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Operations Quality Risk Management

Introduction

Fonterra is a New Zealand dairy company established through a farmer’s cooperative. It has grown to become the world’s largest producer of dairy products. The products are exported to over 100 countries across the world (Fonterra, 2016). The company’s product range includes; milk powders, cheese, cream, yoghurt, butter, beverages and pastries. Fonterra sources its milk from over 10,000 New Zealand farmer shareholders as well as suppliers in Australia, Brazil, Chile, Sri Lanka, North America and China (Fonterra, 2016).

The dairy industry extends from the farmers in the rural areas to consumers in urban areas and encompasses core processes such as transportation and pasteurisation. The dairy food supply chain comprises multiple stakeholders and the system is likely to be disrupted due to much vulnerability (Gold, Hahn & Seuring, 2013). The perishable nature of milk as a raw material creates many risks and uncertainties. Many of these risks are related to shorter product life cycles and customer demands regarding the products and services. Dairy companies have to find ways of minimising or eliminating such risks in order to remain viable (Glover et al., 2014).

The presence of many stakeholders increases the supply chain risk in any industry. In today’s business environment, risks and uncertainties in the supply chain cannot be handled within the company only. It requires the involvement of various stakeholders both within and outside the company. Any disruption at one stage can affect the entire supply chain. Risk management is a proactive approach that involves identification and mitigation of risks through various strategies (Gold, Hahn & Seuring, 2013).

Operational risks

Production risks are present at the farm level and affect the initial part of the supply chain, with ramifications going all the way to the consumer. They include anything that interferes with optimal production of raw milk from the farm (Gold, Hahn & Seuring, 2013). These include low milching cows, diseases, and labour shortages. Low milching cattle present a major risk as it leads to poor milk yields thus increasing the cost of production. High yields of raw milk lower the cost of production per litre of milk. Low milching cows have a direct impact on the performance of milk producers and also impacts on other stakeholders downstream (Glover et al., 2014).

Traditionally, New Zealand has enjoyed a great advantage in the dairy marketplace due to low production costs as compared to its competitors. Fonterra’s processing plants are highly efficient and produce high volumes compared to its peers. However, on-farm production costs have been rising over the years while competitors such as Argentina’s pastoral based farmers incur relatively lower costs (Trienekens et al., 2012). Fonterra can no longer rely on its comparative lower costs advantage when competing on the global stage.

Farmers are facing increasing costs of production and are likely to push for higher milk prices in order to remain viable (Ayağ et al., 2013). However, this is likely to hurt Fonterra’s bottom line, and transferring the cost to consumers might result in loss of sales. Fonterra therefore has to find ways of helping farmers cut costs of production. The company has managed to do this through subsidising most of the costs incurred by farmers. Through its cooperative arrangement, farmers get help in acquiring feeds, farm equipment and materials, veterinary services, transportation to the processing plant and storage (Gold, Hahn & Seuring, 2013). Fonterra is also promoting improved farming technologies among its farmers to improve yields in terms of both quality and quantity.

Fonterra’s current cooperative structure ensures farmers continue to control the milk supply just like in other competing countries. However, this is expected to eventually result in slower sales growth and lower profits making it difficult for Fonterra to compete with global corporate dairy companies (Glover et al., 2014). Fonterra can only achieve more robust sales and greater profits through large acquisitions. This would require large access to capital.

The loss of labourers on the farm can slow down operations and cause lower production. Many farms still rely on family members and temporary workers to help with various tasks (Gold, Hahn & Seuring, 2013). This creates a level of uncertainty over the availability of adequate labour to handle farm work such as feeding, cleaning, milking, and transportation. Diseases are also a major risk in the dairy industry and can have a major impact on raw milk production as well as product sales. The dairy products market is also sensitive to quality scandals, such as food safety incidents, that can lead to massive loss of sales (Ayağ et al., 2013).

Logistical risks are another category of risks faced by Fonterra globally. The flow of materials from one location to another in the supply chain is vulnerable to disruption. Delays in the supply chain lead to deterioration in quality and poor distribution, which eventually lead to customer dissatisfaction (Blanchard, 2010). Logistical risks account for more than half of the total risks faced at the production plant. When distribution processes are hampered, they cause perishability of products and this can result in significant loss of market share (Melo et al., 2009).

To ensure smooth flow of materials down the supply chain, Fonterra employs strict management of the supply chain in order to reduce risk (Glover et al., 2014). The company has arranged for milk to be collected from farmers on a consistent basis and transported directly to its facilities without delay. The milk transporting trucks are fitted with the latest milk cooling and preservation technology to ensure the freshness and integrity of the products are maintained. The processing plants also used the latest technologies in milk production to ensure the best quality products (Trienekens et al., 2012).

The quality of relationships between stakeholders is an integral component of the value chain performance. Proper management of supply relationships can increase profitability and competitiveness of individual companies and the entire supply chain (Ayağ et al., 2013). The basic structure of the dairy value chain starts from input suppliers who provide farmers with essential products and services needed to run a dairy farm. These include feeds, fertiliser, machines and equipment, and veterinary services. The next stage is milk production by dairy farmers, corporate farmers, and smallholders. Raw milk undergoes processing by cooperatives and both small and large companies. The products are then marketed and exported to target markets (Melo et al., 2009).

Fonterra has to take the lead in value chain governance to ensure that there are valuable interactions between firms along its supply chain (Fonterra, 2016). This requires establishing standards for product quality, processing, and logistics. These standards should apply along the entire supply chain and cover actors, activities, roles and functions of different stakeholders (Blanchard, 2010). The need for value chain governance is caused by increased trend towards outsourcing, especially for non-strategic activities. Product differentiation strategies also require compliance with a number of social and environmental standards. This makes it necessary for Fonterra to govern its value chain effectively.

One of the biggest challenges for global firms like Fonterra is the integration of their supplier chains. Several factors influence the extent to which a supply chain needs to integrated for strategic purposes (Fonterra, 2016). Members in the chain need some form of strategic alignment before their operations can be integrated under the supply chain.  Firms in the supply chain will be required to stop managing certain individual functions and have their activities integrated into key supply chain processes. An integrated supply chain will require continuous flow of information to facilitate smooth product flows (Blanchard, 2010).

Fonterra strives to build good relationships with suppliers and customers as they are the main drivers of the supply chain. This helps the company to build a supply chain characterised by agility, adaptability and dependability. In some cases, firms in the supply chain may form cross-functional teams in order to ensure the smooth flow of materials and activities through the supply chain. Fonterra has developed communication channels with its supply chain partners to enhance interactions across the organisations. This ensures that all parties involved in the supply chain remain focused and are up-to-date on the objectives, processes, changes, and measurements involved (Blanchard, 2010).

Risk Log

Risk Factors Potential failure modes Potential failure effects Severity, occurrence and delectability Risk priority number
Increased cost of production Farmers abandon dairy farming

Farmers increase milk prices

Fonterra receives less supply

Narrow profit margins

Increased prices of products

 

High 1
Logistical risks Delays in transportation

Product losses

Shortages for consumers

Low production rate

Perishability

Loss of customer confidence

Loss of market share

 

Medium 2
Increased competition Competitors with relative low cost of production

Competitors with greater access to capital

Better quality products

 

Loss of market share

Loss of suppliers

Loss of human capital

 

Low 4
Global market changes Economic recession

Tariffs and trade barriers

Corporate global players

Loss of suppliers

Lowe sales volumes

Price cuts

Increased competition

 

Medium 2

 

Risk management strategies

Fonterra seeks to reduce production risks at the farm level by organising bulk purchases of input factors through cooperatives to reduce the cost burden on farmers (Fonterra, 2016). Many farmers see the formation of strong cooperatives as a good way of tackling some of the problems they face. This can help them in hedging risks and realising economic and social goals. Cooperatives help in realising economies of scale in order to increase productivity (Ayağ et al., 2013). This helps dairy farmers to be less dependent on market and policy developments. It can also reduce the workloads of family members involved in farm work. When cooperatives are used in marketing milk, farmers are able to negotiate higher prices than when they operate individually.

Fonterra has also invested towards competitive farm structures that enable farmers to produce higher yields. The expansions of dairy operations and increasing specialisation have become important strategies used by farmers to increase their overall yield. With a strong focus on core businesses, Fonterra helps farmers in acquiring further knowledge, and building on economies of scale. These approaches help in lowering production costs and increasing milk yields. Dairy farmers have to focus on these aspects as they have little room for diversification as a way of mitigating risk.

Fonterra has strengthened its core business by establishing a secure capital structure as part of its strategy to achieve global relevance (Fonterra, 2016). The strategy is designed to grow the company’s cash payout by ensuring that it coverts more of the milk it acquires into higher-returning products. Fonterra’s aim is to create more value through its consumer and food-service operations. This will boost its global growth strategy in terms of both volume and value in key markets such as China, Latin America and Asia (Mishra & Shekhar, 2011). In New Zealand, Fonterra is providing sustainable returns to farmer shareholders over the long-term with its cash payout program.

Fonterra has established partnerships with other companies such as Abbott, A-ware, Beingmate, Nestle, and Dairy Crest in order to achieve growth in volume and value performance. These relationships have given the company access to high-quality milk sources as well as global relevance. As a result, Fonterra has managed to provide growing returns for its farmer shareholders. The company’s ultimate goal is to reach 30 billion litres of milk volumes from New Zealand and five other milk pools in strategic places around the world by 2025. The external milk pools will transform Fonterra from a regional player based in New Zealand to a well-established global company.

New Zealand enjoys a good reputation internationally for dairy products and Fonterra wants to build on this to establish itself on the global stage. The farmer shareholders’ milk is targeted to the highest-returning products in New Zealand where Fonterra enjoys significant powders experience and global market share. The company’s New Zealand ingredients business remains highly valuable to the company therefore the priority is to increase production flexibility. This will help Fonterra to make the most profitable decisions, especially during peak season. The company board approved a $555 million investment towards installing three new plants in Southland and another dryer at Lichfield (Fonterra, 2016). This will see the company increase its capacity for Whole Milk Powder, Anhydrous Milk Fat, and Milk Protein Concentrate.

Fonterra’s investments are targeted at increasing overall efficiency in terms of yield, quality, and cost of production. The Fonterra Farm Source initiative is a comprehensive approach  providing regional support and services, financial options, and discounts on farm necessities to the company’s farmer shareholders so that they can manage their farming businesses better (Fonterra, 2016). This initiative has helped Fonterra to grow its milk pool in New Zealand as well as overall share of total New Zealand milk production.

 

References

Ayağ, Z., Samanlioglu, F., & Büyüközkan, G. (2013). A fuzzy QFD approach to determine supply chain management strategies in the dairy industry. Journal of Intelligent Manufacturing24(6), 1111-1122.

Blanchard, D. (2010). Supply chain management best practices. John Wiley & Sons.

Fonterra (2016). Annual Report. https://www.nzx.com/files/attachments/244185.pdf

Gold, S., Hahn, R., & Seuring, S. (2013). Sustainable supply chain management in “Base of the Pyramid” food projects—A path to triple bottom line approaches for multinationals?. International Business Review22(5), 784-799.

Glover, J. L., Champion, D., Daniels, K. J., & Dainty, A. J. D. (2014). An Institutional Theory perspective on sustainable practices across the dairy supply chain. International Journal of Production Economics152, 102-111.

Melo, M. T., Nickel, S., & Saldanha-Da-Gama, F. (2009). Facility location and supply chain management–A review. European journal of operational research196(2), 401-412.

Mishra, P. K., & Shekhar, B. R. (2011). Impact of risks and uncertainties on supply chain: a dairy industry perspective. Journal of Management research3(2), 1.

Trienekens, J. H., Wognum, P. M., Beulens, A. J., & van der Vorst, J. G. (2012). Transparency in complex dynamic food supply chains. Advanced Engineering Informatics26(1), 55-65.

 

 


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