Sustainability, innovation should be Fonterra’s way forward

Fonterra has posted a $605 million net loss, but says it has a new “back to basics” strategy. Rod Oram questions if the co-op has thought deeply enough about the challenges it faces and the culture changes it needs to make.

In principle Fonterra’s new strategy of maximising the value of New Zealand milk could make its farmer-shareholders wealthier. But to do so the co-op and its farmers need to achieve two significant culture changes which they’ve barely begun.

Indeed the milk is well-renowned abroad for its quality. “It’s good, clean protein,” says Miles Hurrell, the co-op’s chief executive. Moreover, the fact “we’re a little old family business really resonates with consumers”.

But Fonterra has a big problem with the provenance of the milk. The farms that produce it are by far New Zealand’s largest single source of greenhouse gases and are major contributors to the pollution of our rivers and lakes. The milk will quickly lose its reputation and Fonterra the premium it hopes to earn from it if the co-op and its farmers fail to fix those fundamental flaws in their business.

When this is pointed out to our farmers, their response is highly defensive. They argue that their greenhouse gases per litre of milk are among the lowest in the world, and their performance on water and other environmental measures is better than most.

This, though, is a myopic view which completely misses the rapidly intensifying global debate about food and the planet. In aggregate farming and the land use changes to support it are the single greatest source of greenhouse gases, and major causes of ecosystem degradation and biodiversity loss. Production of milk and red meat are among the biggest culprits.

The science of this is abundantly clear, most forcefully in the UN’s recent report on climate change, land use and other studies. There is no doubt that fundamental change is needed to make food more nutritious and abundant and to make the way it is farmed deeply sustainable.

Fonterra, though, seems to have seriously under-estimated the speed and scale of these shifts as it devised its new strategy … Hurrell says plant-based milks “are not yet a trend”.

Yet our farmers argue they are the best at the current dairy technology, and hopefully will make some slow incremental improvements in it. Therefore, they will always have lots of happy and loyal customers. That’s as illogical as car makers believing they will keep selling lots of fossil fuel cars because they’re very nice and efficient. Car makers don’t believe that – they’re investing hundreds of billions of dollars in truly clean cars.

A few of Fonterra’s dairy competitors are equally ambitious about being at the forefront of consumer and technology trends. Danone, for example, paid more than US$10 billion in 2017 for White Wave, a US company producing non-bovine milk from plants, grains and nuts. Such products are by far the fastest growing dairy foods segment in the world, albeit from a very small base. Having appreciated how White Wave innovates so rapidly, Danone made big changes in its company-wide R&D strategy and ethos under the motto Danone Wave. For more on these global food and environment issues, see this column I wrote in February.

Fonterra, though, seems to have seriously under-estimated the speed and scale of these shifts as it devised its new strategy. It says for a decade or so plant proteins have contributed to a few of its products and they will play some small and yet to be defined role in some more of its products. It also touts the one small venture capital stake it has taken in a US biotech company in this field. But Hurrell says plant-based milks “are not yet a trend”.

So, the first big culture change Fonterra and its farmers need to make is to acknowledge this new competition and respond vigorously in two ways: drastically improve the environmental credentials of bovine milk to build stronger consumer loyalty and compete better with plant-based alternatives; and meet changing consumer trends by investing and innovating faster in these complementary proteins.

Fonterra is also failing to lead our dairy sector’s response to the climate crisis. In announcing its new strategy it said its goal was to reduce its greenhouse gas emissions by 30 percent by 2030. But a footnote clarifies that’s only on the 10 percent of its emissions that come from its energy use in transport and production. It has yet to change its position on the other 90 percent, which are from animal emissions on farm, which is for only very minor reductions.

Hurrell said Fonterra is working on these issues with DairyNZ, the research entity funded by farmers and government. However, that’s far from reassuring. The sector is extremely downbeat about its prospects for making even modest cuts, even though some farmers are making substantial reductions while increasing their profitability in the process, as I reported in this column in July.

Consequently, dairy along with meat producers are pushing hard against the Government’s proposals under the Zero Carbon bill.

Don’t downplay the role of innovation

Product innovation is the second big culture change Fonterra and its farmer-shareholders need.

The co-op says over the years its 400 or so scientists have come up with more than 300 potential products. But it has commercialised only a few because of the co-op’s lack of focus under its previous strategy of trying to provide all products, to all consumers, in all markets in its quest to be a global dairy giant.

Under its new strategy it will focus on “core dairy,” which is its main bulk products, plus targeting higher value areas of food service, paediatrics, “sport and active”, and “medical and ageing” plus consumer products in Asia Pacific, particularly China.

Yet, curiously the co-op seems to be downplaying the role of innovation in its five-year financial goals. Marc Rivers, its CFO, said in Thursday’s results and strategy briefing that they can be mainly achieved by lower debt and thus interest costs, further divestment of poorly performing assets and operational efficiencies. If that is the case, then the co-op must have been even more poorly run over the past decade than we all thought.

The key financial goals are to increase return on capital from 5.8 per cent in past financial year to 10 percent in five-year’s time; earnings per share from 17 cents to 40 cents; earnings before interest and tax from $819 million to $1.1b; and net profit after tax from $269m to $800m. Yet over that time, it forecasts its gross profit margin will only edge ahead from 15 percent to 15.6 percent.

Moreover, what it doesn’t add is that milk volume for the whole sector will, at best. only edge ahead because dairying has reached its ecological limits in many parts of the country. Worse, Fonterra’s share of that milk supply could fall if it fails to rebuild its rewards to, and loyalty from, its farmer-shareholders. They would be ripe for picking off by competing processors.

Quite simply, if Fonterra is to deliver the better future it is promising from its new strategy it has to become a global leader in dairy farming sustainability and dairy nutrition innovation. Then it would truly create the wealth inherent in New Zealand milk.