- 1 -

New Zealand Dairy BoardNew Zealand Dairy Board

Presentation to Select CommitteePresentation to Select Committee

27 July 199927 July 1999

- 2 -

Introduction & OverviewIntroduction & Overview

John StoreyJohn Storey

- 3 -

• Process • Consultation• International Market Situation• Strategy• Co-operatives• Structure• Interface with Dairy Companies

Overview

- 4 -

Machinery & Mechanical

Equipment + Electrical

Equipment & Machineryy

Aluminium

Forestry

Meat

Dairy Exports

$5 billion

Dairy contributes22.2% of New Zealand's export earnings

Importance of Dairy to NZ

- 5 -

ProcessProcessJohn StoreyJohn Storey

Process to DateProcess to Date Process Going ForwardProcess Going Forward

- 6 -

• Industry Strategic Plan August 1998 - Feb 1999• Rigorous process• Top consultants employed• Full Industry involvement On Farm to Off Shore

Marketing

• Industry Structure Project March -May 1999• How best to deliver the Strategy

• Implementation Project• Dealing with legislation & high level

implementation issues

Process To Date

- 7 -

• Legislation passed

• Commerce Commission approval

• Merger Proposal Agreed

• 75% Merger Vote

• Integrate merging companies into MergeCo

Process Going Forward

- 8 -

ConsultationConsultationJohn StoreyJohn Storey

Consultation to DateConsultation to Date Future ConsultationFuture Consultation

- 9 -

•1998 October - November 15 response

•1999 March - Strategy

•1999 May - Structure

Overwhelming support for proposals

In excess of 10,000 at meetings (70% of farmers)

Consultation to Date

- 10 -

•Videos (Farming with Pictures)

•Written Material - bi-monthly

•E Mail

•Information via Extension Services

Other Communications

- 11 -

• July/August - Company-Supplier Accounts Meetings

• September - Formal merger proposal to shareholders

• September - Shareholder vote

• Farmer final vote on proposal

Future Consultation

- 12 -

International Market SituationInternational Market Situation

Milk Production

Market Share

Access,Tariffs & Subsidies

Market Trends

NZDB Performance

Warren Larsen

- 13 -

Milk ProductionMilk Production

- 14 -

World New Zealand

Consumed

Domestically 95%Exported 95%

Traded Internationally 5% ConsumedDomestically

5%3% Freely Traded

2% Quota Business

Milk Production

- 15 -

Major Dairy Producers

0

20

40

60

80

100

120

NZ Australia EU US India Russia Brazil

1992 1997

Cow's milk production (million tonnes)

- 16 -

WHO ARE THE MAJOR EXPORTERS?

- 17 -

Major Dairy Exporters

0

2

4

6

8

10

12

14

16

NZ Australia EU US Other

1992 1997

Cow's milk equivalents (million tonnes)

- 18 -

European Community 51%

Other 14%

Australia 6%

USA 4%

New Zealand 19%

European Union

38%

New Zealand31%

USA 5%

Australia12%

Other 20%

1988-90 1997

Share of International Trade

- 19 -

DYNAMICS OF THE WORLD DAIRY MARKET

IMPORT PROTECTION

- 20 -

Access All Products/Low Tariffs (0-30%)Product Specific Access/Medium Tariffs (30-70%)Product Specific Access/Medium-High Tariffs (70-220%)Only Butter/Cheese/Protein Quota Access/High Tariffs (>220%)

World Dairy Access & Tariffs

- 21 -

Protection From Imports

Tariff Rate Ad. Val Equiv

$NZ/MT %

USASMP 1644 59

WMP 2075 74

Butter 2927 120

Cheese 2365 168

- 22 -

Protection From Imports

Tariff Rate Ad. Val Equiv

$NZ/MT %

European UnionSMP 2539 95

WMP 3173 119

Butter 4200 175

Cheese 3700 115

- 23 -

EXPORT SUBSIDIES

- 24 -

Subsidy Rate %Export

$NZ/MT Price

European UnionSMP 1291 48

WMP 1949 73

Butter 3428 147

Cheese 1931 58

Export Subsidies: Rates

- 25 -

Subsidy Rate %Export

$NZ/MT Price

USASMP 2050 87

WMP 2760 100

Butter 2120 87

Cheese (cheddar) 2339 67

Export Subsidies: Rates

- 26 -

Protectionism

Source OECD Secretariat

Producer SubsidyEquivalent

Milk All PSECommodities

Milk All CSECommodities

Australia 31 10 -31 -7EU 61 49 -51 -38Japan 90 74 -74 -50New Zealand 2 3 0 -5United States 52 20 -46 -10

Consumer SubsidyEquivalent

- 27 -

0

50

100

150

200

250

300

350

400

450

500

Butter & butteroil SMP

000

MT

Export Limits 1998 Exports

EU has plenty of scope to expand

- 28 -

A EU guaranteed minimum price US$3072 Underpins milk price to farmers

of NZ$9.00kg milksolids

Cost of butter to EU exporter

B Export subsidy US$1768 Cash payment to export companies

(not farmers) paid at time of export ___________

C European export price (A-B) US$1304 The price we confront in the market

European Butter Pricing (USD/tonne)

- 29 -

A EU guaranteed minimum price US$2137 Underpins milk price to farmers

of NZ$9.00kg milksolids

Cost of SMP to EU exporter

B Export subsidy US$ 936 Cash payment to export companies

(not farmers) paid at time of export ___________

C European export price (A-B) US$1201 The price we confront in the market

European SMP Pricing (USD/tonne)

- 30 -

NZ EXPORT MARKETS

- 31 -

NZ's Dairy Export Markets

United States

Other

European Union

China (incl Hong Kong)

Australia

Taiwan

Philippines

Mexico

Russia

Malaysia

Japan

- 32 -

0

100

200

300

400

500

1995 1996 1997 1998

$M

Tariffs

- 33 -

IMPACT OF SUBSIDIES ON WORLD PRICE

- 34 -

The impact of EU subsidy changes between 1997 - 1999 for Cheddar, SWMP and SSMP =

NZ$498 million lost sales revenue to NZDB

European Union Subsidy Change

- 35 -

NZ PRODUCT VOLUMES

- 36 -

0

200

400

600

800

1000

1200

1400

MT

('0

00)

Total

NZ

40% 30%

16%20%

60%

Share of Accessible International Market

- 37 -

WHAT DOES ALL THIS MEAN FOR NZ DAIRY FARMERS?

- 38 -

USA - 2+% milk growth- low milk prices- feed to milk price ratio lowest in recent history

LATAM - 3-5% increase in Argentina- small increases in Brazil/Chile

Australia - 4-5% milk growth

EU - no growth

NZ - 4-5% forecast milk growth

Forecast World Production

- 39 -

0

5

10

15

20

25

0 50 100 150 200 250

Milk Cost

$NZ/kg Milk Solids

Milk Production

Million Tonnes

NZ

Australia

Poland

Argentina

USA France

Germany

Brazil Netherlands

AustriaItaly

Global Dairy Industry Curve

- 40 -

Globalisation TrendsGlobalisation Trends

- 41 -

Chart Title

-

200

400

600

800

1,000

1,200

Jan-80 Sep-82 Jun-85 Mar-88 Dec-90 Sep-93 Jun-96 Mar-99 Nov-01

c/k

gm

s (

19

97

$N

Z)

Milk shortage in EU, USSR/Afghanistan war EU relaxes

domestic subsidies

GATT round

EU introduces milk production quotas

Collapse of USSR

Real Commodity Revenue (1997 NZD)

- 42 -

Company Dairy Revenues - 1996(US$b)

13.5

6.65.8 5.7 5.5

4.64.0 3.8 3.8 3.7

3.2

Nestlé

Kraft

Snow

Danon

eFC

DF

Besni

erM

orin

aga

Mei

ji

Campi

na M

elku

nie

NZDB

MD F

oods

Sodia

al

1 2

3.6

5.0

Parm

alat

7.5

D Far

mer

s of

Am

eric

a

Selected dairy companies = 25%Top 20 dairy companies = 35%

Leading Dairy Companies

- 43 -

Global dairy market continues to consolidate

•Nestle acquisition of Bordens Klim

•Friesland Coberco Dairy Foods merger

•Formation of Dairy Farmers of America

•Suiza Foods (US) 1998 acquisitions US$1 billion

•Dean Foods (US) 1998 US$1.1 billion in acquisitions

•Parmalat acquisitions continue 1998 US$ 625 million

Mergers & Acquisitions

- 44 -

Recent global retailer activities continue to consolidatebuying power for example...

•Tesco (UK) acquires Lotus Thailand and targeting Korea, Taiwan

•Carrefour (France) expanding in SEA and Latin America with 150 new stores by 2002

•Ahold (Dutch) active in 17 countries up 62% since 1994

•Auchan (France) active in 10 countries up 19% vs 94

•Dairy Farm (HK) focus on Asia post UK divestments

Global Retailers

- 45 -

MarketShare %of foodmarket

Time

30%Stage 1 Stage 2 Stage 3 Stage 4

Medium sizefood companies

Global food companies players Pharmaceutical

companies

1994 2001 2010

Source: Promar International

Entry of pharmaceutical players will drive functional foodsto 30% of total European foods market

Nestle

Unilever

Danone

Novartis

Mead Johnson

J &J

MD Foods

ValioNZDB

Functional Foods

- 46 -

Growth to DateGrowth to Date

- 47 -

0

500

1000

1500

2000

2500

3000

1989/90 1999/00

1836+50%

2747

NZ$M

Payment for Milk

- 48 -

0

50

100

150

200

250

300

350

1989/90 1999/00

333310

Current

250

CurrentPricing

C/kg MS

Under common assumptions B/E milk price around 60c higher 10 years later

Payout

- 49 -

250

270

290

310

330

350

370

1994 1995 1996 1997 1998 1999(F)

2000(B)

Payout/ Retentions

CMP

Note 1 CMP for 1994/1997 sourced from BCG Performance and Efficiency Audit 2 CMP for 1998-2000 sourced from Boards EBIT Reporting Systems

Estimated CMP/Payout Spread

- 50 -

23%

77%NZMP

New Zealand Milk

Business Unit Volume (NZ Milk only) - 1998/99

- 51 -

0

50

100

150

200

250

300

New Zealand Milk NZMP

NZ

D (

m)

Business Unit EBIT 1998/99

- 52 -

0

1000

2000

3000

4000

5000

6000

7000

8000

NEWZEALAND

MILK

NZMP TotalNZDB

Telecom CHH LionNathan

NZ

D (

m)

Comparative Revenue 1998/99

- 53 -

STRATEGIC RESPONSE

- 54 -

Industry Strategic Plan Industry Strategic Plan Warren Larsen

Key Messages

Key Strategies

- 55 -

To create the world’s pre-eminent dairy business which builds and leverages truly distinctive capabilities to

capture opportunities on a global stage

1 Defend and exploit our core position as the world’s lowest-cost producer and seller of basic dairy products. This is our top priority

2 Take urgent steps to earn the right to grow outside the core

3 Pursue growth options outside the core (at the right time) by leveraging our unique skills to capture attractive opportunities

4 Consider options to tailor the structure of the NZDI to deliver the strategy

Key Messages

- 56 -

Global revenues

NZ$30 billion

Revenue growth 15% pa

ROTGA 15% pa

10 Year Financial Aspiration

- 57 -

Time

Profit

Horizon 1

Horizon 2

Horizon 3

Extend and defend core businesses

Build emerging businesses

Create viable options

• Defend and exploit core low cost position• Earn the right to grow

• Industry Milks strategy• ‘Global slivers’ in specialised ingredients• Leverage our ingredients network beyond NZ

Dairy

• Industry biotechnology agenda

• Risk management services

Growth Horizons

- 58 -

0.0

5.0

10.0

15.0

20.0

25.0

30.0

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

$19 billion Horizon 2 & 3 ‘Non-core’ growth

$ Billions

$11 billion Horizon 1 ‘core’ business

Industry Strategic Plan Revenue Growth 1998 - 2008

- 59 -

Industry StructureIndustry StructureTim Gibson

Current Structure Issues

Co-operatives

Options Considered

Recommended Option

- 60 -

The current industry

organisation design will not

realise full value from the strategy

Industry configuration complex and politicised

Traditional emphasis is on placement of NZ milk

Dramatic reduction in interactions cost driven by IT/communications revolution

The success of the strategy demands fast, consistent,

commercial decision making

Many of the growth opportunities require

sourcing of non-NZ milk

Current organisation design does not leverage dramatic

reductions in interaction costs

The Problem With the Current Design

- 61 -

Why Co-operatives in Dairy

Farmer

Milk Vat

Milk- Un-pasteurised- Perishable- Worthless after

48 hours

Processing Company

Factory- $100-150m- Worth scrap

without milk

Farmers• Require a secure outlet

for milk• Require a fair price• Have little choice today• Have highly seasonal

supply

Processor• Requires milk to

recover capital• Want to receive it on a

fair price• Highly seasonal supply

- 62 -

International Co-operatives

• Co-operative Structures are used around the world to overcome bargaining problems in Dairying

Co-operative US$ Bn (Revenue, 1996)

Dairy Farmers of America 7.5

Friesland Dairy Foods 5.5

Campina Melkunie 3.8

MD Foods 3.6

Land O’ Lakes 3.49

MergeCo 4.8*

*Estimate

- 63 -

Current situationOrganisational trends

External equity Internal equity

Corporate gover-nance structure

Co-operative governance structure

Differentiated farmer payouts across NZ

Uniform farmer payouts across NZ

Ownership linked to supply

Ownership delinked from supply

Ca

pit

al/O

wn

ers

hip

De

sig

n C

ho

ice

s

Four Capital/ Ownership Design Choices

- 64 -

Atomised organisation

Centralised organisation

Vertically aligned Horizontally aligned

Multiple manufacturers

Single manufacturer

Multiple marketers Single Marketer

Current situationOrganisational trends

Org

an

isa

tio

nD

es

ign

Ch

oic

es

Four Organisation Design Choices

- 65 -

SingleManufacturer

MultipleManufacturers

SingleMarketer

SpecialisedMarketers

CommodityCompetitors

Fully CompetingMarketers

No integration

Merchant withProcessor

Ingredients withMerchant

Consumer withMerchant

Thirty-Two Options

- 66 -

Single company for processing, merchanting and ingredients. Consumer separate subsidiary

P

M

IC

Preferred Option

- 67 -

• Fair Value

• Governance

• Local Market Competition

Key Issues for the Commerce Commission

- 68 -

TradabilityShare Supply Link Eligibility

A 80-120% Amongst FarmersQ no linkage Amongst Farmers

Fair Value

A Shares Q Shares

MergeCo

- 69 -

• Elected using ward system

Governance

Shareholders’ Council (30-100)

Board of Directors (9-11) • Farmer Directors nominated by Shareholders and/or Shareholders’ Council

• Independent Directors nominated by Board

2-3 Independents 7-8 Farmer Directors

- 70 -

Issue: Dominance of Domestic Dairy Market

DivestCo

Solution: Establish Independent Company by Divestment

• 40% Market share in all key segments• Arms length, non-exclusive milk supply contract

and established brands• Full manufacturing & marketing facilities

- 71 -

Interface with dairy companiesInterface with dairy companies

NZDINZDI Milk SupplyMilk Supply

Payment ProcessPayment Process Product MixProduct Mix

Interface InefficienciesInterface Inefficiencies GovernanceGovernance

David Pilkington

- 72 -

SoleExporter

NZDB

14,700 Farmers

More than 11 billionlitres of milk

8 Co-op ManufacturingDairy Companies

More than 1.3 milliontonnes of product

NZ DairyResearch Institute

LivestockImprovement

800 Specifications

1700 Products

More than 80Offshore Companies

Trading to over 115Countries Worldwide

New Zealand Dairy Industry

- 73 -

0

40

80

120

160

Jun Jul Aug Sept Oct Nov Dec Jan Feb Mar April May

Million Kg 1995/96 1996/97 1997/98

NZ Seasonal Milksolids Supply

- 74 -

NZDB purchases all export product from dairy companies on the 20th of month following manufacture

NZDB manages inland transport, storage, ocean freight and export documentation

Basis for payment to dairy companies has just been reviewed (BDP - Business Development Project)

Product Acquisition Process

- 75 -

Prior to BDP companies were paid: a single pooled milk price (NZDB Base

Price) Modelled standard manufacturing costs Capital cost or return on capital payment Grade penalties or premiums Differential payments to influence preferred

product

Payment Process

- 76 -

Dairy Companies paid to farmers: NZDB base price, plus Dairy company margin

Farmers judged NZDB performance through the NZDB base and dairy companies the margin

Dairy company executives focused on maximising their margin versus others

Payment Process

- 77 -

BDP introduced Commercial Pricing Model. As a result dairy companies will be paid: Commodity product price Additional incremental manufacturing costs

for non standard products For speciality products a share of the NVA

(Profit) A distribution of NZDB margin over

commodity

Payment Process

- 78 -

Changes were introduced to: more closely reflect commercial reality into

the payment system, and; to allow farmers to more transparently

judge the performance of the NZDB

Payment Process

- 79 -

NZDB collates market demand information and advises commodity price data to dairy companies

Dairy Companies decide their preferred mix of products to NZDB

Iterative process required to fine tune mix to match market demand

Product Mix Process

- 80 -

Individual dairy companies make their own product mix decisions based on their analysis

Several iterative steps needed to match combined result to market demand

Allocation of new products to plants debated widely

Dairy companies are drawn into non productive equity debates

Interface Inefficiencies

- 81 -

Current Ownership

14,700 Farmers

New Zealand Dairy Board

NZCDC Kiwi Northland Westland Tatua Tasman Kaikoura Marlborough

58.2% 27.3% 8.7% 2.7% 0.8% 1.5% 0.3% 0.5%

- 82 -

NZCDC Kiwi Northland

NZDB

Current NZDB Governance

Electing Group* Govt Appointed

* NZ Electing Group comprises Kaikoura, Marlborough, Tasman, Westland, Tatua

- 83 -

Wrap Up Wrap Up John Storey

- 84 -

• Complex Industry

• Huge benefit

• Industry committed to make it happen

• Co-operation assured

Summary