The "Old" Industry Model
Historically, New Zealand's competitive advantage in dairy products has been built upon low cost milk production arising principally from the benefits of the country's temperate climate and geography supporting pastoral production. However, increasingly competitive global markets and technical innovation threaten the sustainability of this advantage, as foreign competitors seek to replicate or better New Zealand costs. The strategy underpinning the merger was to vertically integrate the production, processing, marketing and distribution arms of the New Zealand dairy industry, developing a new business model that could further capitalise upon economies of scale in production made possible by technological development and reduce operating costs by better co-ordinating activities across the industry.
Information Use in the "Old" Model
It was considered that the forced separation of marketing and distribution (embodied in the Dairy Board) from production (farmers) and processing (the dairy companies) was restricting the free flow of appropriate and timely market information to processors about the types, quantities and qualities of products demanded by end consumers in the global market. Consequently, the factories were not able to plan raw materials use and schedule production runs to make the products that met the international market demands for high value-added products that would maximise Fonterra's profits.
Between Farm and Production Plant
Basing all payments on milk quantities supplied resulted in farmers being able to increase their incomes only by producing more milk, even though the production of extra milk by individual farmers could compromise the ability of the dairy company to maximise its returns. The incentives faced by farmers resulted in the risk of significant over-production of raw milk, a "toxic" product with a short life that must be processed even if it has to be subsequently disposed. Seasonal fluctuations within the dairy industry mean at times processors are left with little option but to process very high volumes of milk rapidly into low-value commodity products that eventually get sold at low prices (even below cost in some instances) merely to avoid the even greater environmental costs of disposing of surplus "toxic" milk. Lack of information exchange between the dairy companies and farmers thus compromised the ability of processors to optimise production of products to maximise profits.
Planning on the Farm
Lack of transparency in the price of milk and the value of farmer shares in the co-operative processing and marketing companies also prevented individual farmers from making optimal decisions about the quantity and quality of milk to produce, the times of the year (where choice is feasible) at which to produce, and the assets (e.g. cows, land, grass type, fertiliser etc) to commit to the production of that milk. Poor information flows were thus contributing to significant inefficiencies in the use of capital throughout the dairy industry, as well as compromising the ability of the industry to produce a product range that maximised the returns to the sector.
Between Processing and Marketing
Furthermore, the competitive nature of the two large dairy companies, and their legal and operational separation from the Dairy Board, had led to considerable fragmentation of the information that was available within the industry. Data fragmentation was further compromised by duplication of the systems and infrastructures via which information was processed. Each entity maintained separate management systems and management hierarchies, requiring duplication of management information systems, processes and infrastructures. Even though the co-operatives owned the Dairy Board, the lack of computer system standardisation resulting from separate management making uncoordinated decisions and investments created barriers to the transfer of information between entities.
Between the Processors
Moreover, as Kiwi and NZDG were competitors, sharing company information was strongly disincentivised, lest the competitor use it to gain a commercial advantage. Consequently, neither company had a complete "picture" of New Zealand's dairy industry production and processing activities. In order to estimate the "real" state of the entire industry from which to plan production and resource allocation, each company had to devote resources to gaming and guessing the state of the others' information. These activities increased both the transaction costs of acquiring information and the costs arising from decisions made using inaccurate, incomplete or inadequate information.
Resulting in Information "Silos"
In summary, as described by Fonterra Director of Corporate Finance Alex Duncan, the industry was characterised by "silos of information, industry fragmentation and opaqueness". Whilst mechanisms existed to gather data, none of the component companies had been very good at using it to change the way business was done, and none individually could use that information to effect changes that directly linked information and decisions made about marketing milk products internationally to production and investment decisions on the farm. A substantial justification for the merger lay in the better management and utilisation of the sector's information as a key component in keeping the New Zealand dairy industry competitive globally. The objective, according to Chief Operating Officer Jay Waldvogel, was "to move to the point where we stop dealing with reactive bits of data and start actually creating and dealing with information, actually making decisions that affect our business".5
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