we have come from and I will take you through it because it is important it is well understood.

The company is led from a small Corporate Centre at Auckland Airport. It is focussed on the overall performance of the group, its strategy and direction and - most importantly - the development of top talent. It has responsibility for regulatory compliance, government relations, and shareholder and investor relations. Reporting directly to senior staff in the Corporate Centre are both our Shareholder Services division - through the Office of the Chief Financial Officer - and the Fonterra Research Centre, the renamed Dairy Research Institute - through the Office of the Chief Development Officer.

At the operational level, we have three parts. NZMP is responsible for milk collection, processing, manufacturing, and marketing quality bulk ingredients to the food industry globally. It is in NZMP that the integration of manufacturing and marketing, which will generate most of the cost, efficiency and effectiveness benefits of the merger, will take place.

NEW ZEALAND MILK is our consumer milk products arm, with a network of operating companies marketing high-value consumer products globally. It has leadership positions in a wide range of categories, in countries as diverse as Venezuela and Sri Lanka. In New Zealand, it includes Mainland, Tip Top and Peters & Brownes.

Our third part is Fonterra Enterprises, responsible for new businesses that do not fit in either NZMP or NEW ZEALAND MILK but which are linked to our core business of milk. It includes our biotechnology business, Vialactia Biosciences, venture-capital-type businesses, our farm supplies retailers - Anchor, Town & Country and RD1 - and online farming services, through

My leadership team is now in place, and consists of just five direct reports:

· the Managing Directors of NZMP and NEW ZEALAND MILK, Chris Moller and David Pilkington respectively;
· Alexander Töldte, who is Managing Director of Fonterra Enterprises and Chief Development Officer;
· Graham Stuart, our Chief Financial Officer; and
· Glen Petersen, our Group Director of Human Resources.

I am confident it is as strong as any leadership team of any New Zealand company or any major international dairy company, and it has both breadth and depth of experience and new blood with global insight. Beyond our top team, almost all senior appointments have been made, and we have attracted outstanding new talent from places as diverse as Denmark and Mexico.

The team is now in place, as is the structure of the business. Undoubtedly, it will evolve over time, as it does in any business. If there were any excuses through the merger process, there cannot be any now. The onus is on us to perform and deliver. Our focus must be profitability from our network of businesses, and delivering that back to shareholders. We plan to meet your expectations in every respect, and ultimately exceed them.

To do that, and to focus the business in this, our first full year of operation, we identified five key priorities at the start of 2002:

· to Establish our Performance Ethic;
· to Achieve Alignment on the Fonterra Strategy;
· to focus on People Disciplines and Processes;
· to complete our Americas Alliance with Nestlé; and
· to Integrate our Australasian Portfolio.

I'll take you through them one-by-one.

Establishing our performance ethic is about creating a distinctive performance culture for the company. It's about establishing and communicating a shared mission, and using it to inspire. We must be people who commit to targets, and who delight in achieving them and being recognised for it.

The immediate priority is delivering on the Business Case for the merger, with its promise of payout benefits worth 25 to 30 cents per kilogram of milk solids. We are well on track for that, and we are recording every cent, so that we can be accountable to the board and shareholders. Approximately NZ$50 million is likely to be banked by the end of this season, with the company just six months old, and we remain on track for more.

Beyond delivering the Business Case - which is simply an immediate obligation - the key to our wider performance ethic lies in our new capital structure. It is how you can measure our performance and, in many respects, it is the most important new element of our merged company.

The first component is the separation of the commodity milk price from added value returns. Each year, our valuer - Standard & Poor's - will independently identify the commodity milk price, an estimate of what an efficient commodity producer could pay for milk and still make an adequate return on capital. Shareholders will then be able to compare that with their milk payout, to assess the efficiency of our commodity business and the return from our value-added activities. It's a very important change.

The second component is the fair value share. Standard & Poor's has access to information about our business that goes well beyond that available to any external sharemarket analyst. From that information it will take the lead role in establishing the price of our fair value share each season. Again, it is a very important change. Shareholders will know exactly how much value we have created - or not created - in terms of future earnings potential. It allows anyone to assess the actual performance of the company, independent from the vagaries of fluctuating commodity prices.

A cynic could claim it gets us of the hook, when commodity prices fall, as they have done over the last six months. I'm sure you wouldn't let us get away with that, and nor would we shirk from it. But, far more importantly is that it prevents us from being able to claim credit - and become complacent - when the commodity price swings upwards. We will be held to account in a far more open and honest way. It will put far more pressure on us to perform, because it is dramatically more transparent than our old arrangements.

And we welcome that pressure. It's not just a measure of performance, it is a spur for performance in its own right, and I want the entire organisation to relish the challenge of responding to it. It will be a major part of our performance ethic, which is why one of our first initiatives this year, was to ensure shareholders understood the new system, so that you have the tools to put the heat on us.

Some of you may also use the new capital structure to consider managing the risks of your own farming businesses more innovatively. Fonterra is a co-operative, we are proud to be a co-operative, and our co-operative principles demand that our relationship is with the farming businesses that supply us and own us. But, within individual farm businesses, farmers will be able to more clearly separate out the risks and returns you enjoy from producing milk, from those you enjoy from your shareholding in Fonterra.

A precursor to that sort of arrangement, is one New Zealand bank providing the option of borrowing 100 percent of the value of your fair value shares at a very competitive interest rate. It is early days yet, but it is possible we will see more farmers using partners to either take some of the milk production risk - as many of you have always done to some extent with sharemilking arrangements - whilst others may choose to focus themselves on milk production, and bring in external investment to carry some of the risk of their shareholding.

David Wallace may like to speculate later on where farmers may choose to take this in the future. Farmers, individually, will decide whether they want to pursue such arrangements - we don't have a view on it - but they become possible because of our new, more transparent capital structure.

Our second key priority for the year is achieving alignment on the Fonterra strategy. The 1998 Industry Strategy gave the industry clear direction. It drove the creation of Fonterra, as the very best structural option to pursue key growth opportunities. It envisaged the sorts of alliances and JVs that we have only recently been able to pursue and which I outlined earlier. Its general direction almost certainly continues to be right, but by the end of this year it will be substantially executed. Our work now is on looking to the next period out on the time horizon, taking account of the new people and stakeholders our merger has brought us and the world as we find it, today in 2002 and beyond.

Recent market developments are instructive as to where our challenges lie. The unprecedented plunge in commodity prices over the last six months has mostly been driven by increasing subsidies, by the EU and US. Prices have fallen below what economic fundamentals appear to justify. On present forecasts, the price fall will take more than NZ$1.3 billion out of our shareholders' pockets, compared with 2001/2, and we are also very conscious of the impact that will have on the wider New Zealand economy. We think - I stress think - that the commodity cycle is speeding up, and there is a chance that prices will recover faster than they have in the past. But no one should bank on it, and it is no compensation to farmers facing severe cuts in returns for the season ahead.

But that fact that farmers' incomes are so closely linked to the commodity price cycle highlights the extent to which we need to further develop the business, to provide greater stability in farmers' incomes. The new economics of the business both encourages it and ensures that shareholders can be sure that we are adding real value, rather than just smoothing incomes or growing for the sake of it.

Currently, up to 80 percent of the business continues to be commodities - depending on how they are defined - and high-quality bulk ingredients will remain the core of the business in the foreseeable future. We have a competitive advantage in that business, because our on-farm productivity is second to none and because of our experience in large-scale milk procurement, processing, management and logistics.

Essential to our ongoing strategy is maintaining our competitive edge in those areas, which is one of the reasons why this month's Dairy Insight levy vote is so important. The voting deadline is 31 May, and Dairy Insight needs a good, strong mandate so that industry good activities, such as those provided by Dexcel, continue. We cannot afford to see the baby thrown out with the bath water. I urge you to vote, and I urge you to vote yes.

Beyond our expertise in production and industry-good science, our future will see our fastest growth in our speciality and consumer products businesses. It is in those areas that we see the best potential for growing the business: in the developed world in respect of speciality ingredients, and among the growing middle classes elsewhere, in respect of our consumer milk products. We are now in the process of reviewing the global environment in more detail, as part of what we are calling Project Galileo. Already, we are experiencing new insight, which I am sure will result in further refinement of our strategy, and which we expect to be talking to shareholders about before the end of this year.

Our third priority is vital to executing our strategy: our focus on people processes and disciplines. What I refer to here are the systems and approaches that will ensure we have the human capability to deliver our aspirations today and into the future. It is about aligning our talent pool against the challenges we face, and seeing that our capability evolves as our aspirations do.

As new aspirations are established, we need to ensure we have the right people for the critical business challenges, and we'll continue to bring in new talent from outside. When the skills we require change, it is about providing the opportunities for people to grow and develop: we won't be short of jobs where people can really show what they can deliver. And there will be cases where people will move on outside the company as we continue to improve what we do.

Already, we have brought in new talent from outside the industry, from the New Zealand business community - people who've been attracted by both the significant past and the exciting future Fonterra faces. We've also brought in new talent from outside New Zealand to more closing align our talent pool with our global business.

Leadership skills are crucial. We need to develop leadership capability to match our aspirations, and we'll be doing that using local and overseas universities, putting people into jobs where they have real, on-job leadership development, and we're considering ideas like establishing a consortium with other global businesses to exchange executives among us. The idea is that we would all gain twice: from exposing our people to the leadership qualities of others and by developing our people's skills in those other businesses. Leadership capability has to go beyond New Zealand alone. A global business needs people who can lead across cultures. It may not sound the most exciting externally. However, it is most critical internally.

Our fourth priority for this year is to complete our alliance with Nestlé. In the Americas, we see a dairy market worth nearly US$100 billion a year. It includes the wealthy markets of North America, and the fastest-growing markets in the world, in Central and South America - and much of that growth will be in It is a 50:50 alliance, bringing our businesses in the Americas together with those of the world's largest and most respected food business.

I cannot take you through the detail at this time. We are focussed on finalising commercial valuations in countries including Brazil, Argentina and Venezuela. We expect to have announcements to make in the next couple of months, at which stage we would expect to be able to give you the detail that you rightly expect.

Our fifth and final priority is also one where I need to be deliberately vague: integrating our Australasian portfolio. A key characteristic of successful consumer goods companies - our aspiration - is that they have a strong home market. In New Zealand, the former Dairy Board didn't have a home market at all. And, New Zealand's small size means that, it alone, does not provide the market base we need. For that reason, we define our home market as including Australia, and we already have a range of assets there, inherited from our legacy businesses.

Australasian Food Holdings - Mainland, Tip Top, Peters & Brownes, and soon other smaller assets in New Zealand and the Pacific Islands - is already the single largest operating company in our group, and the largest player in the Australasian consumer dairy business. We're now considering how best to organise those assets, and our other Australian assets - such as our 50 percent share of Bonland, and our 18 percent holding in National Foods - so that they do provide us with the strongest possible home base. Beyond that, there may be other opportunities in Australia that we want to pursue, because - aside from EU and US subsidies - it is Australasian production, which has the single biggest impact on world market prices.

Fonterra has begun its journey, with the strongest-possible platform and in the best-possible position. The first six months are always the most dangerous for any merger, and we have come through them successfully, and we have a much stronger business as a result. The market remains difficult, and we know that farmers and the wider community are going to feel that deeply in the coming year. But despite that, the ongoing prospects for the company and the industry are extremely positive.

Our structure is in place. We have assembled a great team. We now have the task of getting on and delivering, and proving that we are up to the challenge. It is a challenge that we relish. And we welcome the pressure to perform from shareholders that has always been a cornerstone of the dairy industry's success, and which we expect will be even more powerful in the new environment.

Thank you for the opportunity to talk to you today, and we look forward to fronting up in the future.


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