Wednesday, 18 April 2018

Guess who doesn't like the Commerce Commission

The NZ Initiative has a new report out on regulatory governance that argues for restructuring the Commerce Commission into a Board + CEO model. There is plenty to read and some nice infographics but when you really get down to it, there is one main justification: the businesses being constrained by the Commission don't like it.

Regulatory governance is an important issue, for sure. And the NZI report is certainly an improvement over the situation 10 years ago, when Telecom was denying that it wanted the Commission abolished after one of its lawyers raised this as a prospect. But I didn't find the report convincing for the following reasons.

First, there is an inherent contradiction in the idea that you should rely on the views of those constrained by a regulator when assessing its performance. For example, I doubt that a survey of prisoners would deliver glowing appraisals of the police, courts and corrections. Similarly, in an era when environmental regulation is increasing, I'd be wary of taking the word of farmers on the quality of local council regulation.

Second, I'd expect that regulators with a narrow focus on particular sectors and repeated interactions in those sectors to score better than those required to make decisions across many industries, many of which will have only infrequent contact with the regulator. So I'm not surprised to see (in Appendix 3) that the regulatory branches inside the Commerce Commission are rated a fair bit higher than its competition branch.

Third, the competition branch has recently knocked back some big mergers (Sky-Vodafone, and Fairfax-NZME), against the expectations of advisors to those firms who were also surveyed. These respondents would have struggled to separate their opinion on those particular decisions from their overall views on the competition branch.

Fourth, despite the NZI's clear advocacy of a board + CEO governance model, the survey data don't support this view. Of the 29 regulators ranked, only 5 of those in the best 15 have this model, whereas there are 6 with this model in the worst 14. Three of the worst 4 regulators have a board + CEO model. 

If this is the best case that can be made for the governance changes NZI wants then you can put me down as a defender of the status quo.

Tuesday, 17 April 2018

Regaining Trust

Surveys indicate that we are becoming generally less trusting of business, governments, NGOs and media. Meanwhile, several empirical studies show correlations between economic growth and the levels of generalised trust in a country.

This macro connection has many micro (sector-level) contributors, where it is indicated by the costs of zero-trust in a trading relationship. Take labour markets: if the boss doesn't trust the worker to be diligent, she incurs extra monitoring & measuring costs. The resulting systems signal to workers that they are not trusted, which tends to erode employee motivation: a vicious cycle.

Compare that to a more trusting give-and-take employment relationship, where clear directions are set and people are trusted to get on with the job. The psychological effect on workers is far more positive and most will respond with more effort, diligence and initiative.

This isn't the normal competitive market story though. The benefits of markets arise from people switching for price/quality related reasons, whereas trust relationships are built over time through mutual give-and-take. Here's how Nobel laureate Kenneth Arrow framed the resulting dilemma back in 1999:
...labour or supplier turnover in response to prices may destroy the willingness to offer trust or, more generally, to invest in the future of the relation. This leads to an important and long-standing question: does the market ... destroy social links that have positive implications for efficiency?
It is not proven that "the market" has caused the measured decline in trust but Arrow was certainly right to worry that lower trust is bad for the economy.

So how do we regain trust? There is no app, that's for sure. Maybe there are some latent exponential technologies, not yet conceived? I hope so.

More probably, we're going to need to fall back on the known methods for (re)building trust. In market settings those with the whip hand will need to take the initiative, for obvious reasons. These are relationship-specific problems, so the methods and results will vary across markets.

A few examples...

  • Fonterra just abandoned a practice of delaying payment to its minor suppliers introduced just two years ago. Though heading in the right direction, this is error correction. At the very best, it repays the trust overdraft, getting them all back to where they were 2 years ago.
  • Mass-market online trading platforms such as TradeMe know that having good systems for monitoring the reputation of their customers increases the number of trades, which is good for business.
  • Media fragmentation allows small groups to form, building inter-group trust. Which is great unless it's achieved at the expense of generalised trust in the wider community, as with anti-social media channels.
  • How's the trust relationship between EQC and the victims of the ChCh earthquakes? Or between environmentally-conscious vehicle buyers Volkswagen three years after the scam was uncovered?
Much of this is for firms to sort out by themselves, and effective competition will help do that, supported by sound anti-trust law, market design and regulation. But maybe we also need pro-trust policies? I'm going to wonder about this for a while and would appreciate any thoughts you might have.

Wednesday, 11 April 2018

Regional Dairy Regulation

The original 2001 version of the Dairy Industry Restructuring Act (DIRA) allowed Fonterra to form, subject to regulatory constraints including free entry & exit provisions. Anticipating that independent processors (IPs) would enter and attack the mega-co-op's share of farm-gate milk supply, DIRA included sunset provisions that would effectively dissolve the regulatory constraints once IPs captured 20% of milk supply in each island.

Last year, two reports cited Fonterra's market share of farm-gate milk at 84% nation-wide and it seems the 80% trigger has actually been breached in Te Wai Pounamu. In response, Minister Damien O'Connor has bought time by getting Parliament to repeal the sunset provisions, and launched an inquiry with potentially quite broad terms.

Regionally different rules should be an important consideration for the inquiry. In regions with plenty of competition the case for regulation is much weaker than in regions where Fonterra remains a monoposonist. This is true for farmers and processors.

  • Farmers in competitive regions have alternative supply options so it is fair to question whether they need still regulatory protection.
  • There may also be a case for using regulation to lean against the further addition of capacity in regions where excessive capacity is a looming threat, in favour of monopsony regions.

The two-island structure of the existing rules seems inadequate for today's market structures. For example, farm-gate milk collection remains a Fonterra monopsony in the top-of-the-south (Nelson-Marlborough) where we are located, even though Fonterra has lost more than 20% share in Te Wai Pounamu as a whole. I'm not sure how a proper geographic market definition analysis would pan out, but I am sure that one is needed. 

If there are regional markets, dairy regulation might need to change quite a bit in response. Here are some obvious questions to get us started.
  • Is there any need for the milk price manual in competitive regions? It was needed when Fonterra was so dominant that "market" pricing would have exposed farmers to hold-up risk, but competition pushes the milk price up so once Fonterra loses enough market share, maybe there should be no constraints on the farm-gate price.
  • How should the farm-gate milk price be set in other regions? Suppose Fonterra starts paying above the manual price to retain market share in competitive regions. Do we still need a milk price manual for other locations, or could those prices be pegged to the market-determined prices in competitive regions?
Obviously there are lots of other interesting questions facing the review, but since one of the objectives is to promote competition/contestability the geographic boundaries of markets are probably about to become important.

Thursday, 29 March 2018

Slow Learners?

We dined last night with a couple of Fonterra directors, a few senior staff and a bunch of fellow farmers at the Brightwater Motor Inn. I didn't learn much, but neither it seems have they.

After the standard review of the half-year results, there was plenty of time for questions. They focused on the Beingmate debacle and Leonie Guiney.

I got the ball rolling with a couple of questions. The slide pack showed the Beingmate share price and indicated that the write-down bought the book value into line with the share price. But if the share price is any guide, then significant write downs should have occurred ages ago - so why didn't that happen? [answer: KPMG mumblefuck Discounted Cash Flow] Also, isn't this a closely held stock with very low liquidity? [um, yes]

Others piled in. Surely there must have been a problem with the due diligence? [hell no, there was over 400 pages of it] After the Sanlu bungle, Sir Henry promised we'd never take a minority stake in China again, why did you? [even a majority in China is no safeguard] Have you set a time-bound decision path for exit? [something about patience, & that Theo will obviously be highly motivated to push this along before he leaves]

I was listening closely for some comment about what Fonterra had learned from this obvious cock-up. On the second go with the mike I noted that according to the board, this wasn't Theo's fault and the due diligence was top-notch. So was it just bad luck, or did we learn something?

The board's answer was to blame execution, i.e. management, but we never got even a vague hint at what we might do better next time.

And please, this was definitely a board error. China has what Bloomberg called a dairy duopoly. They have 44% of the market between them. The next largest has 4.8% and Beingmate is not even mentioned. So when you hear a Fonterra director saying it's a top brand, they mean for infant formula only.

Consider the following timeline, bearing in mind that Fonterra was created by Parliament as a national champion, as requested by the dairy industry leaders of the day.

2001: Parliament passed legislation (DIRA) to allow an almost complete merger of all dairy processors in New Zealand, for various reasons, creating a contestable monopsony that was gung-ho about cost savings and upside potential. 
April 2008: China signs first free-trade deal with a developed country, NZ, which you'd think would give us inside running with China's dairy industry, right?
September 2011: Theo Speirings begins CEO role at Fonterra. Knows all the stuff about international markets and that.  
January 2012: Nestle tips $400m into a JV producing milk in Northeast China. 
May 2013, Danone buys 4% of one of the Chinese duopolists. 
March 2015, Fonterra buys 18.8% of Beingmate for $752m, "paying a high price to raise its presence in China’s branded infant formula market...given that many multinationals are investing heavily and demand expectations are easing".
For reasons unknown, despite being all internationally-savvy & despite having persuaded  the pollies to give them local market power, and even with the first ever FTA edge, Fonterra took the ultra-slow boat to China. Nestle and Danone and others were way ahead: we got goosed because no-one was alive to the game.

Not Theo, not the board, no-one. bugger. We could've been Danone in 2013, paying 325m euros for 4% of a duopolist. I bet we wouldn't be writing that down now. 

Leonie Guiney
Right at the death, using the last question of the night, some wonderful man pointed to the hiterto invisible elephant in the room: Leonie Guiney, suggesting that if Fonterra is going to so much trouble to gag her, there must be a pretty serious problem. 

The responding director was happy to dwell on how crucial confidentiality is to the efficient running of the co-op, then rashly inquired if this sorted the concerns? Not for me, I said: Guiney was voted in by farmers, the board didn't like her, the board persuaded us to change the director appointment process, through which Guiney was knifed.

In response, we were all detained by a long description of how tough the new process is, and why that toughness is so great.

Final Thoughts
The cult of managerialism hasn't worked out well in this case. Theo and his board were all asleep at the wheel for a few years, so they can't blame him. But they don't want to take the blame themselves. So he's leaving and they're staying.

Not just staying, but exerting more control. Being the right people for the job, the board sees its job as including the expulsion of others, like Leonie Guiney, who don't fit a particular mould.

As a shareholder, I'm pretty grumpy about this whole thing. I think the board is captured by its advisors: management, partners, lawyers & merchant bankers.

Friday, 23 March 2018

After the Face Plant

The scandal over Cambridge Analytica's plunder of Facebook user-data has highlighted a much deeper problem: the business model for Facebook is tailor-made for propaganda.

Two issues arose from the scandal:

  • Cambridge Analytica scooped information from all the friends of the people who did their personality test; and
  • Facebook didn't tell those people their data would be used this way.

The first is not much of an issue. Facebook could have sold that extra information but chose instead to turn a blind eye, allowing CA free rein, presumably in the expectation that it (FB) would later be able to charge CA and it's future rivals once this new propaganda business had been proven.

As for the second issue: not telling people? Well that's a breach of trust and FB will obviously have to do better while it tries to regain that trust.

BUT everyone knows that FB sells access to its users, don't they? And is advertising really all that different from political propaganda? If you're happy to allow (say) drink advertisers to test messaging on small target groups and then run the best messages more widely, what difference does it make if the advertiser is seeking votes instead of drink purchases? You're already well into manipulation.

Still, somehow it feels way worse when the ultimate prize is control of a country rather than just more market share for some product or service. Why is this? One reason is that politics often turns out to be a winner-takes-all game, even under MMP, whereas even if you don't like the drinks market leader you can just buy one of the smaller brands. Another is that we have a system of competition and fair-trading laws, and ultimately economic regulation, for commercial merchants but no corresponding constraints on political parties.

So even if we're OK with FB selling our secrets to commercial advertisers, we might reasonably object to those same secrets being sold to political propagandists. But what should we do about it? Here are a few ideas I've come across in recent days.

  1. Prohibit FB from selling access to user info. This is an extreme position that would eliminate the company's existing revenue streams. Usage could no-longer be "free" - you'd have to pay in more explicit ways such as cash.
  2. Break it up because the problem is that it's too big. Also extreme, this one is based on analogies from different industries in the past (Standard Oil and the Bell System).  I think this would just shift the same problem to the baby-FBs as previously occurred with the baby-Bells.
  3. Regulated open-access. An interesting idea that treats FB as a natural monopoly and forces it to offer access to a new layer of competing client interfaces that would have their own rules, norms etc.
  4. Conduct regulation. Forget all that competition nonsense (#3), just formulate some rules about the kind of cash-paying customers FB is allowed, require it to report regularly on its customers & their spending, and stomp on violations.

My feeling is that this scandal has exposed threats to our democracies and that we should the thinking of ways to counter those threats now. There are probably other options but at this point I lean towards #3 or #4. Better quality information for taxation purposes would be an added benefit of these options.

Wednesday, 21 March 2018

Regional Air Services

Regional Development Minister Shane Jones is way out on a limb, beating up on AirNZ for withdrawing air services from Kapiti and (back in 2015) Kaitaia. As Andrew Geddis noted in this thread, AirNZ is not an SOE and its directors are obliged by law to maximise profits.

I'd add that the deficiencies of competition law currently allow/encourage AirNZ to play the following dynamic game:

  1. withdraw regional services from a location 
  2. watch how the smaller airlines fill the service gap
  3. observe that at these lower prices demand increases
  4. eventually decide the market is big enough again
  5. re-enter with price/connection combos that the small airlines can't match
  6. burn them off, increase prices and enjoy life until
  7. demand starts falling away at AirNZ's now higher prices
  8. start again from #1

I'm blaming competition law for giving AirNZ a free rein on #5 and #6.

The same gap in our competition law gives free rein to any firm with substantial market power in any market to use that power to unilaterally restrict competition. Competition professionals have all known this for at least six years.

So, Shane, mate, how about fixing the laws instead of beating up on people who optimise against them?

Thursday, 15 March 2018

Dettloff Delivers

Peel Forest Hall was full on Tuesday for a tutorial from organic vet and old American guy, Dr Paul Dettloff, who ran a cow-based vet practice for 21 years in Wisconsin, until his commercial world changed in 1988. Some of his biggest customers switched to organics and signed up to a new co-op that has since become the massive Organic Valley business. 

Responding to market signals, Dettloff started researching and cooking-up natural cow remedies based on plants such as garlic, echinacea, and aloe vera. Decades later, aged 76 he's still advising Organic Valley's farmers, selling his tinctures and generally staying engaged in his life's passion: healthy cows.

He did 3 talks. The first was about soil and covered the main components of biological/organic farming: Albrecht's cation balancing guidelines for soil structure, trace elements and the foliar feeding of microbes & trace elements. Along the way Dettloff drew parallels between healthy soils and healthy digestive systems in cows. For example, intestinal philli were analogised with root-hairs; and the optimal soil pH was said to be the same as the cow rumen at which fertility is optimised. The theme was: feed your cows a healthy diet & you'll have little need of a vet.

The second talk was framed around a list of about a dozen tools available to organic dairy farmers. I'd have preferred more time spent on this. There was a lot of interesting stuff about the role of different plants and how to get those roles activated in a cow, eg through mucus membranes. It just came through very fast, so I'm looking forward to reviewing it more slowly on the video.

The third talk was about reading cow hair, such as the escutcheon lines between the vulva & udder that identify production and other patterns indicating heat, pregnancy & good health. It included comments on bull configuration and opinions on breeding objectives.

After lunch we went out to see some of Bryan Clearwater's cows and continue the discussion, including about how to avoid dry cow therapy, stray voltage and pointing out features of the cows.

In a diverse crowd, I met 4 people with whom I had previous indirect connections and enjoyed discussing our mutual reasons for being there. For me, it was like a meeting of the slightly off-beat farmers' club. Sadly, I did not run into Glen Herud, though he was there.  

Dettloff invested against a constraint and has developed what looks like a great range of alternative remedies. Competition in action.