Unity and the Vote

If you want to purchase the right to one vote within Fonterra, you can do so for $4520.  Purchasing rights within Fonterra will now be easier in the future thanks to TAF.  Without knowing it, the acceptance of TAF has also enhanced the role of markets within the cooperative to allocate all things, including those things we traditionally placed non-market values on.  But importantly, we didn’t arrive at this state through a deliberate choice. To unify the cooperative, we must now look at how we arrived here and whether this is in our long-term best interests.
To investigate how this happened, consider this:
Should votes within Fonterra be subject to market share, tradeable and therefore viewed as private property, or rather seen as a civic responsibility to the cooperative, and therefore an obligation of membership?  
This is actually a question about the appropriateness of markets without limits within the cooperative.  But why should we worry that we are moving towards a cooperative in which everything is up for sale?  For two reasons: one is about inequality, the other is about corruption.
Consider inequality: Larger farmers who have more money invested in the cooperative should have a greater say because they have more to loose.
 This sounds like a strong market based argument, but implicit in this comment is that smaller farmers are less able to make appropriate decisions for the good of the cooperative because supply size is the best measure of democratic competency.  Of course rational thought says that this argument is flawed, but for the last 10 years, this argument has prevailed largely unchallenged.  For ten years, those with more means have mattered more.
The second reason, corruption, is about the corrosive nature of markets.  Markets change the way we view the things being exchanged.  When we decide that certain things should be tradable, we decide, at least implicitly, that it is appropriate to treat them as commodities, as instruments of profits and use. This means that if you have the ability to influence the outcome of a vote, you would be more inclined to vote towards an outcome that is to your personal advantage. Conversely, if you had no more ability to influence the result than any other member you would be more inclined to vote towards the collective good, believing that everyone else would do the same too.  
Markets should have limits within the cooperative.  Markets promote inequality and corrupt the non-market values of the things they allocate.  They change member attitudes towards the value of the cooperative, towards other members, and towards working together for the collective good.
Encouraging markets into all areas of our cooperative will not promote unity.  A 66% majority of a market-based vote might be the easy way to claim unity, but we all know that to truly have cohesion within the cooperative requires brave leadership.  Leaders who can step back from heady market values and rediscover the truly priceless non-market values that can unit us and drive dairying sustainably into the future.

FONTERRA GOVERNANCE HAS FAILED TAF

When farmers voted to investigate the possibility of a TAF market in 2010, the vote was underpinned by the conviction that farmer members held for the cooperative’s capital structure that ownership and control are non-negotiable.  What was never investigated by the governance team within Fonterra developing the TAF model was the principle behind this conviction.  The principle is that ownership and control allows members to work collectively towards a common good, a way in which all Fonterra members will thrive now and in the future.
The final model of TAF is of a share trading market that promotes individual rights and encourages consumer-like behaviours.  It is not clear how this model supports the principle of enhancing the collective unity of the cooperative or the common good. The final TAF model supports the conviction but confounds the principle. This is why there is increasing uncertainty recently from the general shareholding on the validity of TAF as a capital structure model that is well served for a strong cooperative.
The TAF model itself is very clever and does, in my opinion, exactly what has been asked of it.  However, what has been asked is inconsistent with normal, modern cooperative governance practices.  The TAF model was developed to reduce redemption risk for the cooperative.  In 2008/9 the cooperative suffered heavily from redemption and the governors saw this as a market failure, rather than the constitutional failure which it was. The current governors of Fonterra view their role as being neutral in matters of the common good, allowing individual members the freedoms to pursue their own interests through the cooperative. As a result, they see themselves as fixes of market failures, with a market-mimicking style of governance. This is where the real risk of demutualisation lies.
Demutualisation will happen when TAF market fails, or falters, in the future. Using this market-mimicking style of governance, our leaders will look to fix the problem with a larger, deeper, more liquid market.  We know this for sure as this is how the issue of redemption has been dealt with, how the decision for the 2nd vote was arrived at, and is behaviour that is consistent with current internal Board policies based on the spurious science of cost/benefit analysis.
Governors using market-mimicking governance struggle with working through the sometimes emotive and controversial opinions and convictions that come from encouraging democratic dialogue within a diverse shareholder base.  In an attempt to remove the subjective nature of these emotions, governors strive to reach decisions from a more scientific basis and use cost/benefit analysis to this end.
Cost/benefit analysis involves weighting the benefit of implementing a new policy or project against the costs of implementing it or not, and a decision is made based on the results. The problem with this kind of analysis is in assigning value to those things that we struggle to value in the first place, things such as goodwill, solidarity, succession, loyalty and sustainability.  How these things are valued will alter the results of cost/benefit analysis and renders it insufficient as a complete instrument for governance.  This is why modern governance methods that include member consultation and engagement yield far more consistent and enduring results. This is because it allows governors to arrive at a multi-dimensional understanding of member expectations based on the three strands of just governance; Welfare, Rights and Virtues.
It will be premature for members to enable TAF to proceed without stronger constitutional safeguards around enhancing democratic self-rule and the collective common good of the cooperative. TAF, although a cleaver concept, has not demonstrated how it strengthens or even supports the cooperative and the collective nature of the business for reasons beyond permanency of capital.  Members are becoming increasingly aware that TAF, without a stronger constitutional foundation, will critically and irreversibly weaken the collective strength of the cooperative nature of the business, despite offering increased financial strength to the capital structure in the short term.
Our governors have failed to recognise that right of individuals should not come before the common good, rather the right should be a consequence of the good. It is unfortunate that the cooperative has failed to demonstrate the qualities of leadership required to circumvent this politically delicate situation earlier.  This painful situation must now be born by whole the cooperative, putting members in a very difficult predicament that they are yet to have genuine dialogue on.

TAF and critical thinking

The basis for my concern for the TAF proposal is that the governance of Fonterra appears to lack critical thinking and therefore rational judgement. I would never dispute the absolute importance of ensuring any governance decision meets robust economic scrutiny, but higher reasoning suggests that it should never be the primary motive for decisions. When governance decisions of a cooperative are made to meet economic desires or market preferences firstly, they are without a reasoned and rational judgement basis, and as a result are at the mercy of circumstance rather than being free and unburdened to shape the cooperative’s destiny. Continuous flip-flopping of policy and the protracted capital structure debate are examples how leadership have tied the cooperative to the arbitrary nature of their markets, both internal and external. This is in contrast to a rational judgement position that would allow the governors to unlock the full potential of the cooperative for its members.
Without policy arrived at from a rational judgement basis, the cooperative will lack a unified and clear vision of the future for members.  Members become confused and frustrated with continually changing policy and this generates mistrust of the leaders and their motives, and at times, outrage for decisions that appear dictatorial.  It has been argued many times that these outbursts of anger are emotive reactions to policy members do not, or have not taken the time to fully understand.  But in dismissing this anger, the governors fail to recognise that anger, and especially outrage, are the specific reactions people have to injustices imposed upon them. People are rational beings capable of reason and therefore should be treated justly and with respect.  You can only be ensured that you consistently and deliberately treat people justly if you act with rational judgement in dealings with them.
Governance that is founded on rational judgement is stronger than arbitrary decisions. It is stronger and more enduring because in addition to being able to promote economic sustainability it offers direction to strategy, galvanises membership and enhances the collective recourse value of Fonterra. It also sends a clear message to the government and the wider community that the organisation stands for something of value, and that value is worth protecting.  How individual Boards judge what is right and just is for each board to determine, but through judgement and rational reason rather than arbitrary reaction, governance decisions must be made.
To illustrate my point, I will use environmental sustainability as an example.  It was identified that the approach to environmental sustainability by Fonterra and it farmers’ is becoming increasingly important to markets, both here and overseas.  In response Fonterra has launched a concerted environmental sustainability program throughout its sites and began to introduce a number of punitive measures to try to fast-track farmers into improving their environmental compliance performance and meet customer expectations.  The result was general outrage from the membership base and this was scaled back to the introduction of urgent, but somewhat ad hoc, on-farm environmental support programs such as every farm every day. The decision to undertake these measures was driven entirely by economic need.  The decision to undertake operations sustainably should have been from a rational moral judgement first. Fonterra should choose to participate in environmental sustainability because the governors have engaged with members to understand their positions on the issue, then stripped these arguments back and rationally evaluated them.  From this evaluation they would then drawn a reasoned judgement about the environment having an intrinsic value that is worth protecting for Fonterra, its farmers and the community it serves. Therefore working to improve environmental sustainability becomes the right thing to do for the cooperative and its members.
It could be argued that regardless of the approach, the result still remains the same; environmental sustainably.  But this is only true in the short term.  Once the whims of the market move in another direction, so too will the policy and the commitment that comes with it. The fundamental difference between the two approaches is that a decision based primarily on economics uses environmental sustainability as a means to an end.  Governance based on rational judgement would view environmental sustainability as an end in itself. When the leadership always follows a rational judgement position, it sends a consistent message to members, and the wider community, that Fonterra wants to make a meaningful difference for reasons beyond “it makes good commercial sense.”  People want to interact with an organisation that treats them and the things they value justly.  This behaviour creates a powerful competitive advantage; but this should not be the motive in itself.
The practice of reacting primarily to economic stimuli and market pressures for making governance decisions is why I still hold grave concerns for the TAF proposal.
The most enduring reasons that have been presented to me as the driving purposes for the TAF proposal is to remove redemption risk and free up capital to pursue economic options as part of the strategic plan.  What has not been made clear is the how the capital structure plan is intended to support and protect the collective resource value of Fonterra.  Although some issues surrounding this have been addressed in-part by the proposal, their handling is somewhat clumsy and critically impinges on the justice of such a proposal.   On the face of it, it appears that this proposal presents a capital structure that uses members’ rights and the collective resource value of Fonterra to galvanise the economic flexibility of the company, rather than to galvanise member rights and preserve the collective resource value as the end in itself.  Below I present my reasoning on how I arrived at this position.
(It is important to note that I am not supporting the current system as an alternative as this too is heavily flawed and fails the critical thinking test.)
My first clue to the reasoning of TAF comes from when I question how free the TAF market will be. In a regular investor market a potential investor is free to choose, when, how often, and to what levels they participate. This means investors are free to participate with the market as they choose, creating a free market.  In contrast, farmer members are coerced in their participation by the compliance aspect of membership into the cooperative.  The primary motivation for participating in the TAF market by cooperative members is not investment, rather access to the cooperative, investment is secondary. This means that to participate with the cooperative to supply milk, farmers are required to participate with the market. This policy works on the assumption that because all members of Fonterra are farmers, they are also equally capable as investors.  This position is morally contingent in so much as their success in this market is contingent on their natural talents and abilities or their opportunities to acquire satisfactory trading skills. Farmers are choosing to be farmers but are being coerced into being investment traders.  As farmers are also bound in the level they can participate due to the membership compliance requirements I feel that there is also a material level of coercion in their freedom to interact with the market, which is in addition to their desire to even engage. This inequity in access to the market between farmers and investors could expose the cooperative to free-riding on the capital value and the distributable profit.
The second clue to the reasoning comes from member access.  Under the current constitution, members wishing to access the cooperative are free to transact directly with the cooperative.  Under the TAF proposal, farmers wishing to join or increase membership in the cooperative can only do so on the condition that they compete for membership through the market.   Making supply conditional, transfers members’ rights from a collective constitutional arrangement to an individual contractual agreement. It could be argued that this is now a condition of supply and anyone wishing to supply the cooperative must adhere to the rule of supply. This reasoning is flawed as it implies that producing milk constitutes consent to participate in the market because farmers must engage with the market if they receive services.  It moves consent from explicit to tacit. Tacit consent to compete in the market in this case means that the agreement may not be wholly voluntary, due to the superior bargaining position of Fonterra created by the perishable nature of milk.  It moves membership from a position of freedom to one of condition.
The third clue to the reasoning is how membership entitlements are protected.  Take as an example two farmers.  Farmer A meets the share standard to supply based on their three-year rolling average.  This farmer chooses to place 10% of their shares into the fund.  In effect has laid out total capital for 100% of supply minus the 10% that he has re-couped by placing shares into the fund.  Farmer B also meets the share standard to supply based on his three-year rolling average.  This farmer has a bumper year producing 10% above this three-year average, a one-off year, and now has in effect invested capital for 100% of supply minus 10%. Each farmer is supplying 10% more than the shareholding they have money invested in the cooperative for.  Both qualify for full membership by meeting the three-year rolling average share standard, but only one, farmer A, will be entitled to the just deserts of this membership (full milk price and full voting rights).  If farmer B wishes to also receive the just deserts, he is forced to engage with the market in addition to meeting the share standard for membership.  This creates an inequity in membership entitlements that is not equally reflected in membership obligations.  This action appears to put the need for liquidity in the market ahead of membership rights.
The forth clue to the reasoning is the milk pricing mechanism.  In investor owned companies, producers of raw products are contracted to supply a pre-determined volume of goods for a particular price.  If the processor experiences unforseen increases in the cost of producing their product that they are unable to pass on the their customers, the shortfall for this amount would be met by investors through reduced distributable profit, not by the supplier of the raw materials that are contracted at a fixed price.  This is in contrast to Fonterra where this shortfall would not come from distributable profit, rather the milk price as this fits with the milk pricing formula.  The important thing to note with dairy cooperatives is that the farm-gate milk price is set after the company knows what it has achieved from the market, not before as is the case with other types of contractual supply. This means that the success or failure of NZ milk supply must be born entirely by the suppliers, as the owners of the milk, because the profit from the value-add portion of the business must be distributed as dividend and not subsidise the performance of NZ milk.  This model works well in times of market largess because an economic based policy dictates milk price will be the focus.  This becomes an issue when the market shifts and greater economic rewards can be found for value-add, or more worryingly, off-shore supply (distributable profit); as apposed to enhancing and following the collective purpose. This puts Fonterra’s economic growth needs ahead of the collective purpose.
My overall assessment of the TAF proposal is that Management have produced a clever option that does exactly what was asked of it. Unfortunately I have serious concerns about what was asked. It appears that the Board has failed to match the proposal to the collective purpose of the cooperative resulting in a miss-match of synergies. The four objections I presented are just off the top of my head, and I know others would be found if critical thinking was applied to the whole proposal in any great detail.   The mere existence of these objections says that no reasoned judgement has been applied. The only judgement appears to have been whether it met the financial objectives for restructuring set by management. There is no rational judgement as to rights, responsibilities, entitlements, desirable virtues, just deserts, honours, loyalties and collective purpose that TAF should encourage, protect and enhance.  The proposal is about securing Fonterra’s financial future alone.  This proposal appears to use the inter-generational collective resource value and members’ rights to achieve this end, rather than the protection of this value and these rights being the end in itself.

What is the Government doing with DIRA?

The Government has failed the people of New Zealand with their DIRA review.  This legislation is not about taxing those with surplus incomes and re-distributing it as a civic good, rather its better viewed for what it is; the Government sanctioned enforced re-distribution of assets from a group of NZ citizens to foreign owned companies. 

1.       Compensation does not reflect free market exchange

a.       Ability of private processors to drive down the milk price.

b.      Increased value of the raw milk for on-demand uptake.

c.       Inability for individual farmers to refuse consent to participate in the scheme if they feel compensation is inadequate.

2.       There is no civic duty aspect

a.       The purpose of the original DIRA regulations is not being met.

b.      Obligations do not reflect entitlements for participating in the scheme.

1.       Collective consent is tainted.

a.       Farmers could not have known how they would feel about corporate free-riders on the cooperative.

b.      The honour of NZ farmers as world leaders in the cooperative model is under threat.

The Raw Milk Regulations works on the premise of taking some milk from the larger processor and re-distributing it to some smaller processors who are less able to source the milk therefore enhancing the utility of the dairy industry as a whole within New Zealand.  This theory works on the assumption that the environment is of a larger processor dominating the NZ milk supply where smaller processors are trying to emerge to add competition at the farm-gate price and choices for farmers around who to supply.  This reasoning is flawed because it misunderstands the cooperative model.  The cooperative is actually individual farmers processing their own milk through a collective resource system, and are doing it in an organised way, creating the Fonterra organisation. This means that all farmers using Fonterra are in-fact still the legal owners of the milk and must bear the responsibilities and receive the rewards that ownership of the milk bestows.  The justness of this proposal critically hinges on whether compensation to farmers for their milk reflects a genuine free-market exchange, is any civic duty met and how untainted is original consent given by farmers to participate in DIRA.

Firstly I will explore the compensation to the NZ farmers for their raw milk (products of their time and labour) that is removed from them, and whether the farmers’ compensation reflects what would be achievable in a free market exchange. To investigate this we look at the farm-gate milk price.  It is important to note that the farm-gate milk price for a cooperative is set after the company knows what it has achieved from the market, not before which would be the case if this was a type of contractual supply to a company independent of the individual farmer’s business. This means that the success or failure of NZ milk supply must be born entirely by the suppliers, as owners of the product. Due to the mismatch in size between the domestic market and the domestic milk supply, the majority of the value for the milk produced in NZ comes from exporting it.  By farmers organising themselves into a way which, for the most part, creates a single point of sale from NZ enhances the profitability of the saleable product, and therefore the reward each farmer is able to achieve for their milk.  The emergence of private export processors, supported by the DIRA regulations, has seen this position as a single point of sale for NZ dairy products weakened.  This action has a negative effect on the farm-gate milk price, because as discussed before, the milk price is set after it is known what the market will pay, not before.  Farmers are now not able to maximise their income from the cross-boarder sale of milk due to increased competition coming from NZ and the decreased collective volumes available to sell. This means that private processors subsidized by DIRA can weaken the farm-gate price, the very price that determines the justness of the confiscated raw milk from individual farmers.  The farm-gate milk price now becomes inadequate to reason a fair exchange due to the superior ability of private processors to influence the market ahead of individual farmers.

The ability of private processors to choose when they take raw milk intrinsically increases the value of this raw milk to them, as it allows them to maximise their processing capacity for longer, maximising their profitability.  This further value added to the raw milk by the regulations is not reflected in the basic milk price alone; meaning the milk-price alone is not adequate compensation.  It is critical to ensure the compensation is fair as individual farmers do not actually have the freedom to refuse participation in the scheme if they do not feel compensation is just. 

The second aspect to this claim is whether the NZ public are benefiting from the redistribution of the raw milk and any civic responsibility is being met.  Part of the purpose for the DIRA regulations was to ensure that the NZ public would have adequate competition in the supermarket to keep dairy products affordable.  The success of this aspect cannot be accurately measured because despite the high level of uptake from new and established private processors, the majority of the milk is being exported rather than finding its way to the domestic market.  The reason for this is that the entitlements processors receive for accessing the Raw Milk scheme are not met with any obligations around promoting domestic competition, or to the NZ dairy industry as a whole.  The ability to receive entitlements without obligation is a gaping injustice in the scheme and one that encourages free-riding on the collective resource value of Fonterra to maximise profits for overseas investors.

The third aspect to this claim is how this lack of obligations and the consequential free-riding on the farmers’ collective resource system of Fonterra, taints the original collective consent the Fonterra farmers gave when the scheme was set up.  Farmers collectively entered into consent for the scheme to enable the formation of Fonterra, but would have been unable to know at the time that the scheme would not produce the originally consulted on outcomes and expose the cooperative to the free-riding on capital by private processors, and critically, how they would feel about this.  There is also the question of honorific value in forcibly removing the fruits of farmers’ time and labour.  Farmers have worked for a number of generations to increase the strength of the cooperative model and are proud of their position in New Zealand and on the world stage as an example of the power of the cooperative model.  The DIRA scheme undermines this honour and sends a message to the NZ public that the government does not value individual producers of export products working collectively to take on larger and better geographically positioned countries successfully.

This scheme amounts to nothing more than a re-distribution of income and wealth away from NZ farmers to overseas based investors.  It empowers private processors to free-ride on the cooperative model for their own ends.  This behaviour does not support or enhance the purpose of the original legislation and does not add to the civic good.  The lack of obligations attached to the entitlements seriously erodes the fairness of the scheme.  Tainted consent and the derogation of fair compensation coupled with the lack of freedom for individual farmers to refuse participation in the scheme makes the scheme unjust to those it was intended to protect; the NZ farmer and the NZ public.

As minimum measures to protect the NZ farmer and the NZ public we believe that the following actions are the least the government can take to ensure a basic level of justice is restored.

• ·         Limit the number of years a private processor can access the scheme.
• ·         Remove virtual processors.
• ·         Failure to uptake one month should constitute withdrawing from the scheme for that season.
• ·         Introduce some form of obligation to the NZ domestic market for those that access the scheme, at least while they are in the scheme.  

Controlling the Cooperative

The key difference between a cooperative and an investor-owned company is that a cooperative is a business owned and operated by its members for their mutual benefit.  An investor-owned company’s only owner focus is financial. 

Because a cooperative is operated for the mutual benefit of its members by its members, member control beyond the levels usually accepted in an investor-owned company is imperative to achieving successful outcomes for members, both financial and in services.  Control by cooperative members is important because in cooperatives, purpose includes how the cooperative interacts with its members’ businesses and this can vary and change over time. By contrast in investor-owned companies, purpose is always clear, to make money through shares and dividends.

The types of controls members have over the decision making of cooperatives are:

1. Redemption of membership – Ultimate form of control, very dissatisfied, Rarely used.
2. Voting rights at AGM – Official level of control. Used annually, more frequently with concern.
3. Engagement with the co-operative – co-operative level of control and is directive or interactive only. Used regularly/daily.  Used in a variety of mediums. NB: Increases in reciprocal engagement decreases the dependence on other forms of control by improving outcomes for members.

Redemption of membership (ownership) – Exercised Anytime

1. Remove capital and cease trading with the co-op. 

• Personal risk to own business as trading security reduced.
• Galvanises remaining members to direct the board

Voting rights at AGM: - Exercised Annually

1. Election of Board members
2. Changes to constitution – changes are to the parameters of the business (not on how the business is run)
3. Passing the annual report
4. Appointment of Auditor
5. Winding up the organisation

Engagement with co-op: - Varied and ongoing

1. Directive remits at AGM/SGM
2. Speaking rights at AGM/SGM
3. Access to co-op communications and publications
4. Access to Directors
5. Access to member representatives
6. Invitation to member update meetings
7. Access to member only areas on co-op website
8. Participation in focus groups or local forums
9. Clear complaints procedures on operational or governance issues
10. Information-sharing networks
11. Member/management working parties
12. Cooperative training and education
13. Advocacy
14. Other forms of formal and informal communication through-out the co-op

Improving member participation is the key to a successful, member controlled, member focused cooperative.  It all starts with the constitution. Having a constitution that clearly defines the parameters of how the cooperative operates, how membership is defined and the rights and responsibilities of members is important in setting the framework for a successful cooperative. 

Unlike investor-owned businesses, reciprocal engagement with members is a key component to the success of co-operatives.  Having a Board that works to develop strong member engagement directly with members will strengthen outcomes for members.  There needs to be a clear pathway from the Board to the members and back again.  The use of external PR firms in communicating with members is extremely damaging to this process and actively destroys value for members.

Member control of a co-operative is vastly different from owner control in an investor-owned business.  It needs to be protected through the constitution and actively encouraged by a member-focused Board.  Lack of co-operatively focused professional development training by the Board, the use of outside PR firms to communicate with members, an overly complicated constitution that does not focus on the important issues, and no clear lines of open communication are all warning signs of poor co-operative health.  The use of reciprocal engagement methods that promote strong lines of formal and in-formal communication by the Board and member representatives is one of the key ways of helping members exercise control over their co-operative. Strong member control creates strong outcomes for the co-operative. 

Does the treatment of the Organic suppliers herald the introduction of Farmgate Pricing?

My concerns about the Fonterra decision to axe Organic milk from New Zealand are not so much the decision, but rather the way it was handled, and that this behaviour could this be an ominous preface on how Fonterra could treat other farmers under less cooperatively focused capital structures in the future.

Telling Organic farmers twenty minutes before the national media that their world was about to change can never be argued was genuine consultation.  It was nothing short of tyranny.  Organic farmers are still shareholders, they still have put the same capital in as every other supplier.  This does not bode well for the future of some regional supply groups that may be less profitable to pick-up and process than other regions. 

If Fonterra decides at some time in the future, that it was no longer economical to pick up from a certain region, what will stop them dis-incentivising them from producing.  The Chairman, Henry van der Hayden, has never made any secret of his desire to introduce farm-gate pricing.  He knows this can never happen under the traditional co-operative model, so has spent the entire time at the helm of the Board, trying to actively change the capital structure.  To this end, you will note that every capital structure option put forward has involved a trading platform of some kind.  If you don’t take the thinking that a form of share trading is the best model to transition Fonterra in to an investor owned company, you will concede that any form of share trading will all but remove redemption from the control mechanisms members have over their Board.  By doing this, the Board will be free to treat different groups of farmers as they chose, because although shareholders will still be free to leave, any mass exudes will not be felt on their balance sheet like it has in the past.  Farm-gate pricing will always be in the best financial interests of Fonterra, but not the best interest of all the members.  

The Role of Redemption

Redemption risk. Two very dangerous words if you believe the rhetoric from Fonterra. But what is redemption risk and what function does it play in co-operatives?

Redemption comes from the co-operative principle of voluntary and open membership. This principle has been set in place to ensure that individuals and businesses wishing to transact with a co-operative are able to do so if they are prepared to put in the required investment. But equally, if we choose to stop interacting with a co-operative, we are able to have our investment returned under the rules in that co-op’s constitution.

Redemption is the favoured method worldwide for managing member capital. In an investor-owned firm, shares only benefit their owners either through dividend payments or by increases in the share price. Co-operatives, on the other hand, primarily support their members through guaranteed access and maximised return for products. This means that redemption from a co-operative is not driven solely by lack of profit, but rather by dissatisfaction with the co-op.

Essentially, when members ask for their investment to be refunded they are not just withdrawing capital, they are withdrawing support and product. This is why redemption is so important to a co-operative. When members start redeeming their membership, they are sending a very strong message to the Board that their decisions are no longer meeting their needs as members. A strong co-operatively minded board should look on the risk of redemption as the flame under them to keep them agile and member focused. Redemption is the ultimate form of control for members.

This is all well and good in theory, but does the principle stack up in reality? In 2008, Fonterra suffered a major redemption crisis, and this is one of the most persistent arguments for the “Trading Amongst Farmers” proposal.

At the end of that season, Fonterra members were capitalising on the significant change in share price by cashing in any excess shares caused by the nationwide drought or by going to a capital-free competitor for one or more seasons. Like most New Zealand businesses, Fonterra was struggling to access debt to fund this due to the GFC. This put enormous strain on the balance sheet and would have been unbelievably stressful. On the face of it, much of this situation appears to be the result of circumstance, but look a little deeper any you will see that the Board had set themselves up for this fall.

Over the previous eight years, Fonterra had taken no retentions, choosing instead to pay everything out to members. This meant that a sudden need for capital had to be met entirely by debt during the GFC. At the time, the Board was also incentivising management to grow “Total Shareholder Returns,” of which the share price was a major component. On top of this, Fonterra was not discussing the non-financial benefits of belonging to a co-operative with members, which could be argued was because, less than 12 months earlier, the Board had proposed a partial listing. So when investor-owned competitors came knocking, the promise of accessing tied-up capital was all that was needed to win some farmers over.

Things have now improved due to more co-operatively focused governance. Fonterra has begun taking retentions and this has strengthened the financial position. The share price is now far more stable. Changes to the constitution allow farmers to hold shares well above their production, milk-price penalties for production above the season-opening shareholding have been introduced, and capacity adjustment all work to discourage gaming of shares. And most importantly Fonterra is beginning to talk the co-operative talk to its members. All these changes have been driven by Redemption Risk.

A death by a thousand cuts?

IS TRADING Among Farmers (TAF) the first step towards a public listing, and the demutualisation of Fonterra? This is the key question dairy farmers have been battling with, both at the time of the June 2010 vote and again now.

While practically every dairy farmer wants to retain the co-operative status of our company, we are aware that the economic world is rapidly changing and we believe our leaders when they tell us the business needs more capital to grow. So how do we take the steps towards trying something so far removed from a traditional co-operative, without risking it all?

For me, the argument that TAF is a step in the direction of public listing is very compelling. The previous Shareholders Council was very clever in building into the June 2010 vote a longer timeframe for the roll out of the changes. This has allowed dairy farmers to be sure that we really do need TAF for the long term. It has also allowed farmers to see how the investor community has been behaving in the lead-up to its introduction. 15 months on, I have serious doubts with what I am seeing.

My main concern stems from the fact that there has been very little communication between the Shareholders Council and members regarding TAF. We are being told there is very little happening, so nothing to communicate. I don’t dispute this. Perhaps the changes were so insignificant on a piece by piece basis that it would have looked silly discussing them all with members.

But when the Chairman, Simon Couper, finally did come out and update farmers, what we saw was that the small changes over the 15 month period actually amount to significant change around control of the shares within the proposed fund. Although Couper dismisses this as evolution, farmers need to see that this process, if applied to the whole concept, as exactly how our co-operative could “evolve” into an investor-owned business without us being aware of where it began to unravel.

So exactly how significant is this evolution of control of the shares within the fund? Any farmer who uses the fund through either design or need, will have already taken that first step towards letting go of the cooperative ethos. This group of farmers, who will receive the full benefits of being a cooperative member without the full financial commitment, will be able to vote to increase both the percentage of shares an individual farmer can put into the fund and the percentage of total Fonterra shares held by the fund. Given the relatively low percentage of shares that will initially go into the fund, it is highly likely that the fund in its current form may not fulfil the purpose for which it was set up for. Although it could be argued that this group, who will not receive a dividend payment, would work to protect the milk payment through their voting rights, they won’t protect the co-operative ethos and the non-financial benefits of being a co-operative. Now mix this with the far more sinister threat on the horizon – the Fonterra “guardian” controlled shares in the fund.

We were originally told that control of the shares within the fund would remain with the farmer. This small evolution has meant that control of these shares will be blocked together under a single body.

So now there would be a group of farmers, with full voting rights, that no longer links in practice why full shareholding should be the only way to access full cooperative member benefits. After all, the only penalty so far has been the loss of the dividend. This will not have been of major concern as this group primarily cares about the milk price, and this has been protected by the constitution through their voting rights – which they may, or may not, be using. It would not be too difficult to convince the majority of this group to give up these shares entirely, especially if the price was high enough.

This means there would be a nicely packaged chunk of Fonterra shares with their farmer owners wondering if they actually need them. Controlled by a single entity, this bloc of shares is highly marketable and very valuable.

When small details evolve, they mark the first steps to change. The real risk now is that the Shareholders Council fails to see the wood for the trees. Because it was voted on, the Council may now be convinced that TAF is the only capital structure option available, so they tweak it to fit until it’s no longer of value to anyone.

Fonterra was set up as a consolidated co-operative to provide the best returns to New Zealand dairy farmers. Reducing export competition, sharing resources and being the largest processor all help make this happen because co-operatives are always the price setters at the farm gate. This comes about because co-operatives return their profits, after retentions for growth, back to their member/suppliers. Without the profits being returned to suppliers, are we still a true co-operative or will we be seeing the death of our cooperative by a thousand cuts?

Must read for all Fonterra members

Taken from Cooperatives NEWS october – november 2009

A must read for all Fonterra members looking into the proposed Capital restructuring.

Caroline

Aligning with member interests
and democratic control
by Peter Harris
Historically, cooperatives and mutuals have played a massive part in the New Zealand economy. Despite this, the standard governance texts and best practice manuals fudges the distinction between different forms of commercial incorporation. Specifically, cooperatives form to correct imbalances that develop when traditional investor-owned companies operate in market economies.
These are to:
● Protect members from poor quality, unsafe services and overpriced goods that result from weak competition;
● Gain access to markets where infrastructure is weak or expensive (eg packaging, transport, distribution);
● Provide services that are not profitable to commercial operators (such as in remote areas);
● Capture a share of value added from commercial provision;
● Secure economies of scale with buying or selling power.
DUTY OF CARE
Cooperatives pursue mutual interests as users of services as opposed to the investor interests of providers of services. They therefore form and persist as an alternative to the delivery of service through conventional, investor-owned enterprises. Both are owned. Both are governed. Both have to have regard to commercial disciplines or else they will go broke. Both need to be aware of the interests of other stakeholders in order to retain patronage and support. Where they part company is where the directors focus their attention when they exercise a necessary “duty of care”. Commercial company directors do develop a set of tools that are of benefit in a cooperative company: audit and risk oversight, remuneration of senior managers, investment of treasury type funds, legal compliance disciplines and so on.
However, those common competencies are not sufficient. There is a need for an almost 180 degree reorientation of the duty of care in relation to promotion of the interests of the owners as users as opposed to owners as investors.
In checking whether co-ops are being governed in a way that is fully aligned with member interests and democratic control, I think we can develop some tests. Here are ten questions, but this is by no means an exhaustive list.
1. Do the directors ask whether there is more value to the owners from continuing in business and accumulating assets, or selling up and distributing them?
If they do, they don’t get it. They are operating outside the primary area of responsibility as directors of a cooperative, elevating the interest of investors to the cardinal interest. In fact most co-op members have very little skin in the game as investors, but a lot at stake as users. By way of example, owners of a fertiliser co-op do not really care what the value of their shares is:
they care passionately that the co-op delivers the right quantity and quality of fertiliser on time at a good price.
If directors ask whether there is still a market imbalance that needs to be addressed, or whether the interests of co-op members are being met by conventional enterprises, they are still focussing on the cardinal interests of the owners.

2. How often do directors review the shape and form of the benefit that their members get from participating in the co-op?
If the co-op simply matches the competition in form and price of service, it is not correcting a market imbalance: it is perpetuating it. The competition leads, the co-op follows. It competes essentially by using the margin created by its “free capital” (owners’ equity and accumulated reserves on which it does not have to pay a dividend). Nominally anyway, a “real cooperative” does pay owners market rates on capital left in the business: it just does not give voting rights pro rata with capital contributed and distributes surpluses (above those needed to sustain adequate reserves) on the basis of level of participation in co-op activities. In practice, accumulated reserves are an undifferentiated wash-up from past activities, so payment of a market rate to contributors is not a realistic option. But this should not detract from the need to keep the member interest top of mind, or else the co-op is largely benefiting directors and staff, not members.

3. Do directors regularly assess the extent to which their service configuration and price ensure that returns to members are pro rata with their participation in the trading activities of the co-op?

If they do not, they can easily see the co-op drift as members who cross-subsidise others react to another form of market imbalance (administered imbalance) and walk away.

4. What innovations has the co-op introduced in recent times?
Market outcomes change in a modern dynamic economy, so the member benefits that the co-op
can capture will alter as competition and technological change both reduce old imbalances and create opportunities for new benefits.
Innovations can be quickly imitated, so an effective co-op is innovating ahead of the competition.
If it simply imitates market innovations it loses that fundamental driver of its reason for being: to do things differently.

5. Is there an explicit succession plan for directors?
Co-ops need to be democratic and accountable. In a profit-maximising company, shareholders who are dissatisfied with the performance of directors can simply sell their shares, extract their capital and walk away. The threat of a hostile takeover bid tends to apply incentives to investor-owned company directors to maintain performance (although spectacular failures are still very frequent). However, because co-op shares can be issued with a nominal value and can be redeemed, capital market disciplines on directors are virtually nonexistent.
There is nothing wrong with that: it is just a consequence of the orientation of a co-op.
Especially in larger co-ops with diffuse memberships, it is very hard to articulate effective member voice. Hence democracy, transparency and accountability have to be worked on and led.

6. Is there a regular review of whether the organisation has been captured by a minority or special interest: be that an activist grouping within the membership, management and staff, or the incumbent directors themselves?
It is very easy, in a large organisation where owners have very little investor interest in its asset base, for complacency to set in, and for directors and managers to overlook the vested interest of minority activist groups. They are the ones that need to be pacified, so it is easy to build up a comfort blanket that says that the activists are the members.

7. Are there formal limits on the scope and level of trading with non-members?

Some form of transactions with non-members is inevitable in any co-op. The question becomes whether non-member transactions start to dominate the financial affairs of the cooperative to the extent that they subordinate the interests of members. This is particularly acute when various covenants are placed on the terms of loans and when constraints are placed on the discretion of the organisation as a contractual condition of some other transaction. The risk is that there can be a tipping point, beyond which the non-members, by virtue of financial weight, become de facto cardinal stakeholders, and the fundamental character of the coop is lost.
8. What processes are in place to ensure
capital adequacy to underpin possible
expansions of activity and to ride through periodic
difficult trading conditions?
There is a delicate balance to be struck. With relatively few exceptions (Fonterra being a major one!), members of co-ops do not have a fundamental commercial interest in the co-op: it is a part of their lives, not the centre of them. Hence they will stump up a joining fee in the form of a capital contribution but cannot be expected to regularly subscribe to new capital issues, especially since the co-op is not designed to serve their interests as investors. There are many options for capital raising:
retained surpluses, joint ventures, preference shares, subsidiary investor-oriented companies,
capital notes and the like. The point here is that it is usually too late to seek
capital to ride out a crisis, but over-capitalising “in
case” runs into demoting the member service orientation of the company. A formal recognition of where the capital adequacy boundary lies, how it is to be sustained, and how capitalisation strategies support the member interest focus of the co-op is required: capital management
should not be a default outcome of governance.
9. Are special steps taken to reinforce a sense of belonging among members: to reinforce and refresh the “common bond”?
A robust cooperative relies partly on individual members seeing personal value in the collective
benefits that flow out of their joint activities, but that attachment can be weak and fickle.
The co-op can be reinforced if there are routine reviews of what binds members as opposed to simply what benefits them.
10. Is there a director approved programme of induction of managers and staff to reflect the member benefit orientation of the organisation?
Organisational values penetrate management and staff slowly and unevenly, and can be a source
of tension within the staff (especially among managers) if they are not formally communicated and supported. Fundamentally, the question that directors need to ask is whether the co-op is a membership mutual benefit organisation, an insiders’ support facility, or a directors and staff benevolent society.

SHORTCOMINGS
The Institute of Directors has assembled a framework for the governance of companies that brings together values, principles and practices. On the face of it, they seem like the sorts of values that might sit easily with any co-op: integrity, enterprise, fairness, transparency, accountability and efficiency. What is missing is a clear specification of what the interests of the “shareholder” are. There is not a robust recognition that the very reason for owning an enterprise can reflect different and divergent dimensions of the personal interests of the shareholder. It is covered in the overall wash-up of achieving the “mission and purpose” of the organisation, and to be fair that can be something other than value maximising. My question, though, is if in practice the natural orientation of directors of co-ops leads them as a matter of first principle to question the fundamental orientation of the interests of the owner.
Even if it happens, I really doubt that it is pervasive, but for co-ops to be fully on mission, that orientation needs to be pervasive.
If it is, all is well.
If not, the question becomes how to overhaul cooperative director induction, training, assessment, and compliance routines and manuals to achieve it.●

Fonterra's "new" Capital Structure

I have to say, when I look at the new Fonterra capital structure proposal, I feel completely underwhelmed. There is nothing here that we have not seen or heard before. It looks like a rehash of previous ideas, rather than looking at the issues in a whole new light; which all the build-up hype led me to believe was happening. I have to concur with other skeptics that this is just a small step towards the ultimate goal of floating the company as there is nothing new in this proposal that would make me think otherwise.
The key omission in this proposal is how these changes in the capital structure will support the co-operative nature of the business. Retaining the co-operative nature of Fonterra has been a clear message from shareholders since the 2007 capital restructuring option and one I would have thought this option would capitalise on. I suspect that genuinely using the co-operative principles as the cornerstone of Capital Structure discussions has not happened. Rather the ideas of farmer ownership and control have monopolized debate, producing a clumsy and difficult option.

I wonder what the original proposal put forward by the Board to the SHC looked like and how different is the proposal in front of us compared with that one???

Effluent Improvement System

Taranaki Federated Farmers Dairy applauds Fonterra for investigating ways to help reduce effluent non-compliance amongst its shareholders; however we have some concerns around how the new Effluent Improvement System (EIS) will impact on sharemilkers working on Fonterra supplying farms. Information from Fonterra explicitly states that Regional Council infringement notices and prosecutions will incur the Fonterra effluent deduction and Fonterra staff will not be involved in any decision about whether compliance or non-compliance has occurred. Fonterra also anticipates deductions will be directly in line with the existing payment structure the Company has in place for that supplier. This means that if grades are the responsibility of the sharemilker, Fonterra will deduct this amount from the sharemilker with no regard for where the fault actually lies. In the interests of equity, Fonterra needs to commit to negotiating with the Regional Council, the farm owner and the sharemilker every time there is an infringement involving a property that has a sharemilker on it before deductions are justifiably made. The lack of consultation from Fonterra staff before deductions are to be made and the method of these financial deductions are of concern to us because most sharemilking contracts require both farmers and sharemilkers to indemnify each other against effluent non-compliance because effluent non-compliance could be the fault of the sharemilker, farm owner or both.
In addition, if a sharemilker does incur a deduction from their milk payment for non-compliance, they would be unlikely to be eligible for the “relief” as they would not be required to undertake capital works to up-grade or improve the farm’s effluent system. It appears, therefore, that sharemilkers will be the ones that are penalised the hardest under this system. This is of concern to us given that, as a cooperative, Fonterra is bound to act with equity, treating people justly and fairly, and with social responsibility to ensure that key stakeholders, such as sharemilkers, are not disadvantaged or prejudiced against in policy development. Acting with concern for our key stakeholders (sharemilkers) plays a major roll in creating a modern cooperative culture. This group is likely to become the cooperative’s future members and by properly valuing them now they will become important ambassadors for our future cooperative success.

The Success and failure of cooperatives

The modern cooperative movement began in Rochdale, England at the end of 1844 as a way for workers to help themselves out of poverty and provide a future for their communities. Since that time, cooperatives have spread throughout the world and continue to promote sustainable economic and social growth. Globally, co-ops have more than 800 million members. They employ in addition 100 million people across more than 130 countries. The estimated economic contribution of the top 300 co-ops globally in 2006 was almost 1 trillion $US. To put this in perspective, this is about equivalent to GDP of the world’s 9th largest economy, Canada.

The top co-ops are some of the most successful large organisations globally, and provide their members with a level of economic and social support they would be unlikely to receive without them. Although cooperatives can be big business players, cooperatives also exist at the other end of the economic scale, acting as the financial lifeline for many third world people struggling to make a living. Regardless of their size, cooperatives play an important part in the world’s economies and support many people. The number of people who are benefitting from cooperatives is significant enough for the United Nations to assert in 1995 that, “Cooperatives contribute directly to improve the standards of living of half the world’s population.”

Cooperative structures vary in size and complexity, but here in New Zealand they are essentially formed by a group of smaller businesses or sole traders who identify a common need they have when operating in a larger market. Private businesses will sometimes come about to meet this same need, usually when an individual identifies this need as an opportunity to make money from others, or when the business community involved is not willing to participate cooperatively. As co-ops are formed to serve members’ needs, cooperatives have to be owned entirely by their members because any profit a cooperative makes is distributed back to its members and their communities, instead of going to outside investors who often have little or no connection to the community the co-op serves.

Regardless of the size or complexity of the cooperative, voting and the election of directors is usually conducted on the basis of one member one vote. This is because it is believed that all members play an important role in the overall success of the business, and therefore are entitled to an equal say. When a single member holds a larger financial investment in the co-op they should engage and communicate actively with the co-op to ensure their needs are addressed; not look to control the co-op with a dominating voting right.

Unlike shares in private business, the value of the membership share is usually fixed. In addition, these shares need to be withdrawable as membership to the cooperative should be voluntary. A successful cooperative should value the importance of membership and be continually responding to members’ desires to become involved in their business. The complexity of some cooperative structures comes about from a need to balance members’ rights to withdraw form the co-op and redeem their membership while providing the cooperative with some longer term capital to offer some financial stability.

As cooperatives are groups of people working together for their collective good, it is important that a strong and clearly defined set of values binds them together in a unified direction. How these values are implemented is up to individual cooperatives, but their existence should be at the bedrock of the organisation and underpin any activity of the cooperative.

The core cooperative values are:
Self-help: working together for a mutual benefit.
Self-responsibility: acting responsibly and playing a full part.
Democracy: where members control the organisation.
Equality: where members have equal rights, and according to their contribution have equal benefits.
Equity: treating people justly and fairly.
Solidarity: supporting each other and other cooperatives.

Cooperatives also hold a strong set of ethical values which should extend through the membership to it employee, suppliers, customers and the wider community. They are:
Honesty
Openness
Social responsibility
Caring for others

Strong cooperative and ethical values have lead to a set of cooperative principles that all cooperatives should hold. These principles flow from the values, the primary motivation of co-ops, and their unique operating structures. Following these values and principles should drive the way cooperatives approach business and if applied properly will promote the health of the cooperative, as well as offering guidance and direction for the cooperative members and its governors.

The seven principles of cooperatives are:
à 1st Principle: Voluntary and open membership
à 2nd Principle: Democratic member control
à 3rd Principle: Member economic participation
à 4th Principle: Autonomy and independence
à 5th Principle: Education, training and information
à 6th Principle: Cooperation among cooperatives
à 7th Principle: Concern for community

These cooperative principles are not only important in guiding the development and growth of cooperatives, they are also important in assessing the soundness of a cooperative and its chances of success. In 1999 Sir Graham Melmoth, the former Chief Executive of the UK Co-operative Group stated that, “Most failed Cooperative Societies over the last twenty years failed not only commercially but democratically as well.” His comments come about because democracy, the second principle, is seen as pivotal to the effectiveness of a cooperative and is the key indicator for assessing cooperative health. Ways of a measuring the vibrancy of the cooperative’s democracy are the voter turn-out, the number of contested elections, the average term length of directors, and how current directors support succession planning and emergent leadership. Are all members able to participate equitably and fairly, and how effectively are the values and principles of the co-op communicated to members, employees, customers and the wider community?

Cooperatives should have a strong value system and set of principles, a complex mission and operating structure, unique governance structures, and a requirement for different leadership skills from traditional private businesses. These unique qualities of a cooperative are there to serve its members and, if harnessed properly, provide a distinct competitive advantage.

Successful cooperatives are those that truly embrace their cooperative difference. They work towards meeting their cooperative and ethical values and strongly adhere to the cooperative principles. By doing this they effectively work for their members, through their members. Successful cooperatives see the importance of a strong and active membership and engage in activities that promote and enhance this. Cooperatives that fail do so because they lose sight of what it is that brings them together. They are unable to clearly see their cooperative competitive advantage and as a result start to act like a clumsy private company. What makes a cooperative fail is simply a failure to be a cooperative.

Effective Cooperative governance

When a member of a cooperative is newly elected to the board, they are taking on a demanding role which will require them to foster and enhance the relationship between the members of the cooperative who own the business and elect the Board that govern the business, and the management who manage the business for its owner members.

To manage this role and be an effective cooperative governor, individual board members have to uphold four duties as part of a code of conduct for directors. They are to undertake:
* a duty to obey the law
* a duty of good faith
* a duty to take care, and
* a duty to maintain the cooperative status of the organisation.

A duty to obey the law means that directors undertake to comply with or ensure the statutory requirements of the various Acts of Parliament imposed on them as directors, and on the business are met.

A duty of good faith is an undertaking to protect the interest of members by working in a manner that is truthful and honest at all times. Good faith ensures confidentiality when individual directors have no legal authority to disclose things that are not already in the public domain. It means always acting in the best interest of the cooperative and not using their position for personal advancement. A duty a good faith also includes working to avoid conflicts of interests and, if they arise, any material conflict of interest should be declared to the board and the members of the co-op.

A duty to take care simply means that each director should give the task their best. This includes reading board papers before meetings, attending meetings, taking advice from the executives and independent advisors, at the same time asking questions of them and challenging them, as well as undertaking ongoing relevant training.

Every board member in addition is responsible for maintaining the cooperative status of the organisation. This includes continuing to provide the goods and/or services that the cooperative was established to provide for its members, and ensuring that the business remains committed to cooperative values and principles.

To achieve a well-constructed cooperative board, the required skills of potential candidates should be clearly articulated to the members of the co-op so that appropriate members come forward for election. Elected board members are not expected to be experts, but rather to actively use and develop the expertise they have.

In following the directors’ code of conduct, board members should also undertake professional development training. It is not sufficient to rely solely on current knowledge and experience if they wish to carry out their responsibilities effectively in a continually changing environment.

Regardless of the skills required on a board, candidates for election to the board of a co-op should always come from its membership. An effectively governed cooperative will identify and articulate the skills required of potential candidates to ensure the right balance of skills and experience sit around the board table. That these governors are elected from the membership base is important as it means the membership is at the centre of a cooperative’s governance and ensures that cooperative principles and values will continually underpin governance.

When a governance board works to uphold cooperative values and principles they should use them to support the development of a strategic framework. This should be a cyclical process that involves setting a vision and strategy for the business. The implementation of the strategy and vision should have clear targets that are clearly communicated to both management and the members.

An effective board monitors the implementation of this plan, gathering feedback and reviewing it. It will learn from the feedback and adjust their vision and strategy to ensure their members’ interests are maintained. This process forms the bedrock of effective cooperative governance.

An effective cooperative board comes from its membership. They will develop a robust strategic framework that grows the cooperative for the mutual benefit of all its members who collectively own the business. They will work to uphold the cooperative values and principles, ensuring the competitive advantage of being a cooperative is maximised and assets remain robust and in trust for future generations.

Trust

Golbaldairytrade is Fonterra’s new on-line milk powder trading platform. It was launched in 2008 as part of the Board’s strategy to offer greater transparency around the true value of milk and so shareholders could more accurately measure the price of milk in their final payout. Since its launch, world commodity prices have plummeted. Critics of Fonterra have been quick place responsibility, perhaps not so much for the decline in commodity prices, but for more the speed and levels to which they are falling at the feet of globaldairytrade., So concerned, the Chairman of the Independent Milk Processors Association, Wyatt Creech, wrote an open letter to Fonterra farmers calling for them to demand a review to the Board’s decision to introduce this new and untested auction system at this time in the commodity cycle. So is there cause for concern?

When I ask farmers how they think Globaldairytrade.com is performing, the message I get is that they don’t really understand how it works, or how its success could be measured. Interestingly, when I have asked industry analysts the same question, I get the same response. This leads me to ask three questions. Why is there not more information available on the objectives of Globaldairytrade? How does it actually work to achieve these objectives? And finally, if the success of the online auction is so hard to measure, how has the Board developed meaningful risk management and key performance indicators for them to assess its ability to meet their objectives and adding value to the cooperative?

To me, the only clear objective of globaldiarytrade is to offer greater transparency around the true value of milk. In their own discussion document to Fonterra Networkers, the Board argues that as the price generated by globaldairytrade is a function of supply and demand, “shareholders can be confident of Fonterra getting the best prices at each trading event.” It is not clear on how they reach this conclusion. Firstly no-one outside Fonterra is entirely sure how many buyers are eligible to trade on-line, or how many of these eligible buyers are participating in each event. Being able to measure this would add confidence to this argument. In the same discussion document Fonterra say, “it simply provides a means by which all our customers are gathered in one spot to compete for product.” Yet a Fonterra Director has conceded to me that bidding at each trading event is optional. This means that even if buyers are signed up, they can just watch others bid for the basic commodities, then when the event is finished, use the price achieve at auction as the starting price for contract negotiations. Whether the ability for customers to do this was part of the design or has happened by default is not clear. A review would clarify this issue, and answer questions around who the transplant prices benefit most and, whether a transparent milk price is in fact the true value of milk.

When it comes to the governance of the auction platform, shareholders can only trust that the Board’s performance criteria and risk management assigned to globaldairytrade is robust. But herein lies the problem. Trust. The introduction of globaldairytrade comes at the end of a rocky year for the cooperative members. They have felt devalued by the Board following the capital structure review. Betrayed by the Board’s initial embracing of contract milk supply as a solution for inaccessibility to shared membership for some suppliers, then shocked to discover that the board’s risk management policies lacked adequate robustness as the San Lu disaster unraveled. When trust is gone, you have nothing. For the sake of the cooperative I hope the Board can rally and begin to repair some of the damage that has been done to credibility over the last 18 months. Open and honest dialogue with cooperative members to ensure they understand the objectives of globaldairytrade, and all the identified risks and benefits they could expect would go a long way towards making this happen.

The Board is a servant of the cooperative who in turn is a servant of its members. Globaldairytrade is a tool created by the board to assist them with their job. The members need to trust that their directors have the right tools to do their job, and the humility to honestly review the caliber of the tools and adjust the tool kit accordingly. In turn, the directors need to trust that the members have the capacity to understand and offer valuable feed-back on them to support the Board’s performance. If the cooperative’s leaders can’t make this happen then some dramatic steps need to be taken by shareholders to ensure trust is restored; for the sake of confidence in the cooperative’s performance, principles and future. Federated Farmers has asked for a review of the GlobalDairytrade, without that review, we farmers cannot begin to repair that confidence.

The Board's PR Process

The Fonterra board has a very slick and proven PR process that they use. They present a highly rehearsed presentation that is high in gloss and low in detail. They present only details in a broad context of what they are explaining. In doing this there is no detail to dig around in or theories to question. Once this basic information is out in the open it is always questioned by both farmers and dairy commenters alike with many assumptions made confusing the counter arguments. Fonterra’s response is to keep repeating their basic messages, rather than to elaborate or acknowledge they have heard what is said. For example, The strategic plan: When it was questioned how behind boarders milk would add value to NZ milk the response was always the same: “Cross boarder trade only accounts for 1.2% of all dairy product traded. The biggest growth will be in fresh liquid dairy.” Often the accompanying figures would also be included. On the preferred option: Farmers expressing concern that the nature of the corporate would force them to reduce their shareholding level in the company and therefore their control, they roll out, “Any decision to go below 50.1% must be approved by shareholders with a 75% majority shareholder vote – and that could be 20 – 30 years away.” There is no elaboration on what market conditions could be present that would lead to that vote, what would happen if the vote failed, or any further explanation as to why that 50.1% level needs to be movable. (And to say we can’t legislate from the grave is not the right answer Mr. Van der Hayden.) Anyway this will go on for a while, along with the promise of more information to come. Once farmers agree they understand the information in front of them the board will shut the whole debate down from their end and nothing will be heard until the next installment of the saga, ie the milk pricing mechanism. The announcement of the milk price will be conducted as above and if any queries are raised about the float structure they will be met with, “There was general agreement amongst farmers in the last round of consultation that this was the direction they want to see Fonterra go down.” Which should actually be read as, “There was general agreement amongst farmer that they understood the information in the last round of consultation and would like more detail before deciding that this is the direction they want to see Fonterra go down.”
So my message to farmers is be aware of their PR process and demand more detail. Tell them what you already know and ask them to elaborate on risks associated with floating as well as the positive points.

Validity of Strategic Plan

I am still not convinced on the Board’s strategy. I am still unsure as to how it is going to add value to NZ milk. I can see that if management can pull it off, it would add value to Fonterra, but surely it is to maximize returns on our milk that Fonterra was originally set up. Extra ventures that Fonterra undertake should just be supporting this end. I am still to be convinced of the wisdom of throwing large amounts of money into Chinese dairy production. I know the statistics presented by the board earlier this year on the growth in demand in China are impressive and certainly warrant a second look at that opportunity. However further investigation of the statistics reveal something very interesting that was never mentioned by the board. Although there is a dramatic increase in demand across the whole of China, individual consumption levels are at around 20lts fresh milk equivalent per person per year. This does mean that there is plenty of room for increases in personal consumption, however it also means that if there is a rise in grocery prices in China, dairy products can be easily dropped out of the diet because they account for very little of it. As the Chinese currency is pegged against the USD, the cost of food in China is rising quite considerably and now the pressure is coming on that all important discretionary spending to keep dairy sales in China growing. The truth is China is not the sure bet the Board would have you believe. Perhaps we should spend more effort working on the areas of core competencies and tread carefully in these unpredictable markets. Perhaps the urgent leap into new horizons is the excuse to make the capital structure changes, rather than the driver for them. This thought is echoed by the directors in their own Capital Structure book when they say, “The current capital structure will not support Fonterra’s strategy… (and)…doing nothing would mean retreating from our current position as a dairy company with global cow-to-customer reach…(and)… Fonterra would become a regionally-focused commodity player.” I would suggest that any backwards steps by Fonterra would be more a result of short coming by the board and senior management rather than a failure to remove ownership away from the farmers, and this whole argument smacks of a threat rather than rational business reasoning.

Farmer control

A farmer’s ownership in Fonterra is not just part of their investment portfolio. Fonterra is an extension of their business. Without Fonterra collecting and processing their milk, and providing them with the best return possible, their milk would be worthless. It was to protect these fundamental rights of the producer from profit driven private processes that co-ops were originally set up. As the co-op is in essence part of a farmer’s business, having a good level of control over the decisions make within the co-op is critical to the long term success of each individual farmer’s business. Under the preferred option announced by the Fonterra board two weeks ago, the board is asking farmers to put all their voting rights together to become one shareholder, the farmer co-operative. What our board has conveniently brushed over is that although the co-op will be the majority shareholder, individual farmer will not get a say. The farmer control that the Board emphasizes so heavily will be exercised exclusively through the co-op’s board and not through individual farmer votes. The performance of Fonterra’s board would be monitored by the board of the co-op and if the board of Fonterra wanted to make constitutional or strategic changes they would need to get the support of the co-op’s board. This is were the devil is in the detail; the board of the co-op will be largely the board of Fonterra. This leaves the whole process without any of the usual check and balances around the governance and strategic planning the board should have. It also means that suppliers are stopped from having any direct influence over the way Fonterra chooses to operate.
Although there are many things I like and don’t like about the preferred option, having to hand all my rights as a shareholder over to the board of the new co-op affects my farming business too much and is a deal breaker as far as I am concerned. I was told that within Fonterra there is a saying, “Co-ops are always a dollar too short and a day too late.” Implying that co-ops never have enough money because capital is linked to milk supply and it takes too long to make any decision because of the high level of consultation required in dealing with so many supplying shareholders. With board members upholding a culture that encourages opinions like this to justify underperformance, this whole capital structure review smacks, at least in part, of a move by the board to get around the issue of shareholder consultation. I would suggest that a lack of freedom for the board to make decisions is not the root of Fonterra’s problems, but is rather a result of a Board and Chairman lacking in strong leadership and hands on governance. Farmers are not idiots and know when they are being played. As my husband said when he initially heard the preferred option, ‘It sounds too good to be true.” Perhaps there is some truth in the saying, “All that glitters is not gold.”

Fonterra Capital structure

My two main issues with the Fonterra capital structure proposal as it stands are as follows:
1. The pre-conditions. Although the pre-conditions set by the board are a good idea, most of the pre-conditions are very subjective and are widely open for interpretation. I would prefer to see the board come out with some clearer guidelines on how these pre-conditions will be met because although I think it is a valuable tool, the success of the final product is dependant on the quality of the tools they are using.
2. Protection for suppliers. As a PLC directors must treat all shareholders equitably and must work solely towards the interest of the shareholders over the suppliers, even if the suppliers are a majority shareholder. As NZ dairy farmers move away from the lowest cost producers of milk, it becomes even more important to protect the NZ milk supply. Fonterra is going overseas to capture cheaper milk and this cannot be at the expense of NZ milk. Although Henry Van der hayden noted, it will be in shareholders interest to keep stainless full so the price Fonterra pays for it's milk will have to be competitive. This argument has two flaws, the first is that there isn't any serious competition to Fonterra and at this time most farmers have no alternative but to supply Fonterra. Secondly, and more importantly is that this stainless has a limited life span and it is only in the supplier's interests to replace it in NZ. Fonterra would be better off investing new stainless overseas to better capture the cheaper milk supplies as this would be in the interests of the shareholders, and as a PLC shareholder interests must take precedent.
With this in mind I would like to see some stronger mechanisms in place to protect the price paid for the NZ milk supply before the co-op is floated.

Land Prices

It amazes me how one good year and only the promise of others can cause such frantic land speculation. The prices being paid for dairy farms and the number of confirmed conversions for next season is unbelievable. Everyone is getting in on the act and pushing the price of land well above what it can reasonable expect to return. This is great of you farm for capital gain, not so good if you are starting out and what to work towards farm ownership. The recent surge in land prices is particularly worrying as you can now only buy land if you have a lot of cash behind you. This well healed buyer is often not interest in working the piece of land they have purchased, rather seeing it as an investment opportunity. The increase in this kind of buyer is leading to an increase in absent land owners who expect others to do the work. This change in farmer demographic from owner/operator to investor is worrying for the industry and could be it's down fall. Owner/operators will ride the commodity cycles because they are in it for the love of their land and stock, they will go without to keep their farm going. Investors on the other hand have no emotional connection with the land and see it as a business that must perform. This clinical view of a farm as a business only has brought some people high levels of success, but it also weakens the industry. This is because of a number of reasons:

1. Labour. It is all good and well owning 60 farms, thousands of hectares of prime dairy land and tens of thousands of cows, but who are you going to get to run the dam things. With all these new conversions going in and the increase in high-input operations, the demand for labour is going through the roof. But the problem is the more the farm becomes a factory, the less passion workers hold for the farming lifestyle. This is exacerbated by the growth of service towns around these new dairying areas and the increase in milk volumes that conversions and high-input creates. Dairy factories, tanker-drivers, stock-truck drivers, fuel-tank drivers all take their labour from the same pool as farms, however these services can pass the costs on to their customers and dairy companies get first dibs on the milk cheque so to compete in these markets farmers need to squeeze the higher labour cost out of their bottom line. Workers need to be paid their fair value regardless of the payout.
2. New entrants into the industry. With the prospect of farm ownership, and now even owning your own herd a near impossible feat for most people starting out in the industry, it can be very difficult to retain enthusiastic, motivated people within it. Why would someone with any ambition slog it out for years in the pouring rain or someone else's cow shed if they can never get anywhere? Stuff that, why not take your ambition and drive and apply it somewhere you can make money, develop equity and have every weekend off as well. (and not have to live in a shitty, small, cold 1940's house).
3. Intensification. Apart from the labour issues this creates, intensifying your farming operation to produce more MS per hectare leaves NZ dairy industry in jeopardy. The higher cost of importing feed, fert, fuel and soon, carbon credits erodes NZ's place as the lowest cost producer of milk even further. Don't even get me started on the issue of skyrocketing import costs as the world's supply of feed and fuel dwindle into non-existence and how much longer before those who have built their cost structures around intensified production to "grow" their business crap out because they either can't afford or just can't get them.
Good luck to you if you see farming as only a business investment to grow your personal wealth, and not as a treasured lifestyle to promote the growth of people, families, animals and plants. I hope the price you play will all be worth it in the end and that the rest of us in the industry wont have to pay as well.