The Commerce Commission has today released its final report on the state of competition in New Zealand’s dairy industry. The review began in June last year at the request of the Minister for Primary Industries as required under the Dairy Industry Restructuring Act 2001 (DIRA).

Having considered submissions on the draft report released in November, the Commission’s view remains that there is not sufficient competition at the farm gate and factory gate to consider full deregulation at this time.

Deputy Chair Sue Begg said that while the costs and benefits of the DIRA Regulation are more or less balanced, the risks of removing it too soon outweigh the risks of it remaining longer than it should.

“As it stands, without regulation Fonterra would be able to increase the price of raw milk it sells to other domestic processors and this would likely flow through to higher retail prices of dairy products for New Zealand consumers. Increased competition is needed, particularly at the factory gate, and our view is it is better to err on the side of caution before embarking on full deregulation,” Ms Begg said.

The final report recommends that a pathway to deregulation would be smoothed by facilitating the development of a factory gate market for non-DIRA milk. Options the Minister could consider include:

• reducing DIRA milk entitlements;
• investigating if and when the DIRA milk price covers Fonterra’s opportunity costs; and
• tightening the terms and conditions for DIRA milk supply.

“Keeping the open entry and exit provisions in place during any reforms would help with the transition by aiding the growth in competition at the farm gate by suppliers that could then enter the factory gate market,” Ms Begg said.

“However, we think it is worth exploring whether open entry for new dairy farm conversions should be removed. Open entry for new conversions contributes little to supporting competition in the farm gate market, while imposing costs on Fonterra.”

The final report also confirms the recommendation to reset the market share thresholds in both the North and South Islands to 30 percent (up from the current 20 percent), as well as resetting the time limit threshold to the 2021/22 season as the triggers for the next competition review of the dairy industry.

“The support of the dairy processors, industry bodies and experts has been integral to enabling us to complete this work in such a short timeframe.  On behalf of the Commission, I would like to thank all those who provided information, gave interviews and submitted on our draft report,” Ms Begg said.

A copy of the final report can be found here.

Background
Why did the Commission undertake this review?
The Dairy Industry Restructuring Act 2001 (DIRA) requires the Minister of Primary Industries, in consultation with the Minister of Commerce, to request a report on the state of competition in the New Zealand dairy industry:

• when the DIRA market share thresholds in section 147 are met, or
• in the event that they have not been met by 1 June 2015, as soon as practicable after that date.

The Minister of Primary Industries requested the review in June 2015 and required the Commission to complete its final report by 1 March 2016.

What was the purpose of the review?
The DIRA regulatory regime is transitional in nature and designed to expire if and when the New Zealand dairy markets are considered to be sufficiently competitive, so that industry-specific regulation is no longer required over and above the normal application of general competition law.

The Commission must provide an assessment of the state of competition in the dairy industry and, if the state of competition is insufficient, advise the Minister as to whether the market share thresholds should be reset and provide options for a pathway to deregulation (if any).

Were there any substantial changes to the Commissions views following consultation on the draft report?
Our final conclusions are consistent with our draft views that:

• the DIRA regulation has reduced barriers to entry and constrained Fonterra’s market power;
• some competition (varying by region) has developed in the farm gate market; and
• little competition has developed in factory gate market.

What are the farm and factory gate markets?
The farm gate market is where processors of raw milk including Fonterra compete to acquire raw milk from farmers.

The factory gate market is where processors supply raw milk to each other (primarily when they do not collect it direct from farmers themselves). For example, cheese, fresh milk or yoghurt producers routinely purchase raw milk from Fonterra.

What are the market share thresholds?
When the Minister is satisfied that independent processors collect 20 percent or more of all milk solids in a season in either island, this would trigger a competition review of the dairy industry. The Minister would then consider whether the market share threshold should be reset or alternative regulation adopted. The 20 percent threshold was met in the South Island in the 2014/15 dairy season.

The Commission’s recommendation is that the threshold should be increased to 30 percent for both islands. Should this threshold not be reached the next review would be triggered instead by the time limit provision and be held in 2022.

How do the current regulations allow for contestability in the market?
The Act also contains provisions that have the purpose of advancing the efficient operation of New Zealand dairy markets by promoting:

• contestability in the market for farmers milk through an open entry and exit regime; and
• access by independent processors to raw milk and other dairy goods and services that are necessary for them to compete in dairy markets.

How do the Raw Milk Regulations support independent processors?
The DIRA Raw Milk Regulations require Fonterra to supply independent processors with up to 50 million litres of raw milk per independent processor, capped at a total of 795 million litres per season of the raw milk it collects. This provides a stepping stone for new processors and an ongoing source of supply for niche producers.

The Act also promotes the setting of a base milk price that provides an incentive to Fonterra to operate efficiently, while providing for contestability in the market for the purchase of raw milk from farmers. The Commission annually reviews Fonterra’s Milk Price Manual and its base milk price calculation.

How does the final report compare with the 2011 inquiry into domestic milk markets?
In relation to the wholesale and retail dairy markets, we found no new information that would alter the conclusions reached in our preliminary inquiry into whether the Commission should initiate an inquiry under Part 4 of the Commerce Act 1986 into domestic milk markets in 2011.

What has been the process for this review?
The Commission released a consultation paper on 12 June 2015 outlining its proposed approach, timeframes and the scope of the review. Submissions closed in July. Interviews have been held with a number of market participants, including Fonterra and independent processors, and a significant amount of further information was sought and received from across the industry.

The draft report was released for consultation in November, with submissions and cross-submissions concluded by 18 December.

The final report has now been provided to the Minister for Primary Industries. The Minister has 90 days to respond to the report’s recommendations.