Fonterra shaves 50c off forecast milk price
Fonterra has dropped its forecast milk price mid-point by 50c as a surge in global milk production is putting downward pressure on commodity prices.
This is the first of five articles aiming to demonstrate dairy industry strategies in NZ and provide a perspective for viewing Fonterra’s strategy.
The aim of this article is to briefly explain why strategy is important, identify the key strategic positions within the NZ dairy industry and outline three observable firms that lead in these positions.
So what is a strategy and why is it important?
A strategy is a framework for how we make business decisions. Every decision within an organisation should fit in or be guided by the strategy. A good strategy should determine an organisations purpose, what its long run goals are and scrupulously prioritise its capital of natural resources, intellectual capability and financial assets to achieve them. If a strategy is unfocused an organisation runs the risk of going in too many directions, suffering confusion and loss of its competitive advantage.
Later on we will look at the key elements a good strategy should contain.
Right now we will look at the three distinct strategic positions currently available in the NZ dairy industry.
Cost leader – (lowest cost producer)
Product leader
– customer intimacy (customer intimacy and specialised products)
Product leader
- differentiation (identifiable point of difference )
Open Country Dairy (OCD) – cost leader
OCD describes its vision, business and values as taking pride in creating quality world class dairy products.
We all know that OCD’s core strategic advantage is the low cost production of dairy commodities. OCD incurs little research and development, marketing cost and has low overheads. Producing less than 30 products keeps the operation simple and efficient. We can measure OCD’s success by observing its growing infrastructure (factories), 18% debt to debt plus equity and an 11% Return on Capital Employed (ROCE)*.
Tatua – product leader – customer intimacy
Tatua describes its vision and business as striving to be “the leading global supplier of specialised dairy products”. With a clear customer focus its values describe how it aims to achieve this.
As has been clearly observable, Tatua’s core strategic advantage as a product leader is its ability to provide specialty ingredients and value add products. Tatua’s success can be measured by its low debt to debt plus equity of 37%, leading payout to farmer suppliers and a ROCE* of 19%.
a2 Milk Company – product leader - differentiated
a2 Milk Company clearly commands a point of differentiation in the dairy market. At this stage success of a2 can be observed by its market capitalisation (now greater than Fonterra) and a stranglehold of the a2 consumer market. a2 Milk Company has achieved success by focussing on marketing the scientific differentiation of its product. With ownership of patents and clever strategic supplier agreements it has (at this stage) locked other milk producers out of this market. As a milk marketing company (a2 owns shares in Synlait) and is now potentially buying into Mataura Valley Milk)).
The triangle below illustrates the three firms occupying three different strategic positions. They have the competitive advantage for their respective strategic positions as defined by ROCE, balance sheet strength and growth of supply or capitalisation.
These three firms have been outlined to identify the three distinct areas within the NZ dairy market where a strategic business advantage can be found and how it has been achieved.
With a ROCE* of 6%, where would Fonterra sit within this framework?
In the next article we will look further into how processing companies seek to defend their strategic positions in their pursuit of operating at the efficient commercial frontier.
• Return on Capital figures are 5 year average sourced from TDB advisory 2019.
