PROJECTS

Hypothetical Efficient Competitor and Raw Milk Pricing

The problem

Fonterra is New Zealand’s largest dairy processor, accounting for more than 80 percent of all milk collected from farmers and about 20 percent of the country’s exports. The Government wanted to promote contestable dairy processing. To enable entry of independent processors, the Government wanted to regulate the price that Fonterra paid for raw milk to farmers. This regulated price would provide a benchmark for independent processors and farmers.

How we helped

Fonterra proposed a pricing model that would calculate the raw milk price as the difference between world prices of key processed dairy commodities (milk powders, butter and standard cheeses) and the costs of a hypothetical, efficient processor. The Government commissioned Castalia to review the pricing model. We recommended several improvements to the model. Castalia concluded that Fonterra’s model, if applied without modification, would inefficiently deter entry by independent processors.

Impact

Under the light-handed regulatory regime, the Government was able to make suggestions to Fonterra based on our recommendations. Some of those suggestions were accepted. However, concerns with the pricing formula persisted. A more recent (2018-19) review—in which Castalia also participated—recommended more heavy-handed regulation.