Can “pacemaker” co-operative Murray Goulburn reverse its vicious spiral?

In an article published in April 2016, I wrote about the challenges facing Australia’s largest dairy business, Murray Goulburn Co-operative Ltd (MGC). At that time the collapse of the farm-gate milk price (FMP) and concurrent freefall of the share price within the ASX listed MGC Unit Trust, had triggered a crisis within the co-operative’s board, management and membership.

This year the situation facing MGC has continued to remain difficult, with global commodity prices for dairy produce depressed or volatile, and significant falls in the supply of raw milk from local producers.  For example, by August 2017, MGC announced a loss of around $370.8 million for FY2016/17, and a shortfall of around 300 million litres of milk supply, leading to speculation that the co-operative might become a takeover target by rival processors.

The aftershocks of the calamitous collapse of both the FMP and share price in 2016 continued to plague MGC during 2017. Although it promised an opening FMP of $5.20 per kilogram of milk solids (p/kg ms) for the new season, this was still lower than the prices offered by rivals Fonterra, Lion, Warrnambool Cheese and Bega. This led to many farmers moving their supply to overseas competitors such as Fonterra, which saw its supply increase by around 500 million litres.

While Fonterra and other rival dairy processors increased their production, MGC commenced a retrenchment process, announcing the shutting down of its Edith Creek processing plant in north-west Tasmania, and its Rochester and Kiewa plants in Victoria. This activity within the co-operative was accompanied by townhall meetings of aggrieved dairy farmer members voicing their anger at the impact this was having on their own small businesses. It was accompanied by similar anguished cries from employees of MGC facing redundancies as the co-operative’s production plants moved towards closure.

At the same time, the media was replete with stories of a possible takeover of MGC by overseas competitors. For example, in September 2017, New Zealand dairy co-operative Fonterra confirmed that it had made a bid for MGC. This bid was also reportedly matched by Chinese dairy company Yili during the same month.

MGC is now under new management, and the challenge facing CEO Ari Mervis and the board, is how to reclaim the trust and loyalty of the Australian dairy farmers who are, or were, its members and owners. In May this year he announced the factory closures, forgiveness of the Milk Supply Support Package, and the $410 million write-downs and associated deviation from the profit sharing mechanism. He also announced a suspension of the payment of dividends and a review of the dividend payout ratio. He concluded with the following comments:

“At MG we are acutely aware of the impact that our decisions will have on our various stakeholders, including the communities in which we operate. We are committed to ensuring that we provide our affected employees with appropriate levels of support and the recognition that they deserve during this period of transition. MG will support employees by providing access to career transition and redeployment services as well as working with Federal and relevant State Governments to leverage existing programs.”

He also noted that a “strong MG is of fundamental importance to the Australian dairy industry and these decisions are necessary to lay the foundation for the future.”

This last point is important, because as I noted in the earlier article, the size of MGC and its structure as a co-operative, provides a form of stability for the Australian dairy industry in an otherwise unregulated market.

Virtuous and vicious spirals

In her 1983 article on the theory of agricultural co-operatives Clare LeVay identified the concept of the “pacemaker” co-operative, which refers to a co-operative that grows to such a size that it has the power to set market pricing. However, while this can enable a large co-operative to set and stabilize prices in the best interest of its members, it also risks generating disenchantment amongst its members.

The reason for this disenchantment is that the co-operative’s ability to set market price results in a situation in which there is little or no difference between the prices offered by the co-operative and those offered by its competitors. As pricing becomes benchmarked by the pacemaker co-operative, its members’ sense of value in remaining loyal to the co-operative becomes eroded. This serves to undermine the cohesion of the co-operative’s membership, who cannot see the relative benefit of continuing to trade with it.

When pricing is positive and benchmarked, the switching costs for members remains unimportant. The co-operative’s openness and transparency about its pricing, and the principle of rewarding members through their economic participation, will generate a positive upward virtuous spiral.

However, when pricing deteriorates the co-operative can find itself trapped in a vicious downward spiral. This is particularly the case for large co-operatives that have high overhead costs and who need high volume of supply from their members to ensure their operational efficiency and profitability. 

Faced with such conditions, the ability of a pacemaker co-operative to pull out of this vicious downward spiral can be addressed with several possible strategies. One option is to maintain flexibility in its infrastructure, that can enable it to reduce its overhead costs during times of low supply volume. However, this cannot always be achieved as large capital items such as plant and equipment are generally difficult to outsource. The experience of MGC in having to shut down factories is a good example of this.

Another option for a pacemaker co-operative facing a vicious spiral is to engage in a diversification strategy. This might take place via the formation of joint ventures, or the acquisition of subsidiary companies in related and supporting industries. However, here too there can be challenges as such diversification risks shifting the focus of the co-operative away from its core purpose and ability to deliver value to its members. MGC has formed several joint ventures. For example, in has a joint venture in China, MG Qingdao, that produces infant formula, and in 2012 it formed a joint venture with Japan's Mitsubishi Corporation in the Tasmania Dairy Products Co.

Developing and sustaining member loyalty

Perhaps the most sustainable option is for the pacemaker co-operative to invest significantly in developing and strengthening the loyalty of its members. Where a co-operative’s relations with its members is based primarily on price paid in patronage, or dividends distributed from shareholding, it can be difficult to sustain member engagement when pricing or share value declines.

Member loyalty needs to be built on more than just patronage and investor relationships. These address the economic outputs of the co-operative, but they are relatively weak and transient drivers of loyalty. Of greater sustainable value are the co-operative’s ability to engage members through fostering a strong sense of ownership over the business, and an identification with a common sense of purpose. These are social outputs from the co-operative, and while they can be difficult to manage and measure, they remain key to the sustainability of member loyalty and engagement.

A member’s decision to join a co-operative is motivated by a perception that membership will deliver to them value that they cannot readily obtain from alternatives. This perceived value may be based in part on rational economic factors such as price or service quality, or the opportunity to gain financial benefits from share capital appreciation.

However, the perception of value is also influenced by more intangible factors such as the emotional value that members feel in being part of a democratically governed organisation, in which they have an equal voice, and that is focused primarily on providing benefit to them. Any co-operative, in particular large pacemaker enterprises, that fails to recognise this, risks placing itself in jeopardy when pricing and share value enter a vicious downward spiral.

Can Murray Goulburn recover from the vicious spiral?

This raises the question as to whether MGC, can recover from the current vicious spiral it now finds itself in? Much will depend on how well the co-operative can appeal not just to the economic motivators of FMP, share price and dividends, but also to the social motivators of a sense of collective ownership and common purpose.

Sadly, the board and executive leadership of MGC over recent years seem to have encouraged the members to view themselves primarily as patrons and shareholder investors. In the good times such an appeal is easy to make and membership grows as the pacemaker co-operative leads the market. However, in the downturn the social capital that has been built up around the less measurable motivators of ownership and purpose are the foundations of resilient loyalty.

It may not be too late for MGC to turnaround its fortunes and recover from this vicious downward spiral. Over the company’s long history, it has faced similar challenges. However, through its decision to focus away from its co-operative principles, and flirt with the ASX, MGC has undermined the trust and loyalty of many within its membership base. Winning back their trust and patronage will require the board and senior management to revisit their co-operative roots and revisit their member value proposition (MVP). This must recognise that the essential focus of their business, as with any co-operative and mutual enterprise, should be on delivering both social and economic benefits to members.

Note:

Tim Mazzarol is a Winthrop Professor at the University of Western Australia where he is the Director of the Co-operative Enterprise Research Unit (CERU). However, the opinions expressed in this article are entirely his own.

 

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