[This post was first published in the New Zealand Sunday Star Times on 1 December 2013]
There is broad agreement that reform in the red meat processing industry is necessary. However, there is no industry consensus as to how it should occur.
The fundamental issue is that the red meat industry has been in decline, with the main problems concentrated in the sheep industry. It is very difficult to be profitable in a meat processing industry which has over-capacity combined with strong competition.
In terms of industry structure, the meat processing industry and the airline industry have key features in common. Both have high fixed costs and low marginal costs. Low marginal costs means that each additional unit of throughput has low additional cost relative to overall cost of operation.
In the airline industry, where two or more airlines are servicing the same route then there tends to be fierce price competition to get passengers on seats. This can work very well for passengers, and even for the airlines, as long as the industry is growing. But when times are tough and the market is contracting in size, then the competition becomes destructive. In those conditions, the best way to make a small fortune is to start with a big fortune. The long-term history of the airline industry is of a few successes and many failures, but there always seems to be someone new willing to step up to the plate.
In the meat industry it is somewhat similar. Our sheep industry has been in decline for more than 30 years. Productivity gains both on the farm and in the processing works have been enormous, but the shift to other land uses, and to dairy in particular, has made it impossible for most processors to prosper. There is too much capacity, and this leads to destructive competition.
Over the years, as one company fails, there have always been others willing to step up in the belief they could do better. The last big crash was of Fortex in 1994. Since then, the major companies have struggled on, with some plant closures, one big amalgamation, and ongoing cycles of staff redundancies.
Much of the current over capacity is in the South Island and this is where both of the meat co-operatives are based. Invercargill-based Alliance Meat Cooperative has about 30% of the national sheep meat market, and Dunedin-based Silver Farm Farms has about 25% national share. However, Silver Fern Farms has New Zealand dominance in beef processing, and is overall New Zealand’s biggest red meat processing and marketing company.
If there is to be overall industry rationalisation, then the co-operatives will be the key to this occurring. Many believe that the two co-operatives should be combined. The Meat Industry Excellence (MIE) group is a nation-wide group of farmers, with some high power people in the background, who are pushing for this. They are currently seeking to get their nominees onto the Board of each company.
Some six years ago there was a similar push by a somewhat similar group called the Meat Industry Action Group (MIAG). In 2007 they did manage to get their nominees on the Board of each company. However, once on the Boards these new directors realised that amalgamation was a lot more complex than had appeared from the outside.
Both Alliance and Silver Fern Farms have recently announced their financial performance for the 2012/13 year, which, unlike most other industries, runs from October to September so as to fit with the meat industry season. Alliance has reported a small post-tax and post-restructuring profit of $5.6 million and a large cash flow operating surplus of $89 million. Their balance sheet equity has recovered this year from 51% to 61% of total assets. This followed a disastrous 2011/12 year with a loss of $51 million. For the last four years in aggregate they have made losses of $47.9 million after tax and restructuring costs.
At Silver Fern Farms the current situation is somewhat worse. The 2012/13 operating loss was $28.6 million, operating cash flow was a deficit of $5.1 million, and equity has declined to 39%. However, their aggregate performance over the last four years is very similar to Alliance with an overall loss of $44.9 million. There is some industry debate as to whether or not Silver Fern Farms has further restructuring costs yet to be dealt with.
Both co-operatives want reform but both are also agreed that there is no ‘bankable case’ for amalgamation. They say that it would mean the co-operatives would bear all the costs and pain of restructuring, with too many of the benefits leaking to other industry participants. However, an across the industry approach facilitated by Government is also off the table.
The Government has privately indicated that it would need to see 80% processor support and 80% farmer support before being in a position to consider facilitating change. It is clear that this level of support does not exist, with some of the investor-oriented firms keen that market forces should play out unimpeded.
So what is the likely solution? The answer is that in the long-term it will most likely be the banks who decide which co-operative survives. It is also possible that some of the investor-oriented firms will fail. Whatever happens, there will be both winners and losers, but that is a story for another time.
[Two earlier posts on meat industry reform, one an analysis of tradable slaughter rights written in May 2013, and the other an analysis of the challenges associated with merging the two co-operatives written in April 2013, are posted here and here.]