Fonterra’s farmgate price formula sound

Competition in domestic dairy production has increased since Fonterra was formed and the way it sets its farmgate milk pirce is sound.

This was the finding of internationally renowned competition expert, Compass Lexecon, which has been ranked as one of the leading antitrust economics firms in the world by Global Competition Review for the past seven years.

Fonterra commissioned Compass Lexecon to provide an economic evaluation of the competitive environment for dairy processing and to also review the methodology for calculating the milk price paid to Fonterra’s farmer-shareholders.

The report found that:

• There had been a growth in competition in the New Zealand dairy industry under the Dairy Industry Restructuring Act.
• There has been a significant investment in expanded dairy processing capacity in New Zealand by competitors as well as Fonterra since Fonterra was formed. This investment in new more efficient plant was driving down manufacturing costs.
• The way Fonterra calculates its milk price – based on global prices for commodities, less the costs of a notional competitor – was correct.
• Domestic dairy prices in New Zealand have increased less than global prices for dairy product, largely because of the growth of supermarket home brands sold at a discount. (Around 70 per cent of domestic fresh milk sales in New Zealand are now home brands.)

Compass Lexecon endorsed the fact that the Fonterra milk price was based on the costs of a notional competitor using efficient processing facilities, rather than Fonterra’s actual manufacturing costs. It noted that there had been considerable expansion of dairy processing in New Zealand, with more efficient plant commissioned by both Fonterra and competitors: “Even if Fonterra (and other processors) … have higher average variable costs of processing, the farm gate milk price will be bid up by competitors utilising efficient plants,” the report concluded.

“The history of actual expansion by both Fonterra and independent processors … indicates a strong belief by both Fonterra and competitors that they can secure a supply of raw milk at a price that allows them to operate profitably.”

Fonterra Group Chief Financial Officer, Jonathan Mason, said the Compass Lexecon report essentially concluded that the New Zealand environment was fostering competition in the dairy sector and that the way Fonterra set its milk price was fair.

“The Milk Price reflects international dairy commodity prices, less the costs to produce and export those commodities. . . “

This should allay fears that Fonterra is using its dominent position in setting prices which disadvantage its competitors and consumers.

The company has announced that it will be reducing the domestic price of butter and cheese in response to falls in international prices.