This is the rationale behind Fonterra’s recent announcement that it intends to sell its Consumer Brands business. Collecting and processing milk is Fonterra’s strength and anything beyond that must be highly profitable if it is going to remain part of the business.
One thing that became apparent following this recent announcement is very few people understand what is meant by value add, and even fewer have looked at the financials behind it.
The cries echoing over talkback and in opinion pieces is that without Consumer Brands, Fonterra will have totally abandoned its drive to add value and will be a player purely in the low value commodity market and that it will lose its social licence to operate.
VANESSA LAURIE / STUFF
I have never been shy to call out a stupid idea when I see one. I was pessimistic when Fonterra announced the sale of Tip Top five years ago, and I had some reservations when the Milk in Schools programme was changed. So before heading to Twitter to snarkily tweet about the proposal, I first had a look at the figures behind the decision.
Fonterra’s Consumer Brands which puts cheese, milk and butter on our supermarket shelves utilises 7% of the milk solids Fonterra collects in New Zealand. This contributes $3.3 billion in revenue and returns a gross profit of $781m.
Fonterra’s Foodservice business sells culinary cream, whipping cream and special mozzarella to restaurants around the world. Foodservice utilises around 13% of our milk while earning $3.9 billion in revenue and delivering $749m in gross profit.
What these figures don’t show is that getting goods to the consumer is a far more expensive exercise than getting Foodservice ingredients to customers, and it is only after you subtract the operating expenses from the gross profit that the true financial performance of these two operations can be seen.
Consumer Brands’ earnings before interest and tax is half that of Foodservice on roughly the same revenue. While Foodservice delivers a 15% return on capital, Consumer Brands delivers a negative 4.6% return on capital. That is not a figure any shareholder should be happy with, and it is certainly not the type of return any farmer would tolerate in their own business.
Adding value can come in many forms. When you buy an ingredient from Fonterra, be it 1000 tonnes of whole milk powder or 100 tonnes of cheddar cheese, the products will come with an independently audited certificate detailing the emissions associated with your purchase. Currently no other milk processor does this. When considering Scope 3 emissions, that is a serious value add.
Fonterra will send teams of chefs and technicians to test kitchens around the world to teach customers how to best use its products, and to gain insights into what customers need. That is value add.
At the South Canterbury Clandeboye factory just south of me, Fonterra manufactures a product called Individually Quick Frozen Mozzarella, and with a name like that you’d expect it to be impressive. Giant machines scan every single shred of cheese to check it is identically sized. You may wonder who would care if their mozzarella strand was a few millimetres larger than the next piece, well the restaurants that buy the cheese care.
Uniform strand size means that one cup of the cheese is always one cup of cheese. Getting that right will impact on a restaurant’s bottom line and ensures that every pizza that a company like Pizza Hut makes will be exactly the same every time. That is value add.
Things have changed from since Fonterra was formed 23 years ago. As the business has grown and global consumer tastes and trends have evolved, so too must Fonterra evolve. Fonterra used to have salespeople travelling the world knocking on doors pleading with customers to buy our products. But now New Zealand’s milk pool is no longer growing, and we have evolved from trying to find a buyer for our products to being very selective about who we sell it to.
As Fonterra chairperson Peter McBride said at the recent suppliers conference held in Auckland, “There is absolutely a quest for value add, but it’s a quest for net value.”
While it would be easy to get outraged about the potential sale, at the end of the day it sounds like sanity to me.
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