MY COLUMNS

Why a farmer based cooperative can never be a consumer food company.

Many companies have faced the dilemma of being a consumer products company and running a business to business (B2B) operation at the same time. Most companies tended to be both in the not so distant past.

It is easily forgotten that Ford Motors owned extensive rubber plantations in Brazil. Unilever had its own palm oil plantations in Malaysia and animal feed factories in Europe. I even remember passing Nestle milk processing plants in small villages in my native Friesland in the 1960’s.

Ford could not rely on a secure supply of tyres for its cars; Unilever wanted to control the supply of palm oil for its margarine plants and pork for its production of sausages.

The ensuing result for Unilever was having an animal feed business that partly supplied its own meat plants through contract livestock farming but mainly sold to third parties.

All these “backward integrated” activities disappeared in the last few decades of the 20th century. Nestle and Unilever, most notably, developed into selling consumer products only.

Dairy and ice cream represent 20% of Nestle’s turnover and 15% of its profit today. To illustrate: Nestle’s pet care business needs only half of the dairy turnover to generate the same profits!

For Nestle and Unilever the increased profitability was an important driver behind shedding those activities. Two other forces accelerated the process.

Reliable third party suppliers had developed and existed for a long period of time. Security of supply could, therefore, be found in the market. The most important reason, however, was cultural. Nestle and Unilever realized that you need different people, different systems and different qualities for each activity. Trying to meld consumer products and commodities into one organization and fitting into one mould, just did not work.

Cooperatives are faced with strategic restrictions

Cooperatives and dairy cooperatives in particular do not have that choice. They exist primarily to take all milk produced by farmers, process it into such products that the total mix will get maximum value in the markets that it sells in. Those markets can be B2B markets such as commodity and ingredients or consumer markets.

Saying goodbye to its milk collecting and processing infrastructure, concentrating on selling high value and marketing intense consumer products and adding a personal care or even a pet care division to its portfolio is not an option for a dairy cooperative. Unilever and Nestle, though, have proven that it can be a very sound and profitable strategy.

An important conclusion must be that strategy formulation in a cooperative is different from that in “normal” companies. Strategic options in farmer based cooperatives are limited by the requirement to collect inputs from its shareholders; be it milk, fruit or potatoes.

My principal observation, therefore, would be that dairy cooperatives such as Fonterra can never become fully fledged consumer product companies. If consumer trends and a profitable product mix would start to move away from products based upon milk, Fonterra would not be able to follow suit.

So if that option is not realistic, Fonterra can choose to be a company with B2B and Consumer businesses in one organization or to shed all Consumer businesses and become an Ingredients and/or Commodity business only.

The inescapable fact that companies such as Unilever and Nestle have concluded that Consumer and B2B businesses cannot live profitably (and peacefully) under one roof, should be an indication to question the present Fonterra strategy of doing just that.

27 November 2012