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Dairy Board annual general meeting – Sutton Speech

Jim Sutton Speech
Dairy Board AGM

Good afternoon chairman Graham Fraser, chief executive Warren Larsen, ladies and gentlemen.

In terms of scale, the dairy industry is one of New Zealand’s most successful sectors. Last year, dairying exports were NZ$4.9 billion out of total merchandise exports of NZ$22.5 billion.

Put another way, better than one in every $5 earned in exports is earned by the dairy sector.

If we think about what this statistic means, we can start to appreciate that what effects the dairy industry affects all New Zealanders in one way or another.

The Government is certainly aware of this fact.

Looking to the future, there are many factors that will have major effects on the New Zealand dairy industry. The pace of change is greater now than ever before.

The future poses huge challenges for the entire sector. Much of what is now occurring internationally poses serious threats to future dairy returns.

But, many of these recent developments also offer opportunities for greater growth and diversity in the industry.

Most people here will be aware of the kind of factors I am referring to. They are things like:

- shrinking profit margins, especially the long-term trend of falling commodity prices;

- rapid productive efficiency gains by New Zealand’s competitors;

- scientific advancements, especially the biotechnology revolution;

- liberalisation, albeit slow; - changing consumption patterns, like substitution of vegetable based products for butter in some important offshore markets;

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- the rapid expansion of multinational competitors;

- the conglomeration of international retailers and the trend to category management; and

- the increased use of TBT as trade distorting protectionist devices.

It is these factors that are driving the industry towards major change.

Each of these developments must be assessed and strategies put in place to respond to them. The challenge is to turn the threats into opportunities and opportunities into competitive advantages.

What is clear is that commercial pressures, driven by the kinds of factors I have just referred to, make change in the industry inevitable, and - in fact - essential. Failure to respond to these challenges would see the industry quickly losing its status as a global leader.

And, because commercial pressures are driving change, it is vital that commercial interests develop and implement their own plans for change.

That is why the Government believes that major change in the dairy industry must be driven by the dairy industry itself, rather than imposed by Government.

Nearly two weeks ago the Dairy Industry Restructuring Act expired following the breakdown of MergeCo negotiations. No doubt there are some that believe the Government should now step in and dictate reform - or at least impose a deadline for reform. Certainly, the industry does not have unlimited time in which to address its future.

I appreciate the frustration of some in the industry following the breakdown of merger negotiations. The negotiations have been costly both financially and in terms of precious time.

But, while acknowledging the frustrations and costs, I am conscious that the risks to dairy farmers and the potential loss of value in the industry from Government imposed reform, make that option unacceptable.

The Government’
s policy is clear. It is prepared to support and facilitate change provided change is in the national interest, addresses the interests of minorities and is broadly supported by farmers.

This is not to say that a proposal must have the unqualified support of every farmer and interest group. Clearly, there are diverse views in the industry, and it is unrealistic to expect total consensus. No group should assume it holds some sort of veto power.

Nor does it mean that the Government will necessarily implement the first reform proposal put up by the industry and supported by a majority of farmers.

Before facilitating any change, the Government must be satisfied that public policy and national interest issues have been addressed. This was the critical function of the Commerce Commission under the Dairy Industry Restructuring Act.

Ensuring that public policy and national interest issues are properly addressed is the legitimate role, indeed the obligation, of Government.

I want to come back to these public policy issues a little later, because I believe it is important that government makes the industry aware of the kind of issues it expects to be considered as industry develops its proposals for the future.

It is appropriate to raise these issues, in this forum, at this time, because the dairy industry is now at its most important crossroads since the formation of the New Zealand Dairy Board.

I am of course referring to implementing the industry?s development strategy, including the growth strategy.

While negotiations on the merger have ebbed and flowed, a lot else has been happening in the dairy sector.

The Dairy Board has taken significant initial steps to pursue growth strategy opportunities.

Three recently announced examples of this are the Heads of Agreement with Australia?s Bonlac, announced in April; and, the formation of a partnership between the Board and the US co-operative, Dairy Farmers of America, announced in May this year. And last week, the move to acquire a major corporate stake in Latin America's powerhouse, Brazil.

No doubt the Board continues to identify and assess other opportunities.

At the same time, I note Kiwi Dairies? confirmation late last month that it is in the final stages of negotiations to acquire a majority shareholding in Australian Company, Peters and Browns Foods. I also note reports that New Zealand Dairy Foods intends to lift the intensity of its discussions in Australia, once the implications of Australian deregulation become clearer.

Perhaps even more significant is the recent agreement in principle between the two largest New Zealand dairy companies to form a unified structure with which to pursue the dairy industry?s growth strategy.

It is clear that, to meet the challenges of the future and take advantage of the opportunities that now present themselves, the dairy industry must change. It must ensure that it invests its precious capital in those areas that offer the greatest returns.

The reality is that in many instances this will not be by investing in increasing milk production.

Rather, it may be investing in the areas of research and development ? creating the know-how to make new products with new functionality and more desirable properties.

It might be in acquiring consumer brands, manufacturing technology and service networks in other parts of the world.

It might be in developing new technology and platforms to trade food products directly with customers around the world.

Or, it might be building high technology production capability right here in New Zealand.

The possibilities seem mind-boggling now! One thing I predict, in ten years time there will be other opportunities nobody has yet dreamed of.

It is fair to say that, in the past, the dairy industry?s investments and its very structure have tended towards increasing milk production and consequently producing large volumes of commodity type products.

New Zealand has been extremely good at this, to the point that the industry is probably the most efficient producer of these products in the world. For the last 50 years this strategy has served the dairy industry fairly well.

But the threats and challenges I spoke of earlier make the continuation of such an approach unlikely to succeed in the future. Commodity prices will continue to fall long-term, some competitors are catching up to New Zealand?s productive efficiency, margins are shrinking, and new technologies may even make some commodity products redundant.

The need for change has never been more evident.

Without significant real growth and investment in the right areas, New Zealand?s dairy industry runs the risk of being consigned to little more than supplying commodity products to our competitors at the lowest possible price. That is not a comforting thought.

Industry leaders know this, even if some farmers are reluctant recipients of the message. It is the recognition of the challenges that the industry faces and the desire to take advantage of the opportunities that now exist, which is behind the strategy of growth.

I welcome this new strategy. Some would say it is overdue.

It is clear the Board is serious about pursuing the strategy. Nowhere is this more evident than in the Board?s recent and fundamental change to its mission statement.

In its new mission statement the Board emphasises its intention to create wealth for its shareholders, rather than its historic focus on income for dairy farmers.

This is a radical shift, the consequences of which farmers are starting to think very carefully about.

As farmers come to terms with the implications of both the Board?s new mission statement and the growth strategy, some are beginning to ask serious questions about whether the industry has the necessary structures in place to implement such initiatives.

To be blunt, I do not believe it does as yet. But, I do believe industry leaders are now working hard to create the right structures.

Given the way the industry is currently organised, farmers? concerns about its structure are understandable.

Farmers are beginning to ask questions like how they will share in the wealth being created under the growth strategy using their money, if that wealth is not necessarily to be reflected as additional income to dairy farmers.

For example, if offshore investments build the equity of dairy companies, how will farmers access their share of this equity, given the current structure of nominal share values? Clearly this raises questions about the entry and exit values of farmers? shares in their dairy companies. This in turn raises questions about the future tradability of those shares.

There are also important questions about any distribution of profits from offshore investments. If these were bundled with milk payments in the traditional way, this in turn would further distort investment decisions in New Zealand, leading the industry back towards investing in ever-increasing milk production. It might also have an unwelcome effect on domestic consumers by inflating the cost of raw milk.

Farmers are no doubt asking what additional commercial and financial risks they will be exposed to, and what mechanisms will be in place to allow them to manage these risks.

For example, would farmers have a choice whether to invest in particular growth strategy opportunities, or would their participation be compulsory ? through mechanisms like retentions of milk payments?

And farmers will need capital and governance structures that ensure they receive full and transparent information. In particular, they would need information about any milk payment retentions being used to fund investments and the returns from those investments.

All these issues will need to be considered by the industry as it works towards implementing the strategy.

In particular, those working on the ?unified structure? I referred to earlier will need to bear these issues in mind as they work out the details of such a structure.

The Government too will follow these issues with interest, as many are issues of significant public policy and national interest.

To summarise, it is my view that commercial pressures are driving the dairy industry inevitably towards major change.

Many of those same commercial pressures also offer tremendous opportunities for growth. It is clear that industry leaders have recognised those opportunities and have agreed on a strategy to take advantage of them.

I welcome and support this initiative.

But, major questions remain as to whether the industry has the appropriate structures under which to implement the strategy. My view is that it does not, but that many in the industry are now applying their minds to the issue.

It will be a major challenge for the industry to put in place the right structures, which ensure the success of the strategy and the long-term future of this vital industry.

I offer my support in this, and wish you well in your efforts, and every success in the coming year.

Office of Hon Jim Sutton

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