Friday, 6 December 2013

Farmer-led certainty & discipline

As I said yesterday, excess meat processing capacity is probably good for farmers because it intensifies competition for stock, driving up prices. Processors hate this cut throat competition, but they can’t easily escape it because none of them wants to close down factories. 

The processors are in a nasty bind. If firm X shuts a plant, it bears the entire cost while all its rivals get a benefit from reduced competition. In that context, everyone waits politely for someone else to exit first: “after you…. no, I insist, after you…”

This is why the meat industry is constantly seeking new ways to “collaborate”, a delightful term which in this sector is code for “reduce competition”.

Earlier in the year, there was an attempt to revive a much older proposal known as Tradeable Slaughter Rights (TSRs). At its heart, this is a market sharing scheme. Processors sit down together and allocate themselves the same share of animals for killing as they had last year. Then they go out and buy stock from farmers secure in the knowledge that if they don’t fill their quota (eg because their prices are too low), one of their rivals will be obliged to reimburse them. This is the “tradeable” part. 

Keith Woodford suggests that TSRs were intended to promote exit by weak firms who would sell their rights to expanding firms. But side payments like that could happen anyway, so its hard to see the merit of TSRs, and the market division aspect of it is most unappealing. I can’t see why farmers would support it, and I'm not surprised it was apparently turned down by the policy community in Wellington this year. 

Oddly enough, Federated Farmers seemed comfortable with TSRs. National President Bruce Wills didn’t share my pessimism and told me by email that the Feds support anything that brings “certainty and discipline” to the market. 

That's a worthy goal, for sure. But if the Feds and the MIE want to stimulate some farmer-led certainty and discipline, they should perhaps start by recognising that their interests and problems are very different to those of the processors. The most obvious strategy from that point would be to get a big group of farmers together and call tenders for processing and onward sale services. 

That would inevitably lead to long-term contracting arrangements between farmers and processors. But farmers would have the whip hand, at least initially. And if enough farmers joined the club then the scale of their collective business would likely force exit of some processors, which would address the core problem. Moreover, in a well-run tender process, the strongest processors should win, which is efficient.

The reason I prefer this approach to the merger route is that it focuses directly on the contract between farmers and processors, and exit of some firms is a by product that is sorted out by market forces. By contrast, having farmers try to force mergers is very difficult (as we are seeing) and even if it succeeds it still leaves unanswered two crucial questions. Which plants will shut? And then, finally, what kind of deal will the remaining firms offer farmers now that they have less competition?

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