The role of co-operative enterprise in Australian agribusiness

22 January 2014

Australia’s agribusiness sector has been in the headlines recently. An example is the decision by federal Treasurer Joe Hockey in November last year to block the takeover of GrainCorp by US agribusiness giant Archer Daniels Midland. Despite the newly elected Abbott government’s claim that Australia was now “open for business”, this issue opened a major rift within coalition ranks.

Not only were the National’s implacably opposed to the sale of GrainCorp, but many rural Liberals also joined the call to keep the business in Australian ownership. While the farmers expressed delight at the decision, business leaders and the investment community were highly critical and remain so. Their criticism is based on their view that it sends the wrong signals to foreign investors.

Another international acquisition bid that has attracted attention is Canadian dairy foods company Saputo’s interest in taking control of Victorian dairy processor Warrnambool Cheese & Butter (WCB). This attracted media interest due to the arm wrestle that has been taking place between Saputo and local dairy co-operative Murray Goulburn.

These events have garnered attention here in The Conversation with Ian Lee’s piece on the motivation of Saputo to acquire WCB, and Brigit Busicchia’s article on the “bleak” outlook for Australian grain co-operatives, in particular that of WA based Co-operative Bulk Handling (CBH).

These articles are both very good in their analysis of what are quite complex issues. However, they highlight two things that I feel deserve some follow up comment. The first relates to the motivation of Saputo’s bid for WCB as outlined by Ian. The second relates to the wider outlook for farmer co-operatives in Australia as discussed by Brigit.

Saputo’s motivation for the WCB bid

In his article on the Saputo bid for WCB Ian Lee provides an interesting background on the forces that are motivating this Canadian firm to invest in Australia. The strategic imperative for Saputo, like most major dairy processors around the world, is that the dairy sector has grown into a global industry.

Demand for dairy products has grown significantly in the Middle East and Asia, particularly in China, where rising household incomes, changing dietary habits and the ownership of refrigerators has boosted the consumption of dairy products. According to Dairy Australia, global milk supply has been rising across Europe, North and South America and New Zealand. Even China has implemented plans to significantly expand its own dairy sector to help meet local demand.

Ian points to the high cost of milk supply within Canada as compared to Australia. This is supported by Dairy Australia’s statistics that show Canadian farm gate milk prices as significantly higher than those in other dairy producing countries. By comparison Australia’s farm gate dairy prices in the past decade have been broadly at or below those in other countries.

Since the deregulation of the Australian dairy industry in 2000, the dynamics of Australia’s dairy sector have been subject to global competitive forces. Farm gate milk prices are effectively determined by international pricing. Australia exports around 40% of the milk it produces and our farmers have generally received farm gate prices that are lower than world standards. This has led to a significant decline in the number of dairy farmers over the past ten years.

For example, in the early 1980s there were around 22,000 registered dairy farms across Australia. By the end of the 1990s this number had fallen to about 13,000. In 2011/12 there were fewer than 7,000 dairy farms left in business, although those that remained were generally much larger. According to Dairy Australia this decline in the number of farms is correlated with the farm gate price of milk.

Dairy farming is a tough business that requires significant capital investment and constant work to maintain the daily milking cycle. It is also subject to the impacts of drought, flooding and other natural environmental risks. Low farm gate milk prices squeeze the farmers’ profit margins at times when input costs (e.g. feed, power, and wages) are constantly rising.

It is therefore unsurprising that Saputo would be keen to secure a foothold in Australia where it can access milk supply at much lower prices than can be obtained in Canada. Another key attraction for it to purchase WCB is the latter’s export business. WCB exports about 40% of its cheese products, with Japan, Korea and South East Asia being key export markets.

WCB also exports milk powder and Whey Protein concentrate to the USA and Japan. These are used in health and sports drinks products and within food processing as a binding agent. The profit margins on this product are reportedly very high. The company also entered into an agreement in 2012 to supply premium milk powders to Japan.

The co-operative alternative

A keen rival to Saputo for the WCB takeover bid has been Murray Goulburn. I wrote about this battle last year in The Conversation where I highlighted the significant concentration of market power that exists in the Australian dairy industry. I also pointed to the benefits that co-operatives offer to farmers who – as small business operators – lack the bargaining power to negotiate farm gate prices with major processors.

It is worth noting that in all segments of the industry supply chain a handful of large processors control the majority of the market. Of these firms only Murray Goulburn is an Australian farmer owned co-operative. The other processors are either Australian investor-owned firms such as Bega Cheese Ltd or WCB, or foreign owned subsidiaries such as Lion (owned by Kirin, Japan); Parmalat (Italy/French), or Fonterra (New Zealand). The last of these is a farmer co-operative in its home country, but it operates as an investor-owned firm in Australia.

As the bidding for WCB has unfolded Murray Goulburn and Saputo have gradually increased their offer per share. At time of writing Saputo was offering $9.60 per share if it could secure 90% of the share capital. By comparison Murray Goulburn was seeking a minimum of 50% the share capital for $9.50 per share. Murray Goulburn was already a major shareholder in WCB at the start of this process with around 17.5% of the company’s share capital. The other key shareholder has been Bega Cheese who held another 19%. Bega was the third major bidder in the ring.

The recent decision by Bega Cheese to sell their stake in WCB to Saputo appears to have tipped the bid in the Canadian company’s favour. A report in the Sydney Morning Herald of 17 January 2014 suggested that Lion, which owns a 10% stake in WCB, might enter the ring.

This same article quoted Bega’s Executive Chairman Barry Irvin as saying that his board would have preferred to see WCB (Australia’s oldest listed milk processor) remain in local ownership. Yet one can imagine that the potential profit of around $68 million for the sale of their shares would have overcome any nationalistic sentiment.

Murray Goulburn is not completely out of the race, but it has met some resistance from both the WCB board and the Australian Competition and Consumer Commission (ACCC). In January 2010 the board of WCB rejected a proposal by Murray Goulburn to take over a controlling share of the company. This antipathy towards the co-operative’s bid to control WCB by the firm’s board and management has been a feature of this recent bid.

The ACCC has also expressed its concern over Murray Goulburn’s bid to acquire WCB. These concerns appear to be founded on the existing market share controlled by Murray Goulburn within the Australian dairy market. The co-operative has a major share of fresh milk, milk powder, butter and cheese. However, the major area of concern was in the supply of raw milk and involves a complex argument over whether the raw milk market is defined on a state-by-state basis, or a national interstate level.

In 2013, Murray Goulburn, working in concert with NSW-based dairy co-operative NORCO, secured a significant contract with Coles to supply fresh milk. These contracts had previously been held by Japan’s Lion, and they signalled a strategic move by Murray Goulburn to move across the Victorian border and sign-up farmers in NSW.

The announcement by Coles in relation to this deal with the two co-operatives was that it would offer a better deal for the thousands of small dairy producers in those states, provide more secure long-term contracts, plus higher and more stable farm gate prices for milk. It comes on the back of a lengthy period of retail milk price discounting by the major retailers Coles and Woolworths, and concerns that this was damaging the financial viability of farmers.

What goes for dairy also goes for grain

While these events have been unfolding in the dairy sector the Australian grains industry has been undergoing its own revolutions. As noted above, the aborted takeover bid for GrainCorp by ADM became highly political. This was an issue that I discussed here in The Conversation in an article that examined the history of market deregulation in the grains industry, and the need to consider the interests of farmers.

In her article on the future of grain co-operatives Brigit points to the decline in the number of farmer co-operatives and factors that contribute to this. Key factors suggested were the declining number of farmers, market deregulation, farmer indebtedness, and a fragmented legislative system with a multitude of outdated State Co-operatives Acts that impeded cross-border trading.

While these observations are all largely correct, they overlook the complexity of the co-operative business model. There is little question that the number of Australian farmers has fallen significantly over recent decades. Like many businesses farming has become increasingly mechanised and farms have had to grow larger and more capital intensive to remain competitive. For example, in Western Australia the membership of CBH was around 15,000 in the late 1960s, today is around 4,500.

However, the decline in the number of farmers is not necessarily a cause of decline in agricultural co-operatives. Neither is the fragmented legislative system that governs co-operatives. There is indeed a case to be made that the lack of a National Co-operatives Act was an obstacle to interstate expansion for some co-operatives. Yet it was not the most significant factor.

For example, Murray Goulburn has operated under the federal Corporation’s Act and its predecessor for the past 50 years. Its constitution enshrines the democracy and values of co-operative enterprise and provides protection from a minority taking control of the company’s share register. Other major Australian co-operatives (e.g. Capricorn Society in the automotive trades industry) have followed a similar path.

Over the past decade Australia’s state-based co-operative’s legislation have been significantly overhauled. There is now the introduction of a Co-operatives National Law, designed to facilitate the growth and expansion of co-operatives across state and territory borders.

Perhaps the most significant force that has impacted on farmer co-operatives has been the deregulation of agricultural markets. The movement to open up the Australian economy to greater international competition commenced in the 1980s and early 1990s under a federal Labor government. It was keenly pursued by the Liberal-National Party (LNP) coalition from the mid-1990s and has continued ever since.

Market deregulation is generally a positive objective and one that has helped to transform Australia from a closed and largely uncompetitive economy, to an open and efficient one that compares well against most other nations. This trend in market deregulation has been mirrored around the world and reflects the broader “globalisation” process that has proceeded since the end of the Cold War in 1989.

However, while enhanced competition is a good thing, it can have negative consequences, particularly for small business operators such as farmers. These producers sell their commodities into national and international supply chains. They have relatively limited – if any – power to negotiate farm gate prices with major buyers who control “choke points” in the supply chain.

Taking care of the little guy

It was this powerlessness in the market that triggered the emergence of farmer co-operatives across Australia in the last century. In the bulk grains handling and marketing sector the solution was handled differently by each state. Western Australia and South Australia formed farmer owned co-operatives, while in NSW and Victoria the state governments established Grain Elevator Boards.

The process of market deregulation that swept through Australia’s grains industry over the past twenty years led to the privatisation of these former state owned enterprises. Once they became publicly listed companies they embarked on a process of merger and acquisition resulting in the rise of GrainCorp with around 80% control over the grain storage and handling network in east coast Australia.

Joe Hockey’s denial of the ADM bid continues to upset many who accuse him of caving into “bush socialists” and arguing that the only way to run our agribusiness sector is to allow in more not less foreign ownership. Once again the argument is more complex than this. There is a need for more foreign direct investment into Australia’s farm and agribusiness sector. However, we also need to consider the future of our farmers and the rural communities that rely upon them.

A key concern for many grain growers in relation to the GrainCorp deal was whether ADM would retain grain receival points in their areas, and also what this takeover might do to farm gate pricing and the cost of handling and storage. Any business – whether it is a co-operative or investor owned firm – must operate efficiently. However, there are situations in which the excessive focus on profit maximisation and shareholder return can result in negative consequences for small producers.

To illustrate this we can look at the dairy industry in NSW. Despite the presence of NORCO the NSW dairy industry is dominated by large, international processors. These companies impose a two tier pricing system on farmers that offers them a fair price for “tier-one” milk that the processor wants, but a very low price for “tier-two” milk that they don’t want. The dairy farmer cannot easily control the amount of milk their cows produce and they can’t readily dump milk (at least not legally).

This two-tier system has impacted significantly on farm gate pricing for raw milk and squeezed the profit margins of producers. It has been attributed to the decline in the number of dairy farms in NSW and as more farms close, those that remain become “stranded”. Their isolation makes the collection of their milk less economical for the processor and the cycle continues.

By comparison the policy of Murray Goulburn is to take all the milk its members wish to supply, and to pay one fair price. As a farmer owned co-operative the company is concerned primarily with its farmer owners who are also its shareholders.

The same general pattern of behaviour can be seen in Western Australia where CBH operates. As a “non-distributing” co-operative, CBH does not issue dividends to its member shareholders. It also offers a storage and handling network that seeks to provide uniform access and handling charges to producers across the state.

Co-operatives have a different purpose to Investor-Owned Firms

In summary, the co-operative enterprise continues to offer benefits to Australia’s farmers just as they still do across most other countries which compete with us within global food supply chains. They have a different overall purpose to investor-owned firms and this “co-operative difference” revolves around the fact that they are owned by their members who also supply to and buy from them. They also operate with a highly democratic governance model in which it is not possible for a small number of shareholders to take control of the company.

Comparing co-operatives and investor-owned firms is difficult due to the different purposes that drive them. Like any business their performance and efficiency compares favourably with investor-owned firms when run well. However, they need to be assessed not just in their share price and profitability, but also in the wider benefits that they deliver to their members. This may not be best measured in price per share, but in their ability to offer fair prices, and greater stability of farm gate pricing and supply contracts.

Note: Tim Mazzarol is President of the Small Enterprise Association of Australia and New Zealand (SEAANZ).

SEAANZ is a not-for-profit organisation founded in 1987. It is dedicated to the advancement of research, education, policy and practice in small to medium enterprises.

Tim Mazzarol also receives funding from the Australian Research Council, Co-operatives WA, Co-operative Bulk Handling, Capricorn Society and Ravensdown Fertiliser Co-operative. However, the opinions expressed in this article are his own.

This article appeared in The Conversation, January 19, and is reproduced here under Creative Commons.