But maybe the co-op can’t really become a higher-value business if the payout to farmers is the main measure of Fonterra’s success.
That may seem a bit backward. But the payout is an inward-facing metric and the focus on the payout being high is having an adverse effect on the co-op.
Co-ops are a bit different.
If you started a 300-cow dairy farm and you wanted to supply Fonterra, you would have to buy a Fonterra share for every kilogram of milk solids you produced. The share price at the moment is $4.33 for every kilogram of milk solids.
Assuming you know how to farm, your cows will produce 120,000 kilograms of milk solids, which, multiplied by $4.33, is $519,600.
That’s how much money you would have to pay Fonterra for the right to become part of the co-op. Theoretically, this money is used by Fonterra to pay for the stainless steel and staff needed to process and sell your milk.
If you decided to leave Fonterra and start supplying another milk company, Fonterra would have to pay back your shares.
This is a problem for co-ops. If 5 per cent of shareholders leave, Fonterra would have to pay back $272.8 million and they would also have lower sales because they would have lost 5 per cent of their milk. Its a double whammy hit on the Fonterra balance sheet.
Co-ops can only get more capital from existing shareholders or the bank. They can’t easily issue more shares as a corporate company can. So “redemption risk” is a big deal for co-ops.
This means Fonterra has to keep it farmer shareholders happy. At the moment more than 80 per cent of farmers are loyal to Fonterra.
The most important thing to farmers is the payout and the payout is the best way to keep farmers happy. So in real terms, the payout has become the measurement of Fonterra’s success.
The payout is a short-term measurement that is determined by the global dairy trade event auction. Which if we’re honest, is out of everybody’s control. It’s not really an indication of Fonterra moving to a higher-margin business.
The metrics that would indicate Fonterra’s long-term success are things like: What percentage of sales are powder versus consumer products? What does it cost Fonterra to acquire a Chinese infant formula customer? What is the lifetime value of that customer? What is the market share of various products? What is the gross margin of these products? What are the sales enquiry numbers? How many retailers stock Fonterra products?
I’m sure Fonterra wouldn’t dream of sharing these figures. But if these sorts of metrics were going in the right direction and the global trade event was low, resulting in a lower payout. Farmers should still be happy because it would indicate the company is moving to higher value business.
Theoretically, the the value of Fonterra should go up over time. Which is ultimately good for farmers.
When typical investors invest in a company long-term, they often prefer profits to be reinvested so it can continue to grow the value of the company.
In Fonterra’s current environment, the pressure is on Fonterra from farmers to make the payout as high as possible. That’s adding pressure to the already strained financials.
Obviously, there is the Dairy Industry Restructuring Act and the milk price manual which restrict what Fonterra can do. Hopefully, they will be amended in the coming years.
Imagine if every cowshed had a screen with a dashboard showing a range of key consumer business metrics. Everyone from the most junior farm worker to Fonterra managers all focusing on the measures that will determine future profitability.
The focus would slowly begin to change away from the payout.
But what happens if the metrics don’t change? There will be nowhere to hide for the people responsible.
That’s why Fonterra will continue to be payout-focussed.
Glen Herud is the Founder of the Happy Cow Milk Company.