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Fonterra's 'Velocity' programme doesn't appear to have delivered - ComCom

Thursday 12th September 2019

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Fonterra Cooperative Group's 2015 'Velocity' restructuring doesn't appear to have achieved the savings expected and pushed up the dominant dairy exporter's costs used in setting the regulated milk price. 

The dairy exporter bumped up its administration and overhead costs for the 2019 and 2020 seasons by $20 million in each year in calculating the milk price, according to the Commerce Commission's final report on the 2019 milk price.

The regulator said the extra costs relate "either to the failure to achieve efficiencies provided for in the 2015/16 setting of provisions for administrative and other overhead costs or to errors in the allocation process" in 2015/16 when the regulator was of the view that adjustments for the Velocity restructuring could be included as non-recurring items. 

"It appears that up to $20 million of the costs being reinstated relates to the original Velocity adjustments," the commission noted in a footnote in the final report. 

Fonterra has provided for an additional $90 million of administration and overhead costs over two years as what a notional processor would spend to be efficient. Of that, $45 million in 2019 was recoverable but non-recurring, and the other $45 million was ongoing and recoverable in 2020. 

The regulator said Fonterra didn't comply with its governing legislation by lodging the information after the July 1 statutory deadline. Because of that tardiness, the commission wasn't able to reach a conclusion on whether those costs provided an appropriate incentive for Fonterra to operate efficiently. It will take a more intensive look in the 2020 review. 

The Commerce Commission is required to test whether Fonterra calculated the milk price in line with legislative efficiency and contestability principles at the end of every season, as a means to ensure the country's dominant milk processor isn't abusing its market position. 

Deputy chair Sue Begg said Fonterra's calculation was largely consistent with the law, but that Fonterra's late filing of the administrative costs meant the regulator couldn't form a view on whether they were appropriate. She also said Fonterra's asset beta - a component used to calculate the cost of capital - remained too high to be practically feasible. 

A beta is a measure of the volatility, or systemic risk, of a security or a portfolio in comparison to the market as a whole. A lower asset beta allows a higher milk price to be paid.

The report notes that Fonterra will commission a fresh review of the asset beta to be introduced in 2020/21. That would align the proposed date of proposed legislative changes. 

Agriculture Minister Damien O'Connor tabled legislation to amend the Dairy Industry Restructuring Act limiting Fonterra's discretion in setting the asset beta. It would also spell out that Fonterra can pay a different farm gate milk price to its shareholder farmers from the base milk price. 


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