The Fonterra Story - Craig Norgate Speech

Thank you for this opportunity to speak with you today about all we have done, here in New Zealand, over the last year. It has been the most important year in the history of the New Zealand dairy industry. We’re delighted to be hosting the World Dairy Summit, here in Auckland, here in New Zealand, the home – but not the boundary – of Fonterra.

Internationally, our industry grows more competitive by the year – in fact, by the week. Every two and a half days we read of another merger or another acquisition or another joint venture in the global dairy business. Sometimes it’s been us making the news, from here in New Zealand. What we see are the world’s dairy companies coming together, to achieve the scale we need to survive and the scale we need to thrive. We’re responding to challenges on two dimensions.

The first? Our customers are growing bigger, and more powerful. We need scale to service them and to have leverage with them. Throughout the global dairy industry, we’ve merged with similar businesses to get the scale we need.

And the second dimension that is driving consolidation? We are bringing together complementary skills and strengths, to be the complete, integrated food businesses that we need to be. Many of our dairy industries have begun their histories as farmer co-operatives. We were established to provide a guaranteed buyer, for our shareholders’ milk. Others of us have our histories growing more from the marketing end. Businesses with different strengths are coming together, to strengthen both partners.

Some of the initiatives that we, Fonterra, have announced on the world stage have had these characteristics. Our initiative with Arla in the UK, for example, is about establishing an entity that will have the scale to start out as the number two in that very-competitive spreads market. Our proposed JV with Nestle in the Americas is more about complementing one another’s strengths. We aren’t alone in these types of deals.

Our industry consolidation here in New Zealand has enabled us to rigorously pursue completion of several important initiatives since our farmers voted for the merger, just a few months ago:

 Our skimmilk export arrangement with Dairy America;
 Our purchase of two key Mexican companies, making cheese and spreads;
 The Nestle alliance in the Americas;
 The Arla JV in the UK and EU;
 And, most recently, our first step into India.

Many of the same strategic imperatives behind these deals on the world stage have driven our industry consolidation here at home.

Our history in New Zealand lies in our land, uniquely suited for efficient dairy production. Our dairy farmers established co-operatives to provide a guaranteed buyer for their milk for the highest possible price. We’re still a small country. But 50 years ago we were smaller, and we had more than 400 dairy factories – most tiny, and some within sight of each other.

The Dairy Board, that you have watched and worked with internationally, was established to give the industry scale. It’s been an important part of our growth. But, domestically, the small dairy co-ops merged. They sought efficiency, they sought scale and eventually there were only two major players collecting and processing milk in New Zealand. Now, with the exception of two small companies that have chosen to go it alone, we have brought our whole industry together, into one company, Fonterra. We employ 20,000 people and have over NZ$12 billion of assets. We operate in 120 countries around the world, and have revenues of more than NZ$14 billion a year.

Getting here has been a long process. The spotlight on the need to complete the consolidation of our industry first began in the mid 1990s. The pace of dairy company mergers was accelerating. Companies were achieving scale, we were seeking to branch out, and the Dairy Board’s export monopoly was no longer as crucial as it once was. In fact, it was becoming a constraint. And the complex interactions between the two large dairy companies and the Dairy Board – their joint marketing company – was slowing the industry down and preventing it from responding fast enough to opportunities in the market.

Politically-driven attempts to resolve the impasse failed. Only when the two large co-ops themselves reached agreement on a way forward – when they signed their merger agreement at the end of last year – could we take the next logical step.

As a regulated industry, seeking deregulation, the Government needed to be involved. It placed strong conditions on us to promote competition in the domestic consumer market and to allow for competition for milk supply. But it also gave us the go ahead to put the proposition to our shareholders, who voted for it overwhelmingly.

The merger of our industry gives us a different perspective on the world, where we see ourselves as a key player in a home market that we define as encompassing Australia and South East Asia. There were challenges – and complex, difficult issues – that had to be resolved right through the process. Mergers are never easy. But, with the benefit of hindsight, it seems remarkable that I can stand here before the World Dairy Summit, just a week or so over ten months since we signed the Merger Agreement, as CEO of a unified New Zealand dairy company, New Zealand’s biggest company, and one of the top ten dairy companies in the world. We now have to deliver.

From a customer point of view, nothing should have changed over the last year, or in the last couple of weeks since the merger was finally completed. The two big business units – NZMP, NEW ZEALAND MILK- and their subsidiaries continue in the market offering the same service our customers have come to expect. We’ve sent that message very clearly to our teams around the world. The benefit from the merger is our ability to operate as one unified company with the shackles removed.

We continue to be a co-operative, and proud of it. To be a shareholder of Fonterra is to be a supplier of milk to our company, and vice versa. We exist to deliver to our shareholders the maximum possible price for the milk that they produce on their farms. Our capital structure is a co-operative capital structure, but one modernised for the challenges we now face.

Shares must be held in direct proportion to the quantity of milk produced in any given season. The change is that we have moved away from an old-fashioned, dollar-in/dollar-out system. For the first time, new shareholders will be required to purchase, for fair value, their proportionate stake in our business. And shareholders with declining milk production – or who exit altogether, to leave the industry, or supply a competitor – will be able to take the fair value of their share in the company with them. It is a major step forward in terms of ensuring that new milk pays for itself. And it is a major new accountability on our board and on our management team.

Each year, an independent valuer – appointed by our Shareholders’ Council – will come in to the business and establish the range of how much a share in the business is worth. They’ll value it on the same basis as you or I would if we were buying a business. The shareholder will look not just at what we have paid them for milk in that year. The shareholder will look at the underlying value we have created for them – or that we have not. That will be a very intense, new pressure on our business to perform.

The other major component of our capital structure is the peak note. It has been estimated that, in New Zealand, we carry twice as much production capacity as we would need if our milk supply curve were perfectly flat right through the year. The peak note asks shareholders to contribute extra capital to reflect the extra milk they produce at their season peak. That’s fair. What the system also does is provide an incentive for shareholders to seek a lower peak – to flatten out their production through the season. That incentive promises to help our industry become more efficient.

The capital that we hold on behalf of our shareholders is invested in our manufacturing infrastructure and in our portfolio of marketing companies around the world. We have made a commitment to our shareholders to be ruthless in our management of their capital. In the milk price that we pay to shareholders we will clearly show how much represents the commodity price of milk and how much represents return from marketing and other value-add activities.

In deciding what assets we want to buy, hold or sell – or what joint venture opportunities to pursue – we will not be interested in anything which we do not have a high degree of confidence will deliver well above the cost of that capital. And it will need to fit very clearly into our strategy to invest in those regions and in those product lines where we see the greatest potential for long-term growth. Increasingly, that is going to be fresher products in emerging markets, including Mexico, Brazil, China, Indonesia and India. We will want to form JVs where we are convinced we can offer unique value in terms of our knowledge, skills and brands.

Those of us who are co-ops know that our business is about milk, and about our shareholders’ milk in particular. We may, from time to time, invest in businesses where we source milk from other suppliers – times where we apply the unique skills that our different businesses have built to deliver a higher milk price to our shareholders. There may be other times when we apply those skills to product lines that have very little milk in them, if any at all. But, ultimately, we are about milk.

In New Zealand last century, our geographical isolation meant that we developed unique skills in procuring milk, removing the water from it – and adding value per kilogram in other ways – and transporting it over long distances to markets spread around the world. I’m confident to say that Fonterra knows as much about milk as anyone in the world. But there is a new race on – a race to unlock the hidden potential of milk that new science is bringing into focus.

All of us are in the race and we are all striving to win it. There are riches for the first to unlock the value, and commercialise it, and bring new products to the market, which line up alongside consumers’ desires for healthier nutrition. We all have a collective interest in the race, to ensure that dairy products are positioned as healthy products for the world, not simply a staple of life.

We need to continue to drive efficiencies in the production of the raw material. We need to seek efficiencies in the collection, processing, manufacturing and marketing chains. Here in New Zealand, we’ve set a goal, for a four percent productivity gain, through every aspect of the value chain. To achieve that goal, we have become our country’s biggest non-government investor in Research & Development. Those productivity improvements through the chain are vital. They are our priority now.

As an industry, New Zealand has a lot to offer our partners, and the wider dairy industry globally. We have a lot to offer our customers and consumers with our tried and tested products and those we develop in the future. We have even more to offer now that we have unified around Fonterra.

As much as being a company, Fonterra is a promise – a promise to our shareholders, to our Government, to our community, and to our customers and consumers. We are now focussed on delivering on those promises, on earning the status of a leading multinational dairy company, and a champion for our country, New Zealand.

Fonterra is committed to the IDF. We trust that this week will contribute much to the sharing of ideas and to the growing of the value of dairy products in the global consumers’ basket. May I welcome you again to New Zealand, and trust you have a pleasant stay in our country.

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