AGRICULTURAL MARKETING
REGULATION
Reality versus Doctrine
A REPORT PREPARED BY
for the New Zealand Business Roundtable
The principal author of this report was Denis Hussey, Director of ACILÕs Economics and Policy Division. A particular debt is owed to Roger Kerr, Executive Director of the New Zealand Business Roundtable, who provided valuable professional advice and support throughout the duration of the study. The assistance of ACIL colleagues David Campbell, Greg Cutbush and David Trebeck is also gratefully acknowledged.
ISBN 0 908722 26 5
Table of Contents
Page No.
Preface ix
Executive Summary ixii
Overview and Recommendations xiii
1. Producer Objectives Ñ The Most Important Issue xiii
1.1 Maximising returns Ñ emphasis on the wrong objective xiii
1.2 The relationship between an investment and its return xiv
1.3 The consequences of a bundled return xiv
1.4 Marketing success increases the distortions xv
1.5 The regulations put marketers on a hiding to nothing xvii
1.6 There are non-distortionary alternatives xix
2. The Quest For Improved Market Returns xix
2.1 The essential features of market failure xx
2.2 Making markets work better Ñ the logical response to market failure xx
2.3 Market solutions can usually remedy free riding xxi
2.4 Monopolies and exploitation Ñ unfounded producer fears xxii
2.5 Exploitable market power is very limited xxvi
2.6 Is a changing world leaving New Zealand behind? xxxii
3. Competition And A Focus On Profitability Ñ Keys To Beneficial Change xxxiii
3.1 The conclusions apply to all industries xxxiii
3.2 Some pain for a greater gain xxxiii
3.3 Removal of the anti-competitive regulations xxxiv
3.4 Approaches to implementing the changes xxxvi
3.5 Vested interests and the change process xxxvii
List of boxes (Overview and Recommendations)
Box 1: An Illustrative Example of the Consequences of Bundling Returns xvi
Box 2: The Reason Why Brian Jersey DidnÕt Pay Any Tax xviii
Box 3: Who Really Pays to Meet Mr WatanabeÕs Quality Control Requirements? xxii
Box 4: Except in Marketing, Producers Do Not Appear to Fear Competition xxiii
Box 5: Reducing Transport Costs in the Meat Industry Ñ A Case of Analysis Paralysis xxv
Box 6: The Apple and Pear Marketing BoardÕs Attitude to Entrepreneurial Endeavour xxviii
Box 7: Weak Selling or Strategic Marketing? Ñ It Depends on the Judge
xxxi
n n n
Chapter 1: Introduction 1
1.1 Reversing Economic Decline Ñ New ZealandÕs Challenge 1
1.2 Why Another Review? 1
1.2.1 Debate reflects opposing views 2
1.2.2 If it ainÕt broke donÕt fix it 2
1.3 What Does Sensitivity to Criticism Indicate? 3
1.4 The Cooperative Culture is an Enigma 4
1.5 Report Structure: General Principles and Reviews of the Major Industries 4
1.5.1 Acknowledgements 4
Chapter 2: Objectives Ñ What Are They and Who Decides? 5
2.1 Agreed Objectives Would be the Ideal 5
2.2 Objectives of Existing Arrangements? 5
2.3 The National Interest Should be the Priority Objective 7
2.4 Producer Objectives Often Conflict 8
2.4.1 The need to focus on profitability 8
2.5 Priority Objectives and Resolving Conflicts 10
Chapter 3: The MarketÕs Role in the Economy 11
3.1 How Well Markets Work is a Key Issue 11
3.1.1 Human behaviour is relatively predictable 12
3.1.2 Markets are where individuals pursue their opportunistic tendencies 12
3.1.3 Market failure is relatively rare 13
3.2 A Systematic Approach to Market Failure 14
3.2.1 A need to reconcile marketing and economic principles 14
3.2.2 The three steps of a systematic approach 15
3.3 How Do You Know Market Failure Has Occurred? 15
3.3.1 Spillovers not being priced 16
3.3.2 Natural monopolies 16
3.3.3 Unexploited market power 17
3.4 How to Respond to Market Failure 17
3.4.1 Is the market failure diagnosis valid? 18
3.4.2 Intervention which helps the market should be favoured 18
3.5 The Consequences of Intervention 18
3.5.1 Intervention encourages Òrent seekingÓ 19
3.5.2 Intervention increases risk and uncertainty 20
3.5.3 Performance measurement and accountability 20
3.6 Concluding What is Best 20
Chapter 4: The Importance of Prices and the Consequences of their Distortion 21
4.1 Most Incentives Are in the Form of a Price 21
4.1.1 The creation of distortionsÑ where did it all begin? 22
4.1.2 Distorted international prices are unfair Ñ but a reality 22
4.2 The Distortions Resulting from Price Pooling and Stabilisation 23
4.2.1 Pooling costs has obvious consequences 23
4.2.2 Pooling returns from differing markets and investments 23
4.2.3 Stabilising prices can also be distortionary 25
4.2.4 Price averaging does occur in competitive markets 26
4.3 Distortions Caused By Benefits and Costs Not Being Properly Priced 27
4.3.1 Look first for crowding out 27
4.3.2 Concern about under-investment in R&D 28
4.3.3 Quality control Ñ market failure unlikely 29
4.3.4 Generic promotion Ñ better benefit capture needed 32
4.4 The Creation of Price Distortions is the Major Issue 33
Chapter 5: What Influences the Structure and Behaviour of Organisations? 35
5.1 What Structures are Best and Why? 35
5.1.1 Structures evolve as markets change 35
5.2 Cooperatives as Business Structures 37
5.2.1 What constitutes a cooperative company? 37
5.2.2 The cooperative as a club Ñ dangers with the analogy 38
5.2.3 Strengths and weaknesses of the cooperative structure 38
5.2.4 There are structures which retain the benefits without the costs 41
5.3 Producer Fears of Competition are Unfounded 42
5.3.1 Monopolies only emerge in very particular circumstances 44
5.3.2 Guaranteeing an outlet for produce may not mean guaranteed profitability 45
5.3.3 Why would companies under-invest in product and market development? 46
5.3.4 Expected advantages from more competition. 46
5.4 Performance Assessment and Accountability 48
5.4.1 Differences between activity and performance 50
5.4.2 The democracy of political accountability 50
5.4.3 Auditing is a second-best alternative to market sanctions 50
5.5 Organisational Structures Ñ What Producers Wanted is Not What They Got 51
Chapter 6: Market Power Opportunities and Their Exploitation 53
6.1 Market Power is Used as a Key Justification for Regulation 53
6.2 When Will Market Segmentation Deliver Higher Returns? 53
6.2.1 The determinants of successful market segmentation 54
6.3 Evidence of Exploitable Market Power Opportunities 56
6.3.1 Quota markets provide opportunities 56
6.3.2 The evidence of market power in unrestricted markets is unconvincing 59
6.4 Weak Selling Ñ A Matter of Mind over Market? 60
6.5 A Changing and Increasingly Competitive International Environment 63
6.5.1 Natural endowments no longer guarantee international competitiveness 63
6.5.2 The location and characteristics of markets are changing rapidly 64
6.5.3 Capitalising on opportunities is the major challenge 65
Chapter 7: Apples and Pears 67
7.1 Introduction 67
7.2 Industry Features 68
7.2.1 New Zealand production is expanding 68
7.2.2 How payments to growers are determined 69
7.2.3 Grower returns currently very high 70
7.2.4 A long history of statutory marketing 71
7.2.5 The industry is highly dependent on exports 73
7.3 Major Issues 75
7.3.1 The BoardÕs domestic market monopoly 76
7.3.2 Relationships between market prices and grower returns 80
7.3.3 The Second Tier Levy and Transferable Crop Certificate saga 86
7.3.4 Board performance and future strategies 89
7.4 Conclusions 94
Chapter 8: Dairy 97
8.1 Introduction 97
8.2 Industry Features 98
8.2.1 Production and producer returns 98
8.2.2 Cooperatives process all milk 100
8.2.3 The role and responsibilities of the NZDB 102
8.2.4 Markets and marketing 106
8.3 Major Issues 111
8.3.1 Does the single seller extract market premiums? 111
8.3.2 The distortions created by a bundled return 115
8.3.3 Mergers and cost minimisation in the processing sector 119
8.4 Conclusions 122
Chapter 9: Kiwifruit 125
9.1 Introduction 125
9.2 Industry Characteristics 125
9.2.1 Production 125
9.2.2 Markets 126
9.2.3 Marketing arrangements 129
9.2.4. Grower returns 133
9.3 Major Issues 135
9.3.1 The main determinants of market returns cannot be influenced by the Board 137
9.3.2 Maximising returns takes the focus off profitability 141
9.3.3 Suppressing competition Ñ rational behaviour for a monopoly 143
9.4 Conclusions 148
Chapter 10: Meat 151
10.1 Introduction 151
10.2 Industry Features 151
10.2.1 Production and incomes 151
10.2.2 New Zealand Meat Producers Board 153
10.2.3 The meat processing industry 159
10.2.4 Markets 160
10.2.5 Marketing 163
10.3 Major Issues 165
10.3.1 Marketing meat for maximum returns 166
10.3.2 New Zealand meat processing Ñ distortions, restrictions and
lost opportunities 172
10.3.3 Transport and freight Ñ very slow improvements under the influence
of the Board 178
10.4 The Emerging Deer Industry 182
10.4.1 A transition from feral deer to farming 183
10.4.2 Exports are forecast to grow rapidly 183
10.4.3 The game industry Board and other regulations 183
10.4.4 Political compromise the main explanation of current arrangements 184
10.5 Conclusions 185
Chapter 11: Wool 189
11.1 Introduction 189
11.2 Industry Features 189
11.2.1 Production 189
11.2.2 Markets and market features 190
11.2.3 Marketing system 193
11.2.4 The New Zealand Wool Board 194
11.2.5 Transport 95
11.2.6 Promotion and the International Wool Secretariat 196
11.2.7 Research and Development 196
11.2.8 NZWB investments 196
11.3 Major Issues 197
11.3.1 Market and price intervention 197
11.3.2 Wool promotion Ñ a need for contestability 205
11.3.3 The marketing system has been slow to innovate 208
11.3.4 The Board is busy finding new things to do 211
11.4 Conclusions 214
Appendix 1: A Technical Explanation of how Pooling Distorts Production Decisions and a
Discussion of Alternative Corrective Actions 217
1. Introduction 217
2. The Economics of Pooling 217
3. Alternatives for Overcoming the Distortions 222
4. The Impact of Regional Monopsonies 226
Appendix 2: Influences on the Structure of Organisations 229
1. Introduction 229
2. Key Considerations 229
3. Incentives for Organisations 230
4. The ÔBestÕ Type of Organisational Structure 234
List of boxes
Box 1.1: Pointing the Bone at ÒThe Officials of IscariotÓ 3
Box 2.1: Objectives of Producer Boards 6
Box 3.1: Human Behaviour Is Similar The World Over 13
Box 3.2: Rent Seeking Ñ A Cancer in the Market Place 19
Box 4.1: An Illustrative Example of the Consequences of Pooling Returns 24
Box 4.2: A Levy for the Herbage Seed Growing Industry Ñ
Was Compulsion Necessary and How was This Decided? 30
Box 4.3: Who Really Pays to Meet Mr WatanabeÕs Quality Control Requirements? 32
Box 5.1: What Changes Would John and Mary Friesian Notice If Their Dairy Cooperative
Was Corporatised? 43
Box 5.2: The Chilean Kiwifruit Industry: Prospering Under a Competitive Marketing System 47
Box 5.3: Except in Marketing, Producers Do Not Appear to Fear Competition 48
Box 6.1: Restraints on Market Access Ñ the Form of the Restraint is the Major Determinant of
Who Benefits 57
Box 7.1: The ÒGranny Smith/Red Delicious DilemmaÓ Ñ The BoardÕs Problem in a Nutshell 84
Box 7.2: Use or Abuse of the BoardÕs Monopoly Exporter Powers? 90
Box 8.1: Reviews of NZDB Performance Ñ What was proposed and what is now proposed 107
Box 8.2: Dairy Farmers Are Essentially Price Takers in the World Market 113
Box 8.3: Research Into Export Performance Ñ The Board is Quick to Criticise but
Not to Contribute 114
Box 8.4: Estimates of the UK Butter Quota Premium 116
Box 9.1: Private Investors and Entrepreneurs Developed the Kiwifruit Industry 127
Box 9.2: Elected Producer Representatives Effectively Control Marketing Arrangements 131
Box 9.3: Adjusting Grower Payments for Unsound Fruit 136
Box 9.4: Varietal Premiums Ñ What are the Consequences if the Board Gets it Wrong? 144
Box 10.1: Electoral Accountability Ñ Reviewing the Detail but not the Fundamentals 155
Box 10.2: Export Licensing by the NZMPB 164
Box 10.3: Significant Efficiency Differences Between Individual Meat Companies 175
Box 10.4: Regulations Will Not Achieve Quality Control Objectives 177
Box 10.5: Progressive Meats Limited Ñ By Name and By Nature 179
Box 10.6: Reducing Land-Based Transport Costs Ñ A Good Example of Vested Interests at Work 181
Box 10.7: Competition Lowers Freight Rates Ñ When It Is Allowed To Occur 182
Box 11.1: The Use of Objective Measurement in the Wool Marketing System 194
Box 11.2: Intervention Can Add to Woolgrower Risk and Uncertainty 204
Box 11.3: Wool Dumping Ñ A Case of Intervention Slowing the Adoption of
Improved Technology 209
The 1990s are destined to be a decade of profound and potentially beneficial change in the New Zealand economy.
The process of structural reform is well advanced and is laying the foundations for a significant and sustained reversal of our inferior economic performance. Enhancing competition, reducing real tax burdens, removing price distortions and restoring the role of incentives and choice in business and private decision making Ð all have been key factors in getting New Zealand back on a path of economic growth and rising living standards.
Competition, clear price signals and choice are just as important to agricultural producers and their associated industries as they are to the economy as a whole. Within the rural sector, an array of past subsidies and support measures, which proved to be very distortionary and destructive, have been removed. The process has been painful for many, but necessary and beneficial.
However, the reforms of the past decade have impacted only slightly on the regulations that affect the export of agricultural products. As the Porter study on New ZealandÕs international competitiveness noted, the present controls apply to a large fraction of our total exports. There has been no detailed and conclusive examination of whether they still represent the best approach to these important economic activities.
The basic features of New ZealandÕs agricultural marketing arrangements date back in some cases to early this century. They reflect market circumstances and an international and domestic policy environment vastly different from todayÕs. Their contemporary appropriateness should be reassessed given the sea-change which has occurred in the operating environment of agriculture and the speed at which the international market place continues to change.
The primary purpose of the New Zealand Business Roundtable is to contribute to the development of policies which reflect overall national interests. The importance of agricultural marketing in the New Zealand economy is the major reason for our interest in whether existing structures and systems continue to be appropriate and how well they perform. Like transport regulation or controls on foreign trade, the impact of marketing regulation on the performance of the economy is of interest not just to participants in the sector but to the wider commercial community and the nation as a whole.
The Business Roundtable commissioned this independent and objective study by ACIL Australia Pty Ltd to ascertain whether there is anything special about agricultural products which continues to justify the present extent of intervention. Why is it that deregulation and privatisation, which have worked so well in other areas of the economy both here and overseas, are not considered appropriate for agricultural products?
The study is a review of marketing arrangements rather than being a report on producer boards. What is evaluated is the appropriateness of our current regulatory arrangements as they affect exporters of agricultural products in the context of the global environment in which New Zealand trades.
There is a strong focus on the extent to which New Zealand exporters have Ômarket powerÕ, a fundamental plank of current arrangements. Given the general consensus that New Zealand should endeavour to reduce its dependence on commodity lines, the report also discusses the impact of regulation on the incentives to take risks and invest in the development of branded and differentiated products and in new and emerging industries.
The conclusions are that New Zealand has very limited market power over the worldÕs commodity markets, that regulations inhibit innovation and the development of differentiated products, and that market distortions created by overseas governments are a reality that can only slowly be changed. These factors combine to justify a much lower level of regulation than is the case at present.
A key thrust of the report is the negative impact on farm profitability caused by what ACIL calls the ÔbundlingÕ of returns by cooperatives and marketing boards. At present they channel all their net income to suppliers through the price of the raw material, rather than separating out returns from investments. This concentrates attention on farm gate prices rather than profits which means present arrangements are sending the wrong signals to farmers. Some are no doubt producing some output at a loss to the industry.
The Business Roundtable is publishing the ACIL report in the belief that it represents a thought-provoking and, in many respects, disturbing analysis of the consequences of restrictions on choice in agricultural marketing.
We do not believe the report will prove to be the last word on the subject. If the broad thrust of its findings were to be accepted, a great deal of further work would be needed to develop a programme of reform. There are some who will place a different complexion on some of the facts and the analysis. It is important that those involved in the debate concentrate on the main issues raised because they are too important to be trivialised or reduced to slogans.
The Business Roundtable hopes the report will be a catalyst to some real
debate about agricultural marketing arrangements throughout the rural industries. We shall
be pleased to facilitate explanation and discussion of its findings with those interested
because of their national interest implications but see producers as the ones most
directly responsible for ensuring beneficial change is progressed. It is hoped that the
producer boards and others will not simply seek to defend present legislative arrangements
and that they will be prepared to examine the analysis in a careful and open manner. The
report provides a framework for looking at issues which we believe will interest all those
who share an interest in a healthy future for New Zealand agriculture.
Douglas Myers
Chairman
New Zealand Business Roundtable
18 September 1992
Preface
This is a report about agricultural marketing arrangements in New Zealand. It was commissioned against the background of continuing and extensive regulation of agricultural marketing in an economy which elsewhere has seen a consistent and substantial winding back of regulation, with beneficial results.
Agriculture comprises a large and important part of the New Zealand economy. Why has it been immune from the types of policy prescriptions implemented in other sectors of the economy? Is there something different or special about agricultural marketing systems which justifies the extensive regulation of commercial activities beyond the farm? Or is it the case that agriculture would benefit, as have other economic activities, from less regulation and more competition through the marketing chain? These are the types of questions which this report addresses.
The answer, in essence, is that there is little that is different or special about agriculture. New Zealand producers are forgoing substantial profits each year as a direct result of the marketing structures they have established. Most regulations and the marketing structures associated with them were established to benefit agriculture and producers. In fact, they harm the intended beneficiaries and, along with them, the nation.
There are five principal reasons why this is so:
¥ first, the objectives are frequently wrong: to concentrate on maximising farm gate prices rather than profitability. The farm gate price usually comprises a bundle of items Ñ different returns achieved in different markets, and returns from off-farm investments in processing and marketing. When they are combined in the output price received by the producer, they inevitably create incentives which lead producers away from profit maximising farm output;
¥ second, producers have frequently advocated regulations to correct what they believed to be examples of the market failing to work properly Ñ Ôfree riderÕ problems, concerns about monopolies and failure to exploit market power. In practice, the initial diagnosis has usually been wrong and it has been the intervention which has caused, not corrected, the market failure. Concluding that market returns which are sometimes unattractive constitute proof of market failure is a common mistake in New Zealand agriculture;
¥ third, producers have viewed the markets providing processing and marketing services as different from the competitive markets providing other farm inputs. This is a serious misconception Ñ maximising farm profitability requires that all goods and services be supplied as competitively and efficiently as possible, processing and marketing services included. Paradoxically, competitive markets for most farm inputs have many features which producers fear when they appear in processing and marketing;
¥ fourth, the regulations and marketing structures provide the wrong incentives to the marketers, and prevent return on investment being measured. The marketersÕ objective is to maximise farm gate prices and this is the basis on which performance is judged. However, this is not necessarily synonymous with profit maximisation. The structures lack conventional performance indicators and are not exposed to the usual market sanctions so that producers cannot assess investment performance or exercise effective control through investor choice; and
¥ fifth, the most distortionary consequences of the regulations are hidden. Neither producers nor marketers realise that the bundled farm gate price results in farm profitability not being maximised and resource use being distorted.
The case for fundamental change to current arrangements is overwhelming. Virtually none of the regulations have any economic justification. The regulations deliver few benefits but their distortionary costs are high. Producers are not maximising profitability and national income is being reduced.
Changes must be made in the national interest, as well as in the future interests of producers.
Two significant changes are recommended:
¥ to remove all the regulations (with some minor exceptions) which are preventing competition and choice in agricultural processing and marketing; and
¥ to corporatise all the statutory marketing businesses, issue the shares to producers, and allow the shares to be traded freely.
Regulations will still be needed where genuine market failure is occurring or where importing countries require exporter government involvement. The issues requiring attention are some areas of R&D, entitlement to the United Kingdom butter quota, and government-backed certification requirements.
Many producers may view the recommended changes as dramatic relative to how marketing has been conducted. However, without the changes the future of existing agricultural industries looks bleak and opportunities for new industries will remain constrained. Also, the explicit dismantling of existing marketing structures is not proposed. In this regard, the recommendations differ from those in the report of the Porter Project. These businesses simply need to be exposed to competition and given a profitability focus.
In implementing the changes there are naturally intermediate options and transitional issues that need to be considered. There are trade-offs between the costs and benefits of a gradual approach and one that is more rapid.
This is not the first occasion on which decisive and deliberate spring cleaning of regulatory legislation has been necessary and undertaken in New Zealand. Past experience generally favours fairly rapid change, both to enable industry participants to identify the characteristics of the new environment more clearly, and to increase certainty that the process will not be interrupted by successive rounds of lobbying and political indecision.
Producers will be the major direct beneficiaries of regulatory reform in agricultural marketing. Amongst producers, those aspiring to a long and successful future in agriculture should have a strong interest in ensuring the changes occur Ñ younger producers, aspiring entrants and anyone with a desire to be different, innovate or seek new opportunities. The government will look to producers for a lead in initiating reform. Producers, therefore, have their future success very much in their own hands.
The government also has a responsibility as the custodian of the national interest. In discharging this responsibility it must look not only to the interests of existing producers but also to the interests of future producers and possible new entrants. In other industries where reform has been necessary vested interests have, rightly, not been allowed to dictate the shape of regulation affecting them. Legislation underpins all that is currently wrong with agricultural marketing; legislative changes will be needed to put things right.
Executive Summary
This Overview draws together the conclusions from a study of agricultural marketing regulation in New Zealand and recommends significant changes. Regulations and controls constraining competition are costing New Zealand and its rural producers dearly.
There are fundamental flaws in existing arrangements which make change imperative. Arguments that existing marketing arrangements extract more from the market than would a competitive system are for the most part wrong. The costs are very high and the benefits largely imagined.
The necessary changes do not involve dismantling of existing organisations. It is unnecessary to break up marketing organisations like the single seller boards, the commercial subsidiaries of boards, or producer cooperatives. These businesses simply need to be exposed to competition and given a profitability focus.
How to market successfully is not central either to diagnosing what is wrong or to fixing it. This report is not a marketerÕs manual. The important results from the study relate to how producers have concentrated on the wrong objective, with distorted incentives and lower profits the consequence. New Zealand is also a loser.
New ZealandÕs primary objective is to maximise standards of living. This will be achieved by getting the best possible returns from the countryÕs resources.
There are two requirements for achieving this objective. Everyone in the economy must have:
¥ the clearest possible information on the economic and commercial consequences of their decisions; and
¥ the ability to choose freely between alternatives when investing or consuming.
Competition and minimum regulation best ensure that these requirements are met. A reform strategy based on competition and less regulation throughout the economy is now well advanced and the gains are starting to emerge.
Agriculture is an important part of the New Zealand economy and producers are among the most technically efficient in the world. Distorting subsidies and price support arrangements have been removed.
However, beyond the farm an array of regulations and controls stymie efficient decision making and disadvantage producers. Their main rationale is the belief that they are necessary to maximise farm gate prices.
Regulated structures are significantly distorting prices and severely restricting choice, competition, innovation and profitable growth. Why, therefore, do the regulations persist? The answer lies in mistakes and myths surrounding the quest for maximum market returns and the fact that the serious consequences of distortions to farm gate prices are hidden.
The debate over marketing regulation is not focused on the important issues. There are also political constraints at work. Many regulations and arrangements have been in place for a long time so that attitudes, misconceptions and vested interests are well entrenched.
1. Producer Objectives Ñ The Most Important Issue
The main producer objective is to maximise prices received for output. However, the primary objective of any commercial activity Ñ farming included Ñ should be to maximise profitability. When businesses strive to maximise profitability in a competitive market national benefits are also maximised.
The costs to producers and New Zealand of the focus on maximising returns instead of profitability is the most significant issue arising from ACILÕs study. The reasons why and the implications are summarised in this section.
1.1 Maximising returns Ñ emphasis on the wrong objective
Periods when prices were low or falling coincided with the introduction or modification of marketing regulations and controls. Producers, distant from markets and specialising in what they do best Ñ production Ñ sought explanations and solutions for what they considered unsatisfactory output prices.
They concluded there were two major reasons, both reflecting a belief that competitive businesses do not have producersÕ interests at heart. First, processors and marketers were believed to be under-exploiting opportunities and lowering returns by unnecessarily competing with each other. Second, and somewhat contradictory, was the belief that these businesses were making profits at producersÕ expense.
The solution producers chose was as logical to them as it was satisfying to implement. If they had ownership and control beyond the farm gate, and if they behaved in a coordinated and disciplined fashion, they would, seemingly by definition, ensure their output was marketed in their best interests.
There are significant differences between industries in how regulations have been used to achieve the primary objective of maximising returns from the market. They range from the total control of export and domestic marketing in the apple industry at one end of the spectrum, to the wool industry, where the selling system is open and competitive but the producer board is compulsorily funded and is involved in commercial and regulatory activities, at the other.
Despite the differences, all industries have regulations which enable producer funds to be invested in marketing. In most industries producers also have investments in processing. The objective of these off-farm investments has been to raise producer output prices. They do not have maximising profitability as their objective. The difference between the two is significant.
The entire approach to marketing, particularly the design of regulations and statutory organisations, and the predominance of cooperatives in some industries, has been driven by this market returns objective. However, the priority objective of producers, whether investing on or off the farm, should be to maximise profitability. Trying to maximise only one component of profitability Ñ output prices Ñ is neither an indicator nor a guarantee that profitability is being maximised.
However, the problem is more serious than that. To varying degrees across New ZealandÕs agricultural industries, the regulations and marketing arrangements deliver farm gate prices which steer the producer away from profit maximising production decisions. This happens because the farm gate price does not tell the producer what the market is paying for another carton of fruit, litre of milk or lamb.
Producers receive a farm gate price which is a commercial cocktail. It contains returns from a range of differently priced markets plus profits from off-farm investments in marketing and processing. In the case of dairy, for example, it includes profits from commercial activities completely unrelated to the New Zealand dairy industry.
1.2 The relationship between an investment and its return
Profitability determines investment decisions. If a producer invested in shares, say in the retailing sector, it is implausible that the profits would lead the producer to increase farm output. The farm and off-farm investments would be seen as separate. The amount invested in each would be determined by the profitability of each.
The producer decision Ñ commonly enforced by regulations Ñ to invest off-farm in processing and marketing is analogous. Profits from the off-farm investment are not a reason for more investment in farming. Farming, processing and marketing are separate investments. The level of producer investment in each should be determined by their respective profitability. Furthermore, many producers may want to invest only in farming.
If processing or marketing cheese is profitable, this is not necessarily a reason for producing more milk. Obtaining a windfall profit in the United Kingdom butter market because New Zealand has a quota entitlement is definitely not a reason to increase milk production.
Lamb production should not necessarily increase because Meat Board investment in lamb marketing in Japan is profitable. If the Wool BoardÕs new wool marketing company is profitable the owners (producers) will expect a return but should not see this as a reason to increase wool production, and would not if the profit was received as a dividend on shareholding.
Producers hold off-farm investments in marketing and processing that do not return separate profits or dividends because their wrongly-formulated objective led logically to this type of business structure. Because their objective was to maximise farm gate prices, and the competitive system with conventional business structures was believed not to be doing this, producer boards and cooperatives were seen as the appropriate approach. In effect they vertically integrate the farm with processing and marketing and deliver the return on this investment package solely via the farm gate price for output.
The farm gate price is a ÔbundleÕ of returns from separate investments Ñ it is a pooled return. However, the producer, not surprisingly, treats it as a return to the farm investment only and acts accordingly.
1.3 The consequences of a bundled return
The consequence of a bundled return is that production moves away from the level which maximises profitability on the farm assets. This happens because no one in the production, processing and marketing system is sent appropriate signals to prevent it. No participant realises it is happening.
Producers expand production to the point where the return for the last (marginal) unit of production equals the (marginal) cost of that production. They do this because they know it maximises their own farm profitability.
However, if the market price for additional production is less than the bundled return Ñ which is the price the producer receives Ñ then this production will be loss-making because it will be sold for less than it cost to produce. Although industry and producer gross revenue will be higher than otherwise with a bundled return, farm profitability will not have been maximised, and that is what is important to producers and the economy.
Given this incontrovertible logic, why do producers expand production when it is sold at a loss, and why do marketing organisations not discourage them more effectively from doing so?
Apart from not receiving the right output price information, the producerÕs problem is that even if the consequences were appreciated, an individual producer would be worse off taking unilateral action. Each producer, receiving a bundled return, faces a situation where expanding production until this return equals marginal production costs will maximise that producerÕs profitability. However, when all producers take the same rational action, the collective consequence is to push industry production further away from the point of maximum farm profitability for every producer.
The marketers, responsible for maximising producer prices, observe production expanding and conclude that marketing performance is satisfactory because market returns are apparently profitable to producers.
A simplified example is presented in Box 1 which is reproduced from chapter 4. It explains a situation where different returns from two markets are bundled Ñ or pooled. The logic and consequences can be extended to more complex situations where the bundled return includes more than two markets, each with different returns, returns from off-farm investments in processing and marketing, and premiums from markets which have entry restrictions or quotas.
Why have producers not shown greater concern about regulations and marketing arrangements that reduce their profitability? ACIL believes the explanation lies in producersÕ lack of appreciation of the consequences and their significance. The following statements reinforce this view:
ÒWoolgrowers need a much better net return for their wool. How that is achieved doesnÕt really concern them as much as whether it is achieved;Ó
and:
ÒIn the light of current low prices and the harsh economic climate, dairy farmers are more concerned at the amount the Dairy Board is paying at the end of the dairy season than where it comes from, necessarily.Ó
1.4 Marketing success increases the distortions
The key reason for existing marketing arrangements is their claimed ability to secure higher market returns. The focus on this objective means producers overlook the distortions and costs.
Maybe the costs are worth the presumed benefits of higher market returns? This raises two important points:
¥ the distortions and their unfavourable consequences for producer profitability are unarguable, but whether the arrangements deliver better farm gate prices can be convincingly questioned; and
¥ the more successful the marketers argue they are in delivering the benefits, the greater the consequential distortions under existing arrangements.
These points encapsulate the ultimate irony of current marketing arrangements. Regulations aimed at improving producer well-being effectively deliver the reverse. To add insult to injury, they make the country worse off as well.
Even if boards and cooperatives do not achieve market returns higher than a competitive marketing system, the bundled farm gate price is still distortionary. If boards and cooperatives earn normal profits like competitive, non-statutory marketers, then this profit is included in the farm gate return. The producer receives the wrong price signal and is led into loss making production.
The circumstances under which there would be no distortion to farm profitability would be if the boards and cooperatives earned no profits (no return on the producersÕ off-farm investment) and all markets delivered the same price. The former would presumably be unacceptable to producers, and the latter is unrealistic.
The distortions are far from trivial. In the dairy industry current marketing and pricing arrangements are resulting in very low producer incomes from milking cows and extensive distortions to asset values.
ACIL has estimated that over the three years ending 1990/91 each dairy farmer effectively made an annual average profit of only $8800 as the return to the resources and effort devoted to milking an average herd of 155 cows. In 1990/91, a year of low international dairy prices, the average farmer made a loss of $5000 on dairy farming effort and assets.
The detail behind these estimates is presented in chapter 8. Very low profits occurred because a significant proportion of the dairy farmerÕs farm gate return was derived from revenue other than market receipts for New Zealand dairy products. However, dairy farmers reacted as though it was a return to the labour and capital they devoted to producing milk.
Dairy farmers have around $2.3 billion invested off-farm in their cooperatives and the board. Assuming this investment returned 10 per cent, it would contribute $230 million of profit to dairy farmers. To this can be added the estimated $125 million quota premium from UK butter access which, while attributable to the sale of New Zealand dairy products, is also not a market return related to marginal production. Over recent years dairy farmers should have received around $355 million per year in profits from off-farm investment and the quota premium over and above any profits from milking cows.
However, because these off-farm profits were bundled in their farm gate price, dairy farmers made production decisions based on a milk return much higher than their additional milk production could be sold for. The consequence was highlighted in 1990/91 by the very low priced sale of butter to the USSR. The butter had been produced and therefore it had to be sold. It was sold at a price less than it cost to produce.
It is likely that many dairy farmers have a feeling that all is not well, even if they do not appreciate in detail what is occurring. The interchange Ñ fictitious but realistic Ñ in Box 2 illustrates how ACIL believes many dairy farmers would try to work through the logic.
There is evidence that dairy industry leaders are aware of the distortions created by the current arrangements. However, suggestions that the distortions are not significant are wrong and could mislead dairy farmers.
For example, the Chief Executive of the Dairy Board, in suggesting the distortions were modest, said:
ÒAt present, the largest proportion by far of both dairy company and Dairy Board payouts arises from the basic processing and marketing of milk products. In the BoardÕs case, profits earned from other activities, after allowing for tax and interest on the cost of the investment, was less than 5 cents per kg milkfat in 1990-91. The majority of dairy companies would probably be in a similar situation.Ó
The Chief Executive was referring to profits from non-dairy activities only. In 1990/91 some 9% or $400 million of the BoardÕs sales revenue came from this source.
However, a further 20% of sales or $900 million was revenue from trading dairy products that were not produced in New Zealand. The profit from this trading must also be included in any measure of the distortion created by the bundled return. Furthermore, the premium from the UK butter quota must also be included. Clearly, 5 cents per kg is a gross underestimate of the distortion.
Another approach ACIL has heard used to assess the size of the distortion is to estimate the profit on dairy farmersÕ off-farm investment as a proportion of total sales revenue. In the late 1980s NestlŽ was reported to have achieved a net profit of 5.2% of sales. If, to ensure a conservative estimate, it is presumed the New Zealand Dairy Board achieves a profit of 4% on sales, then this would represent a profit of around $170 million on 1990/91 sales of $4.3 billion.
If the UK butter quota premium, estimated at $120 million in 1990/91, is added to the $170 million sales-based profit estimate, then dairy farmersÕ off-farm profit in 1990/91 was at least $290 million. This is equivalent to $22,300 per farm or 85 cents per kg of milkfat. MAF estimates that in 1990/91 the average dairy farmer had a net farm profit of $21,800 from milk production.
To conclude that the distortion is trivial is to believe that if dairy farmers knew they made a small income loss from milking cows in 1990/91, they would not have adjusted the number of cows milked or the extent of feed supplementation to avoid loss-making output and improve their incomes as a result.
There are only two ways in which marketers can ensure producers avoid loss making production and maximise farm profitability. One is to own the farms Ñ as would occur in a normal vertically integrated business Ñ and turn producers into employees. The marketers would know how much to produce, because they would have the necessary cost information, and could instruct the employees accordingly. Producers, given their independent and entrepreneurial nature, are unlikely to find this option attractive.
The other is to deliver farm gate prices which elicit only that amount of production which marketers can sell profitably. Producers would also maximise profitability on the farm assets because this farm gate price would be non-distortionary. This is how a competitive, non-statutory marketing system works. Interestingly, if this approach were adopted and producers owned the marketing business, they could at least pursue an objective of maximising market returns without the distortionary consequences.
1.5 The regulations put marketers on a hiding to nothing
The focus on maximising farm gate prices also influences the behaviour of the marketers in the boards and cooperatives. Producers require them to maximise farm gate returns and their performance is judged on how well they achieve this.
In these circumstances they are on a hiding to nothing because the more successful they are in achieving the objective, the more difficult the task. Producers reward their success by producing more output. The extra output has to be sold, usually requiring lower prices to achieve sales. This pushes the average market (bundled) return down and exposes them to criticism for not achieving their objective.
These unenviable circumstances explain much of the marketer behaviour and rhetoric in the marketing debate in New Zealand.
For example, these circumstances explain why statutory marketers place so much emphasis on maximising quality and so frequently exhort producers to raise quality or use the regulations to make it happen. All markets exhibit clear quality/price relationships. There are profitable markets for lower quality produce if it is labelled and priced appropriately.
However, lower quality produce selling at a lower price does not help the marketer raise average market returns. There is a disincentive in current regulations for marketers to encourage or allow lower quality output to be marketed, even if it can be sold profitably. Taken to its extreme, statutory marketers could achieve their objective by only selling one container of product of spectacularly high quality. This does not happen because its absurdity would be apparent.
The marketing debate is heavily concentrated on how well marketing functions are performed. Performance assessment and reporting revolves around indicators of marketing activity and practice, and measures of output prices. This reflects the primary objective marketers have been given. It is contradictory, and somewhat unfair, to ask marketers to maximise farm gate returns and then criticise them for actions which demonstrably constrain profitability or do not allow it to be measured satisfactorily.
Sensitivity to criticism and emphasis on arguments supporting regulation must be seen in this light. The marketers are advocating what they believe is necessary to achieve their objective. In most respects this behaviour is rational given the incentives they face.
Their dilemma is acute: if they try to maximise the profitability of the (producer owned) processing and marketing assets under their control they will not achieve, and will be seen not to achieve, their primary objective of maximising farm gate returns. This objective is rarely synonymous with maximising profitability. In a nutshell, they are the victims of a system which has evolved as a consequence of producers not focusing on the most important objective.
1.6 There are non-distortionary alternatives
Two significant points emerge from the discussion so far:
¥ many producers believe a competitive marketing system will not extract fully the market returns available for their output; and
¥ they have therefore established Ôvertically integratedÕ regulatory systems to improve farm gate returns, although these arrangements turn out not to be in the best interests of either producers or New Zealand.
An alternative approach, which would not be distortionary, would be to ÔunbundleÕ the bundled return. It would involve returning profits from off-farm investments separately from the market returns for farm output.
Under such an approach marketing organisations and cooperatives would maximise profits as their primary objective. If they only paid producers the price necessary to call forth the output that did this, the distortions which lead producers into loss-making production would be removed. Additionally, producers would be able to trade their off-farm investment and receive an explicit dividend.
This approach is different from current arrangements insofar as it requires the off-farm organisations to work in the interests of producers in their capacity as investors in the organisations, rather than in their capacity as suppliers of raw materials.
However, this approach assumes the continuance of regulations constraining competition and choice. Such regulations are not costless. There is valid suspicion about the efficiency of organisations not exposed to competition and conventional market tests. There is reasonable concern that not all opportunities and ideas are being exploited and that innovation and investment are suppressed.
Existing marketing arrangements also assume there are market returns which competitive marketers would fail to capture. While producers would probably accept that they would be better off if returns were identified with the investments that generated them, many would still hold the view that market returns would not be maximised if competitive exporting were allowed.
It is therefore necessary to consider these issues in more detail.
2. The Quest For Improved Market Returns
All businesses try to maximise market returns and farmers should be no exception. However, there are important differences between market returns which are sometimes unattractive and returns which reflect a failure of the market to work properly Ñ market failure. Understanding these differences is very important in deciding whether marketing regulations will benefit producers and New Zealand.
Deciding that unacceptable output prices mean markets are failing to work properly is a common mistake in New Zealand agriculture. Market failure is relatively rare. However, it is often used as a justification for regulations.
Understanding and recognising true market failure is important for two reasons:
¥ it is the only legitimate basis for concluding regulations may be needed to benefit producers and New Zealand; and
¥ it can be used to explain why producer fears of competitive marketing systems are unfounded.
The two reasons are interrelated. Using regulations to correct market failure which does not exist usually causes the market to fail. It results in intervention failure.
Most of New ZealandÕs marketing regulations result in intervention failure after having been introduced in the mistaken belief that there was market failure of some kind. Market failure and the consequences of its wrong diagnosis are discussed throughout the main report. Only key issues and illustrative examples are presented here.
2.1 The essential features of market failure
There are three situations where market failure may arise. They are:
¥ free rider problems (ÔspilloversÕ not being priced);
¥ natural monopolies; and
¥ unexploited market power.
Free rider problems (the main type of unpriced spillover) arise whenever someone receives a benefit without paying for it, or a cost is incurred without the perpetrator having to meet that cost.
The following are commonly discussed examples of free rider problems:
¥ an exporter delivers quality lower than that contracted and spoils New ZealandÕs reputation for reliability Ñ the actions of one Ôrotten appleÕ cause costs to everyone in the ÔbarrelÕ;
¥ a marketer does not invest in market development because others will also benefit without contributing to the cost;
¥ a marketing system does not discount pelt damage so producers take no action to reduce it Ñ the benefits of good farm management are not reflected in a higher price; and
¥ transport costs are pooled so processors construct plants in remote, high cost locations because they pay only a small proportion of these higher costs.
Monopolies are a form of market failure which underpins both producer fears of a competitive system and producer support for restrictions on entry. Two different sets of circumstances explain this apparently contradictory attitude towards monopolies.
On the one hand, producers fear that without regulation, monopolies will emerge and they will be disadvantaged when dealing with them. Being exploited by multinationals like NestlŽ or Chiquita, or having only one processor for milk or livestock, are examples of this producer fear.
On the other hand, it is sometimes suggested that regulations which restrict entry are needed to ensure businesses are big enough to benefit from economies of size. These regulations are believed to be needed to control ÔdestructiveÕ competition. If monopolies result, producers allay their normal fears by owning and believing they control them. This logic explains support for large producer cooperatives in the dairy and meat industries and is one of the justifications for single sellers.
The third market failure situation relates to circumstances where New Zealand is believed to have market power which would not be exploited if there were competitive exporting. This fear has been a major reason for regulations. ÔWeak sellingÕ and competitive exporting are often given as reasons for unsatisfactory market returns. So are assertions that collective action is necessary because markets are distorted and unfair.
Before considering these market failure arguments it is useful to have a framework for determining how best to respond.
2.2 Making markets work better Ñ the logical response to market failure
If markets fail to work properly, the logical response is to do something about the cause of the failure. This means making benefits and costs fall where they lie and ensuring there are no barriers to competition. If a New Zealand industry does have market power, the benefits should be secured with minimum distortionary side-effects.
A regulatory response commonly makes matters worse. Governments, and vested interests that lobby them, too often opt for regulations which control and direct rather than improve market functioning. They try to supplement the market instead of helping the market do the job better. Commonly the outcome is worse than the original problem.
Most markets are not perfect. However, there is no gain in jumping from the frying pan of imperfect markets to the fire of greater regulatory distortions. Many marketing regulations in New Zealand are making problems worse instead of reducing them. The regulators rarely opt for action which would make the market work better. Frequently, regulations prevent alternatives which would deliver a better result.
Extensive regulation also flies in the face of the accepted role of competitive markets elsewhere in the economy. Competitive markets drive the New Zealand economy. They have a good record as efficient adjudicators in the competitive contest. They help resolve an amazing web of competitive objectives and needs. They ensure diversity and maximise opportunities for innovation and ideas-testing.
The track record of competitive markets reinforces their choice as the best means of achieving growth and prosperity. The alternative Ñ centrally planned, control and command systems Ñ has now collapsed in most parts of the world. Consequently, the approach in this study is to ask why a competitive market would not deliver the better outcome for producers and New Zealand. Only when this is thought unlikely is it necessary to consider regulation.
2.3 Market solutions can usually remedy free riding
The areas where free riding is thought to be a problem are quality control and grading, market and product development, market intelligence, promotion, and research and development. In all these areas a history of regulation has entrenched the view that market solutions will not work or are not available. This view has become part of the raison dÕtre for producer boards. However, more often than not, the regulations have suppressed or crowded out competitive market solutions.
Market solutions involve ensuring that benefits and costs fall where they lie. The importance of this principle has been recognised in the removal or reduction of cost pooling in a number of industries.
Take the case of quality control. Poor performance by a few will only unfavourably affect the majority if customers are unable to distinguish the poor performers from the rest. The solution is supplier identification Ñ most commonly through branding. Branding usually takes the form of physical labelling but a reputation for reliability as a supplier is also a brand.
The use of regulations to enforce and police quality and grade standards has a number of adverse consequences:
¥ it reduces the incentives to differentiate products which is an important means of non-price competition; the regulations increase the focus on price competition which all marketers are trying to avoid;
¥ minimum quality or grade standards become maximum standards because the individual receives no benefits for exceeding the minimum;
¥ buyers, who should accept some responsibility for ensuring they deal with reliable suppliers, come to expect that the regulators will solve problems and pay the cost Ñ the hypothetical case in Box 3 illustrates this distortion; and
¥ it provides the wrong incentives to marketers in the boards; they will concentrate on quality as an end in itself instead of the more important quality/price relationships.
When an industry wants to promote a New Zealand brand it is important to control performance. A market solution is to license the brand and only allow it to be used by those who accept and comply with licence requirements. Brand users meet the costs of promotion and policing. They can opt in or out depending on how they view the net benefits. These principles underlie franchising, which is common in parts of the food industry.
There are few reasons for expecting market failure in the quality and grading area and therefore little justification for regulation. Regulations may be needed in areas of public health and safety, and in meeting importing country requirements through government certification.
Similar conclusions apply to product and market development, and market intelligence. Businesses will pursue opportunities which are profitable if they can secure the profits. If there are no profits then the benefits in relation to the costs need to be questioned, as does compulsory funding.
An absence of the activity is not necessarily proof of market failure. However, a frequent consequence of regulation and controls is to raise the risks businesses face and reduce the incentives to invest. Why would a marketing business invest in product or market development if, at any time, regulations could be used to change where and how exporting can be conducted? In chapter 10 the extent to which this influence has suppressed product and market development in the meat industry is discussed.
Research and development is where some market failure is likely. There is considerable private investment in R&D where the benefits can be appropriated Ñ farm chemicals and animal health products are examples. In some areas, however, there may be under-investment from the national viewpoint because of free rider problems.
Market solutions are sometimes available in these circumstances. Plant variety rights are a good example. They enable investors to secure the benefits of their R&D investment. The alternative approach would require administrative decisions on how much to invest in plant breeding and what R&D to do. Public funding or a compulsory levy would be needed to avoid free riding. The performance of plant breeders would need to be monitored to ensure they performed satisfactorily. PVR uses the market to do all this.
New Zealand currently has some of the normal policy remedies for market failure in R&D such as government funding and compulsory levies. They have been improved recently by introducing more contestability. However, the expenditure of producer funds on R&D is tied closely to the marketing arrangements and producer boards.
This should be changed and the Australian experience is instructive. In Australia, independent and expert R&D Corporations are steadily improving the effectiveness of allocating producer levies to areas where market failure is real and the benefits greatest. Concurrently, this is reducing crowding out in areas where the private sector is willing to invest and reducing the need for compulsory producer funding and investment in these areas.
This approach also has potential for generic promotion. Branding and licensing are ways of making the market work better. However, if the benefits of generic promotion are proven, and free riding a problem, then the R&D approach could be used. As with research, there would be advantages in making generic promotion funding contestable Ñ in the wool industry, for example, the International Wool Secretariat is a virtual monopoly.
2.4 Monopolies and exploitation Ñ unfounded producer fears
The principal aim of any business is to maximise profitability. Poorly performing businesses are deserted by shareholders and quickly fall by the wayside if corrective action is not taken.
In a competitive environment, profit maximising is in the national interest. Competition results in investments which deliver the greatest national benefits. If a business is making poor use of resources they will be bid away by a competitor. If an industry is particularly lucrative this will attract new businesses, drawing in resources and driving profits back to normal levels.
Competition typically results in businesses of differing size and structure. Diversity arises because market opportunities are immensely varied and businesses are constantly seeking new and different ways of doing things as part of their competitive strategies. Where size economies are important, large businesses will emerge. However, small entities Ñ producers, for example Ñ are not typically disadvantaged when dealing with large players provided markets are competitive. Furthermore, it is rare for any market to have only large businesses. In competitive markets there are almost always fox terriers keeping the great danes honest.
With few exceptions, competitive markets work this way and successfully maximise national benefits. Where this is not the case it is usually because government intervention and regulation prevent the market from working properly. In this study market failure is repeatedly identified as arising because of regulation and controls on competition rather than the reverse.
Many producers have apparently concluded that in processing and marketing, competitive markets would not work this way and they would be disadvantaged if markets were not regulated. They have concluded that the delivery of processing and marketing services is susceptible to extensive market failure.
Boards and cooperatives have been the response to these producer misconceptions and fears. The fears are largely unfounded.
Why are the fears unfounded?
It is frequently asserted that under a competitive, free enterprise system New Zealand agriculture would be driven into feudalism and producers into serfdom Ñ producers would become peasants. These assertions are generally wrong because they ignore producersÕ ability to exercise choice in a competitive market.
Availability of choice is a fundamental proposition often overlooked by producers. Businesses processing and marketing producersÕ output need producers just as much as producers need these businesses. What is the point in having an off-farm business dependent on producersÕ output and then lowering their returns until they exercise their option to do something else?
Producers do have significant bargaining power if markets are competitive. They know this from their experience in markets other than those delivering processing and marketing services. Such markets Ñ farm inputs, for example Ñ have most of the characteristics producers fear in processing and marketing, but this does not disadvantage producers because these markets are competitive. Some examples are given in Box 4.
It is particularly important for producers to appreciate that all markets beyond the farm provide services and goods. It is in the producersÕ interest that all these services and goods be delivered as efficiently as possible regardless of whether they involve farm inputs or farm outputs. Competition will ensure this; regulations do not.
It might be argued that choice is fine in principle, but producers do not have the flexibility to change their production mix or vocation quickly. However, there are numerous examples of rapid and extensive change in agricultural production. The rate of growth of the kiwifruit industry in the 1970s and 1980s, and changes in sheep numbers as output prices first rose and then fell, are examples of what is both physically possible and has been achieved.
Two particular producer fears commonly raised are that without regulation:
¥ competition would prevent processing businesses from becoming large enough to achieve economies of size fully ; and
¥ single sellers or regulated coordination are essential where the importing country is a single buyer.
The economies of size fear is misguided for two reasons. First, costs are not the only influence on profitability. Minimisation of unit costs is not necessarily synonymous with maximising profitability. Often higher cost processing or marketing is profitable because it delivers higher value output. Moreover, competition does not imply a fragmented industry structure when scale economies are important. Forestry and fishing are examples of industries in which large firms, in New Zealand and internationally, have emerged under competition.
Second, economies of size only lead to monopoly problems in competitive markets when there is homogeneity in processes and products and no alternatives. This makes it difficult for a competitor to be different. Processing lambs into carcases or milk into butter might be seen to have this characteristic. However, even here monopoly problems are very unlikely because there are alternatives, and without restrictions they would emerge. This is apparent from the growth and diversification occurring in meat processing despite regulations and distortions. It is less apparent in milk processing because regulations force an unnatural focus on economies of size. Dairy company payouts are improved by unit cost reductions because board payments are related to these costs.
Extensive regulation by the boards in transport and ocean freight are a variation on this theme. It is asserted that the intervention reduces costs and improves service. The fear that without regulation shipping may not be available is also part of the justification.
Most reductions in freight rates have resulted from more competition. Often shipping companies have had to fight to be permitted into the trade in order to deliver reduced freight rates. The intervention and coordination also produced vested interests which became concerned that competition-enhancing reform would disadvantage them. This retarded beneficial change Ñ an example from the meat industry is presented in Box 5.
Another justification for single sellers is that they are needed to deal with countries which have single buyers. If the commercial world worked in a way which gave single sellers significant market power then it would make sense for buyers to organise themselves similarly to avoid being played off against one another. But single buyers are a rarity, at least in successful countries, suggesting that the claimed commercial advantages of the single seller are spurious.
Where countries do have single buyers it does not follow that single sellers are needed to deal with them. The wool industry deals with single buyer markets without such a structure. Multiple sellers can and do share information when it is in their interests to do so and can, if necessary, cooperate in more formal ways. In any event, it is questionable how much longer single buyers might survive in some countries Ñ in the former USSR and Mexico, for example, where current changes are inconsistent with the concept of monopolies.
Perhaps the final word should be left to the Trade Development Board. In a report on agricultural marketing methods which supported single sellers and coordinated marketing, the Board said:
Ò . . . there is clear evidence from the market place that a single marketing system is not sustainable without some form of statutory underpinning.Ó
The corollary must be that without regulations monopolies would not emerge.
There are disadvantages from restricting competition
The disadvantages of restricting competition and choice are mirror images of the advantages of competitive markets. Some have already been discussed. Producer fears about the structural implications of competitive markets have been shown to be unfounded.
Unsatisfactory accountability is frequently raised by the critics of regulation. It is invariably countered by the assertion that producer boards and cooperatives are more accountable than commercial companies. By implication, therefore, their performance is readily scrutinised and poor performance quickly rectified. These assertions overlook a fundamental requirement for effective commercial accountability Ñ the ability of investors to exercise choice.
Regulations restricting choice explain why politics pervades the marketing debate. The differences between ÔpoliticalÕ and ÔcommercialÕ accountability are at the heart of this issue.
Political accountability is a form of behaviour whereby directors, managers and industry leaders use various forms of advocacy to try to keep shareholders happy and retain their support. It occurs in all organisations Ñ public and private sector. However, in statutory organisations Ñ including producer boards Ñ political accountability is dominant.
Where commercial accountability dominates, performance indicators explicitly measure return on investment Ñ dividends and share prices Ñ and investor choice is not restricted. In these circumstances political accountability and politics are severely constrained. Rhetoric, manipulation of information and use of intimidatory tactics are largely ineffective. Even the smallest investor can examine the companyÕs results, take advice if necessary, and then decide whether to retain the investment. Without investor support directors and managers are unemployed. This is a powerful incentive and sanction against under-achievement.
Producer boards and cooperatives do not produce the performance indicators characterising the commercial model. Producers do not know what their investments return Ñ they have no profitability information and no markets which value their assets. If, on the basis of available information, producers believe performance is unsatisfactory their option for disinvesting is to leave that particular industry Ñ a drastic choice. An alternative option is to try to exercise their so-called democratic rights. If this were the most effective method of accountability in the economy it would be much more prevalent. The recent review of the Meat and Wool BoardsÕ electoral arrangements reported that farmers felt they have little control over their boards through the democratic process.
A typical regulatorÕs response to this logic is: what about the high-profile corporations which have failed spectacularly? They are argued to be poor advertisements for the private sector. This misses the point by a country mile. There is no suggestion that commercial mistakes are confined to producer boards Ñ although they make their fair share. The relevant question is which organisations, on average and over the long haul, make the most good decisions. In the absence of choice and market tests, we cannot know the answer to that question.
When producer boards make mistakes every producer is forced to share the consequences and, in some cases, so do taxpayers. No regulations forced people to invest in private sector companies. Furthermore, these companies and their principals are dealt with by the market. All the producer boards Ñ large losses in some instances notwithstanding Ñ continue on apparently regardless.
What producers must understand is that information is not an adequate substitute for lack of investor choice. No matter how much information is supplied to producers, current structures and regulations limit the usefulness of the information and the actions producers can take. More of the same type of information, meetings and electoral reform will not remedy this. It is akin to asking a prisoner to accept that improvements to the jailÕs reading room are an adequate substitute for lack of freedom.
Finally, there are the costs incurred by producers and New Zealand from lack of diversity. These costs are hard to quantify accurately because regulations prevent alternatives from developing.
However, even with existing regulations, examples of entrepreneurial innovation and success can be found. This is just a glimpse of what would occur were more opportunities available. Examples documented in this study include a cooperative which brands and promotes wool, a private meat company contracting lamb supplies to strict technical specifications, and the role of the private sector in launching the kiwifruit industry. Likewise there are examples of effective marketing strategies being pursued by the producer boards.
Unfortunately, there are also examples of innovation being suppressed or constrained by regulations and the boards. One from the apple industry is presented in Box 6. Among other things, it illustrates the heavy-handed way in which the Apple and Pear Marketing Board blocked an innovative entrepreneur. The significance of this example is not only that innovation was suppressed, but the BoardÕs actions had deleterious effects for the entire industry. The report contains similar examples from other industries.
2.5 Exploitable market power is very limited
The third type of market failure used to justify regulations is the availability to New Zealand of exploitable market power. This justification has been examined in detail (chapter 6) and the only significant situation necessitating intervention is New ZealandÕs UK butter quota. This could be subsumed by a wider access arrangement in the event of a successful conclusion to the Uruguay Round.
Market premiums believed to be secured by existing marketing arrangements are actually returns to investment in marketing infrastructure and services to customers.
Exploiting market power means controlling overseas competitors
Exploiting market power necessitates being able to neutralise the competition. The most common marketing approach is branding and other forms of market differentiation. The aim is to convince the consumer that a particular product is different and worth more. Often consumer perceptions are as important as the reality.
Unfortunately, successful exploitation of market power attracts competition Ñ competition from other suppliers, competition from substitutes, and competition in the form of technology which enables transport and storage. The following two observations from Professor Wayne Cartwright (see chapter 6) illustrate the point:
ÒIt is easy for new producers and producer groups to enter fresh food markets which means there is always a threat of entry by new competitors. Examples of this form of commercial entry that have affected New Zealand include Chilean apple producers, kiwifruit producers in both northern and southern hemisphere regions, and the early entry of Australian producers offering chilled lamb cuts to the United States and Europe.Ó
and:
ÒThe entire structure is also subject to competitive entries from new types of products using new technology. For example, the introduction of controlled atmosphere storage in Europe has made it possible for French Golden Delicious apple producers to carry forward their supplies to compete in the seasonal niche market previously occupied solely by Southern Hemisphere suppliers, especially from New Zealand.Ó
All marketers try to exploit market power. Sustaining successful product differentiation is not easy or common. Three pieces of evidence supporting this conclusion are:
¥ prices remain the dominant influence on buyer decisions Ñ certainly for New ZealandÕs major exports;
¥ where brands have been successful in product differentiation they have high market value, indicating the difficulty and high cost of success; and
¥ there is little evidence of multinational food companies making other than normal profits; are producer boards likely to make market power a big earner if these corporations cannot?
Quota markets can provide premiums
Market power most readily exploitable by New Zealand arises through preferred access to a higher priced market. However, these market premiums or rents are not just for the taking. The exact nature of the restrictions and quota entitlement, and the behaviour of the exporting country, are important in securing these premiums. The relevant detail is discussed in chapter 6.
The only clear-cut cases of quota premiums available to New Zealand are in the dairy industry. The UK butter quota is by far the most significant and is conservatively estimated to be worth some $125 million a year to New Zealand. However, the size of this quota is now around one third its initial volume and its longer term future is uncertain.
To capture the quota premium in full means competitive exporting has to be managed. This does not necessarily require a statutory single desk seller. Alternatives involve voluntary coordination or some form of competitive bidding or tendering by marketers. Critics of the latter approach raise concerns about the costs of tenure discontinuity and the wisdom of allowing a marketer to have a monopoly. However, the approach is not new or untested. It is used in allocating radio frequencies, for example. It has been used for many years in New Zealand and Australia for allocating import quotas in industries subject to import protection.
A distorted international market is reality
Another justification advanced for regulation is the need to counter the intervention and distortions in agricultural markets and trade in other countries.
Market distortions are frequently portrayed in terms of level playing fields, or the lack of them. There is much nonsense talked about level playing fields. There is the spurious argument that New ZealandÕs playing field needs to be tilted because that is what other countries do. New Zealand, so the argument goes, cannot be expected to leave it all to the market when countries which constitute New ZealandÕs major export destinations intervene extensively and play by different rules. This argument suggests New Zealand should follow a policy of tilt for tilt. It was a central element in the case for industry protection (put forward by advocates such as W B Sutch) and is prominent in the agricultural marketing debate.
Unarguably, if all production subsidies and trade restrictions were removed New Zealand would be a major beneficiary. Therefore New Zealand should pursue all avenues for achieving these changes. This is the reason for New ZealandÕs involvement in GATT and the current Uruguay Round of trade negotiations.
However, distorted external markets have no general implications for domestic policies such as industry protection or marketing regulation. These distortions are real and it is in New ZealandÕs interests to invest only in production which provides satisfactory profits when sold in the market that actually exists. To do otherwise is like holding your breath until the other person turns blue.
From the viewpoint of using resources in New ZealandÕs best interests there is no difference between, for example, the Common Agricultural Policy (CAP) of the EC, and the efficiency and low cost of the electronics industry in Asia. In both cases, New ZealandÕs investment decisions need to take into account the ability of New Zealand industry to compete successfully with other suppliers, regardless of how they derive their competitive advantage and how genuine it is.
Obviously New Zealand concentrates effort on the CAP because the competitive advantage the CAP delivers does not have a sound economic basis and the well-being of both the EC economies and New Zealand would benefit from its reform. The sounder economic base of the competitive advantage enjoyed by the electronics industry in Asia is readily accepted as reality Ñ there is no logical or defensible grounds for criticism.
Contrary to protectionist rhetoric, New Zealand cannot ÔtiltÕ its own Ôplaying fieldÕ in favour of its own producers. Subsidies and regulations can only confer benefits on some domestic producers at the expense of other domestic producers. Subsidies cannot make the whole economy more competitive. Selective intervention misallocates resources and harms the economy.
Weak selling Ñ a matter of mind over market?
The need to prevent weak selling is often used to justify single sellers or the regulating of exporters. The term is used in situations where apparently an individual seller accepts a price lower than might have been available on the day, forgoing revenue and lowering prices for the same product from other sellers.
It is an extremely tempting and attractive explanation for producers to grasp when wanting to blame someone for unacceptable market returns. Its plausibility is aided by difficulties in ensuring all the facts are known and proving that returns may not have been higher had so-called weak selling been prevented.
Weak selling cannot be judged to have occurred simply on the basis of only the price received. Marketer success should be judged on the basis of profitability. Marketer profitability will determine both the price that can be paid to the producer and the continued existence of the marketing business. It is possible that the best marketers may be able to take less in the market, pay more to the producer and make profits sufficient to remain in business.
There are many reasons why lowering prices Ñ interpreted as weak selling Ñ could be a sound commercial strategy. It might be used to increase market share or prevent it being reduced. A lower price may reflect other aspects of a commercial relationship which are hidden Ñ indirect promotion assistance, cash payment instead of credit, and the like.
It may be commercially sensible to discount a consignment of perishable product rather than incur storage costs or product loss. Examples of this happening in the kiwifruit industry are described in Box 7 where it is pointed out that private exporter pricing behaviour which is labelled weak selling is called strategic marketing when practised by a single seller board. How much so-called weak selling is actually sound commercial practice reflecting market fundamentals?
There are a number of other questions which producers should address when deciding whether weak selling is common enough to justify regulation.
¥ What are the commercial implications for any exporter than persistently engages in weak selling? Marketers need product to market and must therefore deliver producer prices which ensure it is supplied. If they do not they are unlikely to stay in business Ñ either through going broke or being taken over by exporters that can extract more profitable returns from the market.
¥ If weak selling is real, how can New Zealand control this behaviour by marketers from other countries? How is the ÔrogueÕ marketer, so often cited as the weak seller dragging the entire market down, controlled if operating from overseas?
¥ If product prices are pulled down by the availability of substitute products, how can this be combatted? Might substitutes not also be characterised by weak selling? How is the marketing of these products to be controlled Ñ even when they come from New Zealand?
¥ If so-called weak selling is prevented, and prices are higher than otherwise, how is the supply response from competitor producers to be controlled? Advocates of regulation appear to presume that their price-raising successes will not encourage others to increase production which will pull prices down again.
The present Chairman of the New Zealand Trade Development Board, Barrie Downey, has commented Ñ when working in the corporate sector Ñ on the weak selling issue in relation to kiwifruit. He cited a newspaper article which referred to Òa sale where 1500 trays of kiwifruit were being sold at $7.50 and then another exporter came along and cut the market, and the sale went through for exactly the same type of product for $4.50Ó. (See chapter 6).
Downey observed:
ÒFrankly, I donÕt believe it. The licensed exporters [this was when New Zealand kiwifruit exporters were licensed before the BoardÕs establishment] compete for product and their future is determined by the net price they achieve for growers. They just do not leave that kind of money on the table.
ÒOn the other hand if a mistake of such gross proportions was made the best correction is public ridicule. The article named no names but if it had, I bet there would have been a strong defence.Ó
It is an indisputable fact that in all markets some participants perform better than others. The many reasons for this ultimately boil down to commercial competence. It is inevitable that some so-called weak selling will occur because marketers Ñ statutory monopolies included Ñ make commercial mistakes on occasions. Producers will be better off if marketers which do this persistently go out of business as rapidly as possible. Ironically, a regulated monopoly is the only form of business likely to be able to survive if it engages in weak selling on a persistent basis.
The arguments about weak selling had their counterpart in the debate over labour market regulation. Proponents of monopoly unionism argued that the introduction of competition would allow employers (buyers of labour) to drive down wages and harm workersÕ interests. Experience has confirmed that wages are instead determined by labour supply and demand and that workersÕ best protection is bargaining freedoms and competition for their services. Monopoly marketing organisations can be seen to stand in the same relationship in this debate to the former monopoly unions, and to employ similar arguments and rhetoric.
If, despite the above logic and arguments, producers remain convinced weak selling exists and significantly disadvantages them commercially, then they should consider both alternatives to regulation and how the costs of regulations stack up against the potential benefits.
Product differentiation and branding are effective marketing strategies to minimise weak selling. Weak selling is never raised in industries where marketing revolves around branded, differentiated products. Producers should reflect on the fact that regulations designed to protect them from weak selling have retarded growth in product differentiation and branding, and consequently held back the most obvious and effective solution to weak selling if it exists.
More generally, the use of regulations and single sellers, aimed at trying to reduce competitive exporting from New Zealand, undoubtedly suppresses innovation, product development and different ways of doing things. In other words the chosen (regulatory) response to price competition is actually suppressing remedies the market could be expected to deliver.
In essence, producers in all major rural industries have made two major mistakes in regard to weak selling. They have allowed weak selling to become a grossly overrated rationale for marketing regulation. Weak selling has become the Loch Ness monster of the agricultural marketing debate: often talked about, but positive sightings are seldom documented. In turn, the regulations have resulted in a range of competition-suppressing costs which far exceed any benefits which might reasonably be expected from trying to prevent the relatively rare occurrence of weak selling.
2.6 Is a changing world leaving New Zealand behind?
A changing world scene is not new. However, some of the fundamental international changes currently occurring have important implications for New Zealand as a small, primary product-dependent export economy.
The trends most relevant to New ZealandÕs rural industries can be encapsulated in the following three generalisations:
¥ the rate of change is increasing because technology, especially in communications, is causing the world to shrink commercially, resulting in continual reassessment of the best approaches to doing things;
¥ a technologically-driven and shrinking world means increased labour and capital movement as owners show less concern for national borders and seek locations where profits can be maximised; and
¥ markets are increasingly characterised by consumer sovereignty with marketing success being dependent on total commitment to meeting consumer needs which are diversifying and expanding rapidly, and becoming very sophisticated.
While New ZealandÕs agricultural marketers are aware of these developments and their importance, it is difficult to avoid the impression that they are being under-rated by many participants, including producers. This applies particularly to the acceptance that economic integration and the movement of people and investment mean diminishing relevance of national borders and the downgrading of natural resource endowments in the competitiveness equation.
The last point is important given New ZealandÕs history and the widespread attitudes that are its legacy. The conclusions of Schroder, presented in chapter 6, were as follows:
ÒIt has been argued for a long time that New ZealandÕs comparative advantage as an agricultural producer is based on low cost systems for ruminant animal production. . . . This comparative advantage has been eroded. It remains to be seen whether or not the producers, processors and exporters of New ZealandÕs agricultural and horticultural products can find a similarly advantageous comparative niche based on activities other than the efficient utilisation of pasture.Ó
A similar but more generalised conclusion was presented in the Porter Project report:
ÒIn todayÕs global economy, success is a function of a nationÕs ability to develop competitive advantage in advanced industries and industry segments rather than its ability to exploit comparative advantage of inherited endowments of factors of production.Ó
New ZealandÕs major rural industries are still reliant both on the export of commodity products and on markets in the United Kingdom, Western Europe and North America. At the same time, commodity markets are on the wane, shrinking relative to consumer products, and the markets offering the best prospects for New Zealand are located in the Asia-Pacific region.
The emerging economies of Asia are fast becoming the economic engine of the world. Their total income, currently less than 10 per cent of world income, is projected to be 45% of world income by 2040. The regionÕs food demand is expected to grow by 4 to 5% annually over coming decades. The fastest growing part of the world is at New ZealandÕs front door.
Associated with this economic growth are changes in consumer wants. Consumers are becoming more demanding of quality, variety and services. A new era in food demand and marketing has already commenced. There are relatively few generic markets for commodities such as bulk dairy products, meat or wool. Instead there is an increasing diversity of markets for products derived from these raw materials, with increasing variety in product form, packaging and methods of retailing.
These developments are reflected in changes to the structure and diversity of businesses trying to secure advantages from the widening range of opportunities. The conclusions of a leading marketing professional in the United States, quoted in chapter 6, cast doubts on whether New ZealandÕs existing marketing structures, particularly the producer boards, are the successful way of the future. He concludes that:
ÒThe days of a uniformly accepted view of the world are over. Today diversity exerts tremendous influence, both economically and politically . . . new technology has spawned products aimed at diverse, new sectors and market niches. Consumers demand Ñ and get Ñ more variety and options in all kinds of products . . . Marketing in the age of diversity meansÊ.Ê.Ê.Êchanging company structures as large corporations continue to downsize to compete with smaller niche players that nibble at their markets. Diversity and niches create tough problems for one-line companies more accustomed to mass markets.Ó
Essential requirements for marketing successfully in the future are flexibility, adaptability and diversity. For a country with the size, location and resources of New Zealand, this means ensuring all sources of ideas, enterprise and capital are exposed to the opportunities. Current marketing arrangements and regulations are not conducive to this happening. When their distortionary consequences and the absence of offsetting benefits, are also taken into account, far-reaching change becomes imperative.
3. Competition And A Focus On Profitability Ñ Keys To Beneficial Change
The case for extensive change to New ZealandÕs agricultural marketing arrangements is overwhelming. Most of the existing regulations have no economic justification Ñ market failure is rare and arguments to the contrary are invalid. The regulations deliver few benefits but their distortionary costs are high. The benefits of diversity, more widely sourced investment Ñ including from offshore, and bringing with it valuable market connections Ñ and greater innovation are being forgone. The consequences are that producers do not maximise profitability on farm assets and national income is reduced. Changes must be made in the national interest, as well as in the future interests of producers.
This raises the questions of exactly what changes are necessary and how should they be made. The purpose of this study has been to analyse the need for regulations and identify their significant consequences. The focus has not been on providing a detailed prescription or blueprint of how changes should be implemented. This is something which follows from the general conclusions and recommendations and requires further consideration of options and implementation mechanisms.
Before outlining the broad directions that desirable changes might take, some observations on the nature of likely adjustments to a more competitive environment are presented.
3.1 The conclusions apply to all industries
The reasons why regulations are distortionary and disadvantage producers apply to all agricultural industries. It is often said that because the arrangements in each industry are so different, generalised conclusions cannot be drawn. While it is true that there are practical differences between, for example, the apple industryÕs single seller board and the wool industryÕs competitive auction market, allowing these differences to mask the underlying similarities in regulations and their consequences is mistaken.
The advocates of single seller boards frequently use these operational differences to support their case. For example, poor performance in the meat industry is, they say, an excellent example of unregulated, private sector marketing. If the history and circumstances of the meat industry are examined in even the most cursory way, it is difficult to see how anyone could believe the industry remotely approximates an open and competitive marketing system Ñ in the past or now. Perhaps more than anything else, citing the meat industryÕs performance or its current arrangements as the role model of competitive marketing underlines how out of touch many in New Zealand agriculture are with what constitutes minimal regulation and intervention.
The distortionary consequences of a bundled return in the dairy industry have been examined in detail because they are large. However, in other industries the importance of ensuring that the performance of off-farm investments in processing and marketing is transparent, that producer-investors have choice, and that profits are not delivered in farm gate prices should not be underrated. There is no merit in poor investments and distorted prices regardless of whether they are large or more modest. Furthermore, it is where humble beginnings can lead an industry that is usually the reason for greatest concern.
Before meat and wool producers become too attracted to the view that they have less regulation and fewer distortions, they should examine the detail of their industryÕs regulatory structure and remember how it has been used in the past. Both the meat and wool industries still have legislation which could be used to install single seller arrangements.
For as long as statutes provide for extensive intervention and control, there is always the risk that they will be used for this purpose. The risk increases as memories of the most recent disasters dim. In the meantime, the regulations provide statutory organisations with the ability to devise alternative things to do as a means of continuing to justify their existence.
3.2 Some pain for a greater gain
The types of changes needed to agricultural marketing regulations are the same as those implemented in many other sectors of the New Zealand economy where they are now producing unarguable national benefits Ñ many directly benefiting farmers.
For example, increased competition in the ports has led to at least a doubling of productivity and savings for farmers on both inputs and outputs of at least $7000 on average. Following deregulation and corporatisation, the Electricity Corporation has reduced real unit costs by 29 per cent over the past four years and average wholesale prices are down by 16 per cent in real terms. Service standards in organisations like Telecom and New Zealand Post have improved enormously. Alarming levels of waste and inefficiency were revealed when state-owned enterprises were exposed to competition.
However, securing the extensive benefits of competition in agricultural marketing will not be achieved without some pain. The reason is that the economic effects of regulatory distortions become capitalised into asset values ensuring there are losers as well as winners, at least in the short term, when inevitable change occurs. In essence, improving future prospects for agricultural producers and New Zealand will mean some adjustment costs.
If distortionary regulations are not removed, they eventually either collapse or their costs become so obvious and large that change becomes politically unavoidable. The collapse of wool price intervention is an example of the former and the removal of SMPs and meat plant licensing are examples of the latter.
When pre-emptive reforms are not introduced, producers, who claim ownership but have no effective control, have to watch circumstances deteriorate until change becomes unavoidable or regulated arrangements collapse. Producers, often in conjunction with taxpayers, then have to meet the costs.
It is never possible to forecast precisely the consequences of regulatory reform. However, the results of this study provide numerous insights into the types of distortions that exist and the general consequences of their removal. One important aspect of the analysis is that some of the distortions are very obscure and indirect.
Take the beef industry as an example. Of all New ZealandÕs major rural industries, beef stands out as the least regulated. While it has not grown spectacularly it has maintained its size and, by implication, been profitable. It is, therefore, an example of an industry which has survived in a competitive and distorted international market without the need for extensive regulation. That is an interesting lesson in itself.
What is not so apparent, however, is the extent to which regulations and intervention in other industries have disadvantaged the beef industry. Past distortions to wool prices would have disadvantaged beef production because higher land prices Ñ boosted by artificially inflated wool prices which were capitalised into asset values Ñ increased beef production costs.
Similar consequences flow from the bundled return received by dairy farmers. Because dairy farmers receive returns in the farm gate price from off-farm investments, they bid up the price of land beyond its value based on actual market returns for milk. This disadvantages other producers Ñ quite often beef producers Ñ because land costs rise.
The bundled return produces other indirect distortions. The UK butter quota premium which a dairy farmer receives in the milkfat price raises the apparent profitability of dairy farming and hence the value of dairy farming land. If the neighbour is a beef producer, then that producerÕs land value also rises. While this makes it more difficult to produce beef profitably, the incumbent beef producer has at least obtained some of the benefits of the UK quota premium. However, from the dairy farmerÕs point of view some of this premium has unavoidably been shared with the neighbouring beef producer. Contrary to some claims, it is not fully capitalised into the dairy farmerÕs land value, in which case it would at least be capable of being realised on sale.
Another important issue for the dairy industry is the extent to which marketing and pricing arrangements have distorted investment decisions in the processing sector. When dairy farmer returns are unbundled, as sooner or later they must be, will the existing size, type and location of processing plants always be appropriate? Probably not, in many cases, if the experience of the meat processing industry after distortionary plant licensing was removed is a guide.
Exactly the same logic suggests that new or emerging horticultural industries are disadvantaged by distortions to asset values arising from arrangements which bundle returns and mask market signals in the apple and kiwifruit industries. An international marketer suggested to ACIL that New Zealand was making a mistake by concentrating its horticulture in two fruits Ñ apples and kiwifruit Ñ when lower cost countries were expanding production of competing fruit rapidly, the products could be stored, and price competition was intense because of the commodity nature of the products. Such propositions remain commercially unchallenged because of regulatory restrictions on innovation and choice.
While some commercial pain is inevitable in the short term from removing regulatory distortions, the costs of the distortions usually keep rising the longer the regulations are left in place, and eventually these costs have to be met.
3.3 Removal of the anti-competitive regulations
The conclusions from this study unambiguously indicate two significant changes are necessary to New ZealandÕs agricultural marketing regulations. They are the need:
¥ to remove all the regulations (with some minor exceptions) which are preventing competition and choice in agricultural processing and marketing; and
¥ to corporatise all the statutory marketing businesses, issue the shares to producers, and allow the shares to be traded freely.
The implementation of these changes will require the following major steps:
¥ to confirm, as a matter of principle and government policy, that all the assets of the statutory marketing businesses (all producer boards and their commercial subsidiaries) belong to the producers currently in the particular industry;
¥ to define the businesses in terms of assets and activities, compile shareholder registers, allocate shares and publicly list the businesses;
¥ to identify those situations where genuine market failure is occurring, or where importing countries legally require government involvement in the exporting country, and design cost effective regulatory solutions to deal with these specific situations. Some areas of R&D, entitlement to the UK butter quota, and government-backed certification requirements will comprise this list;
¥ to introduce completely new legislation, or modify or add to departmental responsibilities as necessary, to implement the decisions from the previous step; and
¥ to repeal all other legislation and regulations which restrict competition, prevent exporting, and compel levies relating to activities beyond the farm gate; the principal Acts are those supporting each producer board and those which regulate minor agricultural industries.
Who can be shareholders in the marketing businesses?
It is suggested that only producers in the industry at the time of corporatisation should be entitled to shares initially issued. For example, all current dairy farmers would become shareholders in a corporatised Dairy Board, all lamb producers would become shareholders in the Meat BoardÕs lamb marketing businesses, and all woolgrowers would receive shares in the Wool BoardÕs commercial ventures. Entitlements should relate to production levels in the immediate past.
This is not a perfectly equitable approach but it is the only practical method. The assets of the boards belong to a diversity of involuntary investors Ñ for example, those who have retired or departed from farming were investors. Entitlements would also vary depending on enterprise mix and past levels of production. The producer who some time ago switched from dairy to beef may rightly feel aggrieved when the Dairy Board is corporatised. The sheep farmer who recently switched to dairy receives something of a windfall gain.
Past experience demonstrates that the complexity of perfect equity does not justify the costs, and is usually not possible anyway. The wool industry found this when its market intervention scheme collapsed. In fact, during the operation of the scheme there were significant equity distortions between those who contributed (in the good seasons) and those who received the assistance (in the market downturns).
Contract the UK butter quota to the corporatised Dairy Board
The UK butter quota is the only significant source of market rent available to New Zealand. Legally, the entitlement is the property of New Zealand. How should the capture of this rent be ensured and the proceeds distributed?
One option is for the government to sell the entitlement to the highest bidder. What would then happen to the proceeds from the sale? On the basis that the government (representing the community as a whole) is arguably the true owner, the proceeds could be retained by the government. This would not lead to any economic distortions. If, however, it is intended that dairy farmers receive the proceeds, a means of distribution would be needed. They must not be distributed in proportion to a dairy farmerÕs production because this would reintroduce current distortions to returns at the farm gate. An alternative approach would be needed Ñ ideally an approach related to the producerÕs off-farm investment in marketing.
ACIL recommends a compromise solution. The New Zealand government, as owner of the entitlement, should contract the corporatised Dairy Board to supply the UK market and allow the Board to retain the rent as a contribution to its profits. The same could be done with the much smaller EC cheese quota.
There are a number of reasons for this recommendation. First, it is a practical approach which ensures the rent will be returned to dairy farmers in a non-distortionary manner. At the time of corporatisation all dairy farmers will be shareholders in the Board. Second, it is a benefit which can be seen as helping the launch of a corporatised Board. Third, the quota premium could decline or disappear over time for a number of reasons, for example if EC restrictions were converted into tariff form as a result of international negotiations. While this approach confers a competitive advantage on the Board, this advantage will diminish over time.
What about the cooperatives?
What, if anything, happens to the producer cooperatives by way of structural change would be in the hands of supplier/shareholders. The analysis here highlights current deficiencies and proposes alternative approaches. However, it would be inconsistent with the logic to suggest change should be forced. If a group of producers wish to operate cooperatively they should be allowed to exercise that choice.
What is most likely is that competitive pressures will cause shareholders to look more closely at the costs and benefits of the cooperative form of business structure. When they do so they should look particularly closely at the structure adopted by Wesfarmers Ltd Ñ AustraliaÕs most successful rural cooperative. Its approach to overcoming the major deficiencies of cooperatives while retaining majority producer shareholding is described in chapter 5.
3.4 Approaches to implementing the changes
Many producers may view the recommended changes as dramatic relative to how marketing has been conducted. Two immediate points are important in this context.
First, the recommendations do not propose the explicit dismantling of any existing structures or organisations. In this regard, ACILÕs recommendations differ from those in the report of the Porter Project. Amongst the boards, their commercial subsidiaries and the cooperatives are successful processing and marketing businesses. It would be foolish and unnecessary to dismantle them in securing the benefits of more competition and a greater focus on profitability.
The consequences of regulation have been to constrain and distort, rather than suppress completely, the success of these businesses. It might be argued that the boards contain some of the worldÕs best agricultural marketers because they have been forced to perform in circumstances where every success made the job that much harder.
The recommended changes will improve the ability of managers in these organisations to capitalise on existing expertise and market presence, and enable them better to demonstrate successful performance as marketers.
Second, without the recommended changes the future of New ZealandÕs major agricultural industries looks bleak, and opportunities for new industries will remain constrained. At the same time as resources are being misallocated and producers are forsaking income opportunities, international market changes are making existing arrangements increasingly anachronistic.
The need for change is widely, if not always enthusiastically, recognised. Many deregulatory changes have already been made or are under consideration. Most price stabilisation and producer income support policies have been removed, as has the concessional Reserve Bank finance associated with some of them. Boards have been given greater commercial autonomy, more directors with appropriate commercial expertise and there are reduced requirements for ministerial consent. More explicit forms of performance review have been introduced for some boards, although their effectiveness can be questioned. Cost pooling has been reduced in a number of industries and more competition introduced in some areas of R&D funding.
Some of the organisational and competition issues are also receiving attention. Producers are insisting that commercial ventures by the boards in the meat and wool industries be separately accountable so their performance can be better assessed. The Meat Board has announced the creation of two commercial holding companies to separate statutory responsibilities from commercial investments more clearly. According to the Board, an important consideration was to Òkeep options open for any future involvement of producers in ownership of these investments, as conditions may dictate.Ó
Proposed amendments to Dairy Board legislation will indirectly provide dairy farmers with non-tradable ownership certificates. Ownership entitlement will be based on milkfat production in the immediate past two seasons. The architects of these changes seem to envisage eventual corporatisation of the Board. AFFCO, the meat industryÕs biggest cooperative, is suggesting structural changes are needed to meet future investment needs and growth aspirations. More generally, discussion of the need to change cooperative structures in the meat industry has been going on for some time.
All these changes can be interpreted as a recognition that existing arrangements have had their day. Nevertheless, they are very much changes at the margin. Cosmetic and marginal changes will not do Ñ they leave untouched the most unfavourable consequences of the regulations. Nothing short of corporatising all the statutory organisations and their commercial subsidiaries, and then allowing the market to reveal the benefits of competition and a profitability focus, will suffice if the full potential economic benefits are to be achieved.
While ACIL has concluded that this end point would offer the greatest benefit to New Zealand producers and the economy, there are naturally intermediate options and transitional issues that need to be considered. There will also be trade-offs between the costs and benefits of a gradual approach and one that is more rapid. Much of New ZealandÕs deregulatory experience argues for reasonably rapid change, both to enable industry participants to identify the characteristics of the new operating environment more clearly, and to provide greater certainty that the process will not be interrupted by successive rounds of lobbying and political indecision.
One specific issue which will arise in evaluating transitional options is whether ownership and trading of shares in the boards and cooperative businesses should be confined to producers or open to any investors. Another is whether corporatisation should proceed but, at least initially, single selling arrangements and other controls over competitive exporting should remain.
Who can invest in the businesses?
Ownership and control have been important issues to producers. However, the analysis clearly demonstrates that ownership has not always benefited producers and when confined to them has constrained access to investment funds and the diversity, expertise, technology and marketing networks associated with them. It is also very clear that effective control has not been ensured by producer ownership under current arrangements.
Permitting anyone to invest in the marketing and processing businesses does not preclude producers from investing. Also, it has been demonstrated in this report that producer fears of the consequences of ÔoutsiderÕ participation are largely unfounded if the market is competitive. The issue is therefore whether the considerable benefits of diversity of shareholding and investment should be forgone if the costs are largely imaginary.
There are options which retain producer control but still deliver greater shareholder diversity. Various conditions or restrictions could be included in a companyÕs articles if desired. These might require majority producer shareholding or the retention of a Ôgolden shareÕ by producer interests. Inevitably such options involve trade-offs, such as an increase in the cost of capital to the business, because willingness to invest is usually inversely related to the effective control that can be exercised over the investment. However, these types of options may have appeal as part of the transitional arrangements.
Why should export restrictions be retained?
A second issue for consideration as part of the transitional arrangements is whether some or all of the current restrictions on competitive exporting should be retained for a period. With the main exception of the UK butter quota, there are no substantive reasons for maintaining controls over exporting in any industry.
State-owned enterprise policy in New Zealand has generally attached importance to the establishment of a competitive market environment before trading enterprises are corporatised or privatised. There would be a number of disadvantages in maintaining exporting restrictions unless they applied only for a very limited period and the transitional arrangements had effective ÔsunsetÕ provisions. The disadvantages of monopolies have been canvassed in detail. There would be significant risks in allowing corporatised monopolies to entrench their position and establish new and rearranged vested interests. This could be as disadvantageous to producers and as difficult and costly to reform as the current arrangements. It would be a tragedy for producers and New Zealand to create circumstances where the reform process and its associated costs had to be repeated.
The introduction of competition will be very important in delivering the benefits of reform. The performance of the corporatised marketing organisations would be stimulated by the possibility of competitive entry, whether or not it occurred. Entry by overseas investors into activities from which they are currently shut out could help forge new international linkages of the type that have yielded significant benefits for industries which have been more open, such as forestry. While the obstacles to competition remain, potential new entrants, including some in New Zealand, will be considering alternative options for investing in other countries. Put simply, delays to the introduction of competition postpone benefits and increase costs.
There are also important interrelationships between ownership issues and exporter regulations. For example, producers may be more sanguine about the immediate removal of exporter restrictions if, at the same time, corporatised boards had ownership restricted to producers Ñ or at least majority ownership. This would involve circumstances where producers Ñ on a voluntary basis Ñ could maintain ownership of existing organisations in competition with new entrants. If these producer-owned businesses, which in the past have had monopoly protection or only faced limited competition, perform as well as claimed, competitors might find it difficult to establish. If, on the other hand, their performance slipped at any stage, producers would have the protection of being able to exercise real choice over their marketing organisation by switching to alternatives.
3.5 Vested interests and the change process
This is not the first occasion on which decisive and deliberate spring cleaning of regulatory legislation has been necessary and undertaken in New Zealand. However, none occurred without analysis, debate and strong resistance from some quarters. The resistance was invariably concentrated among those standing to lose privileges or incur adjustment costs. Effecting deregulation in agricultural marketing will be no different. As Machiavelli said some five hundred years ago:
ÒThere is nothing more difficult to take in hand, or perilous to conduct, or more uncertain in its success, than to take the lead in introducing a new order of things.Ó
MachiavelliÕs ghost is alive and well in New Zealand. Shortly after the commissioning of this study was publicly announced, a producer board senior executive asked the studyÕs director whether ÒACIL had lost interest in keeping any of its friends in Wellington?Ó
All New Zealanders, be they investors or consumers, will derive benefits from the recommended changes because of improved national income. Amongst producers, those aspiring to a long and successful future in agriculture have the strongest vested interest in ensuring the changes occur Ñ younger producers, aspiring entrants and anyone with a desire to be different, innovate or seek new opportunities.
However, some producers will be less enamoured of the recommendations. The political spoils associated with regulations Ñ institutional career opportunities, world travel, perceived status Ñ will largely disappear. This will concern a small minority.
There will also be producers who consider that life is agreeably comfortable at the moment and that removing the regulatory cocoon will only cause discomfort. Competitive markets are effective in serving the national interest but are not liked by those who lose out. In the most regulated industries Ñ apple growing, for example Ñ producers in traditional regions who have been slow to adjust varietal mix (not entirely through their own fault) will experience increased competition from other regions, other growers, market preferred varieties and a burgeoning of alternative horticultural enterprises. The regulations have constrained this competition in the past. There will be similar short-term consequences for some producers in other industries. In all cases, the most desirable economic response should be to join in and compete, rather than resist.
Forward-looking marketers in the producer boards, subsidiaries and cooperatives should enthusiastically support the recommended changes for the reasons already outlined. They will find themselves spending less time on wasteful political accountability and better able to achieve their marketing objectives. However, some may feel a need to resist because they have clearly nailed their flag to the regulatory mast. They may feel obliged to go down with the ship. Their dilemma will be the incontrovertible logic of the conclusions Ñ the more they claim the regulations are essential to their marketing success, the more supportive they become, even if unwittingly, of their distortionary and costly consequences.
Producers, particularly those seeing their future in agriculture, and the government are the two key players who must address the need for changes. Producers are the major direct beneficiaries. The government will look to them for a lead in initiating the process of reform. Producers, therefore, have their future very much in their own hands.
The government also has a responsibility as the custodian of the national interest. Policies which favour sectional interests are invariably harmful to the national interest. The government must look not only to the interests of all existing producers, or even to majority opinion among them, but to the minority interests in the industries, to potential new entrants, and to future producers. Existing producers in manufacturing and service industries and labour unions have, rightly, not been allowed to dictate the shape of regulation affecting them. Wider national interest perspectives have been adopted. The government, or more precisely the parliament, makes the laws. Legislation underpins all that is currently wrong with agricultural marketing; legislative changes will be needed to put things right.
Overview and Recommendations
Box 1: An Illustrative Example of the Consequences of Bundling Returns
Assume a board or cooperative has a product which can be sold in two
markets. One market pays $100 per tonne but will only accept a maximum of 10,000 tonnes.
The other market will accept as much as can be supplied but only at a price of $25 per
tonne. Suppose there are 100 producers supplying the board or cooperative, each with total
production costs of $30 per tonne regardless of how much each produces, and all of whom
can expect to capture the same market shares.
It is in the best interests of producers Ñ individually and
collectively Ñ only to supply 10,000 tonnes to the higher returning market. Every tonne
sold on the lower priced market incurs a loss of $5 per tonne.
If the board or cooperative supplies only the higher priced market an
industry gross margin (profit) of $700,000 will be realised. The organisation needs
mechanisms to ensure the 100 producers supply only 10,000 tonnes in total, and to
distribute the $700,000 margin. A range of mechanisms could achieve this.
The problem is that the board or cooperative does not have the necessary
cost information for each producer. It does not know that returns from production over
10,000 tonnes will make a loss. Therefore it does not know that it should restrict sales
to 10,000 tonnes. It will seek to supply the lower priced market and pay producers a
bundled or pooled return.
Because the pooled return will Ñ initially Ñ be higher than the cost
of production, producers will be encouraged to continue expanding output. Every extra
tonne sold over 10,000 tonnes will act to reduce the pooled return.
Eventually the point will be reached when the pooled return is $30.
Producers will not expand production beyond this point because that equals their cost to
produce. But the total industry margin will have declined to zero. The $700,000 margin
earned on the high priced market is offset by equivalent losses on the low priced market.
The margin has effectively been Ôre-exportedÕ as a subsidy to consumers in the low
priced market.
From a national viewpoint, the industry has not only earned no profit,
but it has wasted considerable investment producing output at a loss when this investment
would have been better allocated elsewhere.
Each producer behaved in a rational manner in response to the bundled
price signal. As a result, each ended up worse off. The board or cooperative did not know
this because it saw production expanding. It was probably pleased with its efforts.
Essentially, the pooled price hid from producers and from the marketing organisation the
fact that all production in excess of 10,000 tonnes yielded a return to the marketing
organisation which was less than the producerÕs cost of production.
The following table summarises the difference in outcome between
restricting production so only the higher returning market is supplied, and allowing
producers to expand production until they drive the pooled price down to their marginal
costs of production. In the absence of restricting production, industry gross revenue was
maximised but profitability certainly was not.
Restricting production Pooling with no
to 10,000 tonnes production restrictions
Price received by producer ($/tonne) 100 30
Quantity produced and sold (Ô000 tonnes) 10 140
Gross Revenue ($ million) 1.0 4.2
Total Cost to produce ($ million) 0.3 4.2
Gross Margin (ÒprofitÓ) ($ million) 0.7 zero
Box 2: The Reason Why Brian Jersey DidnÕt Pay Any Tax
Brian Jersey is a better than average dairy farmer. Nonetheless, heÕd just finished a pretty tough year with the only piece of good news coming from his accountant Ñ he wouldnÕt have to pay any income tax this year.
Brian was in the accountantÕs office when he received the news. ÒWhyÓ, he asked, Òhave we had such a bad year?Ó
ÒWell, as I understand itÓ, the accountant said, Òthe world is awash with dairy products and thatÕs the best return the Board and co-op have been able to achieve. IÕm sure theyÕve tried their best because they do have your interests at heart.Ó
ÒBut hang onÓ, said Brian, Òwhat about the $125 million extra we make from the UK market because the Brits feel sorry for us and give us special access? Even I can see thatÕs a bit like a lottery win and nothing to do with butter prices elsewhere. What happened to that profit?Ó
ÒYou received itÓ, said the accountant. ÒYou received it in your milk return from the co-op.Ó Brian looked quizzical.
ÒWell, what about profits from the investment we all have in co-ops and the Board?Ó, Brian asked. ÒAccording to the Board these investments total about $2.3 billion. If the return were 10 per cent that would be $230 million. What happened to that profit?Ó
ÒYou received itÓ, said the accountant. ÒYou received it in your milk return from the co-op.Ó
Well I might have received it, but I donÕt seem to have it in the bank, Brian thought to himself. He decided to change tack.
ÒWhat do you knowÓ, Brian asked the accountant none too politely,Ó about that butter sale to the Russians?Ó
ÒOh, the Board said that was a real blessing,Ó beamed the accountant, Òbecause for a while it appeared no one wanted to buy the butter.Ó
ÒBut IÕve been told by a director of the co-op Ñ off the record and over a beer you understand Ñ that the sale was made at a loss,Ó Brian said.
ÒOf course it was,Ó said the accountant, Òbut you fellows had produced the stuff and you should be thankful your marketers managed to sell it.Ó
Goodness me, Brian thought, if IÕd known it was going to be sold at a loss I wouldnÕt have produced it Ñ but he said nothing, he was too busy thinking.
Brian concluded that what the accountant was telling him didnÕt add up. There were profits being made which he didnÕt seem to receive, and he was milking cows so the output could be sold at a loss. He reached across the desk and grabbed the calculator. After a few minutes he looked up; it was as though he had made an important discovery.
ÒTell me what you make of this,Ó Brian asked the accountant.
ÒAccording to MAF, the average dairy farmer made a profit from milk production of $21,800 in 1990/91. There are about 13,000 of us, so I figure thatÕs an industry profit of $285 million. But according to those earlier calculations, we made at least $355 million out of just the UK market premiums and our off-farm investment in the Board and the co-ops.Ó
ÒWho is pocketing the money?Ó Brian asked accusingly, as though it was the accountantÕs fault. ÒIt seems to meÓ, said Brian, Òthat IÕd have been better off just supplying the UK market, taking the marketing and processing profits, and doing something useful with all my spare time. As far as I can see, IÕve spent a fair bit of my time working for the Russians.Ó
ÒWell Brian, the sad fact is that your conclusions are correct,Ó the accountant said with an almost apologetic tone. ÒItÕs because of the way youÕve set up your processing and marketing arrangements. You get the wrong price signals and you donÕt even realise.Ó
ÒLookÓ, shouted Brian, half out of his chair by now, ÒI pay you for advice Ñ why havenÕt you explained all this to me before?Ó
ÒActually I haveÓ, said the accountant. ÒDonÕt you remember that Treasury report I gave you to read a few years ago? It was all set out very clearly in that.Ó
ÒTreasuryÓ, scoffed Brian, Òwhat would it know about dairy farming? I threw the report in the bin.Ó
ÒWellÓ, said the accountant, Òmy advice is that when next you see a professional report that explains why you are not making any money, you read it very carefully. And next time you go to one of those producer meetings, why donÕt you ask the fellow up the front all these questions?Ó
ÒAfter allÓ, said the accountant, ÒitÕs silly to pay both him and me
for the same information!Ó
Box 3: Who Really Pays to Meet Mr WatanabeÕs Quality Control
Requirements?
The hypothetical Mr Watanabe is an importer of horticultural products
into Japan. His customers are very particular about quality. They want quality produce
and, perhaps of even more importance, they want it consistently. They certainly want the
quality they have paid for.
Mr Watanabe sources from a number of countries. He doesnÕt want to rely
on only one supplier and he needs to allow for seasonality and production fluctuations.
Because he is a reliable importer, his business is growing. He decides to look to New
Zealand as an additional supply source. He takes some trial shipments and is happy with
the product. He increases his purchases, and the number of New Zealand suppliers. Then he
receives an ÔoffÕ shipment from one of his New Zealand suppliers. He canÕt put at risk
his hard earned relationship with his customers in Japan so he takes the loss on the chin.
Then he considers what to do.
Mr Watanabe could simply stop sourcing from New Zealand. He doesnÕt
want to do this because New Zealand has become important in filling a seasonal niche in
the market and he knows the country has the capability of supplying what he wants. He has
to convey appropriate incentives and signals to the New Zealand suppliers, and do this at
the lowest cost to himself.
Experience has taught him that this type of problem is best solved by
visiting the suppliers with a view to establishing relationships that will work reliably.
He needs to have the same types of relationships with suppliers that he has with his
customers. The suppliers need to understand that steady business is available but only if
the buyerÕs requirements are met consistently.
Establishing and maintaining these relationships around the world is
very time consuming and expensive Ñ but Mr Watanabe has found it to be worthwhile
commercially. This is what he will have to do in the case of New Zealand.
And then he receives a lucky break. A business acquaintance in Japan
tells him the New Zealanders are paranoiac about quality control and its importance to
their countryÕs reputation as an exporter. At the first hint of a quality problem they
spring into action with a system of government-backed quality controls, regulations and
policing. Usually they do it pretty well, quality problems largely disappear and the trade
returns to normal.
Mr Watanabe puts out a press release berating the New Zealanders for
their terrible performance on quality and threatening to cease sourcing from New Zealand
unless the situation improves. The New Zealanders do the rest and he doesnÕt have to
leave his office.
Who paid to sort all this out and ensure it doesnÕt happen again? Mr
Watanabe knows he didnÕt and to him thatÕs all that matters. Whether the problem could
have been solved at lower cost to the New Zealanders through the well established market
process of commercial selection is the question New Zealand producers should be asking.
Box 4: Except in Marketing, Producers Do Not Appear to Fear Competition
A fascinating aspect of producer attitudes towards competitive markets
for processing and marketing is the contrast with their attitudes towards competitive
markets supplying inputs. Producers recognise and gain the advantages of competition in
the latter area and yet it has many of the features they fear will disadvantage them in
marketing. The following are some examples:
¥ The world motor vehicle industry is very competitive and distorted.
Toyota and Ford are the equivalents of NestlŽ and Chiquita. Why is it not feared that
they dominate the market for commercial vehicles? Why do producers not worry about being
ripped off when they buy a vehicle? Do they worry about being exploited when it comes to
spare parts and service? Is it just a matter of time before New Zealand producers can buy
only a Toyota? Will this turn them into peasants?
¥ New Zealand does not produce most of the processing and manufacturing
equipment used in the dairy industry. This equipment is imported from a small number of
specialist manufacturers located in Europe and the United States. The dairy industry is
very dependent on this equipment. Do producers fear their relatively small equipment
orders will be ignored? Is it possible that the suppliers will collude and raise equipment
prices because there are no alternatives? How can after-sales service be reliable when the
suppliers are so far away? Might the suppliers withhold the equipment to make their own
dairy industries more competitive? Will this turn New Zealand dairy farmers into peasants?
¥ The worldÕs key financial institutions are gigantic. New Zealand is
a minnow in the international finance ocean. Is this being reflected in a lack of
competitive finance for producers in New Zealand? Are the producer boards exploited by the
Gnomes of Zurich? Do producers worry that the Bank of Tokyo will use predatory pricing to
entice them away from local institutions and suppress this competition? Is it possible
that the availability of credit to New Zealand will be controlled in an attempt to
suppress its competitive agriculture? Will this turn New Zealand producers into peasants?
Producers need to consider carefully why they do not fear the above
examples of competitive markets involving very large corporate entities. The explanation
almost certainly is that they see and experience the benefits and, therefore, would
dismiss any suggestions that they are disadvantaged. Yet these competitive markets have
many characteristics which, when they appear in processing or marketing, cause producers
to reject the notion of competition being good. It is a curious paradox.
Box 6: The Apple and Pear Marketing BoardÕs Attitude to Entrepreneurial
Endeavour
This is a story about the endeavours of a small company to develop a
trade with Japan in a processed apple product, and the Apple and Pear Marketing BoardÕs
attitude and reaction to the opportunity. First some background and context to the story.
Japan recently removed import quotas on apple juice concentrate. As a
consequence, Japanese buyers and investors increased their commercial interest in sourcing
for the Japanese market, which has considerable potential for such products. As part of
their strategies they are investing in processing plants in South America and Eastern
Europe. New Zealand is also a potential source of supply.
The small entrepreneurial company is the Christchurch-based JATRA
Corporation Ltd. A principal of this company has over twenty years experience with Japan
and the Japanese market, having lived and studied there, acquired language skills,
operated a professional advisory business, and then developed into horticultural-based
value adding and trade between New Zealand and Japan. The company has a small processing
plant in Christchurch and has been steadily increasing its production and trade of new and
speciality processed products to Japan. An example is its growing trade in high quality
processed plums.
As part of JATRAÕs development strategy it has established commercial
relationships with Japanese companies Ñ an aspect of commerce with Japan which is
recognised as very important. It is a classic example of a small company which has done
its homework well and developed, over many years, a reputation for product quality and
commercial reliability which it is now capitalising on in the Japanese market. New Zealand
desperately needs companies like this, run by people who are prepared to put in the
effort, invest and take risks.
The Japanese connection in this story is one particular food processing
and distributing company with whom JATRA has built a relationship over many years. This
company approached JATRA to source cloudy Jonathan apple juice concentrate. It made the
approach for two reasons. It had a good relationship with JATRA, and it had been informed
by the Japanese trading company which it normally used to source from New Zealand that the
Apple and Pear Marketing Board had said its requirements could not be met from New
Zealand. Jonathans are a minor and declining apple variety in New Zealand. Growers have
been reducing production because of relatively low returns from the Board.
The saga unfolded as follows.
JATRA contacted the BoardÕs Industrial Products Division and, following
discussions, formally applied to the Board to become a Ôdesignated processor of apple
juice concentrateÕ so it could purchase apples for processing direct from New Zealand
growers. After some prevarication the Board advised JATRA by letter that Òapproval has
been granted for purchase direct from growers.Ó A condition of approval was that JATRA
provide the Board with information on who it purchased apples from, the quantity, and the
price. JATRA agreed to this condition.
The Board also agreed to process the apples to JATRAÕs specifications
at its Nelson plant. To secure the quantities required, JATRA considered sourcing apples
from Central Otago and Hawkes Bay, as well as from the Nelson area. The Board would not
provide JATRA with grower contact information, describing it as a Òcommercial assetÓ.
JATRA therefore was forced to contact growers direct; in advertisements it requested
growers interested in supplying Jonathan apples to contact JATRA. There was a strong
response with JATRA offering growers prices considerably higher than those being paid by
the Board.
Box 6: (continued)
Then the Board started to change its mind. It said it was worried about
effects on its marketing strategies and trading relationships in Japan. It had
ÔrecommendedÕ to the Japanese that they should not use Jonathans because volumes were
small and falling. The Japanese buyer particularly wanted Jonathans and had technology
which could blend small quantities if necessary. The Board couldnÕt decide whether it
could or would process what it now described as a very small volume. Documentation ACIL
has seen suggests that within the Board the issue had now gone ÔupstairsÕ.
The Board then withdrew its earlier agreement to do the processing. By
this time JATRA had contracts with growers based on the BoardÕs earlier approvals and
agreements. JATRA was not able to locate a suitable alternative processor in the limited
time available.
After about two months of intensive effort at the beginning of 1990 to
have the Board agree to allow the business to proceed, JATRA threw in the towel. It wrote
to growers who had agreed to supply apples saying it was unable to proceed. The Board
requested a copy of the letter. The saga received some attention in the media. In one
radio interview the Chief Executive of the Board said that it had Ònever exercised the
monopoly power over processing applesÓ.
Having lost this particular battle, at considerable cost (although JATRA
did receive some compensation from the prospective Japanese buyer), the Managing Director
of JATRA wrote to the Board suggesting that the saga raised some important principles
regarding grower welfare and national trade policy. He also questioned whether the
BoardÕs existing commercial arrangements in Japan would be appropriate for the changes
which were emerging in the market for processed apple products. JATRA has been told by its
Japanese client that the company which the Board uses as its agent in Japan is
independently investing in processing capacity in South America.
In his brief reply, the Chief Executive of the Apple and Pear Marketing
Board merely noted the points raised by JATRA, and went on to say:
ÒI must say I was extremely disappointed that you took your case to the
media and that in my opinion such public debate does nothing to build business
relationships.Ó
However, this was not the end of the matter. The Board then proceeded to
supply the apple juice concentrate to JATRAÕs Japanese client. The Board paid growers
around 50 per cent less than JATRA had offered for the apples. The quality of the
concentrate did not meet the customerÕs requirements. The Japanese company, which sources
these products from around the world, subsequently wrote to the Board indicating that it
was disinclined to do any further business with New Zealand, and particularly with the
Board, because of both the poor product quality and the manner in which the Board had
treated JATRA.
It is inevitable that individual participants in this saga will have
differing views on exactly what happened. This detail is largely irrelevant. It is what
the saga illustrates that is important. The Board did not supply what a Japanese customer
wanted after having prevented someone else from doing so. The end result is a very
dissatisfied Japanese customer unlikely to consider New Zealand as a supply source in the
future. Discussion of these events in Japan will have sullied New ZealandÕs reputation
even more. JATRA lost out, and so did Jonathan apple growers and the New Zealand economy.
Box 5: Reducing Transport Costs in the Meat Industry Ñ A Case of
Analysis Paralysis
During the first half of the 1980s the fact that New Zealand-based
transport and handling costs in the meat industry were unacceptably high was discussed and
analysed continuously. The following excerpts from New Zealand Meat Producers Board Annual
Reports suggest that the issues received plenty of attention, but little in the way of
effective action resulted.
In 1980 . . .
ÒA disturbing factor during the year has been the ever increasing
shore-side costs, both in transport from works and on the wharf. The question of on-shore
charges was the subject of lively debate and considerable publicity at the Exports and
Shipping CouncilÕs ÔForum 80Õ held in June, 1980. There was a consensus that costs in
New Zealand are excessive and moves should be made to identify each cost sector in an
endeavour to arrest these spiralling charges. The Board has been looking extensively at
this question during the year and, as yet, no firm conclusions have been made, but it is
hoped, by continuing investigations, solutions may be found during this season.Ó
Then in 1981 . . .
ÒThe Board has continued to look at ways to reduce or even hold rates
at reasonable levels to avoid any further erosion of New ZealandÕs export earnings.
Investigations have focused on shore-side costs that form a high component of our total
transport bill and over which we have some degree of control.
ÒStill to be completed, the investigation will also identify ways and
means of containing costs within the current arrangements and develop with the industry
the implications of changing current practices to reflect actual costs.
ÒIt is expected that this review will be completed and various options
put forward for discussion early in 1982.Ó
By 1982 . . .
ÒA Board study of livestock and export product transport within New
Zealand progressed through the year and concluded that either economies must be found
within current arrangements or a structure based on a more direct allocation of costs be
implemented.
ÒIt was initially considered that changes in the allocation of
pre-shipment transport costs would be implemented on October 1, 1982, but this has now
been deferred while a detailed analysis is carried out on the cost implications the
proposed changes will have on individual works and the farmers in the various regions.Ó
So that in 1983 . . .
ÒThe Board has continued its review of pre-shipment practices and the
costs associated with the transport of meat exports. Various options for change were put
forward, but a further review will be required before alternative arrangements can be
made.Ó
However, in 1984 . . .
ÒThe port works system for internal transport charges was the subject
of intense investigation by the Board, the NZFCA [New Zealand Freezing Companies
Association] and some provinces of Federated Farmers. It was not possible to reach a
consensus on a new system and a decision has been held over.Ó
Ò. . .the report commissioned by the MIC [Meat Industry Council] into
farmgate to ship side costs, which is due for completion in the first quarter of 1985, has
the potential to initiate worthwhile cost savings and improve productivity. Costs in this
area are high both in terms of labour and poor utilisation of capital. It was therefore
logical that the MIC should direct attention to this area as a matter of priority.Ó
The explanation for the above is simple and self-evident. Trying to
reform policies, and achieve consequential cost savings for the industry as a whole, is
not an easy matter when attempted by investigation and consensus. The reason is that this
process results in some farmers and meat companies being worse off. They obviously carried
enough sway to make sure there was always something further to investigate. Meanwhile,
pricing was distorted and transport costs remained high Ñ meaning there was, in fact,
still a problem to investigate!
Box 6: (continued)
Then the Board started to change its mind. It said it was worried about
effects on its marketing strategies and trading relationships in Japan. It had
ÔrecommendedÕ to the Japanese that they should not use Jonathans because volumes were
small and falling. The Japanese buyer particularly wanted Jonathans and had technology
which could blend small quantities if necessary. The Board couldnÕt decide whether it
could or would process what it now described as a very small volume. Documentation ACIL
has seen suggests that within the Board the issue had now gone ÔupstairsÕ.
The Board then withdrew its earlier agreement to do the processing. By
this time JATRA had contracts with growers based on the BoardÕs earlier approvals and
agreements. JATRA was not able to locate a suitable alternative processor in the limited
time available.
After about two months of intensive effort at the beginning of 1990 to
have the Board agree to allow the business to proceed, JATRA threw in the towel. It wrote
to growers who had agreed to supply apples saying it was unable to proceed. The Board
requested a copy of the letter. The saga received some attention in the media. In one
radio interview the Chief Executive of the Board said that it had Ònever exercised the
monopoly power over processing applesÓ.
Having lost this particular battle, at considerable cost (although JATRA
did receive some compensation from the prospective Japanese buyer), the Managing Director
of JATRA wrote to the Board suggesting that the saga raised some important principles
regarding grower welfare and national trade policy. He also questioned whether the
BoardÕs existing commercial arrangements in Japan would be appropriate for the changes
which were emerging in the market for processed apple products. JATRA has been told by its
Japanese client that the company which the Board uses as its agent in Japan is
independently investing in processing capacity in South America.
In his brief reply, the Chief Executive of the Apple and Pear Marketing
Board merely noted the points raised by JATRA, and went on to say:
ÒI must say I was extremely disappointed that you took your case to the
media and that in my opinion such public debate does nothing to build business
relationships.Ó
However, this was not the end of the matter. The Board then proceeded to
supply the apple juice concentrate to JATRAÕs Japanese client. The Board paid growers
around 50 per cent less than JATRA had offered for the apples. The quality of the
concentrate did not meet the customerÕs requirements. The Japanese company, which sources
these products from around the world, subsequently wrote to the Board indicating that it
was disinclined to do any further business with New Zealand, and particularly with the
Board, because of both the poor product quality and the manner in which the Board had
treated JATRA.
It is inevitable that individual participants in this saga will have
differing views on exactly what happened. This detail is largely irrelevant. It is what
the saga illustrates that is important. The Board did not supply what a Japanese customer
wanted after having prevented someone else from doing so. The end result is a very
dissatisfied Japanese customer unlikely to consider New Zealand as a supply source in the
future. Discussion of these events in Japan will have sullied New ZealandÕs reputation
even more. JATRA lost out, and so did Jonathan apple growers and the New Zealand economy.
Box 7: Weak Selling or Strategic Marketing? Ñ It Depends on the Judge
Weak selling or competitive exporting is seen as a major marketing crime
which boards were created to stamp out. The Kiwifruit Marketing Board is no exception and
weak selling was an important justification for its establishment in 1989. Since then it
has had some experiences in the market where cutting price was found to be sound
commercial practice or a necessity, particularly given the perishable nature of the
product. The Board has portrayed the activity as strategic marketing.
In the 1989 season the BoardÕs desire to avoid the stigma of weak
selling cost growers money. In its recent performance review of the Board, Deloitte Ross
Tohmatsu concluded:
ÒThere were substantial fruit losses offshore later in the season,
partly due to the inflexibility of pricing policy. This tended to reflect the
understandable desire to obtain the best price for growers and the consequent reluctance
to reduce price when market signals indicated that this was necessary.Ó
By the 1990 season the BoardÕs behaviour in the Australian market
suggests it had accepted that weak selling might be appropriate in certain market
circumstances. Again, from the Deloitte Ross Tohmatsu report:
ÒLate in the season, volume problems in Europe influenced the NZKMB to
sell in Australia at a price lower than budgeted. Although this was not the course of
action originally preferred by the Board, it served to demonstrate the importance of the
Australian market as part of the NZKMBÕs overall global strategy.Ó
In late 1990 the Board diverted a shipment of kiwifruit en route to
Japan, to California. This was a response to protests from Japanese importers that the
shipmentÕs arrival would drive prices down. The Californians were unimpressed and
instigated anti-dumping action against the Board. According to a newspaper report the
Californian Kiwifruit Commission charged the Board with Òimmature, pernicious
practices.Ó The United States imposed a large anti-dumping duty on New Zealand kiwifruit
in mid-1992.
In a special report to growers, the Board, in explaining its decision to
contest the anti-dumping case, had the following to say:
ÒThe preliminary decision relates to the NZKMB sales in the United
States in the 1990 season when we had large volumes of fruit to move. The volume pressure
in the United States and the comparatively short shelf life of New Zealand kiwifruit late
in the season resulted in lower selling pricesÓ.
It seems likely the case will cost the Board - that is, New Zealand
kiwifruit growers - at least $1.2 million. This is equivalent to $2 per tray over the
shipment that triggered the action. The average payment to growers for the 1990/91 season
was about $4.60 per tray. Maybe the Board should have let the shipment continue its
journey to Japan!
Marketing invariably involves situations where dropping the price to
clear supplies is commercially sound. The evidence suggests the Board has learnt and
accepted this reality. Trying to make distinctions between price cutting strategies which
are commercially sound and so-called weak selling is a nonsense. The Board does what the
market demands Ñ it cuts the price when that is the most appropriate commercial strategy.
Either the Board is guilty of weak selling or nobody is. There is no logic which can be
used to make a distinction which would allow price cutting to be called strategy when the
Board does it, and weak selling when done by others.
Furthermore, in facing up to commercial reality the Board has effectively demonstrated that the arguments in support of a single seller, and thus its raison dÕtre, are spurious. Its current reductions in payments to growers are again a recognition of market supply and demand realities.
1.1 Reversing Economic Decline Ñ New ZealandÕs Challenge
Over the past twenty-five years New ZealandÕs standard of living has fallen from a world ranking in the top ten to twenty-third. The principal reason has been New ZealandÕs poor economic growth. This fall from grace is an unhappy and socially stressful outcome for an agriculturally based economy which justifiably claims to be one of the worldÕs most technically efficient producers of temperate agricultural products.
Agriculture contributes 60% of New ZealandÕs merchandise exports and 13% of Gross Domestic Product (GDP) when production, input supply, processing and marketing are included. Consequently, agricultureÕs performance has probably been partly responsible for the deterioration in economic performance.
The traditional New Zealand response has been to ignore the reasons and resort to excuses. The world was large, cruel and did not play fair. A ÔNew Zealand against the world philosophyÕ bred an inward-looking culture with protection, subsidies, and a state-will-provide mentality.
Efforts to reverse the decline commenced in the late 1970s but initially proceeded in a fitful way. New Zealand is now painfully rediscovering the importance of non-distorted prices, performance-enhancing competition, and minimal restrictions on investment and consumption. Policy reform is steadily restoring these important attributes throughout the economy. The reforms may not be producing a quick fix but they are laying the groundwork for a sustained turnaround in New ZealandÕs economic performance.
Some of the benefits of deregulation have been quickly and obviously available Ñ the airline and taxi industries, telecommunications and shop trading are cases in point. However, to think that reform can be quick and painless is naive. It is, after all, a process similar to overcoming a serious drug addiction. What needs to be done simply cannot be achieved without considerable economic pain.
New ZealandÕs farmers are experiencing substantial pain in adjusting to a less regulated environment. Most agricultural support and assistance was removed relatively quickly. The OECD has noted that New Zealand stands out as one of the few developed economies which has moved to liberalise its agricultural policy comprehensively.
This has not been the case, however, in agricultural processing and marketing. Despite withdrawal of government involvement and periodic reactions to crises, fundamental characteristics have changed little. Extensive regulation controls commercial activity and constrains choice beyond the farm gate.
Less than 20% of New ZealandÕs agricultural production can be exported without a licence. This is the tip of a regulatory iceberg involving statutory monopolies, restrictions on entry, institutional oversight of marketing, market access and prices, and many other controls over businesses. There are differences between industries but they owe more to history than fundamental differences between products or markets.
The primary marketing objective has been to maximise producer returns. It has been a long-held view of many producers that they benefit if they have direct control over their output beyond the farm gate. Producer boards and cooperatives have been seen as a way of ensuring this.
The extensive use of regulations is fundamentally at odds with the competition-oriented policies being introduced throughout the rest of the New Zealand economy. The obvious question is whether this important part of the economy would also benefit from more competition, and having its regulations reduced or removed.
1.2 Why Another Review?
How best to market New ZealandÕs rural output is a hotly and continuously debated topic. The debate is complex, detailed and, at times, doctrinaire.
It is apparent that many have grown tired and frustrated with having their arrangements and activities reviewed. One producer board refused to cooperate with this study and two others indicated cooperation would be limited to publicly available information.
Nonetheless, many have a continuing strong interest in the issues, and they are not confined to Ôacademics and theoristsÕ. Rural industry leaders, representatives of other sectors of business and individuals in agriculture and associated industries regularly discuss and question existing arrangements. A noteworthy feature of the debate is that its ÔpoliticalÕ nature constrains and tempers much of what is said, particularly publicly.
1.2.1 Debate reflects opposing views
Past reviews have not resolved the major arguments. This contrasts with most other exercises in regulatory reform over the past decade where the issues are now largely settled. In many respects the debate has become polarised.
Those who believe choice should be restricted, and certain marketing arrangements preferred over others, put forward the following three major propositions:
¥ politicised export markets involving subsidies and entry controls need to be managed and this can only be done effectively by large, government-backed marketing organisations either doing the marketing or controlling it extensively;
¥ private or corporate marketing organisations do not have producersÕ interests at heart and will compete with each other to drive down prices received by New Zealand in export markets (weak sellers), and/or dominate the industry and commercially exploit small, vulnerable farm businesses; and
¥ fluctuations and differences in short-term market circumstances, between markets and over time, disadvantage farmers depending on what they produce, where, and when; and farmers want to pool these variations because of the importance of equity.
The opposite propositions are that:
¥ the management and control of politicised or distorted markets, including any market premiums, can be achieved at least as well with competitive and commercially-oriented policies that may require some degree of regulation but considerably less than at present, or result from natural incentives for joint action;
¥ statutory monopolies and other controls over entry lead to cost-padding and the suppression of risk taking, diversity and innovation associated with competition; and
¥ pooling distorts price signals and leads to resource misallocation and, therefore, economic efficiency losses and reduced profitability.
Associated issues include the extent to which the roles of market participant and regulator are combined, and the merit of a New Zealand Incorporated approach to countervaile size and concentration.
There is also a vigorous debate about accountability. Critics point out that the current marketing structures provide no satisfactory performance indicators. Advocates of current arrangements argue that accountability is extensive, transparent and better than the corporate sector. Producers are said to have democratically elected representatives throughout the system.
The discussion of accountability offers one window of understanding on why the debate is so intense and polarised. It is a debate which does not adequately recognise that two very different types of accountability are being discussed Ñ political accountability and commercial accountability. Important differences between the two are discussed in chapter 5.4.
1.2.2 If it ainÕt broke donÕt fix it
The adage Òif it ainÕt broke donÕt fix itÓ has been used by those who believe current approaches to marketing are best and there are no substantive reasons to justify fundamental change. This adage puts the onus of proof on those who argue for significant change. Since laboratory experiments cannot be conducted, it is necessary to establish fundamental respected principles, logic, and relevant empirical and inferential evidence to sustain conclusions.
There are, of course, no unequivocal answers or perfect policies. Objectives frequently conflict and trade-offs have to be made. Theories evolve and improve as a result of continuous research and technological, social and political change. Particular events have a role in reaching judgments about the merits of ways of doing things, but alone are an inadequate basis for reaching conclusions.
A study such as this is seeking to establish whether the logic and evidence points in any consistent direction, thereby suggesting one policy or approach in preference to another. Frequently, logic alone makes a compelling case. For example, harnessing competition to restrain costs and stimulate continuous innovation is powerful by itself.
Finally, the adage carries the connotation that if existing arrangements are found wanting, they can be improved by changes to the detail as different from fundamental reform. In other words the Òbreaks can be fixedÓ. However, if a particular approach to marketing or pricing is flawed fundamentally, then changes to detail are unlikely to correct the fault. Consideration at least has to be given to whether or not an existing approach needs major reform, rather than marginal adjustment. There may be cases where reconstruction rather than fixing is required, and the adage encourages this possibility to be overlooked.
1.3 What Does Sensitivity to Criticism Indicate?
Many involved with current arrangements exhibit a high degree of sensitivity whenever current systems and structures are critically examined. In 1990, the Minister of Agriculture noted that as soon as the issue of Òproducer board reformÓ is raised there is a predictable reaction. He went on to say:
ÒIt seems to me that as soon as these three dreaded words are mentioned, our farmers, their leaders, the producer boards, all go into a defence mode bordering on a siege mentality.
ÒBoards have a profound impact on the working of our economy.
ÒThat is why their structures and powers are subject to frequent analysis, not just by politicians, but by academic and business groups as well.
ÒThe world trade environment is changing ever more rapidly, and one senses that producer boards as institutions struggle to keep up with the change.
ÒThis is not their fault, but I expect these comments will draw a defensive reaction from some producers.Ó
An example of how a producer leader reacted to the work of public officials is presented in Box 1.1.
A common reason for a strong (and non-commercial) defence of any status quo is a perceived threat to a privileged position based on some form of government intervention or favour. The reactions referred to by the Minister and illustrated in Box 1.1 are similar to those of other protected interests threatened by reform, such as monopoly labour unions.
Defensive emotional reactions such as calls for ÒdisciplineÓ, industry or national ÒunityÓ, and accusations of ÒdisloyaltyÓ are particularly instructive. They point to where regulation is likely to be conveying the greatest benefits to sectional interests, and therefore likely to be inconsistent with the national interest. While politicians are noted for picking up the oil can when they hear such squeaky wheels, good researchers reach for their magnifying glasses.
An aspect of this study has been to ask who benefits from existing marketing structures and systems. Clearly, if these benefits are of a national character, existing arrangements should continue and be defended, if necessary. An intriguing question is why so many parties should have persisted in scrutinising them if the national benefits are so clear-cut. A possible explanation, in addition to the protection of vested interest, is that some of the unfavourable consequences are not readily apparent.
1.4 The Cooperative Culture is an Enigma
New ZealandÕs farmers have a strong cooperative culture. The view is that unless farmers cooperate they will be commercially exploited. Sharing gain as well as pain is also relevant.
The culture developed in an environment where governments involved themselves in marketing as part of historical links between Britain and New Zealand and special arrangements during the two World Wars. It has led to the widespread perception that small farm businesses must cooperate or perish.
New ZealandÕs farmers are also independent. Their survival in fluctuating and often difficult economic circumstances is testimony to their adaptability.
The adherence to a cooperative culture is an enigma when viewed alongside this independence and adaptability. Farmers often behave quite differently when making individual commercial decisions than they do when deciding on the best form of collective action. For example, they might collectively support pooling of transport costs, knowing it is distortionary and inefficient, and yet act quite rationally as individuals to minimise transport costs.
Farmers in some of New ZealandÕs major industries have little experience with alternative systems for processing and marketing output. Uncertainty about the unknown, therefore, might also help to explain the cooperative culture.
1.5 Report Structure: General Principles and Reviews of the Major Industries
The structure of this report reflects the sequencing of the research which it documents. The next chapter reviews objectives, highlighting inevitable conflicts and the overriding importance of producer profitability and the national interest. Chapter 3 reviews the role of the market in resolving conflicts between objectives, and the circumstances in which markets might fail or deliver unwanted outcomes, providing justification for regulation.
Chapters 4-6 review various forms of intervention and examine the validity of arguments advanced to justify their use. The major consequences (good and bad) of intervention, particularly regulations which involve compulsion and restrict choice, are reviewed.
Chapters 7-11 examine and analyse the main features of production, markets and marketing for the apple and pear, dairy, kiwifruit, meat and wool industries. Emphasis is placed on using the principles and arguments developed in earlier chapters to assess the consequences and effectiveness of marketing arrangements in each industry. Each chapter concludes with brief recommendations relevant to the particular industry.
1.5.1 Acknowledgements
Many people and organisations assisted ACIL with its research. This assistance has been very important to our work and is sincerely appreciated.
At the commencement of the project the New Zealand Business Roundtable approached each of the producer boards at chief executive level with the terms of reference of the study and sought their cooperation. Cooperation was not generally forthcoming and as a result ACIL had only limited contact with producer boards, their directors and senior management. ACIL did not seek to make demands on their time, or request access to what are believed to be extensive but unpublished information bases.
This lack of formal contact, while extending the effort needed for the research, was not a major handicap. There is considerable information on producer boards and their activities on the public record. Public reporting of statements by senior producer board personnel has also been very useful in our work.
The political nature of the marketing debate in New Zealand means many of the individuals who assisted ACIL could be embarrassed and possibly more substantively disadvantaged if their help were acknowledged publicly. To all these people, we owe a debt of gratitude. However, responsibility for the content of this report is ACILÕs alone.
The study was commissioned and funded by the New Zealand Business Roundtable. We appreciate the opportunity to undertake work of such potential significance to New Zealand and New ZealandÕs farmers. ACIL believes that members of the non-rural corporate sector will also find much in this report which is as relevant to their policy environment and commercial activities as it is to farmers and their marketing organisations.
Chapter 1
Introduction
Box 1.1: Pointing the Bone at ÒThe Officials of IscariotÓ
In an editorial, under the heading ÒThe Officials of IscariotÓ, the President of the New Zealand Fruitgrowers Federation used the April 1989 edition of The Orchardist to say the following about producer board reviews and the role of public servants in them.
ÒIt is not the function of paid officials to tell fruitgrowers how they should organise themselves. Fruitgrowers are perfectly capable of deciding how best to arrange their own marketing operations. Indeed, they have been doing so for over seventy years. Treasury ignorance is accepted and the sacking of their previous Minister is a telling example of how singularly unsuccessful Treasury has been in coming to terms with what actually happens in the market place. However, the Ministry of Agriculture and Fisheries should know better and needs to be mindful of where its client base lies.
ÒIt is staggering to see the commitment of time from Treasury and MAF to Producer Board reviews over recent years. Organisations like the Dairy and Apple and Pear Boards for example, have placed huge industry resources into setting up world renowned marketing structures with the help and encouragement of producers, only to have to defend the same against bureaucrats who should have plenty of meaningful assignments to occupy them. It is both futile and frustrating to see our very scarce resources taken from their primary role to defend our system against ignorance and theory.
ÒOne of the main weaknesses of our fruit industry has been a lack of market discipline and hence control. If we are to survive as an export industry, let alone New ZealandÕs fastest growing one, then we need to be very well organised and disciplined.
ÒThe advent of CER will offer further opportunities for both New Zealand and Australian growers to combine for additional market strength. In the meantime, the last thing we need is to be stabbed in the back.Ó
While this conveys an impression of firm and strongly held views, it
hardly constitutes a rigorous or logical defence of the status quo. It is interesting to
note that governments and their officials have undertaken numerous reviews of industry
protection over the past decade, often in response to the urgings of primary sector
interests and despite the use of similar rhetoric by manufacturing industry
representatives. All forms of government-provided regulation are of legitimate public
interest as they affect the use of economic resources and the welfare of the wider
community.
2.1 Agreed Objectives Would be the Ideal
It would be ideal to have unambiguous objectives against which to assess alternative approaches to marketing. However, different individuals, groups, and industries have different objectives. They also have multiple objectives which are often in conflict. There is also a need to consider New ZealandÕs overall objectives Ñ the national interest.
Because there will be differing views on which objectives are the most important, the focus of attention shifts from the objectives themselves to a means of resolving conflicts between them.
The starting point for evaluation is to examine the objectives underlying current arrangements. It is then necessary to consider their appropriateness and whether they conflict with each other, with objectives held by other interest groups in the economy, and/or with the national interest. The final consideration is what objectives should be the most important and how conflicts between objectives should be resolved.
2.2 Objectives of Existing Arrangements
Existing arrangements for rural marketing in New Zealand have been designed to benefit producers. Legislation and formal statements from producer boards are appropriate sources of information on objectives. Relevant extracts are summarised in Box 2.1.
Three of the five boards have their objectives specified in legislation. The Dairy and Apple and Pear Marketing Board legislation contains only statements of functions and powers. Statements by the boards themselves are a mix of explicit objectives or mission statements and descriptions of what they do, and how.
The Commodities Levies Act 1990 allows organisations representing a group of people with common commercial interests to request the Minister of Agriculture to impose a compulsory levy on the group. The money raised can be used for a number of purposes including promotion, representational activities and R&D. The Act creates a responsibility to administer any levy-based activities in a manner consistent with the wishes of the substantial majority of those responsible for paying the levy. Any change to levy arrangements requires the support of a majority of the levy payers and, in the case of commodity-based levies, of persons responsible for Òconsiderably more than halfÓ of the production of the relevant commodities. This legislation gives producers the right to decide and therefore it is designed to meet their objectives.
ACIL has distilled the following objectives that existing marketing arrangements aim to achieve:
¥ to maximise net market returns to producers (farm gate prices);
¥ to maximise returns to a particular rural industry;
¥ to protect producers from exploitation by others in the marketing chain;
¥ to give producers greater control over their industry;
¥ to deliver equitable returns to all producers; and
¥ to introduce greater stability/predictability into producer returns.
This collection of objectives raises a number of important issues. First, it carries the strong implication that what is good for the individual producer will also be good for the industry and the New Zealand economy. To the extent that national interest is considered to be important, this can only be derived by deduction.
The way governments have used their powers to regulate marketing reinforces the implication that producer and national interests coincide. This might seem reasonable given the importance of agriculture in the New Zealand economy, particularly as an export earner. However, as farming and its immediately associated industries comprise only 13% of GDP, the majority of the economy competes with agriculture for scarce resources. Producers in other industries and consumers, therefore, may well have objectives which conflict with those of farmers.
Second, there is the question of whether particular objectives conflict with each other. For example, it is quite likely that maximising farm gate returns to an individual producer will conflict with maximising industry returns. Similarly, maximising returns to a particular industry is likely to conflict with attempts to do the same for a different rural industry.
Third, there is the question of what is being maximised Ñ how objectives are defined. It is not always clear that objectives relating to maximising returns refer to net rather than gross market returns. Are the returns being maximised those relating to a unit of production, an individual farm, or the industry as a whole? Does maximising returns necessarily mean profitability (return on investment) is maximised? These can be very important considerations when it comes to deciding which objectives are the more important and how they can be achieved.
The way in which the objectives of existing marketing arrangements have been defined and discussed leaves many of these questions unanswered, or answered ambiguously. This is probably one reason why debate over alternative arrangements is inconclusive. It is not surprising that conclusions about the best approaches to marketing would differ if views on objectives differ.
2.3 The National Interest Should be the Priority Objective
Marketing arrangements should produce outcomes which are in the best interests of New Zealand. When commenting on producer boards, and the need for periodic reviews of their performance, the Prime Minister said:
ÒI also acknowledge that, in future, reviews should be well spread, carefully prioritised, and conducted from the perspective of the national good rather than an individual industry perspective.Ó
The generally accepted national economic objective is to maximise the welfare or economic well-being of the population as a whole. The report of the Porter Project said the principal economic goal of a nation Òis to produce a high and rising standard of living for its citizens.Ó This can be measured by a proxy such as GNP Ñ the total goods and services available nationally which determine material standards of living.
Other relevant national goals may include national security, reducing risk, quality of life, equality of opportunity, and minimum welfare standards. These often involve trade-offs between maximum economic output and other objectives nations pursue.
At the heart of achieving national economic objectives is the need to obtain the maximum return from the countryÕs resources. Governments are generally viewed as having responsibility for ensuring the economy functions in a manner most likely to achieve this.
In a democratic, market-based economy like New Zealand, it is considered legitimate for all individuals and groups to hold and express views on what is in the national interest, and how it would best be achieved. Consequently individuals and groups will find themselves competing for resources as they pursue their particular objectives.
When it comes to rural marketing arrangements, it appears common for producers to assume that their objectives have primacy over those of most others. However, others in the community rightly claim that their objectives should also be considered.
First are those who might be rural producers were it not for existing arrangements. This groupÕs objectives could differ from those of existing producers. Similar considerations might distinguish well-established producers from recent entrants Ñ young farmers particularly.
Second, non-rural producer groups might legitimately ask whether rural producer objectives would conflict with their own. An interest in marketing policies by these groups is as relevant as the interest farm groups have in broader policy issues, such as tariff reform.
Consumers have an interest in whether the pursuit of rural producer objectives conflicts with theirs. If marketing regulations are distortionary, the unfavourable consequences for consumers would not be confined to prices for agricultural produce. A failure to make the best use of the nationÕs economic resources would reduce the income available to consumers in New Zealand.
Adam Smith noted the tendency for the consumer incorrectly to be overlooked in the quest to meet producer objectives when he said:
ÒConsumption is the sole end and purpose of all production, and the interest of the producer ought to be attended to only so far as it may be necessary for promoting that of the consumer . . . But in the mercantile system, the interest of the consumer is almost constantly sacrificed to that of the producer; and it seems to consider production, and not consumption, as the ultimate end and object of all industry and commerce.Ó
Third, professional analysts, including public sector advisers, have skills in examining the appropriateness of various forms of market intervention. This group also has a legitimate role to play.
When individuals and groups pursue their particular objectives they tend to argue that their objectives and the national interest coincide. It is the unenviable but necessary task of governments to decide the merits of the arguments and arbitrate on them. Generally, governments should be aiming to create an environment which facilitates the alignment of self-interest and national interest rather than trying to determine the answer and deliver prescribed outcomes with ad hoc policies and regulations.
2.4 Producer Objectives Often Conflict
There are obvious conflicts between primary objectives in the rural sector and major distortions arising from the policies that have been used to try to resolve them. A useful starting point is the individual farm. ÒThe worst enemy of a sheep is another sheepÓ is an old Australian adage which illustrates that conflict extends all the way down to the smallest unit.
A producer can rarely maximise returns from a sheep and a cropping enterprise simultaneously. The conflict has to be resolved by striking an acceptable balance between the two. An immediate complication is that maximising farm profitability Ñ an ultimately more important objective Ñ may require both enterprises to operate on a certain scale because of their technical inter-relationship.
There are many instances where the objectives of individual farmers will be in conflict. Producers who fatten stock for slaughter compete with each other and sellers of store stock. This example also illustrates the conflict between producers wanting to maximise returns from a fattening enterprise and to achieve equity amongst all producers. Is it equitable for buyers of store stock to pay less than sellers might want? Is it equitable for some producers of store stock, because of location, seasonal conditions, or market circumstances, to receive higher returns than others? When are these differences equitable and when are they not?
The conflict between maximising returns and ensuring equity also arises from the pooling of returns or costs. If transport costs are pooled, those closest to a processing facility, for example, will subsidise those more distant. Producers closer to the processing facility will be relatively disadvantaged in maximising their returns because of pooling which gives effect to the equity objective.
The same logic applies to individual industries. Beef and sheep compete for many resources, including land. Similar objectives but different policies pursued by each industry will result in conflicts to be resolved. Supporting wool prices will possibly benefit wool producers (in the short term) but disadvantage beef producers in their quest for maximum profitability.
Then there is the question of producer board objectives. Does the objective of maximising net producer returns from the market apply to each unit of output or to aggregate industry returns? If the objective is to maximise the return for a unit of output then considerations like minimum quality standards and levels of production become important. This is because low quality and extra production tend to lower unit returns. However, if the objective is maximising aggregate industry returns, then this suggests an approach of producing as much as the market will buy regardless of price.
2.4.1 The need to focus on profitability
These issues are far from trivial and go to the heart of what should be the main producer objective. Currently, the emphasis is on trying to raise farm gate prices. However, the producerÕs pre-eminent objective should be to maximise returns on investment Ñ profitability. Yet this objective receives very little attention or emphasis past the farm gate.
It is a major conclusion of this study that in setting up and supporting marketing arrangements, producers have focused on the wrong objective. Maximising farm gate prices does not necessarily result in farm profitability or the profitability of off-farm assets being maximised. Furthermore, the objective of maximising market returns means marketers face incentives which can lead to producer profitability being reduced rather than maximised.
There are a number of important reasons why producers should focus on profitability rather than farm gate prices. The most obvious reason is that maximising market returns does not necessarily mean profits are maximised. Activities aimed at maximising market returns elicit competitor and production responses and are not costless to achieve. Any activity or regulation aimed at improving market returns must be evaluated on the basis of both its effectiveness in raising market receipts and the associated costs (direct and indirect) of achieving this Ñ that is, the effect on profitability. This reasoning seems to be generally ignored under most current marketing arrangements and in the debate.
The provision of marketing services provides one example of the need to account for changes in both returns and costs. If a customer is provided with a range of marketing services, higher market returns would be expected since a higher value product would be purchased. Profitability would be influenced by the cost effectiveness of this marketing activity. Considering only the extent to which market returns have been raised could be quite misleading and would certainly not constitute evidence of unambiguous producer benefits.
Returns are also influenced by the quality of the product. If a marketing body raises minimum export quality standards through the use of its statutory powers, then, assuming nothing else changes, it is axiomatic that export market returns will rise. This outcome owes more to logic than to marketing. Some examples are documented in the industry chapters where marketing bodies have attempted to raise average export returns to producers by raising minimum quality standards. Since they are judged on market returns they face strong incentives to take this type of action.
Another example is the consequences of higher returns in some markets leading to increased New Zealand production which must be sold in lower priced markets. Maximising market returns will not necessarily maximise producer profitability unless the quantity supplied to the export market as a whole is appropriately controlled. This can be achieved either by institutional controls or correct producer pricing, both of which are discussed in chapter 4. Neither approach is applied effectively in any of New ZealandÕs major rural industries and yet all have intervention policies said to be aimed at exploiting market power and raising producer returns.
A major study into agricultural marketing systems conducted by the New Zealand Market Development Board provides a good example of the emphasis being placed incorrectly on returns alone. That study posed the following as one of the key questions to be addressed:
ÒFrom a foreign exchange earnings viewpoint, how does a single desk system match up against the alternative of competing exporters?Ó
There is no logical basis for assuming a systematic, positive relationship between foreign exchange earnings and producer profitability. There are circumstances under which increasing foreign exchange earnings could reduce producer profitability and hence the performance of the industry and the economy. This is occurring in some of New ZealandÕs rural industries at the moment because the cost of securing the export earnings is greater than the value of the resources used in producing them. To pursue maximum foreign exchange earnings as an objective does not ensure resource allocation in the national interest. If it did, there would be a case for open-ended subsidisation of exports.
One researcher summed the argument up in the following terms:
Ò . . . there is nothing intrinsically meritorious about providing goods for other countries; the essence of economic activity is to use resources to produce goods and services which people wish to buy, whether the whole process occurs in one country or partly in one and partly in another. The common suggestion in New Zealand that exports were especially desirable was a shorthand way of saying that the demand for imports was higher than could readily be financed, and this could be alleviated by higher exports.Ó
Maximising market returns or foreign exchange earnings is no guarantee that producer profitability or national well-being are maximised. Assessing whether these latter objectives are being achieved requires consideration of the costs associated with securing higher returns on export markets.
2.5 Priority Objectives and Resolving Conflicts
There are four major conclusions that can be drawn from this discussion of objectives.
¥ The national interest (maximisation of national economic welfare) has the strongest claim to be the ultimate objective of any government regulation of agricultural marketing.
¥ The pre-eminent objective of rural producers should be to maximise profitability (return on investment). This applies equally to investments on and off the farm. Maximising market returns or farm gate prices does not necessarily achieve this.
¥ There is not necessarily a coincidence between the objectives of individuals and groups, and the national interest. There are also conflicts between multiple objectives and these extend right down to the individual farm.
¥ The appropriate role of the government is to provide an environment where the pursuit of individual and group objectives, and the resolution of conflicts, delivers outcomes which are in the national interest.
An important issue raised by these conclusions is how to resolve conflicts between objectives so that rural producers maximise profitability in a way that is consistent with the national interest. What is necessary is an incentive structure which ensures that everyone, in pursuing their individual objectives, behaves in a manner consistent with the national interest.
The market place has proven to be the best mechanism for resolving conflicting objectives in this manner. When operating efficiently it is a neutral and impersonal arbiter for the allocation of resources between competing demands or conflicting objectives. The role of the market in fulfilling this conflict resolution process, while ensuring producer profitability is maximised in the national interest, is discussed in the next chapter.
Chapter 2
Objectives Ñ What Are They and
Who Decides?
¥ Establishing clear objectives, determining which are the more
important, and deciding how conflicts between them should be resolved are essential
prerequisites of any assessment of marketing arrangements and regulations.
¥ The objectives of existing marketing systems and structures are
frequently poorly defined, ambiguous and in conflict. However, maximising producer returns
Ñ usually farm gate prices Ñ is the dominant objective. Producer equity is also an
important objective.
¥ There is a strong implication that achieving these producer
objectives is consistent with the national interest. Since rural activities are only part
of the economy, this coincidence is not automatic. When governments intervene in the
economy it must be presumed that their objective is the national interest.
¥ The appropriateness of current producer objectives needs to be
questioned. The ultimate producer objective should be to maximise returns on investment Ñ
profitability. Maximising farm gate prices does not necessarily maximise profitability.
The lack of emphasis on profitability reflects the fact that most existing marketing
arrangements are not focused on this objective and do not permit measurement of how well
it is achieved.
¥ No individual or sector can be expected to have the national interest
as a primary objective, but it should be the pre-eminent objective of all government
policy. It is thus vital to create an economic and regulatory framework which ensures that
individual and group behaviour is consistent with the national interest.
Box 2.1: Objectives of Producer Boards
The legislation underpinning producer boards in the wool, meat and
kiwifruit industries contains explicit statements of objectives. This is not the case for
the dairy or apple and pear industries. For all five legislation and regulations set out
functions and powers in detail. This information is supplemented by mission statements or
their equivalent contained in annual reports.
Legislated Objective Statements in Annual Reports
WOOL The general object for which the Board is The BoardÕs long-term strategy is to build
established is to obtain, in the interests of international consumer preference for New
growers, the best possible long term returns Zealand wools. It also undertakes a range of
for New Zealand wool. activities to ensure the efficient production of
wools to match this demand.
MEAT The object of the Board is to ensure that the The Board seeks to do this [achieve objective]
producers in New Zealand of stock from through:
which meat is derived obtain the best - A strong producer-ownership position in the
possible long term returns for that stock. meat processing industry
- Orderly and regionally coordinated
marketing of New Zealand meat, plus
improved trade access
- Coordination of international promotion to
develop a consistent image and greater
awareness of the qualities and benefits of
New Zealand meat
- Cost efficiencies from continuing research
and development, quality control and stream-
lined distribution.
KIWIFRUIT The object of the Board is to obtain, in the Mission Statement: To maximise the return
interests of New Zealand producers, the to the New Zealand grower by being the most
best possible long term returns for efficient supplier and most effective marketer
kiwifruit intended for export. of kiwifruit internationally.
DAIRY No specific objective in legislation. Major Its prime function is to market overseas all
functions are specified as: dairy products manufactured in New Zealand
- To acquire and market such export produce for export. The Board works with the dairy
as the Board may from time to time determine companies to ensure their manufacturing
- To control the export of dairy produce other programmes match the demands of the
than dairy produce acquired and marketed by international market place. It also integrates
the Board the industryÕs shipping, packaging, transport,
- To promote and organise the orderly storage and quality control needs and provides
development of the dairy and bobby calf vital support in the form of financial facilities,
industries in New Zealand. data processing, livestock improvement and
administration.
APPLES No specific objective in legislation. Principal To maximise the return to its suppliers
AND PEARS functions are specified as: primarily by the worldwide marketing of
- To acquire and market apples and pears pipfruit, horticultural products and related
grown in New Zealand or imported into products and services.
New Zealand
- To determine the prices which the Board
is to pay for such apples and pears.
3.1 How Well Markets Work is a Key Issue
Individuals and groups have conflicting objectives and the market place is well established as the best means of resolving them. Markets and market forces drive the New Zealand economy. For the most part they perform quite satisfactorily. They handle the economic resolution of an amazingly intricate web of competitive objectives and needs.
Markets provide a decentralised system for decision making, ensuring diversity of opportunity and maximum scope for innovation and ideas testing. Markets have a unique ability to sort and select the best from a dynamic and varied range of options. Repeatedly, competitive markets have demonstrated their superiority over command systems for delivering outcomes in the national interest.
As the World Bank recently noted:
ÒA central issue in development . . . is the interaction between governments and markets. This is not a question of intervention versus laissez-faire Ñ a popular dichotomy, but a false one. Competitive markets are the best way yet found for efficiently organising the production and distribution of goods and services. Domestic and external competition provides the incentives that unleash entrepreneurship and technological progress.Ó
While markets require some government involvement, the clear implication is that less rather than more regulation is associated with well-functioning markets. The governmentÕs role should be confined to establishing and maintaining the legal framework and important rules under which trade and commerce can proceed. The government should concentrate on providing an open and fair environment where competition decides how resources will be used and resolves conflicts between objectives.
The role of markets and the need for regulation are issues central to agricultural marketing in New Zealand and this study. Intervention in marketing is extensive and the common justification is that without it the market would fail to work properly. This study challenges that justification and concludes that almost always market failure is used as an excuse to justify marketing regulation, rather than as a soundly-based reason.
Extensive regulation has resulted in the consequences of having more competitive markets being either obscured, completely forgotten or, most commonly, shrouded in myths and misconceptions. It is therefore necessary to put aside the doctrine and folklore and examine the role of competitive markets, the circumstances in which they fail to work in the national interest, and what, if any, intervention is needed when this happens.
Markets do not form or function without human beings. The fundamental traits of human behaviour are therefore an appropriate place to start.
3.1.1 Human behaviour is relatively predictable
In an increasingly complex and fast-changing world, the fundamental characteristics of human behaviour have changed little. The way people react remains relatively easy to predict. Equally, policy makers and others trying to influence market outcomes frequently ignore these fundamental characteristics. These same people then express dismay when the policies fail to work as expected and deliver unwanted consequences.
Some feel uncomfortable with the proposition that most people are driven by self-interest. This is probably because it carries connotations of selfishness and greed which are forms of behaviour not admired in the community. It is also possible that a society or industry which likes to think it has a cooperative culture would feel uncomfortable with the concept of self-interest.
Most people do not pursue self-interest to the exclusion of all other objectives and values. Honesty, respect for the legitimate rights of others, and willingness to help the less fortunate or disadvantaged, humanise societies and economies.
In view of these considerations it is probably better to describe normal behaviour in terms of Òopportunistic tendenciesÓ. All people exhibit opportunistic tendencies. They prefer to be better off than worse off. This has two important implications in understanding how markets work and the consequences of intervention.
First, it underscores the importance of incentives as influences on behaviour. Second, it means it is relatively easy to predict behaviour when people are faced with any set of circumstances or incentives.
Take the example of pooling. Pooling alters the prices or costs faced by individuals and therefore affects investment and operational decisions. The outcomes will be different from those which would have resulted had the prices or costs not been pooled. In most circumstances actual prices and costs ensure outcomes which are in the national interest. The corollary is that pooling results in outcomes which are not in the national interest.
The way people behave Ñ pursue opportunistic tendencies Ñ does not change when the incentives change. However, the outcomes do change. This is why the nature of incentives is so important in determining market outcomes.
One particular aspect of human behaviour germane to this study is the tendency for people to pontificate publicly about how people Ñ themselves included Ñ should behave, and then act differently when pursuing their individual interests. A good example is the producer who says everyone should supply the cooperative meatworks to ensure its survival, and then sells to the buyer offering the highest price on the day. This type of behaviour is illustrated by the anecdote in Box 3.1.
3.1.2 Markets are where individuals pursue their opportunistic tendencies
A market is nothing more than a collection of human beings with opportunistic tendencies, trading with each other. The government is also a participant with the nature and extent of its involvement being a key issue.
Given the characteristics of human behaviour, it is unsurprising that most people have problems with competitive markets. They can make life difficult. There is an incentive to try to influence the market so that it delivers for the individual desired outcomes with more certainty and at lower cost. Few market participants can be expected to advocate competitive markets if they see alternative opportunities for modifying the way markets work so as to favour them, especially via government intervention.
The following view expressed by a New Zealand business executive is an excellent example of this point.
ÒThe whole thing about competition is not that you are seeking to achieve perfect markets but that you are seeking imperfect markets. You are in it for excess profits . . . for an excess and unfair market share. You are not in it only to achieve normal profits . . . . We try to build barriers [against competition from other firms] be it through advertising, or creating a brand. ThatÕs what business is about.Ó
These observations highlight two important points about markets and the conditions necessary to ensure they work in the national interest.
First, they reflect a normal, rational attitude towards the pursuit of individual or corporate objectives in the market place. They reflect an attitude consistent with the pursuit of opportunistic tendencies. It is naive to expect individuals to assume the role of ensuring that the market is fair and competitive.
However, the remarks are reassuring insofar as they indicate commercial vigour and a desire to succeed in the market place. Ensuring this entrepreneurial ambition results in outcomes which are in the national interest is the responsibility of the government. In most circumstances this can be achieved by ensuring there are no impediments, including government policies, to competition.
A competitive market will prevent Òexcess profits and unfair market shareÓ because they will attract other participants. Normal profits quickly return, if they ever disappeared in the first place. Resources end up being used where their return to the nation is highest.
The temptation facing governments is to succumb to lobbying and make their intervention more extensive and aimed at determining the outcome of the competitive contest instead of leaving it to the market. Lobbying occurs because if it is successful entrepreneurial objectives are more easily achieved Ñ or at least that is what the entrepreneur believes. When governments do this they favour some at the expense of others and usually at a cost to the nation.
3.1.3 Market failure is relatively rare
Competitive markets usually work quite satisfactorily if governments only intervene to ensure their efficient functioning. However, markets are not perfect and sometimes fail to produce outcomes in the national interest.
True market failure is much less common than many suggest or would wish to believe. The common mistake is to interpret market outcomes which are unsatisfactory for individual participants, or require a competitive response, as market failure.
Using market failure to justify agricultural marketing regulation is very common in New Zealand. The earlier discussion of human behaviour explains why many might want to advocate regulation and its retention. It is quite likely that much of this advocacy is based on misconception and misunderstanding about which regulations deliver what benefits, and to whom. In other instances, this is clearly understood and the advocacy is aimed at protecting vested interests.
The approach taken in this study is to examine the validity of the market failure propositions used to support marketing regulations. The emphasis is not on proving whether there is sufficient evidence to justify changing existing regulations. Rather, it is on examining whether there are substantive reasons for believing the outcome from a competitive market would not be in the national interest. If there is no substantive reason then regulations which reduce market competition should be removed. Similarly, this logic is applied to identify circumstances where intervention may be warranted to modify market outcomes in the national interest.
3.2 A Systematic Approach to Market Failure
If the justification for agricultural marketing regulation is market failure, then it is necessary to have a framework to assess systematically the circumstances where failure is likely to occur. Such a framework can also be used to examine the best form of intervention and its consequences. It is an imperfect world and a key consideration is to minimise the risk of jumping from the frying pan of imperfect markets to the fire of intervention and its consequences.
The remainder of this chapter examines the circumstances under which market failure is likely to occur. Frequently, market failure occurs because of existing distortionary regulations. In these circumstances the solution to market failure may be less rather than more intervention.
The tendency for unsatisfactory market outcomes to be diagnosed incorrectly as market failure usually stems from confusion over the relevant principles. The marketing debate tends to be polarised around two dogmas Ñ one which embraces marketing principles and the other which embraces economic principles. A key reason why the debate is doctrinaire is that the clash of these two dogmas has apparently proved difficult to reconcile.
3.2.1 A need to reconcile marketing and economic principles
The related disciplines of marketing and economics embrace principles which are frequently common but sometimes differ. If the differences are not recognised, then unproductive debate is inevitable.
The focus of marketing is how to beat the competition and trade as profitably as possible. The marketing analyst tends to be primarily concerned with the structure of markets, the behaviour of consumers, and the strategic and operational business approaches that will increase market share and maximise sales and profits.
Economics has a primary focus on efficiency and distributional issues, and how markets function. It is concerned with producing the most from limited resources, and achieving a desired distribution of the results of economic progress.
Marketing principles tend to dominate when marketing strategies for best commercial performance are being devised at the level of the individual firm or industry. Economic principles feature more prominently when the role of the government and the national interest is the focus. Marketing principles do not lead the analyst to a point where national interest is the focus.
That said, the two disciplines have much in common. Both recognise the importance of prices in determining behaviour and outcomes. The appropriateness of market segmentation and differentiation for increasing sales revenue is firmly underpinned by both disciplines. Both acknowledge the importance of competition, although they frequently lead to different prescriptions for combatting or capitalising on competitive situations.
The disciplines are most likely to conflict when marketing practitioners deliver outcomes which, while rational from an individual business viewpoint, are not in the national interest. This is well illustrated by the debate over a ÒNew Zealand IncorporatedÓ, or single seller, approach to agricultural exporting.
The following is a blunt description of how the two disciplines vary:
ÒThe sub-discipline of business marketing is oriented towards practical activities; it is in some ways ideal for a bureaucratic institution interested in the improved performance of well-defined functions but not wanting much basic questioning of its fundamental objectives;Ó
and:
ÒAlthough the business marketing approach may contribute to the operational problems of private or public marketing organisations, it does not have much useful information to offer concerning those more fundamental economic issues affecting trade, development, and the prices and incomes received by agricultural producers.Ó
Producer boards such as those in the dairy and apple and pear industries, appear to measure up quite well from a marketing standpoint. Given product and market characteristics, they are well suited (not necessarily uniquely well suited) to successful marketing in a competitive, international environment. They are big and have well-developed marketing and distribution systems. They seem to be well regarded by their customers. They can exercise strategic control over product flows and mixes, and market development activities, ensuring internal coordination, control over competitive selling, and achievement of scale economies.
In the view of some observers they are amongst the strongest international performers in the New Zealand economy. Their success might be emulated by other rural industries.
However, this conclusion conflicts with fundamental economic principles. For example, economics is suspicious of monopolies because they are inadequately exposed to the competitive tests necessary to ensure maximum efficiency, innovation, and overall performance in the best interests of stakeholders. It is usually difficult to prove this suspicion unequivocally because the monopoly marketing bodies do not produce the required performance indicators. More to the point, their structure and legislated status means they cannot do so, even if they wanted to.
Economic principles also suggest that a single seller business like a producer board would need to control supply to safeguard the benefits. If the board is successful in its marketing and role of improving producer returns, it will encourage more production. This may not be required; it could conflict with the objective of maximising industry and producer profitability. The additional production may jeopardise the success achieved Ñ hence the need for supply control.
Another important economic principle is that capital markets should be transparent and competitive to facilitate monitoring of performance. Investors require clear information about returns and the choice to invest where returns are judged to be best. In the dairy and apple and pear industries particularly, producers Ñ via the boards Ñ are required to invest off-farm but do not receive explicit information on investment returns. The boards are not required to obtain their capital from competitive markets.
A danger with assessments and policy prescriptions made purely within a marketing framework is that such deficiencies may never be detected or addressed.
Moreover, organisations with a marketing focus and assessed only on marketing principles cannot expect to avoid the economic monitoring of performance. In competitive markets organisations are subject to market-based sanctions whether they like it or not. Statutory monopolies attract an alternative version of this review process. It involves questioning and examination of performance and of the necessity of current arrangements. This is often driven by the industryÕs shareholders Ñ producers who experience a drop in returns and want to know why. It also involves studies like this one.
The agricultural marketing debate in New Zealand is in part a dispute about the extent to which structures and systems which appear to conform well to marketing principles should also be assessed against broader economic principles. In particular, when the two conflict how should this be resolved? Since the pre-eminent objective is the national interest, economic principles must be taken into account.
3.2.2 The three steps of a systematic approach
There are three steps in a systematic assessment of marketing regulations consistent with maximising producer profitability in the national interest. These can be encapsulated in three questions:
¥ has market failure occurred?;
¥ what can be done if it has occurred?; and
¥ what are the likely consequences of any proposed regulation?
Each of these questions is now considered in more detail. This constitutes the framework used in later chapters when major issues in the marketing debate, and in individual industries, are discussed.
Issues regarding what governments should and can do feature prominently. There are circumstances where markets might not deliver efficient outcomes or might fail to form. There is also scope for government failure and abuse of the political system. Theories have been developed which aid the design of government interventions that are likely to work best in rectifying these deficiencies with a minimum of intrusions on choice and commercial freedoms.
3.3 How Do You Know Market Failure Has Occurred?
Generally, New ZealandÕs economic objectives are pursued through voluntary economic processes within a framework of facilitating laws. The main argument for regulation is market failure Ñ that is, when for some reason prices are apt to be distorted and resulting economic outcomes are not optimal.
Well-functioning markets frequently deliver results that are unfavourable for some participants and this is often confused with market failure. Competition involves losers as well as winners, and outcomes that are unfavourable for some are merely the consequence of the various supply and demand influences delivered by normal markets.
The rules determining whether market failure is occurring are quite strict. There are three situations where market failure may arise and justify some form of government intervention. They are:
¥ ÒspilloversÓ not being priced;
¥ natural monopolies; and
¥ unexploited market power.
3.3.1 Spillovers not being priced
When the actions of some cause costs to be borne by others or individuals receive benefits for which they have not had to pay, the market is said to fail because these spillovers have not been priced correctly Ñ there is a free-rider (or forced-rider) problem.
For example, quality control and the maintenance of quality standards may constitute market failure because Òone rotten apple spoils the barrelÓ. The proposition holds that some exporters Ñ Òfly-by-nightersÓ perhaps Ñ may export produce of inferior quality to a customer wanting something better and prepared to pay for it. As a result, New ZealandÕs entire reputation for reliability of standards may be spoilt by the actions of one exporter.
The market failure is judged to have occurred because the actions of a few have caused costs to a majority, through no fault of their own.
Research is also an activity which can suffer from market failure because the products of research Ñ good ideas and improved techniques Ñ can often be poached. Realising this, potential research investors may hold back and there may be under-investment from the nationÕs point of view. The same logic is applied to market intelligence and market development.
In all cases the diagnosis hinges critically on the existence and nature of property rights, and whether benefits can be appropriated by those who have incurred the costs. An absence of the activity in question is not sufficient to establish the existence of market failure. It may simply reflect the fact that demand does not exist at prices necessary to draw forth investment.
3.3.2 Natural monopolies
The natural monopoly issue is commonly used as an argument for governments to help producers, directly and indirectly, take a stake in rural processing and marketing. It also lies behind arguments that processing investment should be controlled to avoid overcapacity and its apparently deleterious commercial effects.
The natural monopoly argument for agricultural marketing regulation has at least two components.
One concerns a small market with strong economies of scale where open competition would eventually lead to a single supplier. This single business enterprise could, it is argued, charge monopoly prices and thus exploit its customers. If it was a buyer the monopoly behaviour would drive producer prices down. Would-be competitors could be warded off by the incumbent, whose investment by now was a sunk cost, for example through predatory pricing. Later, when the potential competition had been defeated, prices would revert to exploitative levels to the detriment of those dealing with the monopolist and of the national interest.
Another component is the Ònon-sustainableÓ natural monopoly. This occurs in circumstances where competition is said to be wasteful because it prevents the business from achieving a profit-maximising scale of operation. Opportunistic competitors undertake cream skimming, that is, they pick the most profitable parts of the market and only operate there. This makes the business non-sustainable if it chooses to operate in the entire market and prevents it from achieving scale economies.
There are circumstances where, conceivably, a business may need protection against competition so scale economies deemed in the national interest can be achieved. The regulations would prohibit competitive entry while also regulating prices both to enable an efficient monopoly to break even and to prevent excess profits.
This phenomenon of inherent instability in a market is sometimes referred to as the problem of the Òempty coreÓ. An empty core is said to exist if, because of the industry's production characteristics, the competitive bargaining process never produces a stable outcome. In other words, competition becomes wasteful because a competitive equilibrium cannot be achieved.
The commercial and market characteristics likely to result in natural monopoly forms of market failure are rare. Most of the literature and empirical research on the topic has been concerned with the provision of services such as telecommunications, electricity and water. These are industries where, it has been argued in the past, there are considerable economies of scale and often little scope for product differentiation.
Relationships between a firmÕs costs (including the influence of changing technology on costs) and the level of output on the one hand, and the extent to which homogeneity characterises the production process, output and demand on the other, are the two key factors in assessing the likelihood of natural monopoly problems. In most areas of an economy, provided there are no direct or indirect barriers to entry, the variety of production technologies, products and customer needs (heterogeneity) ensures that natural monopoly forms of market failure do not occur.
The argument that regulation is needed to ensure marketing or processing businesses achieve minimum critical size underlies support for large dairy processing cooperatives, is used to argue that a large number of small meat processing companies will lead to commercial difficulties and the demise of large plants, and is said to justify single sellers because of the need to be big enough to compete internationally. In these circumstances it is important to ask whether the apparent need for regulation arises because of ÒenforcedÓ homogeneity in the industry concerned. In other words, would the problem arise if there were no restrictions on choice and a diversity of business structures were free to develop under competition. Achieving cost economies is only one part of the profitability equation. Often higher cost businesses compete effectively because they produce higher value output.
3.3.3 Unexploited market power
A third type of market failure occurs when an opportunity is being missed for a countryÕs producers to collude, either as buyers or sellers, on the world market. Whereas collusion on the domestic market is something which, on national interest and efficiency grounds, governments should normally discourage, a government may endorse collusion by its producers when exporting.
The market power argument figures prominently as a justification for many existing agricultural marketing structures and systems. It is used in support of the view that in competitive and distorted international markets, producer returns will only be maximised if competitive exporting is avoided Ñ intervention is said to be necessary to ensure coordinated and disciplined export marketing and to avoid so-called destructive price competition and weak selling.
The key consideration is determining when an industry has genuine market power internationally which it is not exploiting fully. The ability of other countries to increase supply if New Zealand seeks to exploit its market power, and the availability of substitute products, are relevant considerations. So too is the ability of New Zealand to control further trade in its products once they reach overseas markets.
Institutionalised restrictions on access to export markets may provide opportunities for additional revenue. In certain circumstances a competitive exporting industry may fail to capture any or all of this additional revenue or market rent. However, the nature of the restriction determines whether any additional revenue is available to the exporter and how best it can be secured. This is discussed further in chapter 6.
If market rents are available to New Zealand, there is then the question of who should receive them. Should they go to those producers who actually supplied the market, all producers in the exporting industry, or the New Zealand community at large?
The convention in New Zealand is that such additions to market revenue are the property of the relevant industry. For example, the dairy industry successfully harvests the market rents from the United Kingdom butter quota, and distributes them to all dairy farmers via pooled returns for milk.
However, there is no in-principle basis for concluding that is the best or only method for distributing the revenue. The butter access rights are the property of New Zealand. In principle at least, it follows that these market rents belong to the country Ñ the natural recipient would be the government with the returns being a contribution to consolidated revenue.
Finally, there is a danger that additional revenue Ñ through a price premium Ñ available through the exploitation of market power may be confused with higher prices that merely reward additional marketing services. The latter results from the market working properly rather than failing. For example, if the marketer, as part of a commercial strategy, offers credit, provides storage services to ensure year-round supply, guarantees always to have a full range of products, and/or guarantees tight quality specifications, then returns should be higher to justify the additional investment and risks. To suggest such premiums are an indication that the market power category of market failure is being rectified by a single seller producer board, for example, is an incorrect but common argument.
3.4 How to Respond to Market Failure
If market failure is occurring, the next consideration is what governments might do about it, consistent with their role as custodians of the national interest. In deciding how to respond, governments and market participants should:
¥ scrutinise the validity of the market failure diagnosis;
¥ seek to remove existing impediments and distortions Ñ as a first best solution Ñ rather than intervening further Ñ a second best response; and
¥ favour measures which involve minimum interference, and facilitate rather than control.
This logic is consistent with using market-based outcomes as the benchmark from which to assess regulation. It ensures minimum necessary intervention. It provides an important check against regulation that is either unnecessary or is being sought to assist the achievement of sectional objectives at the expense of the national interest.
3.4.1 Is the market failure diagnosis valid?
It is vital that market failure diagnoses are carefully verified. The predilection of politicians to try to ease commercial pain when it appears to disadvantage vocal individuals or groups is a common reason for incorrect diagnosis of market failure. In many cases it is existing intervention which is creating the market failure. For example, pooling can create market failure because it distorts prices.
Correct diagnosis of market failure is crucial to the long-term interests of producers. If they succumb to palliative action during a market downturn, for example, they can lock-in intervention that not only lacks a sound rationale initially, but which distorts costs and asset values subsequently.
Having experienced the distortions and economic pain resulting from the introduction, operation and then unavoidable removal of Supplementary Minimum Prices and associated price stabilisation arrangements, producers should now be extremely wary of those promising escape from market reality in the guise of fixing market failure. Producers have a strong vested interest in ensuring that market failure is correctly diagnosed.
3.4.2 Intervention which helps the market should be favoured
When market failure occurs, preference should be given to measures which facilitate market behaviour rather than regulate it. Facilitative intervention aims to improve the efficiency with which the market capitalises on the pursuit of opportunistic tendencies in the national interest.
Regulation which attempts to control behaviour is at a disadvantage because it must ensure that the behaviour of everyone is consistent with the policy prescription being implemented. This usually involves extensive policing, and varying degrees of restriction on choice. It creates incentives to circumvent the rules. It places the regulations under continuous pressure which has to be managed and contained.
The role of plant variety rights (PVR) in ensuring plant breeding investment is in the national interest is a good example of a practical application of these arguments. The introduction of PVR in New Zealand was aimed at improving the way the market worked. By extending property rights to the results of plant breeding, it allowed the investment benefits to be appropriated. It reduced the possibility of market failure leading to under-investment in plant breeding.
An alternative approach would have required administrative decisions on how much to invest in plant breeding, and what breeding activities to pursue. To avoid free riding it would have involved public funding from consolidated revenue, or a compulsory industry levy. The performance of the plant breeders would have had to be monitored to ensure they produced the best possible results from this enforced investment in plant breeding.
As this example shows, facilitation involves considerably less interference and constraints on choice, risks, and costs than management and control. PVR improves the way the market functions and reduces, rather than increases, the regulation needed to increase the likelihood that plant breeding investment is in the national interest.
Sometimes a distortion resulting from intervention is recognised but, for political or technical reasons, it may be judged difficult to remove. In these circumstances, a Òsecond bestÓ solution in the form of further intervention may be proposed.
Recent efforts by the meat industry to improve investment and marketing performance via a Meat Planning Council (MPC) is an example. The MPC imposes additional controls on the commercial activities of meat companies. This new intervention, largely a response to the criticism that meat companies are too production-driven, comes on top of the longstanding policy of using export licensing to determine who can sell what types of meat in which markets. In other words, past intervention which has suppressed investment and innovation in marketing is having its consequences treated by more intervention aimed at further controlling and influencing meat marketing.
Rarely do such second best solutions improve efficiency and outcomes in the national interest. They become part of an increasingly complex web of regulations. Thus, far from making the market work better, second best measures usually add to the problem because they extend and entrench distortions.
3.5 The Consequences of Intervention
It is important but not always easy to identify all the consequences of regulation. An attribute of competitive markets is their ability to handle complexity and detail. This ability is often overlooked. It has implications for the design and consequences of regulations. This was well described by an official responsible for President NixonÕs Wage and Price Control programme in the early 1970s:
ÒThe problem that policy makers must cope with, if they are determined to control the system, is the endless detail that is involved in the operation of the system. To control the system and yet keep it running smoothly, the authorities must intercept all of the signals coming from the system (and there are hundreds of millions), interpret them, appropriately change them (assuming they know how) and retransmit them . . .Ó
When markets are functioning satisfactorily, no one questions how they work. It is only necessary to consider the classifieds section of a newspaper, and ponder the institutional arrangements that would be required to execute such a variety of transactions as efficiently, to appreciate what diversity and detail a competitive market can handle.
By definition, intervention changes incentives to change market outcomes. A ripple effect is created as it works through the system. Many consequences will be indirect and, therefore, may be unforeseen, unexpected, or just overlooked.
The direct impact of regulations which change prices is, for the most part, fairly self-evident. Change output prices, for example through pooling, subsidies, or levies, and producers will change production. Change costs, for example through pooling, constraints on plant size or location, or controls over quality and promotion, and businesses will change their input mixes and investments. Link remuneration directly to what farmers produce or achieve, and most will be more motivated and diligent.
Some consequences of changing prices are indirect and therefore more likely to be overlooked. Stabilise or support wool prices but not beef prices, and farmers will tend to move out of beef into sheep. Pool transport costs and the price of land in more remote areas will rise. Pay all producers the same for hides and skins regardless of their value for further processing, and there will be no incentive to change management practices and improve quality. Enforce quality standards that relate a quality range to a particular price and producers will aim for the bottom of the range because anything better is not rewarded.
3.5.1 Intervention encourages Òrent seekingÓ
Regulations create vested interests and the politicisation of commercial life. The powers governments have to make laws which all must follow encourage lobbying for forms of intervention that will lead to selective advantage. This behaviour is known as rent seeking, and is amplified in Box 3.2.
Intervention which creates vested interests is potentially very costly. Resistance to change leads to an industry structure which is increasingly out of line with market outcomes. Intervention eventually has to be removed or it collapses because of its unreality. High adjustment costs are then incurred, adding to the losses sustained while the distortion was in place.
As one writer has noted:
ÒRegulation itself is thought to result essentially in inefficient outcomes, rather than just income redistribution towards politically powerful groups, because of bargaining and other transaction costs incumbent in the process of regulatory reform. Even when an initial set of regulations is efficient, the inertia of the regulatory powers will ultimately lead to inefficiencies, and the coalition building necessary for reform will occur only when these inefficiencies are extreme.Ó
Rent seeking resulting from intervention is crucial to the agricultural marketing debate because it is the basis on which politics enters and becomes entwined with commerce. The politicisation of marketing arrangements and its consequences are important issues in this report and its conclusions.
3.5.2 Intervention increases risk and uncertainty
Regulation increases the uncertainty and risks businesses face. Governments and the institutions their regulations create have the power to change the rules, and this constitutes one more source of uncertainty for business.
Risks also rise when intervention centralises decision making. Conceivably, centralised decisions may be correct more often than not, although history does not instil confidence that this is the case. When centralised decisions are wrong the consequences are suffered by the entire industry. The recent wool debacle is a graphic example. It would be highly unusual for all participants to make the same incorrect decision. Markets can handle mistakes made by some participants because others, taking a different view or approach, are making correct decisions.
The increase in uncertainty, together with specific constraints imposed by regulations, can also influence the types and sizes of businesses that evolve, and the preparedness of managers to innovate, take risks or invest in particular activities. These factors can also affect an industryÕs culture and confidence. Participants can lose confidence in their entrepreneurial abilities; the will to compete and win is diminished. Because entrepreneurial activity is constrained, important market place experience is not acquired.
3.5.3 Performance measurement and accountability
Regulation changes the nature and mix of performance indicators and methods of accountability. Organisations created by statute, either to administer rules or participate directly in the market, are subject to methods of assessment and sanction which differ from those applying in the corporate sector.
Statutory organisations do not produce conventional commercial performance indicators. Their assets are not traded and priced in an open market. They usually do not have to compete with others on commercial capital markets. They cannot go broke or be taken over like private sector organisations. The measurement of their performance, and the means by which they are held accountable, are very different from the normal corporate model.
These fundamental differences between statutory and commercial organisations are widely understood. However, there is considerable disagreement and debate over their importance and relevance to assessments of the costs and benefits of intervention.
In ACILÕs opinion the differences are vital. Issues associated with performance measurement and accountability are discussed further in chapter 5.
3.6 Concluding What is Best
The principles in this chapter are important in concluding whether particular marketing regulations are in the best interests of market participants and New Zealand. There are two foundation stones to the approach of this study:
¥ the national interest should be the pre-eminent objective; and
¥ competitive market outcomes should be the benchmarks against which the necessity and consequences of regulations are assessed.
Market failure is a legitimate reason for governments to intervene but the existence of outcomes which some dislike is not necessarily evidence of market failure.
Market failure is a necessary but not sufficient condition for intervention. The decision to intervene requires reasonable certainty that the intervention will improve the situation. Intervention failure is also a real phenomenon and can be the cause of problems greater than those created by the market failure in the first place. The consequences of intervention are not always obvious. Intervention which facilitates the operation of the market, rather than constrains commercial activity, is to be preferred.
Both marketing and economic principles have a place in this assessment process. However, if the point is reached where marketing principles suggest policies or outcomes which breach economic principles underpinning the national interest criterion, then economic principles should take precedence.
There can and will be grey areas and trade-offs. However, this systematic approach ensures areas of judgment are minimised, and trade-offs are based on a clear understanding of the gains and losses rather than determined by who shouts loudest or has most political power.
Against this general framework the following chapters examine significant issues in the marketing debate, and assess the validity of current agricultural marketing regulations.
Chapter 3
The MarketÕs Role in the Economy
¥ Competitive markets are best for resolving, in the national interest,
conflicts between the objectives of individuals and groups. The government must ensure
markets are competitive and fulfil this role properly.
¥ Markets can fail to work properly but this occurs only rarely. Often
market outcomes which some do not like are diagnosed incorrectly as market failure. This
mistake is common in agricultural marketing and used to justify extensive regulation.
¥ This study examines the validity of the market failure propositions
used to justify regulations. The starting point is to ask whether there is any reason for
concluding that a competitive market outcome would not be in the national interest.
¥ Systematic assessment of marketing regulations involves addressing three questions:
¥ has market failure occurred?;
¥ what can be done if it has occurred?; and
¥ what are the likely consequences of any proposed regulation?
¥ Accounting for differences between marketing principles and economic
principles is important. While the two have much in common, the application of marketing
principles can breach economic principles which underpin achievement of the national
interest.
¥ There are three situations where market failure may arise and justify regulation:
¥ ÒspilloversÓ not being priced Ñ that is, benefits received by those who did not pay for them, or costs paid by those
who did not cause them (free riding);
¥ natural monopolies; and
¥ unexploited market power.
¥ Existing regulations are frequently the cause of market failure. If
intervention is required on market failure grounds, it is important that all the
consequences are identified Ñ there is no point in replacing market failure with
intervention failure.
Box 3.1: Human Behaviour Is Similar The World Over
There is a tendency in all people not to practice what they preach Ñ to
support a principle or practice when asked in the crowd, but then to do what suits
self-interest best. People are also usually quick to criticise such selfish and
unprincipled behaviour when exhibited by others. Thus it is common to hear calls for
ÒdisciplineÓ from those who see a need to control the self-interested behaviour of
others.
The following anecdote illustrates this common feature of human
behaviour.
In an earlier era a Russian was being examined by his superiors for
admission to the Communist Party. He was asked a series of questions designed to assess
his attitudes towards the Party and his fellow man.
ÔWhat, if you had two ploughs, would you do with themÕ? he was asked.
ÔOneÕ, he said, ÔI would keep, and strive earnestly to raise the levels of ploughing
productivity; the other I would give to the PartyÕ.
ÔAnd what if you had two cowsÕ? ÔI would do the sameÕ, he said,
Ôone into productive use myself and one to the PartyÕ.
The assessment was going well and he knew it.
ÔWhat would you do if you had two shirtsÕ? He looked embarrassed,
muttered, stuttered and failed to answer. ÔWhyÕ, his examiners asked, Ôare you so
troubled by this question when it is exactly the same as the previous two?Õ
ÔBut comradesÕ, he said, ÔI actually do have two shirtsÕ!
With acknowledgement to John Stone, The Australian Financial Review, 7
February 1991.
Box 3.2: Rent Seeking Ñ A Cancer in the Market Place
Because the market place is generally considered to be impersonal and
treats everyone the same, changes in incentives arising from the market cause people to
get on with the business of accommodating, adapting to, or exploiting these changes.
However, when governments intervene they usually create an environment which encourages
lobbying for policies which will create selective advantage. Such rent seeking arises
because people can successfully lobby politicians but not markets.
Politicians turn people into rent seekers, and then are unable to
prevent their activities. Rent seeking is wasteful. However, its occurrence is the fault
of policies encouraging it rather than the people who practise it.
Rent seekers are rational. The effort they devote to pursuing vested
interests will be closely related to what is at stake, and judgments about the probability
of politicians doing what they ask. Rent seekers usually portray their behaviour as moral
and altruistic. It is usually argued to be in the interests of producers, an industry or
even the nation.
Rent seeking is also insidious Ñ it tends to grow like a cancer in the
economy. Once started, it is difficult to contain, let alone remove. As the captured
benefits of a privileged position increase, so too does the effort and resources devoted
to their retention. In turn, the rising political costs of Òchanging the rulesÓ
paralyses managers and legislators.
The best defence against the occurrence of rent seeking is to avoid policies which allow it to occur.
4.1 Most Incentives Are in the Form of a Price
Prices are the dominant form of incentive. They determine purchasing, selling and investment decisions. The most obvious prices are those paid to producers for their output, by producers for their inputs, and by consumers. The return on investment is also a price.
Both marketing and economic disciplines rate the importance of prices highly. However, the application of principles from the two disciplines can lead to conflicts. The principles underlying good marketing strategy may suggest making price comparisons difficult. This aids selling on the basis of non-price factors such as packaging, portion size, product characteristics or promotion. It is part of normal competition in the market.
Economic principles favour clear and undistorted prices so that decisions maximise efficient resource use and national benefit. When a marketer tries to prevent this, economic principles suggest the best response is to ensure competition and alternatives. The role of the government here is to enact laws which require truth-in-labelling and outlaw blatant dishonesty. In instances where free riding can occur governments can enact laws to improve property rights or sanction compulsory levies to fund activities such as generic promotion and R&D.
More directly controlling prices is not preferred because it treats symptoms, can make distortions worse, and is administratively expensive. Certainly, governments should avoid doing anything which contributes to distorting prices. The obvious exception is where a country might be able to influence prices on export markets for national gain.
Many of New ZealandÕs marketing regulations distort prices. The common cause of market failure is a consequence of existing regulation in the marketing system. Instead of minimising market failure many existing marketing policies are contributing to it.
This makes pricing an issue worthy of detailed examination. Some of the issues are complex but are far from theoretical. They are issues in which producers and policy makers should take an intensive and inquiring interest.
A major source of price distortions in New Zealand agriculture is the pooling and smoothing of returns and costs. Over recent years there have been some regulatory changes aimed at lessening such distortions. Some of these changes have been government-determined while others have been initiated by the marketing bodies and generally supported by producers. The removal of price stabilisation measures, and transport cost pooling so that costs fall where they lie, are examples.
These changes indicate an appreciation of the disadvantages of arrangements which distort prices. The continued existence of other price-distorting policies and the support afforded them is therefore all the more puzzling. However, it should be acknowledged that the unfavourable consequences of some of these policies are often hidden.
4.1.1 The creation of distortionsÑ where did it all begin?
To understand why marketing arrangements which were intended to remedy price distortions are causing them, it is useful to review their origins and history.
Producers believed that those handling their produce were making profits at their expense and not doing enough to improve marketing and develop new markets. There was also a belief that different approaches could extract more from some markets. Producers believed that market failure was occurring and remedial action was required. In other words, beyond the farm gate the market was failing to undertake Ñ or was undertaking insufficiently Ñ important activities such as quality control, promotion, market development and R&D.
The remedial action proposed was the creation of boards and cooperatives which producers would own and control, and which would undertake these activities for the benefit of producers. It was a form of vertical integration.
Producers have wanted to do things cooperatively. This extended to concepts of equity which led to various forms of pooling and smoothing of both returns and costs. It is this particular feature of boards and cooperatives that has resulted in them creating price distortions Ñ market failure Ñ at the same time as they were attempting to remedy market failure.
Current marketing structures distort prices in two ways. Returns are pooled from markets which pay different prices. Returns from producersÕ output are pooled with returns from the marketing organisationÕs off-farm investments and commercial activities. The resulting distorted price signals cause producers unwittingly to make wrong production and investment decisions. The consequence of this ÔcreatedÕ market failure is a pattern of production which is not in the best interests of producers, the industry, or the nation.
As noted in chapter 2, there are doubts about how clearly and correctly producers defined their objectives in the first place. This confusion has influenced attitudes to marketing arrangements.
Producers have always had a keen interest in market returns and off-farm costs. Both were correctly seen as key influences on farm gate prices. However, producers should have given more attention to profitability or return on investment. Profitability is the fundamental determinant of economic success and business survival in farming Ñ as in any business. Had maximising profitability been the focus, producers may well have avoided some of the most significant distortions that were created.
4.1.2 Distorted international prices are unfair Ñ but a reality
World agricultural trade is characterised by restrictions and subsidies. This is seen as a major justification for collective action on the part of New Zealand agricultural exporters.
International price distortions are frequently portrayed in terms of level playing fields, or the lack of them. There is much nonsense talked about level playing fields. In particular, there is the spurious argument that New ZealandÕs playing field needs to be tilted because that is what many other countries do. New Zealand, so the argument goes, cannot be expected to leave it all to the market and competition when countries which constitute New ZealandÕs major markets intervene extensively and play by different rules. This argument suggests New Zealand should follow a policy of tilt for tilt. It was a central element in the case for industry protection (put forward by advocates such as W B Sutch) and is prominent in the agricultural marketing debate.
There is an important distinction between how New Zealand should view distortions in the international arena and how it should pursue its own best interests for any given set of international circumstances. This distinction is overlooked by most who discuss level playing fields in the terms outlined.
If all production subsidies and trade restrictions could be removed New Zealand would be a major beneficiary. Even if production surpluses which disrupt trade in third markets could be removed the gains to New Zealand would be significant. It therefore follows that New Zealand should pursue every available avenue for achieving these changes. This is the basis of New ZealandÕs involvement in GATT and the current Uruguay round of trade negotiations.
However, the existence of distorted prices in external markets has no general implications for domestic policies such as industry protection or agricultural marketing regulation. These distortions are reality and it is in New ZealandÕs interests to invest only in industries and production which provide satisfactory profits when sold in the market place that actually exists.
From the viewpoint of ensuring New ZealandÕs resources are allocated in the national interest there is no effective difference between, for example, the Common Agricultural Policy (CAP) of the EC, and the efficiency and low cost of the electronics industry in Taiwan. In both cases, New ZealandÕs investment decisions need to take into account the ability of New Zealand industry to compete successfully with other suppliers, regardless of how they derive their competitive advantage.
Obviously New Zealand concentrates effort on the CAP because the competitive advantage it delivers does not have a sound economic basis and the well-being of both the EC economies and New Zealand would benefit from its reform. The sounder economic base of the electronics industry in Asia is readily accepted as reality Ñ there is no basis for criticising its sources of competitive advantage.
Trying to take action Ñ within New Zealand Ñ to offset the effects of distorted international prices will only make New Zealand worse off. It is like holding your breath until the other person turns blue. However unpalatable it might be, it is in New ZealandÕs interests only to produce products and volumes which can be exported profitably. This should be the primary objective of agricultural marketing policies in New Zealand. Many current arrangements are not achieving this objective.
4.2 The Distortions Resulting from Price Pooling and Stabilisation
In examining the consequences of distorted prices it is worth restating two important considerations. The first is the way producers react to distorted prices. Producers will make decisions which they believe will maximise their profitability. If the consequence is undesirable from the nationÕs viewpoint, this is not the fault of the producer. It is the fault of the distortion to which the producer has reacted.
The second relates to judgments about future prices. Prices are characteristically volatile in agricultural markets. When decision making is centralised, there are high risks that decision makers will make wrong judgments. Interference with prices removes the ability of producers to make their own, possibly differing, judgments about future prices and react accordingly. A diversity of judgments and reactions regarding future prices can also reduce risks from a national perspective.
Three types of price manipulation are common in New ZealandÕs agricultural marketing arrangements:
¥ pooling of costs beyond the farm gate;
¥ pooling returns from a number of markets in which prices differ, and pooling product and off-farm investment returns; and
¥ stabilising prices and paying producers a stabilised or smoothed price.
4.2.1 Pooling costs has obvious consequences
Pooling costs such as processing, land transport and sea freight has usually been justified on equity grounds. It has been considered unfair that differing costs, because of farm location or size of processor, should be reflected directly in the farm gate returns to individual producers.
This pooling has two consequences. It diminishes the incentives for individuals to minimise these costs. It distorts investment decisions by masking the true costs of location and plant size. These consequences are well understood which is why this type of pooling is on the decline.
Pooling Ñ involving groups of people choosing to share the risks and costs of bad luck Ñ characterises the insurance industry. Insurance practices are less distortionary because an explicit cost (the premium) is associated with covering the risk of an unfavourable event. For insurance markets to work efficiently, and for insurance companies to stay in business, cross-subsidisation (or pooling) needs to be kept to the minimum acceptable to customers. It is for this reason that insurance involves a degree of market segmentation on the basis of riskiness. Customers pay more for car insurance if they have a poor accident record, and more for house insurance if they build on flood plains. This limits the extent to which Òpooling for equityÓ is distortionary.
If insurance pooling is a producer objective, a good test of its non-distortionary character is whether or not it is offered commercially. If the insurance business does not see a commercial opportunity in its provision (at a price) then it is likely that a distortionary cross-subsidy of some form is involved. Producers then need to examine how they would benefit from creating such a distortion.
4.2.2 Pooling returns from differing markets and investments
When a board or cooperative pools returns to producers from markets which pay different prices, or pools market returns with returns from off-farm investments:
¥ producers will increase output beyond the point at which individual and industry profitability is maximised in the national interest; and
¥ neither the board, cooperative, nor producer, is aware that this has occurred.
Given the objectives of maximising profitability and national benefits, these are serious problems. The payment of a pooled return can encourage loss-making production without providing the normal signals.
An illustration of the effects of pooling is presented in Box 4.1. While this is a simplified example, the in-principle conclusions are applicable to most market circumstances.
A more rigorous and general treatment of the consequences of pooling is presented in Appendix 1. The following important conclusions can be drawn:
¥ The unfavourable consequences of pooling stem from the fact that most cooperatives and producer boards use farm gate returns as the primary means of distributing operating profits. This is a characteristic of their structure, since they were not established as organisations to maximise profit in their own right. These bodies view their primary allegiance as being to their owners in their capacity as suppliers rather than to their owners in their capacity as investors, even though in most cases the suppliers and the owners are the same individuals.
¥ When returns from a number of markets that each pay a different price, including quota markets where rents are available, are pooled, the producerÕs return encourages production to expand beyond the point where profits are maximised. Some output is unwittingly produced at a loss.
¥ The manner in which pooling works means neither the processing/marketing organisation nor the producer has any way of knowing what is occurring. The producer sees a pooled price which appears profitable and expands production. The cooperative or board sees production expanding and presumes this reflects its success in marketing. Even if the cooperative or board decided to try to solve the problem, it could not do so because it lacks crucially important information on the marginal costs of production on individual farms. It is not structured so as to solve the problem by posting an appropriate price to the producer.
¥ Even if a producer did know that production was beyond the point of maximum profit that producer would Ñ with returns being pooled Ñ be disadvantaged by a unilateral decision to stop loss-making production.
¥ Cooperatives and producer boards were established to secure higher farm gate prices for producers as a major objective. It is paradoxical that the way they have been structured, and particularly the manner in which they pool differing prices from different markets, means that the more successful they are at raising returns and supplying markets with a range of prices, the less successful they are at maximising producer profitability and serving the national interest.
Similar distortions occur when the returns from a producerÕs off-farm investment in a cooperative or board are included in the product price distributed to the producer. The most obvious example is when profit from processing or marketing is included in the farmgate product price. The same applies with profits from a producer board trading product from another country, a producer board operating a motor vehicle franchise, or a cooperative dairy company with a coal mine or a finance company. These issues are discussed further in chapter 5.
4.2.3 Stabilising prices can also be distortionary
It is frequently believed to be necessary or advantageous to smooth or stabilise prices as part of agricultural marketing arrangements. The reasons advanced for doing this vary. It is sometimes considered inequitable for individual producer returns to be influenced by seasonal price variations and other short-term market influences just because of the precise timing of sale. Agricultural prices tend to be cyclical and stabilisation is seen as enabling reduction in producer risk, greater income stability, and improved demand by making prices more predictable. Government action involving taking a longer term view and smoothing the ups and downs is also argued to improve national resource allocation.
These forms of price intervention can, in some circumstances, deliver benefits. They also have the potential to incur considerable costs and, in the case of stabilisation arrangements, usually collapse. The case for using such measures revolves around judgments about whether the benefits are large enough to warrant the costs. Almost always they are not.
Smoothing has consequences similar to pooling
A frequent reason for smoothing returns within a season is to ensure as many producers as possible benefit from periods of above-average prices. However, seasonal price upturns are often associated with higher costs of production and marketing out-of-season. When prices are smoothed in these circumstances, the economic consequences are similar to those of pooling. Market failure is being created rather than remedied.
When seasonal price variations are not smoothed, individual producers consider both market prices and costs of production in deciding which seasonal production mix maximises profits. When intra-season prices are smoothed, all producers receive the same price. Profit maximisation for the individual will then be achieved by producing when costs are lowest. Producers are discouraged from producing out-of-season when, for some, it would have been profitable despite higher costs if they received the full out-of-season price. Price smoothing in these circumstances risks significant loss of income for producers and their industry.
The use of seasonal production incentives is a recognition of these principles and consequences. Such price incentives represent an attempt to correct any loss of potential market returns which is apparent to the marketing organisation. However, it is no more appropriate to determine seasonal production patterns purely on the basis of prices than it is to determine them purely on the basis of costs. The appropriate basis for such decisions is contribution to profits.
As with pooling, the processing/marketing organisation undertaking the smoothing and offering the seasonal price incentive lacks the information needed to assess contribution to profit Ñ specifically information on the marginal costs of production on individual farms during the season. This information deficiency is a fundamental problem with the use of seasonal production incentives other than those provided directly to the producer by actual market returns.
Price stabilisation Ñ a good theory which invariably fails in practice
Price stabilisation schemes Ñ via buffer funds and buffer stocks Ñ have benefits which can be theoretically demonstrated, continue to have an attraction to primary producers in most parts of the world, and collapse at about the same rate as they are introduced.
There are theoretical situations in which intervention to provide more stable and predictable prices will improve demand, and provide producers with beneficial reductions in uncertainty and risk. However, when these schemes are put into practice either markets and industry circumstances do not conform to the theoretical requirements, or administrators pursue objectives that stabilisation schemes cannot or were not designed to achieve. Furthermore, the existence of such schemes suppresses the development of market-based means for handling instability.
Accurate forecasting of price trends and major turning points is required for successful price stabilisation schemes. Administrators have to get it right consistently. Given that many price shocks in commodity markets are unexpected, this is not easy.
Providing producers with more stable incomes is often an objective of stabilising prices. Pursuing income stabilisation through price stabilisation schemes has a major flaw, and a major danger.
The flaw is that stabilising a price will only stabilise incomes fortuitously. Most commonly it will not. Incomes are determined by output prices, volume of production, and costs. Stabilising only prices might even be counterproductive. For example, lowering prices during a market peak when volumes were reduced because of drought can destabilise incomes.
Similar counterproductive outcomes can occur when some product prices are stabilised and others are not. Producers frequently diversify to reduce risks and income variability. Wool prices may be booming at the same time as beef prices are depressed. If a stabilisation scheme reduced wool returns in these circumstances, income variability is likely to be exacerbated.
The danger arising from trying to achieve income stability is that the objective evolves to one of income support. The price stabilisation scheme is then used to pay farmers more than the market Ñ even over time Ñ is willing to pay for that level of supply. The meat industry in the early 1980s, and the wool industry more recently, suffered these consequences.
Finally, stabilisation reduces the ability of the market to provide mechanisms for reducing price variability and its consequences. When individuals are required to look for alternatives they can consider options as varied as saving/borrowing money, off-farm investment, insurance, stockholding, hedging, forward contracting or diversifying production. They can also choose to do nothing.
The market does provide mechanisms and services which individual producers and businesses can use. Frequently, however, stabilisation schemes and associated policies suppress their availability by reducing the demand for such services, and hence their viability. The virtual disappearance and then re-emergence of a wool futures market in association with the existence and then collapse of wool price stabilisation schemes in New Zealand and Australia is an excellent case in point.
The importance of ensuring no impediments exist to the provision of market-based mechanisms and incentives is that they cater for the varying needs of individuals. Sometimes these variations are the reason why some price stabilisation measures work counterproductively. Also, there are many producers who simply want choice to be available. It is likely that one of the reasons for wanting choice is the unfavourable consequences they have experienced when industry schemes have attempted to provide increased certainty and stability but have failed.
4.2.4 Price averaging does occur in competitive markets
A degree of averaging (pooling and stabilising) is common in all commercial organisations. A major reason is that the (transactions) costs of doing otherwise are too high. Attracting business Ñ through offering forward contracts or stabilising prices for a period Ñ would be another reason.
When a competitive business engages in averaging there are some important differences compared with producer boards and cooperatives. The main one is that the business aims to minimise the prices paid for inputs while paying enough to call forth the quantity of production it can process and market profitability. The other forms of organisation are trying to do the reverse in regard to prices Ñ to underpin prices paid to producers Ñ with unfavourable consequences for achieving profit maximising production at the producer level. Also, the competitive business would not be obliged to accept product unless it had entered into some contractual supply arrangement Ñ it may have agreed to accept all output from a contracted area planted, for example.
These considerations give a conventionally structured competitive business much greater control over its supply than a producer board or cooperative, notwithstanding a degree of averaging or pooling by the business. It can therefore be expected to extract available profits more fully from the market place. In the example in Box 4.1, it is likely to ensure the $700,000 profit available in that example was secured. A producer board or cooperative operating pooling would have secured none of it or, if some of the simplifying assumptions were relaxed, only a part.
Ironically, it is the ability of the competitive business to appropriate such profits that caused producers in the first place to believe they were being exploited. This in turn motivated the creation of boards and cooperatives to secure the profits. If they owned these businesses past the farm gate they would be able to have the best of both worlds, it was felt.
Here then is a clue to how producers might restructure boards and cooperatives to exploit the strengths and avoid the weaknesses. This is discussed in detail in the next chapter.
4.3 Distortions Caused By Benefits and Costs Not Being Properly Priced
Many marketing regulations were put in place to remedy market failure caused by unpriced spillover benefits or costs. This type of market failure includes areas commonly referred to as public goods or where free rider problems are said to arise.
These forms of market failure are not always easy to spot. Frequently they are thought to be occurring and used to justify compulsion. If governments contemplate intervention in these situations, careful consideration needs to be given to identifying whether any impediments, which could be removed, are the real reason for the apparent market failure.
In agricultural marketing there are three areas where this type of market failure is commonly argued to be occurring, making regulation and compulsion necessary to achieve benefits being forgone:
¥ research, development and innovation;
¥ quality control and grading; and
¥ generic promotion.
The principles applying to each are the same. However, the precise nature of the market failure that might be occurring and the most appropriate responses do differ in some respects.
4.3.1 Look first for crowding out
Market failure due to spillovers not being priced arises because, for some reason, there are impediments to contracting between parties in the market. This inability of the market to bring parties together in binding and mutually acceptable commercial relationships generally reflects the absence of enforceable property rights over resources and outputs.
Markets are much less prone to fail if property rights are defined, divestible and defendable in court. Freehold title, patents and copyright laws are forms of facilitative intervention designed to reduce market failure arising through a lack of property rights. The introduction of PVR, discussed in chapter 3, is a facilitative intervention of this type in the R&D area.
Some have questioned the extent to which legal enforcement, particularly as it extends to specific laws and decreed sanctions (specific fines, gaol terms, etc), to define and enforce property rights, is essential. It may be that common law remedies are sufficient, or even that it is better to accept some degree of market failure rather than incur the economic costs associated with a legal framework, the use of its provisions, and the distortions it may create.
Nonetheless, the more widely held view is that interventions to improve the definition and enforcement of property rights should be preferred. The alternatives which involve compulsion and institutionalised decision making are less preferred but likely to be required in some circumstances.
Crowding out is a common distortion which can lead to an incorrect diagnosis of market failure. It is something of a chicken and egg problem. It is likely to arise in circumstances where regulation reduces or removes incentives for a good or service to be supplied, leading to the conclusion that intervention is necessary because the market is not delivering. Examples include ÒinsufficientÓ commercial promotional activity in circumstances where there is extensive generic promotion compulsorily funded, and ÒlimitedÓ commercial expenditure on product development where an industry levy is used to fund such R&D on behalf of an industry. Another example is the reluctance of entrepreneurs to invest in market development when this activity is undertaken by a statutory body which might also determine who can market where, and has the power to change such rules at any time.
Similar considerations apply to quality control. If quality control and grading are institutionally determined and policed, incentives for marketers to develop standards of their own will be reduced, and they will be forced to concentrate their efforts to be different and competitive elsewhere. One researcher summed this up in the following terms:
ÒBoards are praised in many quarters for maintaining strict grading controls on a national basis so that the product from one processor is exactly identical to similar grades from all other processors. This in itself takes away a major selling tool Ñ product comparison Ñ from the marketer and leaves the pricing as the major focal point.Ó
Weather forecasting is also a useful illustration of crowding out. Weather forecasts have generally been considered a prime example of a public good. The logic is that if forecasts are not publicly funded they would not be available. It is argued that the market would not provide them because it would be very difficult to prevent free riding Ñ meteorological forecasts have non-rival consumption characteristics. This means an individual could buy a forecast, use it and still have it available to give or on-sell to others.
This logic can now be questioned by observing the consequences of meteorological services being commercialised in many parts of the world. In fact, weather forecasts are often very user-specific, particularly in their detail. Markets have emerged supplying subscription-based climatic advice and forecasts. Increasingly, the person needing very limited information for planning a day at the beach, for example, is not being required to contribute through taxation to the cost of meeting the demands of shipping or airline operators for more detailed weather information.
The point is that crowding out often masks the capacity of the market to deliver needed goods and services. There is little point in extensive regulation if all that is required is the removal of crowding out.
4.3.2 Concern about under-investment in R&D
Research, development and innovation is a widespread commercial activity Ñ entrepreneurs in all sectors of the economy find it profitable. When livestock producers buy an improved animal drench, or horticulturalists buy an improved pesticide, they represent the demand a chemical company targeted when investing in the research and development. Property rights in the form of a patent and/or brand gave the company confidence that it could capture the benefits from the research investment.
It is a widely held view that the market fails to work in this way in some areas where R&D would benefit rural producers. New Zealand makes use of all the normal policy remedies for this form of market failure, namely:
¥ government action to undertake research directly or subsidise private research;
¥ laws which help secure private researchersÕ ownership of research ideas (for example, patent systems and plant variety rights); and
¥ laws which enable all members of an industry to be compulsorily levied to provide funds for industry research, with an industry body responsible for their allocation.
Recent policy changes have increased contestability for government-funded research. The rationale has been that even where government funding is believed to be justified on unpriced spillover grounds, contestability in the provision of this research output has efficiency and national interest benefits.
While none of the above policy remedies offers a perfect solution, the latter two are arguably superior because they leave to industry participants detailed decisions about funding and R&D activities. They allow people involved in an industry and the market to make the important judgments. The governmentÕs role is confined to providing those regulations which attack the cause of the unpriced spillover problems at source.
However, even this is not as simple as it sounds. In the case of compulsory industry levies, for example, decisions are needed on what constitutes an industry, what rate the levy should be, how it should be levied and collected, and what R&D should be undertaken. It is also important to ascertain whether most industry participants want, or see a need for, such intervention.
Considerable difficulty was experienced in addressing some of these questions in the case of New ZealandÕs herbage seed growing industry. It was the first industry to use the provisions of the Commodities Levy Act 1990 which was introduced to allow smaller industries to levy themselves to fund, among other things, R&D. However, it was over two years after the ActÕs introduction before the first industry Ñ herbage seeds Ñ introduced a levy under its provisions.
The saga of the herbage seed growing industry raises the all-important question of how to decide, and who decides, that intervention is necessary. There certainly appeared to be some doubt about how widespread industry support for a compulsory levy was in this industry Ñ see Box 4.2.
In ACILÕs judgment research, development and innovation is an area where regulation may be justified in specific circumstances. This is likely to be the case in certain areas affecting on-farm productivity, and innovation to improve the pricing and operational efficiency of the marketing system. Improved on-farm management systems are an example of the former. The development and introduction of more objective methods of measuring and pricing producersÕ output is an example of the latter.
While detailed examination of R&D issues has not been central to this study, much of the existing compulsorily funded and institutionally managed R&D, usually integrated into existing marketing institutions, is in areas where the market would probably deliver what is required.
The collection, analysis and dissemination of market intelligence involves considerations similar to those applying to R&D. However, it is much more difficult
dustry support for a compulsory levy was in this industry Ñ see Box 4.2.
In ACILÕs judgment research, development and innovation is an area where regulation may be justified in specific circumstances. This is likely to be the case in certain areas affecting on-farm productivity, and innovation to improve the pricing and operational efficiency of the marketing system. Improved on-farm management systems are an example of the former. The development and introduction of more objective methods of measuring and pricing producersÕ output is an example of the latter.
While detailed examination of R&D issues has not been central to this study, much of the existing compulsorily funded and institutionally managed R&D, usually integrated into existing marketing institutions, is in areas where the market would probably deliver what is required.
The collection, analysis and dissemination of market intelligence involves considerations similar to those applying to R&D. However, it is much more difficult to sustain an argument for market failure in regard to market intelligence.
The issue is not one of needing to help relatively small producers distant from their markets keep in touch with developments and trends Ñ of course this is necessary. Rather the issues revolve around whether there are any substantive reasons why the market would not meet this need if it were not being crowded out by producer boards and similar organisations.
The provision and interpretation of market intelligence is one, if not a central, reason given by existing statutory bodies to justify their existence. It is seldom rigorously challenged.
4.3.3 Quality control Ñ market failure unlikely
The often-expressed concern about quality and grading is that a few bad apples spoil the crop Ñ a clear-cut case of unpriced spillover costs. Agricultural marketing regulations are used extensively to set quality and grading standards, and to police them.
Spillover costs associated with poor quality performance by some marketers would be expected if the customer was unable to distinguish from amongst New Zealand suppliers those performing poorly. The issues here concern quality consistent with the specifications agreed for the transaction. There is a tendency to treat the quality control issue as one where the objective is to sell only top quality. There are also profitable markets for medium and low quality produce.
An obvious method of overcoming the problem is improved supplier identification ÐÊmost commonly in the form of branding. Branding is usually associated with some form of physical labelling of the product. However, a reputation for reliability as a supplier is also a brand.
In situations where an industry has chosen to promote a ÒNew ZealandÓ brand, the exporter who performs poorly might need to be controlled. However, even in this instance some form of commercial control over the New Zealand brandÕs property rights would be preferred to absolute control. Sellers could be licensed to use a quality related brand or logo only if they complied with its conditions. Opting out, and incentives to opt in, can exist under such a system with minimum intervention.
Quality and grading regulations have two dangers. The first is that statutory standards, particularly minimum standards, can in practice become the maximum for commercial participants wanting to maximise individual gain. This can severely blunt the incentives to be the best if exceeding some statutory standard provides no additional benefits.
The second danger with regulations is the effect on buyer expectations. The responsibility for ensuring quality specification works and for the associated costs does not lie entirely with the seller in the absence of intervention. Buyers also have a commercial interest in seeking out reliable brands and suppliers to reduce their risks and costs.
If buyers observe that all quality/specification deficiencies are quickly resolved to their satisfaction by regulations, they are likely to exploit this. Anyone who can have a commercial problem solved at someone elseÕs expense will find that solution attractive.
The hypothetical case in Box 4.3 illustrates how this might already be
occurring because of the approaches
¥ One way or another, most incentives take the form of a price. Market
failure occurs when, for whatever reason, prices are distorted.
* Market failure in the form of spillovers not being priced (free
riding) is used to justify many marketing regulations, particularly in the areas of
quality control and grading, promotion and research and development.
¥ Market failure is possible in some of these areas. However, many
existing regulations perpetuate and even exacerbate the problem. Commonly, industry-wide
activities and restrictions on commercial behaviour have crowded out or removed the
necessity for participants to seek market-based solutions.
¥ Quality control and grading is an area where market failure is
unlikely if the market allows poor performance to be identified and commercial choice to
be exercised. Generic promotion, if judged to be worthwhile commercially, could be
susceptible to free riders although market-related solutions are frequently available.
R&D is the area where under-investment is most likely if circumstances prevent
investors appropriating the benefits in full.
¥ Pooling of prices and investment returns distorts incentives Ñ that
is, creates market failure. This is a particularly serious fault of existing arrangements.
Where producer prices combine returns from markets paying different prices and returns
from non-farm investments, producers are encouraged to expand output beyond the point that
maximises profitability.
¥ The seriousness of these distortions is accentuated by the fact that with the existing structures and systems they are not readily apparent to either producers or marketers.
Chapter 4
The Importance of Prices and the Consequences of their Distortion
Box 4.1: An Illustrative Example of the Consequences of Pooling Returns
Assume a producer board or cooperative has a product which can be sold
in two markets. The first market pays $100 per tonne but will only accept a maximum of
10,000 tonnes. The other market will accept as much as can be supplied but only at a price
of $25 per tonne. Suppose there are 100 producers supplying the board or cooperative each
with total production costs of $30 per tonne regardless of how much each produces, and all
of whom can expect to capture the same market shares.
It is in the best interests of producers Ñ individually and
collectively Ñ only to supply 10,000 tonnes to the higher returning market. Every tonne
sold on the lower priced market incurs a loss of $5 per tonne.
If the board or cooperative supplies only the higher priced market an
industry gross margin of $700,000 will be realised. The organisation needs mechanisms to
ensure the 100 producers supply only 10,000 tonnes in total, and to distribute the
$700,000 margin. A range of mechanisms could achieve this.
The problem is that the board or cooperative does not have the necessary
producer cost information. Therefore it does not know that it should restrict sales to
10,000 tonnes. It will probably seek to supply the lower priced market and pay producers a
pooled return.
Because the pooled return will Ñ initially Ñ be higher than the cost
of production, producers will be encouraged to continue expanding output. Every extra
tonne sold over 10,000 tonnes will act to reduce the pooled return.
Eventually the point will be reached when the pooled return is $30.
Producers will not expand production beyond this point because that equals their cost to
produce. But the total industry margin will have declined to zero. The $700,000 margin
earned on the high priced market is offset by equivalent losses on the low priced market.
The margin has effectively been Òre-exportedÓ as a subsidy to consumers in the low
priced market.
From a national viewpoint, the industry has not only earned no profit,
but it has wasted considerable investment producing output at a loss when this investment
would have been better allocated elsewhere.
Each producer behaved in a rational manner in response to the bundled or
pooled price signal. As a result, each ended up worse off. The board or cooperative did
not know this because it saw production expanding. It was probably pleased with its
efforts. Essentially, the pooled price hid from producers the fact that all production in
excess of 10,000 tonnes yielded a return to the marketing organisation which was less than
the producerÕs cost of production.
The following table summarises the difference in outcome between
restricting production so only the higher returning market is supplied, and allowing
producers to expand production until they drive the pooled price down to their marginal
costs of production.
Restricting production Pooling with no
to 10,000 tonnes production restrictions
Price received by producer ($/tonne) 100 30
Quantity produced and sold (Ô000 tonnes) 10 140
Gross Revenue ($ million) 1.0 4.2
Total Cost to produce ($ million) 0.3 4.2
Gross Margin (ÒprofitÓ) ($ million) 0.7 zero
Box 4.3: Who Really Pays to Meet Mr WatanabeÕs Quality Control
Requirements?
The hypothetical Mr Watanabe is an importer of horticultural products
into Japan. His customers in Japan are very particular about quality. They want quality
produce and, perhaps of even more importance, they want it consistently. They certainly
want the quality they have paid for.
Mr Watanabe sources from a number of countries. He doesnÕt want to rely
on only one supplier and he needs to allow for seasonality and production fluctuations.
Because he is a reliable importer his business is growing. He decides to look to New
Zealand as an additional supply source. He takes some trial shipments and is happy with
the product. He increases his purchases, and the number of New Zealand suppliers. Then he
receives an ÔoffÕ shipment from one of his New Zealand suppliers. He canÕt put at risk
his hard earned relationship with his customers in Japan so he takes the loss on the chin.
Then he considers what to do.
Mr Watanabe could simply stop sourcing from New Zealand. He doesnÕt
want to do this because New Zealand has become important in filling a seasonal niche in
the market and he knows the country has the capability of supplying what he wants. He has
to get appropriate incentives and signals to the New Zealand suppliers, and do this at the
lowest cost to himself.
Experience has taught him that this type of problem is best solved by
visiting the suppliers with a view to establishing relationships that will work reliably.
Basically, to establish the same types of relationships with suppliers that he has with
his customers. The suppliers need to understand that steady business is available but only
if the buyerÕs requirements are met consistently.
Establishing and maintaining these relationships around the world is
very time consuming and expensive Ñ but Mr Watanabe has found it to be worthwhile
commercially. This is what he will have to do in the case of New Zealand.
And then he receives a lucky break. A business acquaintance in Japan
tells him the New Zealanders are paranoiac about quality control and its importance to
their countryÕs reputation as an exporter. At the first hint of a quality problem they
spring into action with a system of government-backed quality controls, regulations and
policing. Usually they do it pretty well, quality problems largely disappear and the trade
returns to normal.
Mr Watanabe puts out a press release berating the New Zealanders for
their terrible performance on quality and threatening to cease sourcing from New Zealand
unless the situation improves. The New Zealanders do the rest and he doesnÕt have to
leave his office.
Who paid to sort all this out and ensure it doesnÕt happen again? Mr
Watanabe knows he didnÕt and to him thatÕs all that matters. Whether the problem could
have been solved at lower cost to the New Zealanders through the well established market
process of Òcommercial selectionÓ is the question New Zealand producers should be
asking.
Box 4.2: A Levy for the Herbage Seed Growing Industry Ñ Was Compulsion
Necessary and How was This Decided?
The efforts of the herbage seed growing industry to introduce a
compulsory levy under the provisions of the Commodities Levy Act illustrate key issues in
R&D funding and regulation. The Act requires, inter alia, that the Minister of
Agriculture is satisfied that there is a spillover problem and that, Òon the basis of
information and evidence satisfactory to the Minister, that considerably more than half
the persons who would be primarily responsible for paying the levy support its imposition
on the commodity.Ó The Act does not specify exactly how this majority view would be
ascertained, and this issue figured prominently in the herbage seedgrowers levy saga.
The industry had been operating a voluntary levy
The Herbage Seedgrowers Subsection (HSS) of Federated Farmers is the
organisation representing growers, and the Òbody corporateÓ which applied for a
compulsory levy. The HSS claims to represent all herbage seedgrowers, and says its members
include all farmers who are registered to certify seed. The ÒindustryÓ is believed to
comprise between 1400 and 1600 growers.
The HSS had been operating a voluntary levy since the early 1980s. Seed
traders and merchants co-operated in the collection of this levy. The funds were used for
research, promotion and industry representation.
The funds allocated to research were directed exclusively to DSIR
Grasslands to develop new varieties of herbage. DSIR has an agreement with the New Zealand
Grain and Seed Trade Association (NZGSTA) which provides that all new cultivars developed
by DSIR would be licensed, on the basis of a process of competitive bidding, to individual
members of the Association for promotion and sale. While DSIR retains royalties on the
output of its research, and reinvests them in similar research, it does not undertake
selling.
The exclusive R&D arrangement between HSS and DSIR Grasslands became
an important source of dissatisfaction with the voluntary levy arrangements within the
grain and seed trade. The NZGSTA took the view that the levy was being used to fund
research by an organisation with which it was in competition. In 1988 it withdrew its
cooperation in collecting the voluntary levy and some members actively encouraged growers
not to pay. The levy was suspended in 1989. In 1990 the voluntary levy was reinstated on
the understanding that none of the funds would be used for R&D. Subsequently, it was
agreed that funds earmarked for R&D and collected by the voluntary levy on cultivars
owned (under PVR) by private companies would be returned to those owners to fund their
R&D. The trade then withdrew its objections and the voluntary levy continued into 1991
on that basis.
Prior to 1989, and in 1990 after the voluntary levy was reinstated,
grower compliance was apparently very high. Growers had the right to request a refund and
opt out, but only a very small number did this. Well over 90% of growers allowed the
voluntary levy to be deducted although there is some uncertainty over how many growers did
not agree to the deduction in the late 1980s.
The levy has always been struck at a relatively low rate. The compulsory
levy requested was to be set initially at a rate of 0.8% of the value of seed tested. At
this rate the levy represents a cost which is less than one tenth the current cost of seed
testing and certification.
Non-voting was taken as support
Prior to the change in government in late 1990, the HSS obtained
ministerial support for the introduction of a compulsory levy. The evidence used to argue
that Òconsiderably more than halfÓ of prospective levy payers supported compulsion came
from a series of meetings convened by the HSS in 1989 and 1990.
It is clear that prior to these meetings the issues had been actively
canvassed by the HSS, and extensive material on what was being proposed and why had been
distributed. Seed merchants had also been active participants in the debate as noted
earlier, and it therefore seems unlikely that many growers would have been poorly informed
on what was at stake and being proposed.
Only some 10% of industry members attended the meetings convened by the
HSS. Government officials have estimated that these members represented around 30% of the
industryÕs area and value of seed grown. An overwhelming majority of the growers who did
attend the meetings voted in favour of a compulsory levy. However, because such a small
proportion of growers attended meetings, there was clearly uncertainty about the
representativeness of this support.
In late 1990, the new Minister of Agriculture considered the support
exhibited at the meetings to be insufficient to justify the conclusion that the compulsory
levy was supported by Òconsiderably more than halfÓ of the people who would be paying
it. He required the industry to undertake a ballot of all growers.
Ballot papers were distributed on 7 December 1990 to everyone on the MAF
register of seed growers, with the requirement that they be returned by 17 December.
Growers were asked only to return the ballot paper if they did not support a compulsory
levy. The ballot paper was clearly and prominently marked with the words: ÒGrowers who do
not return a ballot paper will be held to be in favour of the proposal.Ó
However, the ballot paper did not explicitly point out that the vote was
for the introduction of a compulsory levy. The ballot paper stated the proposal being
voted on was ÒThat the Herbage Seedgrowers Subsection collect levies under the Commodity
Levies Act.Ó A fully informed vote would require the voter to know that this Act
permitted compulsory levies, and that compulsion was therefore being proposed.
By the due date for the return of ballot papers, 145 growers (around 10%
of the industry) had voted against the proposal. It was concluded that 90% of the industry
supported a compulsory levy because they did not vote against it, and hence the ActÕs
requirement for Òconsiderably more than halfÓ support had been obtained.
Critics of the voting method have pointed out that it is equivalent to
concluding that everyone not voting in a general election is assumed to have voted for the
government. Other considerations relevant to how reasonable and democratic the process was
include the fate of ballot papers that may not have reached their intended voters, and the
adequacy of the period of ten days allowed for voting given that papers were delivered by
post, and ballots had to be postmarked within that period.
The approach adopted by the ballot appears to have been designed to
exploit apathy and disinterest amongst growers. Attendance at earlier meetings suggests
such attitudes may have been widespread. Alternatively, the very low rates of opting-out
under the previous voluntary levy could be taken to suggest widespread agreement with a
compulsory levy and to be consistent with the low formal no-vote.
However, it seems reasonable to conclude that the ballot paper design,
and the method used to conduct the ballot, were Ôdemocratically unconventionalÕ, and
inherently biased in favour of demonstrating majority support for a compulsory levy.
In early 1991, with the Minister having agreed that a majority of
growers supported a compulsory levy, and the trade no longer opposing its introduction,
the drafting of the required Levy Order commenced. It took some time because of legal
complexities and the fact that this was the first Order under the new Act.
In August 1991, after the Levy Order had been drafted, the Minister
apparently had a change of mind in regard to the methods used to establish majority
industry support. It was decided that a more conventional voting procedure should be used.
The Minister indicated that satisfying the ActÕs requirement for Òconsiderably more than
halfÓ grower support would require a vote to be registered by 75% of all eligible growers
with an affirmative vote from at least 60% of all eligible growers. However, the need to
meet this requirement apparently lapsed for reasons that are not clear. The herbage
seedgrowing industry eventually got its compulsory levy introduced on 1 October, 1991.
Box 4.2 (Continued)
In late 1990, the new Minister of Agriculture considered the support
exhibited at the meetings to be insufficient to justify the conclusion that the compulsory
levy was supported by Òconsiderably more than halfÓ of the people who would be paying
it. He required the industry to undertake a ballot of all growers.
Ballot papers were distributed on 7 December 1990 to everyone on the MAF
register of seed growers, with the requirement that they be returned by 17 December.
Growers were asked only to return the ballot paper if they did not support a compulsory
levy. The ballot paper was clearly and prominently marked with the words: ÒGrowers who do
not return a ballot paper will be held to be in favour of the proposal.Ó
However, the ballot paper did not explicitly point out that the vote was
for the introduction of a compulsory levy. The ballot paper stated the proposal being
voted on was ÒThat the Herbage Seedgrowers Subsection collect levies under the Commodity
Levies Act.Ó A fully informed vote would require the voter to know that this Act
permitted compulsory levies, and that compulsion was therefore being proposed.
By the due date for the return of ballot papers, 145 growers (around 10%
of the industry) had voted against the proposal. It was concluded that 90% of the industry
supported a compulsory levy because they did not vote against it, and hence the ActÕs
requirement for Òconsiderably more than halfÓ support had been obtained.
Critics of the voting method have pointed out that it is equivalent to
concluding that everyone not voting in a general election is assumed to have voted for the
government. Other considerations relevant to how reasonable and democratic the process was
include the fate of ballot papers that may not have reached their intended voters, and the
adequacy of the period of ten days allowed for voting given that papers were delivered by
post, and ballots had to be postmarked within that period.
The approach adopted by the ballot appears to have been designed to
exploit apathy and disinterest amongst growers. Attendance at earlier meetings suggests
such attitudes may have been widespread. Alternatively, the very low rates of opting-out
under the previous voluntary levy could be taken to suggest widespread agreement with a
compulsory levy and to be consistent with the low formal no-vote.
However, it seems reasonable to conclude that the ballot paper design,
and the method used to conduct the ballot, were Ôdemocratically unconventionalÕ, and
inherently biased in favour of demonstrating majority support for a compulsory levy.
In early 1991, with the Minister having agreed that a majority of
growers supported a compulsory levy, and the trade no longer opposing its introduction,
the drafting of the required Levy Order commenced. It took some time because of legal
complexities and the fact that this was the first Order under the new Act.
In August 1991, after the Levy Order had been drafted, the Minister apparently had a change of mind in regard to the methods used to establish majority industry support. It was decided that a more conventional voting procedure should be used. The Minister indicated that satisfying the ActÕs requirement for Òconsiderably more than halfÓ grower support would require a vote to be registered by 75% of all eligible growers with an affirmative vote from at least 60% of all eligible growers. However, the need to meet this requirement apparently lapsed for reasons that are not clear. The herbage seedgrowing industry eventually got its compulsory levy introduced on 1 October, 1991.
New Zealand takes to export quality control in some horticultural industries.
The use and promotion of a New Zealand brand also has some downside. Exclusive or heavy dependence on the country of origin as the brand associated with high quality can create unnecessary problems when it comes to commercially exploiting lower priced markets for lesser quality output.
Buyers come to associate high quality with New Zealand as the country of origin. While the association of a particular brand with high quality is a sound and common marketing strategy, if the brand is the country of origin this may act to restrict the marketerÕs ability to develop markets for lower quality output. If this is to be done it essentially requires the development of an alternative brand and, particularly, the suppression of information on the country of origin so as not to disrupt the brand/quality relationship for the higher quality product.
Generally, there are few reasons for believing that market failure actually occurs in respect of quality control. Governments may need regulations in areas of public health and safety, including meeting certification requirements of importing countries that health and safety standards are met. However, there are no compelling reasons why intervention or controls need to extend beyond this Ñ there are readily available means for pricing and costing commercial practices and standards and having the benefits and costs fall where they belong.
Furthermore, some of New ZealandÕs existing arrangements are creating rather than solving market failure because they stifle or crowd out the development of market solutions which operate quite satisfactorily in all other areas of commerce.
Finally, the emphasis on quality, and particularly minimum quality standards, also reflects the main objective given to statutory marketers. Their prime responsibility is to maximise net market returns to growers. Raising minimum export quality standards can be a quick and easy route to raising export returns Ñ if average quality is raised then, other things equal, average returns should rise. This phenomenon is discussed in more detail in the kiwifruit chapter.
4.3.4 Generic promotion Ñ better benefit capture needed
Generic promotion is directed at improving demand for the output of an industry or a country. It differs from brand promotion which aims to increase demand for a particular, branded product.
Generic promotion can be susceptible to free riders while brand promotion is not. Consequently, funding generic promotion often involves compulsory levies to ensure all beneficiaries pay. The major issues surrounding generic promotion concern whether compulsion is essential, and whether generic promotion is cost effective and how this can be assessed.
The trend in the international food and fibre industry is towards branding. This suggests a diminishing need for generic promotion. However, some marketers argue that it is necessary to maintain a profile in the market for a particular product category, even though branding and associated promotion may be extensive. All New ZealandÕs major rural industries undertake some generic promotion and fund it compulsorily Ñ either as part of their single seller arrangements or by using a compulsory levy.
It does not necessarily follow that if generic promotion is judged commercially worthwhile this necessitates compulsory levies. For example, New Zealand forest owners have recently agreed to raise a voluntary levy on log exports to fund promotion of radiata pine in overseas markets. This shows private or market solutions can sometimes be found without the need for regulation.
Approaches which enable benefits to be appropriated by those who meet the costs are also possible. If, for example, there were benefits in promoting any product as the Òproduce of New ZealandÓ, then licensing and selling the rights to such a label, backed by the generic promotion campaign, would be a method for allowing those that pay to capture most of the benefits. It would have the further advantage of explicitly indicating whether producers and marketers see value in such promotion.
Where this type of approach may not be possible, expenditure on generic promotion should be approached in a manner similar to R&D funding. Contestability or competition for funding to undertake promotion should be maximised.
4.4 The Creation of Price Distortions is the Major Issue
In summary, one of the more important justifications for regulation is market failure because spillovers are not priced. This form of market failure is used to justify some of the current intervention in rural marketing, particularly controls over quality and grading, and levies for R&D and promotion.
Unpriced spillovers and free rider problems do occur and the most clear-cut cases apply to R&D. The evidence of market failure in the case of promotion is weaker. It hinges critically on judgments about the benefits of generic promotion and the effectiveness of options for appropriating costs and benefits. Generic promotion is likely to become less important with the shift away from commodity marketing to marketing based on brands and customer relationships. If generic promotion is beneficial then some form of intervention may be required if free rider problems are severe.
An important issue with both R&D and promotion is that even where market failure is judged to be occurring, and regulation is used, there is still a need to maximise competition. Considerably improved contestability has recently been introduced into the R&D industry in New Zealand. The same principles and practices could be extended to promotional activities where these are funded by levies or retention of producer returns.
Arguments suggesting the market fails in providing appropriate quality control and grading need to be considered in the context of how well the marketing system sheets home responsibility for poor performance. It is relatively easy to establish market failure on the grounds that the actions of a few have implications for the majority. However, this need not be the case if buyers are able to identify how individual sellers perform with respect to quality. The extent to which compulsory industry-wide policies can exacerbate the market failure and suppress efficient solutions is most apparent in the area of quality control and grading.
Many existing regulations are exacerbating the problem rather than reducing it. Interventions which detract from pricing efficiency and crowd out market-based solutions are relatively common. Marketing arrangements designed to benefit the producer and the nation are actually distorting prices with harmful consequences.
Without doubt the major price distortion issues relate to the consequences of pooling and smoothing prices which characterise arrangements in most major industries. Because the producerÕs farm gate return is a commercial cocktail, output is expanded beyond the point at which profits are maximised. In some industries, particularly dairy, the over-production losses are likely to be large.
Perhaps the most important proposition is that there are alternative approaches which can meet producer objectives for having a degree of ownership and control past the farm gate but which do not involve distortionary pricing policies. These options are discussed in the next chapter which considers relevant organisational issues.
5.1 What Structures are Best and Why?
The types of organisation likely to achieve producer objectives feature prominently in the marketing debate. Usually at issue is whether the market, if left alone, will create business organisations which are in the best interests of producers, or whether producers with the help of regulations need to influence their form.
Producer boards, including monopoly marketers, and cooperatives dominate agricultural processing and marketing in New Zealand. They are also common in a number of other countries. Their existence suggests that, at least in the past, producers regarded them as beneficial. There is also evidence that their existence owes much to history and accident.
However, they have not been considered uniquely suitable for agricultural processing and marketing. Large corporations and private firms are also extensively involved in these activities in New Zealand. They also characterise much of the international food trade.
This chapter looks first at the determinants of organisational structure in unregulated markets, and the attributes of structures that emerge. The cooperative as a particular form of ownership and control, and its strengths and weaknesses, are then examined. The issues discussed are equally relevant to producer boards. The evidence on whether any extensive market failure might occur with particular organisational structures is considered. The chapter then discusses performance indicators and accountability, and some important consequences for marketing policies.
5.1.1 Structures evolve as markets change
Business organisations, such as firms, form for two types of reasons.
One is to organise, coordinate and conduct business to minimise transactions costs. Transactions costs are the costs of collecting information, negotiating an agreement or deal, and ensuring and policing its execution. These costs apply in all areas of operation Ñ including the employment of people and management of their performance. In any particular market environment, some organisational structures will incur lower transactions costs than others.
The other main reason for business organisations to form is in the quest for market power. Collusion to obtain higher prices, lower outputs, agreed sales regions and so on is often an anti-competitive phenomenon. As noted in chapter 3 such conduct can only be in the national interest if it is exploiting people mostly outside the country, or if it facilitates activities typically plagued with free rider problems Ñ such as generic research.
There is extensive empirical literature on why organisations form, what determines optimum structure, and how conflicting objectives, such as the achievement of both minimum transactions costs and market power, may have to be accommodated. The key features of this literature and the conclusions it supports are discussed in Appendix 2.
The discussion can be distilled down to the following important points:
¥ The main objective of an organisation is to maximise the net returns to the business (profits). This means that returns and costs are important, and both have to be taken into account in achieving the objective.
¥ The transactions costs model is focused on minimising these costs, which is taken to be the primary determinant of organisational structure in any particular circumstances.
¥ The political economy model approaches the issues from the perspective of the marketing channel, with the aim being both to minimise transactions costs and to maximise commercial power and authority in the market place.
¥ Research on contestability theory, and work relating to dynamic efficiency in a competitive environment, highlight the importance of an absence of barriers to entry (in the case of contestability), competition and rivalry in stimulating innovation and maximising efficiency.
¥ There are inevitably tensions between the goals of minimising transactions costs, maximising competition for innovation and efficiency gains, and ensuring monopoly-type exercise of market power and influence. These conflicts should be resolved in a manner which ensures the primary objective of maximum profitability is achieved.
¥ In an evolutionary way, different organisational structures and firm sizes will tend in the absence of regulation to develop in different business areas because they prove to be the most efficient in achieving the objective of the business. As market circumstances change, so business structures can be expected to change and evolve. It is important that this be allowed to occur if efficiency of resource use is to be sustained Ñ it is in the national interest. Competition between organisational forms is one of the important dimensions of competition in open markets.
Arising from these points are three key conclusions regarding the best form of organisational structure in agricultural marketing and processing, and how it should be owned and controlled.
First, even if there appear to be sound marketing arguments, based on power, influence and market premiums, for a high degree of collective action, such concentration may still not be in the industryÕs, let alone the nationÕs, interest. It is not sufficient to demonstrate simply that higher returns are being achieved from a structure Ñ attention also needs to be paid to the costs which may include distortions to optimal production patterns, reduced scope for diverse and competitive experimentation and innovation, or a breakdown in the accountability of the organisation to industry members (stakeholders) through the absence of relevant performance indicators.
Second, the diversity of organisational structures related to differing market circumstances, and the tendency for structures to change and evolve as market circumstances change, means that structures favoured by commercial imperatives may be at odds with the institutional forms mandated by regulation. The risk in these circumstances is that new structures and new ways of doing things, which could make producers better off, are precluded.
Third, there are important reasons why producers should question whether ownership and control delivers the benefits many presuppose. There is a difference between having ownership and exercising control. Most recent developments in organisational theory Ñ discussed in Appendix 2 Ñ also call into question whether, even if producers had effective control, ownership by them guarantees that profitability is maximised.
Most importantly, there are extensive grounds for questioning whether ownership of the type apparently favoured by producers Ñ producer boards and cooperatives Ñ delivers any degree of control greater than that of the shareholder in an ordinary joint stock company. This means producers could be worse off than shareholders in ordinary companies in terms of effective control because of deficiencies in performance indicators and the lack of negotiability of the capital they hold in ÒtheirÓ board or cooperative.
As McKinlay points out, there is (internationally) widespread concern, based on empirical research, that the increasing size of many cooperatives has undermined the original democratic intent. Growth in organisations usually carries with it increasing separation of ownership and control. Control moves increasingly into the hands of the managers. Owners can only exercise effective control over managers through their investment decisions which are an important aspect of market-based sanctions. If this option is not available Ñ and it is either not available or only available on a constrained basis to producers with capital in boards and cooperatives Ñ then owners are likely to be severely constrained in the control they can exercise, regardless of what they are told or might like to think.
5.2 Cooperatives as Business Structures
Cooperatives play a major role in marketing and processing in New Zealand. While producer cooperatives are not unique to New Zealand, the extent to which they dominate post-farm gate activities in some of New ZealandÕs rural industries is unusual.
Over 70% of New ZealandÕs exports are marketed through cooperative companies. All of New ZealandÕs dairy production and around 70% of red meat production is handled through producer cooperatives. The apple and pear and kiwifruit boards can be characterised as cooperatives for the purposes of this discussion. There is a strong commitment within New Zealand agriculture to the cooperative philosophy as something distinct and desirable in its own right.
Cooperatives are largely creatures of the history and evolution of New Zealand agriculture. Typically, the big changes in arrangements for marketing and processing have been associated with periods of depressed prices. The establishment of many cooperatives can be traced to such periods when it was natural for producers to consider whether greater cooperation would help to improve circumstances.
It is important to examine the appropriateness today of the cooperative form of organisation in the context of producer objectives and the national interest. The issue is not whether cooperatives should or should not exist. In particular, if people wish to cooperate voluntarily via this type of organisation they should be free to do so. The policy issue is whether the use of cooperative structures should be mandated by statute and whether competition with other business entities should be foreclosed.
What is important is to question whether there are drawbacks associated with cooperatives, particularly as currently structured and operated, relative to other organisational options for achieving maximum efficiency in processing and marketing. The importance of this question to producers is highlighted by pre-empting one of the major conclusions in what follows Ñ there are means by which key features of cooperatives can be retained while existing deficiencies are removed.
5.2.1 What constitutes a cooperative company?
A cooperative company is a business primarily concerned with providing services to its shareholders. In agriculture, cooperatives have enabled the vertical integration of production, processing and marketing providing producers with ownership and apparent control over their output beyond the farm gate.
Cooperatives are most readily distinguished from the joint stock company by the way shares are valued and traded, and profits distributed. Cooperative members hold shares but they are not viewed as income earning investments. They are not held to obtain dividends or with the expectation of capital gains. Rather, they are the ticket which provides members with access to the services offered by the cooperative.
Cooperative benefits (normally equated to profits) are usually distributed in proportion to the level of use a shareholder makes of the cooperativeÕs services, and not in proportion to shareholding. These benefits usually take the form of rebates or supplements on purchases and sales by members. Unlike the joint stock company, a cooperative does not have to provide for conventional profit (other than for reinvestment purposes) because there is usually no pressure to provide conventional dividends.
Supplement and rebate arrangements mean the cooperative effectively handles the memberÕs produce on a consignment basis. They also permit the acceptance of supplies from non-members without the need to extend this particular membership benefit.
The objective of the joint stock company is to maximise profit. The objective of the cooperative is maximising trading surpluses so that supplements and rebates can be maximised. This is sometimes argued to be a strength of cooperatives because it avoids incentives to pursue paper profits as opposed to real returns. There is more semantics than reality in this view.
Cooperatives can and sometimes do make normal profit distributions. However, these are used primarily as a means of managing surpluses rather than being the central reason for the cooperativeÕs existence.
Many advocates of cooperatives have a profit-is-a-dirty-word mentality Ñ profit being seen to conflict with a least cost-of-service/club philosophy. Pressures not to accumulate substantial reserves also arise because shareholders are unable to secure these reserves in the form of capital gains when selling shares. Shareholders face an incentive to demand maximum distributions (prices received and paid) through supplements and rebates as the only sure way of obtaining these funds.
An important rationale behind the distribution of benefits by cooperatives is to reward members actively supporting the organisation. Dry shareholders (that is, members who do not trade with the cooperative) are seen as being entitled to their ticket price (a share value), but not to any distribution of surpluses (profits).
5.2.2 The cooperative as a club Ñ dangers with the analogy
Most cooperatives were established because producers believed independent traders and merchants were not working in their interests. They are a form of collective action to meet a perceived need.
Most clubs and non-profit organisations form for the same generic reason. Submissions made to the Justice and Law Reform Select Committee of the House of Representatives on the Companies Bill stressed this club analogy being a feature of cooperatives which could not be accommodated within joint stock company structures.
The analogy is useful in elucidating the cooperative philosophy but extending it too far risks missing some important distinctions between a club and a business. There are also important distinctions between the processing and the marketing functions of an agricultural cooperative. These relate to how well the organisation can ensure that what is supplied aligns optimally with what is being demanded.
Clubs usually exist to satisfy the demands of members Ñ typically as end users of the services of a club. For example, a golf club exists to provide members with golfing facilities as consumers of golfing services rather than as manufacturers or suppliers to third parties. Agricultural (and similar commercial) cooperatives are distinguished by the fact that the final demand on which their commercial activities depends arises outside the membership of the cooperative.
Presumably, golf club members are good at assessing their individual golfing needs. They are able to arrange a reasonably efficient matching of their supply and demand. Similar conclusions apply wherever those cooperating reasonably approximate final demand for services or products. The club analogy may even apply to the supply of distribution and storage facilities beyond the farm gate, provided there is little transformation of the basic product.
However, the analogy weakens when the cooperative is undertaking significant product transformation on behalf of producer members. The dairy farmer is a producer of milk, not milk-based products. Demand for these products is derived not from the dairy farmer but from the product consumer. Similarly, cattle and fat lamb producers, and apple and pear growers, are not the main consumers of their output.
Farmers need information on how consumer demand for final products translates into demand for what they produce. A primary function of the marketing system is to provide information on what and how much they should produce to meet the demand for final products.
This need not represent a major obstacle for processing cooperatives. As long as they are essentially handling their membersÕ produce on a consignment basis it should be feasible to maintain the flow of market signals back to members Ñ although this is not guaranteed in practice. However, the need to transmit market information imposes a layer of complexity on processing cooperatives not typically found in a simple club structure, implying the need for caution both in matching supply with demand, and with ensuring appropriate accountability.
The complexity increases when the cooperative is involved in marketing, particularly if it is able to develop premium or niche markets with the result that prices vary significantly between markets. In these circumstances, the problems in matching supply with demand, and with ensuring adequate accountability, grow markedly under a cooperative structure.
This requirement of the cooperative to send its members (suppliers) the right price signals (which is not an issue in conventional clubs), is one of the major determinants of how well many existing agricultural cooperatives serve the interests of their producer members. This was noted in chapter 4 and is developed further here.
5.2.3 Strengths and weaknesses of the cooperative structure
The ideal cooperative structure is presumably one which enables producers to pursue their cooperative philosophy but which minimises the inherent weaknesses and distortions. Most of the deficiencies relate to structural and commercial features which reduce competitiveness and hence benefits to producer shareholders and the nation.
Cooperatives are perceived to have other strengths enabling the cooperative philosophy to be put into practice. A cooperative may offer greater protection against takeovers than a conventionally structured joint stock company. However, the latter can be structured to give greater protection Ñ but at some penalty in terms of the costs of capital. Cooperatives incur similar costs for protection from takeover but these are less obvious. Furthermore, the accumulation of assets by a cooperative is rarely reflected in its share value, meaning a successful cooperative can have asset backing much higher than its formal capitalisation. This makes it a particularly attractive takeover target. Some cooperatives have found it necessary to have rules which neutralise this incentive.
Cooperatives are commonly viewed as guaranteeing an outlet for membersÕ produce. This is seen as important where production is highly perishable or cannot be changed quickly Ñ for example, milk. Whether this guarantee has any value depends on whether the market would fail to meet the producerÕs needs if the cooperative did not exist. Contracts are an obvious alternative.
There is little evidence that market failure would arise with competition, as discussed in more detail in the next section. The value in having a secure outlet for produce lies in the feeling of security and confidence it gives the producer. What the producer is less likely to appreciate is the cost that is often paid for this assurance.
Another aspect of the guaranteed outlet strength of cooperatives is the belief that they will remain loyal to the interests of members when a joint stock company would not. If loyalty means keeping prices to producers above the market, or continuing to operate when it is not profitable, then a cost will accrue to members in some way. When these costs are ultimately reflected in lower producer prices, farmers have usually not shown as much loyalty to the cooperative as they demanded the cooperative show to them. Recent circumstances in the meat industry, where farmers have sent stock to plants other than their own cooperative to obtain higher returns, provide a good illustration of this lack of symmetry at work.
While cooperatives and producer boards are not without some advantages in meeting producer objectives, the reality is that the way most of them are currently structured and function involves significant weaknesses.
Disadvantages in sourcing capital
Cooperatives are relatively poor structures for attracting equity finance, and can experience problems from the consequential increase in dependence on membership funding and debt finance. Cooperative rules typically and deliberately preclude the organisation from accessing mainstream equity markets. This isolation is exacerbated by any provisions specifically designed to reduce takeover threats.
Because members view their investment as an entry ticket, the scope for equity raising through dividend reinvestment and retention policies is also diluted. Product returns are the measure of cooperative performance and retention policies will tend to conflict with this measure, particularly where a cooperative is in competition with other cooperatives to secure members and product.
Cooperatives are likely to need capital at times when their members will also be experiencing financial stress. Because the members and the cooperative are in the same type of business, a market downturn will place financial pressures on both. Producer members of the cooperative board will be reluctant to increase retentions to meet the cooperativeÕs needs when this will exacerbate the financial stress of members. The effect is analogous to, but likely to be much more intense than, the problems mainstream equity markets have in a recession.
The willingness of people to buy surrendered shares also influences access to equity funds. In the absence of a market for freely trading shares, not all shares being offered for sale may be repurchased. The greater the tendency to maximise trading rebates, the stronger the incentives for members to hold only the minimum number of shares needed to obtain these rebates. With an excess of shares being surrendered, the cooperative faces the twin problems of a net drain on equity and an increased threat of takeover Ñ as the pressures to find additional capital rise while the cooperativeÕs capitalisation is falling relative to its asset backing.
Restrictions on equity funding usually mean relatively more debt finance, although even here the structure of a cooperative, with a limited market for selling equity, may inhibit ability to borrow. Excessive debt may result in a threat to the financial viability of a cooperative. Under extreme circumstances, this may lead to exposure to lending agencies offsetting any advantages of reduced exposure to takeover. Producer control, which lies in large part behind the support for cooperatives, may become illusory if major lenders need and choose to protect their investments.
Some cooperatives argue that they do not currently suffer from capital-sourcing problems of any consequence. In the case of many dairy cooperatives, sizeable equity has been accumulated over time. However, the ability of dairy industry cooperatives to retain earnings may reflect, at least in part, their total dominance of the industry. If all had similar retention policies, and/or similar or at least competitive milk sourcing prices, then members would have less incentive to change cooperatives when retentions lowered returns, because they would fall similarly across all cooperatives. Certainly the meat industry, which has a mix of cooperatives and conventional companies, has experienced equity raising and debt problems, as has the dairy industry in the past.
Ensuring high quality strategic planning and management
Where the rules or culture of a cooperative require a high proportion of producer directors, there is a risk that the board will not have the required range of commercial skills. Producer directors face incentives to run the cooperative as a natural extension of the farms and to seek to use it as a means of addressing short-term farm-level difficulties. These directors can face conflicts between their responsibilities to members as farmers and their responsibilities to members as investors.
These considerations may also influence the quality of senior management a cooperative is able to attract. While good managers have the ability to work positively with a board, most managers of quality prefer to work in an environment where the board provides sound strategic guidance and support and does not attempt to interfere on every occasion a shareholder rings in with a problem. The discipline of the threat of a takeover to replace poorly performing management is also largely absent.
The demands of members will differ
The cooperative structure embodies a logical conflict between the interests of members who are new or expecting to be in the industry a long time, and members expecting to exit in the near future. The net worth of a joint stock company is reflected in the share price, thus avoiding this conflict between shareholders with differing status or intentions.
Because cooperative shares do not reflect the value of the business, there is greater difficulty in aligning the interests and demands of members. To the extent this creates tensions, it is a further factor working against consistent and soundly-based commercial strategies.
This conflict would be diminished if the value of membership were embodied into the capital value of the memberÕs farm. However, this value may be discounted and the producer must, of course, sell the farm to realise the asset.
Symptoms of an ailing cooperative
The cooperative philosophy possibly helps in smoothing over such conflicts, minimising the extent of open dissent. There is clearly a sense of give and take which is well accepted. However, a willingness to compromise does not ensure decisions in the best long-run interests of members or the industry. What seems more likely is that a conservative, steady as she goes strategy would be encouraged, possibly accompanied by reduced flexibility and ability to respond rapidly. There appears to be an inherent bias against long-term investments and against changes in strategic direction which entail the deferral of immediate benefits.
Some of these issues have been addressed in a paper by the General Manager of Wesfarmers Rural Division. Wesfarmers is one of AustraliaÕs largest and most successful rural cooperatives. As it has developed, and particularly over recent years, it has implemented extensive changes to tackle what were seen as serious limitations in the cooperative structure.
Wesley described the traditional cooperative structure as a Òcargo boat Ñ an efficient, reliable yet unspectacular mode of getting from place to place.Ó While recognising the valid reasons for forming a cooperative, he argued that too often cooperatives are slow to adapt to their changing trading and commercial environments Ñ with the objective of the cooperative becoming Òsurvival Ñ for survivalÕs sake.Ó He went on to list six typical failings of cooperatives:
¥ ÒMany rural co-ops have farmer directors and although they may be superb farmers or businessmen in their chosen field, they inevitably try to run the organisation as a day to day concern Ñ as an exercise without any long-term strategic planning. In other words, the directors become management.
¥ ÒMany co-ops lack a focus, a real objective, a long term mission and they try to be all things to all people.
¥ ÒMany co-ops try to speculate in commodity trading or, even worse, back the weather and fail.
¥ ÒManagement of the moribund co-op is often poorly trained with minimal formal management skills. Staff are treated like farm labour Ñ and paid low rates.
¥ ÒProfit is regarded as a dirty word.
¥ ÒEven when a profit is made, it is paid back to shareholders in rebates/dividends and lower retail prices, rather than being earmarked for growth or diversification.Ó
Some of the key structural changes Wesfarmers has made are noted later when the types of changes New Zealand agricultural cooperatives should contemplate are discussed.
Price distortions the major problem with cooperatives
Cooperatives (and producer boards) use producer returns as the means of distributing the results of their commercial success. It is in this respect that they contrast most starkly with joint stock companies which are trying to minimise what they pay to suppliers and maximise profits for their owners.
The consequences were discussed in chapter 4. Production decisions are distorted and the profitability of producers and the industry is not maximised. These consequences are due to the structural characteristics of the organisation. Therefore, structural features need to be changed if the unfavourable consequences are to be remedied.
Possible changes to the structure of cooperatives and producer boards, and their consequences for producers, are discussed next.
5.2.4 There are structures which retain the benefits without the costs
If the main distortion of pooling or bundling returns is industry production beyond the point of maximum profitability, one option would be to retain pooling and find some non-price means of limiting production. Various types of production quota schemes can be used in these circumstances. As discussed in chapter 7, the Apple and Pear Marketing Board attempted to do this indirectly with the second tier levy and transferable crop certificates, and in the mid-1980s the Dairy Board tried to restrict dairy production (see chapter 8). The Kiwifruit Marketing Board is currently trying to restrict production indirectly via grading requirements.
The problem with trying to control production indirectly is that it tends to create distortions similar to those the industry is trying to avoid. It is also unlikely that a majority of producers would find production controls acceptable. They essentially turn producers into employees in the supply department of the cooperative or board. Those wishing to enter an industry or to expand the size of their operations would be most disadvantaged.
A better approach for meeting producer objectives would be to remove the need for prices to fulfil two conflicting roles simultaneously. The pooled price is effectively being used to distribute cooperative or board profits to the owners as well as signal how much to produce. If these two roles could be unbundled the distortions would disappear.
Prices and profits need to be unbundled
Unbundling requires a structure which uses producer prices to signal accurately how much to produce and an alternative method for returning cooperative or board profits to producer shareholders. Doing this is also likely to provide additional benefits to producers through improving the performance and accountability of the organisation.
Assuming these changes need to be achieved within the constraint of producers retaining ownership and control, what is proposed is essentially a corporate structure with restrictions on who can be voting shareholders. If only supplying producers can be voting shareholders little has changed in terms of ownership and control but the profitability of producers and the industry will benefit from the removal of price distortions.
In Australia, Wesfarmers has an unbundled structure which is still majority owned by its farmer members. Wesfarmers started life as a conventional rural cooperative with business activities confined to marketing membersÕ produce and supplying farm inputs. Today it is a large, diversified business with significant rural oriented activities but is also involved in other industries, and is publicly listed.
The most interesting feature of Wesfarmers is that a corporate structure is used for the operating business and a farmer cooperative, as a majority shareholder in this business, is used to provide producers with a significant level of ownership. When the listed company was established, cooperative members were issued shares in proportion to their shareholding in the cooperative and the cooperative was in turn allocated a majority shareholding (54%) in the company. The remaining equity was floated to the public.
Cooperative members therefore had shares in the listed company which they held directly and could trade, and majority ownership of the company via the cooperative. Farmers can trade shares in the company without needing to sell shares in the cooperative.
A further safeguard against farmers losing control of the business is provided through a founderÕs share. This share guarantees the cooperative a voting majority in the company for as long as this status is supported by a majority of members of the cooperative.
What is involved then is the maintenance of control over the assets by the cooperative, with whatever restrictions members wish to place on cooperative membership. However, equity can be raised from a much broader range of sources, including institutional investors. Investors, including cooperative members, can receive the benefits of the profit maximising activities of the company through dividends and capital gains.
Some features of Wesfarmers reflect Western Australian restrictions on the dividends which can be paid by a cooperative Ñ restrictions not applicable in New Zealand. These changes have, from the start, had the overwhelming support of the cooperative members and Wesfarmers still views itself very much as a cooperative. What has been achieved is far greater commercial flexibility; greater access by members to the assets which have been accumulated by the cooperative; greater capacity in the cooperative and the company to create wealth from its commercial activities and to return this wealth to members without it being dissipated in inappropriate production responses; and greater scope for diversification of activities.
The Wesfarmers approach is only one of a variety of alternatives. Choice of approach is very much determined by the extent to which the retention of ownership and/or control by producers is considered important. The use of a golden share, for example, is one means of maintaining control Ñ at least over specific decisions Ñ while allowing ownership to extend beyond producers.
Alternatives carry differing benefits and costs. As a general rule, restrictions on shareholding limit access to capital, management and technology. In turn this is likely to reduce the capital value of the enterprise Ñ an issue important to those producers who currently own the organisations. Eventually producers need to compare the apparent benefits of restricting ownership and control with the costs arising from the existence of such restrictions.
An illustration of the types of changes which might be expected if a conventional cooperative was corporatised Ñ that is, unbundled Ñ is presented in Box 5.1.
As already noted, the problems arising from traditional cooperative structures, and the solutions suggested, apply equally to producer boards. Organisations such as the Dairy Board, the Apple and Pear Marketing Board and the Kiwifruit Marketing Board essentially undertake consignment selling for their producers. While they may have fewer capital raising difficulties than cooperatives because of their control over retention policies, the fact that they bundle returns has the same production response consequences. Moreover, producers that own these boards cannot negotiate their equity other than indirectly through selling their farm Ñ and obtaining the value which has been capitalised into the land, albeit at a discount.
5.3 Producer Fears of Competition are Unfounded
Support for producer boards and cooperatives largely reflects producer fears that they will be disadvantaged by a more competitive system for processing and marketing their output. The implication is that more competition would bring with it market failure problems of some kind.
A frequent and emotive proposition is that under a competitive, free enterprise system New Zealand agriculture would be driven into feudalism and producers into serfdom Ñ the slaves of foreign-owned banks or multinational oligopolies.
For example, the Associate Minister of Agriculture recently told the kiwifruit industry that:
ÒWhen it comes to the industryÕs structure, the optimum way to produce maximum returns for growers is for growers to retain control of their own industry. How many wealthy South American banana growers have you come across?Ó
In a similar vein, the Chief Executive of the Wool Board in a letter to the Executive Director of the Business Roundtable said:
ÒThere is a world of difference between setting out to identify systems that maximise the returns to producers as opposed to the broader servicing industries. If one was setting out to maximise the benefits of the latter group, there are numerous examples throughout the world whereby this has been achieved by fragmenting and weakening the producer such that their net returns are basically at a peasant level.Ó
The ability of these propositions to induce a supportive producer reaction might be seen as compensating for their lack of substance and validity. Two points need to be made in despatching them to the political rhetoric basket.
First, peasantry is a relative economic state. When the Associate Minister finds difficulty in locating wealthy banana growers, with whom is he comparing their wealth? It is likely that banana growers in South America are well removed from the bottom of the socioeconomic scale in that part of the world. Closer to home, and again illustrating the concept of relativity, ACIL has been told by Australian apple growers that if they had to survive on the average incomes received by many New Zealand producers they would choose another enterprise. Clearly there is a difference between Australian and New Zealand growers regarding what they consider as acceptable wealth.
Second, it is not compulsory to be a peasant Ñ certainly not in New Zealand. While agricultural marketing has many regulations, they do not extend to making farming compulsory. This embodies a fundamental point often overlooked by producers. Businesses processing and marketing producersÕ output need producers just as much as producers need these businesses. What is the point in having an off-farm business dependent on producersÕ output and then lowering their returns until they exercise their option to do something else?
The history of marketing regulation, and the fact that many existing producers have never experienced a competitive system, probably explains why many embrace myths and misconceptions about the consequences of introducing competition. However, an objective assessment of the pros and cons of more competition can only be made using the market failure principles discussed here. The question that has to be asked is whether, in an open and competitive system, there are reasons for believing market failure would occur with significantly unfavourable consequences for producers and the nation?
The main types of market failure producers fear in a more competitive environment are:
¥ the emergence of large players and monopolies which will exploit producers;
¥ the risk of not always having an outlet for their produce;
¥ the tendency for private enterprise marketers to under-invest in product and market development; and
¥ failure to exploit fully market power opportunities.
Issues associated with exploiting market power and weak selling are discussed in chapter 6. The other three producer fears are discussed in what follows. However, first some important points on barriers to entry need to be considered.
Barriers to entry frequently explain why the types of organisations that can perform in the best interests of producers and the nation fail to evolve. These barriers can extend beyond direct statutory prohibitions on setting up a business or participating in a particular area of business activity. They can be indirect and consequently not immediately apparent.
A former President of the World Bank concluded as follows:
ÒIn countries where indigenous private sector performance is weak, we might ask whether this is not perhaps in large part the result of barriers and distortions consciously or unconsciously created by policymakers.Ó
Before producers consider remedies for an apparent organisational deficiency past the farm gate they should look for barriers to entry and seek their removal unless there is some economic justification for maintaining them. What needs to be appreciated is that the diversity and evolution of business structures argued earlier to be very important is often unfavourably constrained by barriers to entry.
It is contradictory to constrain business opportunities Ñ through restrictions on where a business can market, how it can grade and price, what freight arrangements it can make and the like Ñ and then criticise the business for being production driven and not sufficiently market oriented. Rational businesses pursue those activities most vigorously where there are the least restrictions on innovation, ideas testing, product and service differentiation, and profit opportunities.
5.3.1 Monopolies only emerge in very particular circumstances
The biggest fear producers have of more competition is the emergence of monopolies or entry of large multinational buyers who will exploit them because of their perceived lack of bargaining power. It is a fear reminiscent of the Ôwage slaveryÕ proposition advanced during New ZealandÕs debate over reform of employment relations and which, for 100 years, underpinned New Zealand industrial law and all its unfavourable consequences.
The particularly strict circumstances which need to exist for this type of market failure to occur were noted in chapter 3 and are discussed in more detail in Appendix 2. Such market failure is unlikely if an industry is characterised by diversity in how producersÕ output can be processed, what it can be processed into, and how and where it can be marketed. This type of diversity characterises all New ZealandÕs rural industries Ñ although its full expression is often constrained by existing regulations.
Diversity of commercial opportunity between the farm gate and the consumer is the best protection against monopoly problems which might disadvantage producers and the nation. While a competitive environment will not prevent the emergence of some large players, small entities are not typically disadvantaged if the market is open to competition. More importantly, so long as there are no barriers to entry any business Ñ large or small Ñ which finds it is able to create monopoly profits will quickly attract competitors, driving profits back to normal levels.
The paradox in New Zealand is that many regulations aimed at protecting producers from concentration and monopolies are actually regulatory barriers to entry which increase the risks of exploitation of the small by the large.
A good example is provided by current circumstances in dairy processing Ñ discussed in detail in chapter 8. Regulatory restrictions affecting dairy cooperative marketing and methods of pricing output place an unnatural focus on economies of scale as the means to improved commercial performance. It is for this reason that dairy cooperatives have steadily increased in size through mergers and amalgamations. Opportunities for improving profitability through non-scale related strategies are restricted, and this shows up in the limited number of smaller, specialist dairy processors and the commercial difficulties they often experience where they do exist. The argument is not that less regulation would result in no large dairy companies but rather that with fewer restrictions, particularly on exporting, a wider range of types and sizes is likely to exist. Without regulation dairy farmers are likely to have increased choice in outlets for their milk compared to the current situation.
It could be that in some areas of agribusiness and the food industry, scale economies are important and organisations need to be large to be successful. It is not necessary to have regulations to ensure large organisations emerge. This is shown by recent developments in the forestry and fishing industries in New Zealand.
Where economies of scale are important a number of large multinational companies may operate. New Zealand producers need to consider the advantages of having such companies involved in marketing their output. Internationalisation of the economy has seen substantial involvement by American and Japanese companies in other parts of the primary sector. In the dairy and horticultural industries, however, entry by such companies is largely blocked. Multinationals often bring management and financial strength, new technology and access to markets and distribution outlets. The key to ensuring that this advantages New Zealand is to have competitive markets. No matter how big the company, it will not secure the supplies it needs if its prices are below those of the competition.
There are other reasons why a competitive marketing system will ensure a few large companies do not in time dominate. First, competitive markets are always characterised by a variety of types and sizes of organisations Ñ see the discussion in Appendix 2. The fox terriers have an important role in keeping the great danes honest. Second, if there is any international trend in organisational structure it is towards downsizing. Many large commercial organisations are finding improved performance comes from operating relatively small, largely independent profit centres, often in competition with each other. The Dairy Board runs its off-shore subsidiaries largely along these lines. Third, there is no evidence that large multinational food companies are making other than normal profits. Discussion in the dairy chapter points out that firms such as NestlŽ operate on slim margins and make normal profits. There is no evidence such multinationals have grown fat at the expense of producers.
The need for single sellers because some countries have single buyers is a variation on the monopoly theme. If the commercial world worked in a way which gave single sellers significant market power then it would make sense for buyers to organise themselves similarly to avoid being played off against one another. But single buyers are a rarity, at least in successful countries, reinforcing the view that the claimed commercial advantages of the single seller are spurious.
Where countries do have single buyer structures it does not follow that single sellers are needed to deal with them. The wool industry deals with single buyer markets without such structures. Multiple sellers can and do share information when it is in their interests to do so and can, if necessary, cooperate in more formal ways. Furthermore, it is questionable how much longer single buyers might survive in some countries Ñ in the ex-Soviet Union republics and Mexico, for example, where current institutional changes are inconsistent with the concept of state purchasing monopolies.
5.3.2 Guaranteeing an outlet for produce may not mean guaranteed profitability
Many producers believe that if they did not own and control the processing business they would be vulnerable if outsiders failed commercially or decided the venture was unprofitable. Producers would then be left without an outlet, a potentially serious consequence for perishable products with high transport costs, such as milk. The cooperative or board, and control by producers, is a response to this type of concern.
The question is what, if anything, producers should do to guarantee there is an outlet for their produce. The appropriate starting point is to examine whether the market might fail in any way.
If there are no significant barriers to entry the incentives should exist for such businesses to establish and be competitive. But what about situations where a business fails commercially? In this situation the plant and facilities would be acquired by someone else at a price that is profitable to the purchaser, and the business would continue. Producers might even band together and buy the facility themselves Ñ that has happened in the past.
A variation on the theme is a processing facility that can only operate profitability when production, and therefore throughput, are at the seasonal peak. If the facility closed when production fell in the off-season, where would off-season producers find an outlet for their product?
What needs to be addressed here is why off-season processing is not profitable. If producers create a cooperative to ensure an outlet in these circumstances they may simply encourage the pursuit of an unprofitable activity. The fact that throughput is too low to support profitable processing when assessed from the perspective of the processing facility indicates that producers are being paid more for their produce during this period than is commercially justifiable.
Essentially producers face a choice between keeping a facility open and running it at a loss which they bear, or taking a lower price for their output. The alternatives end up with much the same impact.
Many businesses with seasonal variations in throughput operate year round because they are profitable on average. This is what a cooperative is likely to do. If a corporate owner were not inclined to do this, but producers were sufficiently keen for the facility to remain operational, there should be some basis for a commercial arrangement between producers and the owners of the facility. If a deal were not possible producers should question the net benefits of continued operation. While a cooperative structure may seem to remove the need for producers to worry about such matters, it is less likely to ensure decisions which are in the best interests of producersÕ profitability.
Finally, it is worth restating an earlier point about the commercial interdependence of producers and businesses which process and market their output. Once companies have invested in processing and marketing they must have throughput to secure a return on that investment. It might be argued that such investors are more dependent on producers for raw materials than producers are dependent on them ensuring an outlet for produce. This imbalance favouring producers was well-illustrated in 1991 when processor competition for supplies drove up lamb prices. In fact these were circumstances where producers would clearly have been better off if they had not owned most of the companies competing for their output.
5.3.3 Why would companies under-invest in product and market development?
There are three reasons why a profit maximising company might not invest in product and market development:
¥ free rider problems Ñ others benefit without contributing;
¥ a commercial judgment that it would not be profitable; and
¥ institutional restrictions which prevent the investment or unfavourably influence potential profitability.
The free rider problem and potential solutions were discussed in chapter 4 Ñ this is a Ôspillovers not being pricedÕ form of market failure.
A judgment that an opportunity would not be profitable seems a reasonable basis for not investing. If others, including groups of producers, have a different view there should be no impediments to them investing.
Differences in commercial judgments between producers and marketing entrepreneurs are at the heart of much of the existing intervention and control. It seems that whenever producer prices fall the explanation producers prefer is that marketers are incompetent or greedy. The more likely, if mundane, explanation is shifts in supply and demand for producersÕ output.
It is certain that if rural marketing were largely unregulated there would be instances of poor performance Ñ as there are from time to time when marketing is highly regulated. However, to blame the marketers for every instance where prices fall, or are said to be unacceptable to producers, is as naive as it is common. Producers have been too ready to use it as an excuse to intervene and control entrepreneurs.
This leads to the third reason why marketing entrepreneurs might under-invest. Regulations either prevent them from investing or make the risks and uncertainty unacceptably high. Regulations which have these effects are most prevalent in those industries with single seller arrangements. However, even in the meat and wool industries there are considerable direct and indirect controls over entrepreneurial behaviour which would have this effect.
Institutional restrictions on entrepreneurial activity are a form of barrier to entry. They are a frequent reason why markets fail. Rules and restrictions increase commercial uncertainty. As shown in chapter 10, the meat industry provides a good example of how entrepreneurial activity is influenced unfavourably by the uncertainty created when the rules are subject to periodic change. This type of uncertainty explains why entrepreneurs are cautious about investment in marketing activities. Similar examples and conclusions are presented in chapter 11 on the wool industry.
5.3.4 Expected advantages from more competition.
The advantages of more competition and less regulation are already well recognised by producers. In mid-1991, when the Minister of Agriculture made remarks which producers interpreted as suggesting further government intervention in marketing, the response was swift and emphatic. Producer representatives were reported as saying that:
Ò . . . history showed when governments became involved, problems were made worse. And when governments spoke of intervention, possible investors were scared off.Ó
There are myriad advantages for producers from more competition in processing and marketing. The diversity associated with competitive markets means greater innovation, more ideas, more risk takers and access to a much larger pool of managerial and marketing expertise. Producers must be better off if they have more alternatives from which to choose. They will share the gains of improved efficiency and performance and, through being able to exercise more choice, have greater ability to ensure this happens.
Even within the existing regulated environment, examples of entrepreneurial innovation and success can be found. This is just a glimpse of what would occur were more opportunities available. Examples in the industry chapters include a cooperative branding and promoting the wool of its members, a private meat company contracting lamb supplies to strict technical specifications, and a fruit processing company developing new, specialist products for Japan. Unfortunately there are also examples of these types of efforts being suppressed or constrained by existing regulations and controls.
Contrary to frequent assertions that competition disadvantages producers, there is evidence that other countries can and will out-market New Zealand with their competitive marketing systems. An example is the report of developments in the Chilean kiwifruit industry presented in Box 5.2.
An excellent encapsulation of why producers need to encourage competition in processing and marketing is provided in the following remarks by John Hyde, a former Australian politician, a farmer, and currently Executive Director of the Institute of Public Affairs in Melbourne:
ÒIn their own interest, it is high time farmers took a long hard look at the organisations which handle and sell their produce after it leaves the farm gate. They have no more reason to assume that statutory marketing monopolies efficiently prosecute farmersÕ interests than we all have to assume that Telecom, Australia Post, the railways and the main road departments give us the best possible service at least cost. Since in each case there is no legal opportunity for alternative services to develop, we have no sure way of knowing whether the service we get is the best possible . . . More legislated accountability . . . wonÕt make the marketing authorities efficient Ñ only competition will do that.Ó
A final point regarding producer fears of competition is the inconsistency of this stance. While producers claim to fear the consequences of competition in processing and marketing, they laud and benefit from competition throughout the rest of the economy. Most markets supplying farm and off-farm inputs to producers and their boards and cooperatives have features in common with markets supplying processing and marketing services. Why is competition not a danger and rather the source of producer advantage in the former but not in the latter? Examples illustrating this inconsistent attitude are presented in Box 5.3.
5.4 Performance Assessment and Accountability
Assessing performance and how marketing organisations account to ÒshareholdersÓ are controversial issues in the marketing debate. While performance measurement and accountability are separable, they are inter-related. Certain forms of performance measurement are required for accountability to occur effectively. Furthermore, the ability of investors to exercise choice is a fundamental determinant of effective accountability.
This conclusion has frequently been reached by other analysts and, with equal frequency, been strongly contested by supporters of existing marketing arrangements. To understand the basis of these divergent judgments, and conclude which is correct, it is necessary to work through the following propositions and logic:
¥ Effective accountability requires that those responsible for the performance of an organisation know that poor performance will have unfavourable consequences for them. At the extreme these include loss of employment, financial loss and the demise of the organisation.
¥ If this motivational fear is to be maximised in the interests of best performance, stakeholders need to have the ability to assess performance adequately, and to exercise choice when deciding how to respond.
¥ The types of performance indicators available govern the ability of stakeholders to assess performance Ñ stakeholders need indicators related to their objectives. If their objective is maximum profitability then indicators of commercial activity such as turnover, market share, growth of sales, and producer prices are inadequate. Indicators such as rates of profitability, dividends and share prices (asset values) are required.
¥ If there are restrictions on what stakeholders can do with their stakeholding, then their ability to act on the consequences of good or bad performance is constrained. This diminishes the motivational fear of managers with unfavourable consequences for achievement of stakeholder objectives.
¥ It is unrealistic to expect directors and managers to ensure they are fully exposed to these incentives and sanctions. It is human nature, and therefore reality, that their objectives, rather than those of the stakeholders, will become the more important if satisfactory performance measurement and systems of accountability are not imposed. This applies to any organisation or form of commercial structure. Problems associated with the separation of ownership and control have long been recognised, and the implementation of effective means of minimising them is crucial to the success of any organisation.
It is also in the nature of people and organisations that those responsible for performance will use an array of techniques to convince stakeholders that all is well. This is where politics, and political accountability comes in.
Political accountability describes behaviour whereby directors, managers, industry leaders and others with a vested interest in an organisationÕs survival use various types of advocacy to try to keep stakeholders happy and retain their support. It involves rhetoric, particularly calls for loyalty, unity and fairness, and the management and selective use of information. Real or alleged enemies contribute to the likely success of such political activity. It includes the use of threat and intimidation, particularly where this may be effective in exploiting the reluctance of an individual stakeholder to speak out and risk being isolated or commercially penalised.
Political behaviour is not confined to organisations dependent on statutes for survival. Companies have important shareholders which they inform and look after in other ways. Large companies have personnel dedicated to satisfying the interests and needs of stakeholders who are likely to be influential in judging performance and determining its consequences. They also keep independent analysts and public commentators well and/or favourably informed. Indeed a willingness to submit to detailed scrutiny by outside analysts, and explain business strategy and performance, has become essential to the success of listed companies.
When the performance of an organisation leaves something to be desired directors and management will be observed practising political accountability. They will try to convince stakeholders that the situation is being corrected, was due to factors beyond their control, or does not take account of all available information. They might even say genuine mistakes were made which they regret. It will then be up to stakeholders to assess these explanations, consider other performance information, and individually exercise their judgment.
It is at this point that differences in the characteristics of accountability mechanisms become important.
With the corporate or joint stock company stakeholders can please themselves how much, if any, consideration they give to this political and public relations activity. They have information on commercial performance indicators such as profitability, dividends and, most importantly, an indicator of expected future performance, the share price, which is comparable across organisations and alternative investments. Additionally, there are public and private advisers and analysts who make these comparisons as aids to stakeholder decision making. Most crucially, they have a choice of whether to retain their investment. Their stakeholding is readily negotiable and if performance is judged unacceptable they can and will move their investment elsewhere.
This choice is a key to the system of market-based sanctions which ensures that commercial accountability dominates politics in the corporate sector. Where this choice does not exist, political accountability will dominate, and lobbying and politics will have greater influence on organisational behaviour and performance than commercial incentives and the sanctions of the market place.
In the case of statutory organisations an important part of this political activity will be directed towards national politicians, on whom the organisations are ultimately dependent for their survival. With one exception, all the producer boards are located in Wellington, despite the absence of any obvious commercial rationale for such a location. Considerable resources are also devoted to industry meetings, relations with politicians, farmer organisations and government officials, participation in conferences and institutionalised consultations with other boards on a scale not found elsewhere in the commercial sector.
Adequate performance indicators and stakeholder choice underpins commercial accountability. This is a superior form of accountability because it allows objective, factually-based comparisons. It also constrains the effectiveness and hence incidence of politics and political accountability. When stakeholders have access to appropriate performance indicators and opportunities to act on them, attempts to account through political processes are dramatically less effective. Managers are ultimately far more exposed to the commercial sanctions associated with poor performance.
5.4.1 Differences between activity and performance
A useful performance measure must relate an outcome to a relevant objective. In chapter 2 the appropriateness of some producer objectives was questioned. It was argued that insufficient priority has been given to maximising profitability or return on investment, and ensuring outcomes are in the national interest.
Reporting undertaken by producer boards and cooperatives places emphasis on indicators of activity. There is ample information on unit returns to producers, total sales, turnover, market share, and changes over time in such variables. This is unsurprising given the structure and objectives of these organisations.
There is an absence of indicators such as profits, dividends (returns on capital), and asset values (through share prices determined in the market) representing capitalised performance and performance expectations. These indicators are required if producers wish to monitor whether these organisations are maximising producer profitability and performing better than the alternatives they replaced or are crowding out.
The absence of important performance indicators is a function of two factors: the structural features of most of the boards and cooperatives, and the willingness to provide proxy information. In the absence of fundamental changes to the structure of the organisations, producers have to seek meaningful information in other ways. They have to ask those responsible for the organisation and politically accountable to them. This is easier said than done because restrictions on choice leave producers in a weak bargaining position.
5.4.2 The democracy of political accountability
The organisational characteristics which lead to the dominance of political accountability frequently involve one-person-one-vote systems of democracy. While this system of voting is accepted by society as the basis of democratic government, it is not the conventional basis on which influence is exerted in commerce. Markets are generally preferred to political decision making in this sphere because they allow preferences to be expressed in a much more direct and continuous manner Ñ in this sense they are more democratic institutions than the political process.
In the corporate world, influence is normally in proportion to the stakeholderÕs commercial interest Ñ shareholding Ñ in the organisation. Political democracy is not considered appropriate because stakeholders with a relatively small holding could dispro-portionately influence outcomes. If companies allowed this to happen they would not be able to attract the capital of relatively large shareholders who would legitimately consider themselves under-represented relative to their commercial stake.
The type of shareholder democracy applying to producer boards and cooperatives does not directly relate effective influence to commercial stakeholding. The philosophy of political democracy is strong, reflecting both the cooperative culture in agriculture and the dominance of political accountability.
The fact that none of the regulated marketing arrangements involves true commercial democracy explains why changes are frequently slow to occur. A number of examples are discussed in the industry chapters. Industry participants who perceived they had most to lose from change have commonly been able to slow or prevent change because they were able to exercise influence far in excess of their relative commercial stake in the industry.
5.4.3 Auditing is a second-best alternative to market sanctions
Increasing emphasis is being given to the use of independent reviews to assess the performance of statutory marketing organisations. In some industries, for example kiwifruit, this has extended to incorporating the requirement for audit into the enabling legislation or regulations. Auditing reflects a concern about prior methods of performance measurement and accountability.
While it might be argued that independent auditing of performance Ñ as distinct from conventional financial audits which aim to ensure accounts are fair and correct Ñ is an improvement on no auditing at all, it is a very unsatisfactory substitute for market-based performance indicators and their associated accountability and sanctions. There are four main reasons why this is the case.
First, the audit can only be as good as the information on which it is based. In situations where commercial choice is restricted and price signals are distorted, the information will, by definition, be incomplete. Apart from deficiencies arising because some commercial options have not been tried and therefore comparative information is not available, there are the problems of distorted prices and their consequences not being apparent to anyone in the system Ñ this was discussed in chapter 4.
Second, while an audit might be independent, it will require considerable judgment and interpretation of available information. It is in the nature of life that even independent auditors will be inclined towards favourable judgments wherever possible, and towards very sensitively expressed unfavourable judgments where these are inescapable. It is unlikely that independent audits over the past decade would have foreshadowed the disastrous consequences of a number of industry policies. Few companies judge outside performance audits (of the overall operation) to be a useful regular management tool.
Third, the effectiveness of audits must be influenced by the effectiveness of sanctions and remedial action in instances where they are unfavourable. This raises again the implications of restrictions on choice and the role and effectiveness of political accountability. It is axiomatic that where an organisation and its management are not exposed fully to market-based sanctions there will be less likelihood that poor performance will result in satisfactory remedial action.
Fourth, and most importantly, audits represent one view, even if expert, on performance. Market assessment of performance allows the views of all stakeholders to be expressed easily.
Other indicators of an underlying concern about producer board performance are the changes made or being made to introduce more directors with appropriate commercial experience and expertise, and the recently completed review of the electoral system for appointing directors to the wool and meat boards. There are indications that widening the experience base of boards of directors has improved the commercial focus of the organisations. However, it does nothing to remove the fundamental problem which is the lack of appropriate performance indicators and market sanctions. The same applies in the case of the electoral system review. The review was not asked to address the fundamental cause of the producer dissatisfaction which initiated it. This is discussed further in chapter 10.
5.5 Organisational Structures Ñ What Producers Wanted is Not What They Got
The fundamental organisational structure issue is that restrictions on choice (barriers to entry) put at risk the dynamic flexibility necessary to ensure organisations of different types and sizes emerge and evolve in response to different market circumstances and opportunities. Organisational theory, empirical research and anecdotal observation lead to the conclusion that this dynamic flexibility is very important. If regulation is to be used to influence organisational structure then it must be confined to those circumstances where there is clear market failure.
In most of New ZealandÕs rural industries there is far too much regulation of the structure and operations of businesses. The market failure justifications for this intervention rarely stand up under close scrutiny. The consequences have been unfavourable to producers and the nation in two ways.
The first is the manner in which cooperatives and producer boards send distorted price signals to producers. This is a fundamental flaw in their design made more serious because it is not apparent to any participants. The consequence is that producers are steered away from the level of production which would maximise farm profitability. In some industries, such as dairy, the economic and commercial consequences are likely to be more significant than any other single issue in the debate about how best to market.
The second consequence of the arrangements producers have favoured is their inability to provide satisfactory performance indicators or be appropriately accountable. Producers have, at the very least, jumped from the frying pan into the fire. They have rejected a market oriented approach believing it did not serve their interests optimally, and substituted alternative arrangements where performance is less readily assessed.
Again, this deficiency is a consequence of structural flaws arising largely from the objective being to maximise farm gate prices instead of profitability. It is not primarily related to the willingness or otherwise of directors and managers to be accountable, although incentives (motivational fears) are blunted by these structural characteristics. Also, it has little relevance to whether or not those responsible for these organisations work hard and are totally committed to the interests of their producer shareholders. In fact, it is somewhat ironical that in circumstances where they do dedicate themselves to producersÕ interests, the systems they work in have been established with the wrong objective and are unable to adequately measure and recognise superior performance.
The problems discussed in this section have close parallels with those
which characterised the former state-owned enterprise sector. Managers and unions
associated with these enterprises devoted considerable resources to maintaining their
political constituency and challenging any criticism of their performance. Little
information was available to verify their Ôpublic serviceÕ claims. Following the changes
in the structure of these enterprises, the massive efficiency gains that have been made
are now available for all to see.
¥ Commercial structures form and evolve according to market
circumstances and changing needs. The ultimate objective of an organisation, and the main
determinant of the best form of organisation, is to maximise profitability.
¥ Restrictions Ñ barriers to entry Ñ on particular forms of
organisation raise the risk that those which are allowed to exist will not be the best at
meeting producer and national objectives. Restrictions on business structures and their
activities can mean that organisational forms which would develop in a competitive market
may be at odds with the structures mandated by regulations. While certain structures might
appear optimal on marketing criteria, it does not necessarily follow that they will
achieve their prime objective Ñ maximum profitability.
¥ Rural producers, dissatisfied with market-based structures, opted for
statutory organisations and cooperatives believing they will improve market returns. They
have supported structures which are not maximising profitability because of fundamental
flaws in their design.
¥ These organisations are inherently unable to produce necessary
performance indicators and cannot conform to effective accountability requirements. This
explains why politics has become so entwined with commerce in rural marketing.
¥ There are organisational structures which can meet many producer objectives without perpetuating these deficiencies. In particular, producers can retain ownership if they wish while ensuring profit maximisation and more effective performance assessment and accountability. An understanding of organisational issues is also important in allaying many of the fears producers have about being disadvantaged by competition beyond the farm gate. Competitive markets would deliver many benefits to producers and they should reconsider the wisdom of their Òown and controlÓ doctrine.
Chapter 5
What Influences the Structure and Behaviour of Organisations?
Box 5.1: What Changes Would John and Mary Friesian Notice If Their Dairy
Cooperative Was Corporatised?
How would the corporatisation of a cooperative affect a producer member?
Take John and Mary Friesian who have a typical dairy farm, supplying their local
cooperative factory. They work hard, believe everyone beyond the farm gate is working
conscientiously on their behalf, and they make an adequate income Ñ or maybe they didnÕt
think it was adequate recently.
They agree with a proposal to corporatise (unbundle) their dairy
cooperative. They are given shares in the new company and told they will receive dividends
and capital gains because their cooperative is profitable. They, along with all the other
members, still own the company and the factory. They continue milking their cows and
supplying the local factory.
What changes might they start to notice? One possibility is that nothing
might alter. They might begin to wonder why the structural changes were necessary.
However, what is being indicated is that there were no production distortions under the
previous arrangements because there were no market premiums or rents, or profits on their
off-farm investment. Alternatively, there were premiums and profits but they were being
soaked up before they reached the Friesians. The absence of premiums is unlikely in the
dairy industry. There are quite significant price differences between the highest and
lowest returning markets. Changes would be expected.
First, the price they received for their milk would fall and, as a
consequence, so would the value of their farm. They would have to consider reducing their
milk production. Their farm income and their farm wealth would fall. However, this would
be offset by dividends from the company and capital gains on the shares.
Remember that with pooling removed, production that was previously sold
at a loss will no longer be required and the companyÕs profit will rise as a result. They
have a share in this profit. What they will need to appreciate is that their income,
previously all embodied in the milk return, is now received in two separate components.
One component is the now market-related milk return and the other is the dividend on their
shares plus any capital gains.
The Friesians should find these consequences unsurprising and
acceptable. They know unprofitable markets have been supplied because, like so many dairy
farmers recently, they say the pooled return is unprofitable and production will fall in
the industry if it isnÕt increased. If the pooled return is unprofitable they can be sure
the old system dissipated much or all the available market premiums and rents.
The Friesians may find they can maximise farm profitability milking
fewer cows. However, they will only contract production to the extent that it makes them
better off. They may not need to if other efficiency gains arising from the changes mean
that New Zealand can now sell into lower priced markets profitability. John and Mary will
simply not know whether this will happen until after the changes are made. However,
regardless of whether or not their production changes, they can be sure their overall
profitability has increased and therefore so has their overall wealth. They must be better
off if they are not producing milk to be sold at a loss.
They might consider changes like taking life a bit easier.
Alternatively, they might look to diversification into beef, or mushrooms, or even
truffles. After what they have seen emerge from changes in the dairy industry they will
probably pick an industry with a minimum of intervention. They certainly will not be
tempted to invest their dairy company dividends and capital gains in dairy production if
they see a factory price for their additional milk which is not profitable. They can
remember that the pooled price didnÕt generally tell them this in the past which is why
they mistakenly produced some of their output at a loss in the first place.
There is only one major reason why the Friesians may not
enthusiastically support these changes to their dairy cooperative and board. If John is on
the board of the cooperative, fancies his chances of becoming Chairman at the next
election, and aspires to finish his career on the Dairy Board, these changes may lose some
of their attraction. Because the field is being opened up to other commercial directors,
they will not help John in achieving those particular career aspirations. In these
circumstances their final attitude will probably depend on the balance of power and
authority between John and Mary.
Box 5.2: The Chilean Kiwifruit Industry: Prospering Under a Competitive
Marketing System
In early 1992 New Zealand Kiwifruit reported on a visit to Chile by the
Chief Executive of the Kiwifruit Marketing Board. The report provides some interesting
insights into how that countryÕs kiwifruit industry is developing within a competitive
system. Highlights include the following:
¥ the industry has exhibited incredible growth with a doubling of
planted area and a three-fold increase in exports over the past decade;
¥ the horticultural industry generally is more concentrated than in New
Zealand with many growers owning orchards of 100 to 1000 hectares, producing a greater
variety of fruits, and having direct investments in export companies;
¥ the industry has a Òstrong infrastructureÓ and effective grower and
export associations; grower focus on the customer is high, as is the level of
understanding of quality and environmental issues;
¥ while there are over 30 exporters, five account for more than 60% of
kiwifruit exports; they also export Òhigh volumesÓ of other fruit and provide support
facilities to growers to ensure that quality standards and improved yields are achieved;
and
¥ European exporters were said to like dealing with Chileans Ñ they
were Òwell-educated, sophisticated, polite and very good to work with.Ó
The article finished with the following conclusion attributed to the
Kiwifruit Marketing BoardÕs Chief Executive:
Ò . . . it is imperative that the New Zealand industry achieves and
maintains the highest standards of quality, promotion and service in the market place and
our customer relations have to be second to none if we are to be compared favourably with
the Chileans.Ó
So much for the alleged inferiority of a competitive marketing system!
Box 5.3: Except in Marketing, Producers Do Not Appear to Fear
Competition
A fascinating aspect of producer attitudes towards competitive markets
for processing and marketing is the contrast with their attitudes towards competitive
markets supplying inputs. Producers recognise and gain the advantages of competition in
the latter area and yet it has many of the features they fear will disadvantage them in
marketing. The following are some examples:
¥ The world motor vehicle industry is very competitive and distorted.
Toyota and Ford are the equivalents of NestlŽ and Chiquita. Why is it not feared that
they dominate the market for commercial vehicles? Why do producers not worry about being
ripped off when they buy a vehicle? Do they worry about being exploited when it comes to
spare parts and service? Is it just a matter of time before New Zealand producers can buy
only a Toyota? Will this turn them into peasants?
¥ New Zealand does not produce most of the processing and manufacturing
equipment used in the dairy industry. This equipment is mainly imported from a small
number of specialist manufacturers located in Europe and the United States. The dairy
industry is very dependent on this equipment. Do producers fear their relatively small
equipment orders will be ignored? Is it possible that the suppliers will collude and raise
equipment prices because there are no alternatives? How can after-sales service be
reliable when the suppliers are so far away? Might the suppliers withhold the equipment to
make their own dairy industries more competitive? Will this turn New Zealand dairy farmers
into peasants?
¥ The worldÕs key financial institutions are gigantic. New Zealand is
a minnow in the international finance ocean. Is this being reflected in a lack of
competitive finance for producers in New Zealand? Are the producer boards exploited by the
Gnomes of Zurich? Do producers worry that the Bank of Tokyo will use predatory pricing to
entice them away from local institutions and suppress this competition? Is it possible
that the availability of credit to New Zealand will be controlled in an attempt to
suppress its competitive agriculture? Will this turn New Zealand producers into peasants?
Producers need to consider carefully why they do not fear the above
examples of competitive markets involving very large corporate entities. The explanation
almost certainly is that they see and experience the benefits and, therefore, would
dismiss any suggestions that they are disadvantaged. Yet these competitive markets have
many characteristics which, when they appear in processing or marketing, cause producers
to reject the notion of competition being good. It is a curious paradox.
6.1 Market Power is Used as a Key Justification for Regulation
Many consider marketing regulation is very important to exploit market power, thus maximising producer returns. References to orderly marketing, weak selling, destructive competition, market premiums and the need to extract the last dollar from the market, are the stock in trade of those advocating for regulations to achieve coordinated and disciplined marketing.
These arguments rest on the proposition that individual industries have the ability to exercise market power when organised as a single entity or extensively controlled, whereas individual exporters left to their own devices do not. One hypothetical form of market failure identified in chapter 3 was the situation where the opportunity was being missed for a countryÕs producers to obtain higher prices through collective action when selling on world markets. To ascertain whether such market failure might occur it is necessary to examine what, if any, market power an industry might have, and the available means and consequences of its exploitation. This chapter examines these issues.
The circumstances under which New ZealandÕs agriculture might be expected to have exploitable market power, and how it might be exploited, are examined first. Consideration is then given to the more important changes occurring in the international market place. International trends are making issues of coordination and discipline increasingly irrelevant because their rationale, if it were ever valid, is rapidly being consigned to history.
6.2 When Will Market Segmentation Deliver Higher Returns?
Market characteristics Ñ essentially the income, price, and cross-price demand elasticities of a product Ñ can vary significantly. A key marketing objective is to exploit these differences for maximum profit. In seeking to do this the marketer is attempting to behave like a discriminating monopolist.
The principles underpinning discriminating monopoly behaviour are well established and non-controversial. They determine the strict market conditions which must exist, or need to be created, for a marketer to be able to discriminate successfully.
The discriminating monopolist seeks to supply each market with the quantity necessary to equate marginal revenue across all markets with the marginal cost of supply. In marketing terminology the discriminating monopolist pursues a profit maximising market segmentation strategy. The requirements for profit maximising are that the markets be kept separate and free from competitive supplies and inter-market arbitrage, and that supply be constrained to the level consistent with profit maximising pricing in each market.
When an industry attempts to coordinate and discipline marketing it is trying to pursue a market segmentation strategy to increase market revenue. Provided demand elasticities vary between markets, and other conditions are met, it can be demonstrated in principle that a market segmentation strategy will generate higher total industry market revenue than if the markets were supplied by independent, competitive exporters.
If these higher returns were returned to producers and exceeded the costs of obtaining them, the consequence would be a larger New Zealand industry generating more revenue. However, that industry would be less profitable than would exist under conditions of discriminating monopoly where profitability is being maximised through both market segmentation and the control of production. This point is particularly important, and relates to the consequences of pooling or bundling returns discussed in chapter 5.
Martin and Zwart have set out the conditions under which market revenue received by a New Zealand rural industry can be raised by a single seller or market coordinating agency successfully pursuing a market segmentation strategy. They developed a model to evaluate the market power available to an agency able to allocate a non-storable product between markets or market segments and concluded as follows:
ÒA framework for evaluating the impact of pursuing a market segmentation strategy in an agricultural industry has been presented. It has been argued that such a strategy is possible where products in a market are non-homogeneous and a marketing agency exists to implement an allocation and pricing policy. The benefits associated with such a scheme are influenced by the presence of a competitive supply sector, and it has been shown that the distribution of benefits over time is also affected by the aggregate demand elasticities and long-run supply conditions in the market.
ÒThe reaction of competitive suppliers is difficult to measure but has also been shown to be a major factor. It may be argued that promotional effort and product developments, such as improved grading, might be used to minimise this effect by creating a less homogeneous product. However, the costs associated with such activities must be offset against the benefits described here.Ó
Many other researchers hold similar views. For example, work undertaken in the 1970s on maximising returns for Australian beef and veal exports reached the following conclusions:
ÒThe need for or desirability of the AMB [Australian Meat Board] controlling the level of export sales to different export markets stems from two related sources. Under agreements with some of the principal beef importing countries, initially the USA and more recently Canada and Sweden, Australia voluntarily agreed to limit the volume of exports to these countries rather than be confronted with more restricted quota allocations. Second, the partial segmentation of the market for Australian beef and veal together with significant differences in the price responsiveness characteristics of some of these sub-markets means that significant gains in aggregate industry returns may be had by adopting a price discrimination marketing strategy. There are however political and practical limits to which the latter can be adopted.Ó
The opportunities arising through restrictions on market access to exercise market power which are referred to by these researchers are a special case of the more general discriminating monopoly theory and are discussed in the next section.
The research by Martin and Zwart, and similar work used extensively by the New Zealand Market Development Board in favouring statutory controls to ensure market discipline, outline both the conditions for successful market segmentation and strategies available to create such conditions. The existence of these conditions, or the reasonable expectation that they can be created, are critical determinants of whether market power opportunities can be exploited successfully.
6.2.1 The determinants of successful market segmentation
Martin and Zwart reached the following general conclusion regarding the determinants of successful market segmentation:
ÒThe extent of these benefits is influenced by the degree of homogeneity of the product and the general price responsiveness of its producers and consumers.Ó
This conclusion encompasses an array of conditions and influences relevant to the successful exploitation of market power. They can be grouped into three categories depending on whether they relate to:
¥ controlling inter-market arbitrage;
¥ differentiating the product (making it less homogenous); or
¥ influencing supply responses.
The first, controlling inter-market arbitrage, is the most straightforward. If New Zealand product can be traded by third parties after it leaves New Zealand, then keeping markets separate and pricing differentially will be well-nigh impossible. Arbitragers will buy in cheaper markets and sell in higher priced markets leading to the same outcome as would occur if competitive exporters operated from New Zealand. The greater the commodity characteristics of the product, the easier this is to achieve.
One way of preventing this arbitrage is to maintain influence over the product after it has left New Zealand by controlling the marketing channel. New ZealandÕs single sellers, such as the Dairy Board, put considerable effort into this aspect by, inter alia, investing offshore in the marketing channel and developing loyalty-based relationships with customers. The multinational food companies do exactly the same.
Exercising effective control over the same product produced by other countries is not so easy. There are examples of New Zealand marketers trading the products of other countries as part of their strategy to control arbitrage. In most instances, however, this is not a practical option because of the small share of total demand supplied by New Zealand. It also raises fundamental issues about how free producer boards can be to maximise returns by sourcing raw materials wherever they are cheapest. In an extreme situation this may have them sourcing none of their raw materials from New Zealand. Multinational companies, on the other hand, are not handicapped in pursuing such strategies.
The best way of overcoming competitive supplies from other countries, or from substitutes which also have to be taken into account, is to differentiate the product Ñ the second of the three strategies listed above. Product differentiation is a very important aspect of successful market segmentation. The marketer wants the consumer to believe the particular product is better value or worth a higher price than alternatives, be they the same or acceptable substitutes. The achievements of Coca Cola in the soft drink market is an often-cited example of successful product differentiation.
The important point is that consumers believe the product is different and buy more, often at a higher price. To achieve this marketers use grading, product modification, packaging, labelling/branding, and promotion. Some of these approaches do produce a product which is different while others target attitudes and perceptions in an attempt to have consumers believe the product is different. It matters little how it is done, so long as the product is differentiated in the eyes of consumers and this increases the marketerÕs profits.
Product differentiation is a significant part of marketing strategies in New Zealand. The statutory organisations, both single sellers and those involved in controlling and coordinating the activities of exporters, attempt product differentiation to improve returns. Making consumers aware that a product is from New Zealand has long been an important element of product differentiation. The possible negative implications of a country-of-origin brand for developing markets for different quality standards was noted earlier.
Exploiting the attributes of new varieties is another example and akin to developing a new product. New varieties commonly have superior qualities providing the opportunity for convincing consumers that this is the case. The opportunity is enhanced if New Zealand is able to control the genetic material which produced the new variety. A controversial example from the kiwifruit industry is discussed in chapter 9.
Controlling product forms is also a type of product differentiation used by New Zealand marketers. A good example is the strategy pursued by the Apple and Pear Marketing Board in deciding the allocation of apples between the fresh fruit market and processing. If a competitive export marketing system existed, the quantities directed to fresh fruit and juicing would be determined by the split which equated marginal prices for apples when used in each product category. However, as a single seller the Board may determine product category shares which are different from this outcome and which it believes will maximise total market returns for all apple production. Whether this belief is correct and the aim is achieved are separate questions.
The third category addresses production response implications of successful market segmentation. The unfavourable consequences for producer profitability of increasing production when higher market returns, due to successful marketing investments, are delivered as a pooled price have already been discussed.
When those in other countries see higher prices for New Zealand products (or those of any marketer) they will try to copy and obtain a slice of the action. They will do this by either imitating or countering successful product differentiation. Frequently the benefits of some forms of product differentiation are small and transitory because they are quickly copied by competitors.
The following observations reflect this reality in respect of fresh food markets:
ÒIt is easy for new producers and producer groups to enter fresh food markets which means there is always a threat of entry by new competitors. Examples of this form of commercial entry that have affected New Zealand include Chilean apple producers, kiwifruit producers in both northern and southern hemisphere regions, and the early entry of Australian producers offering chilled lamb cuts to the United States and Europe.Ó
If New Zealand is able to obtain higher prices during the production off-season in a particular market this will provide incentives to others to store product or spread the production season. This is why it is difficult to exercise market power when a homogeneous product is storable. There is little evidence of genuine market power opportunities in the international grains market for this reason. If storage is not currently possible then New ZealandÕs market advantage might translate into an incentive for the competitor to develop technology to make it possible. From the same source as the previous quotation comes the following conclusions about the role of technology:
ÒThe entire structure is also subject to competitive entries from new types of products using new technology. For example, the introduction of controlled atmosphere storage in Europe has made it possible for French Golden Delicious apple producers to carry forward their supplies to compete in the seasonal niche market previously occupied solely by Southern Hemisphere suppliers, especially from New Zealand.Ó
There are at least as many textbooks on strategies for market segmentation as there are circumstances which give rise to it. Only the basic principles and a few relevant examples have been discussed here. All rational, profit maximising marketers try to create an environment where they can act like a successful discriminating monopolist. When boiled down to its essentials this requires successful product differentiation Ñ successful in the sense that the advantages are not quickly competed away.
This is much easier said than done. Two convincing pieces of evidence are the continuing dominance of price in determining what consumers buy, and the high values the market places on those brands which have proven their effectiveness in securing market share and/or higher prices. In addition, there is little evidence of multinational food companies or marketers making other than normal profits.
6.3 Evidence of Exploitable Market Power Opportunities
Having considered the conditions under which market power opportunities might exist, and established that if they do exist a competitive marketing system would not necessarily capture them, this section considers some of the evidence for their existence and likely size, how well they are captured, and whether their capture improves producer profitability.
6.3.1 Quota markets provide opportunities
The market power most readily exploitable by New Zealand is that arising through preferred access to a restricted and higher priced market. This is a situation where New Zealand is given an entitlement or quota to sell Ñ usually a maximum quantity Ñ in a market where trade and domestic policies maintain prices above international levels.
It is a particular case of the discriminating monopoly theory. It is particular because many of the factors which reduce the ability of the marketer to capture monopoly profits are controlled or rendered ineffective by the importing country. However, this does not mean that rents from quotas are there just for the taking. The detailed nature of the market restrictions and the way the exporter attempts to capture the rents, are important to success Ñ as discussed in Box 6.1.
The most clear-cut case of market premiums available to New Zealand and captured successfully is the United Kingdom butter quota. The premiums are captured by New Zealand because the Dairy Board ensures exporters do not compete them away. This is discussed in the dairy chapter where it is estimated that New Zealand earns well over an additional $100 million annually compared with returns if this product was sold on the international market.
A more complex example, is arrangements for cheese imports into the United States. Research on these quotas illustrates how the distribution of rents is influenced by the method of allocation. As set out in Box 6.1, these researchers note that Òrents and their distribution are jointly determined by the interaction of trade and domestic agricultural policies of both importing and exporting countries; thus the process of determination is often more complex than suggested by the standard theoretical model.Ó
The researchers examined the incidence and distribution of quota rents from the United States cheese market over the period 1974 to 1980. The arrangements were changed somewhat at the end of this period. During this period, however, there was exclusive reliance on country-specific quotas for cheese imports. These quotas (import licences) were allocated to importers in the United States and stipulated the category of cheese and country of origin.
Rents were estimated as equivalent to 30-50% of the United States wholesale price of the cheese involved. It was estimated that in 1980 total rents on imported cheese were around $US130 million but they were not distributed between importers and exporters in the same proportions as their shares of the trade. The researchers concluded that:
ÒEven in the case of Australian and New Zealand cheddar, where the rent size differential is due primarily to differences in cost of production, the proportion of the total quota rent captured by New Zealand is substantially larger than that captured by Australia. This suggests that institutional or other factors are important in determining the division of quota rents.Ó
The researchers suggested that the size and distribution (between importers and exporters) of quota rents offers a partial explanation of why the system continues to survive Ñ the participants do quite well under the system. This might also explain, at least in part, why the New Zealand Dairy Board has invested in cheese importing companies in the United StatesÐ it would enable New Zealand to capture a larger share of the rents.
Recent circumstances in the United Kingdom lamb market illustrate how the value of quota access can be influenced by market developments and competition from other supplies. As discussed in the meat chapter, until recently there has been a need to encourage New Zealand meat exporting companies to fill the quota and in a number of seasons it has not been filled. Presumably New Zealand lamb exporters found other markets more profitable. The profitability of the United Kingdom market would also be reduced by the significant increase in lamb production there and in Ireland as a result of changes to CAP incentives.
The general conclusion from the principles and evidence is that quota markets can provide rents with their distribution determined by how the importing country allocates quota and how exporters attempt rent capture. Where quota or VRA arrangements provide rents available to New Zealand, then competitive exporting could result in market failure. This conclusion does not apply to markets subject only to tariffs, which will become the dominant form of protection of agricultural markets if the Uruguay Round succeeds.
Single desk sellers are not essential for capturing quota rents
If regulation is considered necessary in capturing quota rents this does not necessarily imply the need for a statutory single desk seller. An alternative is to have some form of competitive bidding or tendering by marketers in the exporting country for access to the market. Access rights are invariably available to a country and therefore the government owns them and is free to allocate them as it sees fit Ñ presumably in a manner that best achieves the national interest.
Selling access rights combines the benefits of capturing the premiums and maintaining competition amongst exporters. Two pieces of research on these issues in relation to the Australian beef industry concluded as follows:
ÒConventional economic analysis suggests that a system of auctioning of rights to export to the premium markets, especially to North America, would be a preferred strategy. The paper has argued that such a scheme is feasible, that some potential political criticisms are of dubious merit, that the scheme could readily be adapted to meet the AMBÕs goals regarding the control of exports of beef and veal, and that it would facilitate an efficient marketing system;Ó
and
ÒOn economic grounds, a more efficient alternative to the present system of controls is the allocation of entitlement by competitive bidding. Such a scheme would have no intrinsic distortionary diversification element and would ensure maximum premium was extracted from the quota market. The scheme would not arbitrarily determine market shares, freeze the industry structure, discriminate against new exporters, or remove incentive for exporters to specialise in sales to those markets in which they have a comparative advantage. Furthermore, its flexibility would allow a more rapid adjustment to changing market conditions.
The critics of this approach to allocating access say there are costs associated with discontinuity of tenure of the right to export and this, together with the possibility that one marketer may acquire a monopoly, is not conducive to optimum market development. These arguments are something of a red herring. Tendering or auction systems are not new in allocating access to restricted markets. They have been and are used in many countries, including New Zealand and Australia, for allocating import quotas in industries which are subject to import protection. Similar issues about continuity and monopoly apply in the importing case and can be dealt with by appropriate design of the allocation scheme.
As with other rights that are allocated by auction (for example, radio frequencies), the term of the rights can be set to allow reasonable opportunities for investment or market development to be recouped. When rights are reallocated, the existing holder could be allowed to match the highest bid if the holder is not successful in the first round. The incentives for those winning the right to export to maximise returns can be heightened by making the rights tradable after their initial allocation. This encourages the holders of access rights to do everything they can to maximise the value of a negotiable asset. There could be a limit on the rights available to any one organisation.
There are two political stings in the tail of the competitive bidding approach for some industry incumbents. They may explain the opposition raised against this type of approach.
The first is that letting the market put a price on access rights makes their value explicit. This may lead to situations where an industry, having been told in the past that access was valuable, finds no one is prepared to pay a significant amount for the privilege of owning it.
It is likely that there would be strong demand for the right to sell butter into the United Kingdom. However, it would be interesting to see what discount the market placed on the uncertainty about its longer term future. On the other hand, there is some evidence to suggest there may be no strong bidding for lamb access rights to the EC market.
The second sting was referred to in chapter 3. The premiums from quota markets belong to New Zealand, and hence the community generally. The past mechanisms used for their capture have essentially established the convention that they belong to producers in the relevant industry. It would not be difficult to devise a means of distributing tender or auction proceeds to producers. However, there must be some danger from the point of view of the industry that a government would be tempted to regard proceeds as consolidated revenue and argue that this was appropriate Ñ which logically it is. The temptation to do this would be greater if the premiums were received as a lump sum (capitalised future benefits) by the government or a marketing agency via a tender or auction process.
Regulation of exporting is not necessarily a sound response to the opportunity to obtain quota rents. Many agricultural commodities and industrial products (such as steel, apparel, textiles, footwear and motor vehicles) are subject to quantitative restraints or VRAs in importing countries. As a general rule, governments in exporting countries have not responded by regulating the marketing of these products.
There are at least two reasons why this step is typically avoided. One is the major sacrifices in efficiency (through weakening competitive disciplines and blunting incentives to innovate) that would be associated with such a step. The other is that there are frequently opportunities for competing firms to adjust their pricing and marketing strategies, if necessary in a concerted way, to take advantage of market premiums. The success of the several strongly competing participants in the Japanese motor vehicle industry in obtaining higher returns from the United States market when VRAs were imposed in the 1980s has been well documented. Similarly, New Zealand beef exporters have cooperated to limit supplies and obtain higher prices in the United States market when voluntary restraints have been imposed or threatened.
Even in the case of restricted markets, therefore, it does not automatically follow that export regulation is superior to commercial responses and the maintenance of competition in marketing. If regulation is justified, it will not involve wall-to-wall controls on the whole range of an industryÕs products.
6.3.2 The evidence of market power in unrestricted markets is unconvincing
Evidence that New Zealand has exploitable market power outside quota markets is unconvincing. In competitive export markets evidence of market failure is hard to find.
Consider the apple industry as an example. As discussed in detail in chapter 7, new varieties have been developed but competitor countries have quickly moved into production of the same varieties. Advantages are claimed for New Zealand because it can supply a wide varietal range of apples. An equally plausible view might be that premium varieties have enabled New Zealand to sell the less preferred varieties Ñ take them all or you get none Ñ and allowed, through price smoothing, growers of less preferred varieties to adjust to market change at a more leisurely pace. This cross-subsidisation has then had to be reduced gradually as supplies of preferred varieties from other countries have increased.
As noted earlier, technology, market growth and entry by other producing countries are factors which erode market advantage. They suggest market power and its associated premiums are transitory at best. If so, this situation would be little different from other competitive product markets where a degree of transitory market power is common and provides a reward for innovation.
It therefore becomes difficult to see where the market power opportunities are that would be missed (market failure) if competitive exporting were allowed. The Apple and Pear Marketing Board and its supporters consistently refer to the Australian apple industry as an example of an industry in decline because of competitive exporting. This claim is examined and rejected in chapter 7.
What that discussion highlights is that there is not sufficient information to know whether the New Zealand apple industry really is superior in terms of return on resources. The Australian apple industry may have evolved a level, structure and commercial performance appropriate to its international comparative advantage. Unlike their New Zealand counterparts, Australian apple growers do not receive a return on marketing investments embodied in their apple price. Consequently, they receive price signals which indicate accurately what level of production they should aim for to maximise their profitability in the national interest.
Finally, what is most difficult to assess in the apple industry is the extent to which higher market returns, for which there is evidence, reflect additional marketing services being provided to customers rather than market power per se. There is some inferential evidence that the former is the case. For example, with the removal of Reserve Bank borrowing guarantees and interest rate subsidies, the Board has had to move more of the cost of seasonal finance on to growers through adjustments in the payment schedule. The earlier government assistance was being used to fund marketing services and secure higher returns. If grower returns were not to fall as a result of the removal of concessional credit, growers had to pick up the full cost of finance. Interestingly, by altering the schedule of grower payments, there was no explicit effect on grower returns as reported in dollars per carton by the Board. However, grower costs have risen so profitability per dollar invested has presumably fallen.
Turning to meat, especially sheepmeat, it is possible to study an industry which has in the past attempted most approaches to marketing except leaving it to competitive and unregulated exporters. The results have been far from successful which is the reason why changes in approach have been so frequent. However, there has been some research conducted Ñ compared with the apple industry, meat industry data are relatively freely available Ñ which examined the potential gains from successful market segmentation in meat exporting.
The research of Martin and Zwart referred to earlier modelled a hypothetical reallocation of New Zealand sheepmeat exports for the 1979-80 season. This particular year was chosen for a number of reasons but particularly because the EC had not yet introduced a VRA for sheepmeat and there was minimal intervention in the global sheepmeat market.
A number of market segments were defined, a range of demand elasticity relationships assumed, and market allocations aimed at maximising returns (optimum market segmentation) were simulated. The simulations also included a range of assumptions about supply responses in New Zealand and competitor countries by modelling a range of supply elasticities including zero Ñ that is, assuming no production response.
The insights provided by this research relate to the sensitivity of the results to the underlying assumptions and the extent to which market segmentation premiums fall when suppliers respond to higher market returns. For example, the authors estimated the maximum gain in producer welfare, assuming no response from other exporters, to be an increase in annual market returns of $307 million. However, they observed that Òthese short-run gains may soon be eroded by the response to discriminatory pricing from the supplying country itself [New Zealand] or from its competitors.Ó Further simulations, allowing for supply responses, confirmed the general proposition that the improvement in producer returns from market segmentation tends to zero as the supply response increases.
As part of their conclusions they noted that:
ÒThe extent of the marketing power associated with particular marketing institutions is an empirical question, and based on the preliminary results presented here for New ZealandÕs sheepmeat exports, the returns could possibly be low, especially in the long run.Ó
Not only might it be expected that higher returns would elicit increased sheepmeat production, but also higher prices would encourage consumer substitution to other meats and alternative sources of protein. One of the biggest challenges facing the New Zealand lamb industry is competition from alternative meats Ñ a battle which some believe lamb is losing. This hardly suggests a market place where opportunities for exercising market power and raising prices are extensive. If they were, past marketing policies would have been more successful.
Finally, the kiwifruit industry provides an example of market power not being exploited during the period when it was most likely to have been available. During the 1960s and 1970s the New Zealand kiwifruit industry had a new product which was launched with considerable success by the private sector on the international market. New Zealand also had a monopoly on the genetic material of the only kiwifruit variety of any commercial significance. There is considerable prima facie evidence that New Zealand had some exploitable market power during that period. It has very little, if any, now.
It is unrealistic to expect that New Zealand could have maintained this position indefinitely. However, with appropriate marketing policies at the time it may have captured greater returns for a longer period than has been the case.
Essentially, the New Zealand kiwifruit industry has introduced marketing arrangements suited to exploiting market power after the conditions conducive to the use of such power have gone. If there were any case for single seller arrangements in the industry, it was much stronger two decades ago than it is today. Even the consultants who reviewed the industry in detail in 1988 only recommended Òcoordinated and disciplinedÓ marketing for a transitory period, envisaging a return to multiple exporters after identified problems had been rectified. This aspect of their recommendations has been overlooked by the industry and the government in putting the current arrangements in place.
In summary, there is little evidence of market failure in exploiting market power outside selected markets and products subject to quantitative access restrictions. More importantly, there is little convincing empirical evidence that New ZealandÕs major rural industries have any such market power to exploit, making the market failure question of limited relevance. The markets are extremely competitive and New Zealand has faced consistent strong competition from other suppliers and substitutes for years, a situation that is certain to continue.
6.4 Weak Selling Ñ A Matter of Mind over Market?
The need to prevent weak selling is commonly cited as a justification for regulating exporters. Weak selling is a somewhat nebulous phenomenon but it is nonetheless frequently advanced as one of the greatest evils of competitive exporting from New Zealand. The context in which it is commonly used implies a situation where, for whatever reasons, an individual seller accepts a price lower than might have been extractable on the day, forgoing revenue and tending to lower the prices the market is prepared to pay for the same product from other sellers.
It is an extremely tempting and attractive explanation for producers to grasp when wanting to blame marketers for unacceptable returns. Its plausibility as an explanation is aided by the practical difficulties, in each particular instance, of ensuring that all the relevant facts are known and establishing the extent to which returns might have been higher if the so-called weak selling had been prevented. In considering the likelihood and possible implications of weak selling, and the effectiveness of preventative regulations if they are judged to be needed, it is necessary to work systematically through the relevant logic and empirical evidence.
It is an undisputable fact that in all markets some participants perform better than others. The reasons are many and varied but ultimately boil down to differences in commercial competence. For example, the seller who accepts a lower price because of poor market information could be judged inferior (a weak seller) to the better informed marketer obtaining a better price. However, even here an unequivocal conclusion is not possible. The apparent weak seller in this example may know that the price discount on the sale was less than the cost of being better informed.
The important point this highlights it that weak selling cannot be judged to have occurred on the basis of only the price received. Marketer success should be judged on the basis of profitability and marketer profitability will determine both the price that can be paid to the producer and the continued existence of the marketing business. It is possible that the best marketers may be able to take less in the market, pay more to the producer and make profits sufficient to remain in business. Because they can do this they grow and prosper and investors and producers benefit.
This raises the more general questions of how profit maximising marketers could or why they would want to engage in weak selling pricing behaviour on any sustained basis. After all, unless weak selling is sustained behaviour, rather than an isolated event, its consequences are likely to be relatively minor in the overall scheme of things.
What are the commercial implications for any exporter that persistently engages in weak selling? Logic and commercial reality suggest they go out of business. Since individual marketers need product to market they must deliver producer prices which ensure they are supplied. If they do not they are unlikely to stay in business Ñ either through going broke or being taken over by other exporters more successful at extracting more profitable returns from the market.
The likelihood of weak selling and the ability of New Zealand to do anything about it will also be influenced by other market participants and substitute products. Unless New Zealand has a significant share of the market, even a single seller will presumably be affected by so-called weak selling by exporters from other countries. If New ZealandÕs market share is significant then this logic may not hold so strongly but even then there is the question of how New Zealand can effectively control the ÔrogueÕ marketer who is so often cited as the perpetrator of a weak sale that drags the entire market down. This is the type of weak selling most commonly referred to by those advocating preventative regulations.
The existence of substitutes in the market is also relevant. How is the marketing of these products to be controlled? Might the substitutes not also be characterised by weak selling?
On the other side of this coin is the likely supply response from competitor producers, including producers of substitutes, if the regulatory prevention of weak selling does raise market prices. The advocates of regulation appear to presume that their price raising successes will not encourage others to increase production thus placing downward pressure on prices.
Accusations of weak selling also raise important issues about how observed pricing should be interpreted. There are many reasons why lowering prices Ñ which would be interpreted as weak selling Ñ could be a sound commercial strategy. It might be desirable to increase market share or to stop it being reduced. It may be commercially sound to reduce price to sell a container of perishable products rather than incur storage costs or product loss. Examples of this happening in the kiwifruit industry are discussed in chapter 9 where it is pointed out that private exporter pricing behaviour which is labelled weak selling is called strategic marketing when practiced by a single seller board. How much so-called weak selling is sound commercial practice reflecting market fundamentals?
It is important to remember that buyers are competing with each other to obtain supplies. The true competition in the market is not between buyer and seller but between competitive buyers seeking product and competitive sellers seeking to maximise their returns. Provided markets are competitive, no party operates at an inherent disadvantage.
This highlights the point that if the arguments about weak selling were valid they would be matched by equivalent problems on the buying side. Competition among buyers would be expected to lead to claims of weak buying and calls for discipline, coordination and single buyer organisations to obtain market power. Single buyer organisations are a rarity in successful market economies.
At a practical level, many of the points made here were encapsulated by the present Chairman of the Trade Development Board when he commented Ñ in another role Ñ on weak selling in relation to kiwifruit:
ÒWe have this morbid obsession about being played off against one another on price Ñ part of our generally defensive view of the world. Horror stories abound. Millions lost in kiwifruit undercutting says the NBR headline Ñ this in an industry also held up as a model for its export strategy. The losses in that particular article were assessed at $25 million. We saw a sale where 1500 trays of kiwifruit were being sold at $7.50 and then another exporter came along and cut the market, and the sale went through, for exactly the same type of product for $4.50, said NZ Fruitgrowers Federation President, Peter Taylor. There was more.
ÒSuch examples (and we have them in the lumber industry too) are used to justify the creation of an export marketing board or equivalent to discipline the industry.
ÒBut that kiwifruit seller was one of a few licensed exporters in an already disciplined industry. If the situation is described accurately then the exporterÕs actions were incredibly stupid. Others were said to have accepted 11 or 12 DM when the market was 20. Frankly, I donÕt believe it. The licensed exporters compete for product and their future is determined by the net price they achieve for growers. They just do not leave that kind of money on the table.
ÒOn the other hand if a mistake of such gross proportions was made then the best correction is public ridicule. The article named no names but if it had, I bet there would have been a strong defence.Ó
During research for this study a number of participants in the meat industry talked of persistent weak selling by lamb exporters. It was argued that there were regular instances of sellers undercutting the market and lowering the price for everyone Ñ often to levels which were unprofitable to producers.
The instances always referred to lamb and never to beef, and the reasons why the weak selling problems were confined to lamb were never clearly explained. Ironically, lamb exporting from New Zealand is much more regulated than beef exporting. It is also unclear where exporters who persistently sold lambs at prices unprofitable to producers sourced their lambs. It seems a reasonable presumption that producers would not produce lambs at a loss on any continuing basis and yet the weak sellers always seem to have lambs to sell.
The arguments about weak selling had their counterpart in the debate over labour market regulation. Proponents of monopoly unionism argued that the introduction of competition would allow employers (buyers of labour) to drive down wages and harm workersÕ interests. Experience has confirmed that wages are instead determined by labour supply and demand and that workersÕ best protection is bargaining freedoms and competition for their services. Monopoly marketing organisations can be seen to stand in the same relationship in this debate to the former monopoly unions, and to employ similar arguments and rhetoric.
The conclusion that must be drawn is that some so-called weak selling will always occur because marketers Ñ statutory monopolies included Ñ make commercial mistakes on occasions. If they do it regularly in a competitive market they are very unlikely to stay in business. In fact, a regulated monopoly is the only form of business likely to be able to survive if weak selling on a persistent basis.
If, despite the above logic and arguments, producers remain convinced weak selling exists and significantly commercially disadvantages them, then they should consider both alternatives to regulation and how the costs of regulation stack up against the potential benefits.
Product differentiation and branding are effective marketing strategies to minimise weak selling. Weak selling is never raised as an issue in industries where marketing revolves around branded, differentiated products. Producers should reflect on the fact that regulations designed to protect them from weak selling have retarded growth in product differentiation and branding, and consequently held back the most obvious and effective solution to weak selling if it exists.
More generally, the use of regulations and single sellers, aimed at trying to reduce competitive exporting from New Zealand, undoubtedly suppresses innovation, product development and different ways of doing things. In other words the chosen (regulatory) response to price competition is actually suppressing remedies the market could be expected to deliver.
In instances where unnecessary price competition may occur, there would be incentives for New Zealand exporters to collude for mutual benefit. Should this collusion be encouraged, or even enforced? The meat industry apparently thought it should and this was the main justification for the recently established Meat Planning Council.
Some successes are already being claimed for the Council. Advocates are suggesting it is being successful in ÒteachingÓ meat (mainly lamb) exporters the mutual benefits of collusion in some export markets. While this may be correct, there are two issues it raises which producers should consider carefully.
First, the need to teach lamb exporters about the benefits of collusion reflects the fact that decades of regulation have prevented them from both learning by doing and developing alternative commercial strategies to avoid competitive selling on the basis of price alone. The Council is a regulatory response to the unfavourable consequences of previous regulations.
Second, while it is possible to make an in-principle case for a period of regulation aimed at delivering a sustainable commercial solution Ñ the infant industry argument Ñ the regulations invariably persist and are frequently extended as time passes. A major reason for this is that those who believe they are advantaged by the regulations become increasingly dependent on them and fearful of the consequences of new entrants and more competition.
In essence, producers in all major rural industries have made two major mistakes in regard to weak selling. They have allowed weak selling to become a grossly overrated rationale for marketing regulation. In turn, the regulations have resulted in a range of competition-suppressing costs which far exceed any benefits which might reasonably be expected from trying to prevent the inevitable but relatively rare phenomenon of weak selling.
6.5 A Changing and Increasingly Competitive International Environment
Any assessment of market power opportunities, weak selling and, more generally, what New ZealandÕs rural industries must do to improve competitiveness continuously, must take into account trends in the international environment. This section discusses these trends and draws out the major implications for approaches to marketing.
Major international trends of relevance to New ZealandÕs export-oriented rural industries can be encapsulated in the following three generalisations:
¥ change is occurring at an increasing rate under the influence of technological progress, especially in communications, causing world markets to become steadily more integrated;
¥ a technologically-driven and shrinking world means increased labour and capital mobility as owners exhibit decreasing concern or respect for national borders and seek locations where profits can be maximised; and
¥ markets, including those for food and fibre, are characterised by consumer sovereignty with marketing success being dependent on total commitment to meeting consumer needs which are diversifying and expanding rapidly, and becoming very sophisticated.
It would be wrong to suggest that New ZealandÕs marketers are unaware of these developments or making no changes in response to them. However, it is more difficult to avoid the impression that their importance and impact are being underrated with many participants (including producers) showing a degree of reluctance and tardiness in accepting the need for change.
What New Zealand sells from its rural industries, how it sells, and where it sells will be dramatically different twenty or thirty years hence. The speed of change and the size of the benefits will hinge critically on how quickly rural industries, and particularly those responsible for marketing regulations, come to accept that international economic integration and resource mobility is replacing national sovereignty and the relevance of national borders. A preoccupation with uneven playing fields and with efforts to manipulate terms of exchange in New ZealandÕs favour rather than with commercial strategy, innovation and continuous upgrading of competitive advantages would be a recipe for disaster.
6.5.1 Natural endowments no longer guarantee international competitiveness
One of the most profound influences on future developments will be the increasing international mobility of labour (particularly intellectual capital and skills) and investment funds. Because New Zealand occupies a peripheral position in the global economy the implications of this trend for its economy are far-reaching. Few will notice or be concerned if New Zealand opts, unwittingly or otherwise, not to respond to or exploit these changes.
In this environment national industries operating under institutionalised rules and controls are likely to find it increasingly hard to respond with the alertness and agility that the maintenance of international competitiveness and profitability will demand. This scenario contrasts starkly with New ZealandÕs past circumstances where the conventional wisdom was to consider the countryÕs technical efficiency in agriculture Ñ particularly the ability to grow grass, trees and assorted plants Ñ as the key to comparative advantage. One researcher put it in the following terms:
ÒIt has been argued for a long time that New ZealandÕs comparative advantage as an agricultural producer is based on low cost systems for ruminant animal production ... This comparative advantage has been eroded. It remains to be seen whether or not the producers, processors and exporters of New ZealandÕs agricultural and horticultural products can find a similarly advantageous comparative niche based on activities other than the efficient utilisation of pasture.Ó
A similar but more generalised conclusion was presented in the Porter Project report:
ÒIn todayÕs global economy, success is a function of a nationÕs ability to develop competitive advantage in advanced industries and industry segments rather than its ability to exploit comparative advantage of inherited endowments of factors of production.Ó
The world has never been short of the land necessary to meet effective demand for food and fibre. Future developments will mean endowments of natural resources will be even less likely to approach the status of a binding constraint. For example, New ZealandÕs rural producers should consider carefully the competitive implications of the combination of these international developments and the rural resource base of South America against the background of the policy reforms which are underway in that part of the world. These include widespread privatisation and the deregulation of statutory agricultural marketing bodies.
6.5.2 The location and characteristics of markets are changing rapidly
New ZealandÕs major rural industries are still reliant both on the export of commodity-type rural products and on markets in the United Kingdom, Western Europe and North America. At the same time, commodity markets are shrinking relative to consumer products and the markets offering the best future prospects for New Zealand are located in the Asia-Pacific region.
The economies of Asia are fast becoming the economic engine of the world. Their total income presently comprises less than 10% of world income. They have been projected to comprise 25% of world income by 2020 and 45% by 2040. The regionÕs growth in food demand has been forecast to grow at around 4.5% annually over the next forty years.
Lattimore and Rae, in commenting on past and prospective rates of economic growth in Asia and their implications for food demand, highlighted the following points:
¥ the economies that comprise the Pacific Rim include some of the most rapidly growing in the world;
¥ the newly industrialising economies of Asia, such as Taiwan, South Korea and Singapore, are taking over from Japan as the engine of world growth;
¥ countries such as Thailand, Indonesia and Malaysia may be the economic tigers of tomorrow;
¥ this economic growth has resulted in pronounced and continuing changes in food consumption patterns with grain consumption falling and the consumption of meat, dairy products and horticultural products increasing;
¥ the combination of relatively high income and population growth underpins phenomenal market growth potential in the medium term;
¥ domestic production of major rural products is unlikely to grow as fast as demand resulting, subject to farm and trade policies in the region, in steady growth in imports.
These changes reflect the fact that consumers become more demanding of quality, variety and services as incomes rise and the proportion of income devoted to food and fibre fall. One recent assessment of the modern consumer in the context of food demand put it in these terms:
ÒThe time-poor money-rich consumer is now far more discerning and demanding of a high quality, consistent product. Concern about the safety of foods is also more apparent ... Convenience is now highly valued by most people, and more and more value added product is being purchased.Ó
A new era in food demand and marketing has already commenced. There are no longer principally generic markets for commodities such as dairy products, meat or wool. Instead there is an increasing diversity of markets for products derived from these raw materials with product form, packaging and methods of retailing differing between markets. While there has been a trend from commodity to consumer products in New Zealand agricultural marketing, it is questionable whether it has matched the rate of market change. The tendency of monopoly sellers or marketing regulations to restrict product range and to innovate more slowly than competitive sellers is found in all industries.
6.5.3 Capitalising on opportunities is the major challenge
The task facing New ZealandÕs rural industries is how to capitalise on the immense opportunities offered by a changing world environment. The key issue is how well suited existing marketing structures and systems are to the adjustments and adaptations needed to exploit these opportunities. There is also the question of whether market power, the subject of this chapter, is becoming a trivial issue in this wider context.
Some recent observations by a leading marketing professional in the United States cast doubts on whether New ZealandÕs existing marketing structures, particularly the statutory single selling bodies, are the successful way of the future. According to McKenna:
ÒThe days of a uniformly accepted view of the world are over. Today diversity exerts tremendous influence, both economically and politically... new technology has spawned products aimed at diverse, new sectors and market niches. Consumers demand Ñ and get Ñ more variety and options in all kinds of products ... Marketing in the age of diversity means ... changing company structures as large corporations continue to downsize to compete with smaller niche players that nibble at their markets. Diversity and niches create tough problems for one-line companies more accustomed to mass markets.Ó
A clear picture of what is required for future success in the production
and marketing of rural products emerges from this discussion. Essential requirements are
flexibility, adaptability and diversity. For a country with the size, location and
resources of New Zealand this means ensuring all sources of ideas, enterprise, and capital
are exposed to the opportunities. Only in this way will the benefits to New Zealand be
maximised.
¥ A major justification used for intervening in the marketing system is
to secure market premiums and avoid weak selling. Logic and empirical evidence suggest
that both phenomena owe more to perceptions than reality. They are grossly overrated as
issues of importance in the marketing debate.
¥ Quota and access restrictions in importing countries can result in
market rents being available for New Zealand. Their size and availability depends on the
particular characteristics of the restrictions. When available, managing exports to the
market is necessary to maximise their capture. This does not necessarily require extensive
regulation of the marketing system.
¥ Beyond quota markets, the evidence of market premiums is
unconvincing. There is little evidence that markets would fail and sellers would leave
money on the table. While all marketers aspire to be successful discriminating
monopolists, few succeed because most markets are open to international competition and
consumers are able to exercise choice. Most market premiums believed to result from
regulations are actually returns to investment in marketing activity and services to
customers.
¥ International commerce is becoming increasingly competitive and
complex. People and capital are becoming more mobile and moving to wherever profit
maximising opportunities are greatest. The worldÕs economic centre of gravity is moving
to Asia Ñ New ZealandÕs region of the world. Many of the existing marketing arrangements
which have their origins in links with traditional markets are becoming less relevant.
¥ International developments mean issues concerning market power will be even more ephemeral as determinants of profitability for New Zealand rural producers. It will be much more important to New Zealand to ensure maximum entrepreneurial flexibility, adaptability and diversity so that all sources of ideas, enterprise, innovation and capital are applied to available opportunities and the creation of new ones.
Chapter 6
Market Power Opportunities and Their Exploitation
Box 6.1: Restraints on Market Access Ñ the Form of the Restraint is the
Major Determinant of Who Benefits
There are a number of instances where countries importing particular
products from New Zealand restrict market access. Import quotas and Voluntary Restraint
Arrangements (VRAs) are the instruments usually used to put these policies into effect.
Constraining imports into a country raises prices within that country
and simultaneously has a depressing effect on international prices. Consequently, access
to the constrained market is of value to those participating in the trade. However, who
captures the benefits depends on the exact nature of the restraint mechanism and how well
both exporters and importers are able to organise and collude as groups.
If the government in the importing country sells import quota
competitively then virtually all the benefits accrue as sales revenue to that government.
Those bidding for the right to supply bid away the premium in competing for the quota.
This was the case and the rationale with import licence tendering in New Zealand.
If the import quota is allocated to domestic importers then they have
the potential to capture all the benefits (as was the case with import licences in New
Zealand which were issued on an administrative basis). If it is allocated to the foreign
exporter then that recipient has the potential to capture the benefits.
When an exporter negotiates and applies a VRA, the benefits accrue as if
a quota had been imposed and the rights given to the exporter. Importers in the market
where supply has been restrained compete away their potential to secure the premiums as
they bid amongst each other for restricted supplies.
The considerations outlined are necessary but not sufficient conditions
for the full benefits of restricted access to accrue as indicated. For example, if the
benefits are potentially available to the foreign supplier then their successful capture
requires that New Zealand prevent competitive exporting and manage access to that market.
Even if this is done successfully, New ZealandÕs ability to capture all the benefits will
also depend on whether importers have any ability to collude and negotiate at least some
of the benefits for themselves.
When market access is controlled, an assessment of the available
benefits and who is able to capture them should commence with a consideration of these
basic rules. However, detailed features of the access restrictions and commercial
circumstances in the importing and exporting countries mean definitive conclusions can
usually only be reached on a case-by-case basis.
7.1 Introduction
The New Zealand apple and pear industry has recently experienced buoyant market returns for record levels of production. In the season ended September 1991 the New Zealand Apple and Pear Marketing Board (NZAPMB) achieved record sales revenue of $618 million, with over 75% derived from exports of fresh fruit, mainly apples. Growers received an average orchard gate return of $12.94 per carton from the Board Ñ an increase of 37% over the previous season and around threefold the payment received a decade earlier.
The apple and pear industry is the most regulated and controlled rural industry in New Zealand. Current statutory marketing arrangements have been in place for over forty years. The NZAPMB is the industryÕs sole exporter and a monopoly domestic seller and importer, with the exception of imports from Australia and restricted orchard gate sales. It exercises significant influence over all sectors of the industry.
The association of record sales performance with extensive regulation is of considerable interest to a study of alternative marketing systems. At the very least it suggests an hypothesis that this approach to marketing can result in industry growth and increasing grower returns. However, and as stressed throughout this report, the more important hypothesis is whether profitability is being maximised, and in a manner consistent with the national interest.
The industryÕs marketing arrangements have been reviewed on a number of occasions although with little substantive change as a result. In his reply to a letter from the New Zealand Business Roundtable informing him of the commissioning of this study, the Chief Executive of the NZAPMB said:
ÒThere have been numerous reviews of Producer Boards in general and the New Zealand Apple and Pear Board in particular. Government and our grower suppliers are both continually questioning our structure to ensure that it continues to be appropriate. We see no need for further time-wasting on this question and so would advise that we will not be able to assist your consultants.Ó
This reaction was disappointing if only because publicly available material on the industryÕs marketing arrangements and their commercial performance are not particularly detailed or enlightening. Researchers using only these sources could risk interpreting information on activity (sales, turnover, growerÕs orchard gate returns) as indicators of commercial performance and profitability. They are, of course, no such thing.
The Board does make some information available to growers on a confidential and/or copyright basis. For example, data on Board receivals by district and variety, quantities (but not values) of shipments to individual country markets, and average grower return per carton by variety are published in a confidential statistical section at the same time as the Board publishes its public Annual Report.
Since 1985 the Board has published and circulated to growers three editions of a Planting Guide which contains information on market prospects, variety recommendations and production forecasts. Growers are advised that this information is commercially sensitive and that disclosure to outside parties and competitors could be detrimental to the long term viability of the industry. Material in the Planting Guides cannot be reproduced without prior approval of the Board.
These Board restrictions on the public availability of information are as curious as they are ineffective. ACIL has formed the impression that when the Board does not want information in the public arena it provides it to nobody Ñ growers included. An example is information on actual market realisations which would explicitly indicate the extent of price smoothing and pooling between varieties and markets.
Previous reviews have provided some background material on the industry and the bases on which conclusions and recommendations have been reached. They have also provided extensive material on official producer and Board views regarding the importance of the arrangements and the benefits they are argued to deliver to producers, the industry and New Zealand.
This chapter comprises three sections. The first describes the industryÕs major characteristics. The second examines a number of issues used to illustrate the significance and consequences of the marketing arrangements, and the extent to which all aspects of industry activity, including policy debate, are managed by those responsible for the industryÕs performance and policies. The final section discusses why change is needed and makes appropriate recommendations.
7.2 Industry Features
The NZAPMB is the dominant source of the limited information on the size and recorded performance of the apple and pear industry. The majority of production is delivered to the Board and all the statistics it publishes relate to these receivals and their subsequent marketing either as fresh fruit or processed product on the domestic and export markets.
While Board statistics provide a good indicator of production volumes and sales revenue, there is some dispute over the exact quantities of apples and pears sold outside the BoardÕs system on the domestic market. Growers may only sell two cases of fruit per customer direct from the orchard provided this fruit is not for resale by the purchaser. These regulations are policed by the Board although the policing has apparently not prevented some illegal trade between growers and New Zealand retailers. Data on this black market trade are not available and the Board stopped publishing the number of prosecutions after they started to increase.
The Board says it receives about 85% of all apple production. This would imply domestic sales outside the BoardÕs control of around 65,000 tonnes or 3.5 million cartons in 1990. These estimates, and issues associated with the BoardÕs domestic market monopoly, are discussed in more detail later.
The discussion of industry features and marketing issues also reflects the dominant position of apples in the industry. Pears comprise only 2% of industry production and nearly two-thirds are sold on the domestic market. In 1989 the value of fresh pear exports Ñ including nashi which comprised 65% Ñ was only $5.5 million.
7.2.1 New Zealand production is expanding
There are about 1300 commercial apple and pear growers in New Zealand. While there are a few corporately organised production units, the majority of orchards are owned and operated by family units. Around 80% of the crop comes from Hawkes Bay and Nelson. Auckland, Canterbury and Otago are also pipfruit growing areas.
Granny Smith and Red Delicious are the two major traditional apple varieties. They comprise over 40% by volume of fresh apple exports with this share declining as production and export of new, higher returning varieties increases. The new varieties include Braeburn, Gala, Royal Gala and Fuji.
Changes over the past decade in the area of apple orchards and production delivered to the Board, are presented in Chart 7.1.
Deliveries to the Board have risen steadily during the 1980s and production growth is expected to continue for some years as recent plantings reach bearing age. Growth in new plantings has occurred as a result of orchard restructuring involving a shift to the higher returning varieties and extensive plantings in non-traditional areas such as Canterbury.
Recent projections by the Board suggest apple production of over 30 million cartons by 1995, an increase of around 50% over Board receivals in 1991. This expected increase in production is confined almost exclusively to the premium varieties, particularly Braeburn and Royal Gala. However, small increases in the production of Granny Smith and Red Delicious are also projected although, as discussed later, the Granny Smith projection appears too optimistic.
Production also rising in other countries
At the same time as New Zealand production is expanding, output is rising strongly in a number of other Southern Hemisphere competitor countries. Significantly increased volumes of fruit will therefore need to be sold in markets which are likely to become even more competitive.
Recent levels of apple production in the major Southern Hemisphere producing countries are presented in Chart 7.2.
Chile and South Africa are currently the two major competitive exporters in the Southern Hemisphere. In the second half of the 1980s ChileÕs apple exports increased by over 50% and production is expected to continue expanding. Brazil is emerging as another competitive exporter. Traditionally a net importer of apples, BrazilÕs production has increased rapidly and export volumes are rising sharply. A large proportion of Brazilian production is newer varieties, namely Gala and Fuji.
In fact, premium varieties previously unique to New Zealand are being planted or are coming on to the market from a number of countries which either compete with New Zealand as exporters or are major export markets for New Zealand. In addition to large scale plantings in South America, the NZAPMB says that extensive plantings of premium varieties are occurring in France, Italy and the United States.
7.2.2 How payments to growers are determined
The basis on which Board payments to growers are determined and made has changed quite frequently in the past and further changes are being implemented. However, the payment system has always incorporated two major features and they are the payment of an advance on delivery with subsequent payments determined by actual realisations for the fruit, and a degree of price smoothing across varieties, markets, end-uses, and between seasons. The extent of price smoothing (cross-subsidisation) and stabilisation of returns has been reduced over recent years and the reasons and consequences are discussed in more detail later. However, ACIL is unaware of any information available from the Board which would allow growers to know with precision how the returns they receive for their deliveries to the Board compare with actual market realisations.
Fruit is packed in packing houses owned cooperatively or by individual growers. Board field staff monitor packing and grading operations to make sure they comply with overseas and local market requirements. Once packed, it is the growerÕs responsibility to transport the fruit to the nearest Board depot. The Board owns coolstores and leases others in the main fruitgrowing areas.
When growers deliver their fruit to a Board depot the Board assumes ownership of the fruit, pays the grower an advance and reimburses all packaging costs. The Board is required to consult with the New Zealand Fruitgrowers Federation (the Federation) when determining the advance payment each season. The advance was 70% of expected market realisations for the 1991 season, 60% in the 1992 season and will be 50% in 1993. Eventually, via subsequent payments as the season progresses and after it is finished, the BoardÕs net revenue from its marketing activities is returned to growers less a deduction for the BoardÕs capital requirements. These capital charges are, according to the Board, necessary to fund growth and the maintenance of the essential facilities needed to take the crop from the orchard to the market place.
7.2.3 Grower returns currently very high
Unit market returns to growers, as indicated by Board payments per carton, rose sharply in 1990 and again in 1991. Market conditions indicate another high returning season in 1992. Unit export returns for fresh apples and grower payments for the decade ending 1991 are presented in Chart 7.3.
In the late 1980s growers received around one third of the BoardÕs total sales revenue. This rose to over 40% in 1991, reflecting the particularly buoyant market circumstances. Grower payments as a share of gross sales revenue were around 50% in the late 1970s.
In contrast to the extensive information available on orchard gate returns from the BoardÕs sales, there is no actual or survey-based information on grower profitability. MAF has published estimates of orchard profitability based on a representative orchard. However, the difficulties in knowing how well this ÒsyntheticÓ orchard is representative of the industry severely limits the value of this information.
Major determinants of recent buoyant returns
With export demand remaining buoyant in 1992 the industry will have its third consecutive season of well above average returns to growers. However, the underlying reasons for the upturn suggest that, as in the past, it is a fluctuation around the trend.
The NZAPMB, perhaps understandably, implied that the recent upturn was a reflection of the success of the marketing system. When reporting on the record high payout in 1991 it said:
ÒProducer Boards continue to attract ÔexpertÕ opinions from various outsiders including the Porter Project, the Business Roundtable Review [this study] and the Prime MinisterÕs Conference on Growth. This yearÕs result speaks for itself. The current success of the industry appears all the more impressive alongside the downturn in many other industries in New Zealand;Ó
and:
ÒThe fact that in 1991 the value of apple exports increased 19.3% even though volumes increased by only five percent reinforces the importance of the BoardÕs single desk status and its ability to introduce innovative marketing strategies and operational technologies.Ó
However, empirically based assessments of the reasons for the upturn, including from the Board itself, suggest unusual climatic conditions which reduced production and stocks, particularly in Europe, were significant in explaining recent buoyant market conditions. For example, the Ministry of Agriculture and Fisheries (MAF) has said the following about market circumstances in the 1990 season:
ÒThe EC is New ZealandÕs most important market, taking nearly 70% of our exports. Conditions in this market have the most influence on returns in New Zealand. In 1990 the market was generally very buoyant owing to a low carry-over of stocks from the previous, mediocre EC domestic harvest;Ó
and:
ÒThe NZAPMB had an excellent selling season in Europe in 1990, achieving high prices across all varieties. It ended on a buoyant market with high demand for Southern Hemisphere fruit. Low European stocks, less Southern Hemisphere fruit than expected, and less competing summerfruit and berryfruit have contributed to the strong market.Ó
The Board had the following to say about market returns in Europe in the 1991 season:
Ò1991 was our strongest year ever in Europe. A poor northern hemisphere harvest meant that we entered a virtually empty CoxÕs Orange Pippin market. The strength of the Deutschmark and English pound in comparison to the United States dollar meant that some fruit normally sent to North America was diverted to Europe.Ó
The influence on prices of unfavourable climatic conditions in Europe was also highlighted in the following media report:
ÒGrowers hopes of remaining the outstanding performers in the bleak farming sector have soared after reports that European production this season [1991] is down between 30 and 40% because of early-season frosts.Ó
Fortuitous shortfalls in competitor supplies were not the only reason for an upturn in prices. For example, in both 1990 and 1991 the Board acknowledged the cost advantages of improved port productivity in New Zealand.
Over the longer term there is every reason to expect export prices to return to trend. MAF suggests that:
ÒAverage world apple prices are forecast to continue to trend downwards in real terms over the next five years, as world supplies rise and demand remains moderate. Growth in the range and availability of alternative fruits will continue to provide greater competition for the traditional apple.Ó
The Board has also been anxious to remind growers that current returns are not a sound basis on which to plan for the longer term. It made the following cautionary comments in the 1991 Annual Report:
ÒMany competing countries are now planting substantial quantities of so-called unique New Zealand varieties and competition will almost certainly increase in the future. This means New Zealand growers will no longer be the sole source of supply of these varieties.Ó
The Board summed up its view of prospects for both the 1992 season and beyond when it said:
ÒIt appears that the outlook for 1992 is also promising with a European crop badly affected by frost and US volumes also down. However, we are all aware that this is a volatile industry.Ó
7.2.4 A long history of statutory marketing
The New Zealand apple and pear industry has a long history of regulation. The New Zealand Fruit Export Control Board was created under the Fruit Control Act of 1926 and had a statutory monopoly to market fruit on behalf of exporters. There were no controls over domestic marketing at that time.
In 1939 the outbreak of war resulted in priority for shipping space being given to meat and dairy products. With around 50% of the apple and pear crop then being exported, the Government purchased the entire crop and accepted the responsibility of finding markets.
In 1946 growers and the government agreed to establish a marketing board, similar to that operating in the dairy industry, with price guarantees which, according to the Board, assured the fruit industry some security and stability in the future.
The NZAPMB was established under the Apple and Pear Marketing Act of 1948. It is the sole exporter of pipfruit and has a selling monopoly on the domestic market except for imports from Australia and orchard gate sales. It imports apples, mainly from the United States but also from Australia, during the New Zealand off-season.
The BoardÕs mission statement is:
ÒTo maximise the return to its suppliers primarily by the worldwide marketing of pipfruit, horticultural products and related products and services.Ó
The Board has six directors, four selected by the Federation from nominations put forward by growers and two appointed by the Minister of Agriculture to represent the interests of consumers, presumably New Zealand consumers.
Under its legislation the Board is required to accept all fruit which is offered and which meets specified grading and packaging requirements which it determines. The Board has noted that:
ÒAlthough there is no compulsory acquisition of fruit from growers, the New Zealand Apple and Pear Marketing Board receives approximately 85% of New ZealandÕs annual total production.Ó
The Board portrayed its monopoly position more realistically when it said:
ÒClearly all growers are at risk if the Government decides any amendment to our Act relating to the most important aspect of our marketing structure, total acquisition of the crop.Ó (emphasis added)
The Board is involved in all aspects of the industry
Fruit is delivered to coolstores in all the major growing regions and most of these coolstores are owned by the Board. The Board then takes responsibility for all aspects of marketing. This involves the complete range of marketing services including branding, financing, freight, insurance, promotion and a variety of customer services.
Board field staff keep growers informed on Board policy, make planting recommendations, and advise on harvesting dates and cultural practices. The Board operates an extensive system of quality control in the field.
Growers participate in a compulsory Hail Insurance Scheme to cover all pipfruit destined to be supplied to the Board. The premiums are collected by the Board against fruit supplied to it by growers and the scheme is operated by the Federation.
For export fruit the Board arranges freight under contracts between it and the shipping companies.
The Board manages and funds a program of pipfruit R&D. The Board says the main objective of all R&D is to improve market returns for both fresh fruit and processed products. Priority areas for R&D include plant breeding, improving shelf-life and keeping qualities, and issues associated with market access.
Fruitfed Ltd is a joint venture horticultural merchandising company owned by the Board and the New Zealand Fruitgrowers Federation. In its 1990 Annual Report the Board indicated that it intended to Òrealise this investmentÓ during 1991 because the funds Òcan be more appropriately directed to growth requirements within the Board.Ó
The Fruit Industry Plant Improvement Agency (FIPIA NZ Ltd) is a wholly owned Board subsidiary company which was formed in 1981 as a joint venture with the Fruitgrowers Federation. The Board says the major task of FIPIA is Òto ensure the supply of desirable new fruit varieties and rootstock.Ó
The Board began investing in New Zealand based fruit processing in 1962. It now owns a number of fruit juice brands, and owns and operates three processing plants located in Nelson, Hastings and Auckland. The Board says facilities at all plants are amongst the most modern in the world.
The growersÕ organisation is an active industry participant
In 1916 fruit growers formed the Fruitgrowers Federation in order Òto foster, promote and protect the fruit industryÓ. The Federation has a Pipfruit Sector Committee which represents apple and pear growers. The Federation is a company with no share capital. It is owned by the New Zealand Fruitgrowers Charitable Trust whose trustees are Federation directors.
The Orchard Levy Act requires all fruitgrowers with more than 4000 square metres (planted area not canopy) of trees or vines to pay a levy to fund the Federation, which has an annual budget of some $1 million. The cost to growers of this levy is $25 per hectare with a minimum payment of $120 and a maximum of $1000 - plus GST.
Grower democracy works through a layered system of representation. An individual grower belongs to a Grower Association which appoints members of District Advisory Committees which elect the directors of the Federation. These directors in turn elect the industryÕs four directors on the NZAPMB. While individual growers can nominate candidates to represent them as directors on the NZAPMB, their ability to influence who is actually appointed is very indirect under the current system.
This system of representation and election means that directors of the Federation, representing growers of all types of fruit in New Zealand, elect directors to the NZAPMB which markets for only a part of the industry. The 1991 National Pipfruit Conference asked the Federation to examine alternative approaches for electing NZAPMB directors. Following a review and further discussions within the industry the Pipfruit Sector Committee concluded that the current system should be retained.
7.2.5 The industry is highly dependent on exports
Almost 60% of apples received by the Board are exported fresh to around fifty countries. About one third of receivals are processed Ñ mainly juiced Ñ and about one half of the resulting product is exported. The balance of Board receivals Ñ about 10% Ñ is sold fresh on the domestic market.
In 1991 over 75% of the BoardÕs total sales revenue was derived from the export of fresh fruit. Around 10% of sales revenue was receipts from the export of processed products.
Although the New Zealand apple industry is very commercially dependent on export markets it is a relatively small player internationally. New Zealand accounts for about 1% of world apple production and about 5% of world trade.
Europe is the worldÕs major importer of fresh apples taking over one half of all apple exports. North America is also a major importer. The Asian market is growing rapidly.
The major markets for New Zealand apple exports are very competitive. New Zealand has to compete with local supplies, supplies from competitor exporters, and other fruit. In addition, controlled atmosphere storage has increased competition in New ZealandÕs Northern Hemisphere selling season.
Most well-established markets are mature with stable per capita consumption, generally low rates of population growth and increasing volumes and ranges of competing fruits. Fruit is also inexpensive relative to disposable incomes. Consequently, there are no prospects of rapid expansion in total market size. If New Zealand is to sell significantly increased quantities in these markets it can only be achieved through expanding market share.
As with most products, there is not an apple market as such but an array of markets Ñ apples and their markets are characterised by great diversity.
ÒTo meet the high demands generated by these market conditions the Board divides . . . [the] . . . New Zealand apples it delivers to 50 countries into 1400 product categories differentiated by size, flavour, variety, colour and labelling.Ó
Despite this market diversity the Board has only one export grade and, until recently, did not have a registered brand for New Zealand apples. In late 1991 the Board announced ÔEnzaÕ as the brand name it had chosen for all its products.
Apples which are exported must meet the relatively high quality standards of the single Fancy export grade. Within this grade apples are differentiated according to variety and size Ñ the ÔcountÕ. There are two grades on the domestic market, local fancy and the recently introduced No 1 Grade. Both grades are apples not suitable for the export grade. Apples not graded into any of these three categories are either sent for processing or graded ÔrejectÕ.
Most fruit is sold in overseas markets on a listed price basis. Fruit is marketed either on firm sale basis or through appointed agents in overseas countries who sell on the BoardÕs behalf. The Board has an office in central London which coordinates marketing to Europe and the Middle East while sales to Canada, the United States and the Caribbean are handled by the office in Vancouver. Other markets have agents reporting to Wellington.
The varietal composition of exports is changing in line with planting
trends. The varietal composition of apple exports in 1988 and 1991 is presented in Table
7.1.
Table 7.1: Varietal Composition of New Zealand Apple Exports
Variety Percentage of Export Volume in:
1988 1991
Granny Smith 33 20
Red Delicious 30 21
CoxÕs 8 9
Braeburn and Royal Gala 15 36
Other 15 14
TOTAL 100* 100
* does not total due to rounding.
Source: Department of Statistics.
The new higher returning varieties today comprise well over one third of exports by volume and considerably more by value. However, the lower returning traditional varieties, Granny Smith and Red Delicious, still comprise over 40% of apples exported.
Europe is New ZealandÕs major market
Europe continues to be by far New ZealandÕs most important export market. The EC takes over 60% of exports by volume and an even greater share by value, with the United Kingdom and Germany the largest individual country destinations. The importance of the EC market is reinforced by the fact that it takes a greater range of varieties and sizes than any of New ZealandÕs other export markets.
The EC monitors closely supplies from Southern Hemisphere producers although to date has not imposed comprehensive quantitative import restrictions. It introduced a licensing system for non-EC producers in February 1988 and volumes of imports were registered. Subsequently quotas were introduced for part of the season but not continued after the end of the season.
The action taken in 1988, the manner in which the EC closely monitors import volumes, and the introduction in 1990 of restrictions on the import of small sized apples, all reinforce the tenuous nature of access to this major market. In commenting on the EC quotas introduced in 1988 the Board said:
ÒQuotas imposed by the European Commission not only created havoc with forward commitments to our major customers, but also redirected excess volumes of southern hemisphere apples and pears to markets in Scandinavia, North America and the Pacific. Much of this fruit was sold by our competitors at low prices, placing very real pressure on the Board to maintain volume sales at economic returns.Ó
While these indirect effects of the quotas obviously influenced market circumstances facing New Zealand outside the EC, it was not necessary to limit New Zealand shipments to Europe because Òdue to the reduced crop [in New Zealand] we were not able to fill the allocated volume.Ó
The BoardÕs Chief Executive has told growers that:
Ò . . . the BoardÕs ability to profitably market an increasing crop relies heavily on unrestricted access to Europe as our largest export market and the only one in the world where we can sell the full size range of all varieties.Ó
The Board is continually reviewing and developing its marketing methods and activities in Europe. During the 1991 season the Board reported that:
ÒThe United Kingdom and Eire sales system was completely revamped so that every carton of fruit was sold by the BoardÕs London based marketing staff direct to a major retailer or distributive wholesaler. There was no traditional agent or commission selling.Ó
It also noted increased sales in Eastern Europe in 1991 made via trading partners in West Germany and Italy.
A diversity of other markets and market circumstances
North America is New ZealandÕs second most important market, taking about 15% of exports. Production and exports are increasing in the United States, there is a very active producer lobby, and access is a sensitive issue. The BoardÕs regular imports of United States apples during New ZealandÕs off-season should be viewed in the context of this sensitivity.
There are no quantitative restrictions on exports to the United States but strict phytosanitary requirements need to be met.
Operations in the North American market are conducted through a partnership between the Board, the New Zealand Kiwifruit Marketing Board and Canadian-based David Oppenheimer and Company.
Many potential markets for New Zealand fruit restrict access or are totally closed. Australia and Japan will not accept apples from New Zealand on quarantine grounds. Australia bans imports from New Zealand on the grounds that they would risk the introduction of the fireblight virus; the main reason for JapanÕs ban is to prevent the risk of codling moth introduction.
In both cases negotiation of protocols to allow imports from New Zealand have been underway for some time. In the case of Japan the Board recently said that it was Òstill working towards establishing an acceptable protocol with this country and we should be in the market within the next three years.Ó
The Board has expressed certainty that New Zealand apples will meet AustraliaÕs phytosanitary requirements but that they Òhave some way to go to convince the Australian authorities.Ó However, the Board has stated that Òwe should gain access to this market in the very near future.Ó
The Indonesian market opened to New Zealand fruit in 1990 and small initial shipments were made. Mexico, Venezuela and Brazil have recently allowed access to imported fresh apples. Korea and India continue to ban the import of fresh pipfruit although Korea has announced the removal of all import barriers by 1997.
The BoardÕs domestic market monopoly
Per capita consumption of apples and pears in New Zealand is high by world standards. Apples are the most popular fruit in New Zealand, rating ahead of oranges and bananas, the next most sought after fruit.
The Board has a selling monopoly on the domestic market. It also has a monopoly on imports with the exception of imports from Australia which were removed from the BoardÕs control in mid-1990 as part of the CER arrangements. Only limited quantities have been imported from Australia since then. In 1990 around 10% of locally consumed apples and pears were imported. The major source was the United States.
In the domestic market distribution to the retail trade is either through wholesalers and distributors who sell on the BoardÕs behalf or direct from the Board to retailer. In the latter case the retailer must buy in bulk and fulfil the Board's storage and distribution criteria.
Most fruit on the domestic market is sold at a set price determined by the Board although auction is used occasionally, particularly for lines of fruit that are in short supply. The Board says it has no control over retail prices. It presumably means no direct control insofar as it does not set retail prices Ñ just wholesale prices which invariably have a significant influence on retail prices.
The BoardÕs monopoly on the domestic market is a controversial issue. Two reviews since 1987 have recommended its abolition but the government has allowed it to remain. The domestic market monopoly is one of the issues discussed in the next section.
The BoardÕs legislation provides it with considerable power to sanction growers who breach the regulations restricting domestic sales outside the Board. It is made clear to growers that failure to comply strictly with these regulations will result in them receiving prices which are only 50% of the advance payment set by the Board. The BoardÕs legislation provides for such penalties as well as allowing the Board to withhold all payments pending receipt of evidence to the satisfaction of the Board that the grower has complied with all the BoardÕs terms and conditions.
The BoardÕs major selling agent in the New Zealand market has suggested that these draconian powers are an effective suppressant of grower criticism of the domestic market monopoly.
ÒGrowers who are critical of the New Zealand Apple and Pear Marketing BoardÕs system are unlikely to speak out against the BoardÕs policies for fear of retribution from the all powerful BoardÕs machine.
ÒSection 27AB(8) [of the BoardÕs Act] is being quoted to growers by the Board as giving it total and unrestricted power to pay penal prices to any growers who have not, to the satisfaction of the BoardÕs employees, played by the rules.Ó
One third of the apple crop is processed
Around one third of the apples the Board receives are processed into juices and other apple products because, according to the Board, although this fruit is of good quality, it often cannot be sold as fresh fruit because of its variety, shape, size or colour. Grower returns from juicing apples are very low compared to returns from fresh fruit.
The Board says that while most of the single strength juices are consumed within New Zealand, considerable volumes of apple concentrate and aromas (esters) are exported. Major markets are Canada, the United States and Australia and growing markets for concentrate exist in South East Asia and Japan. Approximately half the volume of fruit processed is now exported.
7.3 Major Issues
Because it is the most regulated and controlled of all New ZealandÕs agricultural industries, the apple and pear industry provides numerous issues worthy of analysis and discussion. However, this industry, more than any other, exhibits a strong inverse relationship between the number of issues of interest and the availability of data which are so important to useful analysis.
The issues discussed here have been selected on two main bases. First, ACIL has been able to obtain information on them although not always from generally available sources. Second, they usefully illustrate the way in which highly regulated industries behave and provide insights into the reasons for this behaviour and its consequences.
ACILÕs research and discussions within the industry produced information on a number of issues not explored in any detail here. In some instances the material could not be used because sources feared that publication would result in commercial retribution made possible by the regulatory environment. For example, one grower told ACIL that immediately after publicly criticising the Board his reject rate jumped sharply and for reasons apparently unrelated to the quality of the fruit.
The next section considers what two inquiries into the industryÕs domestic market monopoly have concluded, why this monopoly continues and with what consequences. Next, some important features and implications of the relationships between market prices and what growers actually receive are considered. Distortions to grower price signals have been an important influence on industry developments. The legal contest over the Second Tier Levy and proposed Transferable Crop Certificates is then examined because it provides an insightful illustration of the capital raising problems an industry can experience when deductions from grower returns are the only source of equity funds.
The section concludes with an examination of how the future plans of the NZAPMB are certain to increase investment distortions if the manner in which returns are received under current marketing regulations and arrangements are not changed.
7.3.1 The BoardÕs domestic market monopoly
The BoardÕs domestic market monopoly has been reviewed twice in the past few years but has not been removed as a consequence. These reviews and their outcomes illustrate many aspects of the industryÕs current marketing arrangements, the arguments advanced for and against them, and the manner in which the growersÕ organisation and the Board justify total control of the industry.
The 1987 review of the domestic monopoly
In late 1986 a major review of the BoardÕs domestic and import monopoly was initiated by the Minister of Trade and Industry and conducted by the MinisterÕs Department. The review and its terms of reference were widely publicised and submissions received from interested parties.
In its submission to the review the Board argued, as one of its major reasons for retaining its domestic and import monopolies, that total control of the New Zealand crop is essential as it gives underlying support to the BoardÕs export activities. In particular, the Board highlighted benefits in controlling quality, export supply and the provision of marketing services.
The Federation submitted similar arguments, stressing the importance of controls over the local market to the viability of the export operations of the Board.
The reviewÕs findings were released in 1987. It was concluded that the BoardÕs domestic monopoly should not be retained. A major consideration was that the monopoly was not crucial to the BoardÕs export operations. It was also concluded that a deregulated domestic market would benefit domestic consumers in terms of price, quality and variety of local and imported pipfruit.
In early 1988 the government rejected the recommendations of the review. ACIL understands that this decision was taken in the context of changes to manufacturing industry assistance being considered by the government at the same time. A decision to retain the BoardÕs domestic market monopoly, and the assistance it was deemed to provide to the industry, was made at the same time as the government decided to retain certain assistance measures for manufacturing industry.
The suggestion that politics rather than the merit of the arguments underlay the governmentÕs decision to reject the recommendations of the review is reinforced by the fact that even the industry was surprised by the decision. Following announcement of the governmentÕs decision it was reported that:
Ò . . . growers were somewhat surprised that the recommendations made in the report commissioned by the Department of Trade and Industry, which asked for the local market to be freed up and for the BoardÕs import monopoly to be removed, werenÕt agreed to by Cabinet.Ó
The NZAPMB was also apparently of the view that the domestic monopoly was unlikely to be retained. In late 1986 it commissioned Coopers and Lybrand to assess the effect deregulation might have on its local operations. ACIL has obtained a copy of the consultantÕs report which, as far as we can ascertain, was never released publicly.
The BoardÕs brief to the consultant noted that the Board was facing the probability of deregulation of marketing of apples and pears on the New Zealand market. The Board said it had a series of options in key areas which it needed to evaluate quickly in order to decide the future direction, scope and viability of its New Zealand fresh fruit business.
Interestingly, the consultantÕs brief instructed that Òthe issue of whether the Board wants to stay in the domestic business anyway, because of related factors such as its market profile and industry unity, do not need to be addressed in this project. Rather the extent of any subsidy necessary to stay in business can be gauged from the studyÓ. It went on to explain to the consultant that Òto retain supply loyalty the growers must be able to see a consistently higher return via the Board than by marketing the fruit through their own endeavours or through another agency.Ó
The brief also noted that the Board Òis already developing a marketing strategy for the deregulated environment which is centred around the establishment of its own brand.Ó
In their report to the Board the consultant noted that Òin a deregulated future the BoardÕs overhead structure alone will make it very difficult for it to compete effectively on the local market.Ó In their recommendations they said that the BoardÕs local business could be halved and that subsidies Òof the order of $7,000,000 to $12,000,000 will be needed to support the local operation.Ó This would represent a cost of over $7000 per grower each year.
The 1990 review of the domestic monopoly
In late 1989 the Minister of Agriculture asked interested parties to submit their views on the BoardÕs domestic and import monopoly.
In its submission, Apple Fields Ltd argued that removal of the domestic and import monopoly would make the domestic market more efficient. It went on to say:
ÒThis will result in the removal of anomalies that presently have an additional cost attached to them, for example, the subsidising of the local and processing markets. It will also make all services relating to the industry more efficient, particularly in the wholesale and retail markets, as well as the actual functions presently being carried out by the Board.Ó
Prior to the announcement of this review, Turners and Growers Ltd published a document arguing for freeing up the domestic market. They summarised their case for deregulation as follows:
ÒThe case for removing the local market monopoly rights of the New Zealand Apple and Pear Marketing Board is overwhelming.
ÒThe justification and logic of the case is unquestioned. C.E.R., and New ZealandÕs place in the Cairns Group of the GATT countries, demands it.
ÒIt is ludicrous that a black market exists for apples.
ÒThe problem will not go away. On the contrary, the anomalies become increasingly apparent.
ÒThe judicature has highlighted the conflict Ñ the Commerce Act and the New Zealand Apple and Pear Marketing Board local monopoly are at odds.
ÒGrowers will receive higher returns. Consumers will benefit by lower prices. Consumption of apples will increase Ñ for the good of the nation.Ó
The New Zealand ConsumersÕ Institute said that:
ÒThe Board may insist it is doing the right thing by consumers, but nevertheless it is a private sector monopoly, and such monopolies rarely benefit consumers.
ÒThe BoardÕs main argument, that it needs control of the domestic market to maintain exports, is not strong. The export market is highly lucrative for growers and, in a deregulated local market, the Board should have little difficulty signing forward contracts with growers for export supply.Ó
In its submission to the Minister, the Federation reiterated the importance of control over the domestic market to the industryÕs successful export effort. In the conclusions to its submission it said:
ÒThe apple and pear industry of New Zealand has the potential to expand its export focus and increase export returns to New Zealand. Removing total acquisition would cost the country some of that export focus through loss of confidence, short term greed and elimination of co-operative spirit. The export window would disappear for New Zealand.Ó
It also reminded the Minister of the continuous and strong grower support for total control of marketing by the Board. It reported the following resolution which was carried unanimously at the 1989 National Pipfruit Conference:
ÒThat this conference reaffirms its strong support for the system of controlled marketing that has been operated by the Apple & Pear Board with general success since 1948, and its determination to resist any further attempts by selfish private interests to undermine that system.Ó
The BoardÕs public position during this particular review similarly highlighted the proposition that those arguing for deregulation represented vested interests wishing to benefit from an uncontrolled domestic market. In a special edition of Pipmark News the Board told growers:
ÒA small number of new entrants and wholesalers are actively seeking change for their own individual benefit. These vested interest groups appear to have embarked upon a substantive campaign to achieve their objectives; however, their information is based on inaccuracies and fallacies;Ó
and:
ÒThere is no level playing field in the pipfruit industry. All our competitors receive some form of government protection. The only competitive advantage New Zealand has is total acquisition of the crop.Ó
Eventually the government decided to defer any decision on the BoardÕs domestic market and import monopoly and to consider the matter further after the implications of CER-related changes, made in mid-1990, had been assessed. The major CER implication for the apple industry in this context was the opening of the New Zealand market to competitive imports from Australia.
Again, however, ACIL understands politics had more influence over the decision than the merit of the arguments. The Minister of Agriculture had decided the BoardÕs domestic monopoly should be removed and was about to take this recommendation to Cabinet. However, before that occurred two other members of Cabinet, while travelling to address a grower meeting in Hawkes Bay, thought they heard the local member of Parliament, who was travelling with them, say that the Òdomestic monopoly was safeÓ. Because of the close family connection between the local member and the Minister, the two members of Cabinet took this to be the MinisterÕs view.
Media reports after the meeting quoted one of the Cabinet members as saying that the domestic monopoly would remain. It was then politically impossible to proceed along the lines of the MinisterÕs recommendation, hence the decision to defer any action. CER changes gave this deferral plausibility.
Who are the winners and losers on the domestic market?
The main argument used by the Board and the Federation in support of the domestic monopoly is its integral role in the export strategy. It is argued that total control over domestic supply ensures the BoardÕs ability to meet export customer requirements for quality and reliable supplies.
The industry also makes much of the responsible manner in which it fulfils its obligations to New Zealand consumers. According to the Board:
ÒThe BoardÕs central marketing system guarantees the New Zealand consumer a year-round supply of good quality apples and pears at reasonable and stable prices.Ó
In a document prepared by Apple Fields in early 1988 it was noted that the Board had stated that losses on sales of apples on the domestic market were $4 million per annum. In a written response to the Apple FieldsÕ document the Board denied the statement and commented as follows:
ÒThe $4 million was an indication of income forgone by pipfruit growers through marketing volumes of exportable preferred variety apples on the domestic market. It was used as an indication of the importance the industry places on the domestic monopoly and the responsible manner in which the monopoly is administered.Ó
ÒIn some years the local market contributes and in other years it may lose money Ñ just like any other business. It is currently profitable.Ó
However, in 1990 during the debate surrounding the second review of the domestic monopoly, the Board said:
ÒThe Board provides New Zealanders with a wide variety of good quality fruit, some of which would attract far higher prices in the export market. We estimate this costs the Board $4 million a year.Ó
It can only be concluded from the above, therefore, that the domestic monopoly has growers forgoing $4 million in revenue on average each season. This is an average of about $3000 per year per grower. It is unlikely that growers are aware that they individually incur this revenue loss as a result of the monopoly.
It is also not possible to validate the BoardÕs claims. It does not publish either information on returns by markets, or unit values or prices for particular markets or sales.
At the same time as there appears to be some agreement on the proposition that the industry loses sales revenue on the domestic market, there are also claims of profiteering by the Board. It is also suggested that the BoardÕs costs of servicing the domestic market are very high. This latter conclusion was also reached by Coopers and Lybrand in their investigations for the Board in 1986.
In exploring these assertions further it is necessary to put them in the context of how the Board operates in the domestic market and changes that have recently been made or are being made to its operations.
In the past a significant source of apples for domestic sale by the Board was the Òloose fruit panelsÓ system. These panels comprise growers who submit their fruit in bulk to the Board which then grades, stores and packs it for sale on the domestic market. This system is relatively high cost and probably explains the high costs incurred by the Board in servicing the domestic market.
One media report described the loose fruit panel system as:
Ò . . . a kind of social welfare system run by the board to keep underperforming growers in business. Panel members send their apples to a special sorting centre where sharp-eyed sorters are paid for the lots more time needed to spot the saleable apples.
Ò . . . loose fruit panels are expensive to operate . . . The board knows it has to get rid of the panels because they cost so much to run. But this means putting unprofitable orchardists out of business.Ó
The Board wrote to all growers in June 1991 to explain changes it was making to its domestic marketing operations. The contents of this letter indirectly illuminate a number of the domestic market issues under debate.
The letter begins by telling growers that:
ÒYou will be aware that over the last few years we have been studying the options available to us to improve the local marketÕs contribution to our business and to better meet the demands of the market.Ó
It is worth recalling that the Board engaged consultants to do exactly this in 1986 and were considerably advanced at that time in developing strategies for improved performance on the domestic market. However, with the continuation of the monopoly it would appear the changes were deferred and/or found not to be necessary.
The letter then referred to the BoardÕs action in 1990 when it introduced a new grade (No 1 Grade) to the domestic market on a limited trial basis. The Board told growers that No 1 Grade had been well accepted by the trade and that in years to come it would constitute Òin excess of 50% of our domestic sales.Ó Growers were reminded that in the 1991 season the Board had Òsubstantially reduced our loose fruit panels and further increased the quantities of No 1 Grade.Ó
In essence, the letter was telling loose fruit panel growers, as gently as possible, that the high cost panels were being abolished. The Board recognised that this would cause financial pressures for many growers:
ÒWe realise these are major decisions with far reaching effects on some growers, but they have been taken to strengthen our local market operation, both in the marketplace and financially through reduced cost in order to improve the marketÕs contribution to growerÕs returns.Ó
Why did the Board take this action, albeit with considerable delay, to remove the loose fruit panels and introduce a new grade to the domestic market? Probably because major commercial players like Turners and Growers and Apple Fields were maintaining pressure for change.
In the first half of 1991 Apple Fields applied to the Board for permission to export small Braeburn apples to a customer they had identified in the United States. They had agreed a price for these apples many times higher than the price for juicing which is where the apples were being directed by the Board. The Board refused permission. Apple Fields then negotiated to sell the apples direct to a domestic supermarket chain and requested Board permission. Again permission was refused. Apple Fields was then left with processing as the only outlet for the apples Ñ yielding a return considerably lower than either the export or domestic deals they had negotiated. Amid considerable publicity, they gave the apples to charity.
At about the same time, Apple Fields issued a press release claiming the Board secured excessive margins on domestic apple sales. It provided an example of the cost breakdown for domestic sales of No 1 Grade Braeburn apples. The figures showed a Board margin of nearly $14 per carton on fruit which was bought by the Board from the grower at $4.32 per carton and wholesaled by the Board at $20.16. After allowing for a wholesalerÕs commission Apple Fields calculated the BoardÕs margin was 320% of the grower price.
The conclusion from the preceding material is that the Board has been simultaneously disadvantaging consumers in terms of availability, quality and price while also losing growers money on the domestic market because of high costs and lost sales opportunities. Some highly publicised competitive pressure appears to have achieved more in the way of a Board response to start to correct the situation than was achieved by two official reviews of the monopoly.
What do the evidence and arguments suggest?
The two reviews of the domestic monopoly have concluded that it should be removed. ACIL finds the arguments and logic underlying the conclusions from the 1987 review to be very compelling. In particular, the reasoning that the Board, with a continuing export monopoly, could contract to obtain its requirements to service this monopoly if the domestic market were deregulated, is logical and persuasive. It would also offer the Board the advantage of being able to demonstrate its ability to secure superior returns from export markets.
There is no question that there would be a set of pricing and contracting arrangements which the Board could use to satisfy its export marketing requirements if it did not have a domestic monopoly. In bidding for its export supplies in this way it would simultaneously be maximising returns for growers. Growers would have more choice and better information on the BoardÕs performance. These propositions have not been convincingly rebutted by the Board or the Federation. The dairy industry does not require a domestic monopoly to operate its export monopoly.
Consumers do not accept the industryÕs assurance that they are not being disadvantaged or that their needs are being fully met. It is difficult to see how the Board can both keep domestic consumers happy Ñ supplying what they want, when they want it and at a competitive price Ñ while also using this market as a supply buffer to give priority to meeting the needs of overseas customers. Who wins when there is conflict between these two sets of consumers?
It is also reasonable to conclude that the Board could and would live without the domestic monopoly. It is clear that it was preparing to do so in 1986 on the expectation that it would be removed sooner rather than later.
In ACILÕs view, and on the basis of the material presented here, the traditional arguments used by the industry for the retention of the domestic monopoly are largely spurious. The real reasons for resistance can be seen in the politics that surround the changes currently being made by the Board. The logic is very straightforward.
The Board has had a very costly system in place for supplying the domestic market with fruit. The domestic monopoly and total acquisition of the crop has allowed the Board to extract significant margins on some domestic fruit which helps offset these high costs, but not sufficiently to prevent operating losses on the domestic market. Both growers as a whole and consumers have been losers.
Resistance to deregulation, and the very tardy way in which the Board has moved to improve the situation, reflect the political difficulties associated with exposing a minority of growers to more competition and potentially lower returns if they did not improve their performance.
On the basis of the earlier discussion, the growers in question were those supplying loose fruit panels. However, it has also been suggested that the Board has resisted change because of a feared backlash from growers securing good returns on the black market and from gate sales. The BoardÕs pricing policies on the domestic market enable these growers to obtain higher prices than would prevail in a competitive market. Turners and Growers have estimated that the black market accounts for between one third and one half of total domestic sales of apples.
The other political element is a fear amongst industry leaders that if the monopoly were removed growers would start taking commercial decisions on the basis of what was most profitable for them. This, together with questions which might arise as a result of growers having improved market information, would threaten industry unity. The inference here is that growers need to be protected from themselves and that loyalty is only achievable through enforcement.
It is amazing that any government would allow the continuation of marketing arrangements which disadvantage so many Ñ consumers, the majority of growers and the nation Ñ in the absence of any worthwhile evidence of necessity or net benefits. Evidence to the contrary, however, is overwhelming. If nothing else, the continuation of the BoardÕs domestic monopoly is testament to the considerable political influence of the few who lead and represent the industry and the apparent disinterest on the part of most growers concerning what is in their best long term interests.
7.3.2 Relationships between market prices and grower returns
Over most of the industryÕs history orchard gate returns have not reflected actual market realisations for the fruit. Systems for stabilising, smoothing and variously pooling market returns and some costs have always characterised the industry.
Detailed public information on actual market realisations and the extent of price smoothing and pooling has always been scarce. Even growers only receive limited information. The lack of data is probably an explanation for the absence of analysis or research into the implications of the pricing policies for individual growers, the industry and the economy.
Economic principles, and research in other industries where market signals are distorted before they reach producers, invariably points to the likelihood of costly economic distortions. There is no reason to expect the result would be any different in the apple and pear industry. This section discusses the extent to which grower returns have differed from market realisations Ñ to the extent available data allow Ñ examines why this has occurred, suggests what the likely consequences have been, and discusses how forthcoming the Board is when growers seek more detailed information.
Recent changes in methods for setting grower returns
Until the 1989 season, growerÕs returns were determined by the Apple and Pear Prices Authority. This body operated under legislation which specified the bases on which the average per carton return at the orchard gate would be set each season, including the provision that it could not move up or down by more than 5% when set at the beginning of the season. Funding for this stabilisation activity was sourced from the Reserve Bank at the concessional interest rate of 1%. While the Board had to pay this average determined by the Authority, it was free to set what it considered appropriate varietal and size differentials when determining payments to growers.
In 1988 the Producer Boards Amendment Act abolished the price setting Authority and transferred responsibility for determining grower returns to the Board. The Act requires it to consult with the Federation in fulfilling this responsibility. The Board was also left to determine, in consultation with the industry, whether a stabilisation scheme would continue. It was decided not to continue the stabilisation scheme.
In setting grower prices the Act requires the Board to have regard to market returns for each variety or grade of apple. The Board, under section 27AB(7), also has to consider:
Òthe desirability of maintaining the stability and efficiency of the apple and pear growing industry.Ó
Consequent on these changes the Board introduced what it described as a market related grower payments system. While this was a discrete and clearly announced change in policy, there appears to have been a tendency over the preceding few years to move average varietal returns closer to actual market realisations. The Board summed up the 1989 changes and commented on their consequences as follows:
ÒAs a result of requests from the industry the Board introduced a new growersÕ payments structure this season with more closely market related returns paid to growers. This has lead to a wider spread between growersÕ incomes with many growers under greater financial pressure than they had been previously. This was particularly true of those who have not restructured their orchards to include newer varieties.
ÒTraditional varieties such as Red Delicious and Granny Smith were, for the first time, not able to obtain sufficient increases in return in the marketplace to overcome the increased costs and higher exchange rates. The Stabilisation Fund was no longer available to assist these varieties as would have been the case previously.Ó
These sentiments were repeated in the 1990 Annual Report:
ÒOur market related system of returns means that there is a wide spread of income levels amongst growers as a direct result of the premiums achieved by our preferred varieties. The financial importance of planting the newer varieties is evident and growers who have heeded the BoardÕs advice on restructuring have clearly benefitted.Ó
Some price smoothing and pooling still occurs
The Board acknowledges that some price smoothing and pooling still occurs. Varietal pools and a general pool are also still operated by the Board. The Board advances a number of reasons why these modifications to actual market realisations are necessary and advantageous to the industry. These reasons are discussed later.
However, not even growers get sufficient information to be able to ascertain exactly how extensive these price modifications are and exactly how much particular varieties and sizes either contribute or receive as part of pooling and smoothing. Since 1990 the Board has included in the confidential statistical appendix to its Annual Report, a table which purports to record the net inter-varietal consequences of smoothing.
Apple Fields has been involved in correspondence and discussions with the Board in an effort to obtain better information on the extent of price smoothing. Copies of correspondence from both Apple Fields and the Board have been circulated widely in the industry. Apple Fields have developed a set of calculations, based on information the Board has published, which indicate that inter-varietal and size price smoothing is still substantial, and apparently much greater than suggested by the information accompanying the Annual Report.
An obvious point to make is that Apple Fields have a strong commercial interest in actually obtaining full market realisation for the newer, market preferred varieties because this is what they have predominantly planted in their 680 hectares of orchard. An incidental but important point in this regard is the basis on which they decided what varieties to plant.
Apple Fields have said that when they were making planting decisions in the early 1980s and requested information and advice the Board was Òloathe to provide what we wanted; the real returns by varieties could not be divulged because of commercial security Ñ and no doubt the degree of price smoothing would be exposed.Ó Apple Fields sought out the information from the market place themselves and decided to plant Braeburn, Gala and Royal Gala, the varieties now providing relatively high returns. They said that at the time they were seeking advice the Board Òwould have preferred us to plant Red Delicious.Ó
In mid-1990 Apple Fields wrote to the Board setting out their calculations on the extent of inter-varietal price smoothing which at that stage appeared in prospect for the 1990 season based on advance payment rates and some information on market realisations published by the Board for the previous season. They pointed out in their letter that on the basis of these calculations there Òwould appear to be a very considerable difference between the actual levels of varietal price smoothing in prospect for 1990, and those notified to growers for 1989Ó. For example, Apple Fields calculated a contribution to the payout of other varieties from Braeburn apples of $8.07 per carton in 1990 compared with a published Board figure of $2.14 for 1989. Granny Smiths, according to Apple Fields, would receive a payment from other varieties of $5.22 per carton compared with a Board estimate of $0.46 in 1989.
In a brief reply, the BoardÕs Chief Executive said:
ÒThere was at the time of the advance, and there still is, no Ôprice smoothing in prospect for 1990Õ as you claim in your letter. Price smoothing is considered only when all pools are finalized. Your conclusions 1,2,3 and 5 are invalid.Ó
Apple Fields again wrote to the Board noting that Òmany growers who expressed interest in the issues raised in [the Apple Fields] letter will be disappointed in your reply.Ó Apple Fields referred particularly to the Chief ExecutiveÕs observation that there was still no price smoothing in prospect for 1990, saying they doubted Òmost growers would believe you.Ó
In this particular letter Apple Fields raised specific questions about the extent of price smoothing across the size range within a variety. They pointed out that their earlier price smoothing calculations included this type of smoothing as well as the average inter-varietal transfers. They asked why payouts to growers differed significantly across the size range when market realisation data published by the Board Òshow a very similar price paid [in the market] across the total size range of each variety.Ó
This time the Board made a more substantive attempt to clarify and explain the situation. On the subject of the expected varietal payments to growers for the 1990 season, the Chief Executive of the Board said:
ÒIn regard to your comment on the expected returns for Braeburn versus Granny Smith and Red Delicious, I can say only that, yes, there is likely to be a considerable difference in the relative payouts, but it is not appropriate for me to comment on what that will be at this time. When all funds from sales have been received and repatriated, all expenses finalised and the audit completed, then that difference can accurately be determined.Ó
This letter was written just after the end of the 1990 season.
The letter went on to explain that as far as Òsmoothing between sizes is concerned, the Board doesnÕt employ this approach as a direct mechanism at all.Ó However, the letter continued with a statement which was both internally contradictory and indicative of inter-size smoothing by saying that payments were close to actual market returns but that they were set with the objective of providing medium term signals. It said:
ÒThe Board sets a market return curve for payment rates which mirrors very closely actual market returns with the key objective in mind to establish incentive for the grower to grow the size range which is more profitable to the industry in the medium term.Ó (emphasis added)
ACIL understands that discussions and correspondence on the same issues between Apple Fields and the Board recommenced in mid-1991. The more recent correspondence has not been circulated in the industry and Apple Fields was not willing to provide copies to ACIL. The obvious inference is that even Apple Fields, despite its past high profile and willingness to challenge the Board publicly, has had to contemplate the tradeoff between public criticism of the Board and the commercial interests of its shareholders.
Apple Fields did tell ACIL that it had received no written communications from the Board since June 1991 despite numerous written requests and promises from the Board. There had, however, been discussions with the Board and verbal feedback. This begs the question: why is the Board not prepared to put in writing further information and arguments in regard to price smoothing? After all, the enquiries are from one of the BoardÕs larger grower/shareholders.
The lack of substantive data and information, and reliance on assertions, also typifies the BoardÕs public explanations for continuing price smoothing. The BoardÕs arguments in favour of smoothing are discussed next.
The Board says price smoothing is necessary and yet acknowledges the consequential distortions
The Board appears to use two substantive public reasons to justify price smoothing and they are somewhat interrelated. The first is that it is necessary, in maximising market returns to the industry, to maintain the ability to provide major customers with a full range of varieties. For reasons that are not altogether clear, this appears to be an important issue in the EC market but not elsewhere. The second reason is that growers could be misled if they made planting decisions on the basis of prices which in the short term can fluctuate markedly around the longer term trends. So the Board accepts the responsibility for ensuring growers are not misled by making judgments about the trends and reflects this in grower payments and advice to growers.
In 1989, at the time the Board said it was introducing a more market related grower payments system, it explained the mix of varieties objective as follows:
ÒThe Board believes it is very important in the long term to maintain a balanced mix of varieties. Its payment policies will be implemented to effect this as far as possible within the overall market returns received by the Board.Ó
In 1990, the Board reinforced the point by telling growers:
ÒFor us to maintain and build on our new standing in the market place we will continue to request a balanced portfolio of products, including substantial volumes of the most commonly traded varieties.Ó
However, by 1991 the Board appeared to be concerned that growers were not heeding their advice.
ÒIt is possible we may even see a situation where our competitors offer the full range [of varieties] while New Zealand has only the new varieties. This will almost certainly reverse the trend of market success we have enjoyed in the past few years.Ó
There is a possibility that growers may have become somewhat confused regarding exactly what the Board wanted them to do and the relative importance they should attach to the price signals they receive from the Board, on the one hand, and what the Board is saying they should do, on the other. For example, at the 1989 Pipfruit Conference growers voted in favour of continued price smoothing between varieties to ensure an adequate variety mix. The Chairman of the Board told delegates at that Conference that the Board would support varieties which had a long term future but that supporting varieties that did not have a future was not appropriate. He went on to say that if a variety is Òtrending down we believe that should be reflected in market returns. Minimal intervention is the policy we ought to pursue.Ó
In 1990 the Board reminded growers that:
ÒThe Board has said price-smoothing is a last resort. We wonÕt price-smooth unless circumstances warrant it.Ó
Most of the issues surrounding the BoardÕs reasons for price smoothing, the responses of growers to both smoothed prices and Board advice, and the consequential problems experienced by the Board were encapsulated in a letter it sent to all growers in May 1991. The letter, the issues it raises, and the major conclusions ACIL draws from its contents, are discussed here because they epitomise most of the major faults in the industryÕs current marketing arrangements and regulations.
The letter in question was titled ÒThe Granny Smith/Red Delicious Dilemma.Ó An edited text is reproduced in Box 7.1. An analysis and discussion of all the commercial and economic issues this short letter raises would be a major study in itself. Only some of the important issues raised by the letter are identified and discussed in what follows.
Probably the best starting point is to consider what the market is telling New Zealand apple growers. According to the Board the market says a full range of varieties is required for commercial success in the future. Also, some markets particularly want Granny Smith and Red Delicious.
However, growers are also told that the market is not prepared to pay sufficient for these two varieties to enable New Zealand growers to produce them profitably. That this is correct is evidenced by declining production of the two varieties in New Zealand Ñ accelerated presumably by the decision to relate grower returns more closely to market realisations.
Clearly, and understandably, the market is telling New Zealand growers what it wants but at the same time making it clear that it will not ÒsubsidiseÓ the supply. It can take this position because if the full mix of varieties, or even particular varieties, are not available from New Zealand at acceptable prices, they can be sourced elsewhere.
The message for some New Zealand growers is that their costs of production are not internationally competitive. This should come as no surprise. In 1990 the Board told growers that because their costs were significantly higher than competitors, New Zealand needed considerable premiums from the market. With the international spread of the so-called unique varieties these premiums, which in the past had supported higher cost growers and less preferred varieties, and discouraged productivity enhancement and orchard restructuring because of pooling and smoothing, are no longer available.
Given these circumstances the Board is telling growers that it Ðwhich means growers Ñ will subsidise the production of two varieties. This will hardly send growers the correct signals regarding either what to produce or the extent to which they need to improve productivity and lower costs. This raises the all important point of grower profitability.
The BoardÕs approach to the problem is based clearly on the premise that all growers have the same costs of production and the same rates of profitability. They do not and, more importantly, the Board does not and cannot know how they vary between individual orchards. One of the biggest problems facing the Board is that, unlike any commercial marketer, it cannot set prices for apples which would deliver that level of production which the Board could market profitably. It has to accept all apples that meet its standards and sell them. This leads to the next two points of interest to arise from the letter.
The first is the question of how successful the Board is in projecting future production. Its projections of Granny Smith production were very inaccurate, which is somewhat surprising given its extensive field operations in New Zealand and its claim to have Òevery pipfruit tree in New Zealand on computer.Ó As noted in the letter to growers (Box 7.1), in mid-1990 the Board was telling growers, based on its production projections and market assessments, that there needed to be a cutback in the volumes of some of the traditional varieties such as Red Delicious and Granny Smith. One year later it is proposing to subsidise their production.
The second point to be made here relates to the fact that the Board has been forced to raise Ògrade standards to maintain our necessary price premium.Ó The problem arising from this action is that it lowers growersÕ packout percentages and may reduce their profits.
From the BoardÕs perspective raising grade standards is an easy Ñ and given the regulations a readily available Ñ option to achieve their objective of maximising grower unit returns from the export market. However, growers have a different primary objective. They are trying to maximise profitability from the production of all their apples. This is unlikely to be achieved by just maximising unit returns on export apples Ñ particularly when the BoardÕs approach to achieving this is simply to raise minimum quality standards and force growers to accept a much lower return for an increased proportion of their crop, or not to produce lower quality, but potentially profitable apples.
This, in turn, raises the issue of grades, quality standards, and quality/price relationships in the industryÕs marketing strategy. The Board is always emphasising the need to produce only top quality apples. This, they say, is what the customers want.
It is, however, much more likely that what the customer wants is an acceptable and reliable set of quality/price relationships across a range of qualities. If, as the Board so often asserts, exporting apples that are not top quality drags down the prices for all New Zealand apples, then presumably exactly the same occurs when lower quality apples are sold by a competitor country. There is no logic or established market circumstances which support the proposition that the export of other than top grade New Zealand apples will pull export returns down but, when sourced from another country, will not. In these circumstances, the New Zealand preoccupation with exporting only the best is futile and is costing the industry revenue, particularly given that New Zealand has only a 5% share of internationally traded apples.
Comments in the letter about the growing market competition from other suppliers across the full varietal range reinforces this conclusion. Because New Zealand has nothing remotely approaching a monopoly position in the world apple market it has no exploitable market power which would justify the type of policies the Board pursues. The market circumstances in which New Zealand operates means it should maximise the returns available for every apple produced. This means a much greater range of grades and quality standards with each priced according to what the market will pay, and with the price/quality relationships clearly communicated to the customer.
The final point made here in relation to the BoardÕs letter to growers, concerns the manner in which varietal assistance will be provided Ñ in particular, the reference to using Òdiscretionary income from outside our core business.Ó
This proposition raises two important points. First, it suggests the Board is disinclined to return to extensive inter-varietal price smoothing. This may reflect its sensitivity to the unresolved debate with Apple Fields about the exact amount of smoothing already occurring. However, it is more likely a reflection of the fact that any price premiums available to New Zealand when the newer varieties were reasonably exclusive have disappeared.
The Board is certainly telling growers that market returns for these varieties will be lower in the future, as production in New Zealand and competitor countries rises. In these circumstances the newer varieties will not be generating sufficient revenue to sustain any extensive inter-varietal price smoothing. Additionally, with orchard restructuring occurring, an increasing proportion of growers will be obtaining a rising proportion of their revenue from the newer varieties. Clearly, the political balance of power between the subsidisees and the subsidisors is moving to favour those producers who would have to fund the subsidies. In these circumstances, extensive inter-varietal price smoothing would place increasing pressure on industry unity.
The second important point arising from the BoardÕs proposal to fund variety support from non-core income is the implications this has for ensuring New ZealandÕs level of apple production is in balance with market demand. As discussed earlier in this report, if price signals to growers are not a true reflection of market demand and prices over time, then growers will not maximise profitability and the nation will also be a loser. Including in the product return to growers income which is not derived from the actual sale of their output will unambiguously result in such distortions.
The Board clearly expects non-core income to increase in the future. The Board has recently made a number of strategic investments which, if profitable, will earn income for the industry in addition to market receipts for New Zealand apples. This carries significant future implications for the industry and the New Zealand economy which are returned to in the last part of this section.
7.3.3 The Second Tier Levy and Transferable Crop Certificate saga
A significant flaw in New ZealandÕs marketing regulations is that marketing organisations like the NZAPMB, in pursuing their objective to maximise grower returns, find their task increasingly difficult the more successful they are at marketing. The reason is that higher returns encourage more production. Increased production has to be sold and this carries two significant implications.
First, with increasing production market clearance usually involves accepting lower prices in marginal markets. This makes it harder for marketers to deliver on the return to growerÕs objective.
Second, increased production means increased marketing infrastructure Ñ growth in the marketing business has to be funded. Under current regulatory structures deduction from grower returns is the only means of equity funding. Not only do such deductions reduce grower returns Ñ the basis on which marketer performance is judged Ñ but they also raise questions of which growers should do the funding. In particular, why should all growers have to contribute capital to fund marketing infrastructure made necessary only by growers choosing to expand production?
The increase in the Second Tier Levy (2TL) and the proposal to introduce Transferable Crop Certificates (TCC) need to be considered in the above context. What the Board and industry were trying to do was design responses to production growth within constraints imposed by the existing regulated structure.
In considering the merit or otherwise of the proposed responses it is useful to keep in mind the approaches which would be used in more conventionally structured commercial arrangements. In particular, if the Board was a conventionally structured marketing business it would raise its equity funds by issuing rights or more shares. There would be no need to consider which apple producers Ñ in their capacity as producers Ñ should contribute what capital. Their decision to invest further in the marketing business could be made independently of their production decisions. The approaches tried in the 2TL and TCC saga would not be necessary if growers unbundled production activities and investments from those in marketing as suggested in the recommendations of this report.
A levy to raise capital
The Board levies growers to contribute to the capital needs of the marketing system. The Act allows it to levy a capital charge which must be a uniform rate per carton of apples and pears. In addition, section 31 of the Act states that Òthe Board, with the approval of the FruitgrowersÕ Federation . . . may impose on growers levies of such nature and incidence as the Board thinks fit.Ó
Prior to 1983 the only levy was the capital charge, collected at a rate which might vary between seasons but which was uniform per unit of production on all product submitted to the Board. In 1983 an additional levy was introduced under section 31 of the Act which applied only to increases in production by existing growers and all production by new growers. It was called the Second Tier Levy or 2TL.
On introduction in 1983 the 2TL was set at $0.50 per carton. It was increased to $1.35 per carton in February 1988. The Board said this increase was to raise capital to allow it to provide and fund coolstores necessitated by increasing production.
The introduction of the 2TL, and the subsequent increase in its rate, needs to be viewed in the context of a number of industry changes which occurred during the 1980s. The more important changes were:
¥ an increasing rate of growth in production which was expected to continue for some time as new plantings grew to maturity;
¥ the location of much of the new planting in non-traditional areas and its concentration on new, higher returning varieties;
¥ the consequential need for increasing storage facilities, particularly in the non-traditional areas;
¥ the relatively higher profitability of apple production in the non-traditional areas compared with traditional areas; and
¥ the cessation of subsidised Reserve Bank credit and the later introduction of a tax liability on profits, both contributing to a need for the Board to find additional capital to replace these concessions.
In 1988, after the 2TL had been increased, the Board proposed it be replaced by a Transferable Crop Certificate (TCC) scheme. Under this scheme a grower would be required to hold one TCC for each carton of fruit submitted. Existing growers would be issued with TCCs free of charge with their entitlement based on average production over previous years. New entrants or those expanding production would have to source their TCCs for the additional production, either from existing growers on an open market or from the Board at a pre-determined price.
The Board said the purpose of the TCC scheme was to give existing growers an identifiable interest in the Board and to finance expanded storage.
The 2TL and TCC go to court
In 1989 Apple Fields brought an action against the Board and the Federation in the High Court claiming that the 2TL, and the TCC scheme, were in breach of the Commerce Act 1986.
The object of the Commerce Act, 1986 is Òto promote competition in markets within New Zealand.Ó The Act is aimed at preventing practices which substantially lessen competition in general, or fix prices, or restrict supply or abuse a dominant position in a market. Unlike Australia, New Zealand did not make its statutory agricultural marketing bodies wholly exempt from the provisions of its competition-enhancing legislation.
Apple Fields argued in the High Court that the 2TL and the proposed TCCs substantially lessened competition and discriminated against new growers. They would effectively constrain supply. Apple Fields contended that the proposed TCC scheme was an attempt at uncompetitive rent seeking by existing members of the Federation at the expense of new entrants to the industry.
The High Court delivered separate rulings on the 2TL and the TCCs. It ruled that the 2TL was a breach of the Commerce Act, in particular section 27 relating to barriers to entry. The Board took this decision to the Court of Appeal.
The High Court ruled against the proposed TCC scheme on the grounds that it contravened the Apple and Pear Marketing Act rather than the Commerce Act. The Court ruled that it was not part of the BoardÕs functions to create assets in the hands of growers. The Board did not appeal against this decision, and so the proposed TCC lapsed.
The High Court judgment also found that the TCC scheme was a rent seeking device and that the Apple and Pear Marketing Act is subject to the provisions of the Commerce Act. However, it is of significance that the judgment did not uphold Apple FieldsÕ contention that the TCC scheme would be a restriction of supply under the Commerce Act.
The Commerce Act requires that ÒpurposeÓ be established before some of its sections apply, and purpose was an important consideration in this aspect of the case. The High Court concluded that the purpose behind the BoardÕs actions was not to restrict supply.
The High Court Judge made a plea for Parliament to amend the Apple and Pear Marketing Act to clarify whether the provisions of the Commerce Act were intended to apply or not to apply in particular circumstances. He went on to say:
ÒBeyond this in a field of such political flavour it is unwise for a mere judge to pass any further commentÓ. (emphasis added)
Proceedings in the Court of Appeal, where the Board took the High CourtÕs judgment on the 2TL, resulted in majority and minority judgments. The majority judgment considered the matter of purpose and concluded:
Òthat the arrangement for the levy between the Board and the Federation, however well motivated, has had the substantial purpose of deterring entry into the apple-growing industry of increasing production.Ó
The minority judgment argued that the Apple and Pear Marketing Act places the Board beyond the reach of the Commerce Act in many respects.
In the end the Court of Appeal ruled that the provisions of section 31 of the Apple and Pear Marketing Act over-rode the Commerce Act in regard to the 2TL but not in general. It ruled that section 31 does specifically allow the Board to impose levies which discriminate between growers. However, the majority decision also concluded that:
ÒSuch a policy will inevitably or is highly likely to lessen competition.Ó
Essentially the Court of Appeal preferred the laws of the land to the laws of economics. However, the judgments did contain some opinions and conclusions which indicated that the judges accepted much of the economics contained in the Apple FieldsÕ evidence.
Apple Fields Ltd took the Court of Appeal decision to the Privy Council. In late October 1990 the Privy Council upheld the appeal of Apple Fields Ltd over the BoardÕs imposition of a Second Tier Levy and awarded costs against the Board and the Federation.
In its 1991 Annual Report the Board noted that:
ÒIn September the Board refunded $1,597,000 from its Capital Reserve Fund to all those who had paid second tier charges in 1988, 1989 and 1990. This represented 50c of the $1.35 originally paid in those years, based on an Out of Court Settlement with Apple Fields Ltd. The decrease in Non-Distributable Reserves will be replaced through a higher Capital Charge in 1992.Ó
What Did the 2TL and TCC Saga Achieve?
The costs of the 2TL and TCC scheme court battles will be met by growers, one way or another. The courts are often an expensive means of resolving disputes and, more importantly, in this case they have not corrected the fundamental reasons for the dispute. Under current regulatory structures growers will continue to be the sole source of equity funding for marketing infrastructure and be required to contribute in proportion to production.
The Board, however, has indicated that the loss in the Privy Council will not affect its financing.
ÒAt this time the consequences of this decision cannot be established. It is expected that this will have no long-term effect on the Board's financing. The way the Board operates in relation to its growers is clearly spelt out within the Board's Act and the Privy Council decision will not alter this.Ó
The Board will still be able to raise finance from its uniform capital levy. It will also have to seek other means of financing its operations. In fact, this has already started, albeit indirectly, with the reduction in the advance payment from 70% to 50% over the two seasons ending 1993. Concurrently, the number of grower payments will be increased from three to four each season with the first in July instead of September as at present.
The effect of these changes in the grower payment schedule is essentially to reduce the seasonal finance needs of the Board. Individual growers will now have to undertake some of the financing previously done on their behalf by the Board.
Given the courtÕs rejection of the 2TL and TCC proposal there is only one effective way in which existing growers can prevent new entrants from free riding on existing marketing infrastructure. The marketing business must be commercially separated from the production business and capital for the marketing business raised as an investment in its own right rather than as a compulsory contribution on all production. If this is not done growers can expect past funding problems to re-emerge as production continues to expand.
7.3.4 Board performance and future strategies
The NZAPMB sells, because it has to, all the apples and pears growers supply. It does this in a very competitive international market where entry is frequently restricted and production often receives assistance. As a marketing organisation the Board also appears to conform to many of the characteristics claimed to be important to success in the international market place.
It is certainly well-experienced in international marketing of fruit, particularly apples. It should have knowledge and experience second-to-none regarding the New Zealand industry and its markets. It possibly contains some of the worldÕs best apple marketers because, under current regulations and arrangements, the more successful they are the harder their job.
On the basis of these considerations, and taking into account current buoyant grower returns but ignoring their underlying reasons, it might be concluded that the Board and its highly regulated and non-competitive marketing system is a success. Certainly, this is what the Board and the growersÕ organisation claim and what many believe.
However, there are two major problems in trying to assess such claims and the BoardÕs performance. The first is the very limited public information on how well the Board performs as a marketer. At its simplest, and as an example, there are insufficient data available to derive any meaningful estimates of how New ZealandÕs market realisations for export apples compare with those obtained by competitors. This is referred to later in the context of discussing how a lack of public information is no constraint to the Board in claiming to be the best marketing alternative for growers.
The second problem is that even if better information on marketing performance were available, it would indicate little about the consequences of existing arrangements for grower profitability and resource use in the national interest. Not even the Board has the information necessary to make this type of assessment Ñ and yet it is the only basis on which the best approach to marketing can be determined.
This section examines two sets of issues relating to the performance of the industryÕs marketing arrangements. Notwithstanding the earlier comments, it examines first the BoardÕs claims of success and what available information suggests. Second, it considers the more important issue relating to grower profitability and, in particular, the extent to which returns from growersÕ compulsory off-orchard investments are included in returns for apples, and how this will be of increasing significance given the BoardÕs planned strategies.
Performance as assessed by the Board
The very general but none-the-less confident manner in which the Board extols its successful performance and congratulates both itself and its growers is epitomised by the following:
ÒThe very good result this season could not have been achieved without the willingness of New Zealand growers to innovate and take risks. The industry has a tradition of efficiency and effectiveness through innovation and we are now seeing the rewards of this philosophy. With growers prepared to meet the challenges that pipfruit growing involves and with their strong commitment to the industryÕs future, our pipfruit industry is well placed to continue to grow and prosper.Ó
The 1991 Annual Report has other examples of performance reporting which, while somewhat more specific, are no more enlightening to either growers or analysts. The following are some examples:
¥ ÒThis [the record sales performance in 1991] was due to our mix of varieties, our high standards of quality and our sales and distribution system. The Board also focusses on containing costs to growers in all areas.Ó
¥ Ò1991 was a record in virtually every aspect with the largest volume of fruit ever in Europe/Scandinavia at some of the highest prices ever achieved, coupled with favourable foreign exchange rates.Ó
¥ ÒIn all markets quality continues to be an absolute imperative and again this year fruit quality contributed significantly to the favourable result.Ó
¥ ÒDespite this yearÕs lower volume the BoardÕs objective of maintaining an acceptable level of market presence [in the Caribbean market] at satisfactory returns was achieved.Ó
¥ ÒA highlight of the shipping programme was the loading of the Ditlev Lauritzen in Napier with a world record quantity of 425,000 cartons of apples and pears.Ó
¥ ÒThe difficult economic environment [in the domestic market] was felt across the entire industry, resulting in lower returns at all trading levels.Ó
¥ ÒAfter two years of generally depressed prices there has been a major shift in demand for apple products. This has increased the base prices and improved returns to growers.Ó
These are all largely qualitative statements about activity. They characterise the way the Board assesses its performance. They tell growers absolutely nothing about the profitability (return on investment) of their marketing body and their investment in marketing beyond the orchard.
In contrast, there are a number of features of Board activity and performance which should be of concern to growers. Some have been noted or discussed in this chapter. Examples include the BoardÕs performance on the domestic market, the only very recent moves to branding, the continued heavy dependence on the EC market, the expensive but unsuccessful moves to raise capital and indirectly constrain production, the confusing and changing advice to growers on the varietal mix at the same time as misleading price signals are being sent, and the continuation of a single grade policy on the export market.
The BoardÕs influence on commercial innovation
The Board and the industry prides itself on the role innovation has played in its claimed success. Many of the available indicators, for example yields, new varieties, market shares and marketing methods give some credence to the claims. However, all the evidence and logic regarding innovation and monopolies point in the same direction. Because they do not face competition they tend to be tardy innovators and also suppress the development of innovative ideas by others. There is no reason to expect the NZAPMB to be an exception.
Assessing the extent to which the BoardÕs monopoly is suppressing innovation and diversity in the industry is difficult because of the absolute nature of the monopoly. In addition, the BoardÕs legislated powers, and the political influence of it and FruitgrowersÕ Federation, tend to constrain public debate and speaking out. The views of Turners and Growers Ltd in this regard were presented earlier.
One example, provided by Turners and Growers, of how the Board used its monopoly to extend its influence over commercial activities outside its legislated purview, is presented in Box 7.2.
Another example uncovered by ACIL, this time in relation to an area of activity which the Board does directly control, concerned the endeavours of a small New Zealand company to develop a trade with Japan in a processed apple product.
Japan recently removed import quotas on apple juice concentrate. As a consequence, Japanese buyers and investors increased their commercial interest in sourcing for the Japanese market, which has considerable potential for such products. As part of their strategies they are investing in processing plants in South America and Eastern Europe. New Zealand is also a potential source of supply.
The small entrepreneurial company in this story is the Christchurch-based JATRA Corporation Ltd. A principal of this company has over twenty years experience with Japan and the Japanese market, having lived and studied there, acquired language skills, operated a professional advisory business, and then developed into horticultural-based value adding and trade between New Zealand and Japan. The company has a small processing plant in Christchurch and has been steadily increasing its production and trade of new and speciality processed products to Japan.
As part of JATRAÕs development strategy it has established commercial relationships with Japanese companies Ñ an aspect of commerce with Japan which is recognised as very important. It is a classic example of a small company which has done its homework well and developed, over many years, a reputation for product quality and commercial reliability which it is now capitalising on in the Japanese market. New Zealand desperately needs companies like this, run by people who are prepared to put in the effort, invest and take risks.
The Japanese connection in this story is one particular food processing and distributing company with whom JATRA has built a relationship over many years. This company approached JATRA to source cloudy Jonathan apple juice concentrate. It made the approach for two reasons. It had a good relationship with JATRA, and it had been informed by the Japanese trading company which it normally used to source from New Zealand that the NZAPMB had said its requirements could not be met from New Zealand. Jonathans are a minor and declining apple variety in New Zealand. Growers have been reducing production because of relatively low returns from the Board.
JATRA contacted the BoardÕs Industrial Products Division and, following discussions, formally applied to the Board to become a designated processor of apple juice concentrate so it could purchase apples for processing direct from New Zealand growers. After some prevarication the Board advised JATRA by letter that Òapproval has been granted for purchase direct from growers.Ó A condition of approval was that JATRA provide the Board with information on who it purchased apples from, the quantity, and the price. JATRA agreed to this condition.
The Board also agreed to process the apples to JATRAÕs specifications at its Nelson plant. To secure the quantities required, JATRA considered sourcing apples from Central Otago and Hawkes Bay, as well as from the Nelson area. The Board would not provide JATRA with grower contact information, describing it as a Òcommercial assetÓ. JATRA therefore was forced to contact growers direct; in advertisements it requested growers interested in supplying Jonathan apples to contact JATRA. There was a strong response with JATRA offering growers prices considerably higher than those being paid by the Board.
Then the Board started to change its mind. It said it was worried about effects on its marketing strategies and trading relationships in Japan. It had recommended to the Japanese that they should not use Jonathans because volumes were small and falling. The Japanese buyer particularly wanted Jonathans and had technology which could blend small quantities if necessary. The Board couldnÕt decide whether it could or would process what it now described as a very small volume. Documentation ACIL has seen suggests that within the Board the issue had now gone ÔupstairsÕ.
The Board then withdrew its earlier agreement to do the processing. By this time JATRA had contracts with growers based on the BoardÕs earlier approvals and agreements. JATRA was not able to locate a suitable alternative processor in the limited time available.
After about two months of intensive effort at the beginning of 1990 to have the Board agree to allow the business to proceed, JATRA threw in the towel. It wrote to growers who had agreed to supply apples saying it was unable to proceed. The Board requested a copy of the letter. The saga received some attention in the media. In one radio interview the Chief Executive of the Board said that it had Ònever exercised the monopoly power over processing applesÓ.
Having lost this particular battle, at considerable cost (although JATRA did receive some compensation from the prospective Japanese buyer), the Managing Director of JATRA wrote to the Board suggesting that the saga raised some important principles regarding grower welfare and national trade policy. He also questioned whether the BoardÕs existing commercial arrangements in Japan would be appropriate for the changes which were emerging in the market for processed apple products. JATRA has been told by its Japanese client that the company which the Board uses as its agent in Japan is independently investing in processing capacity in South America.
In his brief reply, the Chief Executive of the Apple and Pear Marketing Board merely noted the points raised by JATRA, and went on to say:
ÒI must say I was extremely disappointed that you took your case to the media and that in my opinion such public debate does nothing to build business relationships.Ó
However, this was not the end of the matter. The Board then proceeded to supply the apple juice concentrate to JATRAÕs Japanese client. The Board paid growers around 50% less than JATRA had offered for the apples. The quality of the concentrate did not meet the customerÕs requirements. The Japanese company, which sources these products from around the world, subsequently wrote to the Board indicating that it was disinclined to do any further business with New Zealand, and particularly with the Board, because of both the poor product quality and the manner in which the Board had treated JATRA.
It is inevitable that individual participants in this saga will have differing views on exactly what happened. This detail is largely irrelevant. It is what the saga illustrates that is important. The Board did not supply what a Japanese customer wanted after having prevented someone else from doing so. The end result is a very dissatisfied Japanese customer unlikely to consider New Zealand as a supply source in the future. Discussion of these events in Japan will have sullied New ZealandÕs reputation even more. JATRA lost out, and so did Jonathan apple growers and the New Zealand economy.
We are much better than Australia Ñ the most spurious argument
Over recent years the Board and some others have made much of the assertion that the performance of the New Zealand apple industry relative to the industry in Australia is graphic proof of the advantages of a single seller and a well-disciplined and controlled marketing effort. The comparison is spurious.
It is not possible here to undertake a detailed analysis of the performance of the two industries or, more importantly, the underlying reasons for the differences that are most commonly cited. The discussion here is limited to a number of factors which, on their own, are quite sufficient to demonstrate that conclusions commonly drawn from the inter-country comparison cannot be substantiated as unequivocally correct and might even be interpreted as suggesting that New Zealand embarked on the wrong path.
There are two significant features which distinguish the New Zealand apple industry from its counterpart in Australia and which are particularly relevant to any comparisons.
The first is that the Australian industry is now open and competitive. However, for much of its history it did have policies which stabilised returns and used licensing to control exporting. Australia has never had a single seller exporter or a domestic market monopolist.
The second distinguishing feature of importance in comparisons is that Australian apple exports, once a significant component of production, have declined to relatively low levels. According to the Board, Òthis underlines how an unregulated, undisciplined domestic market can destroy the export market.Ó
It might equally underline the merit, from a national perspective, of allowing resources to go elsewhere in the country where their returns are higher than when used in producing apples for export.
Despite the contraction in exports, Australia still has a sizeable apple producing industry. This reflects the size of the Australian domestic market and the fact that competitive imports, particularly from New Zealand, are prevented on quarantine grounds. In 1991-92 Australia expects to produce 320,000 tonnes of apples. This is about 70% of New ZealandÕs total production. Production is expected to rise modestly over the 1990s.
In 1988 the New Zealand Market Development Board published a study on agricultural export marketing systems. It contained a paper prepared by Professor Rae of Massey University. This paper concluded that over the past fifteen years the New Zealand apple industry had out-performed that of Australia. It examined 12 particular factors Òto shed light on the underlying causes.Ó
In the case of most of these factors, the New Zealand industry was clearly a superior performer. It had higher yields, more of the newer, higher returning varieties, more apple trees, more production, more exports and a larger share of the European market. The New Zealand industry was also judged to be more innovative in areas such as new fruit production techniques and quality assurance programs.
However, the study shed no light on the most essential questions for any meaningful comparison. How do the two countries compare in regard to return on investment and the extent to which resources devoted to apple production are at a nationally optimal level? The paper referred to the ÒNew Zealand BoardÕs ability to profitably allocate fruit between fresh use and processingÓ Ñ but provided no evidence of enhanced profitability. It referred to the Òsuperior marketing control made possible by the single-seller approach in New ZealandÓ Ñ but contained only indicators of activity (not investment performance) as proof of this superiority.
Perhaps the most revealing and intriguing aspect of the comparison was the attempt to compare export returns achieved by each country. The totality of the analysis on this aspect was the following:
ÒThe Annual Reports of the NZAPB do not give average export (fob) prices, so comparisons with the Australian data are not possible.
ÒData is published by the United Kingdom MAF, however, on average wholesale prices in England and Wales. While such data are derived from a range of price quotations, carton weights and qualities, they may be indicative of any tendency for New Zealand prices to be persistently above or below those of Australian apples.
ÒOver the three seasons 1979, 1980 and 1981, for example, 19 price comparisons between Australian and New Zealand varieties (involving the CoxÕs Orange, Golden Delicious, Granny Smith and Sturmer varieties over the months of May, June and July) were possible. New Zealand apples exhibited the higher price in all but one case, with an average discrepancy of 6%.Ó
Three points arising from this brief analysis are worth highlighting:
¥ the data available to growers and others on industry performance, at least as far as export returns are concerned, would appear to be superior in Australia;
¥ the indirect basis for making the comparison, that is, use of proxy UK market prices, is usually roundly criticised by the Board as inappropriate when used by analysts; and
¥ an export return advantage to New Zealand of 6% seems small given the extensive and expensive NZAPMB marketing activities, all of which have to be funded from this premium before growers receive the balance.
The bottom line in comparisons of this nature is that they enable very little in the way of defensible conclusions about which types of marketing systems are superior and why. ACIL suspects that a similar analysis of the apple industry in, say, France would show it to be technically superior to New Zealand in some respects because of the distortions created by intervention policies. However, no one would suggest this makes the French apple industry a national asset from the viewpoint of maximising FranceÕs national income. Such comparisons do, however, provide excellent material for public relations activities. They are used very effectively by the NZAPMB for this purpose.
The history and current status of the Australian apple industry must be assessed in the context of past policies and their effects, and the fundamental nature of AustraliaÕs comparative advantage, if any, in producing apples for export. As Rae concluded in his paper, Òit is impossible to conclude whether the adoption of a similar marketing structure in Australia would have reduced costs/or increased prices sufficiently to have reversed the decline that occurred in the Australian apple industry.Ó
The industry in Australia is starting to shake off some of the deleterious consequences of past controls and regulations. Larger growers and selected cooperatives are developing internationally competitive businesses and expanding exports. One comparative statistic not mentioned in the earlier work is the export growth being exhibited by the Australian pear industry. This contrasts with pears in New Zealand which have been described as the Òforgotten fruitÓ.
In the final analysis, both the New Zealand and Australian industries are products of their economic environment and producer/investor decisions. The New Zealand environment is considerably more regulated, and distortions considerably greater, than in Australia. The only significant remaining distortion in Australia is the import restraints, justified on very dubious quarantine grounds.
It is therefore quite likely, now and particularly in the future, that Australia will have an apple industry which uses resources in a nationally optimum way. In contrast, this is unlikely in New Zealand if current marketing regulations and associated controls over the industry persist. The reason is that these arrangements have been distortionary in their effects on investment decisions and these distortions will increase in the future. There is also evidence they have suppressed innovation and diversity.
The Board is diversifying its commercial activities
Limited information on the BoardÕs commercial activities and outcomes means any assessment of whether its approach is the best one for marketing New ZealandÕs apples and pears will be somewhat incomplete in terms of performance measurement. However, notwithstanding the limitations there is sufficient evidence to make growers think carefully about what they are told, and how useful it is in reaching conclusions.
What is unambiguous is the distortions to the economic signals growers receive. These have been discussed at length in this chapter, mainly in regard to the extent and consequences of price smoothing and various other forms of pooling. To these distortions must be added further distortions arising from the fact that the returns from apples at the orchard gate contain an element which is a return to investment beyond the orchard. As explained elsewhere in this report, this is the most serious flaw in New Zealand agricultural marketing arrangements. It sends producers product price signals which lead them away from levels of production which maximise profitability in the national interest.
How serious this distortion has been in the apple and pear industry in the past is difficult to assess because of the lack of information on orchard profitability across the industry and on how much the average orchardist has invested in the marketing system beyond the orchard. Information in the BoardÕs balance sheet suggests growers may have around $70,000 per orchard net investment in the Board. MAF recently published an estimate which indicated the average apple grower had around $110,000 invested beyond the orchard. This figure would accord approximately with the above estimate if account were also taken of the FederationÕs assets, which were some $70 million in the late 1990s, as well as those of the Board.
As a rule of thumb, if growers assumed they received a 10% rate of return on these assets, then around $11,000 of their apparent orchard profits in 1989 came from revenue other than the sale of their apples. While this is not as spectacular as the situation currently facing dairy farmers Ñ discussed in the next chapter Ñ ACIL judges it to be of sufficient size to cause concern.
What should be of even more concern to apple and pear growers is that their Board is increasing its non-core investments and activities, and a continuation of this trend will mean distortions of steadily increasing significance in the future.
In addition to the BoardÕs investment in activities and infrastructure directly associated with the marketing of New Zealand apples and pears, the Board has made a number of diversification investments. Examples include:
¥ expansion into the marketing of flavoured milk, orange, grapefruit and tomato juice, and mineral water;
¥ investment, via Fruitmark Pty Ltd, in business activities in Australia to sell third country fruit products;
¥ investment in North American marketing via David Oppenheimer and Company; and
¥ investment, in 1991, in a Chilean fruit export company, and in early 1992 the Board announced it would commence exporting Brazilian apples to Europe.
When reporting on its 1990 activities in the European market the Board had the following to say:
ÒIn line with the deliberate strategy to diversify our business product base and to use resources outside the New Zealand apple and pear season, a wide range of other fresh fruit and vegetable products from a variety of both northern and southern hemisphere sources were sold successfully, adding additional income.Ó
In the same year, a media report portrayed a similar story of commercial diversification:
Ò . . . the BoardÕs distribution strategy . . . has led the Board into the year-round produce broking business, handling onions and peas out of Australia, kiwifruit from Chile and from New Zealand, Ya pears from China and apples out of England.Ó
The same media report said the BoardÕs Chief Executive had a vision to carve Òa place in the fruit world that is way beyond our sizeÓ in order to fulfil the BoardÕs mission to maximise returns to growers.
This vision highlights the fundamental problem facing the industry in the future. While it might make good commercial sense to diversify the NZAPMBÕs international business activities in areas related to its origins and current activities, if the profits from such activities are returned to growers in the product price their production decisions will be even further distorted. Growers will not maximise profitability in a manner consistent with the most efficient use of the nationÕs resources.
Those responsible for the performance of the Board will also find meeting their objectives Ñ maximising grower returns for apple and pears Ñ increasingly difficult. The more successful they are, the more they encourage production which the market had not been signalling it wanted in the first place.
Apple and pear growers, and all those associated with the industryÕs marketing system, should carefully read the next chapter in this report which discusses how these consequences are already clearly evident in the dairy industry. They are simply unavoidable in a system which invests off the farm or orchard and then delivers the returns from this investment to the grower as part of the return for product produced.
7.4 Conclusions
The New Zealand apple and pear industry is currently experiencing record high production, exports and growersÕ returns at the orchard gate. Not surprisingly, those responsible for this performance are claiming it proves that a marketing system which involves regulation and controls, and unity and commercial discipline, is demonstrably effective.
In the current upturn it is tempting for growers to accept this reasoning at face value. However, what needs to be appreciated is that current returns owe more to unfavourable, short-term climatic effects in other countries than to any fundamental superiority of New ZealandÕs marketing arrangements. It is important for growers to look behind the current upturn Ñ which on the basis of recent market developments seems likely to be short-lived Ñ and ask the more important and fundamental questions about the performance and future appropriateness of the industryÕs highly regulated marketing arrangements.
The international market for fresh fruit, and apples in particular, is very competitive. Its characteristics provide no grounds for believing a particular supplier can exercise any significant market power. It is to be expected Ñ in fact it is essential Ñ that higher returns are achieved for higher quality and when the marketer adds value in the form of marketing services. If, as claimed, the NZAPMB does obtain high returns in the market place, they arise essentially for these reasons and not because New Zealand or the Board has any particular market power.
There are no substantive arguments or market characteristics to support the proposition that a single seller exporter is necessary in the apple and pear industry. The case for a domestic monopoly is completely non-existent.
On the other hand, there is considerable evidence to suggest the current regulations are not in the best interests of the industry or New Zealand. The fact that grower unit returns at the orchard gate differ from actual market realisations has long characterised the industry. It is axiomatic that the various forms of pooling, smoothing and stabilisation have resulted in production distortions. Remedial action has been slow and incomplete. The inclusion in growersÕ output prices of returns from their involuntary off-farm investment in marketing and processing is a distortionary characteristic imbedded in current regulations.
Monopolies are invariably associated with inefficiencies and the suppression of diversity and innovation. There is no reason to expect the NZAPMB to be an exception. The available evidence suggests it is not. Its behaviour has the hallmarks of a monopoly. It manages information and debate, uses its political and commercial powers to suppress criticism and diversity of views, and asserts its performance is superior to any of the alternative approaches to marketing without being willing to expose itself to competitive tests.
This last point is particularly significant. A number of growers ACIL contacted were emphatic in their view that the Board could be considerably more efficient and operate at lower cost but were at a loss to know what to do about it. The same growers believed some form of regulated marketing was needed to compete effectively internationally. The problem growers have is that there simply is no basis for effectively assessing the commercial performance of the Board. Growers do not know whether efficiency and investment returns are being maximised because they do not have the necessary information.
The unfavourable consequences of monopolies derive from their structure and regulated market environment rather than any particular traits of their personnel. Consequently, correcting the unfavourable consequences means structural characteristics must be addressed. This is where growers who are interested in better performance, or at least want better information on performance, need to direct their attention.
The most critical change that is needed is to change the BoardÕs objective so it aims to maximise its profitability as a marketing organisation and is only required to pay prices to growers which are consistent with this objective. If this were the only change that was made, and existing growers were the investors in a corporatised marketing business, they would maintain ownership of the marketing system and have enhanced performance information and control. Growers should then consider the further issue of the costs and benefits of maintaining restrictions on outside ownership.
Such a change would remove the current distortions arising from pooling both across markets and varieties, and of product and off-farm investment returns. The distortions resulting from the inclusion of off-farm investment returns in orchard gate prices for output are certain to increase as the BoardÕs business grows and diversifies. The analysis of the dairy industry in the next chapter illustrates what is in store for the apple industry if the above changes are not made to the industryÕs regulated structure.
Growers should also consider carefully the disadvantages of a monopoly structure and the evidence which questions its effectiveness given international market circumstances. The evidence suggests a single seller exporter delivers very few benefits but incurs considerable costs in terms of efficiency and innovation suppression. The Board, with its extensive experience and involvement in marketing, should have little trouble in surviving in a competitive environment.
A corporatised and deregulated marketing organisation would then be free, if it wishes, to develop as a competitive multinational fresh fruit business Ñ or to diversity further into associated products Ñ without risking harmful effects on New Zealand production patterns. It could extend its marketing to trade in supplies from non-New Zealand sources in much the same way as successful businesses such as Dole or Chiquita. Grower-investors would benefit from a spreading of risk, from an improved year-round utilisation of marketing channels and resources, and from a removal of any future constraints on capital raising. For their part growers would benefit from the competitive spur to the BoardÕs performance, and from the ability to turn to other marketing options in the event of dissatisfaction with the Board.
Chart 7.1: New Zealand Apple Area and Production (1981Ð1991)
Source: Department of Statistics; NZAPMB.
Chapter 7
Apples and Pears
Chart 7.2: Southern Hemisphere Apple Production
Source: Ministry of Agriculture and Fisheries.
Chart 7.3: Export Returns and Board Payments to Growers (1981-1991)
Source: Ministry of Agriculture and Fisheries
Box 7.1: The ÒGranny Smith/Red Delicious DilemmaÓ Ñ The BoardÕs
Problem in a Nutshell
In May 1991 the NZAPMB wrote to all growers concerning what it called
the ÒThe Granny Smith/Red Delicious Dilemma.Ó This is an edited text of the letter with
detail not essential to understanding the message having been removed for reasons of
space. The letter opened as follows:
ÒDear Grower,
Growers are fully aware of the debate over the last few years about the
importance or otherwise of maintaining volumes of Red Delicious and Granny Smith in our
marketing product range. Board Members are aware that growersÕ returns below $10 per
carton for Reds and $12 per carton for Grannys make them uneconomic to grow. Yet our
marketers, and indeed our customers, warn us that we will weaken our overall marketplace
position, and so our performance, should we not have reasonable volumes of the two
varieties in our product portfolio.Ó
Then followed a section under the heading, ÒBackgroundÓ. It pointed
out that in the BoardÕs 1990 Planting Guide growers had been advised to make no
additional plantings of Granny Smith and to replace about 10% of that variety with
Braeburn or Fuji. At the time this advice was given to growers the Board was projecting
receivals of 3.3 million cartons of Granny Smiths in 1993. Actual deliveries to the Board
in 1991 were only 2.4 million cartons and falling. This led the Board to conclude that its
projections made the previous year were Ònow seen as way too optimistic for Granny Smith
in light of growersÕ plans and this seasonÕs receipts.Ó The letter then continued as
follows:
ÒTHE MARKET
Over the last few years there has been a rapid movement within the
market from small retailers to large supermarket chains. With this movement it is becoming
increasingly apparent that the supermarket chains are interested in volume supply of their
requirements from as few suppliers as possible. Up to now we have been able to meet the
demand by having available a reasonable supply of traditional varieties as well as being
the major supplier of the new varieties. In fact, the New Zealand industry has had a major
advantage in this area due to its unique varieties.
However, this is rapidly changing with our competitors now actually
marketing Royal Gala, Fuji, Gala and Braeburn e.g. South Africa exporting Royal Gala,
Fuji, and Braeburn to Europe this year. Chile/Argentina are planting large areas of Royal
Gala and Fuji; Brazil is planting Gala and Fuji. In the future we can no longer rely on
the dominance of the unique varieties to ensure that we are the major suppliers to the
supermarket chains. Major supermarket chains are saying that if we wish to continue to
retain our position with them then we need to ensure we supply a full range of varieties.
Also, there are some markets that either prefer or only take Red Delicious e.g. South East
Asia, including Taiwan; Southern Europe, including Spain and Italy. USA have a preference
for Granny Smith.
Somehow the New Zealand industry has to meet these requirements or risk
putting the success of its future marketing operation in jeopardy.
THE GROWER PERSPECTIVE
Over the last few years we have seen an increasing gap between the price
paid for the unique varieties and that paid for the traditional varieties of Granny Smith
and Red Delicious. We have also seen the competition from our southern hemisphere
competitors increasing in the traditional varieties which has forced higher grade
standards to maintain our necessary price premium. Growers are concerned not only with the
level of price but also the packout percentage they now achieve, especially for Granny
Smith. Growers are removing Granny Smith and Red Delicious quickly and it appears from
information available to us the growers are moving faster than we had previously
anticipated.
Box 7.1: (continued)
THE DILEMMA
The dilemma the industry is facing is that the market insists on being
supplied Granny Smith and Red Delicious either as part of a broad range of varieties or
because the market will only take that variety. However, at the moment they are not
willing to pay the prices that are available for the unique varieties and this had led to
the large differential between the prices for the traditional and unique groups. The Board
believes that the minimum average price for an export tray carton as a target would need
to be $10 for Red Delicious and $12 for Granny Smith coupled with reasonable export
packouts in order for growers to retain the required volumes of these varieties. These
prices would need to increase in the future. There is no guarantee that the market in the
long term can sustain these prices as this is dependent on many factors such as exchange
rate, supply from our competitors, packout percentages and so on. This is true for all
varieties. Every effort is being made to try and achieve prices at this level from the
market place. However, the Board believes it is essential that, if necessary, some support
be given to these two varieties in order to ensure that their decline is not as rapid as
would happen if no support were given.Ó
Having formed the view that these two varieties should receive some
ÒsupportÓ, the Board listed a number of ÒfactorsÓ which it said growers Òshould take
into account when making a decision on these varieties.Ó Growers were told to bear in
mind that:
¥ The Board would consider Òassisting these varieties through use of
discretionary income from outside our core businesses.Ó However, growers were warned that
Òthere is a limit how much it [the Board] considers can justifiably be transferred from
discretionary income.Ó
¥ The Board is Òlooking atÓ retaining the 70% advance rate for these
two varieties rather than reduce it to 50% over the next two years as is occurring with
all other varieties.
¥ The introduction and increasing importance of No 1 Grade on the
domestic market would contribute to delivering higher grower returns for Granny Smith and
Red Delicious.
This section of the letter concluded with a comment clearly implying
that growers of Granny Smith and Red Delicious would get assistance given the support they
had afforded the newer varieties when they were initially introduced. It said:
ÒOver the years Granny Smith and Red Delicious have been the mainstay
of the industry and supported the newer varieties as they were being developed into
marketable varieties. This is recognised by the Board.Ó
The letter concluded with the following ÒSummaryÓ:
ÒOur major customers want us to retain Granny Smith and Red Delicious
in order to ensure our place as a major supplier of a full range of varieties and the
Board believes this would protect our market position not only currently but for the
future when Braeburn and Royal Gala become more freely available. Against this, growers
will only retain a significant volume of these varieties if a sufficient level of return
is paid. Many factors will determine this and the Board can only do so much by way of
financial assistance.
The Board would ask any growers who are planning to remove Granny Smith
and Red Delicious from their orchards give careful consideration to all factors before
making a final decision.Ó
The letter was signed by the Chairman of the Board.
Box 7.2: Use or Abuse of the BoardÕs Monopoly Exporter Powers?
The Board has made no secret of its ambitious strategy to become a more
diversified marketer of horticultural products. At the time of the 1989 review of the
BoardÕs domestic monopoly one of New ZealandÕs larger horticultural marketers, Turners
and Growers Ltd, published a submission which contained insights into how the Board uses
its apple and pear export monopoly to exercise influence over the trade of non-regulated
products.
Turners and Growers suggested that the BoardÕs existing monopoly powers
placed it in Òan invincible position to make buyers purchase other products from them.Ó
The submission then described a particular instance.
ÒAlready the New Zealand Apple and Pear Marketing Board is employing
strong arm tactics to force buyers of their exclusive lines to trade with them also on
competitive products.
ÒThe company Roland Lacour in Paris was FranceÕs largest kiwifruit
importer, receiving the majority of its volume from Turners and Growers Exports Limited.
After the Kiwifruit Board was established, the New Zealand Apple and Pear Marketing Board,
with marketing rights in Europe for kiwifruit, selected Roland Lacour to continue as an
importer.
ÒTurners and Growers wished to continue supplying Roland Lacour with
other products including Nashi. The New Zealand Apple and Pear Marketing Board Officers
made it abundantly clear to Lacour that it could source Nashi only from the New Zealand
Apple and Pear Marketing Board, and not from Turners and Growers, or otherwise it would
suffer the consequences with regard to kiwifruit supplies.Ó
The submission also contained a reproduction of a handwritten memorandum
Turners and Growers received from Lacour. It is something of a gem of French
understatement.
ÒGood morning. As you may know we have been choosed by NZA&PMB
(continent) as a receiver of NZ apples and pears and kiwifruits. So we are not in a
position to distribute your fruits as far as we have them from the Board. If they are out
of stock then will contact you immediately. We hope you understand our position.
Regards.Ó
It is clear that Turners and Growers did understand LacourÕs position.
However, they were far from happy with the manner in which the export monopoly over apples
and pears was able to be extended effectively to restrict competition in the commercial
trade of other fruit.
Box 8.1: Reviews of NZDB Performance Ñ What was proposed and what is
now proposed
The Dairy Board Amendment Bill proposed five-yearly reviews of the BoardÕs performance. This concept was retained in the Supplementary Order Paper but a number of changes were made to the detailed provisions determining the nature and conduct of such reviews and the availability of their findings. The subtlety and importance of the changes made in the Order Paper can only be appreciated fully by comparing the words used in the Bill with those proposed to replace them in the Order paper.
Amendment Bill
What is to be reviewed?
Ò . . . there shall be carried out . . . a review of the BoardÕs performance and efficiency.Ó
Order Paper
Ò . . . there shall be carried out . . . a review of how effectively and efficiently the Board is performing in terms of the policies, procedures and strategies of the Board and its operating companies . . .Ó
The BoardÕs performance and efficiency includes -
¥ The extent (if any) to which the Board has established objectives for the performance of its functions; and
¥ Any such objectives established; and
¥ The extent (if any) to which the Board achieved any such objectives established; and
¥ The extent (if any) to which the Board has put in place policies and strategies to use its resources effectively and efficiently for the purpose of achieving its objectives; and
¥ Any such policies and strategies put in place; and
¥ The manner in which any such policies and strategies put in place were put in place; Ð
but the fact that any other matter is agreed or specified under [the
terms of reference] is conclusive evidence that it relates to the performance and
efficiency of the Board.Ó
(unchanged by the Order Paper)
What period does the review cover?
ÒEvery performance review shall relate to the BoardÕs performance and
efficiency during the five years before the day as at which the review is carried out.Ó
ÒWhile a performance review shall relate to Ð
¥ The BoardÕs performance at the day as at which the review is carried out; and
¥ The BoardÕs prospective future performance, Ñ the person carrying it out shall have regard to its performance during the 5 years before that day.Ó
How are the terms of reference determined?
ÒThe terms of reference of every performance review shall be Ð
¥ Agreed by the Minister and the Board; or
¥ . . . specified by the Governor General by Order in CouncilÓ.
ÒThe Governor General shall not make an order . . . unless satisfied, on reasonable grounds, that Ð
¥ During February and March in the year the performance review concerned is to be carried out, the Minister made reasonable efforts to reach agreement with the Board on the terms of reference for the review; and
¥ No agreement was reached.Ó
ÒAt least 4 months before the day as at which a performance review is to be conducted, the Board shall consult the Minister as to the terms of reference for the review.
ÒNo more than one month after the consultation the Minister shall give the Board written notice of the MinisterÕs views on the terms of reference for the review.
Ò . . . the terms of reference for a performance review shall be determined by the Board.
Ò The Board -
¥ Shall not determine terms of reference for a performance review without the approval of the dairy industry; and
¥ Shall not seek the approval of the dairy industry of proposed terms of reference for a performance review before making known to the industry the views expressed by the Minister . . .
Ò . . . where Ð
¥ The Board has failed to [consult with the Minister]; or
¥ The Board has failed to gain the approval of the dairy industry to any proposed terms of reference for a performance review, Ð the terms of reference for the review shall be prescribed by the Governor General by Order in Council, made on the recommendation of the Minister.
ÒThe Minister shall not recommend the making of an Order in Council . . . without consulting the Board.Ó
How will the reviewer be appointed?
ÒEvery performance review shall be carried out by a person appointed by
the Minister after consultation with the Board.Ó
Ò . . . every performance review shall be carried out by a person appointed by the Board, at least one month before the day as at which it is to be carried out, after consultation with the Minister.
ÒWhere the Board Ð
¥ Has failed or refused to consult the Minister before purporting to appoint a person . . .; or
¥ Has not appointed a person . . . at least a month before the day [a review is to commence], Ð
the review shall be carried out by a person appointed by the Minister after consultation with the Board.
ÒThe Board shall not appoint a person to carry out a performance review without the consent of the dairy industry.Ó
Who will see the result of the review?
ÒEvery person who carries out a performance review shall . . . prepare
a written report on the conclusions the person reached as a result of carrying it out; and
shall give copies of the report to the Minister and the Board.
(Unchanged by the Order Paper)
ÒIf asked by any manufacturer . . . the Board shall give a copy of any . . . report given to the Board . . .Ó.
ÒIf asked by a qualifying company to do so, the Board shall . . . give the company a written summary of the conclusions and recommendations contained in any report . . . which has been given to the Board . . .Ó.
Table 8.4: Dairy Industry Income, Prices, Production and Asset Values
Dairy Farm Incomes (1)
No of
Factory Supply Farmers (2)
Payout from
Board to Co-operatives (3)
Payout from
Co-operatives to Farmers (1)
Board
Assets Ñ
excluding stocks (3)
Year
Milk
Revenue ($)
Total
Revenue ($)
Total
Expend-iture ($)
Net Farm Profit
($)
($/kg)
($/kg)
($m)
1988/89
1989/90
1990/91
Average Three
Years
125059
152154
109149
128787
144872
170908
127576
147785
104123
114853
102193
107056
40749
56055
25383
40729
13593
13357
13089
13346
5.30
5.80
3.70
4.93
5.70
6.30
4.24
5.41
1529
1726
1445
1576
(1) Ministry of Agriculture and Fisheries, Situation and Outlook for Agriculture.
(2) New Zealand Dairy Board, Annual Reports.
(3) New Zealand Dairy Board, Financial Reports.
8.1 Introduction
Dairy farming is one of New ZealandÕs biggest rural industries. In 1991/92 the gross value of dairy output at the farm gate was $2 billion, about the same as the gross value of livestock for meat production.
Dairy products contribute around 17% of New ZealandÕs merchandise export revenue and over 20% if the value of cows and calves for meat production is included. It is an industry of considerable economic importance to the New Zealand economy.
The industry has a long history of regulations and controls which have shaped its contemporary structure. Major milestones in this history include:
¥ promulgation of the first Dairy Industry Act in 1892 which regulated the quality of milk used in the manufacture of butter and cheese for export;
¥ a 1908 Act which effectively ensured that all dairy manufacturers would be cooperatively owned by milk suppliers;
¥ the invoking of emergency powers by Britain in 1915 commandeering New Zealand dairy products;
¥ the establishment of the Dairy Industry Control Board under the Dairy Produce Export Control Act in 1923 to be the central export seller;
¥ the establishment in 1935 of the Primary Products Marketing Department responsible for all dairy products sales;
¥ the requirement that all butter and cheese be exported to the United Kingdom between 1940 and 1954 unless authorised otherwise by the United Kingdom under a Bulk Purchase contract;
¥ the establishment of the New Zealand Dairy Products Marketing Commission in 1947 with sole authority to export and set milk prices; and
¥ the establishment of the New Zealand Dairy Board in 1961.
Following the establishment of the New Zealand Dairy Board (NZDB) the governmentÕs direct role in the industry diminished to one of approving milk prices paid to dairy farmers and financing export operations and an income stabilisation fund. In the mid-1980s the role was further diminished to one of providing the BoardÕs legislative underpinnings including its exporter monopoly.
The industryÕs structure is highly vertically integrated. Milk is produced on mainly family farms and almost all processing is undertaken by producer-owned cooperatives. The number of cooperatives has been declining and their average size increasing over many decades.
The NZDB is the industryÕs statutory single seller exporter. The Board determines the mix of products and markets which it believes will maximise returns to producers and the industry. There is a complex set of arrangements for then determining which cooperatives produce what products. These arrangements include incentives for cooperatives to minimise costs and hence maximise milk payments to farmers. Commercial activity and performance throughout the industry is very much influenced by the decisions of the Board and the large cooperatives.
Very little of the worldÕs dairy production is traded because most countries have self sufficiency policies and protect their domestic industry. A large proportion of the trade is represented by production surpluses arising from these protection policies, which are exported, usually at subsidised prices. New Zealand is exporting into a world market where prices can fluctuate markedly because small changes in world production result in large changes in quantities traded.
In preparing this chapter, ACIL has made use of the extensive published material on the industry and its policies and marketing arrangements. A major study on the industry's structure, markets and marketing strategies prepared as part of the Porter Project has been a particularly useful source document.
Use has also been made of information published by or attributed to the NZDB and its personnel. However, ACIL did not pursue extensive contact with the Board in view of the BoardÕs reaction to the study. In his letter to the New Zealand Business Roundtable the Chief Executive of the Board said that he was Òtotally fed up with the amount of time spent over the last several years on educating academic consultants into the realities of agricultural marketing.Ó
This chapter comprises three sections. The first describes the industryÕs major characteristics with particular emphasis on the processing/marketing system and markets. The second examines a number of key issues which influence industry and producer profitability. The chapter ends with recommendations for change.
8.2 Industry Features
8.2.1 Production and producer returns
New Zealand is generally accepted as being the worldÕs most technically efficient producer of milk. However, it is a relatively small producer notwithstanding its significant involvement in world trade. New Zealand produces around 1.5% of world milk output Ñ about one tenth that of the United States Ñ but has a 25% share of world trade.
There are some 13,000 dairy farms in New Zealand supplying 16 cooperative dairy manufacturing companies. A further 1,000 dairy farms supply the domestic liquid milk market. Over the past two decades dairy farm numbers have fallen by 30% and average herd size has increased by over 50%. Around 90% of production occurs in the North Island.
Most dairy farms are operated by either their owners or a sharemilker. About one-third of farms are operated by sharemilkers who own the herd but not the land and other farm assets, and usually receive around 50% of the profits. The average farm milks 160 cows.
Dairy cattle numbers and total milkfat production in New Zealand over the past decade are presented in Chart 8.1. Both dairy cattle numbers and production have increased only slightly over the decade.
Movements in the price of milkfat received by dairy farmers and dairy farm profits in real terms are presented in Chart 8.2. A downturn in the world dairy market is reflected in the sharp fall in farm gate prices and profits in 1991. A significant rise is expected for 1992. In real terms, dairy farm profitability has shown little trend over the past ten years but fluctuated markedly during the second half of the decade. However, this profit performance is better than the other major rural industries where real profits have declined over the decade ending 1990.
One of the data difficulties in this study has been obtaining consistent information on farm returns and profits both within an industry over time, and for purposes of industry comparisons. Within industries, data series vary in regard to definition and the twelve monthly periods to which they apply, depending on source. Other researchers have experienced similar difficulties.
The dairy industry data on farm profitability are a case in point. Until 1986 estimates are based on annual dairy farm surveys conducted by the NZDB. Subsequent data are estimates made by the Ministry of Agriculture and Fisheries (MAF). The NZDB has apparently conducted farm surveys since 1986 but has not released the data publicly.
In 1990 the NZDB published, for the first time, information apportioning
its sales revenue on a milkfat basis between dairy farmer returns and major cost
components and the proportions for the seasons 1989 to 1991 are presented in Table 8.1.
Table 8.1: Disposition of NZDB Sales Revenue 1989-1991 (%)
Item Year
1989 1990 1991
Milk (received by
dairy farmer) 58 61 49 *
Dairy Company Costs 30 32 43
Reserves 4 1 (-2)
Interest 4 3 4
NZDB Costs 4 3 4
Total Ð % 100 100 100
Ð c/kg milkfat 911 954 741
* includes amount paid from reserves.
Source: New Zealand Dairy Board, Annual Financial Reports 1990 and 1991.
As can be seen from Table 8.1, the return to the dairy farmer is a residual and reflects virtually all the variation in total sales revenue. The proportion of the sales revenue going to the dairy farmer has varied between 49 and 61% over the three seasons for which this information is available.
Dairy farmers did try unsuccessfully to obtain similar information for earlier seasons from the Board. Their frustration in not being able to receive the information is reflected in the following comments made by the Senior Vice-president of Federated Farmers.
ÒI recall one instance of the reaction of the Dairy Board to a Federated Farmers Dairy Section request for information. In the 1989-90 accounts of the Dairy Board, there were graphs detailing the earnings part of milk value paid to the farmer as a proportion of total revenue.
ÒFederated Farmers Dairy Section requested similar information for the preceding year. The Board however, indicated that similar information was not currently available, was difficult to produce and the work and hence the cost of producing the statements would be substantial.
ÒThis was surprising as my impression was the Dairy Board ran a very smart treasury operation . . . that is, until they have to provide dairy farmers with access to the information that they require to monitor the efficiency of their own industry.
ÒCan one assume that as such information has not apparently been compiled, that the board has not been monitoring the proportions of earnings referred back to farmers?Ó
Dairy farmers receive returns from their cooperative on a monthly basis with this payment determined in large part by what the Board pays the cooperative. At discrete points through the season there is usually additional payments made as returns for the season as a whole become more certain The payment system has been described in the following terms:
ÒThe Dairy Board advises at the beginning of each season the sum per kilo of milkfat that they believe they will be able to pay as an advance price. The dairy company in turn advises suppliers the proportion of that they will pay to farmers as an advance. The Dairy Board pays the company every 30 days and the company does the same to farmers. At seasonÕs end there may be an adjustment by the Dairy Board (usually upwards!) to pay out to companies and companies themselves will pay to farmers any additional sums the company has earned from their local market activities, other business interests, town milk and the like. These payments can vary from zero to 70 cents per kg of milkfat or more.Ó
A break in the tradition as described above occurred in the 1990/91 season. According to the Chairman of the Board the season was one of the most difficult the industry had ever had to face.
ÒA series of market reverses, each of them unexpected and in their conjunction unpredictable, forced the Board to take the unprecedented step of dropping its advance price during the season.Ó
8.2.2 Cooperatives process all milk
Virtually all milk is delivered to and processed by farmer-owned dairy cooperative companies. Mergers and acquisitions have resulted in the number of cooperatives falling from 171 in 1950 to 16 currently. There were 500 in 1935.
The output of the smallest ten companies is about 10% of the output of the other six. The largest cooperative is the North Island based New Zealand Co-operative Dairy Company Ltd (New Zealand Dairy Group) which processes around 45% of New ZealandÕs milkfat production. It was recently involved in a further merger which, while initially refused authorisation by the Commerce Commission, was allowed to proceed on appeal to the High Court.
Only dairy farmer suppliers can hold shares in a dairy cooperative although cooperatives do take milk from non-members. While supplier/shareholders are deemed to own the cooperativeÕs capital, the shares cannot be sold to realise the funds.
There are no legal impediments preventing proprietary companies from entering the processing sector. However, if they wished to process milk they would need to secure farmer suppliers and if they wished to export the NZDB would need to agree to buy their output or grant them permission to sell overseas. There are some proprietary companies which package and distribute dairy products on the domestic market.
The Board enters into supply arrangements with the cooperatives on an annual basis. The process has been described by a senior Board Executive in the following terms:
ÒBefore the start of each season the Dairy Board outlines in detail to companies the state of the markets, a projection of the desired product mix, prices, etc. The companies in turn indicate to the Board the product mix they would prefer to make. The companies already know at this time the approximate cost allowances that the Dairy Board will pay for the production of products. A standard costing system is used so that more efficient companies make a higher return.
ÒBecause the overall product mix determined by the Dairy Board to be in the best interests of New Zealand farmers may differ from the sum of what each of the co-operatives wish to produce, there is a system of incentives, disincentives, and penalties to help persuade companies (a series of sticks and carrots!) to better tailor their mix for the best overall result.
ÒThroughout the dairy season the Dairy Board has the capability to finetune the product mix by a further system of incentives and disincentives.Ó
This negotiation process results in cooperatives contracting with the Board to supply specified volumes of Òopen order productsÓ Ñ cheddar cheese, salted butter, skim milk powder, lactic (acid) casein, whey butter and buttermilk powder. According to Cartwright, the forecasted prices to be paid to the cooperatives for these products are derived from four components, viz:
¥ Òthe standard manufacturing cost for the product;
¥ Òthe forecasted milkfat and protein value for the milk components in the product, based on the BoardÕs average net market realisations for these components across all products;
¥ Òa differential payment (incentive or penalty) arrived at by an iterative tendering process that was intended to bring manufacturersÕ aggregate product mix decisions for each quarter into conformance with the product mix estimated by Board executives to make best use of market opportunities. The differentials were applied only to Ôfirst useÕ products (cheddar, skim milk powder, and lactic casein); and
¥ Ògrade differentials; penalty price deductions for quality below contracted specification.Ó
The first component, the standard manufacturing cost for the product, is derived from engineering models based on technology that has been available for at least three years, the average peak day plant capacity, and the operating and capital costs for a plant of the specified technology and capacity.
The standard cost model was introduced in 1987 and replaced an approach based on overall industry averages. Cartwright concluded that this:
Ò . . . provided powerful incentives for cooperatives to ÔbeatÕ the system through adopting technologies and plant scales that incurred costs lower than those recovered from the Board as standard costs. This has hastened the demise of smaller cooperatives and merger of their suppliers into larger operations.Ó
Whether such strong incentives to minimise unit costs have also resulted in profitability being maximised is discussed later in the chapter. The fact that a cost-minimising focus, and the consequential trend to fewer, larger cooperatives, may have been causing investment distortions appears to have been recognised by the industry. In its 1991 Annual Report the Board noted that, at its request, an industry committee reviewed the standard costing system during the year. The Board reported the committeeÕs conclusions as follows:
ÒIts main proposal involves the preparation of standard cost models for all major products on a common intake of wholemilk. This change ensures that there are no distortions through the pricing system that would favour a product which is made on smaller plants compared with other products. Potential biases to the industry's product mix and investment plans are therefore avoided. The change is to be progressively implemented over the next three seasons.Ó
The Board also uses financial incentives to influence a cooperative to divert milk to another manufacturer if it is believed that higher throughput in particular plants will result in net benefits.
In addition to these arrangements for open order products, the Board negotiates supply arrangements for other more specialist products which are a growing proportion of manufacturing output. Cartwright describes these Òsecond tierÓ supply arrangements, and the criticisms made by manufacturers regarding their consequences, in the following terms:
ÒIn most cases several manufacturers had the ability to produce these products, but where only one plant was required the opportunity was usually given to all companies to tender for the establishment of that production capacity. The purchase agreements involved payment on a standard cost basis to ensure efficient production would provide for cost recovery; a production incentive was also frequently paid for these products and companies received a return for them in many cases higher than that obtainable from Ôopen orderÕ products.
ÒThe Board also offered special product incentives to companies that developed new product variants and processes and that responded to requests for difficult processing specifications or delivery schedules. However, some cooperatives complained that incentives for product and process development were inadequate because they recovered current costs only partially and gave no firm assurance that sustained orders from the Board would be awarded to the developer. Payments to cooperatives under these arrangements did not necessarily reflect market realisations. The Board maximised overall returns for milk by ensuring that the overall product mix maximised the marginal return of the last litre of production. Payments to co-operatives did not reflect market realisations, but rather the overall value of milk solids together with payment for manufacturing costs and production incentives.Ó
Because of physical and cost limitations on the transport of fresh milk, dairy farmers usually supply a manufacturing plant within a maximum of 100 kms from the farm. Most dairy farmers have a choice between at least two cooperatives although recent mergers have led to concerns being expressed about lack of competition. Each cooperative aims to maximise pay-out to suppliers to ensure their loyalty and support. However, milk returns between cooperatives do vary and by as much as 15% in some seasons. Cartwright suggests inter-cooperative competition is intense.
ÒDue to scale economies in manufacturing, and since farmers were generally free to switch from one cooperative to another one that could collect their milk, rivalry between adjacent cooperatives to achieve a sustainable superior payout was intense. Rivalry also existed between distant cooperatives as they strove to attain prestige and status within the industry.Ó
The cooperatives have only limited direct contact with their markets since this is the responsibility of the Board. They are free to market domestically and the Board provides some opportunities to export directly in specific circumstances.
ÒThe cooperative dairy companies also increasingly deal direct with the market place. Many dairy companies are making specifications or products to suit particular customer needs and there is growing interchange between the companies and the customers.Ó
Cartwright leaves a somewhat different and contradictory impression when he reports that:
ÒThe BoardÕs policy was to encourage these initiatives in products and markets not being targeted by the Board itself.
ÒThere was growing opinion among the larger cooperatives that their involvement in marketing should be expanded.Ó(emphasis added)
8.2.3 The role and responsibilities of the NZDB
Changes to the legislation are in progress
The NZDB was established under the Dairy Board Act 1961 and it is the statutory monopoly exporter of New Zealand dairy products. It is required by law to purchase all products, within categories determined by it, of export quality. Its legislation confers extensive powers and considerable flexibility in how they are used. Consequently, the Board has become the centrepiece of the industryÕs marketing arrangements and has a significant and pervasive influence on all sections of the industry.
Before considering the main features and activities of the Board in detail, it is necessary to note that amendments to the Act are currently before the Parliament.
In 1990 the then Minister of Agriculture, the Hon. J Sutton, introduced the Dairy Board Amendment Bill. At the time of the 1990 election the Bill was still being considered by a Select Committee. In October 1991 the new Minister of Agriculture, the Hon. J Falloon, introduced a Supplementary Order Paper which removed some amendments proposed in the Bill, modified others and proposed some additional amendments. At the end of July 1992 the amending legislation was returned to the House by the Primary Production Select Committee and left to lie on the table.
The amendments as now proposed will change the composition of the Board and how it is determined. They will also affect the procedures used by the Board in deciding when others can export dairy products from New Zealand. Finally, they introduce procedures for periodic reviews of the BoardÕs performance.
These amendments are discussed where relevant in what follows and provide, inter alia, some interesting insights into the nature of pressures for change in marketing arrangements and accountability, and the reactions of the industry and the government.
It is proposed to alter fundamentally the BoardÕs constitution
Currently the Board comprises thirteen directors. Two are appointed by the Minister of Agriculture, three are appointed by the New Zealand Dairy Group and the remainder are elected by the other dairy cooperatives on an electoral ward basis. These dairy cooperatives vote in proportion to the quantity of milkfat they process. Elected directors are usually directors of cooperatives and it is only on this indirect basis that individual dairy farmers can influence the composition of the Board.
The Amendment Bill proposed to replace the two government appointed directors with two directors nominated by the Board and appointed by the Minister for their commercial expertise. The Supplementary Order Paper retained this change but proposed further and more radical changes to the BoardÕs constitution. It proposed the other eleven directors be appointed by a Òqualifying companyÓ or elected by a group of Òqualifying companiesÓ. Qualifying companies are defined so as only to include dairy cooperatives where ownership is held clearly by suppliers and in proportion to their supply. Finally, and perhaps most significantly, the Order Paper proposed that the Board be given the power to decide which companies are to be authorised to appoint and elect directors, and how many directors each may elect or appoint. Those changes are part of the Amendment Bill returned by the Primary Production Select Committee.
The following extract from the Order PaperÕs Explanatory Note provides further detail on what is proposed:
ÒIn each case the exercise of the power is subject to the approval of the dairy industry (that is to say the approval of persons supplying more than three-quarters of the total own-supply milkfat supplied over the last 2 complete seasons). No single group of companies is to be authorised to elect more than 5 directors, and no single company is to be involved in the election or appointment of more than 5 directors.
Section 3D deals with the situation arising where a company involved in the election or appointment of 5 or fewer directors becomes involved in the election or appointment of 6 or more because it has acquired shares in or gained effective control of another company, or because some other body that effectively controls it gains effective control of another company. The company whose shares have been acquired, or control of which has been gained, will drop out of every group of qualifying companies to which it belongs.
Section 3E empowers the Board, with industry approval, to approve the manner of election of directors by groups of qualifying companies.Ó
These proposed changes have significant implications for how the Board will be constituted in the future. In particular, they will reinforce the already very close relationship between the Board and the cooperatives because of the likelihood that directors of the larger cooperatives will form a majority of directors of the Board.
The BoardÕs role and responsibilities
Currently the legislation lists the main functions of the Board as being:
ÒTo acquire and market such export produce as the Board may from time to time determine; and
ÒTo control the export of dairy produce other than dairy produce acquired and marketed by the Board.Ó
Unlike the Apple and Pear Marketing Board the NZDB does not have direct control over dairy product marketing on the domestic market.
The Board has described its role in the industry as follows:
ÒIts prime function is to market overseas all dairy products manufactured in New Zealand for export. The Board works with the dairy companies to ensure their manufacturing programmes match the demands of the international market place. It also integrates the industryÕs shipping, packaging, transport, storage and quality control needs and provides vital support in the form of financial facilities, data processing, livestock improvement and administration.Ó
Under current legislation the Board has considerable rights, powers and privileges which it is able to exercise for Òthe purpose of performing its functionsÓ. This was apparently seen as a restriction on carrying out its role and the Amendment Bill introduced a new provision that:
Ò . . . relaxes this restriction a little, by providing that the Board must not exercise its rights, powers and privileges except for the purpose of doing anything that is necessary or desirable to enable the Board to perform its functions or obtain, in the interests of the New Zealand dairy industry, the best possible long-term returns for export produce.Ó
This proposed amendment to how the Board may exercise its powers would appear to leave the Board with considerable flexibility and discretion over what is desirable and in the longer-term interests of the dairy industry. It does, however, make explicit that the BoardÕs primary objective is to maximise Òcurrent or future income (whether net or gross)Ó.
Who owns the Board is to be clarified
Who actually owns the considerable assets of the NZDB was clarified to some extent by the Producer Boards Amendment Act 1988 where it was stipulated that the assets of the Board belong to the cooperative manufacturing companies. The purpose of this change appeared to be to remove any doubts that the assets were effectively the property of dairy farmers and could not, therefore, be appropriated by the government. However, it fell well short of giving explicit and tradable property rights in the Board.
The Supplementary Order Paper proposed extensive additions to the Act which would make ownership of the BoardÕs assets more explicit and better defined, but still not tradable. The Board would be deemed to have fully paid up capital on 1 June 1991 of $750 million. According to the OrderÕs Explanatory Note:
ÒIt may alter its capital; but must obtain the approval of the industry to any change, and notify all qualifying persons of any change. The Board must at all times preserve its assets at a level above its capital.Ó
Perhaps of most importance are the provisions in the amendments requiring the Board to establish and keep a publicly available Òownership registerÓ and issue Òownership certificates.Ó Who qualifies to be on this ownership register and hold a certificate is defined in detail by the amendments. However, the only dairy farmers who will actually receive ownership certificates and the associated rights and privileges are those not supplying cooperative dairy companies. In wording seemingly designed to confuse, the amendment defines a Òqualifying personÓ Ñ for the purposes of an ownership certificate Ñ as a Òperson who or that is a qualifying farmer or a qualifying companyÓ. A qualifying company Òmeans a cooperative companyÓ and a qualifying farmer is Òan occupier of land producing milk or cream for supply to a manufacturer who or that is not a qualifying companyÓ.
The amendments specifically state that ownership certificates are not shares and are not transferable. They do serve, however, to lock the cooperatives and the Board into a very close relationship. The proposed changes will also establish an ownership structure for the Board which would make corporatisation a relatively simple step. In this regard it is of interest to note that the proposed amendments set out how the dissolution of the Board would be handled.
ÒThe Board may, with the approval of the industry, decide how its assets are to be dealt with on dissolution; but if no decision has been made before the BoardÕs dissolution the assets will be sold and the proceeds will be distributed to persons on the ownership register in proportion to their milkfat. Holders of ownership certificates will have no liability for the BoardÕs debts.Ó
These changes form part of the amendments returned to the House by the Primary Production Select Committee.
The Board has become a multinational food marketer
Issues associated with the BoardÕs ownership are far from trivial. It has become a large international food marketing business with extensive physical assets, valuable brands and an established reputation in the market place.
Since the mid-1970s the Board has been establishing subsidiary and associate companies around the world. Its main assets and activities are offshore. For example, 85% of its 6,500 personnel work outside New Zealand and it now has 55 offshore companies in 21 countries together with an international network of agents.
It also has investments in New Zealand.
ÒTo strengthen the base for exporting, the Board has made strategic investments in New Zealand proprietary companies, including operations in UHT milk, processed cheese, speciality cheeses and canning milk powder. It also owned a company that manufactured and marketed margarine.Ó
The Board has now developed into a commercial operation where a large proportion of turnover is derived from other than the sale of New Zealand dairy products. The composition of the BoardÕs total sales revenue in 1990 is presented in Chart 8.3.
In 1990 a total of 32% of Board sales revenue was derived from either non-New Zealand dairy products (23%) or non-dairy products (9%). There is only limited published information on exactly how these revenues were generated.
The BoardÕs wholly-owned subsidiary Sovenz Group would appear to be a significant contributor to non-dairy revenue. It is involved in a diverse range of activities including trade in motor vehicles and tractors, meat, peat moss, potash, vodka, and the construction of processing facilities for dairy, meat and fish.
The Board does permit some direct exporting
As noted earlier, the Board does permit some direct exporting to markets and for products not being targeted by the Board itself. While this means that technically the Board does not have an absolute export monopoly, its dominance in exports and the control it exercises over who can sell what products outside its operations means it is a monopoly exporter for all practical purposes.
The Board tends to portray its attitude towards allowing competitive exports as a virtue.
ÒWe welcome applications to export from those who have developed highly specialised and often branded dairy products. For example, ice cream, yoghurt, speciality cheeses and the like. We equally welcome applications from those who, for one reason or another, have access to specialised and valuable niche markets.
ÒOf 37 applications for export permits in the last 8 months, 35 have been approved.Ó
However, it would appear that the quantities of dairy products exported outside the BoardÕs monopoly are very small. They are not quantified separately in any published statistics.
The Amendment Bill proposed subtle but very important changes to the legislation used by the Board to grant approval for direct exporting. The Explanatory Note to the Bill explains the intent of the amendments as follows:
ÒClause 7 has 2 effects. First, it repeals the provision inserted (in 1980) in the principal Act that gave the Board power to control the export of certain mixtures of dairy produce and other substances.
Secondly, it allows exporters to apply to the Board for permission to export dairy produce, and requires the Board to give its permission if satisfied that the produce is intended for markets in States that do not impose quantitative restrictions on imports, and that the export of the produce will not harm overall returns to the New Zealand dairy industry.
The Board will not be able to use its powers of compulsory acquisition in respect of dairy produce for which an exporter has applied for permission to export, unless permission has been refused.Ó
These proposed changes would increase the opportunities for existing cooperatives, or possible new entrants, to undertake export marketing outside the BoardÕs control and direct influence. While this might appear to differ little from current arrangements, the significance of the amendment was in the way it proposed to shift the onus of proof for refusing an application to the Board. If the Board refused an applicant permission to export, it would have to explain, in terms of industry benefits, why permission was refused. It also meant that final decision in the event of dispute would be made by an independent arbiter Ñ the court system.
The Board expressed reservations about this proposed amendment after the Bill was introduced to Parliament. It was apparently concerned that applicants who were refused permission to export would legally challenge the BoardÕs decision and this could involve the Board in costly litigation. This view was probably influenced by the experience of the Apple and Pear Marketing Board Ñ described in the previous chapter Ñ which was taken all the way to the Privy Council and lost over a legal challenge to how it proposed to use its legislated powers.
The Supplementary Order Paper proposed to change this particular amendment in the Bill. The Order Paper proposed to leave with the Board absolute power to decide whether an application to export would be approved. It required the Board to establish guidelines which it must use in making a decision and to make these guidelines available if requested in writing by any person.
The changes proposed in the Supplementary Order Paper differed little from current arrangements and procedures. Compared with the proposal in the Amendment Bill, they left the Board with complete discretion over the conditions under which approval would be granted and hence made it very unlikely that any applicant would find grounds for disputing a decision. After all, it seems reasonable to expect the Board would establish guidelines best suited to meeting its intentions regarding competitive exporting.
The revised Amendment Bill could be viewed as something of a compromise on this particular issue. Drawing on both the original Bill and the Supplementary Order Paper it proposes that:
ÒAny person who wishes to export dairy produce may apply to the Board for permission to do so, specifying the markets where the produce is intended to be sold; and having regard to Ð
(a) The extent to which the markets are in states that do not impose quantitative restrictions on the importation of dairy products; and
(b) The extent to which the export of the produce to the markets might result in a direct or indirect reduction of the overall returns to the New Zealand dairy industry; and
(c) Any other relevant guidelines for the time being established by the Board for the purposes of this section and published by the Board, Ð
the Board shall grant or refuse permissionÓ.
For good measure the revised Amendment Bill gives the Dairy Board wide ranging exemption from the provisions of the Commerce Act. Taken as a whole, it is difficult to see how the practical effects of these provisions differ from the existing regulatory provisions relating to competitive exporting.
The Board is heavily involved in industry R&D
The BoardÕs involvement in R&D funding and management has increased recently concurrent with reductions in direct government funding of industry R&D. According to the Board, ÒR&D continues to be a high priority area with an annual investment now in excess of $40 million.Ó
An R&D Policy Board was formed in 1990 and it comprises NZDB executives and representatives of dairy cooperatives, the Dairy Research Institute and the BoardÕs offshore subsidiaries. Its role is to coordinate the industryÕs R&D strategies, policies and priorities. The Board has also established offshore Òskill centresÓ which focus on product development work relevant to the markets in which they are located. The Board also recently decided to fund an industry Chair in Dairy Science and Technology at Massey University.
The Livestock Improvement Corporation is a wholly-owned Board subsidiary providing advisory and information services to dairy farmers. It employs 27 consulting officers who provide a free advisory service to farmers. In 1990 a user-pays service was established for farms requiring an intensive, individual advisory service. The Board says that the service, Òwhich is currently being offered in three areas, is already operating successfully.Ó
Other industry services provided by the Board are national, daily milk sampling and testing which involves the National Milk Testing Laboratory, national herd testing and performance recording which involves the Livestock Improvement Corporation, and operation of an artificial breeding service.
Regular reviews of the BoardÕs performance
The topic of performance monitoring arises regularly in the case of producer boards and the major relevant issues were discussed in chapter 5. As the opportunity arises, individual boards are having their legislation amended to include provisions for periodic performance reviews. In the case of the New Zealand Kiwifruit Marketing Board, such provisions were included in its originating regulations.
The Dairy Industry Amendment Bill proposed arrangements for review of the NZDBÕs performance every five years. The Supplementary Order Paper, while retaining the five yearly review concept, proposed a number of changes to the detail of how they would be conducted.
The differences between the Bill and the Order Paper are subtle but important. Rather than try to explain the differences in detail, it is more instructive simply to compare drafting differences between the Bill and Order paper. This is done in Box 8.1.
The changes proposed in the Order Paper have the effect of giving the Board greater control over the nature of the review, how the reviewer is chosen, and on what basis the findings will be made available to the industry. The comparison of what was proposed in the original Amendment Bill with what the Supplementary Order Paper proposed leads to the inevitable conclusion that the Board exercises very effective influence over policy formulation in the industry. This is confirmed by the fact that the substantive changes proposed in the Order Paper have been incorporated in the revised Amendment Bill. Curiously, the revised Bill now refers to audits rather than reviews.
Finally, it is of interest to compare the proposed basis on which NZDB performance reviews will be undertaken and the basis on which similar reviews of the Kiwifruit Board are arranged and executed. The relevant Kiwifruit Board legislation reads as follows:
Ò . . . the Minister shall appoint a person or agency to undertake an investigation, analysis, and review of, and prepare a report to the Minister on Ð
(a) The costs, benefits, and efficiencies of the BoardÕs activities, operations, and management, during the period commencing on the commencement of the Kiwifruit Marketing Regulations 1977, Amendment No. 4 and ending with the 31st day of March 1991 (including any operations undertaken by other persons on the BoardÕs behalf); and
(b) Any other matters the Minister specifies when appointing the person or agency concerned;Ñ and the Board shall do all things necessary to enable the investigation, analysis, and review to be undertaken effectively and comprehensively, and the report to be completed promptly.Ó
This provides the Minister with considerably more influence over the conduct of a review in the kiwifruit industry than is proposed in the revised Amendment Bill for the dairy industry.
8.2.4 Markets and marketing
In 1990/91 exports of dairy products from New Zealand were valued at $2.5 billion or around 17% of total merchandise exports. Although New Zealand accounts for only 1.5% of world milk production it has a 25% share of world dairy trade. About 85% of milkfat production is exported to over 100 countries. However, commodity products and a relatively small number of large markets continue to characterise New ZealandÕs dairy exports.
Composition and destination of exports
The disposition of New Zealand dairy exports in 1989/90 by market region is presented on a volume basis in Chart 8.4 and on a sales revenue basis in Chart 8.5. Unfortunately, the NZDB has not used identical definitions of regions or the twelve month period in its volume and sales revenue statistics so precise comparisons of unit returns by region or year are not possible from these data. Furthermore, 1991 data published by the Board are in a different format (bar charts) Ñ which make it difficult to derive percentages precisely Ñ and appear to involve some minor changes in regional definitions.
The information in Charts 8.4 and 8.5 give the impression that the industry has a diverse spread of markets. What tends to be masked, however, is the continuing importance of commodity products and a small number of large markets for these products.
In broad terms, the value of exports of New Zealand dairy products is made up of one-third butter, one-third milk powders and cream, and the balance split equally between cheese and casein/milk proteins.
The major butter markets are the United Kingdom and what was the USSR. The Middle East is also an important market region. The BoardÕs subsidiary, Anchor Foods, further processes and brands butter for sale in the United Kingdom market. While the destinations of cheese exports are widely dispersed, sales are concentrated in Japan, Europe and the United States Ñ the triad markets. Japan and the United States account for around 45% of cheese exports.
The export of casein and milk protein is even more concentrated in the triad markets Ñ around 70% of exports Ñ because of the sophisticated industrial demand in these countries. Milk powder exports go almost entirely to countries outside the triad markets Ñ mainly Central and South America and South East Asia. This reflects the protected nature of milk production in the developed countries and demand growth in developing countries for powders.
A better appreciation of the extent to which a small number of national markets account for a large proportion of exports can be obtained from the information in Table 8.2.
While the product mix has been shifting away from commodity products towards higher value ingredient and consumer packed products, exports are still dominated by commodity products. In 1977 around 80% of export sales were commodity products. Even though this had fallen to 67% by the end of the 1980s, New Zealand remained the worldÕs largest single dairy commodity trader. However, the proportion of commodity product sold on volatile spot markets has been reduced by nearly half in the past ten years.
The industry remains particularly dependent on butter exports to the United Kingdom and the former USSR. As the Board has noted:
ÒDespite all the efforts to date, two thirds of our milk still goes into butter production. This has to be reduced.Ó
The traditional dependence on the UK market has been reduced. In the late 1960s around 80% of total export sales were to the United Kingdom. By 1990 this had fallen to around 20%. However, while the importance of the United Kingdom market has diminished, it still provides price premiums to New Zealand butter exports because of preferential market access. When the UK joined the EC, New ZealandÕs traditional role as a major supplier was instrumental in New Zealand being the only non-EC exporter to obtain a quota for butter into the United Kingdom. This butter quota has been gradually declining over the years. However, returns from that market are still significantly higher than bulk butter prices on the open international market. New Zealand also has a small cheese quota in the EC and there are quota restrictions in the United States market. The additional revenue from both is small relative to the UK butter quota. An analysis of US quota arrangements and estimates of their value are presented in chapter 6.
The former USSR is also a particularly important market for New Zealand butter. In late 1990 major sales of butter to the USSR by New Zealand and the EC prevented international prices falling even further from their then depressed levels. The Board, when commenting on the 1990/91 world dairy market downturn, highlighted the importance of USSR purchases:
Ò . . . the problems and price pressures were most acute for butter and related products. Markets available to New Zealand for these products are dominated by the Soviet Union. The level of its imports and the pattern of its purchases are crucial, not just for New Zealand and for butter but for other exporters also, and for balance of international dairy markets generally.Ó
In mid-1990 the Board also made reference to the importance of the USSR when an executive said that Òserious difficulties would result if Russia stopped buying our butter Ñ either because they donÕt need to or, more probably because they canÕt afford to. We have come to depend on this market to an extent that almost matches our dependence on the United Kingdom.Ó While the industry did not like being so reliant on this market it was a Òsimple fact that there are no alternative markets available capable of taking anything like this quantity of butter.Ó
While the Soviet Union has been an important importer on the world scene, only a small increase in its production would be required for it to be self sufficient. Cartwright noted that NZDB executives Òconsidered that if the USSR increased its delivered production by less than 5% that country would switch from being a net importer to a net exporter.Ó
Board strategy is to diversify products and markets
In the late 1970s the Board implemented a major change in the strategic direction of its marketing activity. It has described the strategy in the following terms:
ÒThe BoardÕs core strategy is to lessen its dependence on uncertain commodity markets and direct as much product as possible into consumer markets, using consumer brands (such as Anchor), or into specialised industrial markets requiring sophisticated products with specific functional properties. Central to this strategy is the continued development of the BoardÕs international marketing structure provided by its network of subsidiary companies.Ó
Essentially, this strategy is aimed at emulating the approach of the major multinational food companies such as NestlŽ, Borden and Kraft-General Foods. These companies are not commodity traders although they often export subsidised commodities from the EC and the United States to subsidiaries elsewhere for manufacturing and packaging close to the final customer. They also purchase commodities from New Zealand. For example, NestlŽ is a substantial buyer of New Zealand skim milk powder for use in its milk recombining plants in South East Asia.
An important part of the strategy has been to shift much of the responsibility for marketing from New Zealand to the BoardÕs subsidiaries in individual markets. Large commodity transactions are still negotiated directly from New Zealand but an increasing proportion of exports are sold to offshore subsidiaries which then further process and package according to individual market and customer requirements.
The success of the BoardÕs diversification strategy is best described as modest. As noted earlier, commodity products still dominate New ZealandÕs exports. However, in an intensely competitive market it is perhaps unreasonable to expect overnight success.
The report of the Porter Project commented on the BoardÕs diversification strategy in the following terms:
ÒDespite the improvement in product and market mix the Dairy Board achieved in the 1980Õs, some questioned whether it had moved far enough in this direction. In 1989, some 67% of New ZealandÕs dairy exports were still basic commodities that could be secured from many countries, particularly those with large export subsidies. Though this was a significant improvement from 80% in 1977, 40% of exports were in commodity butter (and its derivatives), a product line that faces declining demand and chronically depressed prices. While the move into more secure and profitable segments has made significant headway, the move has not been far or fast enough to arrest decline and increasing volatility in the prices received for New Zealand milk.
ÒOther than the Anchor brand in Britain, the NZDB has no significant position in branded consumer goods in the industrialised world, i.e. one of the more profitable segments of the industry. The NZDB has been more successful in building brands in developing countries such as Sri Lanka, Malaysia and Singapore, which are generally smaller and less profitable markets for dairy products.Ó
Cartwright concluded that while the Board had developed significant brands in several markets, Òby world standards, it was not a major player in retail and consumer marketing.Ó`
The NZDB, on the other hand, views the strategy as having successfully positioned the Board in the international market place, viz:
ÒWe could categorise the dairy industryÕs export marketing structure as now being at critical mass. Given even minor improvements in the worldÕs export market we have everything in place to take advantage of the changes. Our research and development is in the forefront of this drive. We have a marketing structure established throughout the world with strong brands, top quality products, and a distribution and marketing structure to take advantage of them. While Kraft, NestlŽ and Bordens have had their consumer brands in the international market for up to 70 years, the New Zealand dairy industry has really only had a strong branded presence outside the U.K. for some 10 years. We are only now getting to the point where we can really reap the benefit for that investment.Ó
There are no statutory restrictions on competition in the domestic market
New Zealand has a high per capita consumption of traditional manufactured dairy products. This reflects earlier policies which subsidised prices and restricted the availability of competitive products, in particular margarine.
Today, the domestic market for dairy products is contestable. There are no legal restrictions or taxes on imports. However, the industry supplies all the needs of the domestic market with the exception of some speciality cheeses. The market is supplied predominantly by the dairy cooperative companies. There are some proprietary companies which buy product from cooperatives and package and market it domestically.
The NZDB owns a margarine manufacturing company to ensure the industry has a strong position in the yellow spreads market Ñ margarine now holds a one-third share of that market.
There are a number of competitive producers and brands in the domestic cheese market. The Board has recently formed a new subsidiary company which will Òcarry out generic cheese promotions and will work very closely with the existing cheese brand marketers, in addition to carrying out industry research and encouraging new product and pack developments.Ó
8.3 Major Issues
There are three major issues relevant to dairy marketing arrangements discussed in this section. They are:
¥ the performance of the Board as a single seller in extracting unit returns higher than world prices;
¥ the implications for dairy farmer production decisions and profitability of pooling Ñ or bundling Ñ returns from markets paying different prices and returns from off-farm investments; and
¥ the relationship between the steady decrease in the number of dairy cooperatives and the emphasis placed on unit cost economies.
In each case the analysis and discussion is specific to the dairy industry. However, the principles being illustrated have been covered in earlier chapters and are relevant to other industries even though the consequential impacts may vary.
8.3.1 Does the single seller extract market premiums?
As repeatedly pointed out in this report, single seller arrangements have, as an important justification, their ability to extract returns from the market higher than would be achieved by competitive exporters. This section examines the logic and available evidence to reach a judgment on whether the NZDB is achieving this particular objective.
The NZDB is just a price taker?
Protection and subsidies, and the small proportion of world milk production traded, combine as influences to ensure a market environment for New Zealand which is very competitive, volatile and often unpredictable.
The International Dairy Arrangement, which operates under the GATT, establishes minimum export prices for certain bulk dairy products including butter. Signatories to the IDA agree not to trade below these minima unless an application to do so is approved under the GATT. Such approval was given to the EC and New Zealand in 1990 when sales of butter were made to the USSR at prices below the IDA minimum and on extended credit terms. The effectiveness of the IDA is reduced by the fact that the United States and Canada are not signatories.
Developments in the EC, the United States and the former USSR essentially drive developments in the international dairy market. The EC and United States both protect their domestic industries from international competition and generate exportable surpluses. The subsidised export of production surpluses from the EC is a particularly significant influence. Japan is also an important market with a protected domestic industry.
Putting aside issues of marketing, particularly strategies to value-add, brand and product differentiate, the reality is that returns on New ZealandÕs investment in dairy production are influenced by these important international market distortions and characteristics. They represent the market reality into which New Zealand sells. Furthermore, they are the influences which mainly determine what New Zealand receives currently for dairy exports. The quotations reproduced in Box 8.2 indicate that this is well recognised by industry leaders in New Zealand.
Others have reached the conclusion that New Zealand is essentially a price taker in this very distorted and competitive international market. For example, the Commerce Commission concluded that:
ÒThe Dairy Board is effectively a price taker. As the companies [dairy cooperatives] recognise, due to worldwide protectionism the international dairy product market is subject to excess supply. This, combined with the existence of a multitude of players in the international arena, means that the Dairy Board sells its goods at the best prices which it is offered.Ó
Cartwright pointed out that world dairy product markets are mature although there are pockets or niches offering good returns and better growth prospects. He concluded that in the dairy commodity trade competition is on price and there are only small differential premiums from loyal customers if good service and reliable supply are provided; otherwise they buy on the spot market in search of the lowest price, viz:
ÒManufacturers who had the option of procuring commodities by tender or who spot purchase sometimes derived higher value from direct contractual linkages with producers. These provided assurances of reliable supply, consistent quality, and prompt resolution of complaints. Contracts also enabled buyers to make requests for limited special features, packaging and delivery schedules. For these services, buyers were prepared to pay a premium up to 5% over free-market prices.Ó
This premium cannot be described as a single seller success margin. There would be costs associated with earning the margin, the margin is very modest, and being a single seller is not a necessary condition for gaining the premium.
Finally, the Dairy Board recognises this price taker environment:
ÒEven when farmers in one country band together to become stronger exporters, they are these days often up against weak exporters from other countries because companies like NestlŽ and Kraft are truly global in their reach. At the same time international freight is getting cheaper as a component of total costs and the information flow is very fast.Ó
Clearly, this recognition by the Board that, in the commodity trade at least, there are no extra returns available from being a single seller would explain their strategies for investing further along the chain in more consumer-oriented and specialist ingredient products. Whether a single seller can expect to extract premiums in this segment of the market is returned to later.
Next, what does available information on Board performance indicate? The answer to this question can only be imperfect because publicly available information is limited, often non-comparable, and lacking the detail necessary for accurate estimation. This constraint is referred to frequently in what follows.
One piece of research, which compared unit export values achieved by New Zealand with those of other exporting countries over the twenty five years ending 1987, concluded that as far as the major dairy exports were concerned, only in the case of milk powder from Canada (which has a very regulated dairy industry) were returns consistently lower than those obtained by New Zealand. The average export returns for New Zealand butter, cheese and milk powder were lower and exhibited a slower rate of growth than both average world prices, and average export prices received for these products by Australia.
The researchers acknowledged that these results were only a Òcrude measure of marketing performanceÓ but Òshould demonstrate the ability of the marketing organisations to enhance the returns for New ZealandÕs produce without reflecting internal protection structures or processing costs which may further influence producer returns.Ó
As an aside Ñ but as a point of some significance Ñ the Board was anxious to ensure that ACIL was aware of its disagreement with these research findings. The detail and ACILÕs reaction are presented in Box 8.3.
Cartwright has also published information which casts some doubt on the
proposition that the BoardÕs single seller status improves unit returns to dairy farmers.
He calculated the value of New Zealand exports of butter products, milk powders and
cheese, at world prices and at prices received by New Zealand, and from the differentials
(New Zealand returns were always higher) concluded Òthat the Board had achieved a price
premium over average world prices for commodity productsÓ during the 1980s. The
percentage differentials he calculated are presented in Table 8.3.
Table 8.3: New Zealand Export Prices Relative to World Prices
(1981-1987)
Year Proportion by which NZ Prices
Exceeded World Prices
(%)
1981 9
1982 1
1983 5
1984 22
1985 6
1986 11
1987 24
Source: W Cartwright (1990), op.cit., p68.
However, these differentials Ñ single seller margins by implication Ñ included Òthe effect of access to the protected UK butter market, which yielded prices 81% higher than the world average price in 1988, and accounted for 32% of New ZealandÕs exports of butter products.Ó At that time about 30% of export returns came from butter. This means a margin over all sales of around 8% for New Zealand just from the UK quota premium. Consequently, the premiums obtained by the Board in some years would have been negative had the influence of the UK quota been removed.
Are premiums more likely for non-commodity products?
Dairy Board strategy is to decrease dependence on commodity trade and increase involvement in value-added and branded products. Conventional marketing wisdom has it that returns are superior in this part of the market. But will it improve the ability of a single seller to secure returns superior to the competition and, by implication, superior to a competitive exporting system in New Zealand?
In the value-added end of the market there is plenty of competition Ñ competition between numerous manufacturers and suppliers, and competition from substitutes.
The latter source of competition seems invariably overlooked when advocates of the single seller extol its virtues. There are very few food products which do not have substitutes acceptable to the consumer if relative prices depart significantly from their average relationships. In the case of dairy products, vegetable oils are an important market substitute. They have increased competition for butter significantly in the yellow spreads market and can be used as a ÔfillerÕ substitute for milkfat in many other areas. There are also alternative sources of protein, particularly vegetable protein, but also meat, fish and eggs.
It is clear that the worldÕs major dairy product marketing businesses are happy to convert into products and market the readily available, price sensitive and highly competitive bulk commodities. It was noted earlier that NestlŽ sources raw materials from Europe for its Asian manufacturing and marketing operations, and is a major NZDB customer. Cartwright pointed out that:
ÒThe major multinational food companies (NestlŽ, Borden, Kraft-General Foods) were not open market commodity traders. However, they exported subsidised commodities, from the EEC and USA to their own subsidiaries for manufacturing and packing in offshore markets.Ó
These large food companies, and the many smaller companies which they also compete with, use a variety of marketing approaches to secure custom and retain it. Technical improvements and continuous innovation are very important. As the report of the Porter Project pointed out:
ÒCompetition is based on technical innovation to achieve superior functionality for the buyer. New product breakthroughs are quickly imitated. Continuous innovation for sophisticated customers is necessary to obtain and maintain leadership.Ó
Because the international market is very competitive these strategies are necessary to stay in business. They do not deliver above-normal prices or profits. To stay in business food marketing companies have developed brands, grown market share, paid particular attention to quality and developed new products. However, as Cartwright concluded:
ÒThe competitive position attained in this way was sufficient to maintain retail sales, but for most product lines did not provide substantial price advantages over competitors. Thus, profitability depended on continual attention to costs to protect and enhance margins.Ó
There is nothing particularly different or unconventional here. Innovation and cost control are necessary to stay in business. Competition ensures only normal profits. Cartwright references a survey of over 150 dairy product manufacturing companies in the United States and concludes that Òentry barriers to the industry were not highÓ and Òprofit margins were tight and the returns on net worth were mediocre in this industry.Ó In the late 1980s Kraft and NestlŽ reported returns only slightly better than revealed in this survey.
It would seem reasonable to conclude that the NZDB would not outperform those already in the market place because of the competitive environment. The corollary is that competitive New Zealand exporters could be expected to do just as well, especially a competitive but well established Dairy Board.
The UK market provides the only significant premium
The only significant market premium secured by the NZDB is from the UK butter quota. A small premium is available from New ZealandÕs EC cheese quota. Quota arrangements in the United States have also delivered small premiums in some years.
The UK butter quota volume has been declining steadily. When the quota was originally negotiated in 1973 it permitted access into the higher returning UK market for some 166,000 tonnes. Its size has declined each year since then.
Negotiations over access for the four years ending 1992 were not finalised until late 1989. This agreement resulted in quota volume declining by 26% over the four years to 55,000 tonnes in 1992.
The value to New Zealand of this market quota varies with both the volume of the quota and the difference between the relatively steady UK price and the highly variable world price. The premium for New Zealand is the difference between these two prices because if the access were removed the butter would have to be sold on the competitive world market.
ACIL has estimated that the UK butter quota delivered a premium to New Zealand of around $130 million in 1989/90 and $120 million in 1990/91. The detail behind this estimate is presented in Box 8.4.
The premium estimates in Box 8.4 are based on the assumption that the Board achieves an average 5% premium over estimated world prices for non-UK butter sales. In fact, the Board probably makes sales at prices around this average. It certainly made sales below this average in 1990/91 Ñ the sale to the USSR was made at $US200 per tonne below the GATT minimum for butter, or approximately $1,850 per tonne. If this price were used to calculate the UK butter quota premium Ñ not an unrealistic assumption Ñ the estimated UK premium in 1990/91 would be $157 million.
8.3.2 The distortions created by a bundled return
A major conclusion in this study is that, in choosing as an objective the maximisation of farm gate prices, producers have distorted their price signals and been steered away from production levels which would maximise farm profitability. It is likely that the consequences of these distortions are as great in the dairy industry as anywhere. This is because the NZDB derives considerable revenue from activities other than trading New Zealand dairy output, there are variations in dairy product prices between markets Ñ the UK quota price being at the upper extreme of the range Ñ and the processing sector consists virtually entirely of cooperatives which also bundle profits and diverse revenue sources in their dairy farmer payouts. This section considers the potential implications for dairy farmer profitability of this bundling of returns.
Producers are unaware how little they earn from milking cows
Indicative analysis ACIL has undertaken demonstrates that the extent of bundling in the producer farm gate return for milkfat is creating significant distortions and reductions in farm incomes and profitability. The data used in the analysis which follows are summarised in Table 8.4.
Prices in the international dairy products market are volatile and this is reflected in variations in farm gate returns. In these circumstances it is unlikely that farmers will change fundamentally the size or enterprise mix of their operations, or join or leave the dairy industry, on the basis of one above or below-average season. With this in mind ACIL has based the analysis on average returns over the three seasons ending 1990/91.
The analysis proceeds on the assumption that there are only two major sources of distortion in the farm gate return. They are the premium from the UK butter quota and the profit obtained from the farmerÕs off-farm investment in the cooperatives and the Board.
The detailed discussion of the consequences of a bundled return, presented in chapter 4 and Appendix 1, highlights the fact that the distortions arise because the dairy farmer does not know the market price being received for marginal milk production, and even if this were known the producer would not be advantaged by unilateral action. The market reality in the dairy industry is that, UK quota premiums aside, dairy products are being sold in markets which return different prices. Even if the two major sources of distortion noted above and included in the analysis were removed from the bundled return, it would still be distortionary for this reason. However, ACIL has not taken this into account. This is one of a number of factors which make the results of the analysis conservative.
The premium for the UK market has only been estimated by ACIL for 1989/90 and 1990/91 Ñ see Box 8.4. The discussion in that section suggested the 1990/91 estimate might be quite conservative. We are not aware of any other published estimates. While the premium does fluctuate with world prices, as illustrated in 1990/91, it is likely to have been higher in earlier years because the quota quantity was higher. However, in the analysis ACIL has used an average of the premium it has estimated for the two seasons ending 1990/91 Ñ $125 million. This is another factor likely to make the estimates conservative.
There is no detailed information on the return (profits) dairy farmers receive on their off-farm investments in the Board and cooperatives. It is therefore necessary to make an estimate. This can be done by applying a notional rate of return to the value of net assets. There is information available on asset values.
The Chief Executive of the NZDB said that the average dairy farmer has Ò$175,000 tied up in the local cooperative and the Dairy Board.Ó Given the date on which this comment was made it is assumed he was referring to 1990/91. In that year there were 13,089 dairy farmers supplying dairy factories (Table 8.4). This implies a level of off-farm assets totalling $2.3 billion. The BoardÕs accounts show assets net of product stocks in 1990/91 of $1.445 billion. This implies the value of cooperative assets were approximately $0.9 billion. This estimate is consistent with an estimate published by Cartwright. It would therefore appear that $2.3 billion is a satisfactory estimate of the off-farm assets in 1990/91 on which dairy farmers should expect a commercial return. Using this estimate of net assets instead of the slightly higher 3 year average would also contribute to making the estimates conservative.
Assume dairy farmers are receiving a return of 10% on the value of their off-farm assets as just defined. This is an annual income of $230 million. The rate of return may be argued over. However, in a different type of analysis undertaken by Cartwright, a notional return of 11.4% was used. This was based on Òthe average return on shareholdersÕ funds in the top 1000 New Zealand and Australian manufacturers, which was 11.4% in 1988 . . . Ó A notional return of 10% would therefore appear reasonable.
These two dairy farmer income items Ñ the UK quota and the profit which could be expected from the off-farm investment Ñ are estimated to have averaged $355 million or $26,600 per dairy farm over the three years ending 1990/91. It should be recalled that this is income received from activities other than milk production and should not influence dairy farmer production decisions.
Estimates made by MAF of dairy farm profits for the same period averaged $40,729. However, these estimates include farm returns received by dairy farmers for production other than milk Ñ mainly cows and calves going for meat production. Over the three years ending 1990/91 milk gross returns averaged 87% of total gross returns on dairy farms. Assuming milk and other production were equally profitable, the annual average net farm profit from milking cows over the past three years would have been approximately $35,400 per farm.
Farmers, however, received in their milk payments income from the UK quota and their off-farm investment Ñ as calculated earlier Ñ of $26,600 per farm. It can therefore be concluded that their annual average profit over the past three years from milking cows was $8800. Over this period the average farm milked about 155 cows.
The point was made earlier that dairy farmers would not make major on-farm adjustments on the basis of one good or bad year. Nonetheless, it is useful to look at the results of applying the above analytical approach to the 1990/91 season Ñ a season when the bundled farm gate return was particularly low. The Board has nevertheless pointed out that the $3.70 per kg of milkfat it paid cooperatives in that season was Òclose to the median for the last ten years.Ó
In 1990/91 MAF estimated net farm profit at $25,383 per farm supplying dairy factories. In that season 86% of gross farm receipts came from milk, implying a net farm profit from milking cows of $21,800 per farm.
The UK quota premium in 1990/91 was estimated earlier as $120 million. To this can be added $230 million being the profit on off-farm investment of $2.3 billion at a notional 10%. Quota premium plus off-farm asset profits therefore total $350 million or $26,750 per farm. The conclusion here is that in 1990/91 the average dairy farmer incurred a loss of $5000 for milking an average sized herd of 167 cows.
This result is not particularly surprising. For example, in 1990/91 New Zealand sold 100,000 tonnes of butter to the USSR at a price approximately 40% below the average butter export return in that year for all butter exports. It is evident that a sale at a price this low would have been unprofitable to dairyfarmers.
While this conclusion might be unarguable, a counterpoint might be that the butter had been produced and therefore virtually any price is better than having to leave it unsold. This is the essence of the bundling distortion. If returns at the farm gate had not included the income from sources other than market returns from farmersÕ milk, they would not have been encouraged to produce at below cost in the first place.
The Board considers the distortions modest
According to the Chief Executive the Board considers the distortions modest.
ÒAt present, the largest proportion by far of both dairy company and Dairy Board payouts arises from the basic processing and marketing of milk products. In the BoardÕs case, profits earned from other activities, after allowing for tax and interest on the cost of the investment, was less than 5 cents per kg milkfat in 1990-91. The majority of dairy companies would probably be in a similar situation.Ó
The BoardÕs 1991 Financial Report indicates that for the 1990/91 season 9% or $0.4 billion of sales revenue (turnover) was derived from trading activities other than the processing and marketing of milk products. It is presumably this part of the BoardÕs turnover which the Chief Executive was referring to when he said the return on this investment was only 5 cents per kg of milkfat over all New Zealand production. The implication is that any distortions would be minor because the amount is small relative to the total payout to farmers.
However, the Board also reported that in 1990/91 some 20% or $0.9 billion of sales revenue came from trading non-New Zealand dairy produce. If profits from this activity are included in the milk payment to dairy farmers then this would be distortionary and should be included in the analysis.
Finally, the above estimate ignores the distortionary consequences of including the UK butter quota premium in milkfat returns to the farmer. This premium, while associated with the sale of New Zealand dairy products, is not a true market-related return to farm investment. For all these reasons the BoardÕs conclusion that the distortions are modest is incorrect.
Another way of approaching the calculation is to consider the profit on dairy farmersÕ off-farm investment as a proportion of sales revenue. Cartwright reports that in 1987 NestlŽ achieved a net profit of 5.2% on sales. Allowing for the fact that the Board may not be achieving a profit rate as high as NestlŽ, and to ensure the calculation is conservative, assume the Board and cooperatives combined achieve a net profit on Board sales of 4%. By way of comparison, the Chief ExecutiveÕs profit estimate of 5c/kg from non-dairy sales is approximately 4.25% of sales. In 1990/91 a profit of 4% of sales would have been $170 million based on Board sales of $4.3 billion. To this must be added the UK quota premium which was $120 million Ñ a total return of $290 million or $22,300 per farm. Even on this basis it can be seen that in 1990/91 dairy farmers made a small loss from milking cows after allowing for the profit on their off-farm investment and the UK quota premium.
A total income of $290 million in 1990/91 from other than milking cows represents approximately 85 cents per kg of milkfat or approximately 20% of the total payout received in that season. This is far from trivial. To conclude it is trivial is to believe that if dairy farmers knew they made a small income loss from milking cows in 1990/91 they would not have adjusted the number of cows milked or the extent of feed supplementation to avoid loss making output at the margin and improve their incomes as a result.
Whichever way the calculation is approached the broad conclusion is the same. Some milk is being produced at a loss, this is not readily apparent to the dairy farmer and net incomes are significantly lower as a consequence.
What if dairy farmers are happy with no return from off-farm investments?
Some dairy farmers may incline to the view that receiving no return from their off-farm assets is an acceptable price to pay for the perceived benefits of having cooperatives and a single seller board Ñ even if this perception is mistaken. An alternative way of looking at the same proposition is to say that these off-farm assets are not returning any profit, in which case this distortionary element of the bundled return effectively disappears.
Given the evidence dairy farmers should be questioning whether there are any particular benefits from current arrangements. Furthermore, it is not plausible to suppose they would be happy to receive no return on such substantial assets.
The national interest certainly requires a return. The notional rate of return used in the analysis is the opportunity cost of these resources. If they cannot produce a return of this order in their current use, the nation would be better off if they were used elsewhere. New Zealand cannot afford to forgo $230 million of national income just so that it can claim to be a significant world dairy player.
Surely the real situation is more complex?
The analysis undertaken here is very transparent and straightforward. More exact calculation of the income losses and resource misallocations arising from the dairy industryÕs bundled return would need to take into account myriad complexities in how farmers and marketers respond to changes in prices and farm gate returns. However, while this would refine and improve the accuracy of the estimates it would not change the conclusions. The current dairy industry marketing arrangements are costing dairy farmers and New Zealand a lot of money.
8.3.3 Mergers and cost minimisation in the processing sector
NZDB policies and practices have a pervasive influence on the investment, innovation and product-mix decisions of the cooperative dairy companies. An important manifestation of this influence is the focus on minimising factory unit costs and the steady decline in the number of cooperatives and increase in their average size.
Earlier in this chapter it was pointed out that the system for determining Board payouts to the cooperatives contained strong incentives for cooperatives to minimise unit costs. This incentive arises because the Board bases its cost compensation payments on a standard cost model. If a cooperative can operate at unit cost levels below those produced by the model, it can appropriate the margin and improve its payouts to suppliers. This distortionary focus on minimising unit costs is intensified by the product payment system which ensures all cooperatives receive the same returns when converted to a per kilogram of milkfat basis. A detailed description of how the system works, contained in the Commerce Commission Decision, is worth reproducing in full:
ÒIn its role as the exporter of dairy products from New Zealand, the Dairy Board pools receipts from all export revenue and then makes payments to the dairy product manufacturing companies. The payment made takes into account the amount of milk used in the manufacturing process as well as the market price received by the Dairy Board for different types of products. The underlying philosophy of the system is that, whatever the particular product manufactured by a dairy company, all companies receive the same return when converted into a kilogram of milkfat basis. NZ Dairy claims, therefore, that no company is better or worse off as a consequence of product mix. Dairy companies strive to produce product at a lower cost per tonne than the aggregate manufacturing and transport cost for which dairy companies are compensated by the Dairy Board. If successful in this endeavour, a company has created a ÔmarginÕ which can be paid out by the company to suppliers above the basic price received from the Dairy Board. Additionally, some companies (including NZ Dairy) receive returns from activities outside manufacturing which increase their payout capacity.Ó
Clearly, given the existence of size economies in milk processing this system provides a strong incentive to get bigger and explains the trend towards fewer but larger cooperative companies. Small processors, which are likely to have unit costs higher than those produced by the standard model, would obviously be at a disadvantage in the competitive contest to maximise milkfat payouts to suppliers under these arrangements.
The industryÕs recognition of this disadvantage was noted earlier. The Board is to introduce changes to the standard cost model apparently to ensure that standard cost calculations are related more closely to milk throughput. It is claimed this will reduce distortions. What this will actually do, given no other changes to the system, is have larger, lower cost plants subsidise the smaller higher cost plants.
The point that appears to be missed, and the reason why the payment system will continue to be distortionary, is that cooperatives should face incentives to maximise the profitability of their processing operations. The profitability of processing is determined by the margin between returns and costs, not just costs.
For example, if a relatively small plant produces a high quality, higher priced cheddar cheese but this means higher than average processing costs, it will face a disincentive to pursue this product line even though it might be profitable. The pooled return for milkfat together with the current incentive to minimise unit costs may encourage such a cooperative to invest in production of another product. The cooperative may, under the current system, be encouraged to invest in wholemilk powder production, for example, even if this is less profitable for the industry and the nation than producing high quality cheese. It will do this because to retain suppliers and stay in business it has to have a competitive milkfat payout price. This will be achieved at the expense of returns to the manufacturing investment.
The current system for milkfat pricing and cost compensation does not provide a set of incentives which ensure individual dairy cooperatives maximise profitability Ñ that is, the return on the off-farm assets owned by dairy farmers. Consequently, the system is distortionary. It is almost certain that current arrangements have led manufacturers to over-invest in cost-reducing plant and technology relative to other aspects of the business Ñ for example, product development, marketing, human expertise Ñ which also influence profitability.
Given the emphasis on unit costs and the benefits to cooperatives from minimising them, the continuous company mergers are quite explicable. In fact, it is widely if erroneously believed that capturing size economies in processing is in the interests of both dairy farmers and the nation. This belief figured prominently in the decision of the High Court to permit the merger of the New Zealand Co-operative Dairy Company Ltd and Waikato Valley Co-operative Dairies Ltd. The reliance the High Court placed on an expert view that economies of size were important is significant because a merger was approved on the basis of benefits the existence of which can be questioned.
The basis on which the High Court approved a merger
In late 1990 a proposal for the merger of the New Zealand Co-operative Dairy Company Ltd and the Waikato Valley Co-operative Dairies Ltd was registered for consideration by the Commerce Commission. In May 1991 the Commission issued a decision refusing to clear or authorise the proposed merger and in June published detailed reasons underlying the decision.
The parties to the merger then challenged the CommissionÕs decision in the High Court which, on 7 August 1991, delivered a judgment which upheld the appeal and cleared the way for the merger to proceed. The two source documents for the discussion in this section are the Commerce CommissionÕs Decision and the judgment of the High Court.
The key reasons for the Commerce CommissionÕs decision, and the grounds on which the High Court upheld the appeal, have relevance to the issues being discussed here. In particular, they provide insights into how increasing scale in dairy manufacturing is believed to deliver benefits and how this influences commercial and policy decisions in the industry.
The Commerce Commission was clearly concerned that the merged company Ñ which would process 45% of New ZealandÕs total milkfat production Ñ would Òhold considerable influence outside its immediate area of operations.Ó It then went on to make the following observations:
ÒAlthough unfortunate, it is perhaps not surprising, given this level of involvement in the industry, that a number of credible parties spoken to by the Commission have been hesitant in making their views known other than orally and/or on a confidential basis;Ó
and
ÒIn respect of the Dairy Board, a number of parties asserted that NZ Dairy [The New Zealand Co-operative Dairy Company Ltd] effectively controlled that organisation.Ó . . . With regard to NZ DairyÕs current position in the Dairy Board, the Commission is of the view that NZ Dairy has a substantial influence over the Board. A merger . . . can only accentuate this influence.Ó
The Commission concluded that the merged entity would acquire or strengthen a position of dominance in two markets Ñ town milk supply and unprocessed milk acquisition. The Commission said that:
Ò . . . NZ Dairy will acquire or strengthen a position such that it can behave to a large extent independently of its actual or potential competitors;Ó
and:
ÒAt the conference, Woolworths stated that NZ Dairy/Waikato Valley merger would benefit 6000 farmers to the detriment of a public of 3 million. While oversimplified, the Commission endorses the essence of this statement, having identified detriments which affect a wide cross-section of the public.Ó
Ten days after the Commission published its reasons for refusing to approve the merger the Minister of Commerce, the Hon P Burdon, sent the Commission a government policy statement relating to the dairy processing industry. Section 26 (1) of the Commerce Act requires the Commission to have regard to Òthe economic policies of the Government as transmitted in writing from time to time to the Commission by the Minister.Ó
The short policy statement from the Minister concluded as follows:
ÒThe Government supports structural rationalisation in the dairy processing industry that will lead to greater efficiencies in resource utilisation and enhanced competitive advantage.Ó
In its judgment the High Court noted that:
Ò . . . as a result of the admission of the further evidence there are some aspects in which we have been better informed than was the Commission and we have the benefit of post-decision developments which, had the Commission been dealing with the application now, might have led it to different conclusions on some points.Ó
The MinisterÕs policy statement to the Commission was part of this Òfurther evidenceÓ and was referred to in the judgment as Òone particular item of further evidence with which we think it appropriate to deal separately at this stage.Ó In doing so the High Court said the following:
ÒIt would be naive to think that the issue of that statement was not a direct consequence of the CommissionÕs decision in the present case.Ó
However, after pointing out that within the context and timing of the appeal the MinisterÕs Statement could not be interpreted as Òa totally unacceptable attempt by the Executive to influence the Court,Ó the High Court observed that the statement was:
Ò . . . the exercise of a statutory right specifically conferred on him [the Minister] by the Legislature for the very purpose of influencing the outcome of applications under the [Commerce] Act.Ó
Basically the Court pointed out that it was obliged to Òhave regardÓ to the MinisterÕs statement, Òas it would have been for the Commission had the statement been given before its decision . . .Ó
Another component of the Òfurther evidenceÓ before the Court was material from a representative of the NZDB. In an affidavit of 17 July 1991, a senior representative of the Board, Mr Mitchell, said inter alia, that:
ÒDairy company amalgamations have historically been a feature of the New Zealand dairy industry, driven by the essential need to minimise costs.Ó
He went on to outline a chain of cause and effect, the essence of which was that lower manufacturing costs resulted in higher net returns, which resulted in increased productive capacity by farmers, leading to an Òincrease in the amount of product available for sale [which] leads to greater export returns Ñ which will be at a profitable level Ñ thus allowing the cycle to continue.Ó
The Court pointed out that it Òwas unfortunate that . . . [the affidavit] . . . was not available to the Commission in time for its decision.Ó It went on to say:
ÒThis affidavit, which was not available to the Commission, when considered, as we must consider it, in the light of the MinisterÕs s.26 statement, makes a strong case for us to give considerable weight to the benefits flowing from the merger which assist with the process of the rationalisation of this vital export industry;Ó
and:
ÒWe consider that the industryÕs ability to compete internationally will be enhanced by this merger. We regard this as a substantial public benefit which is inextricably linked with industry rationalisation.Ó
The Court then summed up its conclusions as follows:
Ò(a) Contrary to the views of the Commission we find no strengthening of dominance in the town milk market.
(b) We agree, although on a somewhat narrower ground, with the Commission that the merger will result in dominance in the raw milk market.
(c) We find some detriment from that dominance but of less substantial degree than appears to have been contemplated by the Commission.
(d) Contrary to the CommissionÕs view we find the public benefits to accrue from the merger substantially outweigh the detriment.Ó
The MinisterÕs policy advice, conveyed to the Commission after its Decision was published, should not be regarded as exceptional or controversial. It makes eminent sense for the government to support changes in business structures if they result in Ògreater efficiencies in resource utilisationÓ and improve New ZealandÕs Òcompetitive advantageÓ. However, all the logic and analysis presented in this study suggests that the policies and marketing arrangements which encouraged the merger do not meet the governmentÕs criteria. The findings here contradict the conclusions reached by the NZDB executive whose affidavit appears to have been relied on heavily by the High Court. While the CourtÕs findings on dominance and public benefits might have been correct, the merger may still have been contrary to the objective of efficient resource use. As such, the problem is not one of competition policy but a consequence of policies underlying statutory marketing arrangements.
In particular, the Board executive suggested that because the merger would lower processing costs and consequentially increase unit returns to dairy farmers, farmers would produce more output and this would increase export returns. Provided the increased output was not given away or sold cheaply this proposition is correct. However, the analysis in this study shows that under current marketing and pricing arrangements the increased output would be unprofitable and therefore not in the interests of dairy farmers or the nation. Essentially, the consequences of the merger are contrary to the policy objective in the MinisterÕs statement.
8.4 Conclusions
The dairy industry prides itself on being one of New Zealand agricultureÕs mainstay industries. It has always been a major export earner and views its history of achievement as being closely related to its marketing arrangements and cooperative culture.
Many dairy farmers may find the analysis and conclusions in this report simply unbelievable. How could such a large and apparently successful industry persist if returns on its resources were so low? Surely the industry must be judged a success because it has survived in an extremely competitive and distorted international market? If it were not acceptably profitable why would people keep milking cows?
The answer to all these questions is as simple as it is disturbing. Dairy farmers are not aware of the low returns they are receiving on total assets because of the marketing, processing and pricing arrangements they have established. Even if they were aware, unilateral remedial action would not benefit the individual dairy farmer. What the analysis presented earlier in the chapter demonstrates is that if dairy farmers demanded and actually received a commercial rate of return on their off-farm assets, they would be exposed to the fact that the true profit on the resources and effort devoted to milking cows is very low.
Dairy farmers might not always be happy with their levels of apparent farm profitability but they stay in dairying because, on average, their incomes are roughly comparable with alternative forms of agriculture. They do not actually experience farm profits as low as the estimates from the earlier analysis. The reason is that the marketing and pricing arrangements effectively lead them to accept, unwittingly, a very low investment return on their off-farm assets. The problem is even worse than this. Not only are the returns on this off-farm investment low, but dairy farmer responses drive them lower. The bundled farm gate pricing system encourages them to produce some milk which is sold at a loss, and they along with their processors and marketers, are unaware this is happening.
It is in the interests of dairy farmers as business investors, and the nation, that the current arrangements be changed. The bundled return needs to be unbundled so dairy farmers can explicitly see what returns come from what investments. Only if this happens will dairy farmers be receiving a farm gate return which correctly signals how much milk they should produce to maximise farm profitability. They can then also decide whether returns from off-farm investments in processing and marketing are acceptable, or whether they would prefer to invest this money elsewhere.
It is neither necessary nor sensible to dismantle the NZDB to achieve this result. It simply needs to be corporatised and the shares given to dairy farmers who can then decide whether and when they keep or sell their investment in the marketing organisation. This will give the organisation a return on investment focus and allow dairy farmers to see explicitly how well the Board performs its marketing functions.
The cooperatives also contribute to the bundled return. However, it will be up to shareholder/ suppliers in each cooperative to decide whether the alternative approaches suggested in this report should be pursued. Certainly the logic, and the unfavourable commercial consequences of bundling returns, should cause dairy farmers to consider carefully the merit of the alternatives.
Finally, the evidence shows that the UK butter quota is the only significant source of market premiums available to the industry. The EC cheese quota delivers some premium but it is much smaller. In these circumstances ACIL recommends that all restrictions on exporting dairy products be removed and that the New Zealand government contracts with the corporatised Dairy Board to supply the UK butter and EC cheese quotas and retain the premiums as contributions to profit. The reasons are set out in the Overview and Recommendations of the report.
Chapter 8
Dairy
Chart 8.1: New Zealand Dairy Cow Numbers and Milkfat Production (1981Ð1991)
Sources: Department of Statistics; Ministry of Agriculture and Fisheries.
Chart 8.2: Farm Gate Price and Real Farm Profit (1981Ð1991)
Source: Ministry of Agriculture and Fisheries.
Chart 8.3: Composition of NZDB Sales Revenue (1990)
Source: New Zealand Dairy Board, Financial Report 1990.
Chart 8.4: New Zealand Dairy Exports by Region on a Volume Basis (1989/90)
Source: New Zealand Dairy Board, Annual Report 1990.
Chart 8.5: New Zealand Dairy Exports by Region on a Sales Revenue Basis (1989/90)
Source: New Zealand Dairy Board, Annual Report 1990.
Table 8.2: Proportion of Exports by Value Sold to Largest National
Markets (1988)
Product Three Largest National Markets Proportion of Exports going to:
Category in Decreasing Importance Largest Three Largest
Market Markets
Butter and Anhydrous United Kingdom
Milk Fat USSR 37 59
Japan
Cheese Japan
United States 29 61
United Kingdom
Casein (incl. Whey
Proteins) United States
Japan 41 77
West Germany
Milk Powders, Fluid
Milk, Cream Malaysia 17 38
Venezuela
Mexico
Source: W Cartwright (1990), op.cit., pp60-61.
Box 8.2: Dairy Farmers Are Essentially Price Takers in the World Market
Market returns received by New Zealand dairy farmers are influenced
predominantly by changes in world supply and demand for primary dairy commodities. This
will continue to be the case in the future.
When dairy farmer returns are reflecting the downswing of the commodity
cycle it is necessary for industry leaders and marketers to explain why this is happening.
The explanations consistently confirm the market reality facing New Zealand Ñ in the
world market for dairy products New Zealand is a price taker.
The following quotations have been sourced from various issues of the
Dairy Exporter over recent years. In all cases, they are comments which have been made by
industry leaders and senior Board personnel.
Ò. . . international dairy markets seem to have a cycle of 7 or 8
years. Higher prices lead to increased production, which eventually collapses the prices.
Then after a low period, there is a re-adjustment upwards, as is now being experienced.Ó
Ò. . . it would have been brave to predict a year ago that skim milk
powder would rise from $US1200 to $2000/t in 12 months. Or that butter would lift from
$US1000 to $1600/t.Ó
ÒThe improved returns to NZ dairyfarmers are due almost entirely to the
reduced milk production in the northern hemisphere. The volume of milk produced in
developed countries, particularly in the EEC nations, will have greatest influence on
short-term market returns.Ó
ÒAdverse changes in the market have considerably affected our earlier
expectations for this season's returns.Ó
ÒManaging the international market as such would not affect the subsidy
decisions made in Europe - unfortunately.Ó
ÒThe volatility in returns that we have experienced over the past
decade is likely to continue into the next.Ó
ÒThe top level NZ can expect from world prices will be the cost of
marginal milk in the US.Ó
ÒThe baseline for world milk prices will not be set by us, but probably
by the Americans.Ó
ÒIt is frustrating that, in spite of our best endeavours, we are so
much at risk to political decisions made in the international arena and out of our control
and influence.Ó
ÒIn a falling market consumers are always inclined to delay purchases,
and will try to push prices down further.Ó
ÒNo marketing board can predict at the start of the season the end
result.Ó
ÒLow cost milk production is NZ dairying's only advantage. The
challenge over the next decade is to capitalise on it.Ó
ÒAn accurate estimation of dairyfarm income is impossible.Ó
Box 8.3: Research Into Export Performance Ñ The Board is Quick to
Criticise but Not to Contribute
Published research referred to in the text suggested that New ZealandÕs
dairy export returns were no better, and possibly worse, than those being achieved in the
competitive international market place. Shortly after the research was published the Board
wrote to the Minister of Agriculture outlining its reasons for disagreeing with the
findings. The Board provided a copy of this letter to the New Zealand Business Roundtable
with the instruction that it be brought to ACILÕs attention.
In the letter to the Minister Òsummarising the defectsÓ in the
research the Board outlined a series of detailed reasons why data used in the analysis
rendered the conclusions ÒmisleadingÓ Ñ interestingly the Board did not claim they were
wrong. They also told the Minister that they found it Òextremely disappointing that an
important chapter in a semi-official publication should be based on poor analysis and
understanding of statistical information.Ó
The researchers have told ACIL that they acknowledge the validity of
some of the BoardÕs points but do not recant from the position that the analysis did
throw some useful light on the propositions being examined, and was supportive of the
qualified conclusions they had drawn. They understandably bemoaned the difficulties facing
researchers because of severe limitations on data availability.
ACIL agrees with both the Board and the researchers. The research is
imperfect but it does provide valuable insights into New Zealand's export performance. The
episode would also seem to have some inferential value.
If the Board is demonstrably doing better because of its single seller
status then it has the opportunity and, most importantly, the information to prove it.
This was such an opportunity. The debate would be greatly illuminated if the Board
undertook and published research in this area, and exposed it to professional scrutiny.
ACIL has attempted some estimation and analysis of its own in this
chapter using published information. It remains to be seen, if the Board disagrees with
our conclusions, whether it will respond in the manner described above. Perhaps on this
occasion, if it disagrees with the conclusions, it might provide more information and
supply what it considers are the correct answers?
Box 8.4: Estimates of the UK Butter Quota Premium
ACIL has estimated that the UK butter quota premium was $131 million in
1989/90 and $118 million in 1990/91. This represents the additional revenue obtained by
New Zealand because it receives privileged access to the higher returning UK market.
The data used to make the estimate are sourced from research published
by Professor Wayne Cartwright and the New Zealand Department of Statistics. The data and
assumptions are as follows:
¥ 27% of butter exports in 1989/90 went to the UK quota market;
¥ New ZealandÕs unit export FOB butter returns averaged $3348 per
tonne in 1989/90 and $3131 per tonne in 1990/91;
¥ Cartwright indicates that unit returns in the UK market are about 80%
above world open market bulk butter prices; he also concluded that good service and a
reliable supply reputation resulted in buyers being prepared to pay a premium up to 5%
above world spot prices.
Using the above information, it can be estimated that the UK premium was
$2140 per tonne in 1989/90 for a total value of $131 million and $2025 in 1990/91 for a
total value of $118 million. The calculations for each year are as follows:
1989/90
¥ Let X be the world spot price;
¥ UK price is 1.8X Ñ a margin of 80% over world spot price;
¥ Assume Board achieves an average 5% margin over spot prices for
non-UK butter sales; and
¥ 27% of butter exports went to UK in 1989/90 and the average New
Zealand export return for all butter exports was $3348 per tonne.
Thus:
(0.27 x 1.8X) + (0.73X x 1.05) = $3348/tonne
X (world spot price) = $2675/tonne
UK price (1.8 spot price) = $4815/tonne
Difference between UK and spot price = $2140/tonne
Quota volume = 61,340 tonnes
Total UK premium = $131 million
1990/91
Using the same methodology as above, with export returns for all butter
averaging $3,131 per tonne, and assuming only 25% of butter exports went to the UK in
1990/91 because quota volume fell, yields:
(0.25 x 1.8X) + (0.75X x 1.05) = $3131/tonne
X = $2530/tonne
UK price = $4555/tonne
Difference = $2025/tonne
Quota volume = 58,170 tonnes
Total UK premium = $118 million
It must be stressed that these estimates are no better than the data and
assumptions used. However, they pass ÔsensibilityÕ checks and are quite adequate for
their purpose Ñ which is to indicate that the UK quota is a valuable, if declining,
market for New Zealand dairy farmers.
9.1 Introduction
New Zealand kiwifruit production has expanded rapidly to become the fourth-largest rural export industry. Most production is exported as fresh kiwifruit. It is worth around twice the value of exports from the long-established apple industry.
The kiwifruit, previously known as the Òchinese gooseberryÓ, was introduced to New Zealand in the early 1900s. Its commercial exploitation commenced in the 1950s but it was not until the late 1970s and 1980s that plantings and production exploded under the influence of both high export returns and government incentives, mainly taxation concessions for investment expenditure.
The industry is now in a maturation and adjustment phase. Lower returns are exerting severe commercial and adjustment pressures on an industry which had become overcapitalised and overgeared Ñ a legacy of the boom period of the 1980s.
The emergence of this new, high returning fruit on the international market attracted other countries into production. New Zealand sourced plant material Ñ there is essentially only one commercial variety world-wide Ñ has been used to establish rapidly growing industries in a number of countries, particularly Italy. Between 1985 and 1990 world kiwifruit production grew by 350% with New ZealandÕs share of this production falling from 60% in 1985 to 40% in 1990.
Changes in production, markets and grower returns in the New Zealand kiwifruit industry have been accompanied by periodic changes in marketing arrangements and regulations. The industry was developed and effectively launched on to the export market by private firms. Cooperative and voluntary arrangements, developed to promote the fruit and exports in the 1960s and 1970s, were replaced by statutory arrangements in the late 1970s, although exporting continued to be undertaken by competing licensed exporters. In 1989 the industry adopted the single seller producer board model for all exporting other than to Australia.
The decline in grower returns parallels closely the steady increase in statutory controls over exporting. World production was expanding at a rate which required lower prices to balance supply and demand, even though demand was growing rapidly from a very small base. It is quite apparent that growers had an expectation that more regulation would improve returns. There is little evidence to suggest this has been the case. Changes in grower returns have essentially reflected fundamental changes in the characteristics of the industry and its markets.
The kiwifruit industry provides a contemporary example of how an industry progresses through establishment, growth and maturation phases in becoming a permanent feature of the market place. What makes it an interesting industry to examine in the context of this study is the concurrent evolution of its marketing arrangements.
The industry now has arrangements which growers considered necessary to exploit market power and maximise returns. However, the period in the industryÕs development when it had characteristics associated with exploitable market power has passed. In many respects the evolution of marketing arrangements has exhibited a sequence which is the reverse of that possibly most suited to the industryÕs pattern of development. When single seller arrangements may have extracted monopoly returns for New Zealand they did not exist. By the time they were introduced, the industry and its markets had developed characteristics which made it very unlikely that New Zealand had market power which it could exploit.
These propositions, and evidence of their validity, are discussed further in the second half of this chapter. First, a description of the industryÕs current structure, circumstances, markets and marketing arrangements is presented.
9.2 Industry Characteristics
9.2.1 Production
Production in New Zealand and overseas has been expanding rapidly. Plantings indicate continuing strong growth until at least the mid-1990s and probably beyond. This rapid growth in production relative to growth in demand explains why unit returns have fallen and are unlikely to rise significantly in the foreseeable future.
New Zealand production increased sharply during the 1980s
New Zealand produced around 20,000 tonnes of kiwifruit in 1981. By 1990 production had risen to 280,000 tonnes Ñ see Chart 9.1. Around 80% of this production is exported as fresh kiwifruit.
There are over 4000 commercial kiwifruit orchards producing for export in New Zealand. Nearly 60% of the industryÕs output is produced in the Bay of Plenty region. Only 10% of production is grown in the South Island.
Production units are predominantly family farm operations. The average commercial orchard is around 4 hectares. About one third of growers also operate pastoral enterprises and nearly one half are involved in one or more other horticultural crops. Productivity varies widely with the most productive units harvesting seven to ten thousand trays per hectare. However, average yields are around five thousand trays per hectare and well over half of all orchards produce yields at or below this average.
Kiwifruit production is a relatively capital intensive industry requiring considerable expertise for above-average performance. Harvesting and packing occurs between April and June and most fruit is stored in coolstores pending shipment to markets.
The industry has developed around one commercial variety called Hayward. This variety was developed for commercial production in New Zealand and its cultivars have been used to establish the industry overseas. Further detail on the origins and development of the industry in New Zealand is presented in Box 9.1.
New Zealand is no longer the dominant producer
By the mid-1980s other countries had emerged as rapidly growing producers of kiwifruit. Italy is about to become the worldÕs largest kiwifruit producer. Production in Chile is expanding rapidly and is expected to equal that of New Zealand around 1995. In 1991, Chilean production increased by 50% compared with a year earlier. By the mid-1990s, New ZealandÕs share of world production is expected to have fallen to around 35% or less.
Production growth is expected to be greatest in the Northern Hemisphere. Italy currently produces 80% of EC output, and production in that country is expected to continue expanding. France, Spain and Greece are also emerging as significant producers. Japan and the United States are also large producers.
European production growth has ended the period when New Zealand was virtually the only seller in the European market. Competition is exacerbated by increased Southern Hemisphere supplies, particularly from Chile, which commence coming on to the market up to two months earlier than New Zealand.
9.2.2 Markets
Almost all New Zealand kiwifruit exports are for fresh consumption. Small quantities of kiwifruit wine, canned slices, pulp and juice concentrate are exported. Demand for kiwifruit has been confined to relatively affluent consumer markets in Western Europe, Japan and North America. Much of the overseas production growth has also occurred in these regions, stimulating total demand because production tends to be counterseasonal to New Zealand.
Kiwifruit has a relatively small share of total fresh fruit consumption in all major markets Ñ usually less than 2%. However, consumption is growing as availability increases and relative prices decline. In 1988 New Zealand and Italy had the highest per capita consumption at around 2 kg per head. By comparison, consumption in West Germany was 0.8 kg per head, Japan 0.7 kg per head and the US 0.13 kg per head.
There are no major restrictions on kiwifruit trade in the markets important to New Zealand. Relatively low levels of import duty apply in the EC and Japan. However, a number of South East Asian markets apply import duties of 50% and higher. In 1990 Californian producers initiated anti-dumping action against New Zealand imports and the legal proceedings culminated in an anti-dumping duty being applied in mid-1992. The EC and US have also recently introduced minimum quality standards.
More than half total exports sold in Europe
New Zealand exports kiwifruit to over forty countries although the bulk of the crop is sold in only a few markets. Major export destinations are presented in Chart 9.2.
Europe is the destination for nearly 60% of exports. Japan, which takes 25% of exports, is the biggest single country market.
In the 1990/91 season the volume sold in Europe increased by 50% over the previous season. According to the Board, marketing agents Òwere initially sceptical about selling the much greater volumes we planned to ship in 1990.Ó However, prices received were Òon average above most observersÕ expectations.Ó Sales in North America increased by 120% in 1990, but sales to Japan increased by a more modest 7%.
The Board competes with other exporters in the Australian market where Board sales increased by 20% in 1990. According to the Board, ÒAustralia continues to be an unprofitable market because of the consignment selling of mixed quality kiwifruit by New Zealand exporters outside the Australia Kiwifruit Exporters Group.Ó
Increasing exports from Chile and increasing European production have considerably shortened the period each year when New Zealand has unambiguous supplier dominance in the European market. Additionally, European summer fruits provide strong competition during the period when New Zealand dominates import supplies. This influence was particularly marked in the 1992 season.
Major markets now enforcing stricter quality standards
In the past two years the EC and the United States have introduced minimum quality requirements for imported kiwifruit. On 1 October 1990 the EC added kiwifruit to the list of products requiring common quality standards across the Community and these standards apply to imports.
Exports to the United States must now meet statutory standards for packaging, grading and size under requirements of the US Federal Marketing Orders.
It seems likely that New Zealand could benefit from the imposition of these minimum standard requirements because New ZealandÕs minimum standards for export fruit substantially exceed these requirements. However, there is the danger that these new EC requirements are a precursor to further regulation or protection through such mechanisms as the Reference Price System and season quotas which, for example, currently apply to apples.
Small quantities of kiwifruit are processed
Small quantities (less than 10% of production) of reject and non-export quality fruit are processed. The main products are pulp or puree (used as a food ingredient or filling) and juice concentrate. About 15% of fruit processed is used to produce canned slices and kiwifruit wine and liqueur.
The commercial development of products from processed kiwifruit has been relatively slow because of technical problems in maintaining colour, clarity and flavour when the flesh is processed. Interestingly, technology now being used in New Zealand to overcome some of these problems was developed in Australia.
In mid-1991 it was reported that the New Zealand Apple and Pear Marketing Board had obtained the first significant export order for kiwifruit juice concentrate from a South-East Asian company. The Board believes there is a growing demand for kiwifruit concentrate from South-east Asian and European countries.
9.2.3 Marketing arrangements
The industryÕs marketing arrangements have evolved as the industry has expanded, export market competition has increased, and grower returns have declined. This evolution has seen the industry move from a small base, to voluntary and cooperative promotion and marketing arrangements, then to statutory controls over who could export and under what conditions, and finally the introduction of a single seller exporter in the form of the New Zealand Kiwifruit Marketing Board (NZKMB).
The New Zealand Kiwifruit Authority was the industryÕs first statutory body
When production began to expand in the 1960s there was concern about the ability of existing markets to absorb increased supplies without significant price declines. In 1970, a voluntary levy on growers and exporters was introduced and the industry formed the Kiwifruit Export Promotion Committee to administer these funds. The Committee also became involved in the development of grading systems and storage and packaging methods.
These promotional activities boosted prices which, in turn, attracted new growers and exporters into the industry. Existing producers then became concerned about free-riding and lower quality product unfavourably influencing market development. This led to grower calls for a marketing board and culminated in the industry and government agreeing to the establishment of the New Zealand Kiwifruit Authority (NZKA).
The NZKA was established in 1977 by regulations made under the Primary Products Marketing Act 1953. It did not undertake kiwifruit exporting but did operate an export licensing system. It was funded by compulsory levies on both growers (contributing two thirds) and exporters (contributing one third). In the last year of the AuthorityÕs existence (1988) total levy income was $30 million. The Authority comprised eight members: one appointed by the government, two elected by licensed exporters, and five elected by growers.
The general objective of the NZKA was to promote the interests and welfare of the kiwifruit industry as a whole through the coordination of export marketing, licensing of individual exporters, control over (minimum) grading and packaging standards, overseas promotion, and assistance in the general development of the industry.
The most important objective of the Authority was to promote Òorderly marketingÓ so that quality was maintained and exporters did not undercut each other. Over time it became involved in encouraging diversification away from traditional markets, and funding and directing production research and product development.
The regulations prevented the NZKA from acquiring any kiwifruit other than for promotional, experimental, or developmental purposes. However, the regulations did provide for the Minister to give consent to acquire kiwifruit Òafter the support of at least 80% of producers producing not less than 75% by volume of kiwifruit for export has been obtained, as indicated through a referendum of producers conducted by the Authority.Ó
While competitive exporting was allowed to continue after the establishment of the NZKA, the regulations prevented anyone from exporting kiwifruit if they did not hold an export licence issued by the Authority. The regulations set out what the Authority should take into account in considering whether to approve an application for an export licence, the circumstances under which it could be revoked, and appeal provisions. In considering a licence application the Authority was required to have regard to:
¥ Òthe need for the issuing of a licence;
¥ the likelihood of the applicant being able to maintain an efficient export distribution service in the interests of the kiwifruit industry;
¥ the financial position of the applicant and his standing and repute in the business world; and
¥ any information which it may have obtained in respect of the application after consultation with the Department of Trade and Industry or the Trade Commission Service of that Department.Ó
Initially licences had to be reviewed each twelve months and could be revoked with a minimum two monthsÕ notice. Following amendments to the regulations in the early 1980s, licences were issued for a period of five years because the Authority recognised the desirability of encouraging exporters to have a longer-term focus. Export licences were not transferable.
In 1987 there were seven licensed exporters. They made up the New Zealand Kiwifruit ExportersÕ Association. The Association did not trade fruit in its own right but was heavily involved in coordinating shipping and marketing activities, compiling market intelligence and sales reports, and acting as a forum for discussion within the industry.
As producer returns declined sharply in 1987 there was increasing criticism of competition between exporters in markets and suggestions that their number be reduced. A series of mergers resulted in the number of licensed exporters falling to four. Undoubtedly, these corporate moves were an attempt to pre-empt pressure from some growers for a statutory single seller, although it is difficult to tell how relatively important this was as an influence.
What is clearer, however, is that the NZKA was a significant influence on commercial behaviour and the way marketing arrangements evolved during its existence. New Zealand researchers captured this sentiment well when they concluded that:
ÒThe Authority was able to maintain control of the marketing strategy through coercion associated with the threat of delicensing an individual company or the creation of a marketing board.Ó
Industry now has single seller export arrangements
In September, 1988 the Kiwifruit Marketing Licensing Regulations 1977, Amendment No.4, replaced the NZKA with the New Zealand Kiwifruit Marketing Board which became a monopoly exporter on 1 April, 1989. On the same date one export licence was cancelled and the others, due for renewal on that date, were not renewed. These exporters received compensation, mainly funded by a New Zealand taxpayersÕ contribution of $5.7 million.
The establishment of the NZKMB came after a period of declining export prices which had placed a severe squeeze on grower profitability by the late 1980s. As the Board noted in its 1990 Annual Report:
ÒFew growers operated profitably in the 1987 and 1988 seasons. The deterioration of market and grower returns caused considerable debate over the most appropriate marketing structure for the industry, culminating in September 1988 with the Government resolving at growersÕ request, to replace the licensed exporter system with a statutory marketing board Ñ the New Zealand Kiwifruit Marketing Board.Ó
Since April 1989 all exports of New Zealand kiwifruit, except those to Australia, have been made by the NZKMB. The regulations state that the object of the Board is Òto obtain, in the interests of New Zealand producers, the best possible long term returns for kiwifruit intended for export.Ó The regulations set out the functions of the Board as being to acquire and market kiwifruit produced in New Zealand and intended for export, to determine payments for the kiwifruit it acquires, to help the general development of the kiwifruit industry, to endorse desirable methods of and standards for the cooling, growing, handling, packing, picking, spraying, storing, transporting or doing any other things, in respect of kiwifruit, and to establish standards of soundness and acceptability.
The Board has as its mission statement:
ÒTo maximise the return to the New Zealand grower by being the most efficient supplier and most effective marketer of kiwifruit internationally.Ó
The NZKMB has eight directors: four elected by producers to represent them, one member appointed by the Minister of Agriculture to represent the government and the interests of consumers, and three members appointed for their commercial expertise by the Board with the prior agreement of the Minister. The basis on which producer representatives are elected and the effective control producers exercise over the Board, and did over its predecessor the NZKA, are discussed in Box 9.2.
The BoardÕs kiwifruit purchasing, exporting and marketing activities are conducted by its wholly-owned subsidiary company Kiwifruit Marketing NZ Ltd. In turn, this company has two subsidiaries. One, New Zealand Kiwifruit Marketing Board (Continent) N.V., is based in Antwerp and markets and distributes kiwifruit in continental Europe, Ireland, and the United Kingdom. The other, New Zealand Kiwi Corporation, protects the interests of the NZKMB in the New Zealand Fruit Company which is an equal share partnership with the New Zealand Apple and Pear Marketing Board and markets pipfruit and kiwifruit in the United States.
In 1989 the New Zealand Fruit Company purchased a share of David Oppenheimer and Company. Oppenheimer is a major US fruit importing company which has been associated with New Zealand apples and kiwifruit for over 20 years. In 1989 the NZKMB contracted the New Zealand Apple and Pear Marketing Board to market kiwifruit in Europe, the United Kingdom and Ireland. With the establishment of an office in Antwerp, the NZKMB commenced its own marketing in Europe in 1990, and in 1991 extended this activity to the United Kingdom and Ireland.
The BoardÕs policy towards investment in marketing infrastructure, particularly overseas, is reflected in the following statement from its 1990 Annual Report:
ÒThe Board has no intention of building up a significant level of assets or investments under its ownership. We are first and foremost a marketing organisation, charged with selling growersÕ export kiwifruit for maximum return. The only area where the Board sees a valid investment requirement is to enhance our marketing thrust offshore. The yardstick will always be whether there are direct and quantifiable benefits to our grower shareholders.Ó
The Board appears to have a similar policy in regard to exploiting market opportunities for processed kiwifruit.
ÒIt is not Board policy to invest in production ventures to capitalise on market opportunities as there is significant existing investment in processing potential. Initiatives for new investment and developments in processing kiwifruit must come from the industry.Ó
The regulations state that Òthe assets of the Board belong ultimately to the producers . . . but are being held and administered for the benefit of the persons who are for the time being producers from whom it so acquires kiwifruit.Ó
Storage and handling are extensively controlled by the Board
Storage, transport and handling practices are particularly important in the kiwifruit industry because of the perishable nature of the product. The Board is extensively involved in setting and policing practices and standards in these areas. The clear objective is to minimise costs and fruit losses between orchard and customer. The means for achieving these objectives and determining who pays are incredibly complex and have been the subject of extensive industry debate and frequent change over recent years. This is discussed in more detail later.
Kiwifruit are not ripe when picked, packed and placed in coolstorage. The fruit will not ripen if stored at appropriately low temperatures. When taken from coolstorage they will ripen in three to five days at normal room temperature. The ripening process can also be triggered by ethylene even when in coolstorage, so kiwifruit cannot be stored near ethylene-producing fruit such as apples, pears or bananas.
A minority of growers have their own packing houses and even fewer have their own coolstores. These post-harvest services are mainly provided by specialist operators. Producers are free to choose the packhouse and coolstore they will use from those operators approved and policed by the Board. The Board meets with the Coolstorage Association, which represents about 80% of all coolstorage capacity, prior to each season to negotiate rates and conditions for coolstorage. The Board audits the performance of post-harvest operators and this information is available to growers to aid their selection of packhouse and coolstore.
The Board has said that it Òbelieves that growers and post-harvest operators are responsible for planning for and providing coolstore capacity to the industry.Ó However, commercial operators in this part of the industry are extensively controlled and constrained by the BoardÕs rules.
There is considerable evidence indicating that the activities of the Authority and the Board have ensured New Zealand kiwifruit are well regarded in the market for its above-average quality. For example, in 1990 a survey of attitudes towards New Zealand kiwifruit in Britain, France, Spain and Germany indicated over 80% of major fruit importers rated New ZealandÕs kiwifruit superior for export standards, keeping quality, and consistency of size and shape. Consumers considered New Zealand fruit quality to be far better than that of Italian fruit.
In a similar vein, two members of the BoardÕs Quality Standards Committee, after having visited customers in Europe and North America, concluded that:
Ò . . . NZKMBÕs customers believe the BoardÕs on and off-shore operation is the best in the world, ensuring a quality product through the distribution chain. Customers assess quality as a total package including fruit, fruit labels, packaging, sales services, promotion and pricing. Overall our kiwifruit quality compares well with competing fruits but is not significantly better.Ó
The last comment is interesting and consistent with a view expressed to ACIL by some kiwifruit marketers to the effect that kiwifruit are particularly hard to differentiate in the market, particularly at a cost which justifies any resulting price premium. This point leads logically to the question of whether quality superiority automatically means superior profits for growers. This question is considered later in the chapter.
Grades are also determined by the Board
Export kiwifruit are graded according to size ÒcountsÓ. There are eight counts and two special counts to accommodate very large or ÒJumboÓ fruit. Returns to growers reflect the considerable variation in market returns across the count range.
Class I kiwifruit is the grade standard the Board uses for kiwifruit of various counts it exports under its monopoly powers. Class II kiwifruit are suitable for sale as fresh fruit but are only sold in New Zealand and Australia. There is debate over the need for the Board to use more than one export grade and the Board has told growers that it is investigating the issue. In late 1991 the Board said:
ÒThe KMB remains totally committed to its Class I ÔNew ZealandÕ brand. It is investigating options for utilising fruit which falls below Class I grade standard.
ÒThis season the volume of Class II kiwifruit has increased as a result of a poorer growing season, reduced orchard inputs and the impact of new Class I standards.
ÒIn assessing a strategy for a second grade and brand the board is investigating:
¥ the impact on Class I markets.
¥ a cost/benefit analysis, since the costs such as packing, packaging, transport, distribution and market development are similar for both Class I and II kiwifruit.
¥ the extent that world supply and demand factors will depress premium grade returns.Ó
The Board also noted that it was investigating processing options for the 15-20% of kiwifruit falling below the Class I export grade standard.
The recent statutory review of the Board recommended that it Òestablish the relative advantages of incurring increased costs by changing grade standards versus possibly increased revenue through more flexible, market-driven grade standards.Ó
In the 1990 season the NZKMB spent $31 million on promotional activities. According to the Board:
ÒThis included television advertising in Japan and selected European markets, cooperative advertising in North America and Europe and in all markets, a heavy emphasis on in-store promotion and effective merchandising at retail level.Ó
After reviewing promotion and marketing strategies in 1990, the Board re-launched New Zealand kiwifruit in 1991 with a new label/logo and slogan Ñ ÒThe WorldÕs Finest.Ó This label is attached to most individual fruit destined for export at the time of packing.
In 1991 the Board introduced an ÒorganicÓ kiwifruit pool with separate product identification, labelling and marketing for fruit grown without the use of artificial fertilisers or chemicals. The organic programme is to be continued for fruit grown in the 1992 season.
The Board determines whether kiwifruit are acceptable for export
The Board may refuse to accept kiwifruit intended for export if:
¥ in the BoardÕs opinion it is unsound, non-standard or inadequately packed;
¥ it is not delivered to a designated coolstore before 1 July in the season of harvest; and
¥ it was not harvested in the period designated by the Board for that particular growing area, the Board having declared this period by notice in the Gazette.
The powers of the Board to decide what kiwifruit it can refuse to accept for export appear to have been strengthened, to the point of being unconstrained, by amendments to the Regulations in 1991. In particular, the amendments modified the functions of the Board to include the following:
ÒEstablish for kiwifruit standards of soundness for the purpose of export;
ÒEstablish for kiwifruit standards of acceptability for the purpose of export (other than standards of soundness for the purpose of export).Ó
The same amendments defined ÒunsoundÓ as not conforming with the established standard of soundness, and Ònon-standardÓ as not conforming with the established standard of acceptability.
The amendments also included a provision which requires the Board, if it establishes revised standards, not to introduce them until the commencement of the next season. This is interesting in the context of the outcry which occurred during the 1990 season when the Board changed the standards for export fruit part-way through the season and at considerable cost to growers.
9.2.4 Grower returns
Over the past decade grower unit returns at the orchard gate have fluctuated around a clearly declining trend. Returns per tray rose slightly in 1991 but are expected to fall sharply in 1992. The downward trend mirrors the strong growth in production, and the seasons in which returns fell most sharply were usually the seasons in which production growth rates were highest. Grower returns and export production for the past decade are presented in Chart 9.3.
As is the case with apples and pears there is no actual or survey information on kiwifruit grower profitability. MAF does publish some estimates but they are based on a synthetic representative farm.
Prior to the establishment of the NZKMB, licensed exporters competed to obtain supplies from growers, sold on commission, and operated pools. Ownership of the crop remained with the grower throughout the marketing chain and individual exporters operated pooling arrangements with progress payments and advances being made to growers. This exporter role has been described as follows:
ÒEach exporter in essence, therefore, deals with the fruit on a consignment basis, is responsible for minimising costs to the pool, for quality control, for insurance, for obtaining advances from importers, for auditing and controlling importer costs, for collecting money from importers, for monitoring importer activity and performance, for foreign exchange management, and finally for the management of grower funds until the final payout.Ó
Under these selling and payment arrangements it could be up to twelve months after harvest before growers knew and received final payment for the crop, although a high proportion of the payment would be made within four months of harvesting. In most respects the same system of consignment selling and payment characterises the operations of the NZKMB. However, the rules have been changed a number of times and become very complex.
There are complicated rules for determining payments to growers
The Board may buy kiwifruit intended for export to Australia, non-standard or inadequately packed, or harvested outside New Zealand, at prices agreed with the seller. That is, the Board can enter into normal commercial arrangements with the seller for such categories.
However, for kiwifruit that becomes the property of the Board by virtue of its monopoly exporter status Ñ that is, most of the harvest Ñ the regulations contain complex rules and criteria for setting payments, deductions and recoveries.
Before 1 May each season the Board is required to consult with the New Zealand Fruitgrowers Federation on payments and advances for the season and then fix payments for the season. It may, however, change this payment at any time during the season but must obtain the approval of the Federation if the revised payment is lower and retrospective to the earlier part of the season. Additionally, a revised and lower payment cannot be less than the advance fixed for the season, and retrospective payments Ñ whether the revised payment is lower or higher than the one it replaced Ñ must be made on all fruit intended for export and acquired by the Board.
The 1991 amendments to the regulations specified the basis for fixing payments to growers as follows:
Ò(6) Subject to subclause (6A) of this regulation, the Board may fix different payments for kiwifruit by reference to all or any of the following criteria:
Ò(a) The kind, variety, grade, quality, or size of the kiwifruit:
Ò(b) The area in which the kiwifruit are grown:
Ò(c) Whether the kiwifruit become the BoardÕs property before the 1st day of July in the season in which they are harvested, or later:
Ò(d) The extent to which kiwifruit produced by their grower in the season concerned remain sound in storage.
Ò(6A) Where the Board fixes different payments under subclause (6) (b) of this regulation,Ð
Ò(a) That part (if any) of the difference arising out of the differing average transport and port costs of the areas concerned shall not exceed the BoardÕs best estimate of those differences; and
Ò(b) The Board shall announce publicly its best estimate of the differing average transport and port costs of the areas concerned.Ó
In fixing payments to growers the regulations also require the Board to have regard to:
¥ the desirability of maintaining the stability and efficiency of the kiwifruit industry;
¥ movements in the costs of acquiring and marketing kiwifruit;
¥ actual realisations for kiwifruit and products manufactured from kiwifruit that the Board is marketing;
¥ the BoardÕs knowledge and views on market prospects and trends;
¥ the present and prospective state of the BoardÕs accounts and reserves; and
¥ anything else the Board thinks is relevant.
The Board may make any part of the payments to growers at any time during the season in which the kiwifruit were acquired but must make the payment in full before the end of the season.
The regulations also specify how the Board should calculate any deductions or recoveries arising from the discovery after the kiwifruit became the property of the Board that the kiwifruit is unsound. For a number of reasons kiwifruit can spoil with a consequent reduction in quality or total loss after entering storage but prior to sale. Orchard management practices have a significant influence on the tendency for fruit to spoil after harvest. Packing and coolstorage practices also influence fruit loss through spoilage. Consequently, the cause of fruit loss is dispersed in terms of who is responsible for its occurrence. This raises issues of how these costs should be calculated and who should bear them.
Trying to ensure these costs fall where they belong has been a source of grower dissatisfaction, changes to regulations and Board policies, and amazing regulatory complexity. The most recent amendments to the regulations for determining and charging costs associated with fruit loss while in coolstorage were made in April 1991. They are reproduced in full in Box 9.3.
The Explanatory Note which accompanied the April 1991 amendments, including those presented in Box 9.3, explained their purpose and intent in the following terms:
Ò . . . they amend the provisions of the Kiwifruit Marketing Regulations 1977 relating to deductions for spoiled fruit, so that in most cases individual growers bear the costs arising from the spoilage of their fruit. The amendment makes clear that growers can make their own arrangements with coolstores for the disposal of spoiled fruit. Secondly, they empower the Kiwifruit Marketing Board to pay a premium for fruit that has a low incidence of spoilage. Thirdly, they require the Board, if it fixes different payments for fruit produced in different areas, to ensure that any difference attributable to differing transport and port costs does not exceed the BoardÕs best estimate of the difference in those costs, and to notify its estimates of those costs.Ó
The fact that growers might have some difficulty in keeping up with and understanding fruit loss policies and associated storage incentives was recognised by the Board when it issued a special edition of Grower Link in July 1991. In that publication the Board, in something of an understatement, said:
ÒThe board has endeavoured to simplify what continues to be a very complex subject. We realise the grower schedules for fruit loss and storage incentives may appear complicated but we believe the explanatory notes will assist. Our staff will be visiting each growing district to hold meetings with growers, post-harvest operators and accountants, to respond to any queries.Ó
The Deloitte Ross Tohmatsu statutory review of the Board recommended in relation to fruit loss policy that Òthe Board adheres to the 1991 policy and resists undue changes.Ó Most growers will be relieved and very happy to support the recommendation.
9.3 Major Issues
The kiwifruit industry is a contemporary example of producers, with willing help from government, implementing increasing statutory control over themselves and their industry in the quest for a solution to ÒunacceptableÓ market returns. As has so often been the case in New Zealand, the response to poor returns and low profitability has been to use regulation and compulsion to try and rectify perceived faults in the marketing system.
The industry has almost completed the introduction of a fully-fledged single seller monopoly for handling its exports. The genesis and implementation of these arrangements is recent, memories of why and how increasing statutory intervention was introduced have not yet dimmed, and politically nurtured notions about such arrangements being the industryÕs salvation and unambiguously in the interests of producers are not yet entrenched as writ. This makes the industry a good case study for examining the consequences for producers when they are carried along in a process involving faulty diagnosis of the problem and pursuit of the wrong objectives. It is also an industry where some of the most easily predicted consequences of establishing a statutory marketing monopoly can be observed as they emerge Ñ some of the modelÕs final working parts are being added as this study is completed.
Three issues are discussed in what follows. They are:
¥ the mistaken diagnosis that the New Zealand kiwifruit industry has exploitable market power justifying the suppression of competition in export marketing;
¥ the consequences of choosing unit market returns as the primary objective when profitability is what really matters; and
¥ the predictable manner in which the NZKMB is quickly moving to try and make its monopoly position absolute and unassailable.
In considering these issues it is useful to restate the obvious Ñ growers seek improved profitability on their investment in the industry. The focus, therefore, must be on whether logic and available evidence provides any support for the view that current arrangements are the best way of achieving this objective.
9.3.1 The main determinants of market returns cannot be influenced by the Board
The international kiwifruit industry has matured. It is now well established in many countries and markets. Even though consumption is relatively low compared with more traditional fruits, prices are determined principally by the supply and demand of both kiwifruit and competitive fruits.
There is little of a fundamental nature which New Zealand can do to influence returns in the market. New Zealand has no clearly exploitable market power and, if anything, the market is likely to become even more competitive in the future. Kiwifruit is essentially a commodity fruit in international trade.
In the late 1980s, before the NZKMB was established, researchers were telling the industry that these normal market circumstances were emerging and that they carried important implications for industry marketing and productivity improvements generally.
The following conclusions were presented in one research paper published in 1988:
ÒThe dynamics of the New Zealand kiwifruit industry conform closely to the product development cycle. Prior to 1978 plantings and production were relatively small in magnitude, with a consequently slow growth in supply. Foreign demand increased relative to supplies, creating excess demand. This, coupled with high rates of assistance, fuelled a planting boom which drove up factor values and created a general development euphoria in the industry.
ÒDuring this expansion phase in the 1970Õs and 1980Õs, the demand curve for New Zealand kiwifruit shifted outwards. With the relatively small volume of fruit on the market this outward shift was sufficient to maintain or increase real returns to growers. However, our analysis indicates these preference/income induced shifts in demand are stabilising. This is consistent with the maturation stage of the product cycle. Kiwifruit is losing its unique consumer status and buoyant demand in overseas markets, and becoming a normal good.
ÒAs demand matures, income elasticities will decrease with time, and cross-price elasticities will increase and as a consequence export prices will become increasingly elastic with respect to volume changes. The result of these changes is that New Zealand is increasingly becoming a price taker unless it is possible to differentiate our product from other suppliers.
ÒOther Southern hemisphere countries will compete directly with NZ supplies, while Northern hemisphere supplies will mean that kiwifruit is available year round in our major markets, that is the fruit is becoming ÒcommodifiedÓ. This will move NZ further down the demand curve and remove any early season premiums that exporters have been able to obtain.
ÒNew Zealand can adjust to make its exports more competitive or differentiable, but this must be done soon before incentives are lost. It is not clear from available evidence that a move to a single desk (monopoly) seller can best achieve a rationalised system able to adapt and survive in a competitive, risky market place. A rationalisation of current export operations may be more expedient, involve fewer transactions costs and offer more industry flexibility in the near term.Ó
The market characteristics of kiwifruit were also acknowledged by Deloitte Ross Tohmatsu in its audit report, viz:
ÒThis review needs to recognise the international developments and trends impacting on the New Zealand kiwifruit industryÕs competitive position.
ÒThe New Zealand kiwifruit industry, along with its international competitors, has moved since the mid 1980s from supplying a seasonal novelty fruit through to marketing a mainstream, more widely eaten fruit. Fresh fruit consumption is generally static in major traditional markets;Ó
and
ÒAnalysis of the historical relationships between annual volume changes and annual price changes indicate that kiwifruit has, since about 1986, moved from being regarded as an exotic fruit to more of a mainstream fruit.Ó
The Board has listed the following factors as impacting on export sales and returns:
¥ crop volume
¥ fruit size
¥ keeping quality
¥ international economic climate
¥ foreign exchange rates
¥ strength of consumer demand
¥ enforcement of quality standards
¥ enforcement of quarantine regulations
¥ political developments in markets
¥ competition from other suppliers and other fruits.
It is quite apparent from even a cursory examination of market developments and outcomes that, of the factors listed by the Board, the ones which exert more important influences on returns are those least able to be influenced by the Board. This conclusion is reinforced by the following comments:
¥ ÒJapan is a price sensitive market where we are encountering increasing competition from other kiwifruit, other fruits, fast foods and confectionery Ñ so maintaining quality is critical.Ó
¥ ÒThe increased volume of fruit was the key driving factor for the 1990 season and this had a major adverse effect on price, which appears to have come as an unhappy surprise to the industry. However, the depressing effect on price of a sudden increase in annual volume had been clearly demonstrated to the industry in previous years.Ó
¥ ÒDuring August and September the NZKMB is virtually the only supplier to the European market, and in 1990 it aimed to sell as much fruit as possible during this period. However, the large volume of fruit to be sold meant that prices were pitched lower than in previous years.Ó
¥ ÒIdentifying and responding to consumer preferences is critical especially in the competitive and relatively mature markets where the board is selling.Ó
¥ ÒThe 50% increase in Chilean production and corresponding increase in exports to Europe has impacted on our early sales in that market.Ó
¥ ÒThe continued presence of California kiwifruit, other seasonal fruits and a stock market crash is depressing prices and slowing sales of our kiwifruit in Taiwan.Ó
¥ ÒThroughout the season growers have been kept fully informed of market conditions, sales and prices achieved and the factors impacting on grower returns. Growers have been advised that volume/price pressures, the uncertainties of the world economic situation and its impact on consumer demand, plus higher freight rates resulting from the Middle East crisis, were all having an impact on the return.Ó
¥ ÒLast year clearly established that there is a direct relationship between the volume of fruit we are able to sell and the return that can be extracted from the market.Ó
¥ ÒThe main reason for this [reduced 1991 sales in Japan] was the increased Japanese domestic kiwifruit production which meant New Zealand did not have market exclusivity until August, three months later than in 1990. In addition, the domestic consumption resulted in weaker opening prices for New Zealand kiwifruit.Ó
These observations, mainly sourced from the Board itself, could be read as a litany of excuses for market outcomes unlikely to make growers particularly happy with their BoardÕs performance. A more reasonable conclusion is that they reflect market reality and are an acknowledgement by the Board that New Zealand can do little to influence the main price determinants.
A further acknowledgement of this market reality is provided by instances where the Board had to make commercially based decisions to lower prices in order to sell fruit Ñ an action commonly called weak selling when done by competing commercial businesses.
Does the Board sometimes find weak selling unavoidable?
So-called weak selling is one of the major marketing crimes producer boards were created to stamp out. The NZKMB is no exception. Some of the myths and legends surrounding weak selling were discussed in chapter 6.
The demonstrable influence of supply on price, and the limitations on and costs of kiwifruit storage, suggest that market circumstances will regularly arise where disposing of fruit at apparently low prices will make good (that is, unavoidable) commercial sense. The important question is: does a distinction exist between such sound commercial behaviour and so-called weak selling?
In the 1989 season, the BoardÕs first, its desire to avoid the stigma of weak selling cost growers money. In reviewing that season, Deloitte Ross Tohmatsu concluded:
ÒThere were substantial fruit losses offshore later in the season, partly due to the inflexibility of pricing policy. This tended to reflect the understandable desire to obtain the best price for growers and the consequent reluctance to reduce price when market signals indicated that this was necessary.Ó
By the 1990 season the BoardÕs behaviour in the Australian market suggests it had accepted that weak selling might be appropriate in certain market circumstances. Again, from the Deloitte Ross Tohmatsu report:
ÒLate in the season, volume problems in Europe influenced the NZKMB to sell in Australia at a price lower than budgeted. Although this was not the course of action originally preferred by the Board, it served to demonstrate the importance of the Australian market as part of the NZKMBÕs overall global strategy.Ó
It is instructive to see this lower priced selling in Australia called strategy when done by the Board but, when done by others, destructive competition and weak selling Ñ sufficient to justify calls for extension of the BoardÕs monopoly to this market. Clearly, the allocation of labels is influenced by who commits the commercial crime.
While it is too strong to suggest this pricing behaviour in the Australian market was dumping, that is the formal label Californian authorities gave to a Board shipment of kiwifruit which arrived in their market in late 1990. This particular example of price cutting (weak selling?) by the Board has features similar to some of the commercial mistakes made by private exporters and used as justification for having a single seller exporter.
A shipment of 600,000 trays of kiwifruit en route to Japan was suddenly diverted to California by the Board when Japanese importers protested that its arrival would drive prices down. The fruit arrived in California at a time when locally grown fruit was coming onto the market. Prices had to be reduced to sell the fruit and this led to the Californians initiating anti-dumping action against the Board.
According to one newspaper report the California Kiwifruit Commission charged the Board with Òimmature, pernicious practices.Ó The same report went on to claim that the Kiwifruit Marketing Association of California had sent a letter to the Board which had the following to say:
ÒThe NZKMBÕs recent instruction to divert substantial volumes of NZ kiwifruit into the North American market as California begins its marketing season not only smacks of dumping but has disrupted traditional California fruit markets, resulted in a serious unsettled low price climate, and demonstrated your failure to implement a constructive seasonal marketing strategy.
ÒWe are well aware of your industryÕs efforts to sell cheap with advertising rebates, free fruit, and other gimmicks which ultimately result in a pricing programme that returns your industry less than the cost of production Ñ a clear dumping violation. We have seen, for example, your invoices for $6.50 with $2.00 advertising rebates, netting a $4.50 cost to buyers in North America. This is $3 to $4 under California-quoted prices for the same sized fruit.Ó
The anti-dumping action initiated by the Californians was defended by the Board. Its significance as an issue warranted a Special Report from the Board to growers in November 1991. This report informed growers that a preliminary decision by the United States Department of Commerce had determined that kiwifruit from New Zealand Òwas sold at less than fair price.Ó The estimated margin of dumping was found to be 78.38% of the assessed FOB (New Zealand) value.
In explaining the decision to growers the Board had the following to say:
ÒThe preliminary decision relates to the NZKMB sales in the United States in the 1990 season when we had large volumes of fruit to move. The volume pressure in the United States and the comparatively short shelf life of New Zealand kiwifruit late in the season resulted in lower selling prices. Even though New Zealand average selling prices are above the level of our competition in all markets, including the Californian selling prices, this is not a sufficient condition to refute an anti-dumping petition.Ó
The assertion about New Zealand prices relative to ÒCalifornian selling pricesÓ contradicts the assertions in the letter the Board is reported to have received from the Californian Marketing Association.
In mid-1992 the United States imposed a 98.6% anti-dumping duty on kiwifruit from New Zealand. In commenting on the decision a respected international periodical observed that Òif anti-dumping duties are every justified, a big if, then this seems like an air-tight case.Ó
The Board has estimated that the final cost of defending the case will exceed $1 million. If the cost is $1.2 million, which seems more than likely, it is equivalent to $2 per tray over the shipment that triggered the action. The Board has also explained reduced sales to the United States in 1991 as Òlargely due to limitations imposed by the anti-dumping action.Ó
Marketing invariably involves situations, particularly with perishable products, where dropping the price to clear supplies is the most commercially sound strategy. The evidence suggests the Board has learnt and accepted this reality. Trying to make distinctions between price cutting strategies which are commercially sound and so-called weak selling is a nonsense. The Board does what the market demands Ñ cuts the price when that is the most appropriate commercial strategy. Either the Board is guilty of weak selling or nobody is Ñ there is no logic which can be used to make a distinction which would allow price cutting to be called strategy when the Board does it and weak selling when done by others.
Furthermore, in facing up to commercial reality Ñ evidenced by the preceding examples Ñ the Board has effectively demonstrated that the weak selling arguments in support of a single seller are spurious.
What can the Board do to improve grower returns?
If a monopoly exporter for the kiwifruit industry is not justified because it has no exploitable market power, what justification might be offered for preventing others from providing export marketing services? Those supporting the BoardÕs role and privileged monopoly position would argue it is required to ensure grower returns are maximised through providing the best possible customer service and product quality, identifying this with a clearly New Zealand brand, and doing it at the lowest possible cost.
The efficient delivery of marketing services is undoubtedly important in achieving producer objectives. In fact, it is the main area where producers of a largely homogeneous product can seek profitable market differentiation. This was the conclusion of Coopers and Lybrand when it said:
Ò . . . because of the homogeneous ÒcommodityÓ nature of kiwifruit, it is more likely to be the service elements that will provide the greatest scope for segmenting the market and for differentiating New Zealand Kiwifruit from that of other suppliers.
ÒThe main reason for this is that the service elements are perhaps the prime area of competition in fruit (in effect determining everything from fruit quality to inventory costs, product margins, etc). As far as New Zealand is concerned, the potential for building competitive advantage in the service area will depend primarily on the application of technology, organisation, management and marketing skills (rather than any natural advantages such as low labour costs).Ó
The central issue, however, is whether this marketing activity is likely to be done most efficiently if there is no competition in New Zealand for the provision of those services. The problem for growers is how they can judge whether their monopoly Board is performing optimally in this area. The necessary performance indicators are not available.
As far as the provision of marketing services is concerned, there are some particular issues, and some ad hoc pieces of information, which growers should consider when trying to assess the merit or otherwise of their single seller.
First, the growers have put all their kiwifruit in the one marketing basket. They are relying on a single organisation to spot opportunities, be the sole source of ideas and innovation, and get the marketing decisions correct. It is possible, but very unlikely, that a single organisation can do this in any industry. The weight of evidence is that monopolies are relatively poor performers in those respects because they retard the process of market discovery, and experimentation and innovation.
Second, one of the reasons why a monopoly exporter was advocated was that growers were selling on consignment with exporters said to be facing limited incentives to innovate and invest in marketing, and growers taking all the risks. To what extent has this situation changed?
In considering this question it is worth remembering that prior to the establishment of the Board, the behaviour of commercial exporters was significantly influenced by the NZKA. At the very least, this makes unequivocal criticisms of exporter performance difficult to sustain. Furthermore, statutory rules and controls were not needed during the era of industry establishment and initial growth.
With a single seller now in operation, growers essentially remain consignment sellers and continue to bear all the risks. Now, however, they do so in an environment where assessing marketing performance is more difficult if only because there is no basis for comparison. Growers have also forgone the ability to change exporters when one is seen to perform better than another. The only scope they now have for doing this is to export to Australia, and the Board has tried to secure control over that market.
Information on how returns obtained by the Board compare with returns received by others in the market place is sparse because of the difficulties in ensuring a comparison of like with like. When the Executive Summary of the recent Review of the Kiwifruit Marketing Board was released, one newspaper report suggested that failure to release the full report, and the direction of inquiries to the Board and not the consultants who prepared the report, might indicate some information useful to growers had not been released. The newspaper report said:
ÒGrowers might also ponder another statistic not in the executive summary. While they were receiving less than $6 a tray in 1990, their Australian counterparts were getting $7 to $16 a tray.Ó
A further indicator of how the Board has performed is provided in a grower letter in the BoardÕs industry magazine. The grower had the following to say:
ÒThe driving force behind the establishment of a single-desk selling agency was the growersÕ desire for a fair return for their investment. The advantages of the change were assessed at just under $3 a tray. These advantages were independent of market forces and therefore it was reasonable to assume they would remain relatively static.
ÒGrower dissatisfaction with the BoardÕs performance to date is therefore understandable. Given last yearÕs average return of $4.56 a tray, grower return in real terms is a mere 92% of that received under the multi-exporter system at its worst and 38% of what should have been realised under a single-desk selling regime. No one would have voted for the change had this level of performance been anticipated.Ó
Some consider that the absence of suitable measuring sticks of board performance can be compensated for by having regular audits of activity and performance. Such audits are a statutory requirement in the case of the NZKMB and the first one has just been completed. Audits such as this can contribute to improved organisational performance by having independent experts diagnose and prescribe Ñ provided the advice is correct and then implemented.
However, audits simply cannot tell an organisation or an industry whether a monopoly is maximising grower profitability. Like everyone else, the auditors have no suitable measuring stick. This is what the authors of the recent audit of the Board concluded in regard to the BoardÕs revenue achievements:
ÒIt is not easy to assess in a simple way the sales revenue achieved by the NZKMB. However, revenue appears to have been reasonable in 1989, less than satisfactory in 1990, and good to date in 1991, in the context of national production volume changes, slow or zero growth in demand for fresh fruit in major markets, increasing international production of kiwifruit, price premiums achieved over other kiwifruit producers, and recognising the overall quality of the NZKMBÕs marketing efforts in each season.Ó
This conclusion is, of course, inadequate as a basis for deciding whether the Board has delivered on its mission statement.
It is impossible to judge how well the Board performs in delivering maximum market returns to growers. However, of more importance to growers is that the emphasis on market returns has deleterious effects on their profitability. This is because the pursuit of maximum returns by the Board almost certainly reduces profitability.
9.3.2 Maximising returns takes the focus off profitability
In common with other statutory marketing arrangements, the kiwifruit industry requires its marketing board to maximise grower returns from the market. As discussed in chapter 2, having market returns rather than profitability the objective of intervention is the major mistake producers have made when seeking to improved marketing systems. There are no systematic relationships ensuring that maximum market returns mean maximum grower profitability.
One consequence of the marketing board focus on returns is the attention given to quality and, particularly, minimum quality standards for export. A general discussion of the issues relating to quality and quality control in marketing was presented in chapter 4. The key point made there was that reliable quality/price relationships which are transparent to the customer are much more important than just exporting the worldÕs best. All marketers know that there are profitable opportunities for lesser quality goods if priced appropriately and clearly branded. However, the NZKMB faces something of a disincentive to do this because, while it might increase grower profitability, it would lower the all-important performance indicator Ñ dollar return per export tray.
In fact, the Board has an incentive, given this performance indicator, to export only the best quality and raise minimum export quality standards Ñ exactly what it has been doing over the past three years.
Raising minimum quality standards is an easy route to higher export returns
Quality stands out as the issue given most attention by the Board in its endeavour to raise market returns to growers:
ÒQuality is paramount. New ZealandÕs reputation as producer of ÔThe worldÕs finestÕ kiwifruit has guaranteed premium prices over competitors.Ó
There is evidence that the Board is probably successful in sometimes obtaining better prices than competitors because of the emphasis and effort devoted to quality. But is this exclusive emphasis on only selling the best maximising grower profitability?
The 1990 season was a difficult one for the Board because of the large increase in New Zealand production. It faced a challenging task in maintaining grower returns, let alone increasing them. Considerable grower dissatisfaction emerged when the Board changed its quality standards during the season. One newspaper reported it as follows:
ÒAfter the fruit had been picked, packed and put into coolstores, the board raised its standard for fruit softness so fruit that was okay when it went into the coolstore was later found to be sub-standard and dumped.
ÒGrowers say the board changed the rules in the middle of the game when it was discovered it couldnÕt sell the fruit.Ó
As a consequence of this action growers faced unexpected reductions in their gross returns in that season. However, the cost to growers of dumping or otherwise disposing of what had arbitrarily been designated as non-exportable fruit was not reflected in the BoardÕs reported performance measure, returns per tray of fruit actually exported.
The 1991 amendments to the regulations contain a provision which will not again allow the Board to change minimum export quality standards during a season. However, they also gave the Board carte blanche to set standards as it sees fit.
Further changes seem likely. In 1991 the Industry Task Force pointed out that Òthe scope of quality standards is likely to widen in future and the proportion of unacceptable fruit may increase.Ó
Growers know they should be able to monitor profitability
The 1991 Industry Task Force indicated that growers are concerned about the BoardÕs accountability and the need for better performance measures. It also implied that growers see profitability as important, and appreciate that maximum export returns are not necessarily synonymous with maximum profits. The report said that:
ÒThe critical motivation for the Task Force was to collect and examine information from growersÕ point of view with recommendations being made which aimed at maximising the total net return to growers Ñ the KMBÕs principal objective.Ó
The report went on to point out that Òprofitability is a major issue for growersÓ, and that Òthe majority of growers judge the boardÕs annual performance on maximisation of the tray price, although growers are aware of other factors important in assessment of profitability.Ó
The Executive Summary of the report prepared after the statutory review of the Board contained Òan overview of the BoardÕs performance to date.Ó Nowhere is it evident that the consultants felt able to express views on returns to investment and profitability, let alone facts or analytical results. This is not surprising since the necessary information is not available. While not the fault of the consultants, it does detract considerably from the value of the review to growers who want reassurance about Board performance.
Growers must appreciate that they will never be able to assess performance satisfactorily while the Board remains protected from competitive market sanctions and is not structured in a way that produces useful performance indicators. Growers have created this problem for themselves. The NZKMB is the type of marketing organisation growers demanded. It is not the fault of the Board Ñ management reacts rationally to the incentives that have been created. And it is not the fault of consultants engaged to audit performance Ñ they cannot be expected to build bricks without straw.
The ability of growers to monitor performance satisfactorily will not improve unless existing structures and regulatory restrictions are changed significantly. Monopolies naturally seek to consolidate their monopoly position and the NZKMB is no exception, as outlined in the next section.
9.3.3 Suppressing competition Ñ rational behaviour for a monopoly
A statutory single seller like the NZKMB will always be subject to scrutiny and debate because normal performance indicators and market-based sanctions are absent. Their managers will seek to demonstrate benefits and exemplary performance to try to satisfy analysts and silence critics. This is a natural and expected response.
The belief that a single seller exporter is needed to maximise market returns to growers means management will try to ensure that the monopoly is absolute. Should critics Ñ including dissatisfied growers Ñ suggest performance is unsatisfactory, managers will respond that one reason is their inability to control all the marketing.
A particular example of how the Board prevents others from testing their marketing ideas is presented in Box 9.4. This example involves a new variety of kiwifruit which has been registered in New Zealand and the desire of its owners and marketers to try and marketing it, as a ÔdifferentÕ product.
Three other examples of the Board deciding or asserting it can do the job best on its own follow.
Why not take more advantage of Apple and Pear Marketing Board expertise?
In 1989, the first year of the NZKMBÕs operations, it contracted the New Zealand Apple and Pear Marketing Board to market kiwifruit in Europe, the United Kingdom and Ireland. In 1990, having established an office in Antwerp, the NZKMB undertook its own marketing in Europe. In 1991 it extended this activity to the United Kingdom and Ireland and ceased using the Apple and Pear Marketing Board altogether for assisting with marketing in this part of the world.
The Kiwifruit and Apple and Pear Marketing Boards still work together in North America through their joint venture company New Zealand Fruit Company, which also holds equity in David Oppenheimer and Company, the master agent for the Fruit Company.
Deloitte Ross Tohmatsu concluded that, in the 1989 season, the Apple and Pear Marketing Board:
Ò . . . imposed much needed selling disciplines in Europe and broke away from consignment selling. While this could have been handled more sensitively it was an important positive development.Ó
A brief comment in the NZKMBÕs 1990 Annual Report implied a somewhat different view:
ÒIn 1990 we have control of our own destiny in Europe and are confident of an improved result, although well aware of the enormous challenge of selling 50% more kiwifruit than last year in that region.Ó
In the 1991 Annual Report the Board said:
Ò . . . our Antwerp office, with a staff of 22, has extended its market responsibility to include the United Kingdom and Ireland, two markets which continued to be serviced until the end of 1990 by the New Zealand Apple and Pear Marketing Board. The emphasis again is to ensure establishing and maintaining close contact with its customers.Ó
Earlier in 1991, the Chief Executive of the NZKMB told growers that the Board had taken over from the Apple and Pear Marketing Board in the United Kingdom and Ireland so as:
Ò . . . to give the KMB direct contact with all its customers and ensure the operations and performance of the board continues to meet the most demanding customer needs.Ó
These changes can be interpreted as the NZKMB believing it could do the job better. However, if both Boards were involved in the marketing it might be easier for others to judge whether this was in fact the case.
Why not let Chiquita help in the United States?
Chiquita is a United States-based international food distributing company heavily involved in banana marketing. In 1990 it had gross sales of $7.5 billion. It employs 46,000 people worldwide, owns its own fleet of ships and operates in more than forty countries.
In October 1990, Chiquita bought the Auckland-based fruit and produce distributor Kiwi Harvest Marketing. The company has expressed interest in kiwifruit exporting and has done so to Australia. It has also built a number of fruit ripening centres in New Zealand and commenced importing bananas when New ZealandÕs import monopoly was removed in late 1990.
According to a newspaper report:
ÒChiquita is investing in New Zealand to try to get access to export fruit crops controlled by single desk seller producer boards, and because New Zealand and Australia have the potential to be one of the garden regions of the world and supply counter-seasonal produce to Northern Hemisphere markets.Ó
In the 1990 season, the NZKMB contracted Chiquita to market kiwifruit in three states of the United States. The Board described the reasons for the move as follows:
ÒThe need for a big increase in sales in 1990 encouraged the board to supply the international fruit distributor Chiquita one million trays of New Zealand kiwifruit under their own label to test market in the states of Ohio, Illinois and Indiana. Chiquita is supporting the programme with substantial consumer advertising, primarily television.
ÒThis move with Chiquita does not in any way detract from our efforts to build an independent distribution system and our own brand identity in North America through the New Zealand Fruit Company and master agent, David Oppenheimer & Associates. The involvement of a second distributor with the resources of Chiquita should improve the effectiveness of both systems.Ó
According to some newspaper reports, the BoardÕs initiative was a success:
ÒThe North American giant handled 10% of the 1990 volume, saying consumption grew from less than 50 grams to 285 grams per capita within a four month trial;
and
ÒLast year Chiquita was allowed to test-market one million trays of fruit in Ohio, Illinois and Indiana where it boosted per capita consumption by 300%. Extrapolating from this success Chiquita says it could increase sales in the United States by 11 million trays.Ó
After the season was over the Board changed its view that this approach was a good idea and decided that using Chiquita would not be continued. The Board told growers that Chiquita increased sales but Òthese were no better than those achieved by the boardÕs other North American brokers.Ó According to the Board:
ÒChiquita sold short of its million-tray target and the board spent heavily on promotions and packaging for the Chiquita label, yet received 30 cents a tray less than from its other brokers.Ó
However, in a debate which became quite public, ChiquitaÕs version of the story was reported as follows:
ÒChiquita says it was nobbled by the board's blunders. Of its one million trays 160,000 trays were incorrectly labelled and sized by the board. This fruit had to be trans-shipped to Italy where Chiquita Italia sold it. That left Chiquita with 840,000 trays, of which 20,000 trays of fruit were frozen by accident and had to be disposed of.Ó
The most recent observations on this experiment and its outcome are contained in the Deloitte Ross Tohmatsu review report. In its summary review of the 1990 season, it had the following to say:
ÒA particular innovation was a contract with Chiquita to market kiwifruit in three states of the USA and in Italy. The Review Team has obtained widely varying views on the outcome of this experiment from the parties concerned. It would have been a major and costly exercise to clarify the validity of their respective positions and in the Review TeamÕs opinion, this would not have been cost effective for the industry. While the parties appear to have genuinely tried to communicate effectively during the test marketing period, there may have been a need for more specific Òperformance milestonesÓ to have been set in place in advance and monitored during the course of the agreement.
ÒPlanning of packaging and size counts should have been done in a manner such that there could be no disagreements between the parties as to what was fair and acceptable. Clearly stated and defined objectives against which performance could have been evaluated in an unambiguous manner might have helped to avoid the misunderstandings and mistrust which ultimately arose between the parties.
ÒIt should not however be assumed that the business outcomes of the venture with Chiquita were unsuccessful. On the contrary, both Chiquita and New Zealand more than doubled kiwifruit sales in their allocated areas of North America in 1990. This outstanding result is a credit to both Chiquita and the NZKMB, and to the other American distributors selling New Zealand kiwifruit.Ó
It can be inferred from these comments that the Review Team considered the use of other marketing companies and expertise to be a good idea and more likely to work harmoniously if arrangements were better defined. However, the NZKMB does not share this view, at least in the case of Chiquita. The Board, in 1991, rejected a Chiquita proposal to buy 20 million trays of kiwifruit at a premium of 20 cents a tray for export under the Chiquita label. It was reported that the BoardÕs main reason for rejecting the offer was Òthat Chiquita would be competing with the New Zealand brand and force prices downÓ.
Why not use existing powers to manage the Australian market?
The third example of how the Board is moving to make its control over exports absolute is the request made in early 1992 to the government to extend its monopoly to the Australian market.
Exports to Australia are not under the monopoly control of the NZKMB. Developments in the trade have led to increasing calls from the Board and parts of the industry for this market to be put under the BoardÕs single seller control. Traditional arguments about the damage caused by Òcompetitive exportingÓ figure prominently in these calls. The recent statutory review of the Board recommended that the Regulations be changed Òso that the NZKMB has the same degree of control over the Australian market as for other markets.Ó
In 1989, major New Zealand exporters formed the Australian Kiwifruit Export Group (AKEG) to impose orderly export practices. The Board is an associate member of AKEG. Exports to Australia, mainly Class II (choice) fruit, have increased dramatically since 1989.
In mid-1990 the Board reported that sales to Australia had not increased as expected and that AKEG members were expressing similar concerns. The Board went on to say:
ÒThe reason is undoubtedly the quality of fruit being shipped by non-AKEG exporters which are currently selling fruit for $1.50Ð$2.00 per bulk pack below most AKEG members. While AKEG are working with longer term industry welfare in mind, it is becoming increasingly difficult not to be drawn into a downward price spiral caused by the weak selling non-AKEG exporters. Unless all exporters to Australia exhibit discipline and co-ordination, returns are likely to fall to the uneconomic levels prevalent in other world markets prior to the establishment of the KMB.Ó
The report of the statutory review of the Board noted that in the 1990 season Òsome other exporters outside AKEG were selling on a consignment basis, and dragging down the gross selling price.Ó
The chorus of calls for intervention rose a few decibels in 1991 when exports to Australia were double 1990 and five times those of 1989. Australian growers started complaining about the competition from New Zealand and publicly acknowledged they were profitably re-exporting New Zealand fruit to third markets complete with New ZealandÕs ÒThe worldÕs finest kiwifruitÓ labels. One Australian marketer told ACIL that in some instances it was not even necessary to repack the fruit before re-export.
In late 1991 it was reported that the Board estimated Òprice undercutting by undisciplined exporters in the Australian market will cost New Zealand $10 million in lost revenue, equating to about 5% of growersÕ income. Meanwhile, greater than expected volumes of Class II kiwifruit remain in the market, hindering price increases and Class I kiwifruit sales.Ó
A touch of intrigue entered the scene in 1991 when New Zealand growers reported concerns about organised crime in the trade to Australia. According to one report:
ÒThe name of a figure alleged to be involved in the organised crime has been passed to a Government MP, Mr Ross Meurant. Mr Meurant said he had not yet been able to follow up the information but he expected difficulty in tracing transTasman contacts.Ó
Suggesting that returns from exports to Australia will be higher if the Board is given monopoly control is simplistic and far too convenient. It has all the hallmarks of a Ôsuppress it and sweep it under the carpetÕ strategy. Growers need to consider what developments in the Australian market are telling them about market characteristics for their fruit, and their marketing system.
Australia is the only export market where growers are free to choose how they sell, to whom, and at what price. Why would they send fruit to Australia, particularly on consignment, if the Board could offer a better return by selling it for them elsewhere? Why isnÕt the Board offering this higher return? Why have exports been growing so rapidly to a market that apparently pays so poorly? Is it because Australia is the only export market where growers can send Class II fruit?
The Australian situation also raises interesting questions about the potential benefits of branding and concentrating on absolute top quality. The Board has invested heavily in raising quality and in branding. Where is the evidence in the Australian market that this strategy is paying off? Why should top quality, branded fruit have its price dragged down by lower quality, lower priced fruit? Perhaps the market does not pay a significant premium for quality Ñ there is plenty of evidence that supply is the major influence on price. A number of kiwifruit marketers have told ACIL that kiwifruit is very much a ÒcommodityÓ and not very amenable to cost effective differentiation.
If supply is the major influence on price then perhaps a controlled reduction in New Zealand exports to Australia would raise New Zealand grower returns. But where would the Board send the diverted fruit and with what price consequences elsewhere? In addition, if New Zealand can raise the price it receives in Australia what does this imply for Australian production incentives, the attractiveness of the market to other countries, and the demand for competitive fruits.
But, the major indictment of the BoardÕs performance evidenced by Australian developments is the fact that New Zealand fruit is being profitably re-exported by Australians. The suggestion that organised crime is involved adds poignancy. It is well recognised that crime can be associated with commerce where the margins are particularly attractive. The obvious question for growers to ask is why the Board is missing lucrative market opportunities that the Australians can find for New Zealand kiwifruit?
Australia is the only export market where growers can glean useful information for monitoring and assessing their BoardÕs performance elsewhere in the world. If the Board controlled the Australian market growers would lose this source of information. They would be unlikely, as a consequence, to see a need to ask the types of questions raised here. At the very least, they should require the Board to demonstrate more convincingly that extending its monopoly to Australia will result in a Ò$10 million increase in earnings for New Zealand growers.Ó If such an increase is available the Board should explain exactly why it cannot capture this revenue with its current almost absolute monopoly.
There is no substantive reason for believing growers will be better off if the Board assumes control over the Australian market. To the contrary, such control will bring no grower benefits but incur the cost of them being considerably less well informed. They should insist Australia remains an export market where the BoardÕs ability to maximise growersÕ returns can be tested explicitly.
9.4 Conclusions
The introduction of statutory controls into the kiwifruit industry, culminating in the establishment of the NZKMB in 1989, provides a contemporary example of the New Zealand penchant for regulation and compulsion when grower returns become unacceptable. What has happened to the industry's marketing arrangements is a classical case of growers erroneously interpreting market returns they do not like as failure of the market to work properly. The decline in grower returns owes very little if anything to the marketing system Ñ something many growers appear to now be realising after three years of Board operations.
Even the Coopers and Lybrand study, which was used to justify the creation of the Board, did not recommend the single seller model as being in the industry's best long-term interests. This was ignored when the Board was established, and has not been revisited since.
The NZKMB is now installed as the monopoly exporter exercising extensive influence over the industry and its producers. It is moving quickly to ensure its monopoly position becomes absolute and well-entrenched. The Board has become the industry's statutory guardian and growers have become little more than employees in the BoardÕs supply department Ñ receiving bonuses for good performance as assessed against rules determined by the Board.
Is it in the long-term interests of growers to be so insulated from buyers and customers, have so many of the commercial marketing decisions made for them, and have no choice in who markets their output? One industry participant recently commented on these issues as follows:
Ò . . . the rigorous quality management approach which dominates the New Zealand industry would be more effective and satisfying to growers if they had some involvement with the marketplace. With the marketing and distribution of fruit now controlled by a single marketing board, New Zealand growers simply deliver their fruit to a packhouse. A grower sees nothing of his produce beyond the packhouse. He simply receives a piece of paper which gives him his reject rate and payment. The whole industry is reject based and audit driven at present. If, on the other hand, the grower had the Scandinavian importer or buyer coming onto his orchard and giving him feedback about his produce, he would put in every effort to get it even better. That makes him aspire to quality rather than having it imposed on him. If he knows that someone at the other end recognises his grower number and his produce, he will welcome quality improvements like better audit systems and better control systems.Ó
The kiwifruit industry and its markets have matured. New Zealand no longer has any exploitable market power as a country which might justify single seller export arrangements. In this type of international market the main avenue for boosting grower profitability (as distinct from net unit export returns) is to be more efficient and innovative than anyone else throughout the chain from orchard to consumer. This requires competition.
While growers may recognise the importance of continually improving efficiency, they have erred in allowing a monopoly organisation to be established to aid their achievement of this objective. They have no satisfactory basis for assessing its performance. However, they have a number of reasons for concluding that it is unlikely to ensure they will maximise profitability.
Providing the NZKMB with an export monopoly and asking it to maximise net export returns has, not surprisingly, led to undue emphasis on quality and minimum quality standards. The quest for quality has become an objective in its own right instead of a means to an end. It has caused the marketers to overlook the more important influence of quality/price relationships on grower profitability.
The easiest way for the Board to achieve its maximum net export return objective, having created a quality-regardless-of-the-cost culture, is to continually raise minimum quality standards. This is what it has done, and there are good reasons for believing standards will be raised further in the future. There is no way of knowing that this will raise grower profitability and many reasons for believing it will do the reverse.
There is also the fundamental question of whether a single organisation, making so many of the industryÕs decisions, can deliver the ideas and innovations so necessary in the future and so much the characteristic of competitive markets. Most monopolies are eventually judged to have failed in this regard.
Growers should also consider whether the very heavy emphasis on marketing is likely to cause the importance of on-farm productivity to be overlooked as a means of improving profitability. MAFTech has concluded that Òthere is tremendous scope for increasing orchard productivity, in terms of export trays produced per hectare, which is seen as being the main factor that can be used to improve orchard profitability.Ó Currently the NZKMB spends ten times more on marketing and promotion than on R&D.
There are many in the kiwifruit industry who laud the marketing arrangements in the apple industry. The kiwifruit marketing arrangements were modelled on the Apple and Pear Marketing Board and some are already suggesting a combined Board is what both industries need. Kiwifruit growers would be well-advised to look closely at the performance of the apple industry before jumping to any such conclusions.
In a relatively short time the kiwifruit industry has grown to around twice the size of the apple industry. This relatively rapid growth occurred in the absence of monopoly exporting arrangements. By contrast, the apple industry's monopoly exporting arrangements have been in place for decades.
In an increasingly competitive market the kiwifruit industry needs a marketing system which will ensure maximum efficiency, innovation and growth. This requires diversity of opportunity and ideas, and investment. It is unlikely that the current arrangements will be able to deliver what is required. One of the conclusions reached by Deloitte Ross Tohmatsu carries the strong implication that it reached the same general conclusion:
ÒIt is important that a shorter term cost minimisation focus does not extend to preventing investment in the innovative projects required to sustain the industry in the longer term. Any major ventures should relate directly to kiwifruit marketing, be structured in a more standard corporate manner than the NZKMB itself and preferably draw on a grower or external equity.Ó (emphasis added).
ACILÕs conclusion is more emphatic. As concluded in the case of the Apple and Pear Marketing Board, the NZKMB should be corporatised with growers being given tradable equity in their marketing company. Simultaneously, others should be allowed to compete for growersÕ fruit for export. If the commercial performance of the Board is as good as claimed, it can be expected to remain a major, if not dominant, player. It can retain shareholder loyalty by demonstrable good performance rather than statutory compulsion.
Chapter 9
Kiwifruit
Chart 9.1: Kiwifruit Production: New Zealand and World (1985Ð1995)
Source: Ministry of Agriculture and Fisheries.
Box 9.1: Private Investors and Entrepreneurs Developed the Kiwifruit
Industry
Exactly when the seed of the Òchinese gooseberryÓ was introduced to
New Zealand has not been recorded. However, it is known that a nurseryman in Wanganui
successfully propagated plants in the early 1900s. Other nurserymen subsequently
experimented with selection and grafting to improve the size and taste of the fruit.
Two nurserymen were particularly instrumental in the establishment of a
commercial industry. Hayward Wright developed the ÒHaywardÓ strain which now accounts
for virtually all commercial plantings in New Zealand and has proven equally popular
overseas. Bruno Just developed the fruitÕs popularity in New Zealand via his direct mail
catalogue and frequent sales trips.
The first commercial plantings were in Te Puke in the mid-1930s. By 1950
there were 13 hectares producing 50 tonnes of fruit for commercial sale. Later in the
1950s small shipments of fruit to London and Sydney demonstrated its export potential.
The New Zealand Kiwifruit Marketing Board has described the introduction
of kiwifruit on international markets by New Zealand exporters as undoubtedly the greatest
success story of a new fruit launch since the banana was made popular at the beginning of
this century. Recognising the fruitÕs export potential, exporters and growers formed the
Kiwifruit Export Promotion Committee in 1970 and funded its activities with a voluntary
levy. According to the Board, the success of this group of pioneering exporters was quite
remarkable and kiwifruit became familiar in households around the world.
Turner and Growers Ltd was the exporter which played a foundation role
in the commercial development of the industry. Its major initiatives, and particularly the
achievements of one of its principals, Grahame Turner, included:
¥ identifying the commercial potential of the Hayward variety and
encouraging growers to plant this variety;
¥ introducing the name ÒkiwifruitÓ to replace the name chinese
gooseberry which had proved a significant disadvantage in market development; and
¥ developing improved methods of transport, packaging and cool storage
and expanding promotion and market development activities.
In the late 1980s the Te Puke Fruitgrowers Association made a Special
Award to Grahame Turner in recognition of his significant pioneering role in the
commercial and export development of the industry. The companyÕs success was also
recognised by government export achievement awards in 1975 and 1982.
By 1988 Turner and Growers Ltd had established a network of 14 branches
throughout kiwifruit growing regions in New Zealand. This network serviced growers with
advice and inputs and undertook marketing. The company had a major investment in the
industry, which provided by far the largest proportion of its turnover. When the single
seller operations of the NZKMB came into force in March 1989, the company was deprived of
its markets and forced to restructure.
Sources: ÒA Profile,Ó New Zealand Kiwifruit Marketing Board, 1989; ÒKiwifruit Industry in New Zealand Ñ An Industry and Exporter Perspective,Ó F Wood, in Conference Papers, Third National Conference of the Agribusiness Association of Australia and New Zealand, Canberra, May 1990.
Chart 9.2: Export Markets for New Zealand Kiwifruit (1990/91)
Source: New Zealand Kiwifruit Marketing Board.
Box 9.2: Elected Producer Representatives Effectively Control Marketing
Arrangements
The regulations which created both the New Zealand Kiwifruit Authority
(NZKA) and its successor, the New Zealand Kiwifruit Marketing Board (NZKMB), specified in
detail how producer representatives would be elected, and how the Chairman and Deputy
Chairman would be selected. These legislated procedures ensure that:
¥ producer voting bears some relationship to the voterÕs commercial
stake in the industry;
¥ producer representatives are able to maintain effective control over
the organisation; and
¥ the Chairman and Deputy Chairman will always be producers.
Five of the eight members of the NZKA were elected producer
representatives. The legislation defined a Northern and a Southern Ward for election
purposes with two representatives elected from the Northern Ward and three from the
Southern. A producer was entitled to one vote if production of kiwifruit destined for
export in the prior season was 5,000 trays or less Ñ including no production for export.
The entitlement was two votes if production was between 5,000 and 20,000 trays, and a
maximum of three votes if production exceeded 20,000 trays.
The election of exporter representatives involved a similar voting
system with a maximum of three votes for an exporter, based on the proportion of total
exports handled by the eligible voter. The Chairman and Deputy Chairman of the Authority
were elected by Authority members from the grower representatives.
The Board of the NZKMB also comprises eight members but only four Ñ two
from each ward Ñ are representatives of growers. The weighted voting system used to elect
these representatives is very similar to that used for elections to the NZKA. Growers are
the only members elected to the board of the NZKMB and the Chairman and Deputy Chairman
have to be appointed annually by the Board from elected members.
A small difference between the two bodies is that producer
representatives are not sufficient in number on the NZKMB to constitute a quorum which is
five members. The grower members did constitute a quorum on the NZKA.
In 1991 kiwifruit growers agreed to change the voting system to one of proportional representation, and abolish the two-ward system replacing it with a single ward or electorate. This new system was used to elect four grower representatives in October, 1991.
Chart 9.3: Kiwifruit: Export Production and Grower Returns (1981-1991)
Source: Ministry of Agriculture and Fisheries; Department of Statistics.
Box 9.3: Adjusting Grower Payments for Unsound Fruit
The regulations determining how the Board calculates and charges growers
for fruit loss while in coolstorage and after delivery to the Board were most recently
amended in April 1991 and constituted the rules for the 1991 season. They read as follows:
Ò(4A) This subclause applies to all kiwifruit (other than non-standard kiwifruit) found to be unsound during a repacking (undertaken on behalf of the Board) of kiwifruit with which they were packed completed before the 28th day of October in the season in which they became the BoardÕs property, unlessÐ
Ò(a) Before the repacking of the kiwifruit with which they were packed was completed, they were moved from
the coolstore at which they were first received by or on behalf of the Board; or
Ò(b) The repacking of the kiwifruit with which they were packed is not their first since they became the BoardÕs
property; or
Ò(c) A critical or major non-compliance (as defined in the standard concerned) with a standard relating to
coolstores, or relating to actions or operations taken or carried on in coolstores, endorsed under regulation
12A (1) (d) of these regulations occurred or was occurringÐ
Ò(i) After they became the BoardÕs property; and
Ò(ii) Before the repacking was completed; and
Ò(iii) While they were stored in the coolstore in respect of which the non-compliance occurred.
Ò(4B) The Board shall make no payments (or, as the case requires, no further payments) to the producer of any kiwifruit to which subclause (4A) of this regulation applies (whether in respect of those kiwifruit or otherwise howsoever) all or any part of the sum of the following amounts:
Ò(a) Any payments it has already made to the producer for them:
Ò(b) Half of the BoardÕs best estimate of the costs it has reasonably incurred in unpacking or repacking them or any
other kiwifruit packed with them:
Ò(c) Any costs reasonably incurred by the Board in disposing of them (whether to their producer or otherwise).
Ò(4D) Where any kiwifruit are found to be unsound during a repacking (undertaken on behalf of the Board) of kiwifruit with which they are packed completed after the 27th day of October in the season in which they became the BoardÕs property, this subclause applies to those kiwifruit, and all kiwifruit with which they are packed, (other than non-standard kiwifruit) unlessÐ
Ò(a) Before the repacking was completed, they were moved from the coolstore at which they were first received by
or on behalf of the Board; or
Ò(b) The repacking is not their first since they became the BoardÕs property; or
Ò(c) A critical or major non-compliance (as defined in the standard concerned) with a standard relating to cool
stores, or relating to actions or operations taken or carried on in coolstores, endorsed under regulation 12A (1) (d)
of these regulations occurred or was occurringÐ
Ò(i) After they became the BoardÕs property; and
Ò(ii) Before the repacking was completed; and
Ò(iii) While they were stored in the coolstore in respect of which the non-compliance occurred;
or
Ò(d) No person had (on behalf of the Board) before the 28th day of October in the season in which they became the
BoardÕs propertyÐ
Ò(i) Checked their condition; and
Ò(ii) Estimated the proportion likely to be unsound.
Ò(4E) The Board shall make payments to producers of kiwifruit to which subclause (4D) of this regulation applies on the same basis as if during a repacking (undertaken on behalf of the Board) of the kiwifruit completed before the 28th day of October in the season in which they became the BoardÕs property, there was found to be unsound the lower of the following proportions of the kiwifruit:
Ò(a) The proportion of the kiwifruit found to be unsound during the repacking completed after the 27th day of Oc
tober in the season in which they became the BoardÕs property:
Ò(b) The proportion of the kiwifruit estimated to be unsound during the checking of their condition most recently
completed on behalf of the Board before the 28th day of October in the season in which they became the BoardÕs
property;Ð
and subclauses (4B) and (4C) of this regulation shall have effect
accordingly.Ó
Box 9.4: Varietal Premiums Ñ What are the Consequences if the Board Gets it Wrong?
In 1982 a New Zealand kiwifruit grower noticed fruit on one vine in an orchard of Hayward variety were longer and more cylindrical than normal. So began the saga of the Wilkins variety Ñ named after the growers who discovered it Ñ which, ten years later and at considerable cost, is the subject of a standoff between the KMB and commercial interests over whether it can command a price premium in Japan and should be marketed as a distinctive variety.
Whether or not Wilkins is a distinct variety has never been in dispute. In 1986 the discoverers were granted a Plant Selectors Right under the Plant Varieties Act 1973 and subsequently a patent in the United States.
Since commercial quantities of Wilkins kiwifruit first started to become available there have been differences of opinion over its ability to secure a price premium if marketed as a distinctive variety. Even today satisfactory information on its potential for superior market performance is limited Ñ mainly because regulatory constraints on the varietyÕs commercial advocates have prevented them putting their views and ideas fully to the test.
Doubts about the varietyÕs ability to command a premium have not been confined to statutory marketers. In late 1985 Turners and Growers Ltd, in a letter to the varietyÕs owners, reacted to samples of the new fruit as follows:
ÒWhile the fruit is attractive, it is no more attractive than normal Hayward kiwifruit. We do not believe that the market response will be more favourable for this variety than for normal Hayward kiwifruit.Ó
The new variety was first test marketed in Japan in 1987. However, this was at a time of considerable instability and uncertainty regarding New Zealand kiwifruit marketing with exporter licensing under the KMA coming to an end and the single seller KMB being created. Quantities involved were small and it was not really an ideal basis for firm conclusions. However, the fruit that was exported did command a price premium in Japan.
In early 1989 Grocorp Pacific Ltd entered the saga. Grocorp is a New Zealand based, vertically integrated horticultural producer and marketer. In a short period it has demonstrated creditable success in exporting horticultural products to Japan. In large part this reflects its in-house expertise on the Japanese market and the fact that while publicly listed in New Zealand its largest shareholder is a Japanese company. Grocorp is a kiwifruit producer with both Hayward and Wilkins varieties. It is strongly of the view that Wilkins can obtain premium prices if marketed correctly in Japan and has been keen to cooperate with the KMB to this end.
It is not practical here to document fully the efforts Grocorp and the varietyÕs owners have made to demonstrate what they believe is the commercial potential of the Wilkins in Japan. What follows are highlights only, illustrating dogged determination but a frustrating lack of success.
In 1989 and early 1990 GrocorpÕs efforts to arrange marketing trials in Japan in cooperation with the KMB were unsuccessful. Apparently Grocorp did not satisfactorily meet the BoardÕs requirements for Òa suitable marketing programme for 1990Ó, or satisfy the Board that their programme would Ònot disrupt or prejudice the overall marketing of Hayward variety in Japan.Ó
The KMB undertook its own test marketing in Japan in 1990 and in a report made available to Grocorp and the varietyÕs owners concluded as follows:
ÒWhile the Wilkins variety was adequately packed, shipped, identified and promoted as a different variety, this difference could not be transferred into a sustainable premium at retail or consumer level.
ÒIn the course of our discussions with importers, an importer who had previously handled Wilkins with Kiwi Harvest Ltd, reiterated these points and confirmed that market demand was low for Wilkins and that a premium was not achievable.
ÒIt is recommended that for 1991 Wilkins variety is not identified or sold as a separate variety.Ó
Grocorp were far from satisfied with the way the marketing trial was conducted and disagreed strongly with its conclusions. In a written response in March 1991 to the BoardÕs marketing report, Grocorp had the following to say:
ÒWe have our own in-house Japan market expertise with extensive contacts in Japan, and have an in-depth knowledge of the Japanese market.
ÒIn many instances the market information we have obtained is at variance with that provided in your report.
ÒOur primary concern is that the NZKMBÕs efforts to date appear to have been in the selling of the Wilkins variety, and not the marketing of the variety (emphasis added).
ÒWe believe the BoardÕs efforts . . . have been totally unsatisfactory
and that the Board has not used the accepted principles of marketing to ensure that a
demand was created for this variety, at a premium price.Ó
Box 9.4: (continued)
The Grocorp letter concluded with the following request:
ÒGiven that our company and associated groups of growers has the investment in the orchards, and that our company has the marketing and Japan market expertise to effectively handle this variety in Japan, we now request that our company be given a chance to market this variety for the 1991 season into Japan working alongside the NZKB.Ó
A direct response to this request has never been received from the Board.
The varietyÕs owners were also very dissatisfied with the BoardÕs marketing trial and conclusions. After repeated but unsuccessful requests for more information on the Japan trials the owners approached the Office of the Ombudsman for assistance in July 1991. Almost one year later the Ombudsman succeeded in having the Board provide information from Japanese sources on the basis that their identities not be revealed. It was an expensive and pyrrhic victory over the Board.
Around this time both Grocorp and the varietyÕs owners attempted to enlist the support of ministers and members of parliament. Replies were invariably of a courtesy nature Ñ after all the saga was now at a stage where no politician would voluntarily want to become involved. This was reflected in a response from the Associate Minister of Agriculture who said:
Ò. . . I have no mandate to compel the Board to accept your proposal. That decision rests entirely with the Board (emphasis added).
ÒI would be concerned if New Zealand is missing an opportunity to develop export markets for a new kiwifruit variety. Therefore I recommend you prepare a sound proposal to present to the Board.Ó
The judgment on whether any proposal was ÒsoundÓ would rest, as the Associate Minister points out, Òentirely with the BoardÓ. In essence that is what this saga is all about Ñ the view of only one participant, the Board, determines the strategy for the entire New Zealand industry.
The Board has argued that its priority objective is the interests of the entire industry. However, it has not and really cannot produce convincing evidence that its activities and decisions are in the best interests of the industry and New Zealand.
It is difficult to avoid the conclusion that as the saga progressed the Board became increasingly concerned with ensuring there was no basis for comparing its marketing performance in Japan with the performance of others. Given GrocorpÕs Japanese connections, in-house expertise and exporting track record, this concern was probably more real than imagined.
To date Wilkins plant material has not been exported. The owners say GrocorpÕs interest and investment in trying to develop the variety commercially in New Zealand has been an important reason. One can only speculate on how much longer Grocorp investors and the owners of the variety will tolerate the restrictive environment in New Zealand before deciding to take their expertise, money and plant material to another country.
In late 1988 the KMB offered to buy the rights to the variety but the offer was unacceptable to the owners. In a letter to the Board rejecting the offer the owners referred to overseas parties Òinterested in sourcing all New Zealand grown fruit from Wilkins Super vines in 1989Ó. The reply from the secretary of the KMB included a reminder of who was in charge.
ÒThe interest of overseas parties in sourcing . . . Wilkins . . . in 1989 is noted. Nevertheless, as the Board now has a statutory monopoly on the export of New Zealand kiwifruit to all markets except Australia, the negotiation of any such sale would be between the Board and those overseas interests, unless the latter were Australian. Should you wish to put the overseas interests in contact with me, I would be happy to discuss their proposition.Ó
If the commercial development of Wilkins moves to competitor countries then the New Zealand industry could lose a major competitive advantage, at least for a number of years. The Board appears to be prepared to take this risk.
From New ZealandÕs point of view it would undoubtedly be better to take the much lesser risk of having a Grocorp marketing trial cause some short term disruption in Japan. This seems very unlikely because of the small quantities of fruit involved and the companyÕs expertise. It would, however, also carry the risk that the Board is proven wrong. Maybe it is this particular risk which the Board now wishes to avoid above all else.
One can only wonder, by way of analogy, what might have happened to
Coca-Cola if a Softdrink Marketing Board had been able to decree that, notwithstanding the
views of the drinkÕs originators, it was just another softdrink distinguished only by the
unique shape of the bottle.
10.1 Introduction
New Zealand is an efficient producer of grass fed meat animals. Internationally it is a minor meat producer but a significant trader. Three quarters of New Zealand's meat production is exported; 95% of lamb production, 75% of beef, and 55% of mutton. New Zealand supplies one sixth of the meat traded in the world, being a major player in the world sheepmeat market (45%), but a less significant participant in international beef trade (7%).
The meat industry is New ZealandÕs largest rural industry. In 1990/91 its gross value of farm production was $2.4 billion and exports (including live animals, and hides and skins) were worth around $3.2 billion, or 21% of New Zealand's export income.
The 1980s was a turbulent decade for the meat industry being characterised by an array of studies and changes to institutional arrangements and policies which appear to have made some contribution to establishing a platform for improved performance. Nevertheless, the industry entered the 1990s in a sorry state notwithstanding its considerable potential and fundamental competitive advantages. The focus of this chapter is an examination of why this occurred and what needs to be done to the industry's marketing systems to ensure past mistakes are not repeated.
The Chairman of the New Zealand Meat Producers Board made it clear that this study was not particularly welcomed by the Board when he said:
ÒAt the same time that producer boards are being expected to fill the void left by government retrenchment in our overseas markets, our role is still being questioned by both politicians and officials. This issue of producer board reviews has been raised at nearly every meeting of this [electoral] committee over the past five years. Just as one review is completed, another seems to take its place.
ÒOur Board's policy to date has been to fully cooperate with people charged with carrying out such reviews. This cooperation is costly and time-consuming and we have now come to a stage were we will become more hard-nosed and concentrate our efforts on our principal function of improving long-term returns to meat producers. The consultants recently commissioned by the Business Roundtable to review producer boards will find that we may not be as forthcoming or cooperative as we have been with previous review teams.Ó
It would be surprising if industry participants had not grown tired of the continuous reviews which have characterised the industry for at least the past decade. These reviews have not all been initiated by interests outside the industry. There have been numerous internal, or internally-commissioned studies of the industry and its problems over this period. However, the problem of unsatisfactory commercial performance persists Ñ so it will require a good deal more than a hard-nosed attitude by the Board for them to go away.
This chapter describes the meat industry, and its markets and marketing arrangements. It then examines some notable features of the history and current circumstances of sheepmeat and beef processing and marketing . The rapidly growing deer farming industry is discussed briefly in a separate section. The chapter concludes with recommendations for change.
10.2 Industry Features
The New Zealand red meat industry is based on grass-fed production of sheep and cattle. The deer farming industry is small but growing rapidly. The processing and marketing sectors of the industry are now owned predominantly by producers. The New Zealand Meat Producers Board is the centrepiece of the industry's institutional arrangements. The deer industry has a separate Game Industry Board.
10.2.1 Production and incomes
Around half, or 40,000, of New Zealand's farms are involved in meat production. Most of these farms also produce wool or milk or crops. There are 24,000 predominantly sheep farms and 10,000 predominantly beef cattle farms. One quarter of beef production is sourced from the dairy industry. This is mainly cull cows but includes around 750,000 bobby calves slaughtered annually for veal and use in pharmaceuticals.
Sheep and beef cattle numbers since 1981 are presented in Chart 10.1. Beef cattle numbers have changed little over the past decade while sheep numbers have steadily declined. In 1988/89 combined sheep and beef stock units were at their lowest level since 1967/68. The effects of the removal of price subsidies were exacerbated by severe drought in the late 1980s.
Sheep numbers in particular have been influenced by price support and subsidies provided in the 1970s and early 1980s, and their subsequent removal. There was also extensive intervention in sheepmeat marketing by the NZMPB during this period. These interventions have also probably affected beef cattle numbers indirectly.
Supplementary Minimum Prices (SMPs) for farm produce were introduced in 1978. Under this scheme minimum prices were set by the government for sheepmeat and beef at the beginning of each season. If international market returns fell below these minima the government made up the difference. Payments were made to farmers via the NZMPB.
SMPs worked in tandem with the Board's price stabilisation scheme (described in the next section). In situations where the Board's stabilisation floor was below the SMP level, and the market return was below the stabilisation floor, the government paid the difference between the two support prices and the Board paid the balance from its stabilisation account.
A Livestock Incentive Scheme, introduced prior to SMPs, helped stimulate a 25% increase in sheep numbers over the six years to 1981. Subsequent SMP and Board stabilisation payments made in the early 1980s continued to encourage increased sheep production and provided some, but considerably less, assistance to beef producers.
By late 1985 both forms of price support had ceased completely. With the removal of support, sheepmeat returns to farmers dropped sharply.
The profitability of sheep and beef farms is presented in Chart 10.2. Depressed market returns, meant that between 1981/82 and 1984/85 there were two years when farm profits comprised subsidies and price supplements totally, and two years when they were a significant proportion of profit. During this period in particular, farmers were receiving price signals very different from actual market realisations.
Meat production has reflected changes in the livestock inventory. Contraction in the sheep population since the mid-1980s led to declining slaughterings and exacerbated over-capacity problems in the meat processing industry. Levels of lamb, mutton and beef production since 1981 are presented in Chart 10.3.
The beef industry has been subject to relatively little intervention either through output assistance or marketing intervention. It appears to have contracted in the face of artificially superior returns for sheepmeat during the decade ending in the mid-80s, and is now starting to expand again following the removal of assistance to the sheepmeat industry.
The entire meat producing industry is now recovering from the consequences of distorting price support. With the removal of support, and the consequential fall first in incomes and then in asset values, farmers had to curtail productive investment. The rate of improvement in farm profitability will determine how fast the productive asset base of the New Zealand sheep and beef industries is rebuilt.
10.2.2 New Zealand Meat Producers Board
The New Zealand Meat Producers Board (NZMPB) was established under the Meat Export Control Act 1921-22. This legislation gives the Board considerable powers to intervene in the industry and control commercial activities, and it has used these powers extensively, particularly in the sheepmeat industry.
Recent legislative changes increased powers and commercial autonomy
The Meat Export Control Amendment Act of 1989 contained major changes to the Board's existing Act and repealed the Meat Export Prices Act 1976. The most significant feature in the amending Act was the provision which gave the Board the powers of a natural person. The Board is now free to do whatever it likes unless it is specifically prohibited by legislation. The Act prohibits very little. In particular, the Board is free to invest as it sees fit without the need for Ministerial approval.
The Amendment Act re-defined the Board's functions to include involvement in the promotion of access to overseas markets, grading and quality standards, research and development, consumption of New Zealand meat, orderly systems for the export and marketing of meat and by-products, and efficiencies in production, transport and distribution.
The legislation now specifies the object of the Board as being:
Ò. . . to ensure that the producers in New Zealand of stock from which meat is derived obtain the best possible long term returns for that stock.Ó
The Act defines stock as cattle, sheep, goats or horses. The deer industry, and its Game Industry Board, are the subject of separate legislation.
The BoardÕs 1990 Annual Report states that its purpose is to maximise the returns to New Zealand's meat producers through:
¥ a strong producer-ownership position in the New Zealand meat processing industry;
¥ orderly and regionally-coordinated marketing of New Zealand meat, plus improved trade access;
¥ coordination of international promotion to develop a consistent image and greater awareness of the qualities and benefits of New Zealand meat; and
¥ cost efficiencies from continuing research and development, quality control and streamlined distribution.
Consequent on passage of the amending legislation, four new Board members with commercial expertise were appointed in March 1990. The Board now comprises eleven members: six representing producers and selected by the Electoral Committee, one representing the dairy industry and appointed by the Minister of Agriculture on the nomination of the New Zealand Dairy Board, and four chosen for their appropriate commercial expertise and appointed by the Minister on the nomination of the Board. A review of procedures for electing producer directors and mechanisms of accountability was undertaken in mid-1992. An explanation of why its recommendations will do little to reduce producer concerns over accountability is presented in Box 10.1.
A compulsory levy provides the majority of the Board's funds
The Board's activities are funded by a compulsory levy on all stock slaughtered in licensed premises and income from investments, including commercial investments in the meat industry. The Board had a total expenditure budget of $34 million in 1991. This was funded by levy income of $24.8 million and investment income of $9.2 million.
The Act allows the Board to fix levy rates annually by notice in the Gazette. Levy rates were increased at the beginning of the 1990/91 season sufficient for the Board to estimate that its annual levy income would increase by nearly 90% in that season. A large part of the levy increase is to replace funding for R&D and promotion previously sourced via the meat processing companies.
In an address to the Electoral Committee discussing the proposed levy increase, the Chairman of the Board stated that the additional funds would be used exclusively for R&D and promotion. It was apparently considered necessary to stress that Ònot one cent from this increase will be spent on Freesia Investments or any other Board subsidiary operation.Ó
About 60% of the BoardÕs expenditure is directed through its overseas offices in London, Brussels, Bahrain, Tokyo and Virginia. According to the Board, the role of these offices is:
ÒTo keep New Zealand meat processors and exporters informed on market place conditions and opportunities; to ensure exporters are assisted where possible and not disadvantaged by any changes in laws or regulations introduced by individual countries; to service customers for New Zealand meat and co-ordinate and conduct promotional activities ranging from catering advice and food fair exhibits to media advertising programmes.
ÒBoard offices handle many statutory functions and deal with exporters, importers, consumers, officials and members of Governments. They are the boardÕs eyes and ears in the market to promote and protect the New Zealand meat industryÕs business.Ó
The Board is currently reviewing the location and role of some of its overseas offices.
Export licensing powers underpin much of the BoardÕs intervention
Meat exporters must hold an export licence issued by the NZMPB. These export licensing powers are crucial to the BoardÕs ability to control and influence commercial activities in the industry.
The BoardÕs legislation also allows it to attach conditions to the export licence. In this way the Board is able to determine how and where meat companies can trade. Such provisions allow the Board to determine which companies can export to which markets, or whether markets Ñ Japan in the case of sheepmeat, for example Ñ will essentially be under the complete control of the Board.
The Board also uses these export licensing powers to ensure any requirements it determines in regard to grading and quality control are met. The recently established Meat Planning Council Ñ discussed later Ñ has the back-up of these powers to achieve its stated objectives.
The Board has power to acquire and market all meat
Section 10 of the Meat Export Control Act provides the Board with wide-ranging powers to control the export of meat from New Zealand. The extent to which the Board can absolutely control exports is illustrated by clause (5) of section 10 which says that:
ÒAll meat of which the Board has assumed absolute control shall be graded and shipped as the Board directs, and shall be sold and disposed of only by the Board, or by direction of the Board, at such times and in such manner and on such terms as the Board in its discretion determines.Ó
It was these powers which enabled the Board to acquire all sheepmeat for export between October 1982 and December 1985.
Grading, quality control and promotion
Section 7C of the Act allows the Board, after consultation with the New Zealand Meat Industry Association (MIA), to set grading standards for export carcases. There are currently grading standards for export beef, lamb and mutton carcases. Exporters are permitted to develop their own grading standards and systems if breaking down carcases prior to export. The Board has no involvement in grading or quality control on the domestic market.
Grading standards can vary depending on the product and the market. In the case of lamb, for example, the nature of Board involvement is illustrated by the following extract from the BoardÕs 1990 Annual Report:
ÒThe Board also continued to allow minor butcher-damaged carcases, normally unexportable in carcase form, to be exported as carcases to a restricted range of markets. Within certain regions of Europe all lamb exports must be to a standard of AC & A and for other regions to AC. The Board has now implemented this agreement with industry into all new licence conditions.
ÒThe Board allowed variations to hogget classification fat classes for a processing company to enhance producer returns. The BoardÕs colour identification for carcase coding was varied on two occasions to enhance Middle East marketing opportunities.Ó
The MIA used to operate a promotion committee, which included a representative of the NZMPB, and which provided a forum for the discussion of promotion matters of mutual interest. It used to organise the participation of meat companies in overseas trade fairs on a user pays basis, with matching contributions from the NZMPB. The Trade Development Board has now assumed this role.
The New Zealand Lamb Promotion Council (NZLPC) conducts generic promotion of New Zealand lamb in the United Kingdom. Until 1991, it was funded jointly by the NZMPB and the meat companies exporting to this market. The exportersÕ contribution was provided by a levy of 0.66 pence per pound on product destined for the United Kingdom with an additional 0.33 pence per pound paid by the NZMPB. In 1991 these arrangements were changed and the Board resumed Òresponsibility for generic promotion in the UK.Ó
In 1989, a proposal to extend the CouncilÕs concept to a global system of generic promotion of New Zealand beef and lamb funded by a slaughter levy was discussed but not progressed. It was concluded that Òwith the rationalisation taking place within the industry, and consequent changes in commercial structures, it would be premature to proceed with such a proposal at this time.Ó
Instead it was agreed that the NZMPB would fund generic promotion within a strategy determined by the promotion committee and that the Board would Òjoin with individual companies to undertake specific promotions on a shared funding basis, again within agreed guidelines.Ó
The New Zealand Beef and Lamb Marketing Bureau (Inc) is jointly funded by the NZMPB and the retail meat industry, and carries out generic promotion of beef and lamb in New Zealand.
Price smoothing used to be a Board activity
The NZMPB was given expanded price stabilisation powers in 1955. The Meat Industry Stabilisation Account (MISA) was used to retain pay-ins and fund pay-outs.
According to the Board Òthe price smoothing scheme was established with the principle of funding by a self-balancing account. It aims to take the peaks and troughs out of producer returns for individual categories of export meat.Ó
When the stabilisation account was in debit, funds were sourced from the Reserve Bank at an interest rate of 1%. This concessional rate of interest was also earned on surpluses in the account. From 1984 market rates of interest applied to this account.
MISA went deeply into debt in the first half of the 1980s when production was increasing and markets were depressed, and the Board was making extensive support payments.
In 1986 the government announced the end of producer board stabilisation accounts. It also announced that the Meat Industry Reserve Account (MIRA), which had a credit balance, would be wound up. This account was established in the early 1950s with funds and assets originating from bulk purchase arrangements for meat during and immediately following the second world war.
The detailed arrangements surrounding the closure of MISA and MIRA have been described as follows:
ÒIn the 1986 Budget the government indicated its intention to write off the MISA debt, providing satisfactory agreement could be reached to put future meat production and marketing on an economic basis. In March 1987, government and meat producer representatives agreed on the terms involved in the termination of MISA, and later that month government wrote off $930 million of the MISA debt. The balance of the debt ($100 million) was met by the MIRA. The remaining MIRA assets of $136 million were passed to the Meat Producers Board in September 1987, augmented by the payment of $20 million from government spread over the following three years, thereby ending the concessional stabilisation of sheepfarmers' prices. Enactment of the Meat Export Control Amendment Act in late 1989 formally ended stabilisation arrangements for the meat industry.Ó
These arrangements for winding up the stabilisation and reserve accounts, writing-off debts, and transferring funds to the Board were agreed and put in place at the same time as the Board initiated new investment activities and marketing arrangements in the industry. In particular, the new role for Freesia Meats Ltd (a wholly-owned Board subsidiary renamed Freesia Investments Ltd) was developed in conjunction with the arrangements discussed above.
Extensive investments in marketing and processing
Until the early 1980s the NZMPB did not have extensive investments in the meat industry. However, its direct involvement in processing and marketing has increased significantly over the past decade. In March 1992 the Board announced plans to more clearly separate the Board from its commercial subsidiaries. Direct Board involvement in export marketing is predominantly in sheepmeats.
In January 1984 the Asian and New Zealand Meat Company Ltd (Anzco) was established by the Board to take responsibility for sales of mutton to Japan, Hong Kong and Taiwan, and lamb carcases and primals to Japan. Since then the company has entered into cattle feedlot and beef processing joint ventures with Japanese interests, agency arrangements in Hong Kong, China and Taiwan, contract processing in Korea, and acquired Bush's Pet Foods Pty Ltd in Sydney. The Board owns 90% of Anzco.
In April 1985 the Board entered a joint venture called Japan New Zealand Lamb Marketing Ltd (Janmark), to develop lamb sales in Japan outside the Hokkaido region. The Board has a 45% interest in Janmark. The majority of the balance is owned by Affco New Zealand Ltd and Alliance Group Ltd which are producer cooperatives and the two biggest meat processing companies in New Zealand.
Southern Foods Ltd is a Janmark subsidiary company operating a lamb handling and processing factory near Tokyo. It is the first plant to be built specifically for New Zealand chilled lamb in any overseas country, and the first New Zealand-owned factory to be built in Japan.
The Board has used its export licensing powers to confine access to the Japanese sheepmeat market to Anzco and Janmark .
The New Zealand Lamb Company (North America) Limited (NZLC), formerly known as Devco, had single selling rights for sheepmeat in the United States and Canada for over thirty years. Sole rights to the United States were removed in 1987 but the monopoly to Canada has been retained. NZLC is a consortium of Affco New Zealand Ltd, Alliance Group Ltd, Richmond Ltd, and the NZMPB. A review of lamb marketing in North America and Mexico in mid-1992 led to no substantive changes to existing marketing arrangements.
Freesia Meats Ltd was established by the Board in 1980 as the vehicle for the purchase of NCF Kaiapoi from Waitaki NZR, CFM and the other minor shareholders. This purchase was made by Freesia with the objective of subsequently re-selling the shares to bona fide farmers and registering the company as a cooperative under the Cooperative Freezing Companies Act. Ownership of the plant subsequently passed to the Alliance Group Ltd which recently closed the plant.
In 1986 Freesia emerged with a different role. The BoardÕs 1986 Annual Report discussed the new role as follows:
ÒThe Board believes that in the restructuring of the meat export industry there is a need for a stronger producer-oriented marketing and processing group of companies. Late in 1985 the Government indicated its agreement and confirmed that consent would be given to the release of a substantial proportion of the Meat Industry Reserve Account funds for investment in such a venture.
ÒThe Board has restructured Freesia Meats Ltd, increased its capital and appointed directors with specific skills to develop it as an investment company with the aim of establishing the proposed producer-oriented marketing group. Progress on these matters has been delayed due to protracted negotiations with Government on funding issues. Negotiations have been held with producer co-operative companies and are expected to reach fruition early in 1987.Ó
Freesia Investments Ltd now has a 37% shareholding in the Alliance Group Ltd (Alliance also has a 25% shareholding in Affco New Zealand Ltd), a 37% shareholding in Richmond Ltd, and a $35 million debenture with conversion rights over Affco New Zealand Ltd. It also has shares in Bernard Matthews Plc (a UK-based specialist lamb roast company), and owns Advanced Foods of New Zealand Ltd, the company which supplies Bernard Matthews Plc.
The Board is currently implementing plans to make its commercial subsidiaries Òarms-lengthÓ. The recently created Primary Resources Ltd will subsume Freesia, Advance Foods Ltd and the BoardÕs shareholding in the New Zealand Lamb Company. The second and yet to be established arms-length holding company will contain Anzco, Janmark and their various associated companies.
According to the BoardÕs Chairman:
ÒThe future of the holding companies will be reviewed annually, as provided in their statement of corporate intent. The most important objective is for their Boards to operate as commercially viable and profitable companies. There is also provision, where appropriate, for the sale of investments. This has always been the stated intention of the Meat BoardÓ.
Lessening influence on freight but still able to exercise control
The influence and degree of control the Board has chosen to exercise over internal transport costs, and overseas freight services and rates, has diminished over recent years. However, section 12 of the Meat Export Control Act still provides it with absolute powers over these commercial activities if it chooses to use them.
Transport costs within New Zealand used to be pooled but now they are the responsibility of individual exporters. With the exception of the European trade, meat exporters have choice in regard to services and rates when shipping to overseas destinations, although on some routes the Board negotiates and sets maximum rates.
In 1988 the Meat Industry Freight Council (MIFC)â was established. It consists of equal representation from the NZMPB and the MIA. According to the NZMPB the role of the MIFC is to:
Òadvise the Board on all relevant freight matters, to undertake freight negotiations based on strategies and limits of action approved by the Board and to act as a forum for a united meat industry approach to freight-related matters.Ó
The CouncilÕs main responsibility is now confined to negotiating services and rates with the European Conference and maximum freight rates on a number of other routes. It is also a forum for discussing freight issues and policies.
The scheduling of services and cargoes with the European Conference is tied in closely with systems for allocating market shares into the restricted EC market. Shipping Conferences also operate on other routes such as to Japan and North America, but they compete with non-conference lines.
At the beginning of 1991, the Board allowed competition from non-conference lines on the North American route and rates fell sharply. The European Conference agreement was renegotiated in late 1991. The Board announced that the new agreement with the New Zealand European Shipping Association Òwill reduce New ZealandÕs shipping bill to Europe by about $NZ21 million.Ó Under the previous agreement, independent shipping companies were used to conduct trials of different shipping methods on the European route. The new agreement allows this to continue.
The Board has increased its involvement in R&D funding and management
The New Zealand Meat Research and Development Council (MRDC) was established in 1990. It operates as a Board committee, is chaired by a member of the Board, and reports to the Board. It funds and oversights industry R&D but does not undertake research. A slaughter levy provides the majority of its funds.
Farm-related R&D has been undertaken almost exclusively by the DSIR and MAF. Meat industry research has been the domain of the Meat Industry Research Institute of New Zealand (MIRINZ). Until recent changes in New Zealand science funding policies, the first two organisations were solely publicly funded. MIRINZ funding was sourced from government, the NZMPB, and the MIA, and an increasing proportion of its revenue has been derived from privately commissioned research and development.
The establishment of the MRDC reflects both a response to the science funding policy changes and a desire on the part of the meat industry to change the manner in which MIRINZ was funded.
The MRDC evolved from the recommendations of an ACIL report commissioned by MIRINZ and conducted in mid-1989. However, the eventual composition of the Council and its methods of accountability differ somewhat from the recommendations and principles outlined in that report. Essentially, the NZMPB has considerably more control and influence over the MRDC and its activities than was recommended in the report to MIRINZ. However, the establishment of the Council has introduced more competition into the provision of R&D services to the industry.
The Meat Planning Council is the most recent policy initiative to coordinate exporting
In August 1991 the NZMPB and the MIA jointly announced the establishment of a Meat Planning Council (MPC).
The MPC is designed to be a policy forum made up of meat industry executives and members of the Meat Board. The meat industry will have up to seven representatives and the Board will have four, including the Chairman.
The MPC will, among other things, make recommendations to the NZMPB on the issue of, and conditions to be attached to, meat export licences. The Council will also be a forum for discussing future export marketing systems and structures, and export market development initiatives including international promotion activity.
Concurrent with the establishment of the Council, a system of Òmarketplace franchisingÓ has been introduced. Under this system the right to export in any specific area will be dependent on agreement to conform with specified conditions, including provision of market plans. The Board will use its legislated powers to grant and police export licences to underpin the operation of this franchising system.
At this stage the CouncilÕs activities principally concern lamb marketing. In its joint media statement the Board and the MIA gave the following details on how the franchise system would work:
ÒIf any exporter does not adhere to the agreed terms, part or all of the franchise fee will be forfeited. The funds will be directed, as agreed by the Council, to export market development activity in the particular area where the transgression occurred.
ÒFranchise fees will vary according to the volume being handled by each exporter, and from region to region. Franchise conditions common to all export regions include the agreement to establish systems to monitor actual volumes and prices. In some areas, there may be an additional requirement to have appropriate export market representation.
ÒSpecific market requirements in the UK include the submission of detailed market plans, to be reassessed regularly. VRA entitlements, previously allocated according to shares of the national kill, will be issued according to these plans and regularly adjusted on the basis of actual performance.
ÒRequirements for the North American region will be put in place after the outcome of the review of lamb marketing which is due to report back by November 30 this year.Ó
10.2.3 The meat processing industry
Producer cooperatives dominate the industry
There are around 60 plants processing meat for export in New Zealand. Over 70% of this meat processing capacity is now owned by livestock producers, mainly through cooperatives.
The two largest meat processing and exporting companies are producer cooperatives. Affco New Zealand Ltd is located in the North Island and is the largest beef processor with approximately one third of the national kill. Alliance Group Ltd is located in the South Island and is the biggest sheepmeat processor with over 20% of the national kill. Between them, these two producer cooperatives process around 40% of all sheep and cattle slaughtered in New Zealand.
The other major producer cooperative is the Dunedin-based Primary Producers Cooperative Society Ltd (PPCS). This company does not publish information on throughput but in 1989/90 did report the highest profit of any meat company in New Zealand Ñ $20.2 million which was 25% higher than the previous year.
There are a number of other significantly sized processors in the industry. Their ownership varies and includes an overseas owned subsidiary, privately owned companies, and companies which are partly cooperatively owned by producers, or include producer shareholders.
Weddel New Zealand Ltd is a fully owned subsidiary of the United Kingdom-based The Union International Plc (part of the ÔVestyÕ organisation) and is the only wholly foreign owned meat processor. Its share of the national kill is 10% for sheep and 20% for cattle.
Fortex Group is now the only publicly listed meat company in New Zealand. It has a substantial number of producer shareholders and just under 10% of its equity is held by a Swiss-based company. It has two sheepmeat plants in the South Island and a 13% share of the national kill.
Considerable rationalisation has occurred over the past decade
There have been extensive structural and ownership changes in the meat processing industry over the past decade. The industry has been plagued by so-called over-capacity problems.
These overcapacity problems, and the structural and ownership changes, reflect the consequences of two major influences Ñ controls over the establishment of new plants which operated until 1981, and a downturn in livestock numbers in the latter half of the 1980s following the removal of price support and exacerbated by unfavourable seasonal conditions. For example, the lamb kill fell from nearly 40 million in 1984/85 to 24 million in 1989/90.
Prior to 1981, entry into the meat export processing sector was controlled by licensing. A licence would only be issued if an economic need criterion was met. The objective was to protect the economic viability of existing processors and avoid over-capacity problems in the industry.
Because the NZMPB had sole responsibility for sheepmeat export marketing for a period immediately after meat plant licensing restrictions were removed, significant adjustments in the industry did not take place until the second half of the 1980s. These adjustments have involved extensive plant closures and changes in ownership.
Plant closures have mainly involved older, multi-chain plants. These closures have been costly because of the need for asset write-offs and large redundancy payments. Restructuring has involved, and still involves, complex inter-company arrangements, mergers and the participation of the NZMPB through Freesia Investments Ltd.
Since plant licensing was removed there have been a number of smaller, single chain plants established using modern technology, different labour arrangements, and delivering improved levels of productivity. This has increased the competitive pressures on older plants.
Two of New Zealand's largest companies, Fletcher Challenge Ltd (FCL) and Goodman Fielder Wattie Ltd (GFW), invested in the meat industry and then substantially withdrew during the 1980s. In 1989 FCL sold its subsidiary, Challenge Meats, to Waitaki International Ltd taking shares in Waitaki in return for assets. Subsequently, three major Waitaki shareholders - FCL, GFW and Freesia Investments Ltd - formed Garway Investments Ltd as the joint vehicle for them to hold their shareholdings in Waitaki. Garway held a 71% shareholding in Waitaki. More recently Waitaki was taken over by Affco and Alliance in a complex set of arrangements involving the closure of some of its plants. Subsequent to this rearrangement, FCL still has an investment in the industry.
The majority of sheep and beef are purchased over the hooks by the meat companies on the basis of schedule prices. The companies publish individual schedules of prices and grades on which producers can base their selling decisions. Some sales are also made on a per head basis and some producers enter into grade-based forward contracts with processors.
10.2.4 Markets
New Zealand exports about equal quantities of sheepmeat and beef. These exports are sold in over 90 markets. The characteristics and requirements of these markets vary enormously Ñ many individual markets also exhibit considerable diversity in their requirements. Despite the market spread and demand diversity, the bulk of exports go to a small number of markets. Around 50% of lamb exports go to the European Community (EC), with half of these to the United Kingdom (see Chart 10.4). The Middle East is a growing market for lamb. Three-quarters of all New Zealand beef exports go to the United States (see Chart 10.5).
Around half the lamb exports are in carcase form, although the proportion exported as cuts or boneless meat has been increasing steadily. Chilled lamb exports are also growing but remain a very small proportion of the trade. In the higher income markets, particularly, consumers prefer fresh or chilled product over frozen.
The beef trade comprises boneless cuts and meat, the latter being dominant and mainly destined for manufacturing uses such as hamburger mince. Higher quality cuts for direct consumption predominate in the trade to North Asia where the markets are increasingly demanding meat from grain fed or younger grass fed animals.
New Zealand sheepmeat and beef compete in export markets with supplies from other exporters, domestic production, and other meats Ñ mainly pork and poultry. The exact nature of this competition varies depending on prices, tastes and traditions, incomes, and the domestic and trade policies pursued by individual countries. However, all markets have one thing in common: intense price competition.
Pork and poultry account for around 60% of world meat consumption. Beef consumption is about three quarters that of pork, while sheepmeat constitutes only 6% of world meat consumption. Generally, red meat is sold into intensively competitive markets where it has been losing market share.
For the majority of the worldÕs consumers, sheepmeat, and particularly lamb, are not traditional meats. There are relatively few meat importing countries Ñ the United Kingdom and countries in the Middle East are notable examples Ñ where there are relatively high levels of per capita sheepmeat consumption as a traditional part of the diet.
Price and convenience Ñ very important influences on demand
Price and, increasingly, consumer convenience, are important determinants of meat consumption given the readily available alternatives in most markets. Competition from other red meat suppliers, from competitive meats, and from other sources of protein, is important when considering what market power, if any, New Zealand has, and what suppliers need to do to make sales and capture market share.
The importance of competitive prices in both export and domestic markets is not a new phenomenon. As the Chairman of the NZMPB pointed out more than a decade ago:
ÒThere is a limit to what consumers around the world will pay for New Zealand meats. Nearly every country has large supplies of cheap pork and poultry and other non-meat foods as well.Ó
The importance of price competitiveness in the meat market is also well illustrated by recent changes in beef consumption in New Zealand. A MAF assessment described these changes in the following terms:
ÒDomestic usage of beef and veal has continued its downward trend having peaked in 1987-88 at 130,000 tonnes. Beef and veal consumption in 1989-90 fell by 11% to 110,000 tonnes, compared to 124,000 tonnes the previous season. The decline in domestic consumption reflects higher overseas market prices, and the consequent increase in the retail price of beef, particularly in relation to poultry and fish. Retail prices of beef in 1989-90 rose by around 13% as against increases in poultry meat and fish prices of 5% and 4% respectively.Ó
The demand for meat is also reflecting trends throughout the food industry for convenience and ease of preparation. Consumers are spending less time on food preparation, looking for high quality and variety, and increasingly eating outside the home. These phenomena are associated with markets where incomes are rising and people are spending proportionately less on food itself, as opposed to food services and non-food consumption items. They are the unambiguous trends in those parts of the world where New ZealandÕs meat export opportunities are expected to be greatest.
As far as beef is concerned, the United States market for manufacturing beef is likely to remain New ZealandÕs major export market. However, opportunities for high quality beef in North Asia, particularly Japan and the Republic of Korea, are growing relatively rapidly. The requirement in these and similar markets is quality and reliable service.
Trade barriers and production subsidies are well-entrenched sources of competition
Most countries interfere in some way with the meat trade. At its most subtle, such interference involves health and hygiene requirements imposed on those who wish to export which are used as non-tariff barriers or impediments. At its most obvious, it involves subsidies on production and unambiguous restrictions on trade, as is the case with the EC.
The EC and its policies have tended to dominate market circumstances for New Zealand sheepmeat. The traditional United Kingdom market, and other markets in the EC, have become increasingly competitive because of the effects on domestic meat supplies of production and storage subsidies within the Community. Subsidy-induced production surpluses, particularly of beef, also increase the competition facing New Zealand sheepmeat both in the Community and in third markets.
In 1980 New Zealand was required to enter a voluntary restraint agreement (VRA) with the EC which constrained market access for sheep and goat meat to 245,500 tonnes per year. A tariff on imports was retained.
A four year derogation from the VRA, which runs until the end of 1992, lowered this annual access to 205,000 tonnes but removed the 10% tariff. Within this quota is a ceiling on chilled lamb imports which will increase slightly to a maximum of 10,500 tonnes in 1992.
The derogation also requires that New Zealand maintain prices within a range which is related to intervention prices in the Community. Between its introduction in 1980 and the derogation in 1988, New Zealand never filled its VRA quota. This suggests the market was relatively unattractive to New Zealand exporters at least at the margin, over that period. Since the derogation came into force there has been some need to encourage exporters to fill the quota for fear of exposing New Zealand to a weak bargaining position in future access negotiations. The Chairman of the NZMPB was quoted as saying:
ÒWe must try to fill the VRA total or it will be reduced.Ó
In the immediate future at least, little change can be expected in the EC market for sheepmeat. In fact, it seems quite likely that New ZealandÕs current market access will contract further when it comes up for renegotiation in 1992, reflecting growth in EC sheepmeat production but little change in demand. A more favourable outcome may result from the current Uruguay Round of GATT negotiations.
Other examples of intervention which affect, directly or indirectly, New ZealandÕs sheepmeat export markets include:
¥ a prohibition on imports of frozen sheepmeat for domestic consumption in the Republic of Korea;
¥ competition in the Middle East from frozen poultry exported from the United States under the Export Enhancement Program;
¥ potential for increases from current Ôzero ratesÕ in countervailing duties on lamb imports into the United States; and
¥ import levies and quantitative restrictions in a variety of smaller markets.
Intervention and protective measures in importing countries have relatively less impact on New ZealandÕs beef trade. The United StatesÕ Meat Import Law places a global limit on imports which was set at 598,000 tonnes in 1991. Under the so-called ÒVoluntary Restraint AgreementÓ Australia and New Zealand had their shipments restricted in the last quarter of 1991 to ensure total imports from all sources did not greatly exceed the global limit. Canada has similar arrangements. Those arrangements have not effectively constrained New Zealand beef exports to North America in recent years.
Japan agreed in 1988 to the phased replacement of import quotas on beef with a regime of declining ad valorem tariffs. Tariffs replaced quotas in April 1991, and will decline from the current rate of 70% to 50% over three years. The Republic of Korea, which currently has a tender quota system similar to that just replaced by tariffs in Japan, will commence liberalisation of access in 1992.
Taiwan, New ZealandÕs fourth biggest beef market, has beef import tariffs which discriminate against low quality (grass fed) beef and favour grain finished beef.
Virtually no New Zealand beef is exported to the EC Ñ New Zealand has a very small quota for high quality beef. The main danger from the EC beef industry is the impact of the CommunityÕs massive stocks which are currently around 1 million tonnes, or some three times New ZealandÕs annual exports.
Under an agreement between the EC and Australia Ñ the ÔAndriessen AssuranceÕ Ñ the Community has undertaken not to export subsidised beef to North Asian markets. Given the current beef stockpile in the EC, this agreement, while it continues, also offers some safeguard to New Zealand in these markets.
The composition of export markets and products has been changing
In 1970 about 85% of New ZealandÕs lamb exports went to the United Kingdom, mainly as frozen carcases. Dependence on this market had fallen to 50% by 1980, and around one third by the end of the eighties.
As the United Kingdom market diminished in relative importance, the Middle East was growing as a market for sheepmeat. The USSR was also emerging as a market for mutton. In 1989/90, no sheepmeat contract was concluded with Iran and Japan became New ZealandÕs second biggest lamb buyer. Since 1984, New Zealand has been the largest single supplier of sheepmeat to Japan. Recently, sales of lamb to some European countries have been increasing and per capita lamb consumption on the European continent has risen slightly.
The proportion of lamb being exported as frozen carcases has been declining steadily. It was over 90% of exports in 1970. By 1990 it had fallen to around half of all lamb exports. There has been a steady growth in the export of broken down carcases or lamb cuts in both bone-in and boneless form, and usually vacuum packed.
Exports of live sheep expanded in the 1980s
The export of live sheep from New Zealand has been subject to two sets of influences. One is controversy in New Zealand arising from concerns about both the welfare of sheep during shipment and the implications for employment in the meat industry due to reduced slaughterings in New Zealand. The other set of influences relates to the variable and somewhat fickle behaviour of authorities in importing countries.
New Zealand recommenced the export of live sheep in 1985 after the removal of a total ban which had existed for a number of years. The trade recommenced on the basis of export quotas set by the New Zealand government in recognition of the above-mentioned domestic concerns about the trade. Exports increased from just over 400,000 head in 1985/86 to 1 million head in 1988/89, the first year of completely unrestricted trade. Most of these sheep went to the Middle East, principally Saudi Arabia.
Australia is the other major supplier of live sheep to the Middle East and its exports peaked at 7.3 million head in 1983. In 1989 Australia exported 5.3 million head. Its exports to Saudi Arabia were suspended in 1990 as a result of disputes over the alleged health status of the sheep. New Zealand capitalised on this opportunity by exporting 1.5 million live sheep in 1990, all to Saudi Arabia. However, at the end of 1990 New Zealand also began experiencing animal health related problems in the Saudi Arabian trade. The trade was suspended for a period and then recommenced in early April 1991 on a restricted basis administered by the New Zealand MAF.
There are two distinct markets for New ZealandÕs live sheep in the Middle East. One is the religious slaughter market related to the Haj festival in Saudi Arabia, which requires long-tailed ram lambs, and the other is the regular consumption market. The former is limited in size and concentrated around the annual festival. The latter has considerably more potential as the regionÕs population and incomes continue to grow.
Australia is expected to continue as the dominant supplier of mature sheep for slaughter in the Middle East. Notwithstanding recent, supposedly health related, problems with the Saudi Arabian market, Australia was expected to send around 4.5 million sheep to the region in 1991. New Zealand should face less competition in the more specialist Haj festival market. However, the festival commences 10 days earlier each year and this means New Zealand will have to develop the ability to supply outside the traditional lamb production season.
10.2.5 Marketing
The bulk of sheepmeat and beef is exported by the meat processing companies. There are also exporters which do not operate meat processing plants. Most companies have overseas offices in major markets and well established commercial relationships with agents and customers. Some own and operate overseas packing and distribution companies. For example, Affco has overseas offices in the United States, Japan, Singapore and Canada and a joint venture importing company (with Alliance) in the United Kingdom. This joint venture company Ñ New Zealand Holdings Ltd Ñ markets about 50% of the lamb and 80% of the mutton sold by New Zealand in the United Kingdom. In early 1991 Richmond Ltd purchased one of the three biggest meat importing and distributing companies in the United Kingdom.
There are significant differences between sheepmeat and beef in how export marketing is undertaken, and particularly the extent of NZMPB involvement. The marketing of beef is largely the responsibility of meat processing and exporting companies. By contrast, sheepmeat marketing, particularly lamb, involves the NZMPB in extensive marketing activity and control and influence over commercial operators.
The NZMPB is extensively involved in sheepmeat marketing
Sheepmeat marketing is characterised by extensive Board involvement and a high degree of co-operation amongst the major meat companies. The BoardÕs power to licence exporters has been an important influence on this cooperation. The Meat Planning Council is a recent development in policies designed to coordinate and discipline sheepmeat export marketing.
The Board is able to control and influence who markets what sheepmeat products, and where, by attaching conditions to the export licences it issues. If such conditions are breached, the Board has the power to withdraw the licence. How the Board operates the export licensing system is described in Box 10.2, which is an extract from the BoardÕs 1991 Annual Report.
It is through the use of its export licensing powers in this way that the Board has exercised extensive influence and control over sheepmeat marketing, market access, and market development activities of meat companies. It uses these powers to ÔshareÕ access to the European Community market amongst processors, to provide companies in which it has an interest with exclusive marketing rights for lamb carcases and primals into Japan, to participate in negotiations and help manage contracts with so-called single buyer markets such as Iran, and to designate special access markets where the number of exporters is constrained and special conditions are applied to the marketing activities of these exporters.
The Board was a sole seller of sheepmeat in the early 1980s
Over the three years ending 1985, the Board assumed control of all lamb and mutton production and with it responsibility for all export marketing. During this period the meat companies processed and marketed sheepmeat as fee-for-service agents to the Board. Immediately prior to this move it had been purchasing livestock in competition with processing companies, and had begun buying (from New Zealand exporters) carcases on the United Kingdom market in an attempt to improve both market and producer returns.
When the Board relinquished its sheepmeat sole-seller role at the end of 1985, the arrangements were replaced by a ÔvoluntaryÕ group structure within the meat industry. These marketing arrangements were coordinated by the MIA although the NZMPB was represented and involved. The aim of the group structure Ñ each group comprised a varying number of individual meat companies Ñ was to coordinate sheepmeat selling into nominated markets (geographic regions) with the stated objective of minimising competitive selling. The number of groups and their composition have varied over time.
This approach to marketing, and the coordination it was designed to facilitate, were conditions of the complex arrangements whereby the Board withdrew from total control over sheepmeat marketing. While the group marketing arrangements oversee exporting of sheepmeat to a range of markets, their principal focus is the EC market. Shares of this market have been allocated on the basis of a companyÕs share of the national kill with individual companies permitted to exchange allocations depending on their ability to supply. These arrangements have now been refined and further modified with the establishment of the MPC.
The Board designates numerous special access markets
The Board uses its export licensing powers to designate special access markets for sheepmeat and to control who has access to these markets and under what conditions. In July 1992 the Board announced a significant reduction in the number of special access markets and a redefinition of the basis of managing some of them. The Board said the decisions were part of their Òdesire to encourage meat exporters to build strong in-market customer linkagesÓ.
Category A special access markets are defined as those where the country has a single purchasing agency and include Iran, Iraq, Jordan, Egypt, Syria, Morocco, Tunisia, Algeria and Libya. In 1990/91 these countries accounted for 15% of New ZealandÕs lamb exports and 18% of mutton exports. Iran and Jordan were the destinations for virtually all this meat.
Category A markets are now to be handled by meat exporter consortium arrangements monitored by the MPC. Individual companies will be allowed to service niche opportunities Òprovided this does not conflict with the principal consortiumÕs business in that marketÓ.
Canada, Mexico, Japan, Taiwan and South Korea are category B special access markets defined as Òthose needing a period protection to encourage and protect market developmentÓ. Access to all category B markets except Mexico is confined to Board subsidiaries or joint ventures. Access to Mexico is confined to a consortium led by Weddel Ltd.
The Board also announced that a total of 25 countries would no longer be deemed to be category B markets and would be subject only to the BoardÕs normal licensing criteria. The change is not as significant as it might appear for two reasons:
¥ 15 of the 25 ÒcountriesÓ listed by the Board are the new nation states which formerly comprised the USSR;
¥ in 1990/91, apart from 15,000 tonnes of mutton to the former USSR, New Zealand did not export any sheepmeat to this collection of 25 countries.
Clearly there is considerable potential for growth in exports to the countries no longer in category B. However, the preparedness of meat companies to investigate or invest in exploiting this potential may be influenced by the following qualification from the Board:
ÒShould a meat exporter successfully develop business with any of these markets, then the MPC may consider whether a consortium approach is warranted to best service that market or whether licensing protection of that exporterÕs business is necessary to encourage further developmentÓ.
While the United States market for sheepmeat is not designated as a special access market, the Board does control the companies permitted to sell there. As noted earlier, the BoardÕs wholly owned subsidiary, Devco, had sole marketing rights to the United States market for twenty five years. The New Zealand Lamb Company (NZLC) (the successor to Devco) and a number of meat companies now export to the United States. During 1990 Òthe Board dispensed with test market licence criteria for lamb exports to the US. Licences are now issued to applicants who meet established specificationsÓ. Exporters wishing to send lamb to the United States must present a marketing plan for Board approval before being granted licensed access. In June 1991 the Board initiated a review of the performance of lamb exporters to North America and it recommended present policies continue.
10.3 Major Issues
From the complex array of policies, policy changes, and commercial problems which have characterised the meat industry, it is difficult to identify clearly all the cause and effect relationships, and their relative influence on industry performance. However, there are some issues and relationships which stand out as both recurring and significant. They are:
¥ the various regulatory approaches which have been adopted in attempts to maximise market returns;
¥ structural and profitability problems in meat processing; and
¥ transport and freight policies and costs.
10.3.1 Marketing meat for maximum returns
New Zealand livestock producers, like their counterparts in most other rural industries, appear to hold the view that they must be involved in some way in the marketing of their output if their returns are to be maximised. The NZMPB and the meat processing cooperatives are the structural manifestations of this view, and are presumably there to ensure this objective is achieved.
The problems and performance of the meat processing industry are discussed in the next section. This section considers various policies and activities of the NZMPB which have aimed at trying to improve marketing and market returns. These are the policies and activities which aspire to Ôcoordinate and disciplineÕ marketing activities to improve net returns to producers.
New ZealandÕs meat industry does not appear to have achieved growth rates superior to other meat export industries. In fact, the data in Table 10.1 suggest the reverse.
For both sheepmeat and beef, and for both volume and value, world trade
increased faster than New Zealand exports over the period 1961 to 1987. However, as the
researchers who undertook this analysis stress, these estimates need to take into account
the influence of subsidies on world trade, particularly for beef. These estimates are a
single and imperfect measure of performance, but an indicator nonetheless.
Table 10.1: Export Growth Ñ Sheepmeat and Beef (1961-87)
Volume of Exports
Real Value of Exports
Average % per year
New
Zealand
World
New
Zealand
World
Sheepmeat
1.3
2.2
1.4
2.9
Beef
3.3
4.0
2.8
4.0
Source: A Zwart and W Moore (1990), ÒMarketing and ProcessingÓ, in Farming Without Subsidies, R Sandrey and R Reynolds (eds), Ministry of Agriculture and Fisheries, Wellington.
Extensive NZMPB involvement in meat marketing reflects the view that private meat companies, if left to their own devices, would under-invest in market and product development, and fail to harvest ÔpremiumsÕ that are believed to be available to New Zealand in some markets, because they would compete unnecessarily with each other. This belief that there are returns available to producers which are somehow left behind or unnecessarily dissipated under competitive selling has underpinned the various approaches and policies the Board has implemented over the years.
Control and cooperation in the United Kingdom Market
In the 1990/91 season much was said about meat companies failing to cooperate in marketing lamb to the United Kingdom. It was argued by some that the industry should have had a marketing plan to coordinate activities better, and extract improved prices for lamb in this market.
However, it was also acknowledged that other factors making a significant contribution to lower prices in the United Kingdom were lower consumption because of the economic downturn, and increased local production. The need for cash flow by New Zealand meat companies, who were competing and having to pay higher prices for a reduced supply of lambs to maintain plant throughput, was also cited as a reason. Nevertheless, the overall view of many seemed to be that New Zealand would have obtained better prices if supply to this market had been reduced through better coordination and cooperation.
It is possible that this view is correct. In theory, and assuming everything else is held constant, reducing supplies would have improved unit prices for the reduced quantity. However, this leaves a number of issues and unanswered questions relevant to determining whether such a strategy would have improved profits for New Zealand lamb producers.
First, what would happen to the lamb carcases which were not being sold in the United Kingdom? They would have had to be sold elsewhere, presumably at a lower price. Can it be assumed that when individual companies decided to ship to the United Kingdom they considered this was the available market likely to offer the best returns? Alternatively, is it being suggested they acted irrationally, and if so, why? It is clear that NZMPB policies restrict the ability of meat companies to develop markets and direct supplies where they think returns are highest so this may have been an influence.
Second, if New Zealand had reduced supplies and raised prices, what effects might this have had in a market where demand was reduced due to an economic downturn? Would consumers have turned to local supplies, or other meats, rather than pay more for New Zealand lamb? It has been suggested that the United Kingdom market is particularly sensitive to price differentials between New Zealand and domestically-produced lamb. Presumably the lower prices in the United Kingdom reflected what was necessary to ensure consumers purchased available supplies.
Third, if coordinated action by New Zealand exporters had successfully raised prices, what influence might this have had on EC production? Is it reasonable to assume that higher prices might have led to increased EC production, although clearly this would only occur with a lag? Farmers worldwide increase production when prices rise.
Fourth, if supplies were reduced how would this reduction have been allocated amongst processing companies, and with what consequences? Some meat companies have lower debts, and more productive plants than others. Consequently, profitability levels would vary significantly at any given United Kingdom lamb price. If higher returns are obtained from coordinated marketing, should they go to the companies with the biggest profitability problems? Traditionally, shares in this market have been based on a companyÕs share of the New Zealand kill. What system is most fair to the producers and other shareholders in the lower cost plants who may find existing prices in the United Kingdom market deliver satisfactory profits?
Fifth, if coordination in the United Kingdom market did result in higher unit prices, New Zealand lamb supplies would not increase instantly. Procurement battles would continue, and prices to producers might even be higher. How would this benefit high cost, heavily indebted companies? If it increased their losses, producer shareholders may lose any benefits obtained if higher prices were achieved in the United Kingdom market.
These are only some of the more obvious questions which need to be answered, and answered correctly, before it can be known with reasonable certainty whether a coordinated strategy in the United Kingdom would have made New Zealand lamb producers better off. To start with, there must be serious doubts over whether New Zealand could have extracted higher returns given the supply and demand situation existing in the market at the time, particularly the competition New Zealand lamb exporters were facing from other lamb supplies and other meats.
A study conducted in 1988 by McKinsey and Company reached the following conclusion about additional returns available from better coordination in the United Kingdom market.
ÒIn the United Kingdom the New Zealand processors, despite efforts to establish an agreed price list, still compete fiercely with one another on price. Even if this price competition was to be totally eliminated, it would only generate maximum additional revenues of between $10 million and $12 million. Achievement of these savings would play a very minor role in restoring the industryÕs profitability.Ó
This is an estimate of additional sales revenue. The exact methodology used to make these estimates is not clear from the source. However, it appears to take no account of other considerations like those raised above, which would all influence whether lamb producers ended up better off or not.
Has sheepmeat marketing in Japan been a success?
In 1983, shortly after taking full control of all sheepmeat marketing, the NZMPB declared Japan a development market for sheepmeat and introduced single selling arrangements for this market. Since 1984 Anzco and Janmark have had sole rights to sell into Japan. They procure their supplies from most of the sheepmeat processing companies in New Zealand. Japan currently takes about 7% of New ZealandÕs lamb exports, making it one of the larger individual markets.
These single seller arrangements were made amid criticisms that the numerous private exporters selling to that market at the time were failing to develop the required products and implement appropriate marketing strategies. The strategy behind the new arrangements was to reposition lamb at the so-called premium end of the market.
When responsibility for sheepmeat marketing was returned to private companies in 1985, these sole seller arrangements for Japan were retained. Although there were some reservations about this decision within the industry, many companies felt that the ÒJapanese operation is successful, and because meat is provided from a wide range of companies, the arrangement is equitableÓ.
New Zealand commenced selling lamb to Japan in the mid-1960s. A major incentive was the need for New Zealand processors to find alternative markets to avoid penalties applying at the time under a United Kingdom lamb diversification scheme. After reaching a peak in the late 1970s, lamb exports to Japan were fairly static for a number of years.
New Zealand exports of sheepmeat and beef to Japan since 1978 are presented in Chart 10.6. Exports of lamb and mutton for the same period are presented in Chart 10.7; while these data are derived differently from those in Chart 10.6, they are adequate for indicative purposes. The main reason for including beef in Chart 10.6 is that beef exports to Japan have been undertaken by the meat companies without NZMPB involvement or restrictions.
It is clear that over the decade ending 1989, New Zealand lamb exports to Japan have increased and mutton exports have fallen, although the latter are still considerably higher than their low point in the early 1980s. Total sheepmeat exports have fluctuated without exhibiting any clear trend.
Over the same decade, beef exports fluctuated without any marked trend and then increased at the end of the 1980s.
Documentation prepared as part of a presentation to government officials by the Chief Executive of Anzco and Janmark added little to the basic data in terms of aiding an assessment of the success or otherwise of the sole seller arrangements in Japan. It contained indicators of activity rather than performance.
There was no information on either unit returns being achieved or the profitability of these two monopoly marketing companies. Information on the profitability of two of JapanÕs largest, publicly listed meat companies was presented.
Unit value information may have provided some indication of whether Janmark is achieving its objective of positioning New Zealand lamb at the premium end of the market. Information on profitability would have given some indication of whether the extensive investments in marketing and distribution infrastructure are producing an adequate return.
At least it can be concluded that the two companies (Janmark and Anzco) are paying meat companies prices for lambs comparable to returns available in other markets Ñ otherwise it is difficult to see how they would secure supplies to meet their market needs.
In 1990, the then Minister of Agriculture expressed the following views about Anzco and Janmark, and the NZMPBÕs continuing policy of allowing them a monopoly on sheepmeat marketing into Japan.
ÒThe Meat Board has maintained this monopoly situation beyond the time frame envisaged by government five years ago when it restored meat marketing to private enterprise, without giving what I regard as a completely satisfactory explanation for declining all other licence applications.
ÒThe Board cites expressions of support for the existing North Asian Programme, or at least certain aspects of it, by various industry or parliamentary representatives. But what does that prove?
ÒPoliticians do not have either the complete information or the commercial marketing experience to form a reliable judgement, and meat companies may or may not feel able to comment freely on the performance of an organisation which virtually has the power of life or death over other exporters, should it choose to exercise those powers to the full.
ÒPersonally, I find it difficult to accept without considerable reservations, that a market of the size and complexity of Japan can be developed to its full potential by a single operator.Ó
In the absence of better information on performance, there seems little that can be added to these sentiments expressed by the Minister Ñ except to agree with them.
The consequences of a single seller of lamb into North America
The NZLC (formally Devco) had monopoly selling rights for lamb into North America for over 30 years ending in 1987. Since then, the monopoly to Canada has been retained but the United States market has been opened to other exporters.
Some companies which were issued with test marketing licences by the Board after the monopoly was removed have withdrawn from the United States market. It is a very demanding and specialist market and over 90% of demand is met from local production. Since the monopoly was removed, the NZLC has maintained about 70% of the trade and there are six other exporters supplying the balance.
Recently there have been suggestions that NZLCÕs monopoly should be restored. As noted earlier, the NZMPB has reviewed the performance of New Zealand exporters shipping lamb to the United States since the monopoly was removed and no substantive changes have been proposed.
As is usually the case, the call for a return to a single seller is based on the argument that this will maximise market returns. However, it is very difficult to see how this argument can be sustained, either by history or logic.
The performance of Devco over the extended period in which it had single seller status is generally considered to have been erratic and at times extremely poor. Losses required the NZMPB to provide a capital injection of $5 million in 1987, and in 1988 the BoardÕs provision for the write-down in the value of shares in the company was increased to a total of $10 million. In 1990, the then Minister for Agriculture described its history and performance as a ÒtragedyÓ, and its failure as the result of the BoardÕs mix of regulatory responsibilities and commercial interests.
Another view of DevcoÕs performance was contained in a report which canvassed the views of New Zealand meat companies.
ÒAlmost all of the companies interviewed stated that they had an interest in marketing products in the United States and had either made exploratory trips to the market or applied for test marketing licences. It was agreed that while Devco had made a substantial commitment to developing the image of New Zealand lamb in that market, it had generally been unsuccessful in exploring all of the opportunities. Reasons stated for these problems include the instability in management, the difficulties of a single organisation handling a dispersed market and also the excessive direction and manipulation of the market from New Zealand.Ó
It is difficult to understand why anyone would suggest a return to single selling after the lessons and costs of this history.
There also appears to be little logic to support the proposition that a single seller would yield New Zealand higher net returns from this market. First, as noted above, the market is dispersed which suggests that opportunities would be missed if the commercial effort directed to the market is concentrated and constrained. However, the existence of other suppliers besides New Zealand is an even more compelling reason why a New Zealand export monopoly is unlikely to achieve anything other than possibly a reduction in the investment and expertise devoted to the market.
New Zealand exporters have to compete with domestic United States producers. They also compete with Australia which currently is the major exporter to this market. While the Australian Meat and Livestock Corporation funds generic promotion of lamb in the United States, the actual exporting is in the hands of commercial meat companies.
In such a competitive market there will be severe constraints on New ZealandÕs ability to obtain sustainable premiums relative to other suppliers just by virtue of having a sole seller. In these circumstances the interests of the New Zealand industry are likely to be served best by maximising the incentives for marketing effort and innovation rather than the reverse.
The Board as a sole seller of all sheepmeats
At the time the NZMPB took control of sheepmeat export marketing, it stressed that these were changes made necessary by Òshort term marketing needsÓ and that it expected Òto return to private enterprise marketing when circumstances make it appropriate.Ó
This intervention by the Board was precipitated largely by a disagreement between the Board and the meat companies over the Òmost realistic level of pricesÓ obtainable in the market at that time. The same researchers who suggested this rationale for the intervention also concluded that Òit was not surprising that many companies felt considerable relief at being released from the burden of establishing market prices and the consequent financial costs associated with this.Ó
About a decade prior to the NZMPB assuming control over sheepmeat marketing, sheep numbers in New Zealand had begun rising in response to government incentives to increase production. Rising production was not being matched by demand growth and prices came under understandable downward pressure. It seems likely that the Board would have been under considerable political pressure to do something in the face of almost certain declines in producer returns.
In the BoardÕs 1983 Annual Report, the Chairman had the following to say about the difficult marketing circumstances and the Board's response:
ÒAt the beginning [of the 1982/83 season] it became clear that exporters would not be able to offer a fair and effective schedule for all the sheepmeat product that was expected to become available.
ÒThe easy course would have been for the Board to have sat back and let market forces operate, but that would have caused chaos in the market place. Consequently it was agreed with the Meat Exporters Council and the Government that the Board, using traditional exporters as commission agents, would sell the product.Ó
Given the supply and market situation prevailing at the time, the Board assumed an impossible task insofar as its actions were aimed at preventing a decline in sheepmeat returns. In these circumstances it might seem churlish to criticise the BoardÕs performance. However, the BoardÕs three year stewardship of sheepmeat marketing cost New Zealand taxpayers around $1 billion, and resulted in considerable quantities of lamb being rendered because markets could not be found. There was also a variety of criticisms about the BoardÕs performance as a marketer Ñ again it is understandable that an organisation without extensive experience in marketing would make mistakes.
The BoardÕs experience as a sole seller of sheepmeat is notable not just because it was a futile and costly attempt to fight the market. It also had significant effects on commercial behaviour and developments in the meat processing industry. These consequences illustrate graphically the effects market intervention can have on the behaviour of industry participants.
The BoardÕs intervention drastically altered the incentives meat companies faced. Because they were operating as agents for the Board on a fee-for-service basis, emphasis was placed on ensuring the fees were satisfactory rather than improving efficiency and productivity. It was, in fact, a period of very satisfactory profitability in the meat industry.
The chief executive of one meat company summarised the situation in the following way:
ÒCompanies had no pressure to innovate or upgrade, instead they prospered from continued inefficient processing methods, supported by high processing charges paid by the Meat Board. All meat companies did very well during those years!Ó
The BoardÕs marketing monopoly also severely restricted and redirected the marketing and market development activities of meat companies. They concentrated on by-products and the development of further processing because these were the only areas not monopolised by the Board.
ÒMost companies withdrew resources from the marketing area and in some cases, cut down overseas staff and agencies. At the same time, increased effort appears to have been expended in areas in which the companies still retained some control. The most obvious of these were processing and marketing of by-products and the development of further processed products.
ÒCompanies were also quick to seek out opportunities to act as agents on behalf of the Board. The wide range of activities which individual companies performed included buying stock, storing meat, cutting and packing of primal cuts, and acting as sales agents in specific countries.Ó
For many companies these changes meant the cessation of agency and marketing relationships they had developed with customers. These had to be re-established when the companies resumed marketing at the end of 1985.
What are the lessons from past intervention and control in the market place?
The examples of intervention in the market place discussed here contain some important lessons about the ability of the NZMPB fundamentally and successfully to alter market outcomes, and the consequences for producers and meat companies when they try.
In the highly competitive international food market there is nothing unique about New Zealand meat. It needs to be price competitive to sell. It is futile to think that New Zealand can extract significant additional revenue by colluding in a market where consumers have alternative suppliers and products, and price has been demonstrated to be the key influence on consumption.
Even the NZMPB has had marketing experience highlighting the importance of price and the need to meet the market if product is to be sold. The Board made the following observations in its 1984 Annual Report:
ÒThe 1983-84 season opened with high levels of lamb and mutton stocks in storage in New Zealand and a projected record lamb and sheep kill. World demand for sheepmeats being on the decline and under pressure from alternative products meant that the Board and the meat industry faced a daunting task.
Under these circumstances a successful marketing year was achieved although prices in some instances had to be cut in order to move volume.Ó (emphasis added).
No reference to weak selling or price undercutting here. Simply the recognition that supply and demand are the fundamental influences on prices.
The major lesson to be learned from the experience of the Board as a sole seller of sheepmeat is that intervention in the marketing system will not solve a problem of oversupply caused by subsidies and distorted prices to producers. This was the fundamental cause of the problem in the early 1980s, and a lower return to farmers was the only outcome likely to bring supply and demand back into balance regardless of who did the marketing. The New Zealand wool industry has recently had a similar experience as a result of trying to dictate to the market.
The diversity and complexity of the international meat market is also an important consideration in determining the likely efficacy of market intervention. In such market circumstances it is in everyoneÕs interest to maximise the amount and variety of expertise and investment devoted to marketing and market development. Only if this happens is it probable that all opportunities and ideas will be discovered, tested, and, where appropriate, implemented commercially.
The Japanese sheepmeat market provides a good example. On the evidence available it is not possible to know whether the Board-conferred selling monopoly in this market is making the industry better off or not. How can it be known whether profitable opportunities are being missed? If the current marketing companies Ñ Anzco and Janmark Ñ have developed the relationships and infrastructure needed for success in this market, then why and how could their success be reduced by permitting others to export?
The other important consideration is whether the monopolist gets it right in terms of determining the best approaches to marketing. For example, decision making on how best to market New Zealand lamb in Japan is currently very concentrated. If these decision makers get the strategy wrong, the whole industry will be affected. Furthermore, how long might it take for mistakes to be recognised and rectified. The Devco experience was a salutary lesson in this regard.
Probably the most significant consequence of past intervention in marketing by the NZMPB has been the stultifying influence it has had on the activities of the meat companies. Intervention, restrictions, and regular changes in the rules have reduced and distorted incentives faced by the private sector to invest in marketing and market development. They were either not allowed, or faced considerable risks of the rules suddenly changing if they tried.
There is some recognition that past approaches are not the way of the future. The Chairman of the Board has said:
ÒWhen it handed control [over sheepmeat marketing] back at the end of 1985, the Board said it did not wish to again become directly involved in marketing meat. Now, seven years later, most people believe us;Ó
and
ÒReform to the way the Board issues meat export licences and reducing the number of markets to which special access conditions apply are among the moves intended to help meat companies. These reforms are part of our belief that greater market place coordination must come from agreement amongst meat companies rather than from legislation and bureaucracyÓ
Nonetheless, and as picked up in the conclusions of this chapter, there remains considerable regulation and control of marketing activity and the entrepreneurial environment, and the BoardÕs very extensive regulatory powers remain in legislation. Restrictions and rule-changes in the marketing area have been significant factors underlying the poor performance and problems of the meat processing sector. These issues are discussed in the next section.
10.3.2 New Zealand meat processing Ñ distortions, restrictions and lost opportunities
It is hard to avoid feeling sympathetic towards the participants in the meat processing industry given the environment they have been required to operate in, and the circumstances they are now experiencing as a consequence.
The processing sector has never been short of critics. The sector is said to have a throughput mentality, lacks management strength, persists in marketing a commodity instead of a food product, has no long-term vision being always driven by immediate profits, competes destructively in markets driving prices down, and does not have the livestock producersÕ interests at heart.
It tends to be portrayed as having few redeeming features. However, to have survived for so long and to have demonstrated some ability to innovate and take risks, with so many faults and unresolved problems, is a creditable feat in itself. Meat is still New ZealandÕs number one industry.
The industryÕs problems have been well diagnosed
There have been numerous studies, inquiries and pronouncements on the industryÕs problems and their underlying causes. There is plenty to suggest that the problems have not been the fault of incorrect diagnosis, but rather an inability, for whatever reason, to correct distortions and ensure improved policies were put in their place.
The following is a recent diagnosis of the industryÕs problems by the NZMPB.
ÒAt sector level the reality is that the meat industry is still largely production-driven. Causal factors are many and include a combination of structural, institutional and circumstantial factors. The majority of meat companiesÕ assets are in the processing area and company emphasis is directed at maximising throughput which results in an excessively competitive livestock procurement market and results in inadequate company profitability. This in turn constrains company investment in the all necessary product and market development initiatives.
ÒThe relatively recent rationalisation of proprietary interests has placed the majority of industry capacity in the hands of farmer co-operatives. While farmer co-operatives may have served the industry well in the past it is recognised that in the current and expected future environment, changes will be necessary. There is an absolute lack of capital in the meat industry. The challenge is a structure that retains and enhances farmer commitment to the organisation, facilitates the entry of new capital to correct any balance sheet weaknesses and allows for growth, and, most importantly, encourages the development of critical mass and scale and thus ability to invest in the all important marketing function, and at the same time allows for commercially sound competition in the livestock procurement and processing areas.Ó
To understand fully why the meat industry is not in better shape, and what needs to be done to restore its confidence and profitability, it is necessary to consider the major features of its operating environment over the past few decades. The factors which have had the greatest impact, and contributed most to the distortions and uncertainty in this environment, are:
¥ licensing controls over the establishment of plants, until their removal in 1981;
¥ government price subsidies and industry stabilisation schemes encouraging increased production when the market was signalling otherwise;
¥ intervention, on behalf of producers, in the processes of structural adjustment and ownership changes in the industry;
¥ costly and inflexible work practices, a product of an outdated system of labour laws;
¥ restrictions and controls over marketing and market development activities, and regular changes in these rules and regulations; and
¥ distortions to transport and freight prices and very slow progress in reforming policies and reducing costs.
In combination, and over time, these influences have resulted in a processing sector which:
¥ is continuing to experience problems of overcapacity, indebtedness and overgearing, and lack of profitability;
¥ has a cost structure which, in the mid-1980s, was estimated to be 50 to 100% higher than in competing countries;
¥ faces disincentives and high risks when contemplating investment in marketing and efficiency-enhancing structural changes;
¥ is predominantly owned by producers, ensuring that they bear the costs of past mistakes and future reconstruction; and
¥ lacks capital.
The industryÕs problems, and their underlying causes, were outlined in 1985 by consultants to the then Meat Industry Council. They had the following to say:
ÒThe New Zealand meat processing industry is a weak competitor internationally and is enmeshed in a web of anticompetitive forces in the domestic environment. Its position is not the fault of any particular group of people, but the result of long interaction of many factors: high barriers to exit; similar technologies and plant configurations; restrictive practices of companies, unions, the Meat Division of MAF and the Meat ProducersÕ Board; optimisation of farm economics to the farmgate but not beyond; and licensing and price controls, which are now lifted but still affect the character of the industry. All of these factors have contributed to an industry where the lower cost producers cannot drive the higher cost producers out. This in turn has led to a general lack of innovation and vigour in cost reduction and to uniformity of pricing Ñ or, using the well-known phrase, to the cost-plus mentality.Ó
However, it does need to be acknowledged that there are some positive developments occurring in the industry which are both a recognition of past deficiencies and a reflection of industry initiatives taken in response. There has been considerable plant rationalisation and improvements in productivity, increased product value-adding and a small movement away from the command-and-control philosophy.
Plant licensing was an effective barrier to entry
Meat plant licensing, which was abolished in December 1980, was designed to be a barrier to new entrants, and it appeared to be successful in meeting that objective. Between 1934 and 1980 only a handful of new plants opened despite a 350% growth in industry throughput.
The resulting reduction in competition undoubtedly had a profound influence on incentives within the processing sector to improve productivity and adjust structurally. For example, it encouraged companies to invest in improvements in older plants when this capital should probably have been directed to upgrading technology and improving productivity through new plants. As the Executive Director of the MIA observed:
ÒThe meat plant licensing system that lasted until 1981 meant that when the European Community demanded we upgrade our facilities, upwards of $1 billion was ploughed into our plants regardless of their age and efficiency.Ó
When the licensing was removed, older plants were overcapitalised and experienced understandable difficulties in competing with new entrants and maintaining acceptable levels of profitability. The implications of this, and particularly the question of who should bear the costs of restructuring, lie behind the extraordinary efforts that have been made to devise painless solutions to the painful problems that are the legacy of intervention and regulation.
The restrictions on new entrants also contributed to the labour cost and productivity problems the industry has experienced over an extended period. In the absence of competitive pressures, and in an environment where it was relatively easy to pass on costs, organised labour had a competitive advantage in negotiating wages and employment conditions. Restrictive labour rewards and conditions, and meeting redundancy conditions negotiated in a less competitive era, have added further to the costs of restructuring.
From the Ôfrying panÕ of plant licensing to the ÔfireÕ of more distortions
During the years immediately following the removal of plant licensing, developments and policies in the industry exacerbated, rather than helped solve and reduce, the structural problems and associated costs. The effects of livestock price subsidies and incentives, which were finally removed in the mid-1980s, were increasing slaughter numbers up to 1983/84 and then the commencement of a sharp decline.
Shortly after plant licensing was removed, the NZMPB assumed full control of sheepmeat marketing for three years. The commencement of the decline in slaughter numbers coincided approximately with the abandonment by the NZMPB of its sole seller role in sheepmeat marketing.
Consequently, for a period immediately following the removal of plant licensing, throughput was rising and meat companies were relieved of the responsibility of marketing and its associated financing and received good returns as agents of the Board. These circumstances further encouraged the establishment of new, more productive plants, and delayed or dulled the incentives for existing participants to restructure.
In the second half of the 1980s the meat industry had to resume responsibility for sheepmeat marketing, and accommodate sharply falling throughput. It was in a situation where its major structural and financial problems had still not been addressed, and if anything had got worse.
It was during the second half of the 1980s also that the government, the NZMPB, and the industry collectively devised plans to restructure the industry. An important objective was to ensure producers retained ownership and control, and this has essentially been achieved. However, from the producerÕs viewpoint, the question which must now be asked is: ownership of what and at what cost? The industry is still far from being satisfactorily restructured, or from having incurred all the costs of doing so.
Restructuring strategies have ensured that producers meet future losses and adjustment costs
The restructuring which has occurred in the meat processing industry since the late 1980s has been very much driven by Freesia Investments Ltd, the BoardÕs wholly owned subsidiary.
Its central objective appears to have been to ensure industry restructuring resulted in producers achieving dominant ownership and control in the industry. The then Chairman of the NZMPB emphasised at the time the importance of returning predominant ownership to producers. The Chief Executive of Freesia was quoted as saying that the company had Òtried to rationalise a processing system that in lurching from crisis to crisis had cost the New Zealand producer dearly.Ó
Central to the restructuring process were the commercial problems of Waitaki International Ltd. This publicly listed meat processing and exporting company processed around 40% of the New Zealand lamb kill and 30% of the beef kill before it was broken up and effectively Ôtaken overÕ by Affco and Alliance. Facilitating the exit of the prominent corporate investors who had entered the industry during the 1980s was also part of the plan.
While some plants were closed as part of the restructuring and ownership changes involving Waitaki, the exercise has very much been one of Ôrearranging the deckchairs on the TitanicÕ. The corporate participants have suffered major capital losses during their withdrawal.
However, FreesiaÕs efforts have left producers predominantly responsible for an industry which still has to incur substantial structural adjustment costs Ñ see Box 10.3. The two major producer cooperatives, Affco and Alliance are highly geared, and have incurred substantial losses which have weakened their balance sheet positions. These costs will add to the losses producers have already incurred through the operations of Freesia Investments Ltd.
Freesia made a substantial loss in 1987/88 which, according to the BoardÕs 1988 Annual Report, was Òtotally due to a downward revaluation of investments made by Freesia. This revaluation is due to FreesiaÕs considerable exposure to the very high debt-to-equity ratio faced by our meat industry.Ó In December 1987 Freesia invested $41 million in Waitaki International. The revaluation of this investment referred to in the Annual Report involved a write-off of $32 million.
Opinions on how successful Freesia has been as an investment vehicle for restructuring the industry on behalf of producers are varied. Clearly, industry restructuring was needed, and Freesia represented a vehicle whereby some funds could be retained by the industry after the BoardÕs unsuccessful excursion into sheepmeat marketing.
Apparently the Meat Board considered that in the absence of this type of intervention the industry could well have needed to accept foreign investment and ownership which would have been Òuncommitted to the longterm good of the industry.Ó It is interesting to note that, more recently, a producer member of the Board said Ò. . . we must look to overseas investment for money, experience and more importantly distribution horsepower.Ó
An alternative view on FreesiaÕs performance has been expressed by a producer member of the Electoral Committee who said:
ÒItÕs important to cut through the posturing and self-congratulation which emanates from any discussion of Freesia, to ascertain its true worth to the industry.
ÒFreesia's initial objectives were cloudy, other than to be a much vaunted marketing ÔcatalystÕ - an area in which it is strangely enough still to make an entry.
ÒWith $32 million written out of the BoardÕs 1988 accounts it says little for the manner in which we do our business, when not a head rolled or backside was kicked.Ó
This producer representative also observed that FreesiaÕs investment in Waitaki allowed the corporate shareholders in Waitaki to extricate themselves with honour, preventing the natural rationalisation that would have followed a Waitaki receivership. This essentially highlights what might have been the consequences of commercial forces being allowed to take their course.
An important feature of industry restructuring during the late 1980s and early 1990s was the fact that few of the assets being traded and rearranged were actually valued in the market place by being competitively transacted. Some insight into the nature of the negotiating processes is afforded by the following:
ÒThe public and recorded events are just part of a larger scenario involving fancy footwork, decisions abandoned at the altar, and above all endless meetings where the same group of people changed from ally to adversary and back again.Ó
Producers can consider themselves somewhat unfortunate that, at the time Waitaki was in greatest commercial difficulty, their Meat Board had just withdrawn from sheepmeat marketing, had secured funds from the government as part of the withdrawal deal, and was looking for something new to do. Had this not been the case, WaitakiÕs problems may have been solved in the market place with producers now being better off as a result.
As it has happened, producers now own meat company assets which have still not been valued by the market place, and most certainly are grossly overvalued relative to what the market place would pay in the absence of intervention.
Asset values will have to be written down one way or another before the industryÕs structural problems are solved. It matters little whether this occurs through commercial collapse and immediate write-offs, or arrangements and schemes which aim to help companies trade out of their difficulties. Either way, substantial costs will be incurred, and at least a proportion of them will be borne by producers.
Constrain meat company marketing and then criticise production-driven culture
Perhaps the most cruel irony perpetrated on meat companies by the NZMPB has been to impose constraints on their marketing activities, and at the same time criticise them for being production-driven and not sufficiently market oriented. The extent to which marketing activity has been controlled has been outlined earlier in this chapter.
Meat companies have had to operate in an environment where there were rules and restrictions on freight, carcase grading and quality control, and who could sell what, in which markets. The consequences of such intervention are easily predicted. Entrepreneurial companies can be expected to concentrate their efforts and investments in those areas where they have been left some commercial freedom. Conversely, innovation and investment would avoid areas where the rules constrain commercial behaviour. The reactions of companies during the period of NZMPB control over sheepmeat marketing, noted earlier, illustrate this logic at work.
Other more general consequences which might be expected include:
¥ smaller companies, not having to worry about higher unit freight costs because of lower volume, would have less incentive to chase opportunities in niche markets and develop higher value products;
¥ incentives facing individual companies to brand, and be prepared to back the quality reputation of their product, would be diminished; someone else is seen to be responsible for that and the commercial benefits of differentiation are constrained by common rules (see the example in Box 10.4);
¥ companies which have markets administratively allocated to them will be under diminished commercial pressure to perform; other companies will ignore opportunities in these markets because they know they are blocked out;
¥ in situations where companies can supply markets but are not responsible for the marketing, they can be expected to behave in an Ôall care but no responsibilityÕ manner; and
¥ assertions about destructive price competition are likely to be common because so many of the other non-price opportunities for competing have been removed or restricted.
These are very much the type of outcomes that have characterised the New Zealand meat industry for many years. Similar conclusions were reached by McKinsey and Company when it examined the industryÕs problems in 1988:
ÒThere is little or no incentive for processors to invest in developing new markets under current arrangements despite the substantial volume opportunities that may exist.
ÒIn many cases Ôdevelopment marketsÕ have been declared by the Meat Producers Board, taking responsibility for marketing away from individual processors as a means of developing a coordinated NZ approach.Ó
The BoardÕs intervention in marketing has also increased the uncertainty and risks meat companies face. The reason for this is the frequency with which the rules and conditions are changed. Meat industry companies have to take this uncertainty into account when making investment decisions. It undoubtedly makes decision making more conservative, and understandably so.
The recently established MPC represents the most recent change in the rules regarding what companies can and cannot do in the market place. It is a new form of entry barrier and its implications will be similar to those which flowed from meat plant licensing.
It will suppress investment, innovation and ideas-testing in marketing and product development. By definition it must do this because those who believe they will benefit from its activities are those who find most of their commercial aggravation coming from innovative, new investment.
It will greatly centralise decision making regarding what is best for the industry in terms of marketing and market behaviour. Conceivably such centralised decision making might make correct decisions more often than not. But history does not inspire confidence that this will happen. As the wool industry painfully discovered, mistakes by centralised decision-makers can have very unfavourable consequences for an entire industry.
Finally, extensive intervention and policing of an industryÕs commercial behaviour unfavourably influence the culture and confidence of companies. Participants lose confidence in their entrepreneurial ability, come to rely on others to make the decisions, and have the will to fight and win diminished. A culture develops where there is a fear to have a go. Those outside the industry find investment opportunities unattractive and look elsewhere.
Some successes are being claimed for the MPC. The suggestion is that it is helping to teach meat companies the commercial advantages of cooperation in certain circumstances. This Òinfant-industryÓ argument has considerable appeal and is frequently used to justify intervention on a specific and limited basis. The problem is that regulations justified on this basis invariably become entrenched and extended well beyond their initially envisaged role and duration. The risks Ñ and costs Ñ of this happening might reasonably be judged as always higher than any benefits if the intervention worked as intended.
Notwithstanding all the restrictions and uncertainties, the industry is not completely devoid of examples of innovation and commercial success. The story of a small meat company and its innovative success, described in Box 10.5, is a case in point.
The fact that some have achieved success, notwithstanding the constraints and risks, is a valuable indicator of what might occur if the meat industry had more commercial and creative freedom.
10.3.3 Transport and freight Ñ very slow improvements under the influence of the Board
The location of New Zealand relative to its markets means that transport and freight costs are an important influence on net market returns to producers. The industryÕs annual freight cost is over $350 million. Maximising the efficiency of transport and freight services, and minimising their cost, have understandably been key objectives since the industry began. As the Board noted recently:
ÒFreight has always been a major concern to the industry. At the top of the BoardÕs agenda when it first met in 1922 was freight.Ó
However, the performance of the Board in achieving these objectives has been fairly unimpressive, and only in recent years, under considerable pressure from the meat industry and in response to developments in Australia, has the pace of improvements in transport and freight arrangements, and reductions in costs, quickened.
The Board does point to significant improvements in transport and freight technology such as palletisation in the late 1950s, mechanical carcase loaders in the early 1960s, containerisation in the 1970s, and unitisation of cargoes in the 1990s. However, the benefits of technological improvements can easily be dissipated, or not shared appropriately, because of incorrect policies and insufficient competition.
Change has been slow because of the consequences of past policies
There would appear to be two main reasons why progress with policy reform and cost containment have been tardy. The first relates to the industryÕs long history of pooling land-based transport costs and ensuring shipping freight rates were generally the same for all exporters, regardless of service requirements or volumes. These policies entrenched distorted investment and cost structures, leading many industry participants to have a vested interest in the retention of the policies, or at least the slowing of necessary reforms to them.
The second reason for tardy progress is that for most of its history the industry has apparently taken the view that decisions about shipping rates and services Ñ both are important but there are trade-offs Ñ needed to be centralised. This underpinned relationships between the NZMPB and shipping conferences wherein the conferences assured a service but, by virtue of their monopoly, were able to capitalise on their bargaining strength when it came to freight rates.
The influence of these factors is well illustrated by the slow progress during the first half of the 1980s in achieving agreement on how to reduce land-based costs, and how they should be paid Ñ see Box 10.6.
Similar considerations underlie the slow progress in moving towards allowing individual companies to negotiate their own freight arrangements. The Chairman of Affco summed up the attitudes of bigger companies towards the system of Ônon-discriminationÕ in setting freight rates in the following terms:
ÒA major area for increased return to Affco is in the area of shipping. Under present legislation Affco must ship product at the same price as a works producing at say 5% of our size. In simple terms if Affco sends 4000 containers to the US and a competing processor sent 40 containers per annum the shipping price to both exporters would be the same. This position is not acceptable to Affco because in simple terms the exporter is being subsidised by Affco with 4000 containers. No other business would find this commercially acceptable. An answer must be found on this matter urgently.Ó
The equalisation of transport and freight costs has undoubtedly had effects on the locational and structural features of the meat industry. If smaller plants are subsidised, larger plants are made less viable and inherently unprofitable smaller plants may be constructed. Past transport and freight pricing policies have undoubtedly contributed to current structural adjustment problems in the meat processing sector.
There has been evidence that competition would favourably influence freight rates
Over the years there has been ample evidence that greater competition in the provision of ocean freight services would have had beneficial effects for the industry. It is ironic that the more recent introduction of greater competition into the provision of ocean freight services has resulted in part from pressure exerted by those shipping lines excluded from the trade by the NZMPB. The fact that shipping companies often fought long and hard to participate in the trade is a significant indicator that the meat industry was paying too much for shipping.
The following are examples of competitive pressures at work and the various responses by the NZMPB:
¥ In 1981 the Board prevented Waitaki from using non-conference shipping on the European trade and this action was challenged legally Ñ Waitaki lost. The Board reported that WaitakiÕs proposed action was Òcontrary to the BoardÕs contractual obligations to the British and New Zealand LinesÕ ConferenceÓ, and used its legislated powers to take control of the meat owned by Waitaki.
¥ In its 1982 Annual Report the Board noted that Òfollowing a freight war in Australia in January this year, the New Zealand meat industry received a 10% reduction in freight rates to North America to retain the relativity it had with its Australian counterpartsÓ.
¥ In the mid-1980s it was reported that ABC Containerline had cut rates to the United States by nearly 20% Òafter winning a five year battle for the right to compete in this trade.Ó
¥ The 1987 Annual Report recorded freight rate reductions to North Asia by introducing competition. The Board said that Òsignificant freight reductions were achieved by tendering the conventional shipping arrangements. This was achieved through the single seller/buyer operation of Anzco, enabling guaranteed tonnages with penalty provisions to be included in the tender document.Ó
An insight into how the Board, at least until recently, viewed the introduction of competition into shipping services is provided by the following comments attributed to the BoardÕs Chairman in 1985:
Ò. . . letting other lines into the trade depends on their convincing the Board that they had something to contribute beyond just expanding the freight war.
ÒWe want to keep capacity in balance. We don't want the trade to become overtonnaged with too many carriers.
ÒThere might be some short-term gain from more competition. But in the long-term someone pays.Ó
These comments are interesting insofar as they imply that the New Zealand meat industry, or more particularly the Board, can and should want to influence significantly international shipping capacity. It would not be surprising if such a suggestion were advanced by a conference shipping company trying to negotiate retention of a monopoly, but it seems inconsistent with the facts and the manner in which the international shipping industry operates. Certainly, the shipping line that had been Òfighting for five yearsÓ to enter the trade apparently had less concern about overcapacity, and it had significant investment at stake.
Furthermore, if shipping companies do overinvest in capacity, why shouldnÕt New Zealand producers benefit? Even if excess capacity leads to some shipping companies failing, this does not necessarily result in the ships disappearing Ñ they would be operated by new owners. Essentially, the Board was misguided in being so concerned about ensuring shipping companies remained viable so services would be maintained. The evidence has always suggested that there were plenty of investors wanting to participate Ñ and this seems to be more the case today than ever.
Significant changes associated with the establishment of the Meat Industry Freight Council
The historical relationship between the NZMPB and the shipping conferences appears to be changing rapidly. Moves to introduce more competition and resulting reductions in costs have accelerated markedly since the formation of the Meat Industry Freight Council (MIFC) and the involvement of meat industry executives in the negotiations.
Meat companies have long argued that they should be responsible for freight negotiations, or at least heavily involved. In this regard it is interesting to note the sharply differing views on how freight negotiations should be conducted to benefit producers by bodies Ñ the NZMPB and producer cooperative meat companies Ñ which all profess to be working in the interests of producers.
In 1989, shortly after the formation of the MIFC, a two year agreement with the European shipping conference delivered modest reductions in rates, and total savings over the two years of $28 million. The conference had to accept a much shorter contract period than it was requesting and agree to allow shipping trials to be conducted using non-conference lines.
Freight rates for beef to North America fell sharply at the beginning of 1991 as the result of introducing more competition to that route Ñ see Box 10.7. In this instance freight rates fell by over 40%, and virtually overnight.
10.4 The Emerging Deer Industry
The New Zealand deer farming industry is a relatively new, non-traditional and small but rapidly growing sector of agriculture. The industry has expressed a strong desire not to emulate the approach to marketing that has been used in the traditional red meat industry.
The characteristics of the deer industry, its institutional arrangements, and the likely consequences of these arrangements are reviewed briefly in this section. The industry has not been studied in the same detail as the sheepmeat and beef industries. Emphasis has been placed on key features and, particularly, the question of whether the policies being adopted will deliver outcomes superior to those experienced by the traditional red meat industry.
10.4.1 A transition from feral deer to farming
New ZealandÕs first commercial deer farm was established in 1970. Prior to this feral deer had been harvested by an industry originating in the 1960s, and a small processing and exporting industry had been established.
Initially, the deer farming industry was driven by good commercial returns from velvet. Taxation incentives were also an important influence on growth in the 1970s and early 1980s. Until the early 1980s there were virtually no farmed deer slaughtered as all breeding stock were retained, and males were kept for velvet production.
The farming of deer is now a well established industry in New Zealand. Nearly 5,000 farms run deer; almost one third of those have deer as the dominant enterprise. Deer farmers formed the New Zealand Deer Farmers Association (NZDFA) in 1975.
The industryÕs exports were valued at over $100 million in 1989/90; an increase of 56% over the previous year. Revenue is derived in roughly equal proportions from venison and velvet production. New Zealand is now the worldÕs largest exporter of farmed venison. Returns fluctuate as they do in every other primary industry. As the President of the NZDFA has observed:
ÒHaving enjoyed dramatically rising velvet prices for the past six seasons, many deerfarmers have forgotten that historically, returns to growers have fluctuated enormously.Ó
The same applies to venison, the returns for which have also declined until recently.
10.4.2 Exports are forecast to grow rapidly
When the exporting of farmed venison commenced in the early 1980s there were about twenty companies involved in the trade. Now there are eight and the biggest three account for around 80% of venison exports. The NZDFA owns about one-third of one of the larger processor/exporters, Venison New Zealand Ltd; the remainder is owned by farmer shareholders. The New Zealand Deer Industry Association (NZDIA) represents processors and exporters.
Most venison exports are in the form of cuts. By the mid-1990s annual venison exports are forecast to be around 18,000 tonnes.
Consumption in Germany has been mainly venison from wild deer which is marketed as game meat. New Zealand is promoting venison from farmed deer as less strong tasting in an attempt to differentiate the product. Germany imports about 50% of its venison requirements and New Zealand currently supplies 10% of these imports. The main competitive import suppliers are in Eastern Europe, where production is from wild deer. Supplies from Eastern Europe have declined since the major political reforms commenced in this region.
The United States is the fourth largest market by volume for New Zealand venison. In this market there is more ready acceptance of venison from farmed deer because there is less tradition with game meat, and consumer resistance to its strong taste. Nearly all the farmed venison consumed in the United States is currently sourced from New Zealand.
New Zealand has a 70% share of the world velvet trade. Its main use is as part of traditional medicine in Asia. The Republic of Korea is New ZealandÕs single biggest market for velvet. Over 90% of velvet produced in New Zealand is dried or further processed before export. Velvet processors recently formed the New Zealand Velvet Processors Association (NZVPA).
10.4.3 The game industry Board and other regulations
The industry's marketing arrangements, and their institutional features in particular, reflect a strong desire not to be ÔincorporatedÕ into arrangements which existed for the red meat industry.
The deer industry has implemented institutional marketing arrangements aimed at coordinating the industry's activities in regard to quality assurance, branding and promotion, while leaving individual processors and exporters to compete for supplies and customers and undertake their own market development initiatives. The overall strategy is to try to position New Zealand grass fed venison and velvet as superior, differentiated products in the international market.
The development and implementation of this industry strategy is the responsibility of the New Zealand Game Industry Board (NZGIB). The Board, which was created in 1985 by regulations under the Primary Products Marketing Act, is funded by a compulsory levy on velvet and farmed deer slaughtered.
The NZGIB was restructured in 1991. It now comprises ten members, of which five are appointed on the nomination of the NZDFA to represent deer farmers. The NZVPA nominates one representative and three are nominated by the NZDIA Ñ the Minister must consider at least one of these four appointees has Òcommercial expertise gained otherwise than by involvement in game processing or game exporting.Ó
Under the current regulations the tenth member of the Board is appointed as a representative of the government to represent the interests of consumers. However, pending amendment of this regulation, and reflecting the purpose of the proposed amendment, the Minister has appointed a member with commercial expertise rather than a representative of the government. The Chairman of the NZGIB is elected by the Board from the deer farmer representatives.
The regulations specify detailed functions and powers for the board. They include the requirement that the board Òpromote and assist with orderly development of the game industryÓ and Òassist in the organisation and development of the orderly marketingÓ of game industry products, the provision of information on all sectors of the industry, and the ability to Òundertake, or cause to be undertakenÓ deer industry R&D.
Importantly, the functions and powers extend to allowing the Board to invest in processing and marketing activities and ventures, both in New Zealand and overseas. However, the regulations prevent the board from acquiring Òany game or products derived from game except for promotional, experimental or development purposesÓ.
Part III of the regulations provides extensive potential powers to license and control the activities of exporters. However, an Order in Council under the Meat Industry Act would be necessary to allow the NZGIB to exercise these powers. Two requests to have the powers activated have been declined by the Minister at the time, as discussed below.
Deer are not designated as ÒstockÓ under the Meat Export Control Act. Deerfarmers insisted on deer slaughtering premises that were physically separate from other red meat slaughter facilities, and licensed by MAF under the Meat Act 1981. It was apparently considered that if deer were processed in traditional meat works this would be detrimental to the development of necessary quality assurance programmes and, potentially, market access.
The NZGIB has introduced a voluntary appellation quality assurance and branding program for New Zealand venison. Processors who agree to have their slaughter premises accredited under this programme are required to meet quality standards which are said to be very high by international benchmarks. All major venison processors and exporters have joined this programme.
According to the President of the NZDFA, Òthe Game Industry Board is moving rapidly to implement an international marketing strategy quite unlike the conventional free enterprise or single desk options associated with most of New ZealandÕs primary sectors.Ó In fact, the industry is implementing umbrella arrangements where compulsion and regulation are used to fund certain objectives and activities, and competition is allowed to occur within these rules.
This type of approach was implied strongly by the previous General Manager of the NZGIB when he said:
Ò. . . deer farmers have little enthusiasm for unbridled free enterprise as many of them consider the wider meat industry to be an example of how that approach too often leaves the producer as the final recipient at the end of a chain of diminishing returns;Ó
and:
ÒIt is extremely unlikely that either of these initiatives [branding strategy and quality assurance programme] would or even could have developed spontaneously in the absence of a body prepared to take a long term strategic view of the needs of the deer industry and in a position to fund them;Ó
but:
ÒFor a new and growing industry like the deer industry there are very strong arguments for having several strong players differentiating their products and seeking out new distribution and marketing niches while broadly adhering to and supporting an agreed marketing concept.Ó
The deer industry professes a desire to develop the industry with a mix of regulations and competition. However, politics and political compromises have already featured prominently in the development and modification of institutional arrangements. This does not augur well for the future.
10.4.4 Political compromise the main explanation of current arrangements
The deer industry, and particularly deer farmers, are essentially making a virtue out of arrangements which owe their main features to political compromise, and an inability to achieve preferred and more interventionist options. Arguments over the membership of the NZGIB, and attempts by deerfarmers to have export licensing powers enacted, are testimony to this conclusion.
Considerable wrangling over Board membership
Restructuring of the NZGIB in 1991 was preceded by an extended period of argument within the industry, and between industry sectors and the government, over the composition of membership. It was largely an argument over whether it should be a Ôproducer boardÕ or an Ôindustry boardÕ. There was also dissension in the industry over the use of levy funds by the NZDFA to purchase equity in a processing/exporting company.
The outcome has been a board which some would portray as representing the industry, but which the deer farmers can effectively control. It has been given the ability to invest in the industry, although not, interestingly, in deer farming.
Requests for control over exporters have been refused
As noted earlier, the regulations contain inactive provisions for the licensing of exporters and extensive control over their commercial activities Ñ they are basically the same powers as those exercised by the NZMPB. Currently, exporters are licensed by MAF under the Meat Act and the issue of a licence is a routine matter if the plant complies with local government requirements. It is more akin to a system of registration rather than licensing, because no controls are exercised over the exporterÕs commercial activities.
On two occasions the deerfarmers requested the then Minister to activate these export licensing and control powers. Both requests were declined on the grounds that insufficient reasons were given as to why it was essential for the Board to have such powers.
This history, and the subsequent action it encouraged, contains an important lesson. The refusal of the Minister simply to comply with a request for greater intervention required the industry to develop an alternative approach to achieving its aims. The alternative was the appellation programme.
This programme is voluntary and its continued success depends, in part, on industry participants believing that its benefits are worth the costs of involvement. Exporters can opt out if they wish and develop their own marketing and promotional activities. However, in choosing to do this they forgo any benefits that result from the programmeÕs expenditure which is funded from the compulsory levy which all must pay.
The outcome is, therefore, something of a ÒcurateÕs eggÓ Ñ good in parts. The concept of a quality assurance and branding programme which is voluntary and survives on the basis of its perceived cost effectiveness, is commercially sound. However, to allow people participatory choice but compel funding contributions is highly contradictory, and makes any assessment of the programmeÕs cost effectiveness very difficult, if not impossible. It is a classical outcome of political compromise.
Will the deer industry end up with the same problems as the traditional red meat industry?
While New Zealand leads the world in deer farming and exporting, it is estimated that up to thirty countries including Australia are copying New ZealandÕs lead. The big challenge facing the industry, therefore, is the maintenance of a competitive advantage over those who choose to copy.
The key questions are whether the industryÕs existing arrangements will ensure competitive advantage is retained, and the problems of the traditional red meat industry are avoided. The answer to both questions at present is: probably not.
The deer industry does not currently have institutional marketing arrangements which interfere in commercial activity to the extent of the NZMPB. However, it has in place a legislated framework which could very quickly be changed to allow this to happen. This carries two dangers or disadvantages.
First, it only requires sufficient industry pressure to gain the responsible MinisterÕs agreement and the deer industry would have institutional marketing arrangements identical to those in the red meat industry. Politics and political compromise have already influenced arrangements so this is a real danger, especially when there is a sustained industry market downturn.
Second, commercial activities in the industry, particularly the willingness to invest, try new ideas, and take risks, will be unfavourably influenced by the uncertainty which the legislation, and the possibility of its application, creates. Furthermore, the ability of the Board to invest in commercial activities should cause industry participants to worry about the possibility of ÔFreesia-typeÕ losses which they would have to pay for through the compulsory levy.
10.5 Conclusions
The history of the New Zealand meat industry, particularly over the past decade or so, is a sorry tale of intervention and under-performance. It is hard to envisage circumstances which would have resulted in producers, the meat industry, and the New Zealand economy being worse off Ñ and still the problems remain and many of the costs of putting them right have yet to be met.
It is often asserted, particularly by supporters of single desk exporter monopolies, that poor performance in the meat industry is an excellent example of the consequences of unregulated, private sector marketing. After reviewing the history and circumstances of the meat industry it is difficult to understand how anyone could believe the meat industry remotely approximates an open and competitive marketing system. Perhaps more than anything else, citing the meat industryÕs performance as the role model of competitive marketing underlines how out of touch many in New Zealand agriculture are with what constitutes minimal regulation and intervention.
The cause of the meat industryÕs problems is simple and self-evident. Successive New Zealand governments, through their subsidies, incentives and interventionist legislation underpinning the NZMPB, have created an environment which distorted prices, constrained entrepreneurial activity, and increased the uncertainty and risks all industry participants faced. The entire industry has been the victim of interventionist thinking and restrictions on choice which have led inevitably to politics and vested interests dominating industry developments at the expense of commercial incentives and marketplace outcomes.
The NZMPB has required the industry to try every known variation for marketing meat except letting entrepreneurs get on with the job without interference. The result has been a production-oriented culture as companies endeavoured to capitalise on those restricted opportunities where there was some commercial freedom.
The Board has perpetuated, and put into practice, the myth that producers have to own and control businesses past the farm gate to maximise their farm gate returns. The result has been the continuation of structural deficiencies and poor commercial performance in the meat industry, and a backlog of adjustment costs that are likely to be borne principally by producers.
It may be that attitudes in this area are slowly changing although it is questionable whether some of the fundamental issues are fully understood. The BoardÕs Chairman has said that:
ÒStrong producer ownership is a reality, but not without controversy. Farmers are not enthusiastic about the level of control they have, and do not seem to understand their role as company shareholders . . . There either is a clear need for improved farmer education in this area of maybe the control of meat processing and exporting doesnÕt belong in farmer hands.Ó
Farmer education will only lead to more effective shareholder control if it results in them understanding the fundamental importance of investor choice and causes them to demand that it be provided.
Intervention in transport and freight has distorted costs and investment decisions, retarded the introduction of beneficial competition and appropriate commercial incentives, and delayed the achievement of available cost savings. It is also interesting that much more of the pressure to reform inefficient port practices Ñ with spectacular success Ñ came from groups like the Business Roundtable and Federated Farmers rather than from board sources.
The industryÕs institutional straightjacket, and associated politics, have delivered inappropriate policy and commercial responses to problem diagnoses which were often correct. In fact, the type of questions that need to be asked, and the commercial and policy principles that need to be applied to improve the industryÕs performance, appear to be increasingly appreciated and understood.
The President of Federated Farmers posed a number of questions about future meat marketing and the role of the NZMPB when he said:
ÒIs, for example, the role and performance of the New Zealand Meat Producers Board apposite for meeting the challenge of the Ô90Õs?
ÒAre cooperative structures, directed by farmers, a suitable ownership structure to meet the challenges that lie ahead?
ÒWhat is the true value of generic promotion for example? And the increased funding that farmers are making towards this pursuit. Is it time to be looking at narrowing the focus of promotion investing more fully in individual branded product areas?
ÒShould the full responsibility for quality control now be placed in the hands of individual companies as well, with the Board stepping back from its role in quality control and grading?Ó
In mid-1991 the Chairman of the Meat and Wool Section of Federated Farmers indicated that any government intervention in the meat industry would be a hindrance rather than a help. He was reported as saying:
ÒWe have learnt the hard way you do not create wealth and real profit by subsidies or supplementary minimum prices. Statutory intervention to stabilise prices has resulted in misallocation of resources, stockpiles and bad decisions.
ÒFarmers, processors, manufacturers, exporters and retailers are perfectly capable of getting on with the job of running their businesses. The basic responsibility for the financial well being of any enterprise rests with the owner.Ó
The Chairman of the NZMPB has also given a strong endorsement of the importance of competition and minimum intervention in achieving commercial success:
ÒGovernment has a responsibility to ensure that efficiency is encouraged across the whole economy, not just in favoured sectors. This process must be unimpeded by legislation and regulation. There should be no barriers to business created or supported by government.Ó
Finally, the Chief Executive of one of the more innovative and successful meat companies suggested that the ÔpainsÕ of competition were well worth the ÔgainsÕ they delivered:
ÒIn fact to succeed, innovation usually requires pressure, necessity, and even adversity Ñ the fear of loss often proves more powerful than the hope of gain. But once a company achieves competitive advantage through innovation, it can sustain it only through relentless improvement. Almost any advantage can be imitated. I donÕt believe that is a bad thing. We have had our fair share of disappointment when some of our marketing innovations have been imitated. But that pressure is what drives us to upgrade again.Ó
Clearly all the evidence and the opinions of industry leaders point in the same direction. The industry needs to remove most of the existing intervention and interference from its operating environment. Achieving improved commercial outcomes, and ensuring the industry performs to its potential, requires that all participants, from farmers to marketers, have more commercial freedom and undistorted incentives.
This can only be achieved by repealing most of the legislation that has been at the heart of the industryÕs problems in the past. There is no need for legislation which confers powers of compulsory acquisition. The Board has said it does not want again to get involved in meat trading. Export licensing powers also need to be removed with the possible exception of VRA and quota markets. A tentative beginning has been made to reducing restrictions on exporters but the process is far too timid and slow.
In situations where market restrictions do exist, for example the EC, the evidence casts doubt on whether any premiums exist. The quickest and most efficient manner for determining whether they do or not is to subject access to competitive bidding. This is also likely to facilitate the industryÕs objective of market diversification and less dependence on the EC market.
Entrepreneurs should be given freedom to market, grade, package and promote as they see fit. Those that are not successful will fall by the wayside because they will not be competitive in bidding for livestock from producers. Investments the Board has in the marketing system should be corporatised. Only by doing this will their performance be unambiguously clear and producers able to exercise choice over whether or not they invest in such ventures.
Making the BoardÕs commercial subsidiaries arms-length businesses will do little to improve performance transparency and improved accountability to producers. It will also leave unaltered the distortionary consequences which result when profits from these off-farm investments are returned to producers via the farm output prices they receive.
The BoardÕs network of overseas offices, and its market intelligence and information-providing activities, are undertaken on the grounds that they benefit the industry. This means they have commercial value and therefore should be run on a commercial basis. If such services cannot survive on the basis of users meeting their costs, then they should cease, or be provided differently.
There are reasons for maintaining statutory involvement in R&D, particularly now that its provision has been made more competitive. The case for continuing generic promotion is much weaker and its justification would diminish further as companies with more commercial freedom developed their own brands and marketing strategies.
The changes needed to the industryÕs institutional arrangements are extensive because they involve virtually the complete dismantling of the industryÕs protective cocoon. They are only likely to occur if producers demand that they happen.
What producers must come to understand, based principally on the lessons of history, is that if the legislated powers to intervene and control continue to exist, then sooner or later they will again be used to the disadvantage of producers and the meat industry, regardless of any promises or assurances to the contrary from those who control the legislated Ôrule bookÕ.
Chapter 10
Meat
Chart 10.1: Sheep and Beef Cattle Numbers (1981-1991)
Source: Ministry of Agriculture and Fisheries.
Chart 10.2: Real Farm Profit Ñ Sheep and Beef Farms (1981-1991)
Source: New Zealand Meat and Wool BoardsÕ Economic Service.
Chart 10.3: Meat Production Ñ Sheep and Beef (1981Ð1991)
Source: Ministry of Agriculture and Fisheries.
Box 10.1: Electoral Accountability Ñ Reviewing the Detail but not the
Fundamentals
In May 1992 an independent review of methods of electing and appointing
directors to the Meat and Wool Boards, and mechanisms of Board accountability, was
announced. The review committee reported in August with 40 recommendations, including
changing the name of the Electoral Committee to Producers Council. The committeeÕs media
release listed other principal recommendations as being:
ÒAccountability standards exceeding those required for the commercial
sector, electoral reform, a new qualification for voting, formal annual general meetings
and improved information flows back to farmers.Ó
The review reflected extensive concern about the ability of producers to
exercise effective control over the Boards, their directors and management. The review
committee failed to address the fundamental causes of this concern and delivered an array
of detailed changes which will contribute little to reducing producer concerns over
accountability in the future. This deficiency mainly reflects constraints placed on the
committee by its terms of reference.
The reviewÕs major deficiency was that it failed to address the
fundamental determinants of effective organisational accountability and shareholder
control. In particular, the mechanisms and approaches the committee was asked to review
cannot, of themselves, improve the effectiveness of accountability to producers unless
significant structural features of the Boards and their commercial subsidiaries are
changed.
Effective shareholder accountability requires both appropriate
information on performance and shareholder choice. If there are restrictions on what
shareholders can do with their shares, then their ability to act on the consequences of
good or bad performance is constrained. In turn, the extent to which they can exercise
effective control over those managing their assets is severely curtailed.
There is reason for asking whether, despite the restrictive terms of
reference, the review committee fully appreciated the significance of this reality. The
committee said:
ÒIt would be fair to say, with some justification as producer/growers
are locked in, that the investment in and the quality of information flows from both
Boards exceeds that which is provided to shareholders in any public company.Ó
The view that copious quantities of information somehow compensate for
lack of investor choice is advanced commonly in arguing that producer boards are more
accountable than public companies. This is simply incorrect.
Information is not a substitute for choice. No matter how well informed producers are, current structures severely limit actions they can take. More information, meetings and electoral reform will not remedy this. It is akin to asking a prisoner to accept that improvements to the jailÕs reading room are an adequate substitute for lack of freedom.
Chart 10.4: Destination of Lamb Exports (1989/90)
Source: New Zealand Meat Producers Board.
Chart 10.5: Destination of Beef Exports (1989/90)
Source: New Zealand Meat Producers Board.
Box 10.2: Export Licensing by the NZMPB
The Board operates a comprehensive licensing system as specified in
Section 9 of the Meat Export Control Act. The licensing system is operated in consultation
with the New Zealand Meat Industry Association (and now involves the Meat Planning
Council) regarding the issuing and amendment of licences.
The Board operates a two-tier licensing system. Successful initial
applicants for licences are provided use of the BoardÕs licence number 235 for a
probationary period of about one year. At the end of this period they may be granted a
full licence in their own right.
During 1989-90 five full licences were issued and three licences were
cancelled. As at 30 September 1990 there were 48 current full licences.
As at 30 September 1989 there were 32 companies using the BoardÕs
licence 235 in a testing phase.
During the year the Board completed a comprehensive review of licensing
conditions. Conditions were altered from a broad licence providing export ability to all
markets unless expressly prohibited, to a system where licences identify specific markets
and products.
This change in licensing conditions places all meat exporters on an
equal footing and requires exporters to review markets for prices and volumes prior to
applying for the ability to export to the market. The Board aims to process all licence
extensions within 24 hours.
The Board also operates specific criteria for licensing special access markets through the use of its licence number 235 (this is in addition to the use of this licence by prospective licensees). Licence applications for these markets are reviewed by a joint committee of the Board and the New Zealand Meat Industry Association. The committee provides a recommendation to the full Board on the issuing of the particular licence ability.
Chart 10.6: New Zealand Exports of Sheepmeat and Beef to Japan (1978-1989)
Source: Japan Ministry of Finance (1990); contained in ÒPresentation by
Graeme Harrison on the Activities of the New Zealand Meat Group in North Asia and New
Zealand Meat Export Prospects to the RegionÓ, Gillingham House, Wellington, 22 June.
Chart 10.7: New Zealand Exports of Lamb and Mutton to Japan (1978-1989)
Source: Japan Ministry of Finance; contained in ÔPresentation by Graeme
Harrison on the Activities of the New Zealand Meat Group in North Asia and New Zealand
Meat Export Prospects to the RegionÕ, Gillingham House, Wellington, 22 June 1990.
Box 10.3: Significant Efficiency Differences Between Individual Meat
Companies
A central feature of the meat processing industry is the significant
differences between companies in the productivity of both capital and labour. These
productivity differences underpin differences in profitability, and are central both to
the need for further rationalisation and the difficulties being experienced in achieving
it.
The chart below provides an indication of the relative differences in
capital and labour productivity for a sample of New Zealand meat companies. It uses data
published by the New Zealand Meat Producer in June 1991, and unpublished research
conducted at Lincoln University. The location of each company in the chart is determined
by the total capital and labour inputs per livestock unit (LSU) slaughtered in the 1989/90
season.
Further rationalisation has occurred since these data were compiled
although this is unlikely to change the general picture. For example, slaughter statistics
for the Fortex Group do not include the Silverstream plant which was commissioned after
these data were compiled. Both capital and labour productivity for the Group have improved
on the figures presented in the chart.
The data in the chart indicate five-fold differences in capital and
labour productivity between the most efficient and least efficient companies in the
sample. The largest companies, which are reported to have the most serious financial
problems, are the least efficient users of capital and labour.
It is almost certain that poor capital productivity reflects, at least
in part, overvalued assets in the balance sheets of these companies. Their labour per LSU
is also higher, reflecting the need for further manning adjustments if they are to match
the labour productivity of more efficient plants.
The overall conclusions are clear. In the absence of non-market
intervention or support, the larger New Zealand meat companies still face further costly
rationalisation. The efficiencies available in new, smaller and specialist plants mean
further investment in such plants is likely, and this will increase the need for
rationalisation and downward asset revaluations elsewhere in the industry. Adding to these
pressures is the likelihood that the Employment Contracts Act will result in further
improvements in work practices and gains in plant utilisation efficiency.
Sources: ÔThe PlayersÓ (1991), Supplement to the New Zealand Meat
Producer, Second Quarter, and Professor A C Zwart, Lincoln University, pers comm.
Box 10.4: Regulations Will Not Achieve Quality Control Objectives
One of the arguments used most commonly for regulation and control of
market participants is that poor performance by a few ruins the market for the majority.
It is argued that if something inferior is sourced from New Zealand, then meat buyers will
avoid New Zealand suppliers.
Calls for control to be exercised over the meat industry on these
grounds continue to be made and the following is an example reported in the New Zealand
Meat Producer in July 1990.
Ò. . ..it is equally urgent that the Meat Board steps in with controls
for the flourishing hot boning activities, particularly of small plants.
ÒThereÕs the example of Singapore Airlines, which feeds its passengers
46,000 meals per day every day and uses exclusively New Zealand beef. In the early part of
this year they picked up some product which had come from a hot boning plant through a
broker, and it was frankly inedible.
ÒAlthough itÕs now known which company was responsible, experiences
like that tarnish the reputation of New Zealand product as a whole. If this situation is
allowed to continue valuable markets built up over many years will be lost.Ó
Hot boning lowers processing costs through raising meat yields, so it is
encouraging to know the practice is ÒflourishingÓ. Whether this would continue to be the
case if the NZMPB started controlling it more extensively is a matter of judgment.
More fundamentally, the suggestion that controls are needed implies that
this approach to quality control has worked well in the past Ñ the evidence is mixed to
say the least Ñ and that there are no alternatives which would work quite adequately
without the need for controls.
The alternatives all revolve around the use of branding and product
differentiation - actions everyone says are needed in the meat industry. In this context
branding need not extend to the attachment of a physical label. It may simply involve the
establishment and maintenance by the supplier of a reputation for quality. The
introduction of controls reduces the incentives for reputable suppliers to brand and
guarantee the quality of their product.
It is noteworthy in the example above that the customer obtained the
meat via a broker. Presumably the customer will be wary of this broker in the future, and
the broker may be disinclined to use that particular meat supplier again if interested in
maintaining the business.
Also, customers are able to learn which suppliers/brands have the best
reputation for quality performance. They are unlikely to stop sourcing from an entire
country because some suppliers are unreliable. If they did that they would probably not be
able to find a country in the world from which to purchase their beef requirements.
However, if someone jumps in and saves them the trouble and cost of needing to find out
who can be relied upon, they are unlikely to complain.
Finally, the extent to which calls for controls over industry
participants are motivated by the competitive pressures new entrants create should not be
overlooked.
Box 10.5: Progressive Meats Limited Ñ By Name and By Nature
Progressive Meats Ltd is an owner-operated, Hastings-based lamb
processing company. It is an example of what can be, and is being, achieved in the New
Zealand meat industry by entrepreneurial and innovative investors. This company has put
into practice what many others have only talked about over the years.
Established in 1981, initially as a lamb carcase-cutting operation,
Progressive Meats does most things differently from traditional meat processing companies.
Its strategy is centred on the year-round production of mainly chilled lamb cuts, produced
from animals which meet strict technical specifications related to what the market wants,
and supplied by growers under contract.
A particularly interesting feature of its operations is the manner in
which it contracts out both animal supply and marketing. Highlights of its innovative
approach include:
¥ contracting forward supplies from lamb producers and paying according
to contract specifications with premiums for the required product and for out-of-season
production;
¥ contracting MAFÕs Management Consultancy Services to ensure lamb
supply to specification (weight and fat measure) by having MCS responsible for arranging
contracts with producers. MCS assists producers with breeding, management, etc to enable
them better to meet contract requirements;
¥ purpose-built slaughterhouse and processing facilities with high
levels of productivity and minimised costs through just-in-time stock receival and product
processing and despatch systems;
¥ a multi-skilled workforce undertaking diverse tasks in the plant as
needs require, and working shifts for higher capacity utilisation; and
¥ using specialist, independent marketing agents to sell the product.
The approach Progressive Meats has adopted means it can concentrate on
its core business Ñ slaughter and processing Ñ making sure it maximises efficiency,
minimises costs, and produces what the market wants. Contracting out animal supply and
marketing also ensures these important Ôlinks in the chainÕ perform well Ñ if they do
not someone else can be contracted to undertake the tasks.
Traditionally lamb production and slaughter has been a seasonal activity
in New Zealand. Processing capacity has to be sufficient to handle the seasonal peak in
production and is therefore underutilised for part of the year. Product has to be frozen
for year-round supply to markets, given the seasonal kill pattern.
Production and processing of lambs throughout the year helps reduce
processing costs by increasing plant capacity utilisation, and allows continuous supply of
chilled product which is preferred by many markets but has limited shelf-life.
The company, with the help of MCS, has assisted producers with
management and breeding strategies designed to extend the lamb-producing season. It also
provides suppliers with slaughter feedback information on which they can base action to
improve performance against contract requirements.
The approach used by Progressive Meats is very efficient in two main
respects:
¥ it uses specialisation and competitive contracting to maximise
efficiency and minimise costs, from farm to customer; and
¥ it accurately transmits market information between supplier and
customer so that the producer supplies what the market wants Ñ and is rewarded
accordingly Ñ and the customer receives what is wanted in terms of quality and price.
It is an approach, currently being put into practice, involving
principles which will need to become adopted more widely in New Zealand if everyone in the
industry is to maximise profitability in the lamb market.
Box 10.6: Reducing Land-Based Transport Costs Ñ A Good Example of
Vested Interests at Work
During the first half of the 1980s the fact that New Zealand-based
transport and handling costs were unacceptably high was discussed regularly. The following
excerpts from NZMPB Annual Reports suggest that the issues received plenty of attention
and investigation, but little in the way of effective action resulted.
In 1980 . . .
ÒA disturbing factor during the year has been the ever increasing
shore-side costs, both in transport from works and on the wharf. The question of on-shore
charges was the subject of lively debate and considerable publicity at the Exports and
Shipping CouncilÕs ÔForum 80Õ held in June, 1980. There was a consensus that costs in
New Zealand are excessive and moves should be made to identify each cost sector in an
endeavour to arrest these spiralling charges. The Board has been looking extensively at
this question during the year and, as yet, no firm conclusions have been made, but it is
hoped, by continuing investigations, solutions may be found during this season.Ó
Then in 1981 . . .
ÒThe Board has continued to look at ways to reduce or even hold rates
at reasonable levels to avoid any further erosion of New ZealandÕs export earnings.
Investigations have focussed on shore-side costs that form a high component of our total
transport bill and over which we have some degree of control.
ÒStill to be completed, the investigation will also identify ways and
means of containing costs within the current arrangements and develop with the industry
the implications of changing current practices to reflect actual costs.
ÒIt is expected that this review will be completed and various options
put forward for discussion early in 1982.Ó
By 1982 . . .
ÒA Board study of livestock and export product transport within New
Zealand progressed through the year and concluded that either economies must be found
within current arrangements or a structure based on a more direct allocation of costs be
implemented.
ÒIt was initially considered that changes in the allocation of
pre-shipment transport costs would be implemented on October 1, 1982, but this has now
been deferred while a detailed analysis is carried out on the cost implications the
proposed changes will have on individual works and the farmers in the various regions.Ó
So that in 1983 . . .
ÒThe Board has continued its review of pre-shipment practices and the
costs associated with the transport of meat exports. Various options for change were put
forward, but a further review will be required before alternative arrangements can be
made.Ó
However, in 1984 . . .
ÒThe port works system for internal transport charges was the subject
of intense investigation by the Board, the NZFCA [New Zealand Freezing Companies
Association] and some provinces of Federated Farmers. It was not possible to reach a
consensus on a new system and a decision has been held over.Ó
Ò. . .the report commissioned by the MIC [Meat Industry Council] into
farmgate to ship side costs, which is due for completion in the first quarter of 1985, has
the potential to initiate worthwhile cost savings and improve productivity. Costs in this
area are high both in terms of labour and poor utilisation of capital. It was therefore
logical that the MIC should direct attention to this area as a matter of priority.Ó
The explanation for the above is simple and self-evident. Trying to
reform policies, and achieve consequential cost savings for the industry as a whole, is
not an easy matter when attempted by investigation and consensus. The reason is that this
process results in some producers and meat companies being worse off. They obviously
carried enough political sway to make sure there was always something further to
investigate. Meanwhile, pricing was distorted and transport costs remained high Ñ meaning
there was, in fact, still a problem to investigate!
Box 10.7: Competition Lowers Freight Rates Ñ When It Is Allowed To
Occur
At the beginning of 1991 freight rates for New Zealand beef to the North
American market fell by over 40%, lowering total beef freight costs to this market by
around $20 million annually. The fall owed nothing to new technology or any changes that
were remotely sophisticated. It was the result of introducing more competition to the
trade in the form of old technology Ñ conventional refrigerated ships.
Prior to this sharp reduction in freight rates, a number of designated
container lines were servicing the trade. The BoardÕs contract with these lines expired
at the end of 1990. At negotiations for a new contract the lines were requesting increases
in rates.
In these circumstances it was suggested by meat shippers that the trade
be opened to conventional refrigerated ships. The container lines immediately dropped
their requests for freight increases. However, in a change of policy noteworthy for its
commercial daring relative to past actions, the Board not only designated additional
shipping companies to serve the route but also permitted exporters to negotiate
individually. These proposals emanated from the Meat Industry Freight Council.
Affco New Zealand Ltd, with 40% of the North American beef trade, was
the first to negotiate a freight agreement with one of the newly designated carriers at
rates over 40% lower than had been applying. In March 1991 a media release from Weddel New
Zealand Ltd said that the company's freight costs had fallen by about one third since
December the previous year. In this release the company's Managing Director said:
ÒOur producer clients then have gained an average of approximately $30
to $35 per head [of cattle] resulting from the savings in ocean freight and pre shipment
transfer costs compared with those applying in December.Ó
Once the Affco deal became publicly known the container lines previously
holding a NZMPB protected monopoly on the route dropped their rates to meet the
competition. Everyone shipping beef to North America is now benefitting from lower freight
rates. More New Zealand ports are also being serviced by the shipping companies with
additional savings in land-based transport costs.
11.1 Introduction
New Zealand is the worldÕs largest exporter of coarse wool and the third largest wool producing country after Australia and the USSR. Virtually all New ZealandÕs wool production is exported Ñ exports (greasy and semi-processed) were valued at $1.9 billion, or 13% of New ZealandÕs merchandise exports in 1988/89. In 1990/91 they had fallen to $1 billion or 7% of exports because of reduced demand and increased stockholding in New Zealand.
Substantial changes are occurring in the New Zealand wool marketing system. In February 1991 the scheme for intervening in the market to influence prices and grower returns was suspended because the New Zealand Wool Board (NZWB) had exhausted its capacity to fund wool purchases and price support to growers, and a similar intervention scheme in Australia had collapsed. The NZWB had approximately one quarter of a seasonÕs production in stock in mid 1992. Growers have been paid for this wool but it has yet to be sold to wool users.
Because of these developments it has been necessary to reduce substantially industry funding for R&D and wool promotion.
All participants in the New Zealand wool market are now having to review their options and commercial strategies to take account of a less interventionist marketing system. There have already been a number of industry reviews of where to from here. Developments in New Zealand are also being influenced by a collapse in the system of market intervention in the wool market in Australia. The Australian Minimum Reserve Price Scheme has been abandoned and Australia has wool stocks equal to nearly one year of its production.
It will take time for the international wool market to absorb and adjust to these dramatic events. In the meantime, all market participants, and particularly woolgrowers, are assessing what went wrong and the lessons to be learned.
The NZWBÕs market and price intervention activity was a key feature of the wool marketing system and Board activity. However, even with the cessation of this intervention, the NZWB remains a dominant influence in the wool marketing system and is already devising new things to do. Continuing legislative and institutional arrangements in the industry involve compulsory grower levies, licensing and regulation of market participants and methods of marketing, involvement in freight rate negotiations, and the funding and management of R&D and promotion. In August 1991 the Board also announced its intention to establish a subsidiary company to market wool in competition with existing exporters.
This chapter commences with a description of the New Zealand wool producing industry, its markets, and the main institutional features of its marketing system. This is followed by a review of the objectives, performance and fate of the market support and price supplementation policies and the lessons learned. While this constitutes the main focus of the chapter, a review and discussion of other institutional arrangements which influence the marketing system is also presented.
11.2 Industry Features
11.2.1 Production
New Zealand currently has around 57 million sheep producing 300 million kilograms of greasy wool. Approximately 40,000 farmers run sheep, of which 24,000 are predominantly sheep farms. Most commercial woolgrowers operate mixed farms. Market returns and climatic variations cause sheep numbers to fluctuate. Over the past two decades, sheep numbers have ranged from a low of 55 million in 1975/76 to a peak of 70 million in the early 1980s.
The gross value of New Zealand greasy wool production at the farm gate rose sharply during the second half of the 1980s to a peak of $1.5 billion in 1988/89. Over the following two seasons it fell sharply to an estimated gross value of $830 million in 1990/91.
Almost all New ZealandÕs wool is produced as a joint product with sheepmeat. Meat producing sheep grow relatively coarser wool than specialist wool-growing sheep. New Zealand wool production decisions are therefore influenced by both wool and sheepmeat (mainly lamb) returns.
Sheep numbers and farm profit for sheep and beef farms are presented in Chart 11.1. Profitability in the first half of the 1980s was influenced significantly by subsidies and price supplements. It was also the period when sheep numbers reached their peak, partly a reflection of the support given to both wool and sheepmeat returns.
11.2.2 Markets and market features
New Zealand dominates the worldÕs trade in coarse wool accounting for around half of all world exports. Some 55% of world coarse wool production is traded.
Around 90% of New Zealand wool production is exported as raw wool, with some 70% of these exports being scoured (removal of grease and dirt) prior to shipment. Approximately two thirds of New ZealandÕs wool scouring capacity is owned and operated by wool exporting companies.
Major export destinations
The major destinations for New ZealandÕs wool exports over recent years are presented in Chart 11.2. The European Community (EC) is the single biggest market although purchases have been falling steadily. This region bought around 37% of New ZealandÕs exports in 1985/86; this proportion was around 30% at the end of the decade.
The USSR is the worldÕs largest consumer of wool and second biggest importer after Japan. It has been an important but fluctuating market for New Zealand. Over the past fifteen years exports to the USSR have fluctuated between a high of 32,000 tonnes (clean) in 1979/80 and a low of 8,000 tonnes in 1990/91.
Until 1988/89 China was a growing market for New Zealand wool. However, in 1989/90 ChinaÕs purchases fell dramatically to only one quarter of its purchases in the previous season. The recent sharp contraction in wool purchases by both China and the USSR contributed significantly to the price decline in the New Zealand wool market. The relationship between wool prices in New Zealand and purchases by the USSR and China over the past decade is illustrated in Chart 11.3.
Other significant markets for New Zealand wool have been the EC, Japan, other Asian countries, the Middle East, India, Nepal, Australia and the United States.
End-uses for New ZealandÕs wool
The range of products in which New Zealand wool is used is diverse. It includes pure wool and fibre blended carpets Ñ ranging from those produced using the latest manufacturing technologies to labour-intensive, hand-knotted carpets Ñ other interior textiles and furnishing fabrics, bedding materials (including new uses such as futons in Japan), knitwear (fashion and casual), and hand-knitting yarns.
The main end-use for New Zealand wool is carpets, which accounts for over 50% of wool production. Wool in turn holds a 10% share of the world carpet market.
WoolÕs share of the carpet market has changed little since the beginning of the 1980s. However, during the 1970s woolÕs share fell from 20% to around its present level. Most of this fall occurred in the early 1970s at a time when wool prices increased sharply. In doing so, it illustrated graphically the importance of price in fibre selection in the carpet market and the competitive pressure from synthetics.
Major determinants of wool demand
Wool is a relatively minor fibre in an intensely competitive world fibre market. Growth in world fibre consumption mainly reflects population growth. Per capita fibre consumption is growing in very few countries, with China being one them.
New Zealand wool faces strong competition from other fibres, particularly synthetics, in most of its markets. WoolÕs market share has been declining Ñ wool now represents about 5% of world fibre production compared with 10% in the early 1960s.
The major influences on the demand for wool are its price, competitive fibre prices, economic activity, fashion, and developments in the processing/retailing chain.
Price is a very important influence on the demand for wool. Manufacturers can, and do, substitute fibres according to relative prices. The price of wool relative to synthetics and cotton was generally stable during the late 1970s and the first half of the 1980s, but then increased sharply. As a result, many processors switched to other fibres or blends and this contributed to the downturn in demand for wool. Wool prices relative to the prices of competitive fibres have declined recently and wool is now very competitively priced.
Technological advances in the manufacture of synthetic fibres have steadily eroded woolÕs natural advantages and this trend is likely to continue. In many end-uses this serves to make price competition for wool even more intense.
Economic activity and incomes are important influences on the demand for fibre products. Consequently, the cyclical nature of economic activity imparts a similar cyclical character to the demand for fibres, including wool. A common characteristic of economic cycles is periodic shocks which can influence the wool market from time to time. Sometimes they affect all fibres, for example an oil price hike which reduces economic activity. Alternatively, the effects of shocks may offset each other, for example a recession in some major economies coinciding with a sudden, climate-induced reduction in wool production.
Past wool stabilisation schemes have aimed to absorb the effects of economic fluctuations via stock holding or buffer funds rather than have them reflected in significant price variability. However, like all such commodity buffer stock and fund schemes, they have invariably collapsed because of fund shortages and misreading of underlying market developments.
Total fibre consumption is only responsive to incomes in those countries with relatively low incomes. At higher levels of income, income growth has negligible influence on per capita fibre consumption. However, short-term changes in income can have a significant influence on consumption. If incomes fall, for example, purchases can be deferred, and this applies particularly to carpets.
In higher income countries discretionary expenditure on fibre products is influenced by fashion. It is in this area of the market that higher prices for fibres are potentially available if consumers perceive the fibre products as ÒfashionableÓ.
Developments in the trading, manufacturing and retailing components of the wool ÒpipelineÓ also influence demand and prices. The importance of meeting consumer needs was highlighted by the Managing Director of the International Wool Secretariat when he said:
ÒThe influence of todayÕs consumers and, related to it, the increased power of retailers, has transformed what was traditionally a supply-led or production oriented industry into one which is now demand-led, with firms geared to giving consumers what they want or going out of business.Ó
The entire wool-using industry has become increasingly demanding of fibre suppliers. It requires quality consistency, conformation to strict technical specifications, prompt responses to orders, and flexibility in services allowing it to react quickly to changes in market demand and new opportunities, while minimising the risks and costs associated with investments. New fibre processing technology is being adopted rapidly because of its productivity-enhancing and cost-reducing advantages and ability to help processors diversify and develop new markets.
Key market characteristics
The consumer is the most important person in the fibre market, driving demand and becoming ever more discerning. The market is becoming increasingly segmented. Meeting these demands and staying competitive requires processors and manufacturers to be responsive and efficient. This places similar demands on fibre suppliers if their raw material is to be commercially attractive to users.
Computer technology is now well established in the textile industry. Computer manufacturing techniques have shortened the time taken for many processes. Electronic communications have had similar consequences and become very important in successful commercial relationships between participants in the entire marketing pipeline. Fibre suppliers have to keep up with this electronic explosion in the industry. This carries important implications for the ability of the wool industry to be able to specify woolÕs technical attributes enabling electronic trading and information exchange.
Technical specification of wool, and efficient communications along the entire pipeline spanning woolgrower to consumer, are also important in ensuring sheep breeding and selection are producing types of wool that the market is demanding.
It is clear from this brief review that markets for New Zealand wool are very diverse. There is, in fact, an array of different markets where influences such as income, fashion, technology and industry structure vary in their impact on demand and price. At the same time all markets have in common a responsiveness to competitive fibre prices, and economic cycles and shocks.
Not only is the market for wool diverse, but the pace at which demand is changing and the textile industry is responding is quickening. These market phenomena are not unique to wool, but they are important to its future demand and price.
Overall, these market characteristics and prospects make it a necessity that the wool marketing system be flexible, adaptive, innovative and able to keep up with the pace of change. The marketing system must ensure that all those with a commercial interest in wool find it commercially attractive to use the fibre. If this is not the case, then loyalty to wool will evaporate quickly.
11.2.3 Marketing system
Around three quarters of New ZealandÕs wool production is sold at open auctions held in New Zealand and run by registered wool brokers. There are 10 registered wool broking companies. The remainder of the shorn wool is sold directly by growers to buyers by private treaty. There are over 100 private wool merchants in New Zealand. Some 10% of wool production is recovered from skins as a by-product of the meat processing industry (slipe wool).
Most New Zealand wool is bought by exporters who have contracted to supply users over some future period. Exporters have to be licensed by the NZWB to be able to export wool from New Zealand. Licences are generally available to any applicant judged Òfinancially viableÓ by the Board. Approximately 140 individual exporters are licensed by the NZWB. However, many of these are inactive or buy and export infrequently. Some 20 licensed exporters would account for 80% or more of all wool exports.
The basis on which wool exporters contract to supply users varies and depends on market circumstances and views about future developments. In some cases exporters will contract a year or more ahead at fixed prices in a nominated currency. Contracting three to six months ahead is more common with most exporters carrying the currency and market risk. Reliable customers may also be offered credit.
The exporter then goes to the auction, or buys privately, to supply these forward contracts. Whether to hedge risk, or speculate on future developments in the wool market and economies generally, is a commercial decision which has to be made in respect of this contracting. Varying use is made of stockholding, credit, foreign exchange cover, scoured wool exchanges and futures markets to manage risk in a manner judged commercially attractive by the exporter. All these mechanisms involve costs and individual businesses would rarely make the correct decisions all the time.
To the extent that wool users have demanded price stability in the currency of their choice, the market developed commercially adequate means of providing it. As discussed later, intervention in the market by the NZWB had significant implications for these price setting and hedging mechanisms.
The development and adoption of objective wool measurement has been very important in improving pricing and operational efficiency in the wool marketing system. Wool possesses a range of attributes which influence its value. The ability to measure these attributes objectively, and credibly certify their validity, considerably reduces risks faced by wool buyers and users and hence improves pricing efficiency. It particularly improves the ability of consumers and users to communicate their requirements to growers and the scope for growers to be rewarded accurately for what they produce.
The use of objective measurement, and its future extension in terms of attributes measured in both greasy and scoured wool, is also important as an influence on the ability of producers to describe (brand) their particular wool. It therefore has important implications for future promotional activities. The improvement and extension of objective measurement will increase the scope for moving away from generic wool promotion. This could be particularly important to those involved in the New Zealand wool marketing system in differentiating their wool from both synthetic fibres and wool being marketed by other suppliers.
Developments in objective measurement to date have allowed most wool to be sold by sample. The buyer has a measurement certificate and a small physical sample of the wool on which to base pricing decisions. Eventually measurement technology will allow wool to be sold using a technical specification only. This will further improve pricing efficiency and reduce handling costs, with the handling and selling functions being separated totally. It will also facilitate growth in the use of computers and electronics in marketing and information exchange throughout the industry.
The NZWB has played an important role in stimulating the development and adoption of objective measurement, mainly through the technical research into objective measurement it has commissioned and continues to fund. In its 1990 Annual Report the Board said:
ÒA long-term strategy and plan is being prepared for the further development and commercial application of objective measurement. Work on bulk and length-after-carding measurements also continues, with international round trials being completed in 1990 and further work planned.Ó
For a more detailed description of how objective measurement is used in the New Zealand wool marketing system see Box 11.1.
The GrowersÕ Alternative Selling System (GASS) is an alternative marketing system, run by the NZWB, for small lots of wool (up to four bales). It was introduced and successfully trialed in 1988/89 with over 14,000 lots from 1,000 growers being sold through the scheme. In its 1990 Annual Report the Board said that GASS trials had been extended to cover the whole of the North Island, giving more growers an alternative option for marketing small lots.
11.2.4 The New Zealand Wool Board
The NZWB, established in 1944 to promote the use of New Zealand wool through research, advertising and related services, now operates under the Wool Industry Act 1977. This Act underpins all the institutional arrangements, regulations, and controls that are used, or could be used, as influences on the wool industryÕs marketing system. The Act states that:
ÒThe general object for which the Board is established is to obtain, in the interests of growers, the best possible long-term returns for New Zealand wool.Ó (Section 16).
The Board has described the main activities undertaken in pursuing this objective in the following general terms:
ÒThe Board is seeking to build demand by stepping up its efforts in research, product development and promotion. It is seeking to reduce the impact of global wool surplus through market support and it is supporting growers with its minimum price scheme and by encouraging greater efficiency on the farmÓ.
The Board comprises ten directors:
¥ six woolgrowers elected through the Meat and Wool BoardsÕ Electoral Committee;
¥ two appointed by the Minister of Agriculture;
¥ one appointed by the Board; and
¥ the Director General of Agriculture and Fisheries or his/her alternate.
The Electoral Committee which chooses the grower directors of the Board consists of 25 members elected by wards on a one farmer one vote basis by all farmers with at least 100 sheep or beef cattle. The Chairman of the Meat and Wool Section of Federated Farmers is also a member. The Board is required to submit its Annual Report to the Committee. A recent review of the Electoral Committee system for electing producer directors was discussed in the meat chapter Ñ chapter 10.
The Board has two sources of ÒincomeÓ. The majority of funds are sourced from a compulsory grower levy on all wool at its first point of sale in New Zealand. This levy is currently 6% of the woolÕs gross sale value. Funds are also derived from a variety of investments held by the Board.
The Board and wool growing industry receive no direct financial support from the government. The availability to the Board of concessional finance from the Reserve Bank and government loan guarantees were removed in 1988.
Government ÒsupportÓ for the Board and its activities, and thus for the wool industry, is confined to the provision of legislation which makes the grower levy compulsory and provides the Board with an array of potential controls over commercial activities which it can exercise at its discretion.
The following are the BoardÕs main activities:
¥ operation of a price support stabilisation scheme which involves intervention to purchase and sell wool (market support), and a guaranteed minimum price to growers (both schemes were suspended in February, 1991);
¥ funding to the International Wool Secretariat which is a joint venture organisation with Australia, South Africa and Uruguay to promote the demand for wool internationally ;
¥ funding and management of R&D in marketing, processing and product development, and wool production;
¥ licensing of all wool exporters and the determination and policing of quality standards and selling methods;
¥ negotiating and determining maximum freight rates and minimum services, and designating carriers (or influencing these outcomes indirectly in some instances), for the transport of export wool;
¥ investing in activities which have potential for commercial returns or which may contribute indirectly to achieving the BoardÕs objectives; and
¥ co-ordinating industry activities in regard to collation of statistics, publication of technical and market information, shearer training and lobbying governments.
In many of these roles the Board works closely with other sectors of the industry such as brokers, exporters, scourers and the domestic wool textile industry. In fact, the Board carries out most of its activities by exercising influence over other participants in the market. However, the Act provides it with considerable reserve powers to intervene directly in the marketing system. No doubt these extensive reserve powers are an influence on the preparedness of market participants to cooperate and their general commercial behaviour in the wool marketing system.
For example, Section 21 of the Act states, inter alia, that the Board can make and carry out such arrangements and give such directions as it thinks proper Òfor prohibiting, restricting, regulating, or controlling the sampling, sale, offering for sale, disposal, or exporting of any wool by any personÓ.
Part V of the Act requires the Board to purchase all wool at prices fixed by the Board, market it, and pool the returns. The Board may distribute any profits to growers. This total acquisition, or single seller power, conferred by the Act is not currently able to be used by the Board. It would require an Order in Council to come into force and the Minister can only recommend such an Order if at least 60% of the votes of sheep farmers are in favour of the powers being activated.
11.2.5 Transport
Section 19 of the Act confers the NZWB with powers to control and influence the transport of wool, both within New Zealand and to export destinations. A representative industry body, which includes representatives of the NZWB, recommends to the Board the rules that will apply in regard to transport and negotiates rates for approval by the Board. The Board can confirm or override the recommendations. Only on relatively few occasions has it overturned the recommendations submitted. More recently, an industry policy group has been given some delegated powers in this area.
Only in the case of wool sent to Europe, North America and South East Asia does the Board require the use of shipping lines it has approved. The Board negotiates a minimum service and maximum freight rate with these approved shipping lines. The shipping companies are free to provide a better service or charge a lower price, subject to a non-preference rule.
Until the late 1980s land transport costs in New Zealand were ÒaggregatedÓ and included in the shipping freight rate. Aggregation involved the regional pooling of a range of land-based transport and port charges incurred in getting wool from store to ship. Within a pool, the freight cost, including these aggregated land-based costs, was independent of volume or original location of the wool. Consequently, there were cross-subsidies between shippers depending on location and volume of trade.
The progressive removal of aggregation commenced in 1988. The Board noted changes to aggregation in the following terms:
ÒAs a result of the 1987-88 industry review of aggregation policy, the Board moved to shipping arrangements which reflected the policy of allowing Ôcosts to lie where they fallÕ. Consequently shipping lines serving Hong Kong, Taiwan and the Philippines, and one carrier serving Europe, were ÔapprovedÕ to carry wool on an aggregation exclusive freight rate structure. With the exception of the New Zealand Eastern Shipping Conference, lines serving Japan and South Korea were also approved to carry wool on an aggregation exclusive freight rate structure for the year commencing 1 January 1989.Ó
The removal of aggregation has had differential effects on the transport costs faced by individual exporters depending on the present location of their facilities in relation to export ports. This is because costs which were previously pooled are now directly user-pays and hence passed on to growers via the wool price
11.2.6 Promotion and the International Wool Secretariat
The NZWB carries out promotional activity in the domestic market and a limited amount of promotional activity targeted at overseas markets. Most overseas promotion of New Zealand wool is carried out on behalf of the industry by the International Wool Secretariat (IWS).
The IWS was founded in 1937. It is funded by contributions from Australia, New Zealand, South Africa, and Uruguay. Its purpose is to undertake market development and promote wool internationally. It has its headquarters in London and, until recently, had a staff of 850 operating from a total of 40 locations in 31 countries. However, its operations are being curtailed and rationalised as a result of reduced funding available from the New Zealand and Australian wool industries. In 1990/91 its total budget was about $320 million.
According to its Managing Director the IWS is involved in:
Ò. . . a full range of marketing-related activities including research, product development, technical service, quality control, fashion and styling innovation and service, the provision of statistical information, merchandising jointly with textile manufacturers and retailers, co-operative projects with the worldÕs top designers, and advertising to consumers.Ó
Promotion activities are mainly generic and based around the registered ÒWoolmarkÓ (established in 1964) which the IWS licenses to users. The IWS also owns a ÒWoolblend markÓ, introduced in 1971, which is available to licensed users for products which contain at least 55% new wool.
In 1989/90 the NZWB contributed $67 million, or 80% of its grower levy income, to the IWS. This contribution increased to $90 million in 1990/91. Nearly 80% of this funding was directed to activities promoting the consumption of New Zealand wool in interior textiles Ñ mainly carpets. Some $3.3 million of this portion of the funding was directed to research and product development by the IWS.
Because of funding constraints associated with the collapse of market support and minimum pricing, the NZWBÕs contribution to the IWS has been reduced to $30 million in 1991/92.
11.2.7 Research and Development
The NZWB manages and funds (from the growersÕ compulsory levy) a diverse range of research and development activities. The Wool Research Organisation of New Zealand (WRONZ) is an industry owned research organisation and the major recipient of the BoardÕs R&D funding. As with promotion, R&D funding has been reduced because of current financial constraints on the Board.
In its 1990 Annual Report the Board said it had re-evaluated its priorities for research and product development. It said that its priority areas for R&D were:
Ò. . . carpets, objective measurement, basic research into the make-up of wool fibre, environmental threats, and the efficiency of the marketing chain.Ó
In 1990/91, the Board allocated $8 million for expenditure in New Zealand on research, product development and technology transfer.
WRONZ projects received $5.6 million with $1.2 million allocated to projects covering on-farm and related areas outside WRONZ. A further $1.2 million was targeted to WRONZ R&D specifically related to new products and technology.
WRONZ was established in 1960 by the NZWB, the government and processors, to undertake research and develop fibre-enhancement techniques, scouring methods, processing, and measurement systems. The Board has five directors on the WRONZ executive and has expressed its commitment Òto ensuring that WRONZ remains the world leader in carpet research and research related to New Zealand wools.Ó
The Board has more than trebled its funding to WRONZ over the past five years. WRONZ receives about 60% of its funding from the NZWB. Funds also are earned from commissioned research.
The NZWB and the New Zealand Meat Producers Board each has a 50% share in the New Zealand Meat and Wool BoardsÕ Economic Service. The NZWB contributes 50% of its operating costs, which totalled $1.4 million in 1989/90. The Service collects and analyses information on farm production and performance in the meat and wool industries.
11.2.8 NZWB investments
In addition to cash investments and investments in land and buildings, the NZWB has interests in two New Zealand companies involved in the wool industry. The Board has a policy of Òassisting development by investing in areas which have potential for achieving commercial returns or which may contribute indirectly to our goalsÓ.
The Board has a one-third interest in the Ferrier Woolscours joint venture with Wrightson NMA Ltd and Robert Ferrier Ltd. The Board is understood to have invested in this venture because it believed there was considerable potential to develop customised wool blends and that this was not sufficiently recognised by the industry.
Annett and Darling Ltd is a company fully owned by the Board. It was acquired in 1989/90 when financial difficulties were threatening it with closure. The company Òis developing and commercialising WRONZ research in strategic areas such as Chemset technology and advanced scouring equipmentÓ.
A more recent initiative by the Board to invest growersÕ fund in a wool marketing venture is discussed later in this chapter.
11.3 Major Issues
Of all New ZealandÕs major rural industries, wool has a marketing system with the least direct restrictions on choice and competition. While the NZWBÕs residual powers are extensive, they have been exercised in a way which has allowed price setting to be reasonably transparent and has resulted in numerous participants in the marketing system.
Until recently, the NZWBÕs major direct influence on the marketing system was its market support and price supplementation activities. While this intervention did not restrict directly how wool could be marketed and who could participate, it did have profound indirect effects on commercial behaviour and market outcomes.
However, in addition to this market intervention, the Act under which the NZWB operates enables it to exercise extensive control over the operations of the wool marketing system if it so chooses. The fact that these powers have not been used directly on an extensive scale, or only used indirectly, does little to reduce the influence they almost certainly have had on entrepreneurial innovation and endeavour, and commercial behaviour generally in the marketing system.
The Board clearly influences the nature and extent of change and innovation in the provision of marketing services. The BoardÕs powers, along with the compulsory grower levy, enable it to exercise considerable influence over industry R&D and wool promotion. A prospective exporter has to obtain a licence from the Board although licences have generally been available on demand.
Control powers which are not currently used still have some influence on commercial behaviour. Uncertainty about what powers the Board might choose to exercise next, and how it might choose to exercise them, increases the risks faced by those who are, or might consider, participating in the marketing system. There are examples of innovations and cost-reducing changes being retarded by the industryÕs Òinstitutional umbrellaÓ.
11.3.1 Market and price intervention
Until its suspension in February 1991, the Board operated a Òminimum price schemeÓ and undertook Òmarket support activitiesÓ. The Board funded and accounted for these market intervention activities separately from other activities.
The concept of a minimum price originated in 1952 when the New Zealand Wool Commission was established to operate a floor-price plan. Amendments to the BoardÕs legislation in 1988 removed the statutory requirement for the Board to operate such a scheme. This change coincided with the removal of the BoardÕs recourse to subsidised government funding and loan guarantees to help finance the scheme.
Market support (NZWB purchasing wool and operating a buffer stock) and the minimum price scheme are interactive policies and this is reflected in their management and in their financial consequences for the Board and woolgrowers. Having set a minimum price for the season, the extent to which supplementary payments are required can depend on how the market support activity is managed and the underlying nature of supply and demand in the market at the time.
For example, if market support holds auction prices above the minimum then no supplementary payments would be required. Conversely, if all wool were allowed to flow through to the trade at below the minimum price (no purchases by the NZWB), then all support for prices would be channelled through the minimum price scheme. Finally, in many past seasons a minimum price well below market levels and very limited market support buying by the Board meant these policies had very little direct financial or physical effects on the market returns to growers.
Having two separate instruments available to support grower returns gave the Board a degree of flexibility, particularly in regard to wool purchasing decisions. This flexibility did not characterise the Australian scheme. If wool did not reach the minimum price in Australia it was purchased by the Australian Wool Corporation. This is probably a major reason why Australia accumulated proportionately more wool than New Zealand when the market started to fall.
However, this advantage was not sufficient to prevent the New Zealand scheme for support and price supplementation from avoiding the same fate as its Australian counterpart Ñ total collapse. The reason was that the NZWB set a minimum support price at the beginning of 1990/91 which turned out to be non-sustainable for the entire season given market developments and the BoardÕs financial reserves and ability to borrow commercially.
Intervention objectives Ñ general and imprecise
The objectives of market support and the minimum price scheme are general and somewhat imprecise both in the Act and in material published by the NZWB. For example, section 17(h) of the Act allows the Board:
ÒTo make to wool growers any payments it thinks fit for the maintenance, stabilisation, or enhancement of returns to them from the sale of wool.Ó
The NZWB has described the two forms of intervention as a two-tier woolgrower price protection system. It explained the intervention in the following terms:
ÒThe market support scheme has been the more commonly used scheme in recent years. In most seasons it operates at prices higher than the minimum price scheme, and is designed to smooth out short term aberrations in the market from auction to auction.
With this scheme, the Board establishes what it considers to be reasonable short-term price levels, taking the market and currency conditions into account. If trade buyers fail to bid as high as the BoardÕs reserve for a particular lot of wool on the auction day, the Board will buy that wool and stockpile it for later sale.
ÒThe minimum price is a second tier of security for growers, with levels set at the beginning of the season . . . If actual market prices drop to less than the minimum price, the Board will supplement (top up) grower payouts to the minimum price level.
ÒSupplementation applies whether wool is sold through auction or privately.Ó
In the same information booklet to growers, the Chairman of the Board also said:
ÒWe need no reminding of the financial difficulties facing many farmers, and weÕre very aware of the role we play in supporting growersÕ incomes.
ÒOur bottom line is your wool income. Maximising this in the short term through using reserves accumulated over recent years is therefore our first priority.Ó
In its 1990 Annual Report the Board commented as follows on its market support policies:
ÒThe BoardÕs stance on market support is that price gyrations are neither in the interests of growers nor their customers.
ÒThe Board therefore intends to support the market and, where necessary, to supplement prices.Ó
These various statements about the objectives of market and price intervention contain a mix of signals and sentiments. Until about 1988, a reasonable interpretation of the objectives of intervention would seem to be that the policy aimed to:
¥ remove short term fluctuations or aberrations in the price received by growers at auction; and
¥ provide minimum price certainty to growers within a season.
Until recently there was little to suggest that intervention policies were intended to influence or Òiron outÓ the larger, longer-term cyclical swings in wool prices which have always characterised the market. However, from about 1988 the actions of the Board in the market suggest that this may in fact have become part of the objective of intervention.
Certainly the New Zealand Council of Wool Exporters considers that the objectives of the intervention policy had changed. In December 1990, the President of the Council described the changes in the following terms:
ÒThe principal change which brought the Board most strongly into difference with the Council of Wool Exporters was the shift in policy from one of market support and stabilisation to one of market manipulation in which the intervention became a forcing card trick designed to achieve, in the words of the BoardÕs Chief Executive of the time Ôa mechanism to extract the last cent on the day from the marketÕ. Even when the New Zealand market was at its highest level resulting from the pressures of Chinese demand at the end of 1988, the Board under this policy was still bidding on a significant proportion of lots and purchasing a smaller, but still significant proportion of the lots it bid on. In early 1989 when the Chinese demand had fallen away and difficulties were being experienced by the Soviet Union in finding foreign exchange, the Council of Wool Exporters urged the Board to be realistic and allow the market to find a level at which demand which had transferred to other sources from traditional users of New Zealand wool could be revived. These urgings were not accepted and the Board continued to purchase heavily on a declining market in an effort to stem that decline.Ó
The extent to which the market price fell from its peak in late 1988 until the suspension of intervention in February 1991, and movements in the minimum price and NZWB stocks over the same period, are presented in Chart 11.4. The manner in which the Board tried to support the market and increased stocks at a time of historically high wool prices would seem to confirm the proposition that the objectives of intervention had changed.
In the 1988/89 season, when wool prices peaked, the NZWB bid on 30% of wool offered and purchased 10% of all wool sold at auction. In the 1989/90 season it bid on two-thirds of the wool offered and purchased nearly 40% of all wool sold at auction. The BoardÕs actions during 1989/90 could hardly be interpreted as Òdesigned to smooth out short term aberrations in the market from auction to auctionÓ.
The Minister of Agriculture expressed the view that market intervention policies had departed from their original objectives when he said:
ÒFor example, we ignored the pleas of the Bradford wool users last year when they said keep supplying us, donÕt keep pushing the price up and putting your wool in stores.
ÒSurely the underlying principle of selling a product is to make sure that those who want it and can afford to pay a reasonable price, have access to it.Ó
Similar sentiments have been expressed in a government review of industry protection:
ÒThe Wool Board is the subject of particular comment from wool using industries. There seems little doubt that the price support activities of this Board have had a significant effect on industries such as textiles, carpet and apparel. By holding up wool prices, the Board has insulated farmers from market realities, and reduced New Zealand manufacturersÕ ability to compete with woollen products from other sources (where wool is often cheaper). It has also had the effect of distorting relationships between wool and synthetic products often competing in the same markets.Ó
The use of terms such as protect and support in regard to growersÕ incomes during 1990 also carries the implication that growers would be shielded from any significant collapse in the market. Other statements at this time suggested that preventing a significant fall in growersÕ incomes was a high priority objective.
However, early in 1990 the Board could clearly see that a major market downturn was underway and appreciated that there were limits on its ability to support the market price and growersÕ returns. When announcing the BoardÕs decision to reduce the minimum price by 7.5% to 485 cents per kilogram clean for the 1990/91 season, the Chairman acknowledged that the Board had to take market circumstances and financial resources into account when determining intervention policy. He said:
ÒAs growers we are on our own, and as a commercially independent body with finite reserves, the Board has had to base its decision on the level at which we can support the market and at which we can assure growers a minimum wool income.Ó
At the commencement of the 1990/91 season the NZWB also reduced its market support price levels. They were reduced again by over 15% in October 1990, suggesting the Board did not wish to ÒfightÓ fundamental changes in the market. The move also probably reflected the rapid decline that was occurring in the BoardÕs cash reserves.
It seems reasonable to conclude that the objectives of the market support and price supplementation policies being followed by the Board were imprecise and changing over time. The lack of precise and well articulated objectives would have contributed to the BoardÕs ability gradually to change its methods of intervening. Changes to the objectives of market intervention were necessitated by the BoardÕs actions rather than determining them.
The Board was an unsuccessful speculator
Poorly defined objectives cannot, however, fully explain why the intervention scheme collapsed. The absence of clear Òoperating rulesÓ to guide the BoardÕs actions should not have prevented significant remedial changes in policy when it become apparent that existing activity could not be sustained. One possible explanation for the lack of corrective action is that the market changes were not foreseen.
It is axiomatic that intervention aimed at smoothing fluctuations in a market requires accurate forecasts of market developments. Regardless of other labels people may wish to attach to these intervention policies, they are essentially a form of market speculation.
Successful market speculators are those that forecast most accurately. For speculators to be successful they must have forecasts (market information) which are superior (and possibly not available) to other market participants, or have a better understanding of price forming relationships in the market.
While the NZWB has considerable expertise in this area, there are no fundamental reasons for believing it had information sufficiently unique or superior to be able to predict the market consistently more successfully than all other participants. In fact, it could be argued that Board intervention made it easier for others in the market to speculate successfully Ñ speculate that the Board could not persist with its policies.
The extent and severity of the market downturn was not particularly surprising and neither was it sudden. Prices started declining in 1988 after a period of steady increase. At the same time world wool supplies (including stocks) were high and rising. Declining economic activity in many major markets was depressing demand and particular difficulties were being experienced in the USSR and China. Wool prices had become historically high relative to synthetics.
When all these factors are considered in conjunction with the well-established cyclical behaviour of wool prices, a significant and sustained down-swing in the market was a high probability.
The Ministry of Agriculture and Fisheries apparently foresaw the market decline and its implications for stock accumulation under Board intervention policies. In early 1990 the MAF published forecasts which indicated that Board stocks were expected to increase nearly six fold between the end of the 1988/89 season and the end of the 1990/91 season. In fact, Board stocks increased by slightly more than this and had done so by the middle of the 1990/91 season.
The discussion in the previous section suggests that the NZWB, like many others, did foresee the market downturn. However, it appears to have either forecast its severity and extent poorly or, for other reasons, was not able to lower support prices and the grower minimum by a sufficient amount, quickly enough, to prevent the schemeÕs collapse.
The latter is the more likely explanation. Intervention schemes of the type used in the wool industry influence the expectations of market participants, particularly woolgrowers. In turn, this influences the ÒpoliticalÓ acceptability of appropriate policy responses at the time when policies most need to be changed significantly and rapidly.
The existence of the scheme gave woolgrowers unrealistic expectations
For over a decade the market intervention activities of the NZWB were largely trauma-free. In the early 1980s substantial price supplements were paid to growers and the Board accumulated and then disposed of stocks. Apart from a price downturn in 1985/86, the market rose steadily and quite strongly from the beginning of the decade until the peak in 1988.
During the 1980s the minimum price was raised gradually but for the most part stayed significantly below realised market prices. In 1988/89 the Board ceased levying growers for contributions to the Minimum Price fund which at the beginning of that season contained nearly $134 million.
The experience of the 1980s helped convince growers that such a scheme could operate successfully. There would have been little apparent reason for them to believe that prices could fall below the minimum established at the beginning of each season by the Board.
The influence intervention policies can have on growersÕ expectations and their behaviour was effectively acknowledged by the Chairman of the NZWB when he said:
Ò . . . many growers did not appear to have a real appreciation of the serious downturn in the international market demand for New Zealand wool that has been occurring this season.
ÒOur actions in paying out large amounts of supplementation to growers, as well as supporting prices at auction, have obviously shielded a number of growers from the reality of the market place.Ó
When market support and price supplementation ceased in February 1991 the issue which immediately gained prominence amongst woolgrowers was the inequity of removing support part way through a season. Growers who had yet to sell their wool would not receive support. The NZWB acknowledged the importance of this issue when the Chairman said:
ÒThe number one issue in front of us all is undoubtedly the inequity which has resulted as a consequence of the Board suspending its minimum prices scheme part way through the season.Ó
The importance growers attached to equity serves to highlight the way in which an intervention scheme shapes expectations. Growers only demand equitable treatment when a scheme exists which purports to, or is believed able to, deliver equity.
When a drought suddenly afflicts part of the country and causes store stock prices to collapse part way through a financial year, there are no producer calls for equity. Such events are seen as part of the normal risks of farming. The reason why equity is not an issue in these circumstances is that there is no scheme in place to give producers an expectation that equitable treatment is available or will be provided as of right.
Intervention schemes also determine how equity is defined. In the case of the wool scheme, growers believe equitable treatment means all growers receiving the same support for an entire season. However, this is not very equitable to those who originally contributed to the funds now used for price support. Not surprisingly, the definition of equity is very much influenced by the views and expectations of those who feel aggrieved as well as the characteristics of the intervention which is expected to provide it.
ÒPolitical paralysisÓ was the BoardÕs major problem
Woolgrower expectations regarding the support they believe they should receive has its most significant influence on the politics of managing intervention schemes in a crisis. Most people dislike delivering bad news. Such action is all the more difficult when the recipients have different expectations and their response has political career implications for the messenger. In these circumstances messengers are often ÒexecutedÓ for the bad news they convey regardless of its importance or accuracy.
This is essentially the situation the NZWB leadership found itself in when it became apparent that the market would experience a significant downturn. It became politically untenable for those who had been so involved in giving growers unrealistic expectations to announce suddenly that market support and price supplementation would have to be reduced significantly. Consequently this did not happen until it was the only option left. By that time it was in circumstances where those responsible for the scheme had essentially lost control of its future. Their hand was forced, because no more commercial credit was available.
Those responsible for the schemeÕs operation faced an unenviable dilemma. They clearly saw and understood what was happening in the market, and its implications. The decision to reduce the minimum price and support levels at the beginning of the 1990/91 season supports this proposition.
However, they were also captives of their earlier policies and actions, and the grower electorate to whom they were answerable. They were aware that growers were facing a difficult season financially. To have pre-empted the market outcome and removed, or drastically reduced, support levels and the minimum price would have been to risk grower accusations that they contributed to what followed. The political risks of this alternative were very high.
In ACILÕs judgement the Board was constrained politically from taking the action which it almost certainly judged to be commercially essential. While a range of fundamental factors play their part in causing market intervention schemes to collapse, a significant, and probably the major, cause of their eventual demise is Òpolitical paralysisÓ.
Those responsible for the management of such schemes eventually find themselves in circumstances where they are Òdamned if they do and damned if they donÕtÓ. The final outcome has little to do with their competence or their commitment Ñ they are victims of an outcome which is the inevitable consequence of these types of market intervention schemes and the politics they involve.
A recent analysis of the demise of the Australian wool price support scheme came to similar conclusions. According to Watson:
ÒIt is of the nature of political organisations that they find it difficult to recognise error, let alone admit or correct it. The paralysis of policy making in the wool industry, and the failure to come to terms with events in the market, eventually resulted in events passing from the immediate control of woolgrowersÕ organisations.Ó
This researcher went on to conclude as follows:
ÒRecent events amount to more than a little bit of bad luck brought about by unusually favourable seasons, or the unexpected withdrawal of major purchasers like China from the wool market. They have more to do with the initial unwillingness of the AWC, IWS and industry leaders to acknowledge the effects that a high reserve price could have on production and consumption and their obstinacy in refusing to act once the effects of their earlier actions became clear.Ó
Intervention also has other deficiencies
There are a number of other deficiencies and unfavourable consequences associated with market intervention policies which add to the already strong case for questioning their merit and concluding they will always fail. They include the consequences of floating exchange rates on price stability objectives, the effects intervention has on attitudes to risk and risk-reducing mechanisms in the wool market, and the consequences on producer income stability of price stability.
Policies to intervene in the wool market were developed in a period of fixed exchange rates. In these circumstances, fixing the price of a commodity in the currency of the supplying country effectively provided stability in the various buyer currencies.
With market determined exchange rates there are now varying relationships between the New Zealand dollar and the currencies of individual buying countries. Fixing the price of wool in New ZealandÕs currency no longer ensures stability in the currencies of buyers. This situation persists even when this price fixing is tied to a ÒbasketÓ of buyer currencies.
Varying exchange rates also increase the risks associated with market intervention. In particular, those responsible for the management of intervention need to forecast exchange rate movements as well as fundamental wool supply and demand influences.
Finally, it is far from clear that all this effort and risk to stabilise prices for users is worth the effort. It is often asserted that wool price stability enhances demand. However, this has been strongly questioned by Quiggin whose analysis centred:
Òon the observation that, whereas the price mechanism redistributes risk between buyers and sellers, price stabilisation through buffer stocks does not permit such transfers. If, as would seem to be the case for wool, fluctuations in final demand or exchange rates are the major source of instability, the long-run effect of stabilising prices is to increase the risk faced by wool users and to decrease that faced by wool growers, relative to a situation where prices move freely.Ó
Uncertainty and variability are typical characteristics of commerce and particular features of commodity trade Ñ wool is not a special case. The market has developed an array of mechanisms for managing such risks.
Intervention policies in the wool industry have had a significant influence on the availability and functions of these normal risk-managing mechanisms. In some instances they have Òcrowded outÓ or replaced them, raising the question of whether there has been any net gain from the intervention relative to market-delivered solutions. For example, the wool futures market became moribund while the Board was operating intervention policies. It has re-emerged since the intervention was removed. Furthermore, when inter-vention schemes collapse, a further element of uncertainty is added to the market about stock disposal policies.
The fact that the activities of the NZWB can have unforeseen implications for other market participants is illustrated by the experience of the Drysdale Carpet Wool Cooperative Company Ltd. This woolgrower cooperative was applying all the well-accepted principles of good marketing in a most innovative fashion. The consequences of NZWB intervention on its marketing strategies and the threat intervention posed to its survival are discussed in Box 11.2.
Individual market participants, speculating or managing risk in their preferred way, also result in a range of market positions existing at any one time. This can contribute to reducing instability. While not everyone will make the correct decision every time, the chances of all participants getting it wrong are less than when only one party (the intervention authority) is making the decisions. More importantly, when the single decision maker gets it wrong the consequences can be disastrous and all participants feel them.
In both New Zealand and Australia the wool futures market essentially disappeared when the respective marketing bodies began operating in the market. The Sydney Futures Exchange listed the first wool futures contract in 1960. Trade peaked at 186,000 contracts in 1973 Ñ close to 3 million bales equivalent. However, in recent years trade on the Exchange has been very limited with only 15 bales equivalent traded in 1990.
Subsequent to the collapse of price intervention schemes in both countries an active futures market has quickly re-emerged. Shortly after the suspension of NZWB intervention the New Zealand Futures and Option Exchange announced that it would be reintroducing wool futures and wool options contracts.
There are self-evident reasons why stabilising the New Zealand wool price does not necessarily stabilise woolgrowersÕ incomes. In fact, it is highly likely that it has the opposite effect, as discussed in chapter 2 in relation to intervention objectives.
Most New Zealand woolgrowers produce outputs other than wool. Even when they do not, the interaction between the price received for wool and other income determining variables like costs and climate (volume of production) means that stabilising the wool price has an uncertain effect on income variability.
A summary of price intervention consequences and lessons learned
The origins, consequences and fate of market support and price supplementation in the New Zealand wool market can be encapsulated as follows:
¥ when prices are low, growers are attracted to schemes which they erroneously believe will improve their returns;
¥ the wool price cycle means the market is usually in an up swing for the early years of such a scheme, making it appear successful and giving woolgrowers expectations that it will support prices and incomes;
¥ those responsible for management of the intervention become steadily more ambitious and confident in their ability to influence prices which in turn reinforces grower expectations; and
¥ when the inevitable significant market reversal arrives (partly caused and exacerbated by the intervention), those responsible for its management find necessary corrective action is politically untenable and this Òpolitical paralysisÓ ensures the intervention collapses.
On collapse, all market participants feel let-down, but for widely differing reasons, resulting in considerable acrimony, anger and bewilderment.
For those who have to pick up the pieces and bear the costs of this most recent market intervention failure, it must be particularly galling to know that this price intervention Òlife-cycleÓ is not new or untested. It has been experienced before in wool in New Zealand and Australia, and in a range of other internationally traded commodities.
Research undertaken in the 1960s prophetically examined the dangers of schemes aimed at intervening in the wool market with the following conclusions:
ÒEven a conservative reserve-price scheme would run some risk of getting into difficulties. Furthermore, because of the limited achievements of a conservative scheme, the supporters of a floor-price scheme are likely to demand a more radical reserve price. There is thus the risk that because of errors of judgement on the part of the authority, or because of pressure from dissatisfied groups of growers, a conservative scheme would escalate into a radical one.Ó
In the aftermath of the collapse of the New Zealand market support and price supplementation schemes, some recognition of the futility of what was attempted is dawning. Recognition within the industry is mainly taking the form of gentle suggestions that woolgrowers may be better off if they individually selected measures to help stabilise prices and incomes which are best suited to their particular needs and circumstances. The following quotes illustrate these sentiments:
¥ Ò. . . as an alternative to operating a minimum price scheme, individual farmers could make their own arrangements to guard against price fluctuations. These arrangements might include hedging on the futures market to reduce shorter term price fluctuations.Ó
¥ ÒThe support mechanisms designed to provide stability and give confidence to woolgrowers have in fact led to a destabilisation of the market. ThereÕs nothing wrong with trying to raise the price of wool. The lesson is that no-one can defy the reality of supply and demand.Ó
¥ ÒEven when the market recovers, farmers might be better served economically if they forgot about both minimum price schemes and price intervention and instead took out individual futures contracts.Ó
A consultantÕs report, commissioned by the Board and completed in early 1991 but not published, recommended against the re-introduction of market support activity of any kind.
However, history provides no confidence that the lessons learned most recently will be understood fully by all in the New Zealand wool industry, let alone remembered. There is only one fail-safe method of avoiding a repeat and that is to remove the legislation which makes these failed forms of market intervention possible.
11.3.2 Wool promotion Ñ a need for contestability
In 1990/91 each New Zealand sheep accounted for around $1.50 to wool promotion activities by the IWS. Each will account for a third of this amount in 1991/92 because New Zealand funding has been reduced sharply.
Despite this expenditure wool has lost market share, although without the promotion the decline may have been greater. However, recent events have again confirmed that price is the major determinant of wool use in the competitive fibre market. There are clearly limits on how effective promotion can be in reducing price competition. So, is promotion worthwhile and how do we know?
Studies show promotion does pay
The major argument for generic wool promotion is that wool must compete with the big promotional budgets of synthetic fibre manufacturers or its market share will fall even more rapidly. This promotion should be funded, it is argued, by all woolgrowers because they all benefit Ñ avoiding the so-called free-rider problem, that is, those not contributing to funding receiving some of the benefits.
A number of studies have concluded that wool promotion is a worthwhile investment for woolgrowers.
In 1976 a report by the Australian Industries Assistance Commission concluded that levels of wool promotion at that time were profitable and increases in promotional expenditure desirable. More recently, a joint study by the Australian Wool Corporation and the (then) Australian Bureau of Agricultural Economics concluded that there was approximately a $2 return in present value terms for each $1 invested in apparel promotion in the United States. In 1988 a Committee established by the Australian Minister for Primary Industries and Energy concluded that strong promotion for wool was necessary.
A study in the early 1980s into the future for New Zealand wool noted the fundamental shift, in favour of wool, in the wool/synthetic price ratio. The study noted that ÒR&D and promotional activities of both synthetic fibre and wool producers over the period would have been the major influences.Ó During this period synthetic fibre producers reduced expenditure on promotion because of depressed sales and profitability. On the other hand, according to Schroder Òwool achieved some successes.Ó
The IWS has an obvious vested interest in arguing that its activities are worthwhile Ñ or at least arguing that most of the time. As noted by Watson:
ÒNot surprisingly, the IWS has been quick over the years to claim credit for increasing prices, but attributes the recent change in circumstances to factors beyond its control.Ó
Another of its critics (a previous employee as was Watson) pointed to the dangers of potentially replacing promotion that would otherwise have been funded privately Ñ a form of Òcrowding outÓ.
ÒOne of the greatest pitfalls in wool promotion is to disburse advertising funds as a form of economic rent, not serving to change the actions of the recipients. In working for many years chiefly with the two giant textile manufacturers, Burlingtons and J.P. Stevens and withholding support from smaller but potentially more responsive firms, I believe the U.S. branch of IWS fell into this error. The two huge multi-fibre processors were glad to take IWS funds to help them do precisely what they would have done anyway.Ó
The research cited earlier suggests wool promotion is necessary and has been a worthwhile investment. Logic and general marketing principles also support the proposition that the product should be, probably must be, promoted. However, the most important questions now facing the wool industry relate to promotion activity in the future, in particular what promotion, who should do it, and who should pay?
Do market changes suggest changes in promotion are needed?
The objectives of promotion are to expand demand and make it less responsive to price changes (more inelastic). Wool consumption has risen Ñ despite a falling market share Ñ and over the longer term wool prices have increased relative to synthetics.
However, the characteristics of markets for New Zealand wool are changing and this may hold important implications for the best approaches to promotion. WoolÕs end-uses are more diverse Ñ when it comes to the type and amount of promotion to undertake there are big and obvious differences between carpets in the United States and hand-knitting yarn in China. The variety of IWS activities recognises these differences.
The use of wool blended with other fibres is also likely to increase. This brings into question the value of promoting wool as an alternative, rather than complementary, fibre. The IWS promotes both pure wool and blends. A question for the future is whether the balance should give more emphasis to blends.
It was also noted earlier that improvements in the technical specification of wool will have implications for promotion. Anything which improves the ability of the seller to differentiate the product enhances branding possibilities and reduces the relevance and likely value of generic promotion. If branding was not important, Heinz would not spend money on promoting its particular baked beans.
Even with current wool specification technology it has been demonstrated that a particular wool can be branded and promoted successfully Ñ see the Drysdale wool story in Box 11.2.
Essentially, changes in the wool market and the marketing system are making decisions about where and how to spend promotional funds more complex and this trend can be expected to continue. A key question, therefore, is whether current approaches, and particularly such heavy reliance on a single organisation Ñ the IWS Ñ is the best way to approach wool promotion in the future.
Would the IWS benefit from some competition?
The wool industry has most of its promotional ÒeggsÓ in the one ÒbasketÓ and this, by definition, is a risky strategy. For decades the IWS has been the ÒmonopolyÓ promoter for the worldÕs major wool exporting countries.
Not only are market developments making promotional decisions more complex, but the reliance on a single body with no real competition makes performance difficult to assess. Furthermore, there are some relevant Òpolitical accountabilityÓ issues in how the IWS is managed and its performance assessed and reported to woolgrowers. They are the same issues as apply in the case of marketing bodies which restrict choice and competition. The same people involved in the political problems associated with market intervention are on the Board of the IWS and accountable to growers for its performance. In many respects, the IWS can be viewed as an extension of the NZWB.
There are many ways in which more competition and better performance assessment could be introduced into wool promotion. These changes could be made even if woolgrowers continue to pay a compulsory levy. In fact, they are all the more important if this is the case.
The NZWB should consider letting anyone bid for promotional funds. There is no reason why the funding of promotion could not be undertaken along the same, increasingly competitive, lines used to fund industry R&D. The principles and techniques used to ensure maximum returns for R&D investments are equally applicable to promotion investment decisions.
Opening up promotional funding would increase the range of expertise and ideas available to the industry. The IWS could bid along with everyone else for funding. This new environment would encourage or even make it necessary for the organisation to introduce performance related rewards internally.
Woolgrowers, in groups or in conjunction with their users, could propose promotional activities to be funded from the levy. This would avoid situations like that faced by the Drysdale woolgrowers who fund their own brand promotion and contribute via the compulsory levy.
Making promotional funding more contestable would make performance assessment more transparent and of gradually increasing use as a guide to where the benefits were greatest. Contestability would ensure that the types of promotion, and the allocation of funds amongst competing needs, kept pace with changing market circumstances. It would actively encourage market participants to examine possibilities for branding and product differentiation.
This last point has important relevance to the free-rider problem at the international level Ñ countries which do not contribute to promotion but reap some of its benefits. With industry subsidies in the EC leading to rapid growth in the sheepmeat industry, the Community has become a major free-rider on New Zealand wool promotion activity. So have Argentina, the United States and other non-contributors to the IWS. Any incentives which encourage the development of product differentiation and branding reduce the extent of the free-rider problem.
These types of changes are likely to maximise the rate at which non-generic and privately funded promotion develops in the industry. Eventually, they could lead to the need for a compulsory levy disappearing, or at least for the levy to be considerably lower without necessarily reducing the total promotion effort.
Continuity of funding also important
Promotion activity is about demand building over the longer term. It is unlikely to be in the best interests of woolgrowers if the funding available for promotion fluctuates violently.
The sharp reduction in New ZealandÕs contribution to the IWS in 1991/92 (down from $90 million in 1990/91 to $30 million in 1991/92) is a direct result of the financial collapse of market intervention. Although market intervention was portrayed as being managed and funded separately from promotion and R&D, the funding was clearly interconnected when a financial crunch finally occurred.
Following the NZWBÕs decision to cut funding to the IWS in 1991/92, the Chairman had the following to say:
ÒItÕs extremely regrettable that we have to cut promotion. However, in making the cuts weÕve been in full consultation with our IWS partners and IWS management to come up with a new streamlined structure thatÕs designed specifically to boost New Zealand wool.
ÒIt will mean a move away from individual country programmes under local direction, which is disappointing. But at the same time the efficiencies it introduces will result in an extremely lean and aggressive organisation.Ó
It is not too churlish to suggest that the ÒefficienciesÓ referred to by the Chairman should have been secured come what may. However, it is common in organisations operating non-competitively for such improvements in performance to be associated with unexpected funding constraints not directly associated with their activities.
The fundamental issue raised by the sharp funding reduction is the implication for promotional activity and woolgrower returns over the longer term. It suggests a need for promotion funding to be secured and managed separately from other activities so similar discontinuities are avoided in the future.
It may be that $30 million is a more appropriate level of investment for New Zealand woolgrowers to be making. This is not the issue being discussed here. Whatever is an appropriate level of funding, the long term nature of promotion and the delivery of its benefits suggests funding should not be subject to the risk of sharp, unexpected and short-term fluctuations.
11.3.3 The marketing system has been slow to innovate
There have been some significant changes in the way wool is marketed over the past few decades. The introduction of objective measurement and sale by sample, and high density dumping are examples.
However, it seems reasonable to question whether innovative change could not, and should not, have occurred more rapidly. An overview of changes in wool marketing since World War II leaves the distinct impression that marketing innovation and cost-reducing improvements have had to be ÒdraggedÓ into the system.
This raises the question of whether, on balance, a statutory body such as the Board actually retards innovative progress even though its raison dÕtre Êis to do the reverse.
An ex-senior executive of the Australian Wool Corporation was quoted recently as saying that Òradical change had not been a feature of the selling systemÓ for Australian wool. Among other features, this newspaper report noted that the open-cry auction system still dominated proceedings, sale by description appeared as distant as ever, lot sizes remained small and international promotion was still based on generic advertising.
In some observations which are directly relevant to the New Zealand scene, the report outlined changes in marketing already emerging since the price support scheme was removed, viz:
Ò . . . whatever havoc the collapse of the floor price scheme may have caused, its demise in February has prompted a number of ideas for marketing wool that were previously stifled by the industryÕs compulsory security blanket.
ÒThe moribund wool futures contract is stirring, projects are under way which aim to link growers directly with overseas processors, and the future of the existing auction system . . . is under serious question.
ÒAt the farm level, the removal of a price guarantee has given woolgrowers a powerful incentive to improve the quality of their clip and to ensure that what happens to it beyond the farmgate rewards that quality.Ó
It is not only price intervention on the part of the marketing authority that can be linked to the possibility of innovation being retarded. The involvement of the NZWB in wool handling developments and land and ocean transport activity provides further examples.
In 1988 the NZWB commenced the gradual dismantling of the policy of aggregation of land-based wool freight charges. The reason given was to enhance competition by allowing Òcosts to lie where they fallÓ.
This action, and its underlying objectives, are in the best interests of the wool industry and woolgrowers. However, the question it begs is why the action has been so long in coming and why the same principles should not be applied to ocean freight arrangements?
The difficulties experienced in removing aggregation arose because the commercial viability of investments made when the policy applied changed when it was removed. It is a classical example of how intervention leads to Òvested interestsÓ which then became an impediment to reform even when the advantages were very obvious.
A particular example of these types of forces at work is given in Box 11.3. This illustrates how the BoardÕs involvement in wool handling retarded the rate of adoption of improved wool-handling technology in New Zealand. There are other examples. New Zealand was slower than Australia in introducing Òbox ratesÓ for containers in the wool trade. The shipping conferences successfully prolonged weight-based freight rates, reducing the incentive to adopt improved dumping technology which would have reduced exportersÕ costs.
Removing aggregation while maintaining controls over shipping services and ocean freight rates has served to introduce some new distortions to the wool marketing system. In this regard, the Council of Wool Exporters had the following to say:
ÒThe New Zealand Wool Board exercises its statutory power to determine the conditions under which the trade may ship wool to certain areas where the Board has approved shipping lines and their maximum rates of freight and minimum conditions of service. The Board has introduced into several shipping services a requirement that the internal transport movement in New Zealand be borne by the shipper and not aggregated into the freight rate. This inland movement is charged for on a basis similar to the destination zone charges applicable in user countries between port of destination and mill. The intention of this exclusion of aggregation is to make inland transport costs more transparent and promote cost efficiencies. Not all wool exporters are in agreement with this policy, and there is increasing debate as to the equity posed to different sources of wool and processing locations in relation to load ports. There is increasing questioning of a system where the Board takes the power to require exporters to ship in accordance with the conditions it lays down, but does not give them the rights to act individually or jointly with other shippers on negotiating their freight rates in the way the Board has opened up the inland transport movements.Ó
Inland wool freight costs in New Zealand now lie where they fall but shippers are still unable to negotiate freight rates and conditions either individually or in common-interest groups for much of the trade. The result is that the removal of aggregation has left some exporters with facilities not optimally located in relation to a suitable port. Their inland freight costs have risen but they have no scope to offset the increase by trying to negotiate a better sea-leg freight rate. They argue the removal of aggregation is, therefore inequitable.
Currently, the NZWB is not faced with strong pressure from the exportersÕ Council to change the system because of this lack of unity in the industry Ñ clearly not every exporter would win.
However, introducing greater exporter choice and therefore competition into sea freight should produce advantages to the industry of the same type correctly claimed for the removal of aggregation of land-based costs. Over the years and across all major rural exports, the worthwhile improvements in the cost effectiveness of shipping services have occurred in association with new entrants and more competition being introduced to the trade.
There would be strong incentives for exporters to work cooperatively Ñ rather than be managed and directed by the Board Ñ to achieve lower cost ocean freight and reliable services. The need for exporters to maintain reputations for reliability would be a principal incentive not to use unreliable services. In fact, a competitive, unregulated market for shipping would have the advantage of quickly identifying poor performers and eliminating them. Poor performance is easier to hide in systems where choice and competition are restricted.
It is often suggested in regard to rural exports that if the provision of shipping services were deregulated and made more competitive, services may decline (in number and frequency), disadvantaging many exporters. This seems unlikely to be a problem. There is evidence that shipping is contestable because of the ease with which vessels can be switched between routes.
When the NZWB has decided to introduce competition to the trade in terms of additional shipping companies the consequences have usually been quite striking. The following newspaper report from 1983 is an example.
ÒThe Wool BoardÕs two-tier freight rates are already paying dividends. Rates 34 to 45% below the New Zealand-European Conference rates have been offered by lines bidding for the 7% of the trade opened up to competition by the Board early this year.
ÒAnd this has forced the conference lines to cut offered rates to try to maintain their share of the freed trade.
ÒThe Board put 12,500 tonnes out to competition Ñ reluctantly and under political duress. Under pressure from the Government, Federated Farmers and the New Zealand-owned sector of our wool industry, the Wool Board has modified its pro-conference stance.Ó
Are there lessons from the cotton industry?
The cotton industry has grown rapidly in Australia since its establishment in the 1960s. It is now ranked fifth amongst AustraliaÕs rural exporters. The Executive Director of the Australian Cotton Foundation described recently how the industry operated in a Òtotally freeÓ market.
ÒThere is no government control, no statutory marketing authorities, no floor prices. They are generally a smarter, more educated group of farmers.
ÒCotton growers had a range of selling options Ñ cooperative pools, merchants, processing through one of the ginning organisations, forward selling, or permutations of the above. Virtually all farmers tapped in daily to world cotton prices.Ó
One of AustraliaÕs biggest corporate cotton producers also owns extensive woolgrowing interests. This places the company in a very good position to compare the relative merits of two very different marketing systems for raw fibre. The company is moving rapidly to apply cotton marketing approaches to wool. Contracts are being arranged for the direct sale of wool to mills in Japan, South Korea and Italy. A spokesman for the company was quoted as saying:
ÒThere is a lot of fat from the shearing shed to the spinner.Ó
Reinforcing the sentiment that the wool marketing system might usefully learn something from the cotton industry was the following statement from the manager of one of AustraliaÕs largest wool producing operations:
ÒThe [wool] industry needs to reduce costs between shed and mill, encourage risk takers, source and circulate more information and create total quality management and just-in-time opportunities.Ó
Recent research on marketing costs also strongly confirms the suggestion that the wool industry has much to learn from how cotton is marketed. In Australia, the costs of marketing cotton (from producer to fibre processor) are about one third those of wool. The incomes of woolgrowers would rise significantly if wool could be marketed for the same cost as cotton.
In regard to wool marketing, the Chairman of the NZWB recently said the following:
ÒWe must also continually strive to see that our overall wool marketing system best meets the requirements of the textile industry.
ÒItÕs relatively easy to identify the problems and to play the role of the DevilÕs advocate. Solutions to complex marketing issues are harder to find, although find them we must.Ó
The cotton industry would appear to have found them, and found them without the need for a board or regulations.
11.3.4 The Board is busy finding new things to do
An innate characteristic of any organisation in a protected, regulated environment is the ability always to find new things to do to justify its continued existence regardless of how it has performed in the past. The NZWB is no exception and since the collapse of price intervention it has been busy reshaping and securing its involvement in the industry. At least some growers have expressed concern about its innate tendencies to misplaced activism.
In December 1991 the Board commissioned consultants to study New ZealandÕs raw wool marketing system and a report was published in May 1992. In August 1992 the Board published, on behalf of a range of wool industry bodies, a report entitled Strategic Directions for the New Zealand Wool Industry. This report was the outcome of an initiative by the Minister of Agriculture who asked the Board in mid-1991 to initiate a strategic plan for the wool industry. The Board has also announced its intention to establish a wool marketing subsidiary company.
A study which finds little has changed since the last study
The Arthur D Little study of raw wool marketing was commissioned by the Board in December 1991 and the steering committee supervising the project included representatives from other sectors of the industry. The consultants said they were in no doubt Òthat the New Zealand wool industry has serious structural problems and that improvement of the raw wool marketing system can go a long way towards restoring the fortunes of the industry.Ó
The report painted a fairly depressing picture of the New Zealand wool industry and its marketing system. It referred to a similar study undertaken in New Zealand in 1971 which was equally critical of wool marketing. The consultants observed that since that study there had been little change to the marketing system and that ÒtodayÕs situation is worse and the price trend . . . is relentlessly downwards.Ó There were no conclusions regarding how much responsibility for this state of affairs might reasonably rest with the NZWB.
The centrepiece of the Little report was the proposal to create a new form of trading entity called the ÒFibre FirmÓ:
ÒThese new firms will provide a link between the grower and the market for standard blends. They will undertake pooling of growersÕ greasy wools, scouring and blending and the sale of standard blends. The maximum return to growers will come about if the Fibre Firms are owned by growers through some form of cooperative venture.Ó
The consultants noted that one way of bringing about change was to have the Board use Part V of its Act Òto acquire, pool and market the entire clipÓ. One of the reasons given for rejecting this option was that:
ÒOver time monopolistic entities tend to become bureaucratised and to lose some of their drive and market orientation.Ó
It was recommended, however, that the Wool Board take a leading role in establishing the new system. The report stated that the Board Òhas the standing, industry knowledge and financial resources necessary to bring the new system into existence.Ó
The recommendations raise two important points which were inadequately canvassed in the report. They are:
¥ the grounds on which it might reasonably be expected that this time around the NZWB will be more effective in producing beneficial changes in the marketing system than has been the case in the past; and
¥ substantive reasons why beneficial changes of the type recommended, or other ideas and innovations, would not emerge from a competitive system with no Board involvement.
The recommended Fibre Firms have been less than enthusiastically received within the industry. According to one report:
ÒThe question was whether woolgrowers would be prepared to invest in such a cooperative, particularly considering New ZealandÕs uneven history of producer cooperativesÓ.
The fundamental commercial flaws in current cooperative structures, raised elsewhere in this report, should also be considered in assessing the Fibre Firms recommendations. Alternatively, the non satutory-based Drysdale Cooperatives might reasonably be taken as an example of the cooperative approach working successfully in the wool industry without NZWB encouragement or intervention.
In the end, however, the recommendations of this most recent study into the marketing system are essentially more of the same. The same diagnosis of what is wrong, the same general prescriptions for what needs to be done, and the same solution of asking a regulated body to ensure it all happens. This approach has not worked in the past Ñ as the most recent study indirectly acknowledges Ñ and there are no reasons for believing it will work in the future.
What is an industry strategic plan?
In the preface of the strategic directions document published by the NZWB in August 1992, the Chairman of the Board said:
ÒThe wool industry has recently been through a difficult period, but its members have a shared determination to turn it around and realise its full potential for the New Zealand economy. This document sets out the strategic directions which we all will follow in order to achieve this.Ó
It would be trite to criticise any industry for attempting to develop a set of shared strategic objectives and means of achieving them for mutual benefit. However, the essential deficiency with a strategic plan for an industry is that it is either so general and consensus-based that it is of little value or influence, or it is the precursor to justifications for regulation and intervention claimed to be necessary to achieve the objectives of its architects.
Strategic planning is about setting objectives and the means of achieving them. When applied in a business it involves directors and managers agreeing objectives and determining what strategies and actions will be used to achieve them. Different businesses in the same industry will come up with different objectives and different approaches to doing things.
The situation in an industry is not analogous. There are no directors or managers with the responsibility or power to ensure things happen in a certain way. Consequently, those responsible for industry strategic plans invariably gravitate towards methods for overcoming this deficiency. Their motivation is to see actions emerge from their strategic plan. This is frequently the genesis of another round of rules and regulations for an industry.
The implementation option which industry strategic planners invariably overlook or avoid is the one which makes the industry as open and competitive as possible. This involves the creation of an environment where opportunities for investment, ideas-testing and innovation are maximised with a view to achieving the ultimate objective of every participant Ñ to be profitable and survive. It is very rare for industries which have such an operating environment to find a need to prepare a strategic plan. What the wool industry should do is take the strategic actions necessary to produce a competitive, non-regulated environment with the major outcome being the removal of the need for centralised planning.
The strategic plan prepared by the wool industry is very general. It is encouraging to see that its objectives Òare directed toward the achievement of increased profitability for all industry participants and greater returns for the New Zealand economyÓ. However, concerns that industry strategic plans usually ensure continuing regulation are reinforced when the plan states that Òthe composition of the Board of Directors of the NZ Wool Board should reflect the interests of the wider industryÓ. It is difficult not to conclude that the strategic plan is just the first step by the industry in Ôrearranging the deck chairs on the TitanicÕ. It is disappointing to see no reference whatsoever in the plan to the competitive option which is the norm for market-driven industries.
A new approach to market intervention
In August 1991 the Board announced it intended to have future Board marketing activities handled through a separate subsidiary company which, at least initially, would be wholly owned by the Board. In making the announcement the Chairman described the proposed company in the following terms:
ÒThe company will be an independent organisation with its own board and directors. Once the company becomes fully operational, which, as mentioned earlier, is expected to take several months, the Board will cease its so-termed Ôdirect salesÕ from its stockpile.
ÒThe new companyÕs objective will be to be a leading and profitable international wool enterprise, focusing on the innovative marketing of New Zealand wools. The Board will expect the company to produce a commercial rate of return on its capital funds.
ÒWe intend to take this initiative because we believe that such a company can make a positive contribution to the marketing of our wool. We support the concept of woolgrowers trying to help shape their own destiny in this important area.Ó
As noted earlier in this chapter, the NZWB already has commercial investments in the wool marketing system. These are seen to be strategically important in stimulating innovative marketing practices and the adoption of improved technology, viz:
ÒOur decision to purchase Annett and Darling (Andar) is an example of this strategy. This company has an integral role to play in the R&D and technology transfer fields and has made very significant progress in getting back on track. Its exports have grown sharply and they look to the future with confidence;Ó
and:
ÒIt is also encouraging to note the improved scour deliveries resulting from the innovative blending equipment installed at the Ferrier joint venture woolscour. This looks as though it may set a standard which other scours emulate in order to remain competitive.Ó
However, the address which contained these observations by the Chairman of the Board also contained the following comments in respect of the recent performance of Board subsidiary and associate companies.
ÒOverall the combined result from those companies was below budget and thus led to a Board decision to write down the value of the investments by $2.2 million.
ÒThis isnÕt good, but there possibly would be many firms which would be thankful to have done as well, in todayÕs economic climate.
ÒThe necessary hard decisions and actions have already been taken, or are in the process of being taken, to ensure that improved financial results are achieved this year.
ÒThe directors of these companies know that they must be profitable to remain in business. At the same time we do need to view these investments within the broad sphere of the BoardÕs operations and strategies.Ó
Two very important points arise from these comments. The first concerns how producers are to know that the performance of these companies is satisfactory, particularly in view of their Òstrategic, technology transferÓ roles. The other arises from the particular reference to how they performed relative to other companies in a difficult economic climate. The important difference overlooked by this remark is the ability of shareholders in ÒotherÓ companies to sell if they considered that the best strategy. This option is not available to woolgrowers.
Woolgrowers reacted to the BoardÕs announcement of a wool marketing subsidiary company with some caution. Shortly after the announcement, the Chairman of Federated Farmers Meat and Wool Section cautioned the Board about getting involved in commercial activities. He was reported as having:
Ò . . . reminded the Board of farmer concern about the commercial activities of producer boards and sought guarantees that the proposed company would not have advantage over other wool exporters because of its relationship to the Board.Ó
About a month later another report observed that there appeared to be:
Ò . . . little enthusiasm for the stand-alone company the Wool Board is proposing to set up to operate in the market. Farmers fear it will just drain away funds that would be better applied elsewhere.Ó
Wool exporters have indicated that they have no in-principle objections to the BoardÕs proposal and the greater competition it implies for them but Òfelt the timing was very inopportune.Ó However, with some timing of their own that seems more than coincidental, the exporters have also proposed more stringent licensing of their members by the Board. The President of the Council of Wool Exporters was quoted as saying:
ÒExporters have no wish to restrict the entry of new firms into the trade, but there is clearly merit in licensing exporters to ensure wool is only traded by companies which are financially sound, have expertise in the wool business and which abide by an industry code of practice.Ó
It is hard to see how companies which did not meet these criteria would survive commercially in a competitive environment. In other industries, for example the meat industry, such controls over exporters have quickly developed into effective barriers to entry. Despite the CouncilÕs protestations there is a strong likelihood that the same outcome would occur in the wool industry if these proposals were actioned.
Woolgrower caution about the BoardÕs proposal is very well founded, and exporter reactions are quite understandable in the circumstances. Perhaps the most important conclusion that can be drawn from these reactions is that affected parties, particularly growers, appear powerless to stop it happening. As is so often the case with regulation, ownership does little to guarantee effective control.
Woolgrowers should ask why it is necessary to have a Board company to ensure innovation and cost effective adoption of improved ways of doing things in the marketing system. If it is profitable investment, then why are private entrepreneurs not taking up the opportunities?
One possible answer is that the existence and activities of the Board are suppressing innovation and risk taking rather than encouraging it. If there are genuine impediments to entrepreneurial innovation in the industry they should be addressed directly and removed.
If there is genuine market failure associated with certain R&D activities it is likely to be more efficient to address the problem within an R&D funding framework. Growers would then have a clearer picture of what their funds were being invested in, why, and with what results. An R&D focus on these issues brings with it the discipline of asking why grower-funded R&D might be necessary. The key point here is that if private entrepreneurs do not find this off-farm R&D profitable, how likely are they to adopt its output if growers fund its execution?
This issue leads naturally to the major deficiency with this type of commercial structure: the inability of producers both to know that it is performing satisfactorily and to opt out and invest in something else if it is not. The fact that such a company will not have its value set in a competitive market means there is no way growers can know whether it is an acceptable investment.
This problem is compounded by the strategic development role given to such a company. If returns are unsatisfactory or it loses money it can too easily be argued that this is a small price to pay for encouraging beneficial innovation in the marketing system. Furthermore, such a company faces an incentive to invest in the application of what it has developed as ÒevidenceÓ that it has achieved its technology transfer objectives.
If the NZWB genuinely believes shareholders will benefit from a company which is at the leading edge of wool marketing the response should be to establish such a company with those sharing the same view taking up shareholding. If such a company would not be commercially viable because of its R&D and technology transfer responsibilities, these objectives should be pursued within a specific R&D funding and management structure to ensure transparency. Trying to have one organisation achieve both objectives will certainly fail and growers will eventually have to meet the costs.
11.4 Conclusions
It is tempting to look quickly over the system of marketing wool and conclude that, apart from periodic disasters associated with attempts by growers to manipulate the market, the system is open, competitive, and performing satisfactorily.
This very much reflects the views of those responsible to growers for the BoardÕs operations. The Chairman summarised it very well when he recently made the following remarks:
ÒI also wish that some armchair experts would at least make an effort to understand the subject before rushing in to voice an opinion. In our own sector there has been no shortage of people telling us how to market primary products. The thrust of their advice seems to be that because competition is ÔgoodÕ, the way forward is to have much more competition introduced into the marketing of our exports. Anything that hints of control must be removed.
ÒSuch commentators have been noticeably silent when asked, if the key is simply more competition, why the wool industry has not performed better Ñ after all, itÕs as free and open an industry to enter as you could possibly get.Ó
The fact is that the ChairmanÕs final conclusion is wrong, and consequently ACIL sees no good reason to be silent when asked the key question. Open and competitive markets only operate successfully in a climate of regulatory certainty. A stable and secure system of property rights is crucial to long-term investment. Where market participants are constantly at risk of changes that can affect the value of their investments, their willingness to invest and take risks is greatly inhibited.
The NZWB operates under legislation which provides it with very general and extensive powers to exercise control over the wool marketing system. The fact that the market has numerous participants, and prices are determined at competitive and open auctions, tells us very little about whether marketing innovation is being maximised and costs minimised.
In fact, the evidence that this is not happening is extensive. While the NZWB has none of the readily obvious features of a statutory single seller its influence on the system is pervasive. In a way it overhangs the entire marketing system like a giant shade tree. While there might be plenty of plants, the fact that they have to grow in the shade is demonstrably stunting their growth.
It is unarguably in the interests of New Zealand woolgrowers, and the wool industry as a whole, to have this regulatory Òshade treeÓ removed. Institutional arrangements should be confined to promotion and R&D, and those arrangements and their funding should be purpose-specific and involve increased contestability in their execution.
Woolgrowers would be unwise to presume that legislators and those responsible for existing market intervention arrangements will learn from their mistakes. History and the fundamental characteristics of the arrangements are two good reasons for taking a sceptical attitude. The BoardÕs proposal for a marketing subsidiary is simply more intervention in a different form and evidence that regulated bodies can always find new justifications for their continuation.
In regard to other influences and controls exercised by the Board, the comparisons made with cotton and the way in which innovation has been retarded in the past are convincing reasons for believing growers would benefit from the removal of the BoardÕs powers in these areas.
There is no need for any market participants to be licensed. The Board has acknowledged that the essential purpose is levy collection. Registration of participants is quite adequate for this purpose.
It is hard to see why thinking and progressive woolgrowers in New Zealand would consider they need a producer board involved in their marketing system. Growers must understand that their security blanket is being used to suffocate, not to nurture and warm. The industryÕs marketing system needs some excitement and entrepreneurial enthusiasm injected, and most of the existing bureaucracy and lethargy swept away. The wool marketing system is too much the captive of tradition.
The Wool Act 1977 should be repealed in its entirety. It should be replaced with legislation that allows the continued compulsory funding of promotion and R&D. There are arguments supporting the retention of this type of intervention in certain circumstances.
These changes are likely to bring dramatic improvements to the pace of change in the marketing system. It is quite reasonable to expect a more competitive marketing system to deliver quite quickly more efficient and lower cost marketing methods. Electronic sale by specification and computers and moves to branding wool will in turn steadily reduce the need for compulsion in the promotion and R&D areas.
Chart 11.1: Sheep Numbers and Farm Profits (1981-1991)
Source: Meat and Wool BoardsÕ Economic Service.
Chapter 11
Wool
Chart 11.2: Destination of New Zealand Wool Exports (1986Ð1991)
Source: Department of Statistics; New Zealand Wool Board.
Box 11.3: Wool Dumping Ñ A Case of Intervention Slowing the Adoption of
Improved Technology
Regulatory powers over shipping wool were introduced in 1972.
Aggregation of land-based costs was introduced shortly thereafter. It was into this
regulated and cost-pooling environment that containerisation technology was introduced.
Prior to containerisation wool was exported through conventional wharf
facilities in seven New Zealand ports. Because considerable investment was involved in
containerisation it was necessary to increase throughput at ports where containerisation
was to be introduced. The number and location of containerisation ports was determined by
the government and decisions administered by the New Zealand Ports Authority.
Containerisation facilities were introduced at only four ports Ñ Auckland, Wellington,
Lyttelton and Dunedin. Aggregation continued so that individual shippers and hence
woolgrowers were not disadvantaged if they found themselves suddenly more distant from a
wool-handling port.
Containerisation had implications for wool dumping (the compression of a
number of bales into a smaller volume). Dumping facilities at some ports were no longer
required. There was also now an incentive to increase the dumping density so that more
wool could be ÒstuffedÓ into a container.
In response to these changes and emerging needs the NZWB became involved
in the Òadministrative guidanceÓ of moves to upgrade dumping facilities and consolidate
them at a number of sites off-wharf. Under the guidance of the Board the shipping
companies and wool brokers established, and jointly funded and owned, regional wool
dumping facilities.
As an inducement to establish these facilities the NZWB agreed that for
the nine years commencing 1975 all wool would be dumped at these facilities. The investors
argued this agreement was necessary to ensure they could satisfactorily amortize their
investment. It effectively removed investor risk.
The only exception to this agreement was on-site dumping by wool
scourers. The scourers successfully resisted NZWB pressure to have their dumping done at
the regional facilities. The continuing ability of scourers to dump on-site was to become
important.
New high density dumping technology (dense dumping) became available in
the early 1980s before the expiry of the nine year agreement with the owners of the
regional dumping centres. They resisted the introduction of the new technology because
they wished to protect their existing investment. They cited the agreement as their
protection against the immediate introduction of the improved technology.
However, scourers began investing in dense dumping because they were not
party to the agreement. Their cost competitiveness relative to the regional dumping
centres improved and throughput at these centres fell as a consequence. These changes were
also influenced by falling sheep numbers and wool production at the time.
The moral of the story is unambiguous. If intervention serves to protect
vested interests, then incentives to improve productivity can be seriously blunted. Had
the scourers not stood aside from the 1975 agreement it is a matter of conjecture how much
longer it might have taken for improved dumping technology to be introduced into New
Zealand.
Box 11.1: The Use of Objective Measurement in the Wool Marketing System
Virtually all greasy wool sold at auction in New Zealand is sold on the
basis of sample and test certificate. Core samples are taken from each bale of wool and
objectively measured for fibre diameter (micron), yield, vegetable matter and colour.
Varying degrees of objective measurement are used in the private treaty trade.
There is also extensive testing of wool after scouring in New Zealand.
Length-after-carding and bulk, as well as micron, will be important features of scoured
wool when meeting buyerÕs requirements.
There are two organisations which compete for business in undertaking
wool testing. They make extensive use of accredited agents to do the actual sampling. The
Joint Quality Control Service is owned and operated jointly by the wool exporter and wool
broker industry organisations and supervises and undertakes regular inspections of
sampling facilities, and trains staff for employment in these facilities.
Wool testing organisations must be accredited by TELARC. This is the
statutory body in New Zealand responsible for all laboratory and measurement surveillance
and accreditation. The NZWB has issued a directive Ñ with industry agreement Ñ that wool
can only be sold on the basis of objective measurement if the certificate has been issued
by an organisation accredited by TELARC. Provided this requirement is met there are no
restrictions on who may undertake wool testing.
Any moves to selling greasy or scoured wool by specification only will require improvements in some existing measures Ñ particularly colour Ñ and the development of measuring technology for length, bulk and medullation. Imaging and new infrared technology is expected to have an important role in delivering these improvements.
Chart 11.4: Market Price, Minimum Price and Board Stocks
Source: New Zealand Wool Board.
Box 11.2: Intervention Can Add to Woolgrower Risk and Uncertainty
The Drysdale Carpet Wool Cooperative Company Limited was formed in the mid-1970s to continue marketing Drysdale wool direct to users. Its achievements and experience in the wool market collapse make it a revealing case study of how a small, independent marketer has fared in an industry featuring compulsory levies and market intervention.
Operations of the cooperative
The Cooperative has a wool handling centre in the North Island and one in the South Island. Each season the cooperative runs three pools each of four monthsÕ duration. Growers receive an advance of around 80% of the woolÕs appraised value. This advance has been important in retaining supplier loyalty given the payment terms available from the traditional auction system.
Shortly after its establishment, the cooperative was approached by, and contracted, the NZWB to provide marketing services. Wherever possible the wool was to be sold direct to end-users. The contract was terminated in the early 1980s because the cooperative was not satisfied with the service. An incorrect pool payment made by the NZWB was a particular event which precipitated this change. Affected growers had to return part of the payment and some 20% of suppliers left the cooperative as a result. The cooperative then appointed its own marketing manager. Policy changes in the mid-1980s reduced protection for the New Zealand carpet industry and the domestic demand for Drysdale wool fell. The cooperative also decided to establish a brand and license its use, to differentiate New Zealand Drysdale wool. This was spectacularly successful and over a period of two years the cooperative moved from selling 80% of its wool on the domestic market to selling 80% on the export market.
The development of a logo and brand is an interesting innovation in an industry where the product is traded overwhelmingly as a commodity with generic promotion. A Certificate of Quality which is guaranteed by the cooperative is attached to each sales contract. In the United Kingdom and in Japan a manufacturer has exclusive rights to the brand on products containing New Zealand Drysdale wool. Each manufacturer has provided significant funding to promote the branded products.
Influence of NZWB activities
NZWB influence on the cooperativeÕs activities started to change markedly in 1987 when the Board began to intervene more aggressively in the market.
The success of any cooperative depends on its ability to maintain supplier loyalty through acceptable returns. To maintain loyalty and throughput, the Drysdale cooperative was forced to try to match the prices being supported by the NZWB during this period. As a result it accumulated stocks of unsold wool in 1989/90.
During 1989/90 the NZWBÕs total wool stocks rose nearly five-fold to 483,000 bales. Board stocks of Drysdale wool rose by only 15% to nearly 500 bales over the same period. The cooperative, in pursuing a pricing policy which was competitive with the auction, had accumulated 4000 bales of unsold wool by June 1990. This placed severe strain on cashflow. In September 1990 the cooperative approached the NZWB proposing it acquire 4000 bales of stocks at $5.80 per kilogram clean. In November the Board agreed to take the wool but only pay $3.53. The cooperative accepted the offer because it had little alternative and needed the funds. A consequence of the resulting loss on this wool was a significant reduction in shareholdersÕ capital and reduced payments to growers from two sequential pools.
The cooperative was forced to change significantly its methods of operation and prune expenditure drastically to restore profitability and shareholdersÕ funds. The pool system has been scrapped and growers now receive an individually appraised value for their wool set by the cooperative.
Options available to the cooperative and their consequences
The NZWBÕs market intervention had an effect on the cooperative akin to predatory pricing. The Board represented a buyer offering prices which the cooperative could not match given what its customers were prepared to pay. The cooperative had to choose between competing with this buyer and accumulating stocks, or watching a large proportion of suppliers redirect their wool to the auction with the demise of the cooperative as a probable result. There would appear to have been three options open to the cooperative when required to respond to the NZWBÕs Ôpredatory pricingÕ.
The first option would have been not to try to compete with the auction.
This would have reduced cooperative throughput, probably significantly, and put the
organisationÕs survival at risk. It would also have reduced the direct supply of wool to
cooperative customers putting at risk well-established trading relationships and the
cooperativeÕs reputation as a reliable supplier.
Box 11.2: (continued)
The second option would have been for the cooperative to receive the wool and then sell it through the auction system, thus obtaining the BoardÕs intervention support. The NZWB has taken the attitude that cooperative wool, unlike that purchased by private buyers, is still technically owned by producers, and therefore eligible for minimum price support with the proceeds of the support going to the cooperative rather than directly to the grower.
This option, while it would have incurred additional selling costs, would have prevented significant supplier/shareholder desertion. However, the direct cooperative/customer relationship would have been broken with the same consequences as under the first option. This second option is essentially what the cooperative did. However, instead of sending the wool to auction immediately it accumulated stocks and then had to negotiate with the NZWB from a position of weakness. The NZWB bought the stocks at a price considerably lower than that paid to growers by the cooperative.
The third option would have been to explain to suppliers the importance of maintaining customer relationships through the market downturn even though this would result in lower returns in the short term. This would have required cooperative suppliers to forego NZWB price support in the short term in the belief that there would be higher net benefits over the longer term from this action. This option is somewhat unrealistic. Besides, cooperative members had been paying the compulsory Board levies throughout.
What are the lessons to be learned?
Cooperative supplier/shareholders decided to market their wool differently. However, they paid compulsory levies which provided, among other things, funds for the BoardÕs market intervention and price support activities. There seems to be no reason why cooperative suppliers should not get the same price support as all other woolgrowers even if they did not sell at auction. This is particularly the case when their commercial difficulties are so clearly related to the unexpectedly aggressive market behaviour of the Board. The NZWBÕs preparedness to buy the cooperativeÕs stocks appears to acknowledge that the consequences of the BoardÕs market intervention were unfair to the cooperativeÕs growers. It also makes good political sense for the NZWB to try to prevent the saga from becoming a highly publicised example of the effects its actions had on a small, previously thriving, and grower-owned wool marketing business.
The cooperative has demonstrated that woolgrowers can successfully market their commodity direct to users. They have demonstrated the commercial viability of a marketing system which is a clear alternative to traditional selling methods. They show producers can and will innovate given the opportunity.
The major lesson from the saga is the vulnerability of such a commercial venture to market intervention by a statutory player. Had behaviour akin to predatory pricing occurred in a normal commercial environment it would undoubtedly have been interpreted as an attempt to put the cooperative out of business and probably attracted the attention of anti-trust authorities.
It would appear the cooperative never envisaged the risks the business could face as a result of NZWB activities. It is likely that the cooperativeÕs experience will make other innovators and investors very wary of testing their ideas while the NZWB retains its current powers. Alternatively, it could be that such investors have been aware of these risks and this explains why innovative and alternative methods of marketing wool are so rare in New Zealand.
Chart 11.3: New Zealand Wool Exports to China and USSR and Average Clean Prices
(1981Ð1991)
Source: New Zealand Wool Board.
1. Introduction
Marketing arrangements in most major rural industries in New Zealand operate some form of price pooling in determining the price paid to suppliers. These industries all supply a range of markets where underlying supply and demand characteristics, and entry restrictions in some cases, mean prices obtained vary between markets.
It is important to stress that the price differences relevant here arise because of entry restrictions (VRAs and quotas) or fundamental market characteristics Ñ for example, differing demand schedules (elasticities) in different markets. They are not the price differences which can arise because of differing costs of marketing, for example higher returns because additional marketing services are provided.
The consequences of pooling discussed here also need to be considered in the context of the underlying objectives. In particular, the objective producers should be pursuing is maximum profitability for them individually, and for the industry as a whole. If this is achieved in a manner consistent with efficient resource use then it is certain to be in the national interest.
Maximum market revenue, or sales, or turnover, do not guarantee maximum profitability. They are indicators of activity while profitability Ñ return to the factors of production (investment) Ñ is a true performance indicator in terms of knowing what returns are being obtained on resources. As will become clear from what follows, having maximum revenue to the producer as the objective has caused present distortionary policies to be implemented and maintained.
2. The Economics of Pooling
The problems which arise with pooling derive from the interaction of a number of influences. To aid in developing an understanding of these influences, and the economic forces involved, they are treated in turn.
The impact of premium markets on pooled prices
If statutory marketing boards or producer cooperatives are successful in extracting some market premiums, or Ômarket rentÕ in a quota market, then it is likely that what will be faced is a range of prices from different markets, tailing off towards the market(s) paying the lowest price Ñ an example being so-called Ôdisposal marketsÕ in the meat industry. These premiums may flow from differences in the characteristics of the different markets or as a result of the specific activities of the marketing bodies in different markets.
For simplicity, assume for the moment there is only one premium market and one other lower-priced market. Assume that the premium market will pay a price PP, for a quantity QP, while any production in excess of QP will return a price of PE. Assume that current production is at some level Q, greater than QP.
Total industry revenue from the sale of this quantity will be:
R = PPQP + PE(Q Ð QP)
Revenue per unit of output sold (unit price) will be:
R/Q = PE + (PP Ð PE)QP/Q
= PE + ¹QP/Q
where ¹ is the price premium (PP Ð PE).
In other words, the average price received can be expressed as the price in the lower returning market plus a factor which has, as a maximum value, the price in the premium market but which diminishes as production increases beyond QP and which approaches zero as industry production keeps rising. This average price and how it falls as production increases is represented graphically in Chart A1.1.
The presence of a range of markets all with different prices will, of course, lead to a different shape for this Ôpooled priceÕ line. However, on the reasonable assumption that the most profitable markets are supplied first, with successive markets being serviced in order of diminishing profitability, it will remain true that the pooled price line will be downward sloping and will approach the price in the lowest returning market asymptotically.
The impact of pooled prices on supply incentives
It is important to recognise that the pooled price line in Chart A1.1 does not represent the market demand curve. For example, for all quantities produced in excess of QP, the demand price is not the pooled price but rather the lower figure of PE. For all production in excess of QP, the pooled price line overestimates the demand price. The actual demand schedule is a step function represented in Chart A1.1 by the line PpRST.
An individual producer selling directly into a market with this demand schedule would quickly realise that the price on offer if industry production exceeded QP is PE rather than the pooled price. The rational response would be to cease production as soon as that producerÕs marginal costs of production rise to PE. Interestingly, exactly the same response would be optimal for that producer in the absence of the premium market, implying the following important conclusion.
If the size of the premium markets is less than the level of production which would be optimal in the absence of these price premiums, then the optimal response of the industry to the development of these premium markets should be to make no changes to levels of production and simply to accept the price premiums as additions to normal profits.
In other words, the successful extraction of true price premiums or Ômarket rentsÕ should not necessarily be seen as a justification for expanding an industryÕs production and size unless these premiums, or rents, can be extended across all production.
However, the incentives for ÔrationalÕ responses by individual producers are rather different when the production is being sold to or through a cooperative or marketing board which pays the producer a pooled return. In this case the individual supplying the cooperative or board will not be selling ÔexcessÕ production at a price of PE, even though that is what the cooperative or board would be receiving for it in the market. What happens is that:
¥ an individual producer supplies an extra (ÔexcessÕ) unit of production to the marketing body;
¥ the marketing body markets this production at a price of PE; and
¥ it then pays the individual producer the pooled price, which is greater than PE.
This sounds too good to be true Ñ and it is. An individual producer increases production and is paid more for that extra production than the market is prepared to pay. Something of course must give Ñ and that something is the pooled price. The extra unit of production sold lowers the pooled price which is paid across all industry production. This means that individual producers receive a lower price for all their production. However, most of this cost (in the form of lower unit returns) is spread across all other producers in the industry even if they choose not to expand production, and is not borne only by the producer who increased output. The individual who increased output may therefore be better off even though the industry is worse off in terms of maximising profitability. If everybody increases production, however, then everybody is worse off.
The mathematics involved are precisely that of two (or multi-) price arrangements where production levels are not fixed. In terms of the simplified example presented in Chart A1.1, the logic can be set out as follows:
¥ The industry receives marginal revenue of PE for all units of production in excess of QP.
Ð The standard first order condition for maximising profitability Ñ that marginal revenue should be equal to marginal cost, implies that the industry would maximise profits by ceasing to expand production when marginal costs reach PE. It is logical that the industry should not expand production beyond the point at which it ceases to obtain a return on the last unit of production greater than the costs incurred in producing it.
¥ Individual producers will, and do, respond to prices in this manner.
Ð The only problem is that they see a marginal revenue in excess of PE Ñ because the pooled price is always greater than PE for production in excess of QP.
Ð It will, therefore, be profitable for an individual to continue to expand production even though the marginal cost of production for that individual has risen above PE.
Ð If all individuals choose to increase production by one unit when marginal costs have reached PE, each individual will incur a drop in profit (assuming for the moment that all have the same marginal costs of production).
¥ However, none will incur a drop in profit as great as would be the case if they chose individually not to expand production.
Ð In other words, individuals face a disincentive to Ôopt outÕ of the counterproductive behaviour of the industry, even when they recognise that it is counterproductive. In fact, individuals are not likely to be aware that their behaviour is counterproductive Ñ the only symptom being a drop in profitability which can and would be sheeted home to a fall in market returns to producers when it was actually caused by Ôover-productionÕ.
¥ To complicate matters further, if the market is in fact strengthening and prices generally are rising, there may be no drop in profitability at all Ñ instead, profits will simply fail to rise as rapidly as they could, being partly dissipated in inappropriate production responses.
Ð These circumstances are likely to reinforce the individual producerÕs impression that expanding production is the correct profit maximising strategy.
¥ There is also no reason to expect that the cooperative or marketing board would be any more aware than the producer that industry output was higher than optimum.
Ð These organisations see their objective as the processing and marketing of product supplied for the highest return to the producer. Provided their processing and marketing costs are covered and their suppliers are actually expanding production, there are no explicit signals to suggest that producer and industry objectives are not being met.
Ð Given the marketing organisations do not have information on producersÕ marginal costs, and producers do not have information on the marketing organisationÕs marginal costs or revenues, there is no-one in the production/processing/marketing system with the information necessary to know profitability is not being maximised as production increases.
Ð A corollary of this is that competition between the marketing organisations would not solve the problem so long as they continued to pool returns and pay a pooled price to the producer. Success would result for the organisation capturing the greatest premiums but would not reward production restraint in the interests of industry profitability.
The above arguments can be represented on an extension of Chart A1.1 as is shown in Chart A1.2. Specifically, Chart A1.2 distinguishes the real demand curve (industry marginal revenue, represented by the line PPWXY), from the perceived curve (industry average revenue, captured by the pooled price and represented by the line PPWZ). SS represents a normal, upward sloping industry supply curve. Point A represents the equilibrium outcome under pooling, with the industry equating supply to perceived demand, and bringing forth an equilibrium production level of Qequ which trades for an average price of Pequ.
However, all production in excess of Qopt involves marginal costs in excess of the actual market price of PE Ñ and is consequently produced at a cost to industry (and national) profitability. The triangle ADE represents the deadweight losses incurred by this extra production These costs could be avoided entirely, and industry profitability maximised, by restricting production to that equating to point B. A profit maximising monopolist would seek to ensure that production did not exceed Qopt and that higher unit net returns would more than compensate for the somewhat lower sales volume.
Producer cooperatives and statutory marketing boards do not, however, behave as profit maximising monopolists; rather they tend to be victims of any success in achieving premiums in certain markets. In comparison with a profit maximising monopolist, they lack both control over production and access to information on marginal costs of production. The above analysis shows starkly how the benefits of achieving premium prices, or harvesting market rents, can be significantly eroded by producers responding rationally to the pooled price rather than the actual market return. The pooled price encourages them to expand production into the region where the actual returns to the industry from the extra production would fail to cover the actual costs of that extra production.
An industry looking back on an expansion in production taking it from B to A would be inclined to congratulate itself for capturing the benefits indicated by BDA (the surplus of apparent price over actual cost), when it should in fact be regretting incurring the losses indicated by area ADE (the surplus of actual cost over actual price). These losses have been largely hidden by spreading them over all production Ñ applying a general average price of Pequ rather than the higher Popt. In reality, the area of ADE measures precisely the drop in industry profits in moving from B to A and can be viewed as a measure of the inefficiency of the price pooling system.
This is not to say for a moment that the industry is made worse off by achieving access to these price premiums. Under fairly broad conditions they can expect to be better off. It is clear from Chart A1.2 that the shaded area represents the net increase in profit flowing from capturing the premiums (a plus) and expanding production from Qopt to Qequ (a minus). The point is that given there are profitability gains to be had from capturing the premiums, the industry could be even better off if the means could be found to prevent the inefficient and costly expansion in production beyond Qopt. Preventing this expansion means higher profits.
In other words, if a case can be made out for the creation and maintenance of the sorts of industry marketing structures which now exist in New Zealand; if this case rests heavily on the capacity of such structures to deliver premium prices from key markets; and if these structures involve strong elements of coercion to elicit industry wide cooperation; then it seems reasonable to ask Òwhy stop half way?Ó If powers of coercion are justified by their necessity to ensure price premiums and rents from these markets are secured, then why are they not also justified for the extraction of full monopoly rents in a manner that maximises producer and industry profitability? In particular, if there is a national interest case for the former, then why not for the latter?
It would seem logical that either the potential premiums are too small to justify the use of such powers of coercion or else the premiums are great enough to suggest that careful consideration should be given to going for the full monopoly rents. The present half way point seems rather unnatural and is one which cannot be expected to deliver on the objectives of maximising producer profitability and the national interest.
Real Life Complications
The simplified example of price premiums analysed above makes a number of assumptions which would not be true of the real markets for New Zealand rural produce. It is reasonable to ask if any of these assumptions are critical to the broad conclusions to come out of the analysis. ACIL does not consider that any are.
The assumption of a single premium market has already been addressed. The conclusions stand provided that the pooled price exceeds the demand price around the point of actual industry production and the pooled price falls with increasing production. This will be true under very general conditions and will usually be strengthened by the success of the marketing body in extracting market premiums.
The costs incurred by the cooperative or marketing board have largely been ignored. This is clearly nonsensical in industries, such as dairying or meat, where significant processing takes place. In all cases, however, grading, packing, distribution and marketing constitute significant costs.
In the course of this study it was put to ACIL that it is because of the nature of these costs, at least in the case of the dairy industry, that the type of analysis set out above is irrelevant. Specifically it was argued that the marginal costs of processing and marketing additional dairy produce are so low that it is just not feasible to look for a point at which marginal costs equate with market returns. In the extreme, marginal costs might be downward sloping, a not uncommon assumption from the perspective of a single processor or marketer. ACIL considers, however, that this argument is both invalid and misses the point.
It may well be true that marginal processing and marketing costs are much less than average costs throughout considerable ranges of production. However, this clearly ceases to be the case as soon as growing production levels begin to indicate the need for expanded processing capacity Ñ for example installation of a new plant.
If, for example, the above confusion in economic signals were to lead to an inappropriate decision to invest in a new dairy processing facility, then the implications would be both extremely costly to the industry and far from irrelevant. Such a possibility seems well within the range of likely outcomes given the gradient exhibited between the highest and the lowest paying markets for dairy products and given that ongoing investment in the industry is significant. For the reasons set out earlier, the industry need not necessarily have any basis for concluding that the investment in extra processing facilities would not be appropriate Ñ especially if world prices were firm and production expanding.
In this context, marginal costs of processing might well be Ôsaw shapedÕ, rising and falling cyclically in line with capacity constraints. The form would probably be characterised by a rapid rise, as capacity limits are reached and new investment is necessary, followed by a much slower decline as throughput across all facilities is expanded and size economies achieved. Ultimately, capacity limits would again be operative and marginal costs would rise sharply. The above analysis applies precisely to the situation of an individual cooperative assessing the value of installing a new plant and concluding in favour of so doing as a result of the price pooling structures. On paper, the new plant could look and prove to be quite profitable even though total industry and even cooperative profitability would have fallen.
This said, it is also important to recognise that farm level production costs are also critical ingredients in this assessment. For a mature industry such as the New Zealand dairy industry it would seem most unlikely that marginal costs of production at the farm level are anything but rising. Farm production could be expanded in two main ways.
¥ Existing farms could seek to expand output. For example, in the case of dairying, more intensive feed regimes could be introduced but presumably the least cost strategies for building and maintaining production have already largely been used or would in any case be introduced as substitutes for existing strategies if they are lower cost in nature. There seems no reason to expect that there are low cost strategies waiting to be used to expand production but which are not currently being used to reduce the costs of achieving current levels of production.
¥ The farmÕs enterprise mix could be changed Ñ for example shifting from beef production into dairying. Presumably most of those farms currently in dairying are there because that seems the most economic use of the farm resources. The fact that a farm is not currently in dairying suggests that such a use would provide relatively low net returns. Switching enterprises, from beef into dairying for example, involves opportunity costs in the form of profits forgone from beef production. These costs are real and form part of the costs of dairy production. Again, the least cost options are likely already to have been exploited, suggesting rising economic costs associated with expansions in dairying production through enterprise switching.
It is also sometimes argued that world prices are so manipulated politically that it is quite inappropriate to read into them any economic signals. This line of argument is totally misguided if used by any body with the objective of maximising producer profitability. ÔCorruptÕ markets may be regrettable, and may warrant corrective action, but any producer or industry seeking to ignore the ÔcorruptÕ prices would want to be very sure that the 'corruption' will not last long. ÔCorruptÕ prices are no less real or important than Ônon-corruptedÕ prices.
A related argument suggests that the frequency of price fluctuations faced by agricultural industries is so great that production levels could not possibly be synchronised Ñ again suggesting that the economic signals have little value. However, the above arguments are about trends in market returns and production levels and producers are certainly in a position to respond to trends. It has been argued that the industry could well move right out of kilter with 'appropriate' levels of investment in productive capacity and not know it. The issue is not one of acceptable fluctuations about a correct point Ñ it is one of unacceptable departures from a correct trend.
There is one line of argument which may suggest that the problem of excess production is not that great. No reference has been made so far to who holds equity in the cooperative or marketing board Ñ it has been assumed implicitly that the equity was built both from levies paid by the industry and from earnings retentions. However, in many cases these bodies are in fact heavily geared.
To the extent that borrowing capacity reflects the profitability of markets captured, a heavily geared body may find itself in the situation of returning most of the premiums to its lenders through loan repayments rather than distributing them to its ÔownersÕ via higher pooled prices. It is conceivable in these circumstances that the adverse supply response is negligible. However, it would seem likely also that the processing and marketing body should then be viewed as a cooperative in name only. Given that the production distortions would only be eliminated in this way if all the premiums were dissipated in borrowing costs, there would appear to be little to recommend this ÔsolutionÕ from an industry perspective.
At levels of gearing which caused market premiums to be lost to lenders, it would be highly questionable whether producers would be exercising effective control and it would be fair to question in what way such a body was acting in producer interests. The same issues would arise if the market premiums were being fully dissipated in heightened costs associated with the marketing arrangements Ñ either direct marketing costs or the costs flowing from any disincentives to innovation and risk taking.
In other words, under current ownership and structure arrangements, and assuming that there are premiums to be captured, then either the body is successful in both capturing the premiums and distributing net benefits to producers Ñ in which case there is a problem of counterproductive supply response Ñ or it is unsuccessful (either by failing to capture the premiums or by dissipating the benefits in heightened costs and loan repayments) in which case the compatibility of such an organisation with stated objectives is questionable. In both cases the organisation would appear to fall short of delivering on industry objectives of control and maximising net benefits to producers.
3. Alternatives for Overcoming the Distortions
There are only two broad alternatives for removing the profit reducing distortions of the price pooling discussed in this attachment. Either alternative instruments for controlling production (other than relying simply on the pooled return) must be introduced, or the pricing mechanism (pooling) must be changed.
Emphasis in this section is on the second alternative because options available under the first involve high administrative costs, the potential for alternative distortions, and are unlikely to be acceptable to the majority of producers. Also, the discussion, as has been made clear to this point, applies equally to cooperatives and producer boards. However, in situations where a producer board markets product supplied by a cooperative, the implications are more complex and similar changes would be needed to both types of organisation for the distortions to be addressed adequately.
The primary reason for considering alternatives to price pooling is to remove or overcome the resulting production distortions. However, the changes suggested to existing arrangements will yield significant other benefits to producers, particularly better accountability and greater choice. These benefits would also, over time, become manifest in further improvements to producer profitability.
Non-price production controls
Since the fundamental problem with pooling is the encouragement of production past the point of maximum profit, if the distorting price is not to be changed (pooling to continue) then some other mechanism is needed to control production. Such mechanisms could include contracts, quotas or product-quality standards limiting the quantities which the cooperative or marketing board would accept.
However, there is a fundamental difficulty involved in setting the appropriate level of production and allocating it across suppliers. Those responsible for determining how much should be produced and by which producers do not have the necessary information on producerÕs marginal costs. It is impossible to envisage an effective non-marketing system for having these costs reported in a useable form to the organisation setting and allocating production quota.
This problem could be solved by auctioning supply contracts, or through similar market-based devices, but this would involve a fundamental change in the basis for determining farm gate returns, thus placing it outside the bounds of the strategy-types being discussed here. Even if this approach were adopted, how the quota auction revenue was distributed back to producers would also need to be resolved. Any redistributions on the basis of production, for example, would reintroduce the distortions that the strategy aims to remove.
The economic losses which could arise from incorrectly setting the level of production and sub-optimally allocating quota across individual producers could well swamp the losses which are the target of the strategy, making the industry worse off.
In essence, it seems very doubtful that contract/quota based supply control schemes could be developed which attack the problem with reasonable efficiency and do not involve fundamentally changing price pooling mechanisms.
One non-price approach which does attack the problem fairly directly involves the development of a two-price (or multi-price) quota scheme. Such schemes have been implemented in various forms and in various countries. Their essential features are as follows:
¥ each supplier is issued with an allocation of quota in respect of the Ôfirst poolÕ and all product delivered within this quota is paid a price reflecting the premium markets available to the marketing body;
¥ any production delivered in excess of the first pool quota is paid a lower price reflecting returns from the lower priced markets; and
¥ quota levels are varied annually as market circumstances dictate.
In terms of the example analysed in Chart A1.2, provided the quota was pitched between QP and Qopt for each producer (that is, between a 'fair share' of the premium market and the point at which marginal costs equal marginal returns), and future quota levels were not expected to be related to production levels in the current year, then production could be expected to be held approximately to Qopt. The inefficiencies associated with excess production would be avoided and the benefits of the premium markets would be distributed via the first pool payments in a manner judged to be equitable.
The mechanism involved is simply that of setting the marginal price faced by producers to be approximately equal to the marginal price set by the market, but maintaining a higher average price through the operation of the first pool. In principle, this seems a neat solution to the problem. However, some difficulties do arise in practice.
Actual demand rarely matches the Ôsingle stepÕ shaped demand curve used in Chart A1.2 for illustrative purposes. The reality is that there tends to be a progression of decreasingly profitable markets. In such circumstances, the price of the second pool will not reflect true marginal market returns, so incentives for overproduction are likely to persist. Any attempt to increase the size of the first pool to minimise this problem risks extending first pool production quotas for individual producers beyond their efficient level of production Ñ again encouraging overproduction.
These types of arrangements are also administratively unwieldy (and costly), and invariably involve a degree of arbitrariness which is likely to be seen as being in conflict with the equity objectives of current arrangements.
Where such arrangements have operated for extended periods, for example in the Australian sugar industry, ownership of quota becomes an asset in its own right. First pool quota represents a right to access the returns from the premium markets. This raises legitimate questions concerning a Ôfair and equitableÕ basis for allocating quota initially, and how future quota changes and their ownership should be handled.
The natural approach would be to allocate quota in proportion to historical production. This might be criticised as rewarding most those who have contributed greatest to the problem of excess production. Were there speculation for an extended period that such quota would be introduced, there would be incentives for individual producers to expand production simply to maximise their claims on future quota. Unless these incentives were eliminated from the start (for example by declaring that production levels during the period of the policy debate would have no impact on quota levels should a decision to proceed be taken) then much of the benefits of controlling production levels might be offset by the short term costly rise in production. As with the present arrangements, all producers responding to the same incentives could make every producer worse off.
Assuming that the problem of allocation were worked out, there are still the difficulties in varying levels from year to year in response to changed market conditions and to changing marginal costs of production. Again there is an information gap, but the quota arrangements afford a buffer to the decision makers. Unfortunately, this buffer is imperfect and, over time, there is a real risk that quota levels could be set at quite inefficient levels.
The fact that quota allocation can be viewed as an asset means that it can be expected to acquire a capital value. This would raise the question of whether the quota would be transferable between properties. The economic arguments for transferability are fairly compelling but it is not uncommon for the quota to be tied to individual properties Ñ in which case the capital value of the quota tends to be built into the capital value of the land.
In either case, new entrants to the industry can expect to be no better off for the operation of the quota scheme Ñ the higher prices and profits captured by these arrangements can be expected to approximate the extra capital costs involved in entering the industry. In one form or another, this can be expected to be a difficulty with any scheme directed at capturing premiums over an extended period. However, where the quota is tied to land, it would also bring with it considerable inflexibility in the use of that land, almost certainly, in the long term, to the overall detriment of New Zealand.
There has, in recent years, been a clear trend away from the sustained use of quota arrangements in agriculture in those countries and industries using them, although many such arrangements persist. A problem is that the very asset value issues which create problems in introduction also create problems, primarily of a welfare nature, in removal, even long past the point at which they cease to deliver demonstrable benefits.
ÔUnbundlingÕ market premiums from producer output prices
A very different strategy for addressing the problems of pooled price distortions is to look to the possibility of granting to the marketing body normal commercial powers to source and market product in the best interests of the marketing body itself, and then separately address the question of how best to distribute profits secured by the industry body in order to meet industry objectives of maximising producer profitability and retaining Ôownership and controlÕ. The starting point is the recognition that it is asking a lot of prices to the producer to see them both as the mechanism for maximising producer returns, and as a mechanism for determining the appropriate, broadly profit-maximising, level of production. The two objectives are in fundamental conflict Ñ with maximum returns encouraging a particular level of production which is very unlikely to maximise profitability. The ÔunbundlingÕ approach involves recognising this conflict explicitly, requiring prices to producers for output to fulfil only one of these functions Ñ determining profit-maximising levels of production Ñ but to do it properly, and then establishing a quite separate mechanism for the other function of ensuring producers receive the market premiums and rents.
The particular attraction in this approach is that reliance on prices to determine production provides an explicit bridge between producers and the demand sectors, including the marketing body, where there is currently a major information gap brought about by price pooling. However, the means by which the benefits captured by the marketing body are returned to producers must ensure that the production distortions of pooling are not introduced via another route.
This last point is critical Ñ for example, distributing the benefits in proportion to product supplied would have the effect of reinstating the former price regime, albeit through a two stage payment system. Any linkage to product actually supplied would be counterproductive. This is itself likely to be a somewhat controversial matter because it cuts to the heart of existing organisational arrangements and industry attitudes. On the other hand, it does not cut to the heart of the stated and apparent objectives in developing these organisational arrangements in the first place.
An 'unbundledÕ view of production/processing/marketing
A New Zealand producer supplying a cooperative or board is, in effect, a participant and investor in two business enterprises Ñ a farm and a processing/marketing enterprise. In instances where the cooperative processes and a board markets the producer is essentially a stakeholder in three business enterprises.
For simplicity, and initially, assume only two enterprises; the principles extend naturally to three and this is discussed later. It is clearly in the interests of the producer to have both businesses (the farm and the processing/marketing enterprise) operating as efficiently as possible and individually providing maximum returns on investment. This need not imply that the maximum possible price is paid for farm output. Suppose the processing/marketing enterprise was not a cooperative, but a joint stock company in which the producer held shares. Further, suppose that this shareholding is roughly in line with the proportion of throughput historically supplied by the farm.
In what sense would this situation differ from the present cooperative arrangements?
Perhaps most importantly, the company's objective would differ from that of the cooperative. The company would aim to maximise returns on shareholderÕs funds and would have no particular interest in providing the producer with the highest possible price for farm output. In fact, its interest would be in minimising the price paid for produce subject to securing the supplies it needed. Every dollar saved in purchases of product should translate into an additional dollar of profit for the company which would be available for distribution to the producer as a dividend related to shareholding. To the extent that this is done and producers continue to supply at historical levels, the producer should be largely indifferent, with the same total ÔrevenueÕ being received in two components Ñ a price for output and a dividend. The dividend would be net of company tax but would carry imputation credits so the post-tax position of the producer should be unchanged.
Not all the companyÕs profit may or need be distributed as dividends. As with the cooperative, there may be commercial justification for retentions which would be reflected, over time, in the market capitalisation of the company Ñ an increasing share value. In sharp contrast to the cooperative, the producer would be able to trade shares and realise capital gains without needing to sell all or part of the farm.
In the case of both a cooperative or a joint stock company, the ultimate justification for retentions should lie in an expectation of boosting future profitability. For the company this is likely to result in higher future dividends while for the cooperative it would most likely result in higher producer prices (the main way increased profits are delivered back to the producer), probably exacerbating the problems of excess production.
Should the producer choose to vary production from historical levels, this would have no direct impact on dividends or capital gains in the short term, and in the long term should only affect these because of an overall boost in industry profitability. In contrast with the cooperative boosting returns to producers in proportion to product supplied, there is no reason to expect an adverse supply response associated with dividend payments or retentions. The only source of a possible adverse supply response would lie with the price paid to producers.
It would be in the producerÕs long term interests to have the price paid for farm output kept down to a level which reflects marginal market demand, to avoid the profitability-reducing excess production, described earlier.
A company maximising returns on shareholdersÕ funds would evolve a pricing structure which moves it naturally to the optimal point B in Chart A1.2. This is because the company, acting on behalf of its shareholders (who it should be remembered are the producer/suppliers in this example), has no incentive to buy production where the purchase price exceeds the net returns expected from the marketplace. To the extent that these returns reflect price premiums created or captured by the operations of the company, they could legitimately be viewed as returns to the company's (and hence shareholders) assets and efforts, rather than farm assets and producer efforts. However, as a shareholder, the producer has access to those premiums through dividends and capital gains. The producer may, also, gain access to some of these premiums through contract arrangements Ñ but the company would have no incentive to enter into such contracts unless there were quantitative restrictions of some form.
The company would be subject to accountability checks not effectively available with most cooperatives, and clearly not available with marketing boards that have statutory monopoly powers. In particular, individual shareholders would have a clear 'exit' option in respect of ownership of the company, without jeopardising participation in the production industry. Related to this would be the formal presence of an equity market which brings with it a level of accountability that simply cannot be matched by audit-type formal reporting requirements, particularly in circumstances of statutory monopoly.
The case for change is compelling
The above considerations constitute a powerful case for addressing ÔunbundlingÕ of returns from processing and marketing from the returns of farm production. Unbundling would go to the heart of the problem, would avoid the arbitrariness and risks of direct production control arrangements, and would bring with it considerably improved commercial accountability. Essentially, current cooperative structures have a serious design flaw and it should be corrected. It is in the interests of producers that this happens.
Why, then, is it not happening? One reason is undoubtedly that the very information deficiencies discussed earlier, and inherent in the present structures, do not lead to a strong focus on the problems of the present arrangements, their costs, or solutions. To a large extent, the costs, and therefore the flaws, are hidden.
It is in the nature of these costs that they are incurred when production increases past the point of profit maximisation for the industry. The tendency, and temptation, is to equate industry expansion with marketing success Ñ yet the above logic suggests that the size of some rural industries in New Zealand may be more symptomatic of the failure of existing structures to deliver on producer and national objectives.
4. The Impact of Regional Monopsonies
The above analysis of unbundling assumes that, under appropriately unbundled arrangements, the price paid by the individual processing and marketing firms for farm production will be PE Ñ the base world price, net of marketing costs. It was assumed that there would be no incentive to bid a higher price because this would reduce firm profits and no capacity to bid a lower price because suppliers would turn to other firms willing to pay PE. The reasons for not paying a higher price are apparent, but those for not paying a lower price warrant closer consideration because they do entail other assumptions.
Provided that there was strong competition between firms to purchase the farm production, there should be no scope for bidding a price lower than PE. Any firm attempting to do so would lose supply to firms prepared to pay the higher price and who would still be able to operate profitably at the higher price. Under these circumstances, profit maximising activities by the individual firms (and farms) should equate with profit maximising activities by the industry as a whole.
The situation changes somewhat if this competition is significantly lessened or removed. At the other extreme from intense competition for supply would be a monopsony purchaser Ñ one facing no competition for supply. Such a firm is constrained not by other competitive firms but solely by the economics of farm production Ñ paying too low a price will reduce supply and ultimately reduce profits. However, under certain circumstances it is at least theoretically possible for such a firm to increase profits by bidding a price somewhat below PE.
The reason this situation could arise can be explained as follows. A characteristic of a monopsony is that it faces an upward sloping supply curve Ñ so that dropping the price for its inputs leads to a reduction but not a total loss of supply (whereas under perfect competition all supply would be lost to competitors). Lowering the price below PE will simultaneously reduce supply (at the expense of the profits from these extra sales) and increase the unit profits associated with the remaining sales (by lowering the cost of inputs). From the firm's point of view, profits could be increased by some such lowering as long as the benefits of the increased unit profits exceed the costs of lost sales.
The source of this opportunity lies in the possibility that, for the firm to increase supply available to it, it may need to pay not only the marginal cost faced by the farm sector in supplying the extra production, but it may also need to pay this higher price for all production, not just the extra production. This would happen, for example, if it simply posts a single price and deals with the quantities supplied at that price. Its marginal expenditure, in order to increase production, will therefore exceed farm sector marginal costs. The profit maximising firm would seek to equate its marginal expenditure to the returns it would obtain from the extra production.
The revised analysis is shown in Chart A1.3, which modifies Chart A1.2 by incorporating this marginal expenditure curve, which must lie above the supply curve.
The analysis of optimal production decisions proceeds as before except that the firm responds to the marginal expenditure curve instead of the supply curve which is of interest to the producers. This marginal expenditure curve cuts the world price curve (PEY) at a lower level of production than does the farm sector marginal cost curve, SS1. The result is a stable level of production below Qopt, the optimal level from the perspective of maximising industry profits. What has happened is that the firm's profits have been increased, at the expense of an even greater reduction in farm sector profits. Total industry profits will be less than optimal, firm profits will be enhanced and farm sector profits will have been reduced. Even if all the profits made by the firm are distributed to the farms, farm sector profit, inclusive of these distributions, will be less than optimal.
Of course profits may still be higher than those being obtained under current institutional arrangements. The point is that unbundling may still be sub-optimal.
However, before this analysis is taken as confirmation that unbundling is not a solution to the problems identified with the present arrangements, a closer consideration of the economic analysis set out above is in order.
The fact that total profits Ñ farm sector and firm Ñ would be reduced by such a pricing mechanism is curious. Surely it would be in the interests of all parties to seek to negotiate an outcome which did not sacrifice those profits. At least here, in contrast to the present arrangements, the fact that profitable sales are being forgone will be apparent to the firm Ñ both because it will be viewing its pricing policy from a profit perspective and because it will be apparent that its marginal expenditure on extra production is, in large part, being used to pay a higher price for production already supplied at the lower price.
The source of the lost profits is underproduction Ñ additional farm production could be processed and marketed for a price PE which exceeds the cost of producing the extra output, as indicated by the supply curve, SS1. All parties would be better off if that extra production (Qopt Ð QM) could be supplied at price PE, provided that that price was not paid for all existing production. There would be incentives for the firm to negotiate contracts with suppliers (or otherwise organise purchasing systems) to achieve this outcome, and for the suppliers to enter into such contracts. The outcome would be payment of an average price below PE but a marginal price equal to PE. Industry profits would again be optimal, although composed somewhat differently Ñ with a higher return on the investment beyond the farm gate (received by the farmers as a return on their investment in processing and marketing facilities) and a somewhat lower return at the farm level.
The extent to which these monopsony effects arise will of course depend on the extent to which competition is limited Ñ by the number of firms involved, by collusion between the firms or by regionally based comparative advantage. ACIL is of the opinion that the scope for significant monopsony behaviour is quite limited by both legal and economic constraints and likely to become more so in the future.
Several of New Zealand's farm industries have, in recent years, provided clear evidence of the scope for new entrants or small but innovative operations in processing and marketing to perform well in comparison with large, established operations. Implementation of the recommendations of this report could be expected to increase significantly the contestability of the operations regionally as well as nationally, while at the same time affording existing operations greater scope for responding to such competitive pressures by cutting costs and increasing their capacity to compete for the supply of farm product.
There are two key messages ACIL would draw from these analyses. If the recommended changes are to be implemented, it is important that emphasis be placed on minimising any artificial impediments to competition for the supply of produce. And, it is in the interest of all parties to pursue pricing policies which afford maximum flexibility to pursue profit maximisation; it would be easy and possibly costly to import from the present arrangements a view that all production should be paid an equal price when to pursue such an objective would be contrary to the interests of all participants in the industry. The first of these messages is directed at minimising the scope for monopsony pricing incentives and the second at minimising the damage.
Chart A1.3: Monopsony vs Optimal Production
Appendix 1
A Technical Explanation of how Pooling Distorts Production Decisions and a Discussion of Alternative Corrective Actions
Chart A1.1: Indicative Pooled Price Structure
Chart A1.2: Equilibrium vs Optimal ProductionWhen Returns Differ Between Markets
1. Introduction
This Appendix considers the forces which encourage particular forms of organisational structure, particularly in relation to marketing activities, and examines the main research literature which addresses the underlying reasons for, and the appropriateness of, these forms.
Many of the issues which logically arise here have recently received considerable attention in New Zealand in the course of recent reviews of the Commerce Act. It is not intended that the extensive material assembled during those reviews be restated here, but some key themes of relevance to the assessment of institutional structures for marketing rural produce have been drawn out of that material. Other literature including recent developments relating to the theory of the firm, and the nature of markets and the evolution of marketing channels, has also been used.
The newer literature on the economics of organisations explains how organisational characteristics such as the degree of separation of ownership and control are dimensions of business organisation which can (and should) differ according to factors such as the ease of monitoring, the homogeneity of suppliersÕ interests, or shifts in the market power of individuals as their functions become more specialised.
Just as the better-known economic factors such as the demand and supply elasticities of products effectively determine whether particular objectives, such as exercising market power, can be met through collective action, decisions about organisational structure cannot ignore these contractualÊconsiderations if efficiency is to be maintained. However, as noted later, the extent to which the consideration of contractual relationships needs to extend beyond the commercial into the political arena is open to conjecture.
2. Key Considerations
Both returns and costs are important
The range of different rural processing/marketing structures apparent in New Zealand can be viewed as representing different forms of organisation directed at meeting processing/marketing objectives. The relevant issues are those that relate to incentives for particular forms of organisation and to the appropriateness of different organisational forms to meeting these objectives. These objectives are perhaps best viewed as maximising the net contribution to performance (profitability) by the processing/marketing activities; this would generally be assessed from the perspective of those investing in the particular organisation, which may be all producers, a subset of producers or a group of outside investors. It is also pertinent to examine whether, in addressing the objectives, particular organisational forms have any implications for the broader industry and the national interest.
Note that the objective of maximising the net contribution to performance could be brought about through either increasing market returns (including expanding the size of more profitable markets), and reducing processing/marketing costs, or both. Organisation into groups, firms, cooperatives or statutory organisations might therefore be motivated by a perception that such organisational structures might bestow added market power; might facilitate greater market influence by encouraging a better targeted product range or distributional network; or might enable cost reductions either through size economies or through the elimination of the costs associated with some market transactions. All of these considerations have been touched on in the economic, management and marketing literatures, although with rather different emphases.
Two models
Particularly important models of organisation have included:
¥ The Coase model, which focused on the desire to contain the transactions costs involved in determining appropriate prices and negotiating and policing contracts for each and every transaction as being the primary incentive for organisation into a ÔfirmÕ.
Ð Most of the literature associated with this model assumes that the scope for the sustained exercise of market power through collusive action is usually quite limited Ñ an assumption which places this model fairly in the economic as opposed to the marketing camp.
Ð Coase specifically rejected size economies, joint production, division of labour, risk management and the coordination of production activity as reasons for forming firms Ñ except to the extent that they may be subsumed in the transactions cost model.
¥ The political economy model, was drawn together from disparate sources through the 1980s. Under this model, the marketing channel is viewed as a social system involving the interaction of social units (single producers, local groups, cooperatives, firms) interacting through exchange processes. Note that the emphasis is again on these points of exchange and on contractual arrangements to effect these exchanges. However, the political economy model addresses the efficient allocation of power and authority, as well as that of scarce resources.
In brief the political economy model recognises a Ôpolitical marketplaceÕ which operates in parallel with the distribution channel which would be the focus of the Coase model.
Under the comprehensive political economy model, particular forms of cooperation and organisation could be motivated by a desire to minimise transactions costs or a desire to maximise power and influence Ñ the ÔcurrencyÕ of the political market place.
¥ Just as a corporate entity might be created to reduce the costs of determining appropriate prices for some contracts, an entity might be formed to bring some elements of the political market place Ôin-houseÕ, thus avoiding the corresponding transactions costs in that domain.
¥ Additionally, the presence of a political market place opens the possibility that the use of power and influence could sustain market premiums Ñ a proposition not entertained by the Coase model.
The political economy model may seem more satisfying in its greater comprehensiveness and flexibility, particularly given that these issues of power and influence, and the associated issue of the scope for capturing and sustaining market premiums, are clearly central to much of the current industry thinking in relation to centralised marketing structures in New Zealand. The fact remains that this greater comprehensiveness is only of value to the extent that CoaseÕs apparent assumption that factors other than political conditions always dominate is incorrect. Whether it is recognised as such or not, debate over this proposition has been central to the debate in New Zealand as to the effectiveness of statutory marketing structures.
A third model
While the Coase and political economy models have played a central role in the recent development of the theory of the firm, other work of relevance to any serious assessment of incentives for the organisation of rural marketing concerns that on innovation. Of particular relevance has been work in the areas of contestability theory and work relating to dynamic efficiency in a competitive environment Ñ particularly that area which has come to be known as ÔAustrian economicsÕ with its emphasis on constantly changing demand and supply conditions and continual experimentation within the product markets. This material is borne in mind in what follows, but there is insufficient space to consider it in detail.
3. Incentives for Organisations
Irrespective of whether the Coase or political economy model is preferred, the modern language of organisational theory always includes the term transactions costs and recognises that there is a price to be paid for taking the organisational or ÔfirmÕ approach to avoiding transactions costs Ñ namely so-called agency costs.
Agency costs
Agency costs arise where the interests of an individual working for an organisation do not align precisely with those of the organisation For example, an employee's interests in taking a ÔsickieÕ when sick leave provisions are included in a set of employment conditions tend to differ somewhat from those of the company. An executive employed by a company may derive more value from plush offices and first class travel provisions than would the owners of the company. In the absence of tightly specified performance-based contracts for each and every activity, there is a risk that the employee will seek to behave in a manner which is not in the best interests of the company.
However, the fact that there would be significant costs involved in organising such contracts, particularly the costs involved in determining a suitable price, suggests that the company may be better off employing an agent under a general employment contract and then seeking to constrain incompatible behaviour through management provisions. These agents are likely still to behave in a manner not entirely consistent with the best interests of the company, but under suitable constraints these agency costs might be kept to acceptable levels. Under these circumstances, the agency costs will consist of:
¥ the negotiation and enforcement of employment contracts designed to discourage divergence from the principal's interests by the agent;
¥ costs incurred by the principal in monitoring agent behaviour;
¥ ÔbondingÕ expenditures by the agent (who may seek more freedom of action through guarantees that certain conditions will be observed); and
¥ the residual loss arising from remaining divergence between the interests of the principal and agent.
In a simplistic theoretical sense, such a company structure built around broader employment contracts and incurring agency costs may be viewed as sub-optimal. However, in a more refined and realistic sense, such behaviour may well be optimal. Provided that the agency costs which arise as a result of the company structure are less than the transactions costs which would otherwise have arisen under a contract system, the 'owners' of the company can expect to be better off.
Taking this approach makes it clear that there is a logical limit to the extent of aggregation which is appropriate.
Different products, different arrangements
As organisations become increasingly large and diverse, the ÔaveragingÕ approach entailed in broad employment contracts is likely to depart further and further from the better specified market-based arrangements. At one extreme, where a company is engaged in a single very tightly defined activity, there is likely to be little difference between an employment contract and an activity-based contract. It would be relatively easy to strike a basis for remuneration which directly reflects the value of the employeeÕs activity to the employer. This, in fact, happens in many companies delivering services or engaged in the sale of fairly homogeneous products Ñ for example, the provision of consulting services or the selling of computers or motor vehicles Ñ where remuneration may be based on sales performance.
At the other extreme, with a vertically integrated corporate entity involved in activities in a wide range of sectors there would, typically, be enormous difficulty in constructing a sensible set of activity-based contracts which would ensure that those under contract behaved consistently in the corporate interest. What is the relationship between the quality of office furnishings for a senior executive and the sales performance of the company through its sales team?
The myth that authority is imposed
The Ôagency costsÕ literature has thus been concerned mainly with the problems for principals in constraining agents.
An important development in thinking has been the recognition that firms are legal fictions and a nexus of contracting relationships rather than simply organisations governed by authority. North has made the interesting observation that CoaseÕs initial emphasis on the role of authority in firms is in some respects close to the view of New Left critics such as Margolin. What North was identifying as a similarity of Coase and Margolin was the apparent agreement between them that in the firm authority tends to be an imposed phenomenon.
The alternative view of the firm as a voluntary and essentially fluid set-up with relationships evolving to reflect underlying cost and revenue conditions is probably now more common.
Owners viewed as one class of agents
Another feature of earlier contributions, which is less common now, is their tendency to characterise the agency problem in terms of a group of owners of capital facing a (more or less separate) group of specialist managers. By and large, as Hogbin and Wills have observed, they have taken the extent of the firm and the identity of the owners as given.
Later contributions have generalised the concept of ownership by looking upon owners simply as a category of agents who contract for the right to net cash flows (termed Ôresidual claimsÕ Ñ the difference between stochastic inflows of resources and promised payments to agents).
Since the early 1980s there has been a stream of literature with this orientation. Two rather difficult papers by Fama and Jensen in 1983 are examples. One of the puzzles posed by these authors, and more recently by Hansmann, is what do different market circumstances imply for the identity of owners. What these researchers have done is take a more generalised view of the relationship between agents and owners, where the identity of the owners, defined as those who contract to accept residual claims, is itself seen as a resource allocation problem which markets resolve.
Who should 'own' the marketing chain ?
Hansmann's study examined a range of US firm-types: investor-owned firms; customer-owned retail firms; wholesale and supply firms; worker-owned firms; utility cooperatives; mutual insurance companies; and non-profit firms. Among other things, Hansmann sought to explain under which circumstances would ownership of firms by input suppliers be most productive.
Hansmann defines the various groups which transact with a firm (suppliers of capital, suppliers of labour, purchasers of the firmÕs product, etc) as ÔpatronsÕ. He identifies the main categories of patrons as either ÔownersÕ (who have control of the firm and receive the residual after all contractual payments have been made) or Ômarket contractorsÕ. In a competitive economy the organisational structure which survives will be that which assigns ownership to a patron group so that the total costs of ownership and market contracting are minimised for the patrons as a whole.
Hansmann's article reports both theoretical and empirical findings.
Put simply, the general theoretical finding of this 1988 study was that ownership by a particular group will be efficient if it reaps a benefit (in terms of redressing the market power or information advantage of the organisation versus those patrons) which is not outweighed by the costs (in terms of loss of management incentives by the operators; reduced or more expensive owner monitoring and control of management; more clumsy or distorted aggregation of divergent patronsÕ preferences than market transactions; or exposing high cost risk bearers to greater risk).
To take an example of the studyÕs empirical findings, in the US, where in 1984 there were approximately 2,200 farm supply cooperatives which in aggregate had 27% of the farm supply market, farmer ownership was found to have been largely motivated by the desire to redress suppliers' market power.
On the whole it was found that these farm supply cooperatives had formed in the face of relatively little product market failure. However, since they were often regional in character and dealt with fairly homogeneous products, conditions for customers to exercise control were favourable.
Interestingly in the farm machinery sector, where market failure (in terms of both asymmetric information and market power) is evidently in the US more severe than with other farm inputs, supply cooperatives have played a minimal role. The capital intensity of the machinery business was thought to be one factor limiting supply cooperative entry, though it was noted that in the equally capital intensive petroleum industry supply cooperatives account for a third of the market. The most likely reason for a lack of supply cooperative entry into the machinery business was considered to be the cost of customer control. Farm machinery is heterogeneous and purchases tend to be sporadic, making it difficult for farmers to engage in continuous monitoring.
Hansmann uses his model to suggest reasons for the survival of a wide variety of firms in the US economy including producer-owned input-supplying cooperatives. It is tempting to view HansmannÕs findings as uniquely relevant to the subject of this Appendix.
However, sometimes his observations that the proportions of particular business structures in different industries in the US are a reflection of their economic suitability for those lines of business are not very convincing. This is because he has not taken (explicit) account of underlying biases in taxation or antitrust laws. Also he seems to pay too little attention to explanations that firms supply public goods, and to the real possibility that patrons might be misled into believing they are receiving benefits (e.g. in relation to promotion or quality assurance) which do not exist..
Martin and Zwart explored the transactions cost issues raised by Hansmann, and their application to the question of agricultural marketing organisation in New Zealand. They concluded that the concepts had considerable potential as a framework for evaluating agricultural and horticultural marketing channels. They compiled a checklist of issues which they suggested could be explored empirically using such a framework.
Harnessing rivalry
Agency cost considerations do not necessarily constrain the size of a corporate entity but they do constrain its desirable structure. Beyond a certain size and diversity, coordination and resolution of agency problems across the entire entity can be expected to become daunting. Under these circumstances, it is often desirable to allow different arms of the company to operate with high degrees of autonomy Ñ even to the extent of reintroducing market mechanisms between these different arms. For example, large car manufacturing operations are commonly structured along divisional lines, with each division buying and selling components and services at market prices and being accounted for as separate profit centres. Importantly, divisions are not necessarily required to source from the company's own supplier Ñ if it is in the interests of the division to source from an outside supplier then it is entitled to do so and this sends a fairly direct message to the internal supplier regarding its competitiveness. In Japan, particularly, this has extended to complex networks of sub-contracting relationships in the motor vehicle industry.
These divisional structures can be equally well extended to separate companies under common ownership. Courier businesses in Australia and New Zealand constitute a case in point. In both markets, courier services are undertaken by several courier businesses, operating in fierce competition with each other, but owned by two major groups. It is appropriate to ask why a large corporate owner, with considerable commercial acumen, would judge it to be useful to a have a number of companies under common ownership competing against each other. This is particularly appropriate when set against the commonly expressed desire of some New Zealand rural industries to operate their marketing systems as statutory monopolies to prevent competition in marketing.
There is, of course, an important strategic difference between establishing markets between divisions supplying each other with goods and services and establishing separate images in a consumer market place. These latter structures are likely to be driven in part by the perception that there is scope for increasing market share by offering a range of products with slightly different images Ñ somewhat akin to Colgate-Palmolive marketing a range of soap powders in competition with each other. Again, however, it seems appropriate to ask if the same logic does not apply to rural produce.
Rivalry, innovation and safety
By the same token, these competitive company structures owe a lot to a recognition of the principles underpinning the development of ÔAustrian economicsÕ, a topic that was introduced earlier in this Appendix. A commitment to a range of competing companies, each seeking not just to survive but also to build profitability and market share, represents a commitment to constant innovation. The prospects of finding the best approach are enhanced and the greater diversity of operations provides safeguards against the entire industry getting it wrong and losing out during the experimentation and innovation process.
These structures can also been seen to show some allegiance to the principles developing in some of the recent competitiveness literature, which has emphasised the value of intense domestic rivalry in the pursuit of sustainable competitive advantage. This work has proven extremely influential in recent years, in part because of the extent to which the case has been based on extensive empirical studies in several countries. This said, the proposition remains controversial, with many economists continuing to argue that contestability, that is the absence of barriers to new entrants, is sufficient to drive efficient operations even if there is only one significant firm supplying a particular good or service. Analysts of the Austrian or Porter schools would argue that the contestability approach is altogether too hopeful in that it underrates the role which the actual presence of diverse firms has on dynamic efficiency and the role of constant experimentation, innovation and individual failures as well as successes in developing a truly efficient market.
However, analysts considering the application of Porter to New Zealand agricultural marketing have argued that PorterÕs analysis is limited to industrial products produced in countries with large domestic markets. They argue, for example, that economies of scale in production and marketing, and New ZealandÕs small population, makes one large company the efficient size. This is quite consistent with contestability theory insofar as there is potential for smaller competitors.
4. The ÔBestÕ Type of Organisational Structure
The reality is that production, product, and market characteristics will dictate the most appropriate marketing and processing structures. However, the theoretical and empirical literature on organisational structure, and observation of broad commercial practice, do not offer automatic support for the proposition that collective action, particularly to the point of statutory monopoly, represents the most efficient approach to the marketing and processing of agricultural produce into external markets.
The technical market conditions under which collective action may be effective are quite strict. For instance, unless it controls a large proportion of the world market, or can create a separate and desired image for its product, there is no reason to expect that a compulsory association of producers will be able to raise export prices. Equally, unless producers are less obliged to be price takers at home than overseas (i.e. unless demand on the local market is significantly less price elastic than on the export market), and output can be controlled, industry returns simply cannot be raised by cross-subsidising exports. Likewise, stabilising prices will backfire and cause less stable incomes unless prices and quantities move independently.
The structures favoured by commercial pressures may be at odds with the institutional forms brought about by statutory provisions. The motivations for choosing particular business constructs include some factors such as opportunities for joint production (or economies of scale) and the minimisation of transactions costs which the authors of the statutory provisions may not have contemplated. In the natural course of things, organisational structures would evolve to capture such opportunities or perhaps retreat altogether when the prospects for them waned. When statutory provisions are imposed which institutionalise one type of collective behaviour (and outlaw or discourage individual endeavour outside the officially-endorsed framework), this evolutionary process is stifled. The risk in these circumstances is that new structures and new ways of doing things, which would have made producers (and New Zealand as a whole) better off, are denied.
The issues discussed here also reinforce concerns some producers are expressing about the consequences of them ÔinvoluntarilyÕ owning processing and marketing organisations. The idea that producers will only prosper if they have Ôownership and controlÕ is being questioned on two counts.
First, as many producers have recognised, having a producer-dominated board is one thing, but controlling the day-to-day operations of that board, especially in the absence of any market test of the performance of those operations, is quite another. That is to say, the letter of the law which sometimes gives farmers legal control of the downstream handling and marketing of their product does not always deliver de facto control. It can be overturned by the practical complexities of large diversified organisations. Organisations can take on a life of their own and become cost plus operations, with no apparent end to the new investments in warehouses, coolstores, containers, offices, computers, faxes, company cars and so on. They can grow ÔorganicallyÕ and their ÔownersÕ can often do little about that.
The other count on which the idea of extended producer control is being increasingly questioned is on the basis of doubts that producer-ownership would deliver the greatest returns even if producers could practically assert control over their agencies. As discussed earlier in this Appendix, students of organisational structure have been grappling with this issue in recent years. Their main conclusions are that it can be misleading, when thinking about the relative effectiveness of organisations, to type-cast the people involved as either owners (principals) or agents, as if these roles in life were ordained, or somehow permanent. In fact the new, functional, term for ownership used in the organisational structure textbooks is Ôresidual claimantÕ Ñ by which is meant the party which takes the profits (or bears the losses) after the organisationÕs cost obligations (including salaries and other fixed payments to suppliers) are deducted from revenue.
In modern competitive organisations, it can be difficult to identify any group which is exclusively either a Ôresidual claimantÕ or an ÔagentÕ. Commercial relationships will often involve people taking on mixed functions and, in almost every case, individual people appear to have found it advantageous to behave more as a residual claimant in respect to some facets of their earning portfolio and more as agents in others. Such mixed roles evolve commercially for very good reasons and to impose a legal structure in the farm product marketing chain which effectively prohibits some structural forms, and/or freezes that evolutionary process, is likely to entail substantial costs.
It is clear that in concluding what forms of organisational structure are suited best to New ZealandÕs rural marketing and processing needs, there is considerable scope for conflict between the purely marketing and the purely economic perspectives. There may well also be scope for conflict between the controllers of the marketing/processing entities and the controllers of farm production.
In essence, the concern must be the validity of the judgment that the benefits of market power, which underlie favouring cooperation, concentration, and monopolies in some instances, exceed the costs which would arise insofar as such organisational structures may not minimise agency costs or maximise innovation and discovery. The role of statutes and controls in constraining structural evolution is another cost which needs to be considered in this judgment. Finally, it is by no means clear-cut that farmers have to own or try to control organisations to ensure their interests are best served. There is logic and evidence from experience to suggest the reverse is often the case.
Appendix 2
Influences on the Structure of Organisations