Media Releases

Commission releases draft report on Fonterra’s 2015/16 Milk Price Manual

15 October 2015

The Commerce Commission today released its draft report on its statutory review of Fonterra’s Milk Price Manual for the 2015/16 dairy season. The Manual sets out how Fonterra will calculate how much it will pay dairy farmers for raw milk.

The Commission is required to report annually on the extent to which the Manual promotes the setting of a base milk price that provides incentives for Fonterra to operate efficiently, while providing for contestability in the market for the purchase of milk from farmers.

Deputy Chair Sue Begg said the Commission’s draft finding is that the 2015/16 Manual is largely consistent with the purpose of the milk price monitoring regime under the Dairy Industry Restructuring Act 2001 (the Act).

“While much of the Manual remains unchanged from last year, the amendments Fonterra has made this year improve the Manual’s consistency with the overall purpose of the regime. We are pleased with the steady progress being made year on year,” Ms Begg said.

“Our draft report encourages Fonterra to continue improving the clarity of the rules in the Manual and its disclosures on their use so interested parties can better see how Fonterra would interpret and apply them.”

Additionally, the draft report recommends that Fonterra consider some further issues, such as how the financing costs of interest-free loans made to farmers should be treated in calculating the base milk price and whether winter milk premiums should be explicitly provided for in the Manual.

The Commission will further review how Fonterra applies the Manual when it assesses the 2015/16 base milk price calculation at the end of the current dairy season.

The Commission welcomes comments on the draft report by 16 November 2015. The final report will be published by 15 December 2015.

The draft report and related information can be found on the project page.

Background

What does the Commission’s review of the Manual look at?

Each year the Commission reviews Fonterra’s Milk Price Manual for the dairy season that has just started. The Manual sets out Fonterra’s methodology for calculating its base milk price (also known as the farm gate milk price) for the season.

The Manual does not cover any other milk price within the milk supply chain.

We are required to consider the ‘efficiency’ and ‘contestability’ dimensions of the base milk price calculation. Our review focuses on whether the Manual provides:

  • an incentive for Fonterra to operate efficiently (the ‘efficiency dimension’)
  • contestability in the market for the purchase of milk from farmers (the ‘contestability dimension’).

Efficiency

There are many factors which can, and do, provide efficiency incentives for Fonterra. Our review of the Manual against the efficiency dimension requires us to focus on only one of these possible factors (i.e. whether the Manual provides an incentive for Fonterra to operate efficiently).

Our view is that the Manual would be expected to provide an incentive for Fonterra to operate efficiently where the Manual uses independent notional benchmarks for the revenue and cost inputs in the base milk price calculation. This is consistent with the Dairy Industry Restructuring Act 2001, which envisages the use of notional values, and involves the assumption of a notional milk processing and collecting business (the ‘notional producer’).

Contestability

As explained by Section 150A of the Act, the ‘contestability dimension’ is a function of whether any notional costs, revenues, or other assumptions underpinning the base milk price calculation are ‘practically feasible’ for an efficient processor. Our review therefore considers whether the assumptions, inputs and processes adopted in the Manual are practically feasible for Fonterra or any efficient processor.

Policy objectives of the milk price monitoring regime

The milk price monitoring regime is intended to promote greater transparency of Fonterra’s base milk price setting processes, and greater confidence in the consistency of Fonterra’s base milk price with contestable market outcomes. The regime monitors whether the base milk price that Fonterra chooses to set provides incentives for Fonterra to operate efficiently but does not preclude efficient processors from potentially competing.

What does the overall monitoring regime consist of?

The Act requires us to do two separate reviews of Fonterra’s base milk price setting each dairy season. The draft report concerns the first phase: the Manual review considers Fonterra’s methodology for calculating its base milk price at the beginning of each dairy season.

In the second phase, we are also required to review Fonterra’s base milk price calculation at the end of each dairy season.

We published our 2014/15 Review of the base milk price calculation in September 2015. In that report, we concluded that Fonterra’s 2014/15 base milk price calculation was largely consistent with the purpose of the milk price monitoring regime.

State of competition review

At the request of the Minister of Primary Industries we are separately carrying out a review under the Act of the state of competition in the New Zealand dairy industry. Our review will examine whether the regulations are helping or hindering the efficient operation of the New Zealand dairy industry. We will be consulting on our draft report from 6 November 2015, and our final report will be provided to the Minister by 1 March 2016.