GPG's Apple Raid

Thursday 5th October 2000

To some in the apple industry it was as though the Devil and all his henchmen had ridden into town. Without warning on the afternoon of July 22 Sir Ron Brierley's Guinness Peat Group and FR Partners, the investment bank associated with Sir Michael Fay and David Richwhite, announced they wanted to buy 39.8% of Enza, the single-desk export marketer of the country's apples and pears.

The two lost little time letting the world know they didn't think much of the way Enza is run. "It doesn't make money," says GPG's Tony Gibbs bluntly. "It's got a huge culture of waste."

Many an apple grower would agree. Enza has lost more than $11 million over the past two years and is expected to report another deficit this year. Returns to growers have hit historical lows. The pip fruit industry is certainly ripe for a change. But whether the corporate henchmen are ones to lead it is another matter. To some in rural New Zealand GPG and FR Partners are synonymous with Big Money getting bigger at the expense of the ordinary battler. Didn't Brierley make his money asset-stripping venerable corporations? And didn't Fay and Richwhite pile up fortunes buying under-priced public assets like the Bank of New Zealand, and manage to shimmy their way through lax tax regimes at the same time?

Growers aren't the only ones worried. Big noters of other producer boards, such as Doug Voss, chairman of the kiwifruit marketing monopoly Zespri, and Sir Dryden Spring, former long-serving Dairy Board chairman, look askance at the Enza play. They fear it could be the beginning of the end for the traditional producer board structure, a structure they say is uniquely beneficial to New Zealand. Basically, under this regime growers own the marketing arm (the boards), and the marketing arm in turn has exclusive rights to the marketing of the products ("single-desk" policy). Don't underestimate their importance. In the year to May producer boards' contribution to exports was $10.2 billion, or 40% of the total. Directly or indirectly they employ around 383,000 people, or nearly 20% of New Zealand's workforce.

Unsurprisingly, these numbers attract a good amount of corporate attention. But non-growers, private individuals and corporations can butt out. "Maybe people like you [non-growers] would like to buy Zespri shares but that's too bad," Voss told me. "We're not looking for big chunks of capital and we're quite happy to fund our own industry and own it."

However, "butting in" is precisely what's on GPG's and FR Partners' agenda. These two could get a stake in Enza because both bought enough apple and pear orchards to entitle them to a maximum allowable 20% each in the apple and pear producer board. They now have two seats on the board.

GPG's Gibbs came out of the first post-raid board meeting giving little away about the corporation's plans. But he hinted that axing the grower-only shareholding rule and allowing anybody to own Enza shares was high on the agenda.

One of many
Despite its high profile, the Enza deal won't go down as one of the year's biggest - GPG and FRP have invested only a few million dollars each. The impact was more symbolic because this year practically every corner of the rural sector is grappling with the implications of a rapidly changing world. The dairy industry has been painfully rending itself over the "Merge-co" plan: an attempt to merge the two largest dairy processors, Kiwi Cooperative Diaries and the Dairy Group. The deal is stuck in politics.

In August farmers voted to dismantle the grower levy-funded Wool Board and set up two separate commercial bodies, like Enza and Zespri, with grower shareholders. The plan's author, consultant McKinsey & Co, said it could find no evidence the board had bene-fited farmers by more than it cost to run. The new entities would "inject further entrepreneurial and commercial discipline into the industry". Earlier, Enza and its kiwifruit equivalent, Zespri, were both corporatised, meaning growers became shareholders. There are calls to restructure the flower export industry to make it a "Holland of the South Pacific".

All are aimed at tackling, by one means or another, ever-falling commodity prices and ever-larger international competitors.

Despite the best efforts (or the worst, depending on where you sit) of pro-market governments, much of New Zealand's agricultural and horticultural sector remains producer owned and controlled. Around 90% of its exports are from sectors with some form of producer board.

Four of these - for dairy, apples, kiwifruit and hops - retain single-desk monopolies on marketing product outside New Zealand. The Meat Board has powers to allocate the quota other countries allow and the rest are non-trading boards focusing on funding sector promotion and research. The deregulation process, started in the 1980s by the Lange-led Labour government, has been long and agonising. The sectors involved are simply too big and important - and employ too many voters - to have radical reform thrust onto them from above.

The question is, can they remain so big and important under their current structures? And if not, then what?

Ownership
At least one organisation thinks change is imminent: when the Ministry of Agriculture and Food briefed incoming agriculture minister Jim Sutton earlier this year, it warned that the "trading environment for New Zealand's agricultural and horticultural exports is changing rapidly. Industry strategies and structures need to keep pace." The implication: something's got to give.

One of the central issues, MAF said, is ownership and governance. "There is a real question about whether continued regulation to provide for special governance arrangements in [these] sectors is justified."

To GPG's Gibbs it's a no-brainer. Although Enza has already been "corporatised" the reformers didn't go far enough. "Corporate disciplines have to be brought to bear on [the producer boards]," he says. "The corporate structure, from farm gate to market, is the most efficient structure. I'm talking about dividends, capital raisings, having shares that are tradeable freely among people rather than only suppliers."

It's worth noting that Gibbs doesn't advocate corporate ownership of the farms and orchards themselves. Farming corporations have a poor track record here, he says. "At the producer level there's nothing like an owner operator."

One factor contributing to poor economics in the horticultural sector is the number of "lifestyle blocks". New Zealand now has more than 100,000 such hobby farms. "One of the problems of rural New Zealand is what I call grower politicians. They build these structures with the very best of intentions but they get defensive once people get inside them." The problem is that lifestyle blockers and other small producers rely on the producer boards to effectively subsidise them. "Having made a lifestyle choice and decided to plant 300 trees of this and 200 trees of that then they should live with the consequences of living on a small block. They must be uneconomic for these large organisations to process. People who roll up with just a few cartons of this and that expect exactly the same service, the same cool stores and so on, as the larger grower who's going to put hundreds of cartons through."

These small producers, Gibbs says, band together into associations, the associations vote members on to boards, "and the next thing you've got another grower politician lobbying for something else".

Gibbs knows what he's talking about - with a 50,000-tree orchard, he's the country's second-largest mandarin grower. He says he can identify with the heartaches of growing and has great respect for some growers. "But my orchard is set up as a full commercial model and it will make money. It has to make money. And that's what's got to happen to all the orchards in New Zealand. They have to be viable, and not with subsidies."

In the family
Gibbs, of course, has the poorly performing pipfruit sector chiefly in mind. Grower returns have been weak for years. Returns per carton over the past five years have averaged $12 a carton compared with $15-plus a decade ago.

By contrast, the kiwifruit industry is booming. Zespri's Voss reckons it can power on without any help from corporates like GPG. Voss, like leaders in other rural sectors, thinks producers need to keep ownership and control of their industries from the orchard right out to the end consumer, or face peasant status. "If your shareholders and your suppliers aren't the same, you get a tension between what is paid to suppliers and how much can be retained as profits for shareholders. The shareholders would want to screw down the suppliers as much as possible."

That, says Voss, is what now faces Enza growers. Zespri's growers, on the other hand, have seen payments for each tray they supply rise from $4.22 in 1996 to $7.62 last year, although Zespri predicts the price will fall to $6.79 this year.

Nor does Voss accept arguments that marketers are dominated by grower politicians to the detriment of commercial discipline. Half of Zespri's board, he points out, are "commercial" directors.

Single desks
The second major area where industry incumbents and free-market purists disagree is on boards' single-desk export mono-polies.

The three single-desk survivors are dairy, kiwifruit and apples. Out they must go, says the Business Roundtable. "Essentially these are archaic structures," says Roundtable executive director Roger Kerr. "Instead of the commercial drivers you'd want to see operating in those industries - a focus on the bottom line, return on investment et cetera - there's all this old-fashioned rhetoric still clouding the debate."

The boards insist that dismantling the monopolies would be a disaster. Without monopolies, the "weak seller" argument goes, every man and his dog would end up knocking on the same doors with the same products and prices would plunge.

Former Dairy Board chairman Spring reckons that's particularly so in the dairy industry. Most dairy farmers, he says, run very small businesses - the average dairy herd size is increasing but is still only 220 cows. The milk has to be processed immediately and farmers are in no position to dictate terms to corporate buyers. "The single desk has suited New Zealand well because it has enabled farmers to exert some marketing leverage and attack the added-value part of the market for the benefit of farmers, not corporate investors."

Few people understand that New Zealand has built the world's only branded, value-added dairy export industry, Spring says - the Nestlés and Krafts of this world use milk produced in the countries in which their products are marketed.

Rather than dismantling co-operative buying and sin gle-desk selling the industry should be aiming for more aggregation, such as the "Mergeco" deal the two biggest co-operatives are still trying to thrash out. Failure, Spring says, will leave the industry facing some large competitors. Farmers of America, for instance, has annual turnover of $35 billion, compared with the Dairy Board's $6 billion.

How serious that problem might be varies from sector to sector. In the deregulated meat business, says Affco chairman Sam Lewis, exporters compete "a bit" for the same foreign buyers but "voluntary discipline" - not collusion, you understand, just sensible people making sensible decisions - means it doesn't affect prices too much. In fact, red meat prices have risen over the past 20 or 30 years. "It's in everybody's interests in sensitive markets like Europe to manage pricing in a reasonable manner to make sure there are no big price fluctuations," says Lewis.

Kerr thinks the "weak selling" argument is nonsense. The notion that New Zealand boards could raise prices by, say, 5% in competitive world markets is ludicrous, he says. All single-desk structures do is distort price signals, resulting in misallocation of the economy's resources, he says.

Ironically, raider Gibbs is of two minds. On the one hand, open slather competition between New Zealand exporters is simply "what a market is all about - competition". But in Enza's case a lot of care would be needed if the monopoly were to be dismantled, he says. Enza borrows around $400 million each year to make progress payments to growers. "If the monopoly was whipped away I wonder whether the banks would be that keen to lend it $400 million. If they weren't you're going to send a lot of growers to the wall."

Scale
As in many sectors, scale is an increasing factor for agribusiness and a hot issue in the ownership debate.

At the producer level, bigger and more efficient operations are prospering but smaller players are under heavy pressure. While the dairy sector, for instance, is in the best heart it has been for eight years, MAF notes the bottom 25% of farms are struggling. Some 96% of these produced a negative disposable surplus this year, "indicating the industry has a serious financial 'tail'".

The vegetable growers' association, VegFed, reported a bumper season resulted in depressed prices - potatoes, for instance, have sold for as little as $35 a tonne compared with $300 a tonne last year. VegFed predicts up to 20% of commercial growers could be forced out of the industry if prices continue falling.

The response has been to get bigger, both in the processing and supply chain and on farms and orchards.

Where there were 75 dairy co-operatives 25 years ago there are now eight. More than 60% of meat production is processed by four companies, while five supply-chain managers handle 90% of the kiwifruit crop.

Complementing the lifestyle-block phenomenon, farms and orchards have also been growing, but as they become bigger and more complex they need more management skills than the average family can provide, hence an influx of corporates into farming and horticulture.

On smaller blocks farmers make ends meet by earning off-farm income, in local towns or rural servicing, for example. MAF says 53% of the farms it monitors survive this way.

Gibbs doesn't see families being replaced on the land by corporates but he says operations need to get bigger.

"Most citrus orchards would be five or six thousand trees at the most. These guys are never going to make money - they'll make a few bob but Dad mows the grass, Mum works at the local store, Dad's a mechanic, too."

A lot of people "far to the right of me" would like to see small growers of anything driven out of the system, Gibbs says, but those arguments run into a legitimate debate about the value of the Kiwi lifestyle.

"I can put my corporate hat on and say growers need to get bigger and more efficient, you only need one tractor per 100 acres, not one per 10 acres."

"At the same time I like the fact that my kids grew up in a semi-horticultural environment. So this isn't a business discussion any more, it's about the New Zealand environment and I'm just as confused as anybody else."

Middle way
There's a third way of looking at things. To Wairarapa businessman Ian Cresswell both the free marketeers and the interventionists are missing the point.

"The question of whether an industry should be owned by producers or corporate shareholders is irrelevant to achieving better returns for the country or industry," says Cresswell.

"I've been farming for 10 years and I've seen the meat, wool, dairy and pip fruit industries restructure. All they've done is change the shape or colour of their tent."

To Cresswell, arguing about industry structures is like arguing about the shape a factory should be before it's been decided what to make in it.

The McKinsey plan for corp-oratising wool, he says, won't put a single extra dollar into farmers' pockets. "And look at the flower industry. It is going through this typical primary sector, very aggressive, very negative change process with lots of animosity between the various factions. Every-one's concentrating on whether they should have a marketing vehicle, not on how we can get better returns and better productivity."

Cresswell thinks New Zealanders have been mesmerised by business leaders who insist exporters have to have a strong domestic base. As a result, he says, we don't gear for the big markets.

His vision for rural sector industries is for a balance - export marketing monopolies where the rationale is strong, but with the flexibility to grant licences to businesses that show strong entrepreneurial flair. The main thing, he says, is to get people thinking about their markets and how to supply them profitably.

"As a supposedly export-led nation we'll continue to fail if we keep looking inwards instead of aggressively chasing the marketplace."

Time to change direction
We're losing the export race. On the one hand, we have increased the prices of our main commodity exports (lamb, butter,

beef and wool) by raising the quality of product (see graph one). "We were exporting Ladas, now we're exporting VW Beetles. Meaning, the price of a car in the world market probably hasn't increased much, but by changing the type of car we export we have managed to significantly enhance the return," says economist Andrew Gawith of Infometrics. On the other hand, when

we subtract the cost of imports, the real return has been in decline since the 1950s (graph two). "We have to produce a hell of

a lot more pastoral product today to buy the same quantity of imports than 20 years ago. It suggests we are producing the wrong goods." Time for a change in direction.

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