Dairy Solutions 2001 > Using Knowledge to Pursue Growth

Transcription

1 Dairy Solutions 2001 > 2002 Using Knowledge to Pursue Growth Integrated Strategy Project for Henley Management College Manu Vallyon 2003

2 Page 2 Fonterra Co-operative Group Contents 1 Introduction 1.1 Fonterra Co-operative Group Report Objectives and Structure 5 Part I INDUSTRY TRANSFORMATION 2 The Local Dairy Industry 2.1 Industry Lifecycle Industry re-engineering 9 3 The Global Dairy industry 3.1 A Dynamic Industry Global Production and Demand Key Situational Factors 16 4 Competitor Strategy Analysis 4.1 Competitor Risk Management Strategies Competitor Growth Strategies Competitor Technology & Product Development 22 Part II ORGANISATIONAL TRANSFORMATION 5 Defining Strategy 5.1 Stated Vision, Purpose & Strategies Strategy Gap Analysis 26 6 Strategic Transformation 6.1 Strategic Repositioning Strategy Development 31 7 Organisational Restructuring 7.1 Current Organisational Framework Transformed Organisational Framework Market Transformation Capital Transformation 40 8 Managing Change 8.1 Leading Change Co-ordinating Mechanisms Design Parameters Configuration 48 CONCLUSION 50 END NOTE 51 BIBLIOGRAPHY 52 APPENDIX 54 PERSONAL DEVELOPMENT REPORT 64 Disclaimer: This document has been undertaken in partial requirement of the Henley Management Collage M.B.A. and is based on guidelines set out within the Integrated Strategy Guide. The information contained within this report does not reflect the views of either Fonterra Co-operative Group or Henley Management College.

3 Henley Integrated Strategy Project Page 3 FIGURES Fig 1.1 Fonterra Group and Key Figures 4 Fig 2.1 Production and Consumption in the Local Dairy Industry 6 Fig 2.2 Phases of Transformation in the Local Dairy Industry 8 Fig 2.3 Stakeholder Map 11 Fig 3.1 Worldʼs 20 Largest Groups by Dairy Sales and Volume 12 Fig 3.2 Lifecycle of International Dairy Prices 14 Fig 3.3 World Market Shares of Major Exporters 15 Fig 3.4 Marketplace: Food Manufacturers and Retailers 16 Fig 3.5 Global Tariff Levels 17 Fig 3.6 PESTLE Analysis 18 Fig 4.1 Typical Growth Strategies; Drivers of Consolidation 21 Fig 4.2 Core Competitor Competencies 21 Fig 4.3 Porters Five Forces Analysis 23 Fig 5.1 Ansoff Growth Vector Matrix 25 Fig 5.2 Gap Analysis 26 Fig 5.3 Key Environmental Gaps 28 Fig 6.1 Strategic Repositioning 30 Fig 6.2 Strategic Mix 31 Fig 6.3 Development Strategies 33 Fig 7.1 Existing Organisational Structure 36 Fig 7.2 Transformed Organisational Structure 37 Fig 7.3 Market Transformation 38 Fig 7.4 Branding Hierarchy 39 Fig 7.5 Competitor Comparisons 40 Fig 7.6 Transformation of Income Streams 41 Fig 8.1 Strategic Change Process 43 Fig 8.2 Value Chain Analysis 45 Fig 8.3 Support Differentiation 47 Fig 8.4 Strategic Alliances 47 Fig 8.5 Superstructure 48 Fig 8.6 Geographic Scope 49 APPENDIX A Local Dairy Industry Profile 54 B Industry Efficiency Comparisons 54 C Global Dairy Industry Market Information 55 D Supply Chain and Resources 56 E Selected Horizontal Alliances 57 F Stated Activities 58 G Stated Targets 58 H The Fonterra Way 58 I Stated Corporate Strategies 59 J SWOT Analysis 60 K Competitor Innovations in Risk Management 61 L Financial Statements 62

4 Page 4 Fonterra Co-operative Group 1 Introduction 1.1 Fonterra Co-operative Group Fonterra is the worldʼs fourth largest Dairy Group measured in sales, with a turnover of more than 6.5 billion $US. It is the leader in many of itʼs markets, owns a number of high profile international brands and is the worldʼs largest manufacturer of dairy ingredients. Fonterra emerged in 2001 from a merger of three organisations with extensive resources in the dairy industry. It is a co-operative, with shares owned by 13,000 dairy farmers. Fonterraʼs vision is to lead in dairy and its purpose is to sell our shareholderʼs milk. The organisation operates in a complex operating environment and commodity market. It has a respected reputation in the industry which has helped it establish significant alliances. While remarkable achievements have been made in a short time, Fonterra also continues to be tested on several fronts. In December 2002, Fonterra announced a further restructuring. The stated objective was to consolidate Fonterra into a leaner, more efficient organisation. NZMP is the worldʼs biggest dairy ingredients group marketing products in over 100 countries. Itʼs customer base is the global food industry and includes New Zealand Milk Employees 6,894 Revenue $7,766 EBIT $301 Assets employed $7,259 New Zealand Milk operates in the dairy consumer foods sector. It owns several high profile international brands and is market leader in many of its markets Employees 12,583 Revenue $5,583 EBIT $302 Assets employed $3,607 Fonterra Enterprises are SBUʼs designed to support Fonterraʼs core business. These include ViaLactia for biotech R&D, Fonterra Research Centre for processing and product R&D and FonterraTech, an incubator to commercialise technological and process innovations Fonterraʼs shareholder services includes RD1 and Fencepost.com. RD1 is the largest agricultural retailer in New Zealand with over 50 stores throughout the country. Fencepost.com is an internet service for farmers to assist in farm management Note: Figures are sourced from the Fonterra Annual Report 2001 (NZ$ millions) Fig 1.1 The Fonterra Group and Key Figures

5 Henley Integrated Strategy Project Page Report Structure and Objectives This report follows the requirements and recommendations outlined in the Henley Management College Integrated Strategy Guide. It was written with the intention of meeting requirements of the Henley MBA programme as well as being a benefit to Fonterra. The purpose of this report is to identify how the current organisational restructuring could be applied to help Fonterra take advantage of strategic opportunities in the international dairy market. In particular, by reducing reliance on commodity markets and utilising knowledge as a means to pursue value added growth through Fonterraʼs alliances and brands. The report is divided into two parts: The first deals with industry transformation. It includes the recent evolution of Fonterra, the industry operating environment and key competitor strategies that have been drivers of dynamic transformation. It also identifies some of the key risks and opportunities faced by Fonterra. The second part covers organisational transformation. Firstly, Fonterraʼs stated vision, strategies and targets are defined. The appropriateness of these strategies to the organisationʼs operating environment are then evaluated and a transformation of the strategic mix is then suggested. A directional framework for organisational restructuring is outlined using terminology defined by Mintzberg. The effect on Fonterraʼs resources are analysed within this context of organisational restructuring rather then as an independent analysis. Issues and generic strategies are addressed at a corporate level and transformation is seen as involving the resources, decision making structures and people of Fonterra as a whole.

6 Page 6 I. Industry Transformation New Zealand Dairy Industry 2. The Local Dairy Industry Production Consumption ,000 1,200 1,400 Fig 2.1 Production and consumption in the local dairy Industry (ʻ000 tons) New Zealandʼs dairy industry has been export focused since its inception and now exports 95% of its produce, establishing a significant presence in international markets (fig 2.1). 80% of exports are commodities. Fonterra represents 98% of the local industry and makes a significant contribution to national GDP (appendix A). Fonterra is less than two years old, but this belies its advanced phase in the organisational lifecycle. Greinerʼs lifecycle model has been applied within the context of the following summarized transformation of the local dairy industry: 2.1 Industrial Transformation By 1848, the year of the New Zealand Dairy Industryʼs first export, several entrepreneurial companies and Mãori tribes had already established a thriving agricultural export trade to support Sydneyʼs burgeoning population. Technological innovations soon made large scale dairy manufacturing and global distribution feasible. The first refrigerated shipment in 1882 marked a significant step. From this time through the early 1900ʼs there was rapid expansion of dairy factories and cooperatives characterised by a make and sell focus and individualistic and informal management. Amongst these, Henry Reynolds opened a factory in the Waikato in 1886 and started selling Anchor products. Anchor has since grown to become one of the worldʼs most global dairy brands and Fonterraʼs most valuable.

7 Henley Integrated Strategy Project Page 7 In 1922 the government started to become more active in the industry. The result was a centralisation of power with a focus on greater operational efficiency and standards. Soon afterwards, the industry collectively established a point of entry into the United Kingdom. Expansion became a strategic priority and in 1947 power was decentralised and delegated through the establishment of a shared public/private sector commission. New Zealand shared a close political relationship with the United Kingdom through the Commonwealth. This was a prosperous relationship for the local dairy industry, but one in which it had little control. When the UK joined the protected European Market in 1973, New Zealand exporters lost most of their market overnight. The industry structure had also become highly bureaucratic and was slow to respond. The government introduced policy shifts to encourage competitiveness. Subsidies were removed and a dairy board established to improve coordination. The industry went through a difficult process of consolidation while seeking new markets. Overall, it did this with some success and built up a large and diversified portfolio of export markets and products. By the late 1990ʼs, consolidation within the competitive framework was developed to its logical conclusion; two efficient competitors and a watchdog (the New Zealand Dairy Board) defined the local industry. Although New Zealand had become the worldʼs largest exporter in many dairy markets, both companies faced limitations for further growth and the prospect of stagnation. The dairy industry was at a stalemate and the competition policies designed to stimulate the industry were now holding back its expansion. Following Greinerʼs definition, the industry had matured to the end of the fourth phase of growth (fig 2.2).

8 Page 8 I. Industry Transformation New Zealand Dairy Industry Event 1814 Missionary Samuel Marsden brings a bull and two heifers to New Zealand Lifecycle Phase Phase one The New Zealand dairy industryʼs first entrepreneur! 1846 First international export to Sydney 1871 First co-op is established in Otago 1882 First refrigerated shipment of dairy products to overseas markets Growth through creativity Rapid technology development enables larger scale production and distribution 1900ʼs Rapid growth of dairy factories Crises of leadership 1922 Government establishes the Dairy Export Control Board Amalgamated Dairies established in London by several NZ companies to market dairy products in the UK State takes over export marketing 1947 Dairy Products Marketing Commission established to share government and industry responsibilities 1973 The industryʼs main market, the UK, joins the protected European market. The local industry is slow to respond 1970ʼs New Zealand Dairy Board develops -1990ʼs overseas markets to sell produce from many regional co-operatives Phase two Growth through direction Crises of autonomy Phase three Growth through delegation Crises of control Phase four Growth through coordination Late 1990ʼs 12 of 14 dairy groups have merged into two export oriented conglomerates over seen by a Dairy Board. Crises of red tape 2000 The merger established a monopoly, but in a non-regulated environment 2003 The future Phase five Growth through collaboration Adapted from ʻEvolution and revolution as organizations growʼ by Greiner (1972). Harvard Business Review. Fig 2.2 Phases of Transformation in the Local Dairy Industry

9 Henley Integrated Strategy Project Page 9 In 1998, a new industry strategy was developed to strengthen the local industryʼs competencies through collaboration, rather then competition. It suggested a merger of the local dairy industryʼs resources into a single organisation with the resources and economies of scale required to pursue growth and market share on a global scale. Entirely new strategies and organisational frameworks would be required and it would involve nothing less then re-engineering the entire New Zealand dairy industry. The ambitious nature of this ʻvisionʼ was evident in its working title; Global Dairy Co-operative, colloquially shortened to Globalco. 2.2 Industry Re-engineering A merger of this scale was never going to be straight forward. There were complex issues and the vision represented change for numerous stakeholders, many of which were crucial for the mergerʼs approval. They included local dairy industry competitors, the parliament who would have to pass new legislation, and most importantly, the dairy farmers themselves. Larger, macro economic factors also played a part. Extensive economic reforms in New Zealand had resulted in less regulation and greater competition and efficiency, but a poorly performing economy. The small scale of local markets, geographic distance from major markets and economic reliance on commodities are also issues the nation faces. This has lead to an ideological transformation amongst an increasing number of business and government leaders that a collective use of resources might be needed to create the economies of scale and knowledge competencies required to compete within a global context. As such, the debate over the re-engineering of the dairy industry has often encompassed political and economic arguments as well.

10 Page 10 I. Industry Transformation New Zealand Dairy Industry Critics of the merger argued that the new cooperative would limit the means in which the local dairy industry can raise capital, and binds it to purchasing share-holderʼs milk irrespective of market demand. Others argued that local competition gave a measure of competitiveness in the share price of milk, which would be lost in a highly consolidated industry with a local market monopoly. This was compounded by the fact that there was no trigger crises of an obvious scale to reduce resistance to change. Proponents promoted maximising shareholder returns as a key driver and introduced merger benefit targets. A shareholderʼs council was established, Standard & Poors were appointed as an independent valuer in setting the share price of milk, and a retired high court judge was appointed commissioner in case arbitration is required. They also promoted the benefits of cost efficiencies and productivity improvements and a greater global presence. Technically, the underlining driver for the merger was planned change to develop a better organisational fit within the global operating environment. The merger was driven by charismatic leadership and a strong vision with varied actions for change. Each organisation brought unique competencies, strategies, cultures and personalities. To help reduce resistance to change, industry leaders agreed to establish an entirely new culture without any existing culture dominating. Two small regional co-operatives elected not to join the merger process. Interest in the merger was high (fig 2.3). Crucial interest and power lay with the New Zealand dairy farmers and three legacy organisations. Gaining approval was problematic from an anti-competition point of view. Although the Commerce Commission had a crucial interest in the merger, it proved to not to have crucial power.

11 Henley Integrated Strategy Project Page 11 New Zealand Parliament New Zealand Dairy Farmers POWER Crucial High The Media The Public Political Groups Kiwi Co-operative Dairies (Board) New Zealand Dairy Group (Board) New Zealand Dairy Board (Board) Westland (Board) Tatua (Board) Employees of all dairy groups Commentators Commerce Commission High Adapted from Johnson and Schloes Fig 2.3 Stakeholder Map INTEREST Crucial Leaders of the merger successfully argued that anti-competition laws designed to protect the local market were not relevant for a merger designed to strengthen the role of the organisation within an international context. The merger was supported by an act of parliament but with a number of concessions. Some assets were divested and mechanisms put in place to protect local competition. Effectively this was a deregulation of the local market to enable any competitor to compete for both market share or suppliers. After considerable debate, a substantial 85% of farmers voted in favour of the merger. New legislation was passed in November and by October 2001, Fonterra was formed. Expectations are high. Industry leaders expect greater organisational efficiency, farmers expect increasing returns and political leaders expect a greater contribution to the economy. The work to carry out the Globalco vision has only just begun.

12 Page 12 I. Industry Transformation New Zealand Dairy Industry 3. The Global Dairy Market Nestlé Dean Foods DFA Fonterra Kraft (Phillip Morris) Danone Parmalat Unilever Lactalis Meiji Dairies Arla Foods Morinaga Friesland Coberco Bongrain Land OʼLakes Campina Melkunie Snow Brand Sodiaal National Dairy Nordmilch 6.5b Dairy Sales (Billion USD) DFA Fonterra Arla Foods Lactalis Friesland Coberco California Milk Land OʼLakes Campina Melkunie Nordmilch Bongrain Dairy Crest Nestlé Humana Westfarm Foods Murray Goulburn Sodiaal Dairylea Foremost Farms Family Dairies Glanbia 13.9b Volume (Billion Litres of Milk Processed) DFA are Dairy Farmers of America. Sources: Rabobank, Dairy Industry Newsletters, Fonterra Fig 3.1 Worldʼs 20 Largest Groups by Dairy Sales and Volume 3.1 A Dynamic Industry The global dairy market has been transforming at an unprecedented pace in its history. Once characterised by highly localised operations, the industry is rapidly expanding into a smaller number of large firms as a result of mergers and acquisitions. Three of the top five dairy groups by sales, and four of the top five in terms of volume are organisations that didnʼt exist five years ago (fig 3.1). The peak of consolidation in the global dairy industry took place between January 1998 and April 2001 with 490 significant acquisitions, mergers and alliances according to Rabobank.

13 Henley Integrated Strategy Project Page 13 The largest of these were the reverse merger of Suiza and Dean in 2001 to became Dean Foods, the worldʼs second largest dairy group. Both companies had expanded rapidly over recent years through interstate acquisitions of scores of smaller US dairy operators. The scale of the Dean merger drew the attention of US antitrust regulators and the company had to divest 11 plants. Eight of the top 20 competitors are co-operatives. The largest of these is Dairy Farmers of America, established in 1998 as a result of a merger between four of the largest US dairy co-operatives. Dairy Farmers of America and Dean Foods have since established National Dairy Holdings, which counts amongst itʼs assets the plants Dean had to divest. In Europe, Denmarkʼs MD Foods and Swedenʼs Arla merged to become Arla Foods in 2000, Europeʼs largest dairy group measured by milk intake. This was unique in that it was a transnational merger of co-operatives, possibly setting a precedent. Campina also emerged from a trans-national merger of dairy groups in the Netherlands, Germany, and Belgium. Also in the Benelux, Friesland Cosberco has expanded rapidly as a result of mergers between a number of large dairy co-ops. The Swiss based Nestlé remains the undisputed market leader in sales. Nestlé have a long history of pursuing growth through acquisitions and over the past year have acquired sole ownership of Häagen-Dazs from Ice Cream Partners USA and Schöller from Südzucker. Schöllerʼs sales alone are over US1.5b. The private companies of Danone in France and Parmalat in Italy are also expanding rapidly through acquisitions. Clearly, the Fonterra merger is part of a global consolidation trend.

14 Page 14 I. Industry Transformation New Zealand Dairy Industry 3.2 Global Production and Demand The total global dairy trade is valued at around US$26 billion, approximately 6.2% of total agricultural trade. According to Rabobank, global demand is growing at 2% per annum, equal to the consumption of a nation the size of Australia or Argentina. Global production is growing at less than 1%. The commodity price of milk is effected by a complex cycle of variables that include consumer supply and demand, seasonal variations (such as climate), exchange rates, and subsidy levels which are adjusted in many markets to help control levels of stock (fig 3.2). Increase in consumer spending Prices Rise Customers increase orders in anticipation of rises. Stock levels increase Demand Increases Reduction in consumer spending Demand Decreases Customers postpone orders in anticipation of falls. Stock levels decrease Prices Fall Fig 3.2 Lifecycle of international dairy prices (simplified) The worldʼs most valuable markets are the EU and the US. These are mature markets in terms of demand and starting to show slight decline in terms of supply. This decline is significant when measured in relation to export market share (fig 3.3). Growth in mature markets are primarily achieved through added value consumer products such as convenience foods, nutrition and organics. The fastest growth is organics, which is emerging from a niche sector into a significant main stream market. Rabobank are forecasting a continued 18-25% annual growth of the organic

15 Henley Integrated Strategy Project Page 15 USA 6% 23% NZ EU 28% USA 1% 31% NZ EU 40% 7% AUS 24% Others Others 23% 17% AUS Source: Danish Dairy Board Fig 3.3 World market shares of major exporters food industry against 2-3% for conventional foods. In the worldʼs three largest organic markets (EU, the US and Japan) the industry is estimated to be worth over 100 billion USD by 2005 with dairy products accounting for about 11% of this growth. The geographic regions experiencing the most rapid growth in demand are South America and Asia which already include some of the worldʼs largest markets by volume (appendix C). This growth can be attributed to a combination of increasing consumer spending and the emergence of more western diets, including greater consumption of dairy products in non-traditional dairy farming areas. Global marketing and distribution undoubtedly plays a role in this cultural change. Australia and New Zealand are leading expansion in supply. India, Russia, Brazil, Ukraine, Poland, China, Argentina and Brazil are nations that could potentially lift levels of competition in supplying export markets. India in particular is an established dairy nation, the worldʼs largest producer of butter and one of the largest for milk. Several European nations entering the EU in 2004 are also suppliers, most significantly Poland the worldʼs 8th largest. New entrants to the global supply market are most likely to result through increased automation and industrial transformation.

16 Page 16 I. Industry Transformation New Zealand Dairy Industry 3.3 Key Situational Factors Competitor strategies within the global dairy industry are being driven by a number of complex situational factors. These include a consolidating customer base, trade liberalisation/protectionism, and increasing need for consumer and environmental awareness. Although legislation, stakeholders and events vary from market to market, these are primarily global factors. The food industry has seen many years of consolidation driven by multinationals such as Nestlé, Phillip Morris (through Kraft), and Unilever. In addition, a small number of retail groups now dominate most mature markets, a trend which is continuing in emerging markets through the expansion of retailers such as Tesco and Auchan in Eastern Europe and Carrefour and Wal-Mart in China. This consolidation of the dairy industryʼs customer base has substantially reduced the overall number of supplier relationships. Top 10 food manufacturers : Nestlé 45 Phillip Morris 40 Unilever 32 PepsiCo 25 Con Agra 22 Coca Cola 20 IBP 15 Kirin Brewery 13 Diageo 13 General Mills 13 Source: Rabobank (USD billions) Top 10 food retailers: Wal-Mart 191 Carrefour 60 Kroger 49 Ahold 48 Metro AG 45 Albertsonʼs 37 Rewe 37 Auchan 35 Leclerc 33 Intermarché 32 Fig 3.4 Marketplace: Worldʼs Largest Food Manufacturers and Retailers (by sales) There are significant barriers to entry for the dairy for industry. These include political/trade barriers, economies of scale, access to distribution networks, access to suppliers, and distance. The most significant barriers effecting global companies such as Fonterra are political trade barriers. New Zealand is one of several

17 Henley Integrated Strategy Project Page % + High Tariffs Only Butter / Cheese Protein Quota Access % Medium-High Tariffs Product Specific Access 30-70% Medium Tariffs Product Specific Access 0-30% Low Tariffs Access All Products Source: Fonterra (NB: National boundary Access inaccuracies All Products are / part Low of Tariffs the original (0-30%) Fonterra map) Product Specific Access / Medium Tariffs (30-70%) Product Specific Access / Medium-High Tariffs (70-220%) Only Butter / Cheese / Protein Quota Access / High Tariffs (>220%) Fig 3.5 Barriers to Entry faced by Fonterra members of the Cairns Group which promote the reduction of trade barriers. The World Trade Organisationʼs involvement through the GATT agreements is the forum for much of this debate. However, the dairy industry remains amongst the most highly subsidised sectors in some markets, with an estimated US$39 billion spent annually on subsidies. The EU and US remain amongst the most protected markets (fig 3.5). The dairy industry is a large producer of emissions and is under pressure as governments attempt to meet environmental targets, in particular the Kyoto Protocol. Most large dairy producing nations have ratified this, the US and Australia being exceptions. Some supplying regions in Australia, New Zealand and South America are threatened by erosion and/or desertification risks. Ecological and biological sustainability is vital to secure long term supply. Consumers are also becoming increasingly conscious of health related issues such as fat content and genetically modified products, a debate which encompasses scientific, political and consumer stakeholders. Most markets are introducing some form of labelling standards for organic and GE products, an area that is

18 Page 18 I. Industry Transformation New Zealand Dairy Industry possibly likely to involve the WTO in the near future. Up to 70% of consumers cite labels as a very important factor in their decision making process, which makes the emergence of product labelling a key factor (Rabobank). Dairy companies face diverse health, ecological and legal risks. Worst case scenarios can be disastrous with fallout and scrutiny lasting well beyond an initial crises. Nestléʼs image is still tarnished by milk powder scandals in the past and faces fresh allegations of unethical business practices in dealing with coffee suppliers in some nations. The BSE and MFD crises in western Europe, particularly the United Kingdom, adversely effected sectors of the economy well beyond agriculture and provided leverage for competitors. Japanʼs Snow Brand have suffered extensively from a food poising incident at itʼs Osaka plant where a lack of quality management was blamed. Political Trade barriers and protectionism including trade marks, labelling, quotas and bio-diversity arguments. Free trade arrangements and negotiation. Deregulation of markets. Social Increasingly demanding consumer markets and growth of labelling standards. Growth in nutrition and bio markets. GM issue. Cultural differences in perceptions of milk. Legal Threats of legal challenges on the grounds of health or environment. Anti-competition commissions may allow increasingly larger mergers. Increasing environmental regulation. Economic Currency valuation. Cyclic nature of production and commodity milk prices. Global demand outstripping supply. Continued consolidation of suppliers and customers Technological Feed stocks for greater productivity and reduced emissions. Advanced ingredients and other products. Reductions in by-products and energy consumption during processing Environmental Unpredictably of climate, bio-diversity and GM issues. Seasonal nature of milk supply. Intergenerational on-farm sustainability of dairy farming. Fig 3.6 PESTLE Analysis.

19 Henley Integrated Strategy Project Page Competitor Strategy Analysis 4.1 Risk Management Strategies Due to health and hygiene factors, the dairy industry has a high awareness of the need for quality control. Internal quality control standards and TQM systems are common place, and increasingly ISO accreditation is also being utilised as a tool for quality management and assurance. Highly defined procedures and standards extend to supply, processing, manufacturing and transportation. The highly automated nature of the industry makes it ideally suited to structured quality management systems. External risks are harder to define and thus identifying and mitigating these prove more challenging. Some competitors are applying some innovative initiatives (appendix K), both in an effort to mitigate potential situational threats (fig 3.6 for PESTLE analysis, appendix J for SWOT analysis), as well as a desire to build public goodwill and improve relationships with stakeholders. Proactive competitors are also taking steps to improve the reliability of supply by minimising resource use and waste, minimising the number of suppliers and on-farm environmental improvements to ensure intergenerational sustainability of agricultural land. The success of the later, depends to some extent on perceived cost benefits and the level of returns for farmers. Many external risks are emerging areas of knowledge. Some competitors stake their risk management frameworks on external consultants, special management task forces and even the PR department. In more effective examples, risk strategies have a high degree of ownership from leaders and are embedded in cultural transformation, integrated with reward systems and driven by measurable targets and reporting transparency. With the right strategy and astute leadership, there are signs that some competitors are successfully turning risks into opportunities.

20 Page 20 I. Industry Transformation New Zealand Dairy Industry 4.2 Competitor Growth Strategies Fonterraʼs global competitors are all large companies with some vertical integration across the dairy industry supply chain, however core competencies vary and competitorʼs growth strategies reflect this (fig 4.1). The industry tends to cluster between local two groups; local suppliers and global producers (fig 4.2). In the first group, competencies lie in milk production. Most large suppliers have focused on lucrative US and EU home markets (explaining the low export volumes in fig 3.3) however some are initiating more steps towards regional and global export markets. There is some threat of new suppliers emerging from low cost nations. Strategic alliances are generally used for forward vertical integration to secure channels of distribution and sales. All cooperatives belong to this group. The second group is primarily made up of food product groups such as Nestlé, Kraft and Unilever. These characterise more global operations and rapid growth. Some of this growth is organic, but the majority is by acquisition and takeovers, sometimes hostile. Strategic alliances and collaboration are generally used for backward integration of the value chain to secure channels of supply. The lack of global suppliers have meant global producers such as Nestlé have traditionally had to enter into multiple supply contracts. A push towards more regional supply contracts such as the Fonterra/Nestlé partnership for the Americas is likely. Although there are exceptions, mergers and acquisitions tend to be driven by horizontal growth strategies while alliances and joint ventures are more commonly driven by vertical growth strategies. Evidence suggests consolidation is sometimes being used as a protective measure as well.

21 Henley Integrated Strategy Project Page 21 Market penetration strategies employed to increase product range including new product development Backward integration of the value chain employed to secure and grow supply and processing channels Supply Local/Niche Supply Markets Many competitors Rapid consolidation Few new entrants Global Supply Market Few competitors Some consolidation Possible new entrants Local/Niche Local/Niche Consumer Markets Many small competitors Some consolidation Many new entrants Global Consumer Market Some competitors Favourable dynamics Few new entrants Consumer Market Forward integration of the value chain employed to secure and grow channels of distribution Global Market penetration strategies employed to increase market share including geographic expansion Fig 4.1 Typical Growth Strategies. Global Drivers of Consolidation. Local/Niche Dairy Farmers of America Land OʼLakes Dean Foods Nordmilch Supply Friesland Coberco Lactalis Campina Melkunie Arla Bongrain Parmalat Danone Consumer Market (New Zealand Milk) Kraft Unilever Fonterra Nestlé Global Fig 4.2 Core Competitor Competencies (indicative only)

22 Page 22 I. Industry Transformation New Zealand Dairy Industry 4.3 Competitor Technology & Product Development The dairy industry is at least 6,000 years old. Technological development could be considered the main driver of dairy industry transformation, historically through overcoming portability issues and by diversifying the range of dairy products available. In one example, Gangas Khanʼs army was said to carry a dried milk powder which soldiers could mix with water to help maintain their health while travelling long distances. In the nineteenth century refrigeration revolutionised the industry and made distribution global. Extensive automation of processing and farming practices over the past century has come to differentiate globally competitive suppliers from labour intensive markets such as India where only 10% of dairy products are packaged. Most competitors have extensive product development strategies, particularly in convenience foods, organics, ingredients and nutrition. Arlaʼs partnership with NASA to work on dairy products for astronauts is one of the more creative ventures while Coca- Cola has also announced a new range of dairy based soft drinks. Technological development also extends to include stock feeds that improve productivity while reduce emissions, technologies that utilise by-products of the industry such as casein, and products that improve the efficiency of farming practices and land use. Milk is a unique natural product without any artificial substitute. However there is development in alternatives including soya milks and non-dairy milks such as goat, buffalo and sheep. Dean, Danone, Kraft, Unilever, Coca-Cola and General Mills have also made significant acquisitions or partnerships with organic milk producers and retailers. Although a dairy product, organic milk products could be considered a parallel value chain as it requires different techniques and knowledge at each stage of the process.

23 Henley Integrated Strategy Project Page 23 SUPPLIERS: Medium Global demand outstrips supply. This opens opportunities for several markets to increase efficiency of production including India, Poland, Russia, Ukraine, China and Brazil Fonterra supplies are secured through the co-operative structure. A significant threat exists if Fonterra can not make competitive milk payouts to shareholder-suppliers NEW ENTRANTS: Medium Barriers of entry and economies of scale are significant for new entrants Global entrants most likely to be low cost supplier nations with a strategy of increasing export share or highly targeted high value niche producers New Zealandʼs de-regulated market structure and relative low cost might attract entrants as a base for export oriented supply and processing INTERNAL RIVALRY: Medium-High Fonterra faces increasing threats as global competitors become aware of its size and influence in the industry Continued consolidation of industry could see competing dairy resources being merged into larger, more efficient competitors Competitors may respond to trade liberalisation through increasingly global growth strategies Rivalry has the potential to increase significantly once large competitors face satiation of growth in their own markets BUYERS: High Continued consolidation of food manufacturing and retailers has the effect of reducing the overall number of buyers in the industry and increasing their purchasing power Most buyers are pursuing strategies to help secure supply channels SUBSTITUTES: Low-Medium Dairy milk is a unique natural product, however substitutes do exist in the form of goat, sheep, buffalo, rice and soya milks Substitutes may effect other parts of the value chain including feeds and markets based on dairy by-products Fig 4.3 Porterʼs Five Forces Analysis

24 Page 24 II. Organisational Transformation Fonterra Co-operative Group 5. Strategic Objectives 5.1 Stated Vision, Purpose and Strategies Since the merger, Fonterra has undergone a strategic review to define its vision, purpose and responsibilities as a cooperative. Fonterraʼs vision is to ʻlead in dairyʼ. Three types of leadership are specified; Industry leadership is defined as holding on to a competitive advantage as lowest cost supplier, developing health and nutritional benefits, new sophisticated ingredients, and being a supplier of choice to the foodservice market. Strategic leadership is defined as exploiting market presence, maximising values on returns and being a partner of choice in all target markets. Performance leadership is defined as a relentless ability to improve and grow, consistent and suburb execution in business, unquestioned integrity and sustainable shareholder returns. Fonterra states its ʻpurposeʼ as being the most successful and innovative dairy company, to sell our suppliersʼ milk and to maximise returns to shareholders. Activities are segmented into four areas. The first two are activities that sell shareholders milk or where shareholders are the predominant source of milk. These are core competencies which Fonterra calls cornerstones. The last two are activities that materially support the cornerstones (appendix F). Few timelines or targets have been publicly identified and there are a noticeable lack of set dates or benchmarks. An overall target exists as a 13-15% annual growth in TSR (Total Shareholder Returns), however this is not an ideal performance target because it is influenced by external pricing factors. A number of targets also exist at operational level for the various revenue streams that contribute to the TSR (appendix G). Measurement criteria is often closely held due to commercial sensitivity and it may take a few years before performance trends emerge in the results.

25 Henley Integrated Strategy Project Page 25 Present MISSION Present Market Penetration Strategy 7 (Geographically specific opportunities and threats) Strategy 3 (Dedicated service relationships) PRODUCT New Product Development Strategy 4 (Expansion of speciality ingredients) Strategy 5 (Expansion of Anlene range) New Strategy 6 (Expansion of Foodservices market) Market Development Diversification Fig 5.1 Ansoff Growth Vector Matrix Seven formal strategies were defined to provide direction for the group at a corporate level (appendix I). The first two are designed to protect the companyʼs competitive advantage, and the remaining five include a mix of market penetration and product development strategies (fig 5.1). No unrelated diversification strategies are applied and there are no references to competition suggesting a ʻsoftʼ growth strategy (or bypass attack as defined by Kotler) utilising methods such as horizontal alliances over direct competition. Most strategies are patterned, or evolutionary and the overall generic strategy is lowest cost price leadership. Stated strategies indicate Fonterra seeks growth through product development and market expansion in the speciality ingredients, speciality milks, nutrition and foodservices sectors. Geographically, China, Mercosur, Eastern Europe and India are targeted. These are expanding consumer markets as well as potential competitors as low cost suppliers. Strategies also focus on maintaining price leadership, customer relationships and improving integration of resources across the supply chain (appendix D).

26 Page 26 II. Organisational Transformation Fonterra Co-operative Group 5.2 Strategy Gap Analysis Are Fonterraʼs vision and strategies in fitting with its operational environment? Compared to its competitors Fonterra is in a relatively unique position as a global supplier (fig 4.2). It is also unique as a co-operative that relies almost exclusively on global markets. In this regard, Fonterra shares much in common with Nestlé, as both organisations have always had to depend on global markets for expansion due their small home markets. Fonterra did not meet itʼs TSR target for 2003, although it is projecting a 14% TSR over the coming year. Exact data is unavailable to breakdown this projection, however indications suggest the largest contributor may be increasing commodity milk prices. Targeted 13-15% Annual Growth in TSR Added Value streams (15% target) Present Sales now STRATEGIC LEADERSHIP Penetration Strategies (some control) PERFORMANCE LEADERSHIP Synergy Strategies (most control) INDUSTRY LEADERSHIP Environmental Factors (little control) future Acquisitions & investments, new product development, branding strategies, geographical growth On-farm efficiency gains (3-4% target) Merger cost savings & process improvements (3-4% target) Cost Base (currency exchange rates, inflation, compliance costs, costs of freight, labour and land) Commodity Milk Prices (supply and demand cycle) Fig 5.2 Gap Analysis and Fonterra Leadership Strategies (Adapted from Ansoff)

27 Henley Integrated Strategy Project Page 27 Fonterra is seeking growth in a number of revenue streams to maintain year on year TSR targets (fig 5.2). These include penetration strategies and synergy gains, including merger benefits. Fonterra has some control over these strategies. Possibly, the largest factor in revenue are environmental factors many of which are outside the companyʼs control including cost based factors of supply and the dairy commodity price cycle (fig 3.2). The success of New Zealandʼs dairy industry has been attributed to price leadership and consistent quality. New Zealand has traditionally been a cheaper and more efficient source of milk then other suppliers and Fonterraʼs cost leadership strategies assume this will prevail. There are significant threats to this assumption. Firstly, there are signs that internal rivalry will increase. Threats exists from new entrants representing emerging and transition economies with formalising dairy industries and lower cost bases. Existing competitors are becoming more competitive as a result of deregulation and processes improvement, and alternatively through intervention such as additional tariffs and export subsidies. Secondly, the industry have lobbied extensively to reduce trade barriers and open up markets. It is debatable how successful this strategy has been when the worldʼs two most valuable markets remain closed to most Fonterra products (fig 3.5). Although the US and EU are verbal supporters of free trade, in practice both have highly protectionist policies for their own markets. Both have increased subsidies (now over 2 per cow a day in the EU) and re-introduced export credits over the past year. In addition, the US has indicated it will not deregulate its dairy market and will exclude the agricultural sector in free trade negotiations with New Zealand, as it did with Australia.

28 Page 28 II. Organisational Transformation Fonterra Co-operative Group Finally, and perhaps the greatest argument for change is Fonterraʼs ability to maintain its status as lowest cost supplier. The co-operative responsibilities require Fonterra to use New Zealand shareholders as the preferred source of supply. However macro economic shifts indicate that the country is starting to evolve from the low cost commodity based economy that has favoured the dairy industry for so long, towards higher value export industries and services. The economy is expanding, inflation is increasing and the New Zealand dollar continues to strengthen. Potential Risks/Threats Fonterra Strategies Increasing home cost base (inflation, exchange movements, increasing compliance costs), Competitors competition for both marketshare and supply Threat of lower cost entrants Strategic focus on volume and low cost leadership. Cooperative responsibilities. Focus on low cost leadership and 13% TSR target Largest markets are highly protected by substantial trade barriers Proactive involvement through legal instruments and spheres of influence but limited power Threats of global social, ecological media crises or resource shortage No identifiable Fonterra strategies or measures Staff discouragement, disillusionment and displacement. Potential loss of key knowledge and talent Rapid restructuring, relocation and leadership changes are having a destabalising effect. Persistence of old cultures, resistance to change Implementation of new culture (Fonterra Way, and on-farm best practices) takes time Fig 5.3 Key Environmental Gaps

29 Henley Integrated Strategy Project Page 29 The short term effect are eroded earnings in export dollars, however the long term consequences could be more serious. Add to this new on-farm ecological and animal welfare standards, which will meet resistance from supplier-shareholders if increasing compliance costs are not met with improving returns. Even if the New Zealand dairy industry did maintain its low cost base, Fonterra faces the prospect of having its suppliers ʻpoachedʼ by both local and international competitors that can offer better returns because they operate in higher value markets with larger margins that can be passed on to suppliers. In conclusion, while Fonterra enjoys a unique leadership position in the global supply market, a low cost leadership strategy and vision is a limited environmental fit. Fonterra is more likely to overcome trade barriers through value added products and astute alliances. This would also give it more control over pricing and lessen its dependence on the cyclic nature of commodity prices. In conclusion, although Fonterra has voiced a need to move towards higher value markets, it has largely retained the same core generic strategies of its legacy organisations which is high volume, low cost leadership. Analysis outlines a number of significant issues questioning the suitability of this as a sole generic strategy for carrying out its vision and meeting its TSR targets (fig 5.3). Fonterraʼs ability to maintain a ʻlowest cost leadershipʼ position is a gamble in itʼs current operating environment and its co-operative structure limits itʼs ability to use supply alternatives.

30 Page 30 II. Organisational Transformation Fonterra Co-operative Group 6. Strategic Transformation 6.1 Strategic Repositioning Although an issue common to many industries, leaders often grapple with the difficulties imposed in increasing the value of commodity industries, particularly when a generic strategy of cost leadership is under threat. An obvious solution is to move forward in the value chain and establish a greater presence in consumer markets. In Fonterraʼs case this means investing more in its consumer products division, New Zealand Milk. This is an option, however it would overlook Fonterraʼs core supply competencies. Fonterra is unique as an export oriented global co-operative (fig 4.2) placing the company in a leadership category of its own. The advanced lifecycle phase (fig 2.2) based on the experience of its legacy organisations also provides Fonterra with a wealth of experience and knowledge which has earned respect within the industry. This global leadership position and knowledge competencies have been foundations for valuable alliances with Nestlé, Arla, Dairy Farmers of America and other industry leaders (appendix E). To better leverage this leadership position, one approach would be to shift the thinking from the sale of milk as a commodity, to one whereby Fonterra provides dairy solutions (fig 6.1). Fonterraʼs ʻproduct rangeʼ would become open ended to provide solutions to client needs and could include consulting and capacity provision that potentially spans on-farm technology, product development, processing, manufacturing, distribution, and financing. This ʻdairy solutionsʼ position would be differentiated from most competitors which employ market penetration strategies through geographic expansion and product expansion, often with a brand oriented approach. Very few competitors can match the knowledge of Fonterra on the global scale that many dairy industry customer

31 Henley Integrated Strategy Project Page 31 operate in (fig 3.4), making it a difficult strategy to replicate. This positioning would enable Fonterra to better utilise its experience and knowledge competencies. The differentiation is between technology push and market pull and the driver would be customer expansion rather than market or product expansion. Milk as a Commodity: We sell branded dairy products such as milk, butter, cheese, processed cheese, convenience foods We sell over 1000 dairy ingredients to the food services industry and consumer product groups We own brands such as Anchor, Fernleaf, Anlene, Mainland, Soprole, In short: We sell dairy products Milk as a Service: We can design, manufacture, and distribute any packaged dairy consumer product We offer solutions for anyone needing to design or add dairy ingredients in their product We offer consulting and capacity solutions for any part of the dairy value chain including development, processing and manufacturing In short: We sell dairy solutions Fig 6.1 Strategic Repositioning 6.2 Strategy Development This suggested repositioning requires changes to Fonterraʼs strategic mix. Porter argues that a single generic strategy is preferable, suggesting low cost leadership be retained as a generic strategy and a differentiated ʻmilk as a serviceʼ component applied at an operational unit level for example. However, corporate level strategies are required to drive organisation wide transformation from a commodity producer to a response end user customer oriented dairy service provider. For this reason it is suggested that the strategic mix be segmented to best match needs outlined in Fonterraʼs stated leadership vision (fig 6.2).

32 Page 32 II. Organisational Transformation Fonterra Co-operative Group Industry Leadership Performance Leadership Strategic Leadership Generic Strategies: Cost Leadership (supply, R&D, trade negotiations) Cost Leadership (processing and manufacturing capacity) Differentiation (knowledge resources & intellectual capital) Suitable Direction Options: Product Development Market Penetration & Market Development Consolidation Product Development Market Penetration & Market Development Suitable Method Options: Synergies Joint Ventures (R&D) Synergies Joint Ventures M&A (bolt on) Joint Ventures Synergies M&A (bolt on) Fig 6.2 Strategic Mix Industry leadership would focus on maintaining an advantageous cost position within the industry, performance leadership would focus on a low cost generic strategy for tangible assets such as processes and manufacturing, while a differentiated core strategy would apply to strategic leadership based on knowledge assets and alliances (fig 6.3). While both industry leadership and strategic leadership retain product development and market penetration direction options, the first would be driven by technology push functions, while the later by market pull functions through customer alliances. An effective service organisation requires an integrated ʻone stop shopʼ approach responsive to customer alliances throughout the value system rather then an end process sales function. This suggests the synergy method be applied to reduce segmentation between existing divisions. Suitable method options are best applied individually to each relationship and brand in response to unique market needs and opportunities. This would require that brands and alliances have a level of strategic independence within the group. Fig 6.3 offers a more detailed analysis.

33 Henley Integrated Strategy Project Page 33 Generic Strategies Direction Options Method Options Cost Leadership Legacy based on low cost leadership and existing organisational and leadership culture based on this strategy. Suits industry and performance leadership objectives, however when considering the operating environment, this is not an ideal environmental fit as a sole generic strategy. Differentiation Suggested this be applied to fulfil strategic leadership objectives through market positioning and customer alliances which are differentiated from the rest of the market. This is a suitable strategy as a tool to strengthen Fonterraʼs unique global supplier leadership position and knowledge competencies. The point of market differentiation is between technology push and market pull. Focus Fonterra could pursue a focused strategy on profitable income streams however it would require radical divestment and is unlikely to meet with approval of employees or shareholders. However, this may be a good approach for specific consumer brands or alliances. ʻDo Nothingʼ Inappropriate, additional growth is required to meet 13% TSR targets Withdrawal/Downsizing Only in underperforming markets. There are no major end game signs, such as declining market share Consolidation Consolidation of processes and organisational structures suitable in some instances Market Penetration & Development Suitable given Fonterraʼs present opportunities and need to meet TSR. Product Development Highly suitable strategy, and an important part of offering solutions for clients Supply Chain Movements Already placed across the supply chain. Any forward move to retailing would bring Fonterra in direct competition with existing client base Related Diversification Already operating RD1 & Fencepost.com which targets farming market in NZ. Unrelated Diversification Less appropriate due to co-operative responsibilities, organisational competencies and leadership position in a growth market Synergies The company has extensive knowledge and industry experience. Internal development processes to foster efficiencies and synergy between different parts of the organisation is an optimum method. Ideally this would also be extended to close alliances with customers. Mergers & Acquisitions Not a specified strategy but bolt on acquisitions and equity investments a suitable both for fulfilling market penetration strategies and new product development. Appropriate gearing levels need to be maintained Joint Ventures Highly suited and already being applied for both strategic, protective and investment purposes. Can serve as a method for overcoming trade barriers and as a method for consolidation. A variety of joint venture methods are appropriate including the VAP approach advocated by Johnston and Lawrance (1998) Fig 6.3 Development Strategies (adapted from Johnson & Scholes)

34 Page 34 II. Organisational Transformation Fonterra Co-operative Group 7. Organisational Restructuring This section deals with the transformation required to shift from a single strategy of low cost leadership to a differentiated market position responsive to customer needs. The terminology is adapted from Henry Mintzbergʼs definitions of organisational structure. This focuses on the Fonterra Group as a whole, each component of the group could expand this within their own context. 7.1 Current Organisation Framework For the purpose of defining organisational structure change it is important to identify the current organisational framework (fig 7.1). The Strategic Apex of Fonterra is itʼs corporate governance structure. It is a small structure for an organisation of this size consisting of a Board of Directors, Fonterra Leadership Team and Shareholderʼs Council. As a co-operative, the Shareholderʼs Council has functionʼs of setting the ʻfair valueʼ of Fonterra shares and ensuring the co-operative nature of the Group is maintained. The Technostructure for Fonterra are the Corporate Enterprises and Fonterra Development division, Finance Division and Human Resources Division. They design the operational systems and work processes for the group as a whole. The role of support staff is taken on largely by consultants such as McKinsey, SAP, Gen-i, Baldwin Boyle and Standard & Poors (in relation to share value). Fencepost.com and RD1 (operated by Fonterra Enterprises) and shareholder services provide supporting roles for the New Zealand agricultural market and dairy suppliers. The Middle Line includes the management structure of Fonterraʼs two major operating divisions; NZMP (ingredients) and New Zealand Milk (consumer goods). These are both large companies

35 Henley Integrated Strategy Project Page 35 with their own global infrastructure, equity holdings, sales offices, pricing strategies, technostructure and support staff. They operate the majority of operating core activities. The middle line also incorporates Fonterra Enterprises, which is made up of smaller operations undertaking R&D, a business incubator and product and market development functions. The operating core includes over 60 global milk processing and food manufacturing plants operated by the NZMP and New Zealand Milk divisions. Fonterraʼs New Zealand ʻsupplying-shareholdersʼ make up a grey area of the operating core. One could argue that because they are shareholders rather then employees they should be treated as external suppliers rather then an integral component of Fonterra. However, supplier-shareholders are an inseparable component of Fonterraʼs financial, management, stakeholder and value chain structures. They are represented at the strategic apex through the shareholderʼs council and closely tied in with technostructure and support structures. Therefore supplying-shareholders are treated here as an integral part of the organisation framework. The formal ideology used by Fonterra is marketed within the company as ʻThe Fonterra Wayʼ which outlines the corporate culture the company seeks to create (appendix H). 7.2 Transformed Organisational Framework In order to grow a knowledge based culture a significant transformation is suggested as part of the current organisational restructuring (fig 7.2). In this suggested framework, the middle line management functions of the previous NZMP and New Zealand Milk divisions would be consolidated into Fonterraʼs existing Technostructure and Support structures.

36 Page 36 II. Organisational Transformation Fonterra Co-operative Group Board of Directors Fonterra Leadership Team Shareholderʼs Council STRATEGIC APEX TECHNOSTRUCTURE MIDDLE LINE SUPPORT IDEOLOGY Including ʻThe Fonterra Wayʼ Human Resources Division Finance Division Corporate Development and Fonterra Enterprises Division & New Zealand Milk and consumer brands Products Manufacturing & Marketing SUBSIDIARY DIVISIONS & global investments in other dairy companies OPERATING CORE Ingredients Manufacturing & Marketing On-farm (Supplier- Shareholders) Farm Liaison Services Cooperative Shareholder Structure Fig 7.1 Existing Organisational Framework (Adapted from Mintzberg) The most radical new element is the introduction of Fonterra Dairy Solutions (FDS). Its function would be to develop and manage Fonterraʼs strategic leadership strategies as a ʻinnovative solutions providerʼ and ʻdeveloper of dairy ingredient partnershipsʼ. The positioning in the middle line (fig 7.2) enables it to establish the range of liaison devices needed to fulfil the needs of both internal and external clients. FDS wouldnʼt hold any operating core assets but would establish a spectrum of knowledge assets spanning the value chain. It would replace the sales arms of existing divisions and become the most global component of Fonterra (fig 8.2).

37 Henley Integrated Strategy Project Page 37 Board of Directors Fonterra Leadership Team Shareholderʼs Council STRATEGIC APEX IDEOLOGY ʻThe Fonterra Wayʼ (including Risk/Quality Management Strategies) TECHNOSTRUCTURE Human Resources Finance Division Fonterra Enterprises Operations External Portfolio (Brands & Alliances) Auditing & Risk Management Portfolio of Customer Alliances and Brands Market Development MIDDLE LINE Dairy Solutions OPERATING CORE Portfolio of Processing and Manufacturing Capacity Processing, Manufacturing Distribution SUPPORT Portfolio of Supply Capacity including supplier-shareholders On Farm (Supplier- Shareholders) Farm Liaison Services External Support Businesses Cooperative Shareholder Structure Fig 7.2 Transformed Organisational Framework (Adapted from Mintzberg) Signifi cant transformation is also suggested for the operating core. All processing, manufacturing and distribution from existing divisions would be integrated to achieve greater synergies of physical capacity and aligned to better achieve Fonterraʼs performance leadership vision. New Zealand Milk would be transformed into a portfolio of consumer brands to focus on market penetration and development strategies. Like Fonterra Dairy Solutions, these would not have physical manufacturing assets but contract these to Fonterra, separating promotion and market development functions from processing and manufacturing functions.

38 Page 38 II. Organisational Transformation Fonterra Co-operative Group Product development and R&D functions of Fonterra Enterprises act as an instigator of new products (and/or brands) as well as an important part in the development of customer solutions. They fall within a grey area between middle line and support functions and are positioned here in the middle line. RD1 and Fencepost.com play a vital strategic role in supporting the supplier-shareholder relationship but are not a core function. These would be treated as external businesses and the prospect investigated of entering into equity/strategic alliances with specialist in the areas of agricultural retail and internet services and prospectively. Three new groups are suggested for the technostructure. The first would be an operations group to ensure performance of physical capacity, the second would be responsible for Fonterraʼs portfolio of consumer brands and alliances and the third would apply risk management and quality performance monitoring strategies and play a part in fostering the ʻFonterra Wayʼ culture. Fonterra owns some of worldʼs most valuable dairy brands. The organisational framework needs to provide brands such as Anchor with freedom to develop strategies in response to own unique market needs. Image: United Arab Emirates; Fonterra Annual Report. Fig 7.3 Market Transformation

39 Henley Integrated Strategy Project Page Market Transformation Most consumers are unlikely to have heard of Fonterra, but many would be familiar with some of its brands. The challenge is to promote Fonterra and itʼs brands while establishing a non-threatening position that promotes alliances with other dairy industry leaders. This confl icting interests of the ingredients and consumer markets was recognised by the New Zealand Dairy Board which instigated the division into NZMP (ingredients) and New Zealand Milk (consumer goods). The suggested organisational transformation would retain this distinction, though not through the existing divisionalisation of physical capacity (which would be integrated). Fonterra would treat the branding of itʼs own brands and alliance brands the same with Fonterra promoted as a dairy solutions provider and manufacturer. This could include variations targeted for specifi c markets (such as organics) or simplifi ed as a Fonterra quality mark (fi g 7.4). Fonterraʼs own brands would be given strategic freedom to establish their own branding presence and market penetration strategies and FDS would treat these brands as customers. The use of a business to business model rather then establishing a high profi le Fonterra consumer brand is a signifi cant factor of the suggested market differentiation strategy. Secondary Branding All products developed or manufactured by Fonterra carry secondary (minor) branding to promote Fonterraʼs production capacity and dairy solutions position (options shown) Primary Branding Brands owned by Fonterra and alliance brands establish own consumer market presence annual report annual report Fonterra Physical Capacity (R&D, Supply, Production) Dairy Solutions by annual report annual report 2001 > 2002 Quality Assured 2001 > 2002 Dairy Ingredients 2001 Organic > > 2002 Fig 7.4 Branding Hierarchy (simplifi ed) Alliance Brands (Market Pull) Fonterra Brands (Technology Push) Consumer Markets

40 Page 40 II. Organisational Transformation Fonterra Co-operative Group 7.4 Capital Transformation Presently, the bulk of Fonterraʼs revenue is achieved through two income streams the NZMP and New Zealand Milk divisions. Both contain a mix of tangible and intangible assets (including brand names) and own equity holdings in other companies. Both divisions are wholly owned by supplier-shareholders. While it is premature to analyse performance trends, competitor comparisons suggest average performance in areas such as ROE during the first year (appendix L). Leaders have expressed the need to lift results. Possible solutions include improving internal efficiencies and reducing costs (including cost of capital), aided by a more transparent and targeted approach to monitoring the performance of individual income streams. The suggested organisational transformation is designed to help make these improvements. All processing and manufacturing (or fixed plant) assets would be integrated, while brands and alliances would be treated as value added income streams and placed in a strategic equity portfolio. The level of equity held in each stream would become strategic (fig 7.6), based on control, performance, and fulfilling Fonterraʼs purpose of ʻselling shareholders milkʼ. Fonterra 76.6% Arla Foods 81.6% Friesland Coberco 96.5% Dairy Farmers of America 52.17% Debt 50% Equity Fig 7.5 Competitor Gearing Comparisons (co-operatives)

41 Henley Integrated Strategy Project Page 41 Growth strategies applied to meet TSR targets will require further capital. While Fonterraʼs gearing is comparable to competitors (fig 7.5) making a greater variety of capital options including market listings available for value added income streams would help manage gearing and reduce the cost of capital. Although brands would have some strategic independence, overall corporate control of the equity portfolio would be undertaken by a new group within the technostructure (fig 7.2). For protection, Fonterra Enterprises and operating core processing and manufacturing assets would remain wholly owned by supplier-shareholders. Equity partnerships would also be a component of FDS customer expansion strategies. Both to attract competencies (an alliance with a retail partner to operate RD1 in the New Zealand market for example) and as a binding tool. Existing equity partners in joint ventures include Nestlé, DFA and Arla (appendix E). This division of fixed plant assets and intangible assets provides for the application of more targeted ratios and a more detailed breakdown of performance. Fonterraʼs process efficiency targets would apply to internal income streams while value added growth targets would apply to the portfolio (appendix G). Existing Internal NZMP 100% (inc.. external investments) New Zealand Milk 100% (inc. external investments) Fonterra Enterprises 100% (inc. RD1 & Fencepost) Transformed Internal Physical Capacity 100% Fonterra Enterprises 100% Value Added (Equity Portfolo) Alliances Strategic Brands Strategic RD1 & Fencepost.com Strategic Income Streams Equity Income Streams Equity Fig 7.6 Transformation of Income Streams

42 Page 42 II. Organisational Transformation Fonterra Co-operative Group 8. Managing Change 8.1 Leading Change Using the organisational ecocycle model of D K Hurst it is possible to define the merger environment as a period of some crises and confusion which to some extent, has been met with rational action required through the strategic review. The ecocycle model suggests the next phases of emergent action are of creative networking, choice and entrepreneurial action. Phases that require charismatic leadership according to Hurst. Leadership uncertainties have effected the clarity and moral of Fonterra. Since the merger, there have been frequent changes amongst them several board members, the chairman and CFO. The CEOʼs future also looks uncertain. There are other weakness as well. Fonterraʼs largest markets are under-represented in the strategic apex and constitutional requirements for leaders with diary backgrounds reflects a heritage of supply driven strategy rather then a focus on customer development and value added market development. The first step in the strategic change process is to address these leadership issues (fig 8.1). Although a competent leadership team is emerging, more charismatic leadership is necessary with greater international representation in the strategic apex and greater diversity of skills to deal with trade negotiations, commodity markets, and the opportunities or threats imposed by specific market conditions and alliances. The establishment of Fonterra Dairy Solutions and transformation of cultural and organisational frameworks to better respond dynamically to customer demands will require many careful decisions and actions. Fonterraʼs vision and objectives will also require continual promotion and astute leadership would further reward successful change agents and establish a framework of transparent monitoring and targets.

43 Henley Integrated Strategy Project Page 43 Operational Environmental Stakeholder Power and Influence Organisational Awareness Structure and Power: Centralisation of power structures and synergies through organisational restructuring Mission and Purpose Stated: Increase total shareholder return, sell shareholders milk Generic Strategy: New mixed strategy with differentiated component focused on provision of dairy solutions Decisions and Actions; Leadership change, organisational transformation including configuration, establishment of FDS and liaison devices Performance Measures: TSR target, process improvement targets, income stream targets, on-farm efficiencies Outcomes/results: TSR performance, link outcomes to internal reward systems, reward successful change agents Leadership Establish charismatic leadership team with greater international representation and diversity of skills Organisational Culture Develop the Fonterra Way and compatible organisational learning and rewards systems Fig 8.1 Strategic Change Process

44 Page 44 II. Organisational Transformation Fonterra Co-operative Group 8.2 Co-ordinating Mechanisms With over 20,000 highly skilled employees and 13,000 suppliershareholder farmers effected by the companyʼs organisational restructuring, co-ordinating mechanisms and design parameters play an intrinsic role in managing change. The dairy industry in developed nations is highly automated. Fonterraʼs operating core is amongst the most efficient with a small number of farmers compared to output and modern plants able to process as much as 3.6 million litres of milk per day. Most operating core labour is horizontal specialised lending itself towards formalised operations. To ensure consistent quality, standardisation of work processes is a commonly applied co-ordinating mechanism throughout the industry. Fonterraʼs scale, and suggested transformation makes it appropriate to diversify these mechanisms (often referred to as divisions of labour) to better align co-ordination with Fonterraʼs stated strategies (fig 8.2). Standardisation of outputs is suitable for managing alliance and brand portfolios as these require greater operational independence to develop strategies in fit with their own market needs. Fonterra Dairy Solutions and Fonterra Enterprises also require mutual adjustment due to their knowledge based functions and small working units. On-farm relationship with supplier-shareholders suit the standardisation of outputs although the standardisation of norms is also being applied through the ʻclean streams accordʼ. Even with a new organisational structure and coordinating mechanisms it can be expected that some legacy patterns and behaviours will persist. This can be alleviated to some extent through the tools of behaviour transformation and training, as well as the evolution of the Fonterra Way culture and reward systems.

45 Henley Integrated Strategy Project Page 45 MARGIN Infrastructure Shareholder Services (RD1, Fencepost.com) Transport Systems Human Resources Standardisation of outputs, standardisation of norms Technology Development Feed and stock dev., automated milking, on-farm practices Procurement Share structure, Aspire milk payment systems, external suppliers Organisational Framework note: not an exact correlation Shareholder Services 1. Maintain the lowest cost supplier of commodity dairy products On-farm strategies including ʻAnimal Welfare and Clean Streams accordʼ, RD1 & fencepost.com Alliances with international suppliers Inbound Logistics Fig 8.2 The Value Chain Over 60 processing and manufacturing plants in world wide. International distribution network. Standardisation of work processes, and outputs, (Larger units sizes) ʻPerformʼ staff monitoring system Processing efficiencies, product development, resource waste reduction, by-product development Aspire milk payment system, ʻOn Your Marksʼ process Improvement systems Operations Division 2. Leading price and inventory manager in the global market Operations Outbound Logistics Fonterra Dairy Solutions consultants represented globally. Standardisation of outputs, mutual adjustment, (Smaller units sizes) Dairy Solutions (Alliance Portfolio) 3. Effective developer of dairy ingredient partnerships 4. Leading speciality milk components innovator & solution provider 6. Leading dairy marketer to foodservice in key markets Customer Development Strategies Fonterra Brands (Brand Portfolio) 5. Leading consumer nutritional milks marketer Consumer Market Penetration Strategies Sales & Marketing Manufacturing, processing, and distribution capacity Consulting on dairy industry throughout supply chain Product Development for both ingredients and consumer foods Regional (to global) supply alliances and alliances Ingredients Channels Foodservice Channels By-Product Channels Consumer Channels Retail Channels Services

46 Page 46 II. Organisational Transformation Fonterra Co-operative Group 8.3 Design Parameters Since the merger, Fonterra has invested considerable resources into developing new planning and control systems to administer its resources. Action planning systems are suitable where there are quantifiable inputs and outputs as in the operating core but performance control systems are more suitable for Fonterra Dairy Solutions which is driven by end user demand. FDS would also form part of the feedback loop with the operating core to ensure constant quality and customer satisfaction. The establishment of Fonterra Dairy Solutions represent a strategy of shifting customer support from specialist mode to consultant mode. This is consistent with Marthurʼs definition of moving towards market differentiation in both expertise and personalisation (fig 8.3). To support this, FDS would need to establish a different human resource culture from other parts of the group. The complexity of client consultation requires greater autonomy, independence and interpersonal interaction. Positions will more likely need to be horizontally and vertically enlarged. FDSʼs will need to be competent in establishing liaison oriented design parameters including liaison positions, task forces and integrating managers in both internal and external relationships. Many of the key alliances FDS will be developing are horizontal alliances (fig 8.4). Bleeke and Ernst (1991) suggests that shared investment in high value assets is a strategic tool to help bind relationships. This could include infrastructure investment as well as knowledge of crucial processes in the value chain. This knowledge base can be leveraged to deepen the commitment of alliances however knowledge is highly portable, strict criteria will need to be applied to ensure highly skilled staff and knowledge resources are not inadvertently lost to alliance partners.

47 Henley Integrated Strategy Project Page 47 EXPERTISE Differentiated annual report Undifferentiated Dairy Solutions Alliance Relationships 2001 > 2002 Consultant Differentiated PERSONALISATION Undifferentiated Adapted from S Marthur. This simplifi ed representation is indicative of the effect transformation will have on marketplace support positioning. Fig 8.3 Support Differentiation Internal Support Systems Agent Support for alliance partners transformed to FDS Specialist Trader Transformed to Brand Portfolio Trader Relationships Substitutes Suppliers Supplier- Shareholders International Suppliers Upstream Alliances Diversifi cation Alliances STRATEGIC CORE OF FONTERRA Horizontal Alliances Downstream Alliances Customers Invaders Adapted from T Reve Fig 8.4 Strategic Alliances

48 Page 48 II. Organisational Transformation Fonterra Co-operative Group Fonterra Fonterra NZMP NZ Milk NZMP Sales NZMP Plant A NZ Milk Sales NZ Milk Plant A Portfolio of Alliances & Brands Dairy Solutions Operations Division* 2 CURRENT SUGGESTED * 1 External Portfolio of Individual Alliances & Brands * 2 Includes all processing, manufacturing and production capacity Fig 8.5 Superstructure (Adapted from Mintzberg) 8.4 Configuration Although only two years old, Fonterra shares similarities in configuration, advanced lifecycle phase (fig 2.2) and scale (fig 3.1) as many of its competitors. Many competitors also share a similar history of growth based on technological development (para 4.3). This supports Mintzbergʼs hypothesis that organisational structure tends to reflect the age of the industry rather than the age of the organisation. Conversely, it could be argued that some competitors face similar lifecycle and environmental factors as Fonterra. Fonterraʼs existing configuration could be described as a conglomerate divisionalised form as each division maintains its own strategic apex, global alliances and investments. This means the group has two large decentralised technostructures and overlapping resources in a number of areas. Apart from inefficiency, this creates the risk of contradictions in goal setting, strategic targets and cultures. Even development new group wide cultures and strategies could be interpreted differently between divisions. The suggested restructuring represents an adhocracy configuration as defined by Mintzberg. An increasing centralisation of power

49 Henley Integrated Strategy Project Page 49 from subsidiary divisions towards a structure with limited horizontal decentralisation is represented in a flattening of technostructures designed to resources and streamline processes to achieve better horizontal integration and synergy between operating units. A modified matrix structure is more likely to support these needs then the current hierarchical superstructure (fig 8.5). The transformation represents a shift towards an end user demand system from a current framework based on output driven needs. An adhocracy configuration requires extensive liaison devises.the role of Fonterra Dairy Solutions would be to add this component. The suggested superstructure would develop a closer relationship between the operating core and customers. It also provides a more integrated framework for monitoring performance, external standards (i.e. labelling requirements) and quality feedback loops. Fonterraʼs strategic apex would be centralised at its new head office as currently planned. However, Fonterraʼs brands would no longer need to be centralised, overcoming potential resistance to relocation. Except in certain situations, the geographic scope of alliances and brand strategies would be determined at an operational level. All existing sales offices would be amalgamated by FDS to become the most global component of Fonterra (fig 8.6). Fonterra Dairy Solutions Brands & Alliances Operations Division Supply Capacity Research & Development RD1, Fencepost Global: Everywhere on Earth Regional/Global Geographic scope of individual brand/alliance strategies Selected: New Zealand plus international plants Selected: New Zealand supplying-shareholders plus international suppliers Selected: New Zealand, plus international facilities including Mexico, Germany Local: New Zealand Market Fig 8.6 Geographical Scope of Strategies

50 Page 50 II. Organisational Transformation Fonterra Co-operative Group 9. Conclusion Fonterra has set itself a vision of leadership within the global dairy industry. The company enjoys skilled human resources, advanced processing assets and valuable brands and alliances. However it operates in a complex environment. Factors include the cyclic supply and demand nature of commodity milk prices, consolidating customer base, access barriers and an increasing cost base. Fonterraʼs legacy organisations have been successful in establishing a global market position based on low cost supply which has placed the co-operative in a unique global leadership position. However, its ability to maintain lowest cost status is threatened, suggesting this core strategy is not a complete environmental fit. A differentiation component to the generic strategy at a corporate level is suggested to establish a more service based organisation focused on value added market growth through customer expansion. Fonterra Dairy Solutions would be established to undertake this aim by focusing on customer solutions and managing alliances. This would be a knowledge based organisation and represent a shift from specialist to consultant mode. Further transformation of Fonterraʼs organisational structure is proposed and more diverse and charismatic leadership suggested to manage change. Consolidation of the middle line would integrate processing and manufacturing functions of existing divisions within the operating core. Co-ordinating mechanisms and design perimeters would be diversified to meet the needs of specific strategies. The superstructure would be transformed and an adhocracy configuration adopted. Brands would be given greater strategic independence and options for raising capital.

51 Henley Integrated Strategy Project Page 51 Endnote Shortly after the completion of this ISP Fonterra announced a new CEO for Fonterra. Head hunted from Toronto, Andrew Ferrier has an extensive track record which includes heading the North American division of British based Tate & Lyle, the worldʼs largest sugar company. He is credited for successfully adding value within this commodity industry and for extensive trade negotiations with the US government. The inaugural CEO, Graig Norgate was not on the short list of candidates. Fonterra Chairman Henry van der Heyden stated it was time for new leadership Critics argue that Norgate should have been given more then two years to prove himself in a tricky operating environment and that he was a victim of internal politics. They point out that Ferrier lacks experience in the dairy industry, and in co-operative environments. However, Ferrierʼs appointment has significant advantageous. An unbiased outsider to internal political and cultural divisions is more likely to leverage internal competencies required to pursue growth. It brings further international and commercial representation to Fonterraʼs board and combined with a recently announced role for former World Trade Organisation chief Mike Moore, establishes a considerable presence in trade negotiations. Will Ferrier gain support from supplier-shareholders? According to Dairy Farmers Association chairman Kevin Wooding; Farmers will give him a fair go, what farmers wanted was some stability in the industry and improvement in their payouts. As long as they got that, they would not be too worried about the personalities at the top.

52 Page 52 Fonterra Co-operative Group Bibliography Ansoff, H Igor ʻCorporate Strategyʼ, McGraw Hill, 1965 Bleeke, J, Ernst D, ʻThe Way to Win in Cross Boarder Alliancesʼ Harvard Business Review, Nov-Dec 1992 Brown, JK & OʼConner, R, ʻPlanning and the Corporate Planning Directorʼ, Arthur D Little, 1974 ʻBeyond Milk - The New Zealand Dairy Storeyʼ Dairy Industry Profile Trade New Zealand, Wellington, October, 2002 Dann, Liam, ʻCanadian steps into the big league at Fonterraʼ New Zealand Herald, Auckland, June 27, 2003 Ebeling, H W and Doorley, T L, ʻA Strategic Approach to Acquisitionsʼ, Journal of Business Strategy, Vol. 3, No. 3, 1983 Greiner, L ʻEvolution and Revolution as Organisations Growʼ, Harvard Business Review, July/August, 1972 Hurst, D K, ʻCrises and Renewal: Meeting the Challenge of Organisational Changeʼ, Harvard Business School Press, Boston, 1993 Johnson, G and Scholes, K ʻExploring Corporate Strategyʼ Prentice Hall, 1993 Johnson, R and Lawrence, P R ʻBeyond Vertical Integration - The Rise of the Value Added Partnershipʼ Harvard Business Review, July/August, 1988 Kotler, P, Fahey, L and Jatusripitak, ʻThe New Competitionʼ, Prentice Hall, 1985 Mallett, Chris, ʻThe successful integration of research with business strategy; the Fonterra exampleʼ, Centre for Advanced Engineering Presentation, May, 2002 Marthur, S S, ʻHow Firms Competeʼ The Journal of General Management, Vol 14, No 1, Autumn, 1988

53 Henley Integrated Strategy Project Page 53 Miller, D, ʻConfigurations of Strategy and Structureʼ, Strategic Management Journal, Vol. 7, 1986 Mintzberg, H, ʻThe Structuring of Organisationsʼ in D Asch and C Bowman (eds) Readings in Strategic Management, Macmillan 1988 Porter, Michael E, ʻCompetitive Strategy: Techniques for Analysing Industries and Competitorsʼ, The Free Press, An imprint of Simon & Schuster, 1980 Porter, Michael E, ʻCompetitive Advantage: Creating and Sustaining Superior Performanceʼ, The Free Press, An imprint of Simon & Schuster, 1985 Reve, T, ʻThe Firm as a Nexus of International and External Contractsʼ Aoki, M, Gustafsson, B and Williamson O F, The Firm as a Nexus of Treaties, Sage, 1990 Turco, Gillian ʻOrganic Produce - An opportunity, at Whose Expense?ʼ Food and Agribusiness Research, Vol. 043, Rabobank, Sydney, 2003 Yves, Leduc ʻWorld Dairy Situationʼ Presentation at International Federation of Dairy Producers, Canberra, 2001 Zwanenberg, Adrie ʻConsolidation in the Dairy Industryʼ Food and Agribusiness Research, Vol. 017, Rabobank, Utrecht, 2001 Zwanenberg, Adrie ʻWill Global Dairy Company be a true Cooperative?ʼ Food and Agribusiness Research, Rabobank, Utrecht, 2001 Internet sources include: Document Length: Part 1: 3,120 words Part 2: 4,250 words

54 Page 54 Appendix Appendix Local Dairy Industry Profile (A) Source: Trade New Zealand Dairy Industry Profile, Fonterra Dairy Industry Percentage of GDP 17% Value to the New Zealand Economy 7.5 billion (NZ$) Annual Milk Production Volume 1.1 billion kilograms Annual Milk Production Litres 12.3 million Number of Dairy Farmers 14,000 National Heard Size 3.2 million cows Fonterraʼs New Zealand Market Share 98% Percentage of Produce Exported 95% Share of Global Cross Boarder Dairy Trade 31% Cost and Efficiency Comparisons (B) Source: Danish Dairy Board Milk Price Average Yield per cow (DKK/kg) Herd (kg/year) New Zealand ,800 EU ,850 USA ,500 Denmark ,100

55 Henley Integrated Strategy Project Page 55 Global Dairy Industry Market Information (C) Source: FAS (Foreign Agriculture Service, U.S. Department of Agriculture) Worldʼs Largest Milk Producers by volume: EU 114,531 Russia 33,500 US 77,100 Brazil 22,260 India 36,500 New Zealand 13,776 Worldʼs largest exporters WMP NDM Butter Cheese New Zealand 475 New Zealand 220 New Zealand 315 EU 450 EU 450 Australia 201 EU 158 New Zealand 305 Australia 154 EU 180 Australia 114 Australia 210 Argentina 95 US 125 Ukraine 48 US 55 China 20 Poland 100 Canada 22 Ukraine 28 Chile 17 Ukraine 70 Poland 15 Poland 17 Worldʼs largest importers WMP NDM Butter Cheese Algeria 112 Mexico 135 Russia 130 Japan 212 Brazil 90 Indonesia 110 EU 114 US 190 Venezuela 70 Philippines 105 Egypt 50 EU 174 China 55 EU 82 Mexico 37 Russia 140 Philippines 55 Algeria 80 Canada 20 Mexico 65 Mexico 45 Malaysia 80 US 19 South Korea 48 Worldʼs largest markets by consumption: WMP NDM Butter Cheese Fluid Milk China 570 EU 850 India 2,605 EU 5,740 India 33,500 Brazil 410 US 486 EU 1,616 US 3,946 EU 32,445 EU 400 Mexico 290 US 604 Brazil 476 US 26,852 Russia 115 Japan 216 Russia 400 Russia 448 Russia 14,140 Algeria 112 Russia 195 Poland 172 Argentina 415 Brazil 12,670 Argentina 94 India 210 Ukraine 123 Egypt 400 Poland 5,000 Worldʼs largest markets by production: WMP NDM Butter Cheese EU 882 EU 992 India 2,600 EU 5,989 China 545 US 700 EU 1,700 US 3,830 New Zealand 505 Australia 252 US 600 Brazil 472 Brazil 330 New Zealand 225 New Zealand 340 Argentina 420 Australia 205 India 200 Russia 275 Australia 411 Argentina 185 Japan 185 Poland 180 Egypt 387 WMP = Whole Milk Products, NDM = Non fat Dairy Milks forecast (in 1,000 Metric Tons):

56 Page 56 Appendix Supply Chain On-farm & Milk Supply Processing & Manufacturing Fonterraʼs Resources Shareholderʼs Milk 13,000 Supplier-Shareholders (New Zealand) Processing and manufacturing Plants 64 plants (International) Additional Milk Suppliers Bonlac/Bonland (Australia) DFA (United States) Dairy America (United States) Nestlé (Americas) Euro Serum (France) Baʼemek (Israel) Fonterra Research Massey (New Zealand) Mexico Germany Shareholder Services On-farm, farm liaison officers, RD1, fencepost.com Supply Chain and Resources (D) Distribution & Inventory Alliances & Brands Distribution Network Global Distribution Alliances & Equity Holdings including: Dairy Partners (Americas) DairiConcepts (United States) Britannia Foods (India) Arla Foods (UK) Soprole (Chile) La Mesa, Eugenia (Mexico) Bonlac, Bonland (Australia) National Foods (Australia) Fonterra Brands including: Including: Anchor, Fernleaf, Anelene, Mainland, Tip Top, Peters & Brownes, Chesdale, Noche Buena, Fanja, La Mesa, Fern, Delicia Marketplace (Channels) Foodservice Channels: Restaurants, fast-food, hotels, caterers, cafés, bakeries Retail Channels: Supermarkets, wholesalers, convenience stores, etc. By-product Channels (inc.): Pharmaceuticals, plastics, biotechnology, fuels Consumer Channels: Milk powders, fluid milks, butters, cheeses, yogurts, convenience foods, nutrition products, organics

57 Henley Integrated Strategy Project Page 57 Arla Foods Market: United Kingdom Partnership: 25/75% JV Sector: Consumer butters, spreads Objectives: Efficiencies gained from consolidation of Anchor and Lurpak brands, both are market leaders in their sector Britannia Industries Market: Bangalore, India Partnership: 50/50 Joint Venture with Britannia (owned by Danone) Sector: Consumer products including milks and cheeses Objectives: Access to one of the largest markets with rapidly formalising consumer sectors National Foods, Bonland Dairies Market: Australia Partnership: Major equity stakes Sector: Extensive range of consumer products Objectives: Local market leadership, access to valuable brands and supply, defensive positioning Selected Horizontal Alliances (E) DFA/DairiConcepts Market: United States Partnership: JV and Alliance Sector: Milk Powders & Supply Objectives: US supply agreements for markets in the Americas. New plant at Portales, Texas. Fonterra becomes leading US milk powder exporter. Dairy Partners of America Market: North, Central South America Partnership: 50/50% Alliance Sector: Most dairy sectors Objectives: Strengthen market positions of both companies, establish new enterprises, integrate value chain processes La Mesa, Eugenia, Soprole Markets: Mexico, Venezuela, Chile Partnership: Majority equity stakes Sector: Targeted consumer sectors Objectives: Leadership positions in targeted markets, access to supply channels, brand ownership

58 Page 58 Appendix Stated Company Activities (F) 1. (Cornerstone) Activities that sell shareholders milk. 2. (Cornerstone) Activities that leverage distinctive capabilities and where shareholders are the predominant source of milk. 3. Activities that materially support the cornerstones. 4. Non-core activities Stated Targets (G) Increase in earnings from value-added sales by 15% This is the largest targeted area of gain representing a desire to shift away from reliance on commodity products. On-farm productivity and improvement gains of 3-4% A target to improve supplier productivity. Although considered an efficient supplier, New Zealand yields per cow are significantly less then the US and EU (appendix B). Overall improvement gain across the value chain of 3% This is a process improvement target, process improvements are implied in several of Fonterraʼs strategies. Merger benefit of $310 million by October This is broken into three categories; cost reductions, productivity improvements, and strategy gains. Of this, an estimated $120 is projected as tangible annual costs savings. The Fonterra Way (H) A culture distinctive to our organisation that encompasses values of open and honest communication, cultivates an ethic of mutual support and help, includes a rewards system that encourages performance and drives growth, and combines to attract and develop the best and brightest people.

59 Henley Integrated Strategy Project Page 59 Stated Corporate Strategies (I) 1. Maintain the lowest cost supplier of commodity dairy products focuses on defending threats to cost base and cost savings in commodity sales, merger benefits, platinizing product portfolio, reduced manufacturing costs and streamlining the supply chain. 2. Leading price and inventory manager in the global market focuses on improving handling of inventory, working capital, pricing and product mixes and closer involvement in tracking market demand. Also, through support of trade liberalisation. 3. Effective developer of dairy ingredient partnerships Targeted at large established markets, and large clients who require dedicated serviced relationship which can extend to specialised product development. This includes the capital and operational management of each partnership. 4. Leading speciality milk components innovator & solution provider This targets the speciality ingredients sector and includes whey and milk protein, hydrolysate products, colostrum and pharmaceutical lactose. 5. Leading consumer nutritional milks marketer This strategy seeks to expand the product range of successful Anlene and Anmum milk powders which are market leaders in seven large Asian markets. 6. Leading dairy marketer to foodservice in key markets This strategy is targeted at convenience and ready to serve food segments and includes a broad range of channels. This strategy seeks to build on recent success in this market by developing capabilities including geographic expansion. 7. Develop integrated Fonterra strategies for China, Mercosur, Eastern Europe and India This is a combined strategy to address geographically specific opportunities and threats. These markets have been targeted because they include rapidly expanding consumer growth as well as potential new entrants as low cost suppliers.

60 Page 60 Appendix SWOT Analysis (J) Resources Milk Strengths Home market is a highly productive environment for dairy farming. Efficient farming practices. Considerable expertise within the industry. Relatively stable source of supply Weaknesses Reliance on sustainability of climate and ecology in the long term. Land competition against other. Increasing compliance costs. Output efficiencies lower then many competitors. Cycle of milk prices, supply and demand Organisational Framework The Fonterra merger has created a strong framework for bringing together the various resources and economies of scale required to pursue growth Overlapping resources and infrastructure. Configuration and superstructure needs rationalisation. Resistance to restructuring and relocation. Supplier- Shareholders Unique shareholder relationship with farmers secures long term supply at a time when global demand is outstripping supply Relationship is vital for survival. Local and global competitors could pinch suppliers by offering better milk prices Products & Development Knowledge extents across the value chain. Well respected by competitors in this area. Well targeted markets Traditional reliance on high volume low cost markets. Reliance on market price of milk and low cost status Situational Factor Market factors including deregulation, Opportunities Potentially reduces barriers of entry in many of the most valuable markets. Threats May increase efficiency of competing suppliers. Increasing tariffs and protection mechanisms in most valuable markets. Increasing value of $NZ dollar. Consolidation of Global Dairy Industry Fonterra is still lowest cost supplier. Growth in demand increasing quicker then growth in supply. WTO trade negotiations. Regulatory bodies may approve larger mergers to compete globally. Some larger supplying competitors may start to adopt more global strategies. Risk Management Factors Increasing opportunities for value added nutrition and bio products. Increases value of ʻclean greenʼ image More demanding consumers. Greater threat of legal or media crises. GM issues. Substitutes such as soya and non-dairy milks (goat, buffalo, sheep) Need to meet higher environmental standards.

61 Henley Integrated Strategy Project Page 61 Competitor Risk Management Innovations (K) Nestlé and Unilever both have significant and measured resource management programmes whereby indicators are used to measure key resource uses and waste (such as fresh water, waste water, air quality, electricity, by-products and so on). Although in the early phases of development, both companies claim these programmes have already resulted in considerable reduction of waste with tangible economic and ecological benefits. Many companies have constitutions and policies which outline a vision for an excellence culture. In some companies this extends to social and environmental performance reviews. Nestlé takes this a step further with a auditing channel whereby any employee can take up a matter to an independent council if they believe ethics or constitutional matters have been compromised. Such matters are often personally scrutinised by the CEO. Dean Foods has a critical self appraisal process which it makes public to encourage feedback. This transparency helps to maintain awareness of weaknesses and threats and is used to help create an honest and open dialogue with stakeholders. Most companies are active members of initiatives such as next step programmes, sustainability councils and community support projects. These relationships can build up community good will, increase awareness of resource reliance issues and also knowledge of the way in which external issues may effect the industry, and how the industry effects external stakeholders. Nestlé and Unilever are members of the UN Global Compact and Councils for Sustainability, and also have senior member from theses organisations represented in their leadership. Dairy companies operate in a hostile environment. Eight of the top 20 dairy groups are co-operatives, a structure which serves a strategic function of preventing hostile take-overs, a protection most private companies do not have. One exception is Nestlé, which maintains a rule whereby no shareholder can accumulate more then 3% of the companyʼs shares.

62 Page 62 Appendix Fonterra Group Financial Statements (L) Source: Fonterra Annual Report Statement of financial position FONTERRA CO-OPERATIVE GROUP LIMITED AS AT 31 MAY 2002 NOTES CONSOLIDATED $M PARENT $M Cash balances Receivables and prepayments 7 1,888 4,670 Inventories 8 3, Taxation receivable Other current assets Total current assets 5,772 4,881 Property, plant and equipment 9 3, Investments ,089 Intangibles 12 1,587 - Other non-current assets Total non-current assets 6,028 5,396 Total assets 11,800 10,277 Bank overdrafts Owing to suppliers 1,015 1,050 Payables and accruals Provisions Current borrowings 15 2,954 2,905 Taxation payable 27 - Other current liabilities Total current liabilities 5,176 4,382 Provisions Term borrowings 16 1,601 1,502 Deferred taxation Capital notes Other non-current liabilities - 2 Total non-current liabilities 2,139 1,729 Total liabilities 7,315 6,111 Net assets 4,485 4,166 Co-operative shares 5 3,229 3,229 Peak notes 5 1,177 1,177 Supply redemption rights Retained earnings (50) (307) Foreign currency translation reserve 6 (257) - Minority interests Equity 4,485 4,166 45

63 Henley Integrated Strategy Project Page 63 Statement of cash flows FONTERRA CO-OPERATIVE GROUP LIMITED FOR THE YEAR ENDED 31 MAY 2002 NOTES CONSOLIDATED $M PARENT $M Cash flows from operating activities Cash was provided from: Receipts from customers 14,427 5,528 Interest received Dividends received Cash was applied to: Payments to creditors and employees (8,038) (355) Payments to suppliers (5,667) (5,679) Taxation paid (103) (1) Interest paid (318) (167) Net cash flows from operating activities (374) Cash flows from investing activities Cash was provided from: Proceeds from disposal of property, plant and equipment Proceeds from sale of subsidiaries Cash was applied to: Acquisition of property, plant and equipment (703) (3) Acquisition of intangibles (95) - Loans to associates (3) - Net loans to subsidiaries - (2,755) Acquisition of subsidiaries 20 (85) - Purchase of Tatua / Westland s shareholding in NZDB (125) - Acquisition of associates / investments (72) - Net cash flows from investing activities (947) (2,094) Cash flows from financing activities Cash was provided from: Increase in borrowings 4,061 4,061 Issue of capital notes Issue of co-operative shares Issue of peak notes Issue of supply redemption rights Cash was applied to: Repayment of borrowings (3,966) (1,877) Surrender of co-operative shares (127) (127) Surrender of peak notes (9) (9) Surrender of supply redemption rights (53) (53) Dividends paid to minority interests (6) - Net cash flows from financing activities 360 2,455 Net decrease in cash held (233) (13) Cash acquired on the formation of Fonterra 326 (1) Effect of exchange rate changes on cash flows (56) - Closing cash balances 37 (14) Reconciliation of closing cash balances to the statement of financial position: Cash balances Bank overdrafts (70) (14) Closing cash balances 37 (14) 46

64 Page 64 Personal Development Report Personal Development Report The following Personal Development report follows recommendations set by the Henley Management College Integrated Strategy Guide, it is not an integral component of the report on Fonterra. The Chosen Industry and Industry Relationship Fonterra is one of the worldʼs largest dairy groups. It operates in a complex global operating environment within an industry that is undergoing dynamic transformation and change. My relationship with the diary industry is limited. I have no previous involvement with Fonterra and my farming experience is limited to a cow on my grandmotherʼs farm! Personal Development Objectives There are two core competencies that I seek to strengthen through this ISP, both of significant interest to me. The first is understanding the way a resource is managed through strategies in knowledge, financial resources, stakeholders, branding, technology and so on. In Fonterraʼs case, the physical resource is milk and the knowledge of milk. The report focuses on the transformation required to focus more resources on the knowledge of milk. The second competency I seek to develop is the ability to make a valuable contribute to any industry, even ifʼs outside my immediate field of knowledge. This is a situation that consultants sometimes face, so this was the position I took with Fonterra. My previous Henley project also followed this strategy. The organisation was the Geneva based ICRC (International Committee for the Red Cross). Although I previously had no involvement with the ICRC, some recommendations from this report are being used in the development of future policies. The learning curve is higher, but the results are far more rewarding.

65 Henley Integrated Strategy Project Page 65 Project Scope I originally started the ISP on Barcelona Activa, a Barcelona City subsidiary that provides ITC incubator and investment services in Catalonia but potential language difficulties prompted me to settle with Fonterra. Fonterraʼs representative in Barcelona was positive. With the ISP well under way I returned to Auckland thinking head office would be supportive. This was not to be. Fonterra outsources its public relations to the Baldwin Boyle Group. In effect communication with them was rarely returned and unreliable. They broke promises and a Henley letter on confidentiality had no benefit. I found myself constrained, sometimes by commercial sensitivity but mostly by an unwillingness to help. I have since discovered the same concerns commonly voiced by shareholders and stakeholders, a poor reflection on Fonterra. I havenʼt let these experiences bias this report, however it did limit my ability to carry out research with the thoroughness I would have preferred. Improvisation has been made in some areas, while others were culled due to the lack of reliable data. Overall this has lead to more of an emphasis on external factors. It was my intention to make this report beneficial to Fonterraʼs leadership and hopefully it still achieves this outcome to some extent. Conclusions Despite the constraints, I believe this ISP has contributed to my field of knowledge in several ways. Firstly, it helps to understand the framework in which resources are managed and strategies applied. Secondly, it is slowly improving my ability to articulate ideas. These were the primary motivation for undertaking an MBA, and the Henley programme has provided this. Finally, I remain optimistic about the future of Fonterra.

66 Integrated Strategy Project for Henley Management College Manu Vallyon 2003