Law change for Fonterra could jack up prices and suffocate competition

Have you seen the price of cheese lately? Squeezed households may be alarmed to learn that the Government is considering a proposal that could send prices further into the stratosphere – and cripple our economy at the same time.

Dairy prices in New Zealand are already skewed upward by Fonterra, a co-operative of dairy farmers that buys up 79% of all the milk our farmers produce. Internationally, Fonterra has been described as a “cartel” for the way it uses its dominance over the market to keep milk prices high.

Fonterra is not strictly a private body. Its near-monopoly status is enabled by Government legislation and a Ministerial appointee even sits on Fonterra’s panel that decides how much to pay farmers for their milk.

With 25% of all New Zealand exports being Fonterra products, the performance of the co-operative has a major impact on New Zealand’s overall prosperity.

Fonterra’s performance has been waning. In the last decade Fonterra’s share price has steadily tracked down, and its farmer members have been peeling off to join competitors like Open Country and Synlait.

Seeking to reverse this trend, in December Fonterra leadership put to shareholders a “capital restructure” proposal.

The proposal would stop member farmers from selling shares to anyone who is not already a Fonterra member or about to become one. In other words, farmers wanting to retire, switch away from dairy, or join a competitor will be denied fair open-market value for their shares.

The move effectively strong-arms disgruntled farmers into sticking with Fonterra and protects the cartel from the competitive discipline of public share markets.

You might be wondering if this is even legal. It turns out it’s not: Fonterra’s enabling legislation explicitly prohibits it from restricting share sales “for the purpose of restricting, preventing or deterring” farmers from shifting their milk supply away from Fonterra.

So how does Fonterra get around this? Simple: they’ve lobbied Damien O’Connor and he’s agreed to change the rules to legalise Fonterra’s lurch towards protectionism.

Officials from MPI have warned Cabinet that the move will weaken Fonterra’s performance incentives and limit the expansion of more innovative competitors, but Damien O’Connor is forging ahead.

Fortunately, there’s a public consultation process, to which the Taxpayers' Union has made a submission.

For all the benefits that Fonterra’s sheer size brings New Zealand, it’s crucial that the co-operative remains subject to competition. Competitors nipping at Fonterra’s heels and investors demanding dividends incentivise the co-operative to constantly improve its productivity and performance.

If Fonterra is protected from local competition, there is a serious risk that it will become complacent and vulnerable to international competitors that may overtake it in efficiency and innovation. Losing our status as the world’s go-to source of dairy would be an economic calamity.

What I've written here barely scratches the surface of this issue. If you're interested in the detail, I recommend the damning reports on the restructure produced by TDB Advisory and Castalia.