2. Case Study: Fonterra
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Contents
Introduction............................................................................................................................................2
Market Factors .......................................................................................................................................2
Fonterra’s Response to the Challenges .................................................................................................3
Management Accountant’s Interpretations..........................................................................................4
Conclusion ..............................................................................................................................................5
References ..............................................................................................................................................5
3. Case Study: Fonterra
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Introduction
This report is a case study analysis of Fonterra’s present state in the dairy industry. The first
part of the report focuses on the macro and micro economic environment of Fonterra’s
position in the over-all dairy market. Some of the major changes within the global dairy
market has been studied in order to recognize their influence in Fonterra’s business cycle.
We have then looked into how Fonterra has evaluated and responded to these factors. The
later part of the paper looks at Fonterra’s reactions to these commercial challenges from a
management accountant’s perspective.
Market Factors
The CRB Index is a commodity futures price index that measures the overall direction of
commodities. It has served analysts for over 50 years as a sentiment indicator for global commodity
markets (Investopedia, 2016). Over the last five years the CRB index (Figure 1 Appendix) has declined
year over year thus signalling an end to the commodity super cycle that began in the late 90’s.
Agricultural based commodities and derivatives of dairy continued to register gains going into 2014
(Figure 2 Appendix). The commodity bull market was largely driven by rapid industrialisation in
China, growth in emerging markets and a historically low interest rate environment.
Decline in Dairy Prices: As of 2013, global milk production was estimated to be
roughly 636 million metric tonnes. New Zealand’s contribution to global supply
amounted to little over 3% (19 million). The EU-28 nations accounted for 25% (159
million) United States 14% (91 million), India 9.6% (61 million) & China with 5.6% (36
million) (AHDB, 2015). In 2015, the European Union lifted quotas restricting the
quantity of milk that could be produced. (Fonterra, 2015). The result was an
additional 9 million tonnes or the equivalent of NZ milk production growing by 50%
(KPMG, 2015). The prolonged boom in dairy saw farmers ramp up production
globally in order to take advantage of higher milk prices. This oversupply of milk
production has resulted in the slump in dairy prices which initially began in early
2014. (Appendix Figure 3.) Over the years China built up massive inventories of
whole milk solids which some analysts estimate amounted to over 300,000 tonnes,
reducing global demand. Decreased demand from China meant that prices fell
further. This was evident by the reported decline in global dairy auction trades
(Agrimoney, 2015).
Increasing Competition: Fonterra’s domestic market share has fallen roughly 15%
since its inception back in 2001. (Source Fonterra Annual Report – Search Dairy
Industry Restructuring Act). A combination of consistent year over year growth and
profitability which was evident from the high farm gate milk prices (Appendix Figure
4.), favourable market conditions, low cost of capital and the belief of replicating
similar success has seen a number of incumbents enter the space. Independent
processors such as Synlait and Open Country are now collecting close to 22% of farm
gate milk supply in the South Island and roughly 15% nationally (Patterson, 2014).
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Since 2004, Open Country has grown to become the second largest dairy processor
in New Zealand. The global dairy industry is highly competitive and the WPC80
incident would have cast the company in bad light. China is actively looking to
become independent and diversification of its dairy supplier base is a first step. The
EU-28 has gained significant market share in China. In 2015 they accounted for 30%
of Chinese Dairy imports (Fonterra , 2015).
Value Added Products: Globally, there has been an increase in demand for value
added products such as grass fed milk, butter and other organic dairy products.
These products are known to deliver higher margins.
Fonterra’s Response to the Challenges
Cost Reduction in Transporting Goods: Transportation takes up a significant portion of
Fonterra’s operating expenses. The company has therefore designed a variety of measures
in its Australian delivery fleets that not only reduces its carbon footprint but also minimizes
fuel consumption (Fonterra, 2014). These include tracking each truck’s weekly fuel usage
and providing new trucks with fuel-efficient engines. Recognizing the importance of tanker
fleets in the firm’s supply chain, Fonterra has continued to invest more resources towards
fuel efficient fleets. Fonterra recently developed an Estimated Tanker Arrival (ETA) App that
enables farmers to track routes with greater precision (Fonterra, 2015). These minor
changes have had a major impact on the company’s cost reduction program. Not only has it
helped to reduce the kilometres travelled to collect milk but it also has cut the business’s
diesel consumption for those kilometres by 10 % for every 100 km travelled since the 2010
financial year (Fonterra, 2015).
Reducing Overhead: Fonterra has laid off more than 750 employees in order to reduce
costs. According to Fonterra, cutting these non-essential jobs enable them to save an
additional $60 million per year (Gray, 2015). Fonterra CEO Theo Spierings, expects these
change will allow for greater flexibility in procurement, operations of business and working
capital allowing the co-operative to “realise increased value” for their shareholders.
(HENSON, 2015).
Increasing Capacity: Since 2013, Fonterra has spent over $2.1 billion expanding processing
capacity in powders and premium products. These investments have been critical to
accommodate increasing milk volumes. (Appendix Figure 3) Furthermore, it allows for
flexibility to switch between products that are likely to deliver favourable returns in any one
season. Thus overcoming the product mix disadvantages that have previously affected
earnings whilst improving peak costs. The completion of a dryer and distribution centre and
accompanying sites across NZ allows the company to increase capacity that is more in line
with current expectations of milk growth (Fonterra, 2014).
Chinese Market: Fonterra made a global Investment in 2015 of around $364 million in farm
development and livestock purchases in China as part of the commitment to the Chinese
Dairy Industry and the creation of milk supply consumer growth within this important
market. Fonterra has over 25,000 cows in China which brings in a production of 12 Million
mg of milk solids in the past year (Fox, 2015).
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Increase in Production Efficiency: Fonterra invests in R&D in the aim to be at the forefront
of innovation, to pursue processes that are more efficient and to develop more innovative
produces. Below are some R&D projects that Fonterra is currently working on:
• Manufacturing Innovation: Increases manufacturing efficiency while driving down
operating costs (Fonterra, 2014).
• High Pressure Processing: Aims to turn the water pressures that are normally used as a
“blunt” food preservation tool into a high precision instrument for working with dairy
products (Hiperbaric, 2013).
• Heat Recovery Loop: This project sees products requiring cooling and heating receiving
stored energy recovered from other product streams. In other words, product streams are
indirectly heated and cooled by each other, which will in turn bring more efficiency
(Fonterra, 2015).
• Highly Automated Manufacturing: This project endeavours to see manufacturing processes
automated by leading edge dairy manufacturing technology and process innovation. A
number of HAM technologies have already been implemented in Fonterra’s manufacturing
facilities (Fonterra, 2015).
• Milk Concentration Technology: Saves cost and energy through decreasing the number of
tanker movements. This has already been implemented at Fonterra’s Tua Marina site in New
Zealand’s South Island.
Responding to Value-Added Demand: Fonterra’s strategy emphasizes “greater volumes
of milk to create premium products with high returns” (Value added). Fonterra’s
consumer and food service businesses have achieved record performance in Asia on
back of low milk costs. This contributed 408 million and achieve 25.5% return on
capital (Fonterra , 2015).
Management Accountant’s Interpretations
As a management accountant, finding ways to deal with the challenge of low dairy prices on
the global commodities market requires the analysis of two primary approaches towards
improving profits, the first is to reduce the cost of producing milk commodities to improve
margins, the second is using milk provided by farmers to acquire the highest level of return
from the market, by selling a range of value-added products (Kuo, 2009).
A main area within Fonterra’s value chain for producing milk solids where cost reductions
can be made is in storage costs, the costs can be reduced by investing enough in improved
storage capacity to reduce reliance on costly third party providers, and increasing the
processing capacity of plants to reduce the required level of overall storage (Fonterra,
2014). The information needed to decide how much should be invested in increased
storage, and where to locate the extra capacity, will require the accountants to collect
information about the current and projected cost of using third party providers, the
geographical regions where most of these costs arise, and the estimated costs of investing
in varying levels of extra storage capacity. After this information is collected the accountants
can use information about the region’s most in need of extra storage, to calculate a balance
between the projected cost of investing in more storage, and the projected costs of
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continuing to use third parties, using this data the accountants can define a suggested range
of extra storage to invest in, tailored to each region (Kaplan, 1995).
When deciding how much more production capacity should be added, the accountants will
want to analyse information about the averages of time for milk being collected from farms,
to the completion of processing at plants, they will also want to know the current levels of
storage being used at plants, the average output of milk being processed, and to identify
these figures relative to the regions served by each processing plant (Drury, 2011). With this
information the accountants can calculate how much it is currently costing to store the milk
that cannot be processed fast enough, and decide the optimal level of additional processing
capacity for each region, to maximise cost efficiency, this will include calculating how much
storage costs will be reduced compared to different levels of additional processing capacity.
In order to receive the highest return possible on their primary resource which is milk,
Fonterra need to not only focus on increasing margins in the sale of commodities, but also
continue to develop and produce value-added products. The value-added aspect of
Fonterra’s sales is made up of products sold direct to consumers under Fonterra owned
brands, and ingredients such as mozzarella sold in bulk. These value-added products have
much higher margins than their commodities counterpart, this is due partly to a less
competitive market in terms of supply, and that producing these products uses milk which is
currently priced very low on the global market (Craig & Brown, 2002). To maximise the
benefits that Fonterra receive from diverting the production towards value-added goods,
the managerial accountants will need to collect information on the projected price of milk
commodities, the current margins for each value-added product being produced, the
projected demand for each subsection of value-added product, and the historic trends in
the relationship between supply of the products and their average market value. The
accounting staff will use this information to calculate what the optimal product mix and
overall quantity of processing capacity to allocate towards value-added output. The optimal
product mix will be decided based on the margin of each product, and the optimal level of
supply the most profitable products can be produced at, without oversaturating the market
and reducing sales value.
Conclusion
To sum up, Fonterra witnessed major changes and volatility in the past few years, especially
in 2015 due to the various ups and downs in the dairy industry. However, the company has
taken the right steps in dealing with these changes. Fonterra recognizes the various
fluctuations within the dairy market and has taken appropriate measures of cost reduction
and improving production efficiency in order to minimize the risk.
References
Agrimoney. (2015, May 26). Chinese milk powder stocks to fall sharply, as imports dwindle. Retrieved
from Agrimoney: http://www.agrimoney.com/news/chinese-milk-powder-stocks-to-fall-
sharply-as-imports-dwindle--8377.html
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AHDB. (2015, June 5). WORLD MILK PRODUCTION. Retrieved from AHDB:
http://dairy.ahdb.org.uk/market-information/supply-production/milk-production/world-
milk-production/#.Vyk-ZPl95dh
Craig, S. B., & Brown, S. G. (2002). PRODUCING VALUE-ADDED PRODUCTS. Retrieved from
Washington State University:
http://whatcom.wsu.edu/ag/documents/foodsafety/Start_w_Food_Safety.pdf
Drury, C. (2011). Cost and Management Accounting: An Introduction. Chicago: Cengage.
Fonterra . (2015, August 26). Financial Results. Retrieved from Fonterra:
https://view.publitas.com/fonterra/annual-review-2015/page/1
Fonterra. (2014, August 13). FONTERRA AND CSIRO JOIN FORCES TO DRIVE SUSTAINABLE DAIRY
INNOVATION. Retrieved from Fonterra:
http://www.fonterra.com/global/en/hub+sites/news+and+media/media+releases/fonterra+
and+csiro+join+forces+to+drive+sustainable+dairy+innovation/fonterra+and+csiro+join+forc
es+to+drive+sustainable+dairy+innovation
Fonterra. (2014, August 27). FONTERRA INCREASES PROCESSING CAPACITY TO HELP MEET GLOBAL
DEMAND. Retrieved from Fonterra:
http://www.fonterra.com/nz/en/Hub+Sites/News+and+Media/Media+Releases/FONTERRA+
INCREASES+PROCESSING+CAPACITY+TO+HELP+MEET+GLOBAL+DEMAND
Fonterra. (2014, October 14). FUEL EFFICIENCY IN OUR AUSTRALIAN TRANSPORT FLEET. Retrieved
from Fonterra:
https://www.fonterra.com/global/en/recycle+bin+28+may+2015/sustainability/environmen
t/climate+change/transport+fleet+savings/fuel+efficiency+in+our+australian+transport+flee
t
Fonterra. (2015, April 6). ENERGY. Retrieved from Fonterra:
https://www.fonterra.com/nz/en/sustainability+platform/sustainable+manufacturing/energ
y/energy
Fonterra. (2015, September 18). FONTERRA OPENS MULTI-MILLION DOLLAR MILK PLANT. Retrieved
from Fonterra:
https://www.fonterra.com/nz/en/Hub+Sites/News+and+Media/Media+Releases/FONTERRA
+OPENS+MULTI-MILLION+DOLLAR+MILK+PLANT
Fonterra. (2015, September 8). NEW MOBILE APP BRINGS FARMERS CLOSER TO THE CO-OP.
Retrieved from Fonterra:
https://www.fonterra.com/nz/en/Hub+Sites/News+and+Media/Media+Releases/New+mobi
le+app+brings+farmers+closer+to+the+Co-op
Fox, A. (2015, 30 November). Fonterra turns off China milk taps. Retrieved from NZFarmer:
http://www.stuff.co.nz/business/farming/dairy/74472740/Fonterra-turns-off-China-milk-
taps
Gray, J. (2015, September 21). Fonterra job cuts rise to 750. Retrieved from NZ Herald:
http://www.nzherald.co.nz/business/news/article.cfm?c_id=3&objectid=11516326
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HENSON, N. (2015, September 21). Fonterra confirms 230 more job cuts. Retrieved from Stuff:
http://www.stuff.co.nz/business/farming/agribusiness/72244467/Fonterra-confirms-230-
more-job-cuts
Hiperbaric. (2013, May). High Pressure Processing. Retrieved from Hiperbaric:
http://www.hiperbaric.com/media/uploads/productos/documentos/Hiperbaric_flyer_dairy_
ENG.pdf
Investopedia. (2016). Investopedia . Retrieved from Commodity Research Bureau Index - CRB:
http://www.investopedia.com/terms/c/crb.asp
Kaplan, R. S. (1995). Measuring Manufacturing Performance. Measuring manufacturing
performance: a new challenge for managerial accounting research, 284-306.
KPMG. (2015, September 24). Prosperity, Dairy and Unleashing the Giant. Retrieved from KPMG:
https://www.kpmg.com/NZ/en/IssuesAndInsights/ArticlesPublications/Documents/Fonterra
-flight-path-v3.pdf
Kuo, Y.-F. (2009). The relationships among service quality, perceived value, customer satisfaction,
and post-purchase intention in mobile value-added services. Computers in Human Behavior,
887-896.
Patterson, B. (2014, January 22). WHY IS FONTERRA LOSING GRIP OF MARKET SHARE IN THE DAIRY
INDUSTRY? Retrieved from Informetrics: http://www.infometrics.co.nz/why-is-fonterra-
losing-grip-of-market-share-in-the-dairy-industry/
Appendix
Figure 1.
