Grant Samuel report on Zespri’s margin

Turners & Growers presentation to Kiwifruit Growers October 2009

NZ Kiwifruit Industry Reform

Grant Samuel report on Zespri’s margin

The Grant Samuel Report In January 2007, Grant Samuel (a specialist consultancy firm) submitted to NZKGI a draft ‘Margin Benchmarking Analysis Report’, for use in a three-yearly review of the margin Zespri charges to growers.

Grant Samuel analysed Zespri’s performance in the financial years ended 31 March 2004, 2005, and 2006.

The draft report had some very interesting things to say about the way Zespri set its margin and the way Zespri allocated costs between growers and shareholders.

4 Refusal to release the Grant Samuel report NZKGI, Zespri and Kiwifruit New Zealand have refused to disclose the Grant Samuel report to Turners & Growers Horticulture Limited, even though: the report was commissioned by NZKGI, for the benefit of growers • the report was paid for using NZKGI funds; and • T&G Horticulture is a member of NZKGI. • Zespri says that releasing the report would be likely to unreasonably prejudice Zespri’s commercial position because the report, supposedly, is only a draft, contains some incorrect information, and is out of date.

NZKGI refuses to release the report, saying it is an historical document, in draft form, which was ultimately overtaken by progress in other areas of the negotiations during 2007.

5 Turners & Growers’ questions Turners & Growers would like Zespri to explain which of the following statements by Grant Samuel are incorrect or out of date and why.

6 Promotional costs had increased by 38% since 2004 Draft Grant Samuel Report page 6 Grant Samuel observed that as at 31 March 2006: These promotional costs were charged to growers. promotional expenditure as a percentage of net sales has increased by 38% since 2004. 7 Draft Grant Samuel Report page 17 Growers pay to develop a brand owned by Zespri The other key point of difference is that “Zespri”, unlike the majority of other fresh produce exporters, is a retail rather than a wholesale brand. During the year ended 31 March 2006 growers contributed $62 million to the Zespri brand by way of promotional expenditure. Other exporters either do not charge any marketing costs to the grower or, in one instance, match grower expenditure on marketing and promotion dollar-for-dollar (i.e. split promotional costs 50/50).

Draft Grant Samuel Report page 7 When advised of the expenditure on promotion disclosed in the Zespri accounts a number of exporters expressed considerable surprise at the magnitude of the expenditure. Grant Samuel believes that the composition of this expenditure and the practice of charging 100% of the Zespri brand promotional expenditure against the grower pools, should be subject to considerable review.

8 Growers bear all risks Although Zespri is responsible for the management and on-sale of the New Zealand kiwifruit crop, ultimately the growers bear all risks. Zespri manages the kiwifruit pools on a consignment basis. This means that the growers carry all of the risks and bear all of the direct costs. Zespri is acting solely as an agent. It is to an extent incentivised, by virtue of percentage commissions, to maximise the return to growers. The majority of its income comes from its 7% commission on net sales (i.e. before the deduction of any costs) reducing the incentive to minimize costs such as promotional expenditure which in 2006 was equivalent to 12.75% of fruit payments made to growers. In Grant Samuel’s opinion the Zespri margin should be based solely on fruit payments to supplier growers.

Draft Grant Samuel Report page 7 9 It is evident from the above table that, even in years where the returns to the grower decline, Zespri’s returns continue to improve. Clearly, all of the risks involved in the export and distribution process are borne by growers.

Zespri’s share of returns had increased, while the growers’ share had declined The results for the last three years demonstrate the relative risk sharing between suppliers and Zespri:

The return to industry is calculated as total fruit and service payments plus Zespri’s pre-tax profit. Draft Grant Samuel Report pages 7-8 Zespri Share of Return to Industry 2004 5.6% 2005 6.3% 2006 6.9% Changes in Returns Year on Year Zespri Grower 2004 52.8% 11.7% 2005 21.0% 0.4% 2006 2.5% (7.6%) 10 Draft Grant Samuel Report pages 5-6 Exporters were disappointed with Zespri’s approach to collaborative marketing

Grant Samuel observed that, in the years ended 31 March 2004, 2005 and 2006:

the proportion of collaborative sales to total pool revenue has declined by 37% since 2004. Almost all of the exporters interviewed expressed significant disappointment with the manner in which Zespri has conducted the collaborative marketing process and believe opportunities have been lost for growers to increase their global presence as a result.

11 Draft Grant Samuel Report page 15 It was difficult to tell whether Zespri was earning its importer margin

What is not clear is whether any retail or wholesale commissions, rebates, discounts or promotional allowances are deducted from Zespri’s net selling “list price” [or] are netted off against the “Gross Sales” figure disclosed in Zespri’s annual report. A comprehensive examination of these discounts and commissions may be warranted to determine the quantum of value added by Zespri as an importer in overseas markets where it performs this function. It is doubtful that a 7% “importer” margin, in addition to the various rebates, commissions and discounts paid to third parties, is warranted in markets where Zespri does not physically perform the importer role. In addition, Grant Samuel found no market evidence that charging an importer margin is standard practice for overseas operations of New Zealand exporters, although some companies did charge a second commission.

12 Zespri should be more transparent

Grant Samuel considered that, as a monopoly, Zespri should be more transparent about its costs and commissions.

Kiwifruit growers must use Zespri to export their fruit to overseas markets. They do not have the option of using another exporter.

In Grant Samuel’s opinion the monopoly rights of Zespri bring with them increased obligations for disclosure and transparency particularly with regard to expenditure charged to grower pools and Zespri’s commission structure (including providing a calculation worksheet in relation to commissions derived.)

Draft Grant Samuel Report page 15 Zespri’s effective monopoly status brings with it increased responsibilities in terms of disclosure and transparency, particularly with regard to the expenses charged to the grower pools and the level of discounts, rebates and commissions charged by Zespri or paid to third parties, as growers have no option but to supply their fruit to Zespri for export.

Draft Grant Samuel Report pages 17 to 18 13 Growers should be concerned by Zespri’s lack of transparency

Lack of transparency should be a source of concern for growers. In the 2005/06 season promotional rebates, claims, discounts and promotion costs totalled $119.3 million as follows:

This equates to approximately $1.46 per tray or 13% of net sales. No disclosure is made as to what this expenditure comprised or in which locations the expenditure focussed. Nor is it clear what in-market premium was derived by virtue of the Zespri brand (ie: what per-tray return was derived from this expenditure). Although Zespri owns the “Zespri” brand both Zespri and the growers benefit, to an unknown extent, from an in-market price premium by virtue of the strong brand. The value of the brand and the cost of maintaining its strength, however, is largely funded by the grower pools.

Draft Grant Samuel Report page 15 ($000) Rebates, claims, discounts 57,471 Promotion 61,868 Total $119,339 14 Zespri’s deductions and margin were very high

…as a percentage of the FOB price (the price paid to the grower for packed product) the Zespri model costs growers a higher percentage of the FOB price. The critical difference is that the pool is charged for rebates, commissions, brokerage, discounts and promotional allowances which total 5.7% of gross sales in addition to Zespri’s 7% of net sales giving a total deduction equivalent to 12.3% of gross sales for the importer margin. This compares with margins of 6% to 8% in Europe and slightly higher margins in the US where the importer is responsible for freight and warehousing etc. The Zespri 7% margin on net sales when combined with payment to offshore agents, importers, wholesalers appears very high.

Draft Grant Samuel Report page 17 15 As a monopoly, Zespri should be transparent about its costs and margins.

NZKGI commissioned a report, on behalf of growers, which was very critical of Zespri’s practices.

Instead of disclosing this report to growers, Zespri and NZKGI have done their best to cover it up.

Growers should ask why they cannot see reports like the Grant Samuel report, even though they paid for it.

Growers should also demand that Zespri answer Grant Samuel’s criticisms and explain what steps have been taken to address them.

Why are Zespri and NZKGI keeping this report from growers?

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