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.
