Price control inquiry into milk not warranted

Price control inquiry into milk not warranted

The Commerce Commission has completed its review of domestic milk markets and has concluded that there is no valid basis for a price control inquiry under Part 4 of the Commerce Act at this time.

A price control inquiry is undertaken to determine whether the Commission should recommend to the Government that price control should be imposed.

“The threshold for undertaking a Part 4 inquiry is high. We can only recommend control if “little or no competition” exists or is “likely to substantially increase” in a market, and that there is no other effective constraint on the exercise of market power. Part 4 regulation is only imposed on firms with a high degree of market power, usually because of the natural monopoly characteristics of the industry in question, such as electricity or gas distribution,” said Dr Mark Berry, Chair of the Commerce Commission.

The Commission has reviewed a substantial amount of information and interviewed 32 participants in the four levels of the domestic milk market. The four markets the Commission considered were:

• Farm gate supply – the regional market for the supply of raw milk by farmers

• Factory gate supply – the markets for the supply of raw milk by processors/collectors to other processors

• Wholesale supply – the markets for the processing and wholesale supply of fresh milk

• Retail supply – the retail supply of milk in supermarkets.

At the farm gate supply level we have determined the grounds for intervening under Part are not met. Part 4 provides for the regulation of the supply of goods or services. It was not designed to regulate the acquisition of goods and services in markets where the acquirer has a high degree of market power. For this reason, Part 4 cannot regulate the price and other terms on which Fonterra (or other processors) acquires raw milk from the farm gate.

Alternatively, if we were to consider the problem is one of supply by Fonterra farmers rather than acquisition by Fonterra, we could not recommend regulation under Part 4 because individual farmers do not have market power.

We note that the interdepartmental team is also considering Fonterra’s farm gate raw milk price.

The Commission has concluded that there appears to be little or no competition in the market for the factory gate supply of raw milk, and little or no likelihood of a substantial increase in competition in this market.

However factory gate supply is already regulated under the Dairy Industry Restructuring Act and the Raw Milk Regulations and these are designed to constrain Fonterra’s market power. An interdepartmental team is currently reviewing the regulations.

The Commission will provide information and assistance to the interdepartmental review where appropriate.

In both the wholesale and retail markets there is more competition than little or no competition (the threshold).

“At the retail level there is competition between the two major supermarket chains, dairies, service stations and other retailers. At the wholesale level, it is the competition between Fonterra Brands and Goodman Fielder that exceeds the little or no competition threshold,” said Dr Mark Berry, Chair of the Commerce Commission.

“Overall our analysis shows that the level of competition, taking into account existing regulation arrangements means that intervention under Part 4 of the Commerce Act is not possible,” said Dr Mark Berry.

You can view the full report on the Commission’s website: www.comcom.govt.nz/reports-and-judgements

Background

The Dairy Industry Restructuring Act 2001 (DIR Act) provides for the regulatory and structural reform of the dairy industry. The DIR Act authorised the amalgamation of New Zealand's two largest dairy co-operatives - New Zealand Co-operative Dairy Company Ltd and Kiwi Co-operative Dairies Ltd - into Fonterra Co-operative Group Limited (Fonterra) and the resulting ownership by Fonterra of all the shares in the New Zealand Dairy Board.

As this amalgamation resulted in an entity with a substantial degree of market power in a number of key domestic New Zealand dairy markets, the DIR Act was designed and implemented to mitigate the risks of Fonterra's market power. The DIR Act allows for contestability in the New Zealand raw milk market and provides for access to other dairy goods or services supplied by Fonterra to be regulated if necessary. This contestability and access is provided under Subpart 5 of Part 2 of the DIR Act.

Part 4 of the Commerce Act allows for regulation that is designed to ensure that suppliers of regulated goods and services have similar incentives and pressures to suppliers operating in competitive markets. Suppliers of regulated goods and services should not be able to earn excessive profits.

Under Part 4 of the Commerce Act, regulation must ensure that on one hand, regulated suppliers have incentives to innovate and invest; improve efficiency; and provide goods or services at a quality that reflects consumer demands. On the other hand, regulation must also ensure that regulated suppliers have incentives to keep prices down and limited ability to extract excessive profits.

Questions and Answers

1. What is a price control inquiry? When can the Commission recommend regulation?

Part 4 of the Commerce Act allows the Commission to recommend to the relevant Minister that certain goods or services should be regulated.

Regulation under Part 4 is designed to ensure that suppliers of regulated goods and services have similar incentives and pressures to suppliers operating in competitive markets. Suppliers of regulated goods and services should not be able to earn excessive profits.

Under Part 4, regulation must ensure that on one hand, regulated suppliers have incentives to:

• innovate and invest;

• improve efficiency; and

• provide goods or services at a quality that reflects demands.

On the other hand, regulation must also ensure that regulated suppliers have:

• incentives to keep prices down; and

• limited ability to extract excessive profits.

Before a market can be regulated under the Commerce Act, the Commission must undertake an inquiry. An inquiry can be triggered in two ways.

• The Minister of Commerce may require the Commission to conduct an inquiry.

• The Commission may hold an inquiry on its own initiative.

Section 52G of Part 4 sets a series of strict thresholds that must be met for the Commission to have the ability to make such a recommendation:

• in the relevant market, there must be little or no competition, and little or no likelihood of a substantial increase in competition. Few markets will meet such a test. While it is not a strict requirement of the test, we note that Part 4 was targeted at “natural monopolies”, such as airports, gas pipelines and electricity distribution and transmission line businesses;

• in addition, there must be scope for the exercise of substantial market power in relation to the goods or services taking into account the effectiveness of existing regulation or arrangements (including ownership arrangements); and

• finally, the benefits of regulating the relevant goods or services in meeting the purpose of Part 4 must materially exceed the costs of regulation.

2. Why can’t the Commission conduct a price control inquiry into milk markets?

We do not think it is appropriate to launch a price control inquiry at this time because:

• in the farm gate market, (Part 4) price control is not the appropriate tool to remedy any competition problem that exists. It was not designed to address the acquisition of goods and services in a market where the acquirer has a high degree of market power. Accordingly, Part 4 cannot regulate the price and other terms on which Fonterra (or other processors) acquire raw milk from the farm gate;

• in the factory gate market, (Part 4) price control is not the appropriate tool at this time. 99.7% of milk supplied in the factory gate market is sold under the Raw Milk Regulations (the Regulations). An interdepartmental team with representatives from The Ministry of Agriculture and Forestry, the Ministry of Economic Development and The Treasury is currently reviewing the effectiveness of the Regulations. We consider it likely that the outcome of their review could lead to a more effective form of regulation for this market than Part 4 could offer. We also are mindful that:

simultaneous reviews by public bodies considering remedies to the same problem is unlikely to be efficient; and

launching a full inquiry would be premature given that the Regulations are currently under review and may be amended; and

• the legal tests for regulation are not met in the retail market and the wholesale market. This is because we considered there is more than little or no competition in each market.

3. What can be done to enable new milk processors to be established, increasing competition?

It is the objective of the Dairy Industry Restructuring Act (DIRA) to promote contestability and efficiency. The Act aims to ensure that there is sufficient actual and potential competition to provide Fonterra with incentives to be efficient and allow consumers to get good value for money.

DIRA, and the Raw Milk Regulations, seek to promote competition through a variety of mechanisms, including open entry and exit of farmers and the availability of regulated milk for independent processors. The Regulations are currently under review by an interdepartmental team.

4. How can a supermarket duopoly be considered effective competition?

The test we are set by the legislation is whether there is little or no competition. This is a strict test. Typically it is intended to cover natural monopolies (gas pipelines, electricity distribution businesses). Few markets will fall into this category. The supermarket market does not.

5. What other complaints did the Commission receive about milk markets?

The Commission received complaints that:

• retail milk prices were too high;

• wholesale milk prices were too low compared to the price of raw milk, making it hard for independent town milk processors to compete; and

• farm gate milk prices were too high, with the linked submission that Fonterra had artificially reduced its share price, making it hard for independent processors to compete.

6. Where did the Commission source the information it has relied on for this review?

We interviewed 32 market participants (e.g., processors, retailers, distributors). We requested and received written information from processors and supermarkets. We also carried out our research on the basis of publicly available information. We also relied on knowledge gained through our previous work involving the dairy supply chain.

7. Has Fonterra cooperated with the review?

Yes. Fonterra has cooperated. It has voluntarily provided the information we requested.

8. Did the Commission engage any independent experts in this review?

No. This was an initial assessment of whether a full price control inquiry was justified. It was not appropriate to engage independent experts for this review.

9. Why did you not consider cheese, yoghurt etc.?

Our review has focussed on liquid milk. Nearly all of the complaints we received focussed on this issue. In any event, the issues in markets for other dairy products are likely to be substantially similar to those for liquid milk.

10. Did the Commission consider the international price of dairy products and the effect on domestic retail prices?

Purely as background, we considered international prices of dairy products and domestic retail milk prices. However this is not relevant to the test of whether there is little or no competition in a market.

11. Is anyone making excessive profits in the supply of milk?

The question for the Commission is whether the conditions exist in the domestic milk market to warrant price control regulation under Part 4 of the Commerce Act. We have not needed to assess the question of excessive profits, in order to decide whether a Part 4 inquiry is warranted.

12. Why is milk cheaper overseas / in Australia?

The price of milk overseas is not relevant to the question of whether price control regulation may be warranted in the domestic milk market. An analysis of overseas milk prices is not necessary in order to reach a decision whether regulation under Part 4 could apply, so we have not done so as part of this review.

However, it is apparent that New Zealand supermarkets have not priced milk as aggressively to date as in Australia. This may reflect that competition in the supply of groceries from supermarkets is less intense than in Australia. Alternatively, it may suggest that the competition dynamic is different, and competition focuses on other products or aspects of their offering.

13. Is Fonterra’s conduct in this market faultless?

We have been considering whether a Part 4 inquiry is justified, which could have ultimately recommended regulation to the Minister. We have decided that either the legal tests for regulation are not met or Part 4 is not the appropriate tool at this time.

We will liaise with officials regarding the current interdepartmental reviews to ensure that they are aware of our analysis. We also intend to make a public submission to MAF’s consultation on potential changes to the Regulations.

We will also now consider the allegations that Fonterra has breached Part 2 of the Commerce Act by misusing its market power.

14. Is current regulation working well?

We consider that the current regulation does constrain Fonterra’s behaviour. Whether it is as effective as it might be is a live issue being considered by an interdepartmental team of officials. We have no further comment on the state of current regulation at this time.

We will be liaising with MAF officials to pass on any useful knowledge that we can. We will also respond publicly to the current consultation on the Regulations.

15. Will the inter-departmental reviews of the Regulations / farm gate milk price

fix the problems in the market?

The current inter-departmental reviews are better placed to solve the problems than price regulation under Part 4. We consider they are asking the right questions as to whether there is a problem and possible solutions.

16. What will be the Commission’s next steps?

We will liaise with officials regarding their current reviews to ensure that our analysis is considered. We will also make a public submission to MAF’s consultation on potential changes to the Regulations.