They were the best of times for meat prices, but by the end of 2012 they were the worst of times, with losses all around for a sector struggling to keep its earnings consistent. Are contracts between farmers and processors the key to consistency, asks Owen Poland?
Earlier this year my power company urged me to beat electricity price rises by signing up to a fixed price plan for the next three years. By paying "a little more" than current prices (11 per cent more, actually) I would be protected from future increases. My initial response was deep suspicion. After all, why should I trust the power company to do me any favours when it was partly responsible for hiking my bills in the first place?
It seems that many farmers view contracts from meat processors in much the same light. Why would you commit to a fixed price for your stock when you can take advantage of the soaring spot prices that emerged last season when farmers created demand by withholding stock to take advantage of superb pasture conditions?
Perhaps predictably, adverse consumer reaction to the rising prices saw demand – and stock prices – suddenly plummet, leaving farmers to reflect on their sharp reversal of fortune. The numbers are ugly. Early November lambs which sold for 761c/kg in 2011 were fetching an average 493c/kg in late 2012, forcing some producers to accept advance cash payments to shore up balance sheets.
The agony was shared by the major meat processors when annual results were unveiled in mid-November. Southland's Alliance Group suffered a net loss of $50.8m, while Silver Fern Farms was out the back door by $31.1m.
Alliance bluntly admitted that it paid too much for livestock for too long and failed to respond quickly enough to falling demand in economically challenged global markets. "Yes, the meat companies paid the money," says Silver Fern Farms Chief Executive Keith Cooper, but they were "caught up in the whole vicious circle" by having to keep plants running while waiting for stock.
Just who takes responsibility for the market volatility is a sensitive issue. No one wants to point the bone lest they offend a valued client. Was it farmers, or processors who have periodically engaged in stock procurement wars to secure market share?
While it may have been "very rational" for farmers to take advantage of the late 2011 grass growth curve, Keith says they "ignored the consumer" who refused to pay top dollar. "We saw a market crash because of a lack of supply causing the price to go up, causing the market to keel over."
Without wishing to criticise, he says "the guts of the problem is the gap between production and consumption in terms of a hard-wired relationship."
"Why did people ignore something pretty fundamental – that you need to keep supply to markets at a consistent value to ensure consistency of markets?"
Southland sheep and beef farmer Andrew Morrison says "we all played games last year," and "we've all got to take ownership of these problems." He doesn't want to play the blame game, but says Keith has misrepresented last season's problems by putting it on farmers who can't ignore the customer because they're not in touch with them. "We put our faith in meat companies to do that." Farmers were simply reacting to price signals from the processors which he believes were procurement-driven and not market-driven.
Despite the "lose-lose situation" for farmers and processors, Andrew says there's still a desperate desire for stability in the industry. "We don't want to ride the highs and the lows; we want to stabilise the prices so we've got a surety of the product we're producing."
It's an issue that's been exercising the collective mind of the meat industry for some time. Efficient and aligned procurement is one of three core themes in the 2011 Red Meat Sector Strategy – the aim being to ensure that suppliers receive a 'fair and sustainable reward' for their performance and to shift the focus of competition from the farm gate to offshore competitors. Most agree that it's easier said than done.
Because it's a seller's market, Keith says farmers and agents "can trot round and ramp up the price to the highest level," whereas if farmers dealt directly with meat companies - and chose a meat company strategy - then that should eventually deliver confidence and alignment, "and farmers would behave in line with that meat company's customer requirements."
Such partnerships would create a "shared objective" about the best way to meet market requirements according to Meat Industry Association Chairman Bill Falconer. However that would require a move out of the 'classical' relationship between farmer and processor operating on the spot market to one based on fixed term contractual arrangements.
The theory is that contracts would iron out the peaks and the troughs, though Bill isn't certain whether the average over time would exceed the average spot price. "I'm not certain that we have the evidence to indicate whether that would be so, but if there wasn't the expectation of it then it wouldn't work."
The fact that contracts have failed in the past doesn't help matters. A case in point was SFF's decision to scrap its so-called 'Backbone Beef' contract in late 2008 when market prices fell 25 per cent within a matter of weeks. "Farmers don't forget those things" says Andrew. "You've got to be bloody careful with these contracts that everyone honours them." And that includes farmers, he adds pointedly.
Recognising that people have been burnt in the past, the MIA is advocating a toe-in-the-water approach whereby farmers contract a small proportion of their production to see how it goes. "We don't have to bet the farm on this," says Bill. "Nobody's going to be hugely scorched by it if it doesn't go right."
Central Hawkes Bay farmers Sam and Hannah Morrah, who operate the 755 ha Ohineumeri Station, are having what they call a "bob each way" by taking out a three year fixed price contract with SFF on around 30 per cent of their lambs. "It's all about de-risking the business," says Sam.
While they might lose out in comparison to what everybody else might get in some seasons, the contract locks in profits and offers a guaranteed cash flow. As it turns out, the Morrahs timed last year's contract with SFF to perfection.
"The general consensus was that the contract they were offering wasn't high enough," says Sam, "but as it's turned out it's well and truly in the money."
However Keith Cooper says contracts have to be linked to customer requirements and can't be about "who's betting who's right and who's wrong on price." If everyone had been committed to supply a meat company, he says last year's boom and bust cycle could have been avoided.
"That is the ultimate solution, where people are aligned in terms of their supply commitment, which would stop the stock being withheld, and stop the price going through the roof."
One of the biggest challenges is to change mindsets. Keith says it's very hard to get people to change their behaviour, and having 85 company reps on the road forging direct relationships didn't stop SFF suppliers from playing the market last year. Bill says any change in behaviour will take time. "It will only occur where the parties see the value in doing so."
Industry consolidation or co-ordination is "the best goal" says Andrew. He believes that farmers and processors could easily achieve an 80 per cent Fonterra-style model if that's what they want, but the processors who subscribe to such a model need to identify themselves.
Despite having a "broken industry model," he says it's worth noting that meat prices haven't dropped as much as dairy prices over the past couple of years.
It's a point echoed by Keith Cooper, who says Fonterra can't control prices in spite of its global dominance as a milk producer. Similarly, if 80 percent of the meat industry was in one organisation it couldn't control prices into Europe or the United States because Australia is paying its suppliers $1 a kg less.
If the meat processing industry consolidated from the present twenty-three players down to four or five choices, Keith senses that suppliers would "bond a lot better" because they couldn't jump ship so easily. However he notes that Fonterra's market share is being slowly diluted "as farmers leap at the next opportunity, and undo what many have advocated as being the solution for the dairy industry."
And while industry aggregation will remove surplus capacity and create a more efficient processing sector, Bill says people who look to it as a silver bullet to solve pricing issues "have missed the point."
What the industry doesn't talk enough about, says Keith, is a strategy for New Zealand meat in terms of its position in the market place. It's all very well buying an animal for $5/kg and selling it for $5.50/kg, but he says no one thinks about how to change the $5.50/kg into $6.
"It’s such a margin-driven industry right through the value chain, it's not a value creation industry."
This story originally appeared in Primary magazine. Click here to subscribe.