UNCORRECTED TRANSCRIPT OF ORAL EVIDENCE To be published as HC 227-iiHouse of COMMONSMINUTES OF EVIDENCETAKEN BEFOREENVIRONMENT, FOOD AND RURAL AFFAIRS COMMITTEE
DAIRY FARMERS OF
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This is an uncorrected transcript of evidence taken in public and reported to the House. The transcript has been placed on the internet on the authority of the Committee, and copies have been made available by the Vote Office for the use of Members and others.
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Transcribed by the Official Shorthand Writers to the Houses of Parliament: W B Gurney & Sons LLP, Hope House, Telephone Number: 020 7233 1935
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Oral Evidence
Taken before the Environment, food and Rural Affairs Committee
on
Members present
Mr Michael Jack, in the Chair
Mr David Drew
David Lepper
Miss Anne McIntosh
Dan Rogerson
Mr Roger Williams
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Witness: Mr Stephen Yates, former Chairman of the DFB Members Council, gave evidence.
Q644 Chairman: Good afternoon, ladies and gentlemen to the penultimate evidence session on our inquiry today, farmers of Britain, and we welcome once again Stephen Yates, who is the former Chairmen of the Dairy Farmers of Britain Members Council. Mr Yates was very kind in coming and talking to the Committee a little while ago when we held a hearing in private, but he said some very important things so we decided to ask him if he would be kind enough to come back and say them in public, so here he is. It is not often, Mr Yates, you get a double booking from this Committee, but it just shows the popularity with the Committee to hear what you had to say. I wonder if we could start with what I might call a mechanical question: could you describe the role and the powers of the Members Council for DFB?
Mr Yates: Yes, thank you, and thank you for your welcome. The Members Council's basic functions are governance functions, to represent the members. If I can start with how we created a Members Council, the total litreage was divided into 25 million litre blocks and that was known as a district. It wasn't geographical, it wasn't by the number of farms, it was by litres of milk and it could encompass any number of farms, depending on the size of those farms. At the outset we had 82 such districts. Those districts then elected a District Chairman once every three years and they did that on one vote for 200,000 litres per farmer. So that was the only form of proportional representation. From that point on the District Chairman took forward the views of that district. He took it to two forums. One was the Regional Council, so that if the country was split up into eight regions theirs would encompass 11 or 12 districts and they would meet, probably, bi-monthly. They also went forward onto the main Members Council, which met somewhere between four and six times a year and it was one man, one vote on there. The Council elected its own chair and vice-chair and its principal roles were the selection and election of the board, the appointment of the auditors, the authorising of any rule changes, the authorising of the business's ability to borrow money and to spend that money if that sum involved - initially £15 million was the ceiling, anything over that they had to come to us for consent - and initially the board could borrow up to £100 million. Two years after our formation we raised the ceiling to £200 million.
Q645 Chairman: I just wanted to look at that particular power because it was certainly obviously on my list, the review of the limit. How did you go about, as a Council, doing that? How often were you asked to come to a decision as to whether the ceiling on borrowings was correct for the company at the time?
Mr Yates: We were only asked once to do so and we agreed to, and that was in the months leading up to the acquisition of ACC. If you recall Philip Moody's evidence, he told you that they were looking at three projects at that time. The Council weren't aware of that. We knew they were looking at projects, but we didn't know what they were. Moody told you one was in the same order as the ACC acquisition and he used the figure 50 - 60 million, and another one was substantially more, it was 200 million plus. So at that time when we asked we were given no details for confidentiality reasons. You have to understand that the Council was only brought into the loop of understanding on projects when they were very, very close to being finalised.
Q646 Chairman: Was one of those bigger projects anything to do with buying out farmer members of Arla, because we found something in the sort of dairy press which indicated that there had been some kind of sniffing around that. It was not entirely clear what was being suggested, but there was public mention of it in the dairy press.
Mr Yates: I can't answer that question categorically because we weren't told. We were clearly told what the second project was, the £50-60 million project. That was actually the potential purchase of the assets of Dairy Crest that in fact First Milk went on to purchase, which is the two cheese factories, and at that time we were clearly told, "We've been in negotiations. We've dropped them. It's too dear," and Malcolm Smith's words were, "At 60 million quid it's too dear. It'll come back on the market in two or three years' time at 40 million." If I can go on to say that the larger one - I suspect the Arla suggestion was a red herring to keep people away from where it actually was. We had constant discussions with Arla over the years about merging, about this, about that, but in fact the target almost certainly would have been Dairy Crest.
Q647 Chairman: On the one occasion you were asked to review this, how did the Council come to a decision that whatever number you said was the number was the right number? What kind of advice did you have access to?
Mr Yates: Mr Moody did to the Council what he did to your Select Committee, with respect, sir. He talked for an hour and a half to the Council and at the end of it he'd bamboozled us into agreeing. What he told us none of us could probably remember to this day, but it all sounded very fine and very noble, and we went down that route. You have to remember that in the first year or two of formation, if you imagine the first year of putting together two very different organisations, the Milk Group and Zenith, the very, very different cultures they came from, putting those together was no easy task and so for the first 12 months we were scrambling and getting the structures in place, and then we on the Council under the chairmanship of the first Council chairman were very heavily involved in training, in understanding our roles and developing the functions of the Council.
Q648 Chairman: But in that context, so that I am absolutely clear, you did not as a council feel the need to go to an external advisor about, if you like, what was the amount of borrowing that a business like Dairy Farmers could actually absorb, stand and service? You did not have any external advice on that?
Mr Yates: Part of the process of creating Dairy Farmers of Britain - and through that period I am talking about we had quite a bit of coaching from Rabobank, we had a guy called Kirk van Dyke from the Dutch institute of cooperation, who used to attend most Council meetings and he would talk us through various aspects of the business and how we should handle it, and that sort of thing. In addition, we would have had speakers. We had the Chairman of Dairy Farmers of America. We had people trying to bring us up to speed in what questions to ask.
Q649 Chairman: You made an interesting point because obviously Mr Moody knew everything there was to know and, you are quite right, he spoke very eloquently in front of the Committee, but perhaps where we have the advantage is that we can conduct a compare and contrast operation between what one witness says about something and what others say. You perhaps were not in such a privileged position to be able to undertake that kind of exercise, but what I am just trying to pin down is, however much you were being trained to be aware of the importance of this kind of financial analysis you, as the Council, were being asked to make a decision, which was, "This is the level of borrowings which we feel comfortable with," that Dairy Farmers of Britain can look after by the various means at your disposal to raise that kind of money. Just for the record, you said you were being coached by Rabobank, but Rabobank at the beginning was one of a consortium of four banks which were effectively part of the funding operation for Dairy Farmers, were they not?
Mr Yates: No, that was subsequent, that was when we were doing the ACC acquisition, but there are two very separate divisions of Rabobank. There is the banking arm and there is the advice and information arm. So we were talking to their advisers.
Q650 Chairman: But did they give you a written opinion?
Mr Yates: No, and we didn't ask for it.
Q651 Chairman: Why not?
Mr Yates: We've all got, as you will understand - I've got a BA Honours Degree in hindsight now! At that point in time, there was a huge wealth of information coming and I have to say, in defence of some of the practices that took place, this coop was created in a surge of enthusiasm to get into processing. So make no mistake about it, the Council was pushing the board, "Get on with it." I told you before when I came we had a clear vision and a clear strategy and our end game was a top quartile milk price in three to five years. We knew that members would not invest heavily without an end game that produced a financial benefit on the farm, so we pushed the board. I have to be honest, we pushed, "Get on with it. Get us into liquid processing."
Q652 Chairman: So with your newly acquired BA in hindsight, when you look at the advantages and disadvantages of a governance model where there is a council made up, if you like, of well-meaning members, some of whom are trained, some of whom have some knowledge and some just have a lot of interest, what do you think the advantages and the disadvantages of the Council set up actually were?
Mr Yates: It was a very robust body, I have to say. I'm sure that once we'd got past that initial surge of enthusiasm and the Council got much more skilled in how to question the board, and through the board the executive, it was a very robust body, but was it the right mechanism? In the beginning it was too large, for certain, 82 was an extraordinarily difficult body to control. Eventually, we actually reduced it twice, we cut it down to 62 and then I, in my tenure as chairman, cut it down to 35. So the mass was a difficult situation to handle, and indeed my predecessor as chairman, John Loftus, one of the reasons I think we elected him was that we knew he was a strong disciplinarian, and he was. He didn't suffer fools gladly and he virtually made the training compulsory. Although we were all free men, if you like, if you didn't do the training he felt your collar and urged you to do it! With hindsight, well done to him, because we all needed it. Most of us were raw off the farm, but as a body I feel that certainly after that first year, 18 months, I think it worked very well.
Q653 Miss McIntosh: Just to follow up on what the Chairman was asking and your comment, how did you get up to a grand figure of 82? You said you had advice from the Dutch and I am very interested in the European model for cooperatives, but how relevant was the advice from the Dutch to what you were trying to do?
Mr Yates: Very relevant. We should have listened harder and acted upon some of it, as we did. For instance, the Dutch on all their cooperatives have a farmer chairman, full stop, and he was very, very, very insistent we should have a farmer chairman and was very upset when we didn't. But the Dutch models are slightly different from ours. They have a board which runs the business, which tends to be all exec, or non-exec, and then they have what they call a farmers' supervisory board, so it is a slightly different model from ours. As ever, we looked at their model, brought it over here and changed it. We never seem to be able to bring something over that's successful and just use it, full stop, we have to change it and fiddle with it! So that was the key difference as far as that was concerned, we didn't have a farmer chairman.
Q654 Miss McIntosh: How did you get up to 82?
Mr Yates: Because at that stage we claimed to have two billion litres of milk divided by, whatever it was, 25, and that's how it worked out. So it was just simply a mathematical equation. For instance, to get down to the final Council that I was chair of with 35, by then our litreage was down to 1.2 billion litres, and we had upped the litreage to whatever, 35 million litres.
Q655 David Lepper: I was unable to attend some of the earlier sessions of this inquiry, so you will forgive me if I ask something which may well have been dealt with then. It is my ignorance, perhaps. At any stage in the formation of Dairy Farmers of Britain was a form of governance other than the cooperative or industrial and provident society model considered? Would other models have been more appropriate? Were they considered?
Mr Yates: From the Council's point of view, the interim board came to us and said, "This is the model you're going to follow," full stop. It wasn't a decision of the Council. When Zenith and the Milk Group were talking of coming together we created an interim board which was part theirs, part ours, and they set the rules, they set the constitution, in negotiation primarily with Rabobank and with the Dutch institute of cooperation. So we were not involved in that. Did the board consider any other models? I don't know, is the honest answer, but certainly from the ethos of the Milk Group I would expect them to have done so.
Q656 Mr Williams: I think you said that the Council had access to the executive team through the board. Did you have any direct access to the executive team?
Mr Yates: Yes, is the answer to that, but part of the training that we did in roles and responsibility, and governance, talked at length about who does what. Now, the board employed the senior executives. They were in effect their line managers, they answered to them, and therefore in open council sessions we would talk with executives, they would make presentations to us, but in no sense would we grill them. We grilled the board, if you like, and it tended to be in council sessions. The morning would be executive presentations on various aspects of the business and it may be the executive's perspective on a proposed move, and in the afternoon we would have a board session where we could, as I say, go into some more detail with the board. But the chairman of the Council and the chairman of the board were very insistent that we did not, as a council, interrogate executives. That was not deemed to be proper, but on a personal basis, as Chairman of the Council, I did of course have access to them, but once again most times I would do it through the chair and if I had a problem I would always approach the chair of the board and say, "Could I talk to the chief exec about this?" So the protocols were pretty strong. I would imagine I'd be fairly confident in saying they were the same protocols that are in the other main dairy cooperatives. The executives can't be answerable to everybody, otherwise they'll never get anything done, and if you allow farmers to do it, the farmers take over and they'll question every aspect of the business and they expect the chief executive to know. So there were some very strong protocols that we respected and which were there for a purpose so that you could get on with the business of the Council.
Q657 Mr Williams: Just to remind us, the board had a majority of farmer members but there were some non-executive directors who were not farmers, but the farmers were in the majority were they not?
Mr Yates: Yes. Mr Knight got a bit confused when he was talking to you about what the board was and wasn't. It started off as an interim board, as I've said, and when we elected a board proper it was five farmer directors and three non-farmer directors. The five farmer directors were selected. The Council instigated an interview process where anybody could be nominated, but they had to go through an interview process, and from that interview process the interviewing panel, which was chaired independently of the Council, made a recommendation to Council of who should be voted for. Now, the Council did not have to follow that recommendation, but it did every time. So from amongst the membership of the large, I think first time round probably 20, 25 people put their names forward and from that five were elected, and can I be clear at this point Mr Knight tried to give you the impression they were five farmers fresh off the tractor. Nonsense! Three of them were already with board level experience. John Grantchester, Michael Arlington and Robert Clarke all had board experience, some of it fairly extensive, so there were actually only two new boys on the block, two completely new boys.
Q658 Chairman: These were paid appointments?
Mr Yates: These are directors, farmer directors employed in exactly the same terms as the other non-execs, at that time £20,000 a year plus some extra days at £400 a day. Can I just go to say the non-exec directors at that stage were gifted to us by the interim board, of which Rob Knight was one and there were two others. We had no say in that, other than to formally elect them, and I think that is a key point for the future. Never again would I sit on a council that took the board's recommendation for a non-exec director as openly as we did.
Q659 Chairman: Can I just cut in for a second? Would you care to comment on a point which was raised in our evidence session with Mr Moody about a possible conflict of interest, because he was a non-executive director, there because of his financial expertise but his company was providing services on a paid for basis professionally and he did not seem to be too troubled about that and, in fairness, did provide the Committee with details of what was involved, but in terms of having a wholly uninvolved independent financially qualified non-executive director who could provide challenge, I think there was a feeling when we probed that that might be a problem. Did you ever think about that?
Mr Yates: The Council constantly challenged that. Certainly in my tenure as chairman we constantly challenged his impartiality, constantly, and indeed I took some persuading by the chair of the board to agree to Mr Moody's re-election for his second term of office. We were very uncomfortable with that and we had twigged by them that Mr Moody talked a lot and delivered very little. We had one member of the board who shared those concerns and I will be unequivocal: if we weren't where we are today with the collapse of DFB he would not have got another term, that is certain, because the Council was tired of the reassurance that it got, which never satisfied it on that point.
Q660 Mr Williams: I probably misunderstood you, but I thought you said that the chairman of the board was not a farmer, but John Grantchester was a farmer?
Mr Yates: No, the chairman of the board was Rob Knight. John Grantchester became chair of the board in November 2008 and Rob Knight was sacked. When we merged the interim chairman was David Stern, a farmer businessman from the Milk Group side of it, and he brought Rob Knight to us and indeed back in February 2003 proudly introduced Rob Knight to us, "This is your chairman." Last night I read through what we were told, the fact file on the new appointments, and I am aghast that we accepted it then, but we did and, yes, I have to hold my hand up, I was part of the Council then. We simply took it as read that this man was capable of chairing the company to where we were. When I look at his brief c.v. in there now I realise there is no way he could ever have done it. He had never run anything other than a bath in his life! He was a sales manager. He may have been a very good sales manager, but he had never run a business. The guy who had run the business, Malcolm Smith, who you are meeting next week, he sacked him after twelve months. So twelve months down the line, having bought ACC, we had a business headed up by somebody who had never run a business!
Q661 Mr Williams: How can you describe the relationship between the Council that you chaired and were a member of before that and the board?
Mr Yates: It was a pretty robust relationship but it wasn't, as somebody picked up from me last time - I can't remember the term we used. It wasn't hostile, but it was robust.
Q662 Mr Williams: It was not a riot?
Mr Yates: It wasn't a riot, no. I am very insistent about this: the Council, both in John's tenure and in my tenure, always conducted itself absolutely properly, but that didn't stop it from being pretty robust. There was only one occasion in my chairmanship where I had to publicly face the chairman and insist that he did something. The rest of the time it was detailed, it was interrogative. They would say that sometimes we were hostile, but at times we had reason to be hostile to them, but nonetheless it was civil, it was proper and it was very thorough. On a private basis, I met the chairman of the board probably once a month. That, most times, was a compete waste of time because I knew what he was going to tell me before I got there, and he told me. He was not a man who liked to share information with us. I think senior executives as a whole don't want to tell anybody more than they have to and I suspect at times they didn't tell the board the whole picture. They told the board what they were asked, but -
Q663 Chairman: That was a point you made before because I have a note of the conversation there. Why do you think there was this resentment from the chairman of the board, and indeed the chief executive, because the Council continued to probe and ask for things? I thought the whole idea of the cooperative ethos was together for the common good?
Mr Yates: Well, some of the Council were more intelligent than him, so that didn't help, did it? I mean, my vice-chairman, for instance, Jane. He was terrified of Jane because she could outnumber him any time of the day! He used to say, "For heaven's sake, don't bring Jane with you." She could just out-think him, full stop. So some of it was protection. He was trying to keep to himself and to hide his inadequacies. He was at his most comfortable when he'd got Philip Moody next to him because Philip could do the talking for him, but all this is with hindsight and I accept that. I mustn't give the impression that there was an internal war going on, there was not. There most definitely was not. If it was commercial information about brand development or project this, they would tell you all the frothy stuff, all the nice stuff, bring out the pictures, this is what they're going to do, that's what they're going to do. When it came to numbers, that's when they get cagey.
Q664 Mr Williams: That is what I was going to ask you. You said you had a session in the morning with the executive and a session in the afternoon with the board. Was it the executive that gave you the sort of turnover figures, the profit margin?
Mr Yates: The CFO would go through the numbers for us, quarterly, half-yearly and yearly. He would go through them. We would then question the CFO, but we would also question the chairman of finance, or indeed the chairman of the audit committee as well, and if there was an area where I felt, as chair, it was getting too intense, I would stop the questioning there and bring it back again on the board session, or indeed on a private session, because we always had the ability to pull it in and say, "Right, it's private now. All staff out, all executives out, and we need to get down to it."
Q665 Mr Williams: What was your impression of the level of financial detail that was provided?
Mr Yates: It was good. I need to pick up some of the NFU's views on this. The reporting standards at Dairy Farmers of Britain were as in a plc. In the last accounts they were done to IFRS, the same standard as any plc, so the reporting standard and the annual report contains all the info that it would have done if it was a plc. In addition to that, I told you earlier we appointed the auditors, Ernst & Young, and we had the same auditors right through. The auditors were good friends to the Council and it irritated Rob Knight that I had a good relationship with the lead auditor, and I have to say it irritated John Grantchester also, who was chairman of the audit committee, and both of those tried to stop me meeting the auditor because they were aware that the auditor was giving me information outside the actual annual accounts and he was flagging warnings up to me about what wasn't being done and what should be done but in monetary terms. But at all times, I have to say, I am totally confident that the financial he gave was proper, was right and it was at a depth that we could understand. Bear in mind most of us had done at least two different modules of financial training to help us to understand the balance sheets and the trading accounts, et cetera, et cetera, so I am satisfied that the level of the -
Q666 Mr Williams: So after the morning session with the executive you then had the opportunity to talk about these things with the board. Did you get the impression that the board understood the figures or was keen enough to interrogate the figures and were they able to answer your questions?
Mr Yates: Yes, is the honest answer to that, I think. The area that they never took us into was the banking, the key area. They would talk to us about the level of borrowing that the business had, the ceilings, and when they re-negotiated - during the course of its life it re-negotiated its banking twice and we were made aware that they were re-negotiating the banking and when the negotiations were concluded we were told, the last time for instance, "Right, the ceiling is now 82 million." We were never told specifically about where the peaks and troughs were and in any dairy business the peaks and troughs are huge. You have two huge spikes every month, on the 16th when you pay your members and on the 25th when you pay your staff, and those are always the problem areas. The further we got down the line, and certainly when we knew there was trouble afoot, then they did open up a little bit but even I, as Chair of the Council, didn't know the truth about the banking numbers until the last three months of the cooperative's life.
Mr Williams: Can we just go back to the composition of the board very quickly?
Q667 Chairman: Just before we leave that point, we probed you earlier on about the Council's role in setting the borrowing limits. It seems to me if you are going to be continually able to respond to that agenda, in other words to know if the company was in good health, that you as a council should have had continual advice on the borrowings of the business. You are almost sort of saying, "Well, we didn't know about it," and I am saying, well, why didn't you know about it? Why didn't you sort of gird your loins and go back and say, "Oi, come on, we want a 'health of the nation' message here"?
Mr Yates: I think it was made pretty clear to us that that was an area of detail that we were not entitled to. In those questions we would have been told clearly, "The farmer directors are your representatives on the board. They know what's going on with the bank and they are comfortable with it," and in fact one of the key challenges I faced in my chairmanship was at the start of my chairmanship I approached both the chief executive and the board chair and said, "What's the key problem?" and they all felt - there was unanimity - the key problem was there was a wall between the Council and the farmer directors and the farmer directors were being held by the chairman of the board saying, "Don't tell them anything," and the Council was saying to these - it's a very, very difficult role, farmer director. It is an extraordinarily difficult role. The non-exec directors do not get tested night and day by farmers, by farmer members, by council members for info. A farmer director cannot do anything. He can't go to a family party, he can't go to market, he can't go anywhere without being buttonholed!
Q668 Mr Williams: Like an MP!
Mr Yates: "What are you doing? What's happening about this? What have you done about that? What have you done about the other?" So their defence mechanism, probably like an MP, is to say as little as possible!
Q669 Chairman: You've learnt something since you've been here, I can see that!
Mr Yates: Because it is extraordinarily
difficult and bear in mind - and the receiver told you this - they investigated
33 projects in five or six years, so they've got a huge amount of info going
through their heads and one slip of an info - and I can give you an example of
this. We were in talks with Milk Link to
merge in 2007 and all our projects had code names and I found out the code name
- it was
Q670 Chairman: So you have got a sort of internal tension then, have you not?
Mr Yates: Absolutely!
Q671 Chairman: I can understand the point you make about farmer directors being vulnerable and I can understand about the need for any company at board level to keep certain confidences, but one of the tasks you had as a council, which was effective communication with the members, was therefore inhibited by a lack of clear information flow? In other words, the candid exchange about the forthcoming attractions effectively was an impossible task to fulfil because people were concerned about information in confidence but they could not subject themselves to the sort of creative challenge which the Council might have given had the Council been privy to some of the things you were talking about. So there is a sort of fatal flaw in terms of the way the relationship operated in these emerging commercial situations. Would that be a fair summary?
Mr Yates: Yes, possibly. The Council would always ask at every half year and every year, "Have we met all our banking covenants?" "Yes." The one time we broke a banking covenant we were told what the covenant was, what that one particular covenant was. Now, I don't know how many covenants there were on it. I would imagine there were seven or eight, but I don't know. So we would ask that and that would be our reassurance, if you like. We didn't need to know the numbers because we'd been reassured that we had met all our covenants, we had stayed within our banking." We were reassured, full stop. I mean, if you look at 2008, in March 2008 the board came to the Council with a proposal to pay dividend interest, something we had been pressing them for, but my Council's capital group had said, "Don't do it yet. You can't afford it." The board came to the Council and said, "We're going to do it and we're going to pay 7.5 per cent," and the Council, rightly or wrongly, said, "Great!" My capital group, the thinkers, the monetary thinkers on the Council, said, "Wrong! Don't do it. You shouldn't promise a dividend before you know what monies you've got to pay." However, the Council passed it. We went round the membership, "Here we are, we're going to pay out a dividend." Happy members! It's not often that happens. In June the board put on a 0.5p price increase. So it's agreed to pay a dividend and it's put a price increase. In September I approached one of the non-exec directors to see if he would act as interim chairman when I removed Mr Knight and he said yes, so I had three clear signals that all was well in the banking world, in the finances, clear, clear signals. We had had Talking Point telling us some rubbish about we were a business on track. We told all our members. This is all at the same period of time. All that tells you everything is well in the world, and yet within six weeks the bank had submitted a letter to the board that caused mayhem, claiming that we were in danger of breaching it. How does that happen in that space of time, in that speed? That's an area that nobody seems to have probed into. It went from satisfactory to in dire trouble in a very short space of time. Now, at what point should the Council have been told that? They weren't told that then and, as I say, it was only in the dying months that I find out the sort of figures they were talking about at that stage. If we had known the banking levels all the way through, it wouldn't have helped us in understanding what happened in that period of time. I still don't understand what happened in that period of time. I haven't had the information. I haven't got the information to be able to do it, to understand it.
Q672 Mr Williams: Thank you for that. I have a few quick questions about the structure of the board. Why did the Council believe that there should be more farming members on the board than non-farming members? Was it because of some of the poor experience you had with the non-farming members?
Mr Yates: No, no, to start with it was thought that we had to have a farmer majority to protect our interests, probably through a lack of understanding of the board members' responsibility, because any board member, it doesn't matter whether he's a non-exec farmer or indeed an exec farmer, he has identical responsibilities. His responsibilities are to the business, not to the suppliers, not to the employees, but to the whole business. So they had in fact got exactly the same responsibilities. In those early days we felt it absolutely paramount that we had a strong majority so, as I have told you, we had 5:3. The board chairman came to us after a couple of years and wanted another non-exec director and at that stage we said, "Okay, you can have another non-exec director, but we're putting another farmer director on to keep the majority." So we then went to 6:4. I think in the last two or three years that thinking changed and eventually when I put a restructure paper forward for the board we restructured it down to 4:3. With hindsight - the degree I told you about earlier - my personal view is you want good directors and what tag they have in front of that doesn't really matter. The key strength the farmer directors have is that they are the key communication tool because they can stand up in front of a meeting of farmers and deliver the good, the bad and the ugly in a robust manner. Some non-exec directors, quite frankly, would run a mile before they'd go into a room full of farmers, and that's perfectly understandable! Some of the farmer directors were less good at that aspect of it, but that was one of their key areas of strength. As I said, I think with hindsight now and looking back now I am sure that the Council as a body would be less concerned about that balance. Having said that, as events have turned out, as DFB appeared to be in trouble the non-execs fled, the rats jumped off the ship, and I was left with four farmer directors, and if we hadn't had four farmer directors left, where on earth would we have been then? But make no bones about it - I have forgotten which one of you it was, but one of you asked Mr Moody why he resigned. I have to say to you he lied to you. He categorically lied to you because he told you - and I have got his words here - he left the board because the company was in severe danger of becoming insolvent and it was not consistent for him as a professional to stay. He told the Council an entirely different pack of lies.
Q673 Chairman: What did he tell the Council then?
Mr Yates: He told the Council - he was stupid enough to put it in black and white so I'll quote it exactly --
Mr Williams: Take your time. I think we would like to hear this!
Q674 Chairman: Yes, don't worry.
Mr Yates: "Non-executive director stands down. Dairy Farmers of Britain non-exec director, Philip Moody, has decided to resign from the board. Philip has taken this decision to allow him to focus on the role of the strategic adviser to the company in his capacity as managing director of Smith Williamson Corporate Finance." That is not what he told you. He's a rat and he's a lying rat!
Mr Williams: Right!
Q675 Mr Drew: It's usually MPs who say this!
Mr Yates: Sorry about that.
Chairman: I think you have made that very clear and it is on the record! Don't be frightened. I won't say anything!
Q676 Mr Williams: Did the Council have a clear understanding of the vision of the board? Was the board able to convey that vision?
Mr Yates: Absolutely, yes, and I have to support the board here. A lot of the evidence you have heard has been about the acquisition of ACC. When we set out the acquisition of liquid dairy processing was our key objective. It was the objective of the Council. It is what we tasked the board with. We wanted to be in liquid and added value. We wanted the top quartile milk price and I think I could say with confidence if the board had ever come to us and put forward the project that Moody talked about, the purchase of the cheese factory from Dairy Crest, personally I certainly would have rejected it. I suspect the Council would have rejected it. We knew that purchasing commodity cheese factories would not get us a top quartile milk price. We were convinced of that, so liquid processing was where we wanted to be, and I have to say to this day - and I disagree with the NFU evidence here where they say our strategy was wrong - I believe our strategy was right. I believe the purchase of ACC was right. Maybe at the wrong money, but right to achieve what we set out to achieve. What was wrong was what we did with it thereafter. We took on some old, tired factories, some not so old and not so tired, but we had customers, we had a product, we had a brand. We had what we wanted. What we needed then was what Rabobank had advised us to get, a nasty dog of a chairman - sorry, a CEO. We were told, "Your CEO should be a nasty dog, kept on a chain! Don't talk to him, don't get friendly with him, just tell him to sort your business out and" - excuse this language - "there needs to be some blood and snot on the floor to sort the business out." That was the language used to us. Instead of that, we got a pussycat - you saw him asleep here last week - Mr Cooksey, who couldn't sort out his 'in' tray, and that's where it went wrong, it was the management thereafter. You have spent a lot of time talking about the acquisition of ACC and the due diligence, and this and that, who could have paid what. The only clear figure I know for certain is that the interim chairman, David Stern, started that negotiation at £57 million. We finished up paying £75 million plus £6 million costs. There is talk of due diligence showing an issue of 10 to £12 million. I would urge you to question Malcolm Smith because Malcolm Smith privately claims he was told to pay £10 million more. I don't know why. That's your job, to question that guy and find that little bit out, but in terms of that due diligence can I just nail that one as well? The Council talked a lot about due diligence and at that stage we were never told it was vendor due diligence.
Q677 Chairman: You were not?
Mr Yates: No. We were told that due diligence had been done but the word "vendor" due diligence was not used. Can I also correct another of Mr Moody's little lies - well, big ones actually? He blamed Llangadog, which was the Welsh canning, drying and butter production factory, as one of the causes of our demise. He also said they didn't know. Lies! When we were asked to approve the acquisition of the ACC group, Malcolm Smith's words were - and I remember them precisely - "Llangadog is a problem. It's a bag of nails. We're going to put Jerry Smith in there to look at it for three months and see whether we can do anything with it." He was true to his word. In the following January he came to the Council meeting. He said, "It is a bag of nails. We're going to get rid of it, but we can't afford to close it now. We're going to close it in the next financial year, on 1st April, and it's losing us £500,000 a month in the meantime." So we did know about it, the Council knew about it, so Mr Moody and his project team for certain knew about it. Why they bought it, Heaven only knows!
Q678 Mr Williams: Okay. Can I just ask you one last question then? What options were open to the Members Council if it did not think that the board or the executive team were doing an adequate job?
Mr Yates: Well, in theory we could sack the board, and indeed Mr Knight left because I asked him to, but he was the only one that we ever asked to leave. Exactly why - that was the board's responsibility. So the board sacked Malcolm Smith. It happened to be that they sacked him - I assume they timed it deliberately - this is about twelve months after the ACC acquisition. The regional chairmen were meeting for the first time ever at a hotel and having an overnight stay before they did some factual visits and training and they sacked him that day and came and told us. We still don't know the reasons why Malcolm was sacked. I have no idea. If you asked different directors in later years you got different stories. So in terms of executives, none, and Rob Knight wasn't inclined to listen to you. I was urging him to remove Andrew privately. I lost faith in Andrew in January 2008 - Andrew Cooksey, the CEO. I knew the week when we had an incident that occurred and I went to Rob and said, "Look, we can't have this." I have to say, and the same goes for Lord Grantchester, I urged John, when we made John chairman - which was a mistake but it was an unavoidable mistake, but when we made John chairman I urged him to get rid of Andrew straight away, and indeed Andrew was waving the surrender flag. Andrew wanted to go because he knew he was out of his depth. It didn't happen, but I didn't have the power. The only time I could have had the power was when John became Chairman. I've told you the rats had left the ship. We had four farmer directors left and I called a meeting of the board, the four and Andrew, and said, "Right, what are we going to do?"
Q679 Mr Williams: You had four left?
Mr Yates: Yes, we had four farmer directors left, no non-exec directors and a chief executive who was waving the surrender flag, so I called a meeting and said, "Right. Who's going to chair the board?" It actually came down to John Grantchester or Stephen Yates, and I wasn't even a member of the board. The board were canvassing me to take the chair of the board. I said, "It's got to be John. He's got the City cred, he's got the integrity. I know he's not a leader, but it's got to be John." It was a mistake, but it's all we were left with. That letter which I've talked to you about before from the bank crippled me as Chairman of the Council. It crippled me for bringing in new non-executives. Once the word was out, there was that letter floating around. The non-exec directors, as soon as they looked at a bit of due diligence on the company, they found that letter and that was the killer. They were gone. Nobody wanted to jump onto the ship.
Chairman: Okay. A brief supplementary from Dan Rogerson and David for the other parts on ACC, please.
Q680 Dan Rogerson: Thank you very much. My apologies for not being here at the beginning of the session. You commented about farmers having a long-term vision for a top quartile milk price. With your experience in hindsight, as you set out for us, do you think there was a tension between that and the sort of medium-term viability of the company, that you were pushing too far too fast on that?
Mr Yates: I think the farmer directors exerted a pressure on the board as a body to build a milk price. That was an unfair pressure, but - and I know they are behind me - First Milk have got exactly the same pressure now and if you yield to that pressure and pay more milk price than you should, you damage the business. If you don't yield to that pressure, you damage the membership and once you've got a member's notice in you've got a problem because when your next milk year starts you can't put your volume in your volumes going forward, so that is the bank covenant. You have to repay his capital. I don't know what First Milk 's terms are, but with us it was ten years down the line and we knew we were looking at having to pay, if we had remained in business, in 2015, the first year of pay out we would have had to find £8 million in capital to pay out to the members. The truth of it is that we wanted to be in dairy processing but we didn't want to pay for it. We wanted to own the business, but we didn't want to pay for it and the price of building - I don't think anybody should underestimate the massive challenge for the three - First Milk, Milk Link and Dairy Farmers of Britain. The challenge of building a modern processing business in this environment with no capital whatsoever to start with is massive. It is an enormous challenge and the mentality behind it of farmers wanting a business but not being prepared to pay is very, very difficult.
Q681 Dan Rogerson: And in the long-term building a culture of cooperation?
Mr Yates: Absolutely! Well, have we got a culture of cooperation?
Dan Rogerson: That is what I am saying, if the members are pushing in that direction there might be tension there, of course.
Chairman: David, I think we have covered a fair amount on that, but there are one or two things you might want to raise.
Q682 David Lepper: I want to just take up a point you have just made. There is perhaps also the problem of having a business model which did not allow the members of the organisation necessarily, even if they were able to, to invest sufficient amounts of money into that capital development?
Mr Yates: Apart from the retention money, which is the compulsory investment, you could buy the investment bonds as well, so you could over-invest if you wished to, and a small number did, quite substantially. I can think of one who put in over £100,000 because he believed in what we were doing and he also saw it, when he was promised 7.5 per cent, as a good investment. It doesn't look so good now! Sorry, I shouldn't be facetious.
Q683 David Lepper: I want to also ask about the acquisition of ACC, which you have already dealt with, but if I could just ask one or two extra points about that. I gather there was as series of regional meetings over the weekend prior to the special general meeting of the Council?
Mr Yates: Yes.
Q684 David Lepper: The directors and the executive management team attended those regional meetings?
Mr Yates: Yes.
Q685 David Lepper: What kinds of information were available at those regional meetings?
Mr Yates: They took two forms. At very short notice, indeed on the Friday
night, the regional chairman was rung by a board member and told, "Get all your
regional chairmen together on Sunday at
Q686 David Lepper: So the timescale of that and the mood in which those meetings took place was one that suggested a kind of inevitability?
Mr Yates: Actually, what I missed out is that we were put on red alert the week previously and that was cancelled, and we were never told why. It was because one of the bankers had pulled out, because Rabobank pulled out. Subsequently we found that bit of history out, but we weren't told why.
Q687 Chairman: Why did they pull out?
Mr Yates: Rabobank? You're asking the wrong guy. You should have asked Mr Moody that. There were two arms of Rabobank involved, weren't there, and if the banking arm didn't follow the management investment arm, I would have thought that was quite a clear sign that there was something not pretty good about this deal, and in fact what happened is the Cooperative Bank stepped into their shoes. It was £11 million, I know what the figure was, and the Cooperative Bank funded that £11 million slice of it and they were the first to be repaid and come out of the syndicate, but I don't know the reasons for Rabobank pulling out and we weren't told at that stage that a banker had pulled out and that had caused the delay. We weren't told that.
Q688 David Lepper: You were anticipating my next question. So that was not known?
Mr Yates: That was not known, no. What was known was - they gave us a
reasonable description of the properties and the customer base. There was no mention of this
Q689 David Lepper: You did not know that the due diligence was vendor due diligence?
Mr Yates: We were not told. We categorically were not told it was vendor due diligence.
Q690 David Lepper: Therefore, my assumption is that members of the Council did not see the due diligence report?
Mr Yates: No, absolutely not.
Q691 David Lepper: You only knew what you were told about it?
Mr Yates: Absolutely! Absolutely! The words Malcolm Smith used were, "When the deal is complete, then we will send a team in to lift the manhole covers." That was his terminology.
Q692 Chairman: I can partly respond to one of the challenges you threw out. As I say, the Committee has many and various ways in which it can find out information and run a cross-check on what people say to us, and we have been given on a commercial in confidence basis the reasons why Rabobank did pull out. I was just interested to know whether you knew that. That was the reason I asked that question. One of the things that comes across from what you were saying, if we just go back a little way, you made it very clear that you on the Council, and therefore reflecting the members' view, were absolutely clear that you wanted to get into the processing business, you had made it absolutely clear that you felt this was the route to a higher milk price. I just wondered whether you reflected at all, because you also made another comment earlier on about the very competitive nature of the world into which you were going and the difficulties financially that that was presenting, because one of the things, again with the benefit of knowing what happened, was that when it came to sustaining the business that was ACC (i.e. supplying the Coop) the package that Dairy Farmers had acquired was not capable of being sufficiently competitive when that business was put to the test in the commercial marketplace because it would appear that when bids went in for the Coop's business, if you read their evidence they had four different tests by which they were judging who was going to win it, but ultimately they accepted a more competitive bid for their milk business than Dairy Farmers was able to make and given -
Mr Yates: "They" being CRTG you are talking about, the Coop Retail Trading Group?
Q693 Chairman: Yes. I was just wondering, because you have obviously got, and a lot of the other members have got a very good feel for the milk business, because that is what you are in, did it ever occur to anybody that there was a potential vulnerability in terms of competitiveness, reflecting on the point you made a moment or two ago about the nature of the assets that you were acquiring? In other words, if you were up against people like Arla and Wiseman, who have got an enormous amount of investment in brand new kit and were obviously aggressive in the way they were pursuing business, did anybody actually think, "Can we keep up with them? How vulnerable is this business?" because it seemed to be like a pack of cards? Once the Coop business had gone, then the rest just fell down around it.
Mr Yates: Very much so, and we devoted a lot of time to talking about this. The great strength of ACC was that it had a distribution network. Malcolm Smith's words were, "The jewel in the crown is its distribution network." The Coop CRTG, the Coop stores, at that stage none of them had central distribution, it was all delivered direct to store. To deliver direct to store you can't do what Mr Wiseman does, which is to back a 39 tonne articulated and shoot the milk out. You have to have 39 tonners, 20 tonners, 7.5 tonners and dot those here, there and everywhere, and we had that. One of the things that CRTG told you was we delivered a brilliant service to them and we thought - the business believed - that the service would maintain it whilst it developed another customer base. We knew we were vulnerable from day one. The Coop was taking 600 million litres a year, or 400 million. The Coop were taking 60 per cent of the volume out of the factories. That was too big a chunk, so we had to win business elsewhere, and I remain very supportive of our ambition to get into Tesco and the local choice scene. That was a deliberate strategy, to reduce our reliance on the Cooperative and get into another major multiple. But sticking with the Cooperative, when we bought ACC Robert Wiseman had not got planning consent to build his new factory down in the South West at that stage, so there was no significant competitor down there at that stage. The day he got planning consent we knew we had a problem, because we knew that Robert Wiseman gets his efficiency by filling his factory, full stop, and we knew he would compete for volume at any price to fill his factory, and that's exactly what he did. When the first term of the contract came up he tendered 1.34 a gallon and we tendered 1.40 a gallon and we couldn't do it for less, so he got it. The second lump of CRTG business, which was in the South East, at that same negotiation Andrew Cooksey negotiated with the CRTG Group that they would build a central distribution centre and they would take on the distribution, so we would deliver milk in the artic lorries and that had a cost in that region of circa £10 million. Twelve months into the contract, which would have been in August 2008, Andrew went to the CRTG and said, "Where's your central distribution depot, which is part of the deal, and if you're not going to build it we need 10 million quid more," but of course by then you've got Robert Wiseman who still wants to fill his factory further, so we got knocked out there. The last third, the third that killed DFB - and let's be under no illusion about this - the last third that CRTG took out they took it knowing it would kill DFB and that was tendered by DFB at £1.60 a gallon. Sorry about the imperial thing but that's how the trade worked, metric going in and imperial coming out, probably to obfuscate it so that none of us can find out what their margin is!
Q694 Mr Drew: The missing money!
Mr Yates: Yes, but we tendered £1.60 a gallon and just to give you a marker at that stage Local Choice milk was making £2.70 a gallon out of their factories. We tendered £1.60 and in the December knew that we had not got it. Gerry Smith went back to the Coop, to CRTG, and said, "Look, you know, the loss of that volume will be fatal to us. If it's a couple of pence we'll have to come down a couple of pence," and the headshake, "No, it isn't." So that tells me that Robert Wiseman took that at £1.55 a gallon. Nobody could have lived with that. Robert Wiseman couldn't, but it gave him his factory efficient because it was that last 15 per cent that filled his factory up, so he's got the efficiencies, full stop. This is not a criticism of Robert Wiseman. I wish we had such a ruthless bastard on our side, but we didn't! Excuse the phrase.
Q695 Chairman: It is important that we understand and you have given us, if I may say, a very helpful chronology of the ultimate removal of the business that finally caused, if you like, the financial pack of cards to fall down because in listening to what everybody says we have been trying to establish where did it go wrong? Did it go wrong because there was something fundamentally flawed in the Cooperative model? Did it go wrong because there were certain suboptimal commercial decisions that were made? Where did it go wrong? Because if you are going to draw any conclusions out of this exercise it is how can you prevent it going wrong again for others who have a cooperative style of doing business as opposed to those who have a more normal commercial style of doing it? So we are very grateful to you for having shone some more light into the way this particular problem occurred.
Mr Yates: With respect, Chairman, it doesn't really matter whether it's a cooperative, an individual, a plc, it is about who leads it and how they lead it. That is all it's about and once again with hindsight, the NFU talked to you about how we need to have better performance benchmarking, we need to have an independent financial scrutiny of the business, reporting to Council. Nonsense, absolute nonsense! How on earth could you do that? Where councils need help is in making sure that the people who run that business are the right people and I would never again be involved with a business where somebody walked in the door and said, "This is your chairman," or, "This is your CEO." If I was in a position of responsibility I would pick that person up, shake his pockets out, say, "Why you?" and when he told me why I would say, "Well, prove it," and when he'd proven it I would take him out and get him drunk and see what he told me then! I would be much more thorough in the choice of the individual. It all, at the end of the day, comes down to one or two key people at the top.
Q696 Chairman: Mr Yates, thank you for your candour. It has been extremely refreshing to have some straight answers to some questions we have been able to put. I am glad you have been able to come back and join us again this time on the record. We very much appreciate your patience with us. I think you have genuinely given us some extremely helpful insights into what occurred and I suppose we do have the luxury now of being able to compare and contrast what you have said with what others have said as well, but nonetheless we are very grateful to you for coming in and giving evidence to us again today. Thank you very much.
Mr Yates: Can I, in closing, just say that when the decision was taken to close the business down can I commend our staff? What happened from 2 June, on through June, was a formidable task to get every farmer away to a safe home with no loss of milk. Thanks to the receiver for the way he acted and the HSBC, who funded that, but predominantly to our staff, not to those rats in the offices but the people on the ground floor, the people on the end of the phone. Our membership team were fantastic because you can imagine what happened, what the phones were like, and not a one ran, not finance, not membership, not anybody. They stayed there and did their job until the receiver said "Enough" and I can't praise them highly enough for that because it would have been so easy to say, "I don't want any of this," because you've got mad farmers screaming down the phone at you. I absolutely commend what they did. If our leadership had been half as good as the rest of our staff, I wouldn't be here today.
Chairman: That is on the record. Mr Yates, thank you very much.
Memoranda submitted by First Milk
Examination of Witnesses
Witnesses: Mr Bill Mustoe, Chairman, and Mr Jim Maguire, Finance Director, First Milk, gave evidence.
Q697 Chairman: Welcome to our second evidence session this afternoon and can I formally welcome Mr Bill Mustoe, the Chairman of First Milk, and Mr Jim Maguire, the Finance Director of First Milk. Thank you very much for coming to talk to us this afternoon. Just before we start, I think you have another engagement that you have to go to, is that correct?
Mr Mustoe: We have made a little bit more time in view of the overrun, so we are fine. Whatever you want to do is fine with us.
Q698 Chairman: Okay. We will try not to detain you unnecessarily long. It has been good, though, that you were here because I think you got a flavour of the main sorts of areas of interest. You at one time as a business, as I understand it, were interested in ACC but you decided not to make a bid on that. What did you learn when you looked at ACC and came to that conclusion?
Mr Mustoe: I think the best person to answer that is Jim Maguire because I have been with First Milk since the end of October so I was not around at that point in time, although I do know some of the stories, but I am sure Jim would like to tell you.
Q699 Chairman: Mr Maguire, what is the answer to the question?
Mr Maguire: Chairman, thank you, I can answer that. I was probably the lead executive looking at the purchase of that business on behalf of First Milk. We did enter the bidding process but our investigations revealed that the business model was fundamentally flawed. The business of ACC was over-reliant on one customer and was therefore very vulnerable when that contract came up for renewal, which I think was for a three year period. Our estimate at the point that that business was for sale was that it needed further investment of around £36 million just to bring the factories up to speed.
Q700 Chairman: When you say the extra, that is just, so that I understand, over and above what -
Mr Maguire: Over and above the purchase price. Our assessment was that the factories needed further investment just to bring them up to a reasonable standard of £36 million.
Q701 Chairman: Are you able to tell us what you thought it was worth?
Mr Maguire: For us, we wouldn't have bought that business. Our assessment was that the assets were tired and inefficient and really it had to be closed down, so therefore from our assessment the only viable purchasers of that business should have been existing dairy processors, who could have closed it down, merged it in with their existing facilities, got the economies of scale and the resultant synergies.
Q702 Chairman: So what you are saying is that if you had bought it, it is the customer base that would have been the thing that was worth something and the assets were worth nothing?
Mr Maguire: Yes. The customer base was certainly worth something.
Q703 Chairman: I do not want to push you into areas where you feel uncomfortable, but can you give us some kind of order of magnitude as to what, from your standpoint, that business was actually worth in money terms? What would have been a purchase price, a range, just a figure?
Mr Maguire: Well, for one of the existing processors a fair price might have been 40 to £50 million, but that's with a view to then closing the factories down and merging the production in with their existing sites. That was one of the reasons why we didn't continue in the process to bid for that business. We stood back because for us the only viable purchaser would have been one of the existing dairy companies.
Q704 Chairman: As Mr Yates said, with the great qualification in hindsight that we have all now acquired we have had a chance to observe the events which sadly unfolded following Dairy Farmers of Britain's acquisition and then subsequent loss of business, and then they lost their whole business. When you watched that, if you like from the benefit of the stands whilst the game was unfolding on the pitch, did you draw any particular conclusions from that apart from the fact, as you said, Mr Maguire, "From our standpoint commercially it wasn't the right move to make"? Was there anything else you derived from that by way of saying, "Hmm, we've learnt a few lessons from that. It will guide our business in the future"?
Mr Maguire: Well, certainly we didn't take any comfort from the demise of the Dairy Farmers of Britain business, absolutely no comfort. What it did do was it proved that our assessment was right, which is not hindsight because we drew that conclusion six years ago when we had an opportunity to buy the business. Certainly what we have learned is that we don't overpay for assets. Any investment that we have made, we have not overpaid and we are very mindful of the balance between the milk price that we pay and the requirements of investment within the business that we have in terms of capital investment or just investments in terms of making the business more efficient. So we are very mindful of the balance between the milk price and the investments we have to make. Unfortunately, you heard from Mr Yates's evidence that they were perhaps overpaying on milk price, which in the end brought the business down.
Mr Mustoe: Could I add a point about that? Having done some 20 acquisitions or divestitures, when you are involved in leaping forward and making a major step there is a tendency among management to underestimate the downside. In fact one always talks about synergies, upsides, all that sort of thing and the first thing you should probably talk about is the risk to your existing business. I think that is something that probably wasn't done, from the sound of it.
Q705 Chairman: In terms of the accounting principles which you obviously will apply, at the end of the day you can have a lot of discussion but it does come down to an assessment of the hard numbers. I think in your evidence to us you describe your approach as conservative with a small "c". Can you just explain what you meant by that and how perhaps that impacted on your assessment of ACC?
Mr Maguire: Well, in terms of our assessment we did go through a rigorous process, albeit sometimes a gut feel gives you an instinct if it doesn't pass the smell test. But we did go through a rigorous process. We involved professional advisers as well just to make sure that our management assessment was being verified independently in terms of the price we were prepared to pay. We certainly wouldn't have paid the sum that was spent in terms of the goodwill premium for that business and in fact in terms of the investment that we have made in our cheese processing, just to give you an example, we bought at net book value or in fact a discount to net book value. We did not pay over the odds. We didn't pay a premium for goodwill. So in terms of conservatism I think that's what we are referring to.
Q706 Chairman: Just help me on one point, because Mr Yates emphasised, if you like, an observation which is consistent with all of the witnesses from DFB, that their wish was to move forward in the liquid milk business because they felt that was the route to, I think it was, being in the upper quintile of prices. You, on the other hand, went down the cheese production side, but your farmers probably were just as enthusiastic about getting a good price for their milk as others were. Just help me to understand. Why did you decide to go down the cheese route and not the liquid route?
Mr Maguire: Well, if I can expand just to give you a bit more background about our business and how it relates to the UK diary industry as a whole, the UK dairy industry is primarily made up of the liquid market, which is around, I would say 50 per cent of milk goes into the liquid market and around 30 per cent goes into cheese and the balance goes into a range of products. So therefore our strategy has been to be involved in all of those sectors, not necessarily owning the business outright, maybe through a joint venture or maybe through a shareholding. For example, we own 10 per cent of the Robert Wiseman Dairies business, so we don't feel we have to necessarily own all of the assets on the liquid side but we have developed a strong relationship over the years with the Robert Wiseman Dairies business. We have a fairly substantial shareholding, being 10 per cent of that business, and we sell a substantial amount of milk to the Robert Wiseman Dairies business. Also, we have a strong relationship with Dairy Crest, one of the other major players. We sell a substantial amount of milk, raw milk, to Dairy Crest. In fact the other major player, Arla, we also sell milk to Arla, so in terms of liquid we have developed our business through our relationships with the major players.
Q707 Chairman: So it is more brokerage than process?
Mr Maguire: It is, yes, but in terms of
cheese, the cheese market is obviously well established in the
Chairman: Very good. That is very helpful.
Q708 Mr Drew: As you appreciate, the premise upon which we started this inquiry was to some extent how fallible was the cooperative model and what level of responsibility was there in the structure of the way in which that model was operated which caused the problems with Dairy Farmers of Britain. What is your view on that premise now?
Mr Mustoe: The cooperative model, in my view, is no different from any other consumer goods business. It is absolutely vital that you achieve four things and those are the right product that the consumer wants, great service to your customers, which is usually the retailer, low cost of operating - and you have to invest to get that low cost - and innovate wherever you can, and in my 30-odd years of experience in consumer goods the great companies do those things. It is very simple. Whether you are a coop, a plc or a private company, those are the bread and butter things of running a business.
Q709 Mr Drew: Notwithstanding that, are there specific things which actually lend cooperation to this sector of farming and are there things, mainly size, which militate against it being as effective as perhaps the plc?
Mr Mustoe: I think size is no guarantee of success in the food industry because the end customers are powerful people and they will make their presence felt if they think you are getting a little bit above your station. So you fall back on the efficiencies of how you operate and the Wisemans of this world are very, very good operators of their business and it is a principle which in First Milk we are pursuing with vigour. There is a difference from the plc and I think it was brought home to me in the first months where I met some 700 farmers out of our 2,500 plus, which is that they are not ordinary shareholders in the sense that they are expecting a dividend and if it goes down it's annoying but it's not material in terms of their existence. The difference with a coop is that you have the ability as a business to mess with people's lives and if you run your business poorly then those people will suffer, and I think that's a huge difference and it makes for a massive responsibility on the coop's shoulders in terms of they have a direct effect on people's lives, not just the people who work for them but their major shareholders. I think that in a sense drives the sort of communication that you need to do, which is different, and you need to understand that relationship in terms of how you actually operate your board and your business.
Q710 Mr Drew: Is there anything we can learn from abroad in terms of the way in which cooperatives operate in the food industry and is there something to do with our legislative framework that makes it more difficult for cooperatives to operate in this country compared with Europe?
Mr Mustoe: With three months' dairy
experience I am probably incredibly dangerous at the moment, but clearly the
coops in Europe historically have been going a hell of a lot longer and I think
you have to look at how the current coops have actually arrived, where they
have come from. They are relatively
young businesses. It would be easy to
say - and I know Jim has a view - in terms of if you look at their history
governments have by and large either supported or not put impediments in the
way of growth. I think your view, Jim,
is that probably there are some hoops that you have to go through in the
Mr Maguire: Yes, just to add to that,
there is a lot to learn from cooperatives throughout the rest of
Q711 Mr Drew: Finally, just looking at a different area, this issue to do with the structure of your board and the relationship between executive and non-executive directors, I presume you are going to tell me you got it right?
Mr Mustoe: No, I am not actually, I am going to tell you we are changing it!
Mr Drew: Right. Okay, you write the script!
Q712 Chairman: This is the afternoon we had expected!
Mr Mustoe: We have a board composed of 11 people, six farmer directors, so they have a majority, three non-execs including the chairman, so non-farmer non-execs, and two executives, the chief executive and the finance director. What I think is difficult - and I feel for farmers greatly - is that in order to be elected to First Milk's board as a farmer director you have to be two things: you have to be a dairy farmer, and presumably fairly good at it, and you have to know how to win local elections. The principle of that means that there is a little bit missing in terms of business acumen, potentially, and it has concerned me. We have got some very good farmer directors. We have got 26 local representatives who are elected by the membership and they then elect the six directors. On my trips around it actually occurred to me that there might be a better way of doing it and I floated an idea in November which surprised me with the response it got, which was, I think we should change the make-up of the six farmer directors to have three elected and three selected, and the process of selection is that the membership can nominate, suggest names from the membership of people who have proven business acumen, who have perhaps done or are doing things within their business beyond the traditional dairy milk side, and we were not tapping into that expertise because of the election system. Some of these people do not want to go down that route of a sort of step change, so I have instituted as of this week a communication requesting if members would like to nominate some people with experience. I have been very surprised at the response, which has been terrific. It is a rule change and we will put that to the AGM subsequently, but I expect to get probably up to ten members who are not in that system who have some kind of expertise that may help the board in terms of their involvement. So I intend to work with those perhaps eight to ten people, however many come forward, over the six months, assess their characters - and they might tell me they don't want to become a director of First Milk, that's entirely possible, but we will use that time before we actually try and make the changes, so I think that is good. The other thing where I think we are wrong has been historically and I think from listening to the earlier session it maybe is something that is worth thinking about, which is that in my experience businesses win because they are good teams, and it is teams right across the business, so what I did in November was to allocate two farmer directors to each side of the business, cheese, liquid and ingredients, because what I want to do is fuse the farmers into the business and vice versa so that you can't have this separation between executives who may wish to, in times of stress, perhaps not be quite as open as they should be, but also it helps the farmer directors in terms of their learning. So we are already doing that and that is actually working quite well.
Chairman: Thank you very much. David.
Q713 David Lepper: I am interested to hear about that change that you are proposing. You know that in their evidence to us I think the NFU suggested an independent evaluation of the business performance of coops. The former vice-chairman of the board of DFB was rather critical of that suggestion. Where do you stand on the issue?
Mr Mustoe: I think we should be as open as we possibly can and we have changed significantly the level of our communication with members. We do have obviously auditors, we have some internal extra work done by an outside company and I think that, frankly, is the way you have to go because I think the dangers come if you don't communicate. So we are communicating most weeks with the membership in some form or other. We started a new system where I record a message to members and they can dial in and listen to what is going on. We tell them, we are fairly open. Obviously when you get into some of the commercial areas it is always difficult and you have to get a balance of that, but I believe you have to be straight with them, you have to tell them when you've got a problem and you have to tell them how you're going to fix it, and just be open and do that. That's what we've done.
David Lepper: Thank you.
Q714 Chairman: I would like to move on to the question of the cooperative model and the tough job of raising capital. You have made the point, and in fact Mr Yates in his earlier evidence underlined the fact that our cooperative dairy ventures are fishing in a pool which is occupied by people who are able to raise money commercially or they are big cooperatives like Arla of very longstanding and they have accumulated a war chest of capital investment funds. Our late starters in the field have got a big job of catch-up to do. You have obviously got a clear strategy for your business and you are a coop, but are there any things in the way that the cooperative model is presently structured which, if you like, inhibits you in terms of the progress you would like to make, because I think you made the point that to all intents and purposes you were like any other plc but you have got slightly one arm tied behind your back because of the constraints of the cooperative model, so what are those?
Mr Maguire: It is probably well documented that there are constraints of the cooperative model in terms of current legislation, which limits the capital investment by individual members to £20,000 and that is set out in well outdated legislation. There are suggested reforms going through Parliament to take away that £20,000 limit, which we would fully endorse. So within a coop there is a balance there that we have to strike in terms of raising capital and at the moment it has to be largely debt-based because of that £20,000 limit for members. It means that for us to grow the business we have to take money from our members in the form of debt, which has to be repaid, and we also have to borrow from banks, which again has to be repaid at some point. Therefore, there are constraints within the coop model that a plc wouldn't have, it is able to tap into shareholder funds, but we are different from a plc. Our aim is to maximise the income for our members, for our farmers, whereas for plcs it is to lower their input cost and to pay as much as they can to shareholders. So the objectives of plcs and coops are different.
Q715 Chairman: Let me just pick you up, because I have been trying to understand the proposed amendment to the Industrial and Provident Societies and Credit Unions Order, which as you right say has been laid before Parliament, and as I understand it what this particular measure proposes is to remove any limit on permanent member capital by stating that any nominal withdrawal of equity in a cooperative is ignored for the purposes of the £20,000 limit. Just help me to understand in practical reality terms what on earth does that mean?
Mr Maguire: What it means is that our
members pay a retention - well, they did up until last year but we have stopped
at the moment, but our members have been building up funds over a number of
years. Cooperatives in
Q716 Chairman: You have given me a very good explanation of where we are, but what I was actually seeking was to understand whether this proposed legislative change would actually make a material difference, which is why I read out carefully my understanding of what it actually achieved because I am struggling. When it says "removes the limit", any limit, "on permanent member capital," in other words it removes the £20,000, the mechanism appears to be by stating that any non-withdrawable equity in the cooperative is ignored for the purpose of the £20,000 limit, because I had understood exactly what you said, which is effectively the retentions became a loan note so they ended up as debt on the balance sheet under the existing arrangements. That is why I was struggling to understand what this proposed change was going to give you that you could not already achieve by the existing mechanism that you so eloquently describe. That is where I was struggling.
Mr Maguire: My understanding is that there would be no cap on the £20,000 so a member could invest £50,000 in capital, which at some point could become tradable and there would be no requirement on the business to fund that exit.
Q717 Chairman: Okay. Just explain one thing to me because there appears to be obviously a conflict between the various ways in which a private company can set about raising capital and what is permitted under the cooperative model. Whilst I can understand that a placement of equity would be incompatible because the business is already owned by the members, so we can rule that out, but what about corporate bonds, in other words capital instruments? What is the problem with them as opposed to going all the time to the banks?
Mr Maguire: The way the coops are set up
the coops are not very attractive to attract corporate bonds and from the
coop's point of view it could create a conflict between milk price and the
interest on capital that I think we would need to pay out to those corporate
bonds. There is not a great demand in
the corporate bond market to invest in coops, especially since the coops in the
Q718 Chairman: If you go to the bank to get your funding the bank will quote you a commercial rate commensurate with the risk they see in your business, it is as straightforward as that, and in terms of long-term finance, which if you are funding capital investment maybe you are looking for funding over five, possibly ten years, I don't know, it depends on the nature of the project, and the characteristic of the debt that you would then be taking on with the bank does not seem to me to be a million miles away from what a corporate bond would look like because the advantage of a bond is that once you have placed it in the marketplace you know what you are in for, you have got a certain percentage or a certain interest rate you have got to pay and you know there is an end date where you have got to pay it back. That is, again, a similar parallel situation to borrowing from a bank, where the bank says, "Okay, you can have this money for ten years and at the end of the ten years you've got to pay it back." So just help me to understand. Technically there is no reason why you could not have corporate bonds, am I right in saying?
Mr Maguire: Absolutely! Technically what you say is spot on. The difficulty for someone investing in our
business is that - it is not just our business, other coops within the
Q719 Chairman: In other words, the rating that your paper would get would be relatively low and the premium would be accordingly high?
Mr Maguire: The premium would be huge.
Q720 Chairman: So we can rule out equity, we can rule out corporate bonds, we have currently got perhaps some strictures on what members can put in because of the mechanism we have discussed, so I suppose at the end of the day it is the banks or bust really, is it?
Mr Maguire: That's right, the banks and members through the debt instruments, but yes, it's all linked to borrowing from members and borrowing from banks.
Q721 Chairman: So there is not another way round the problem of funding? In other words, what we have seen before us is really the only route down which you can go?
Mr Maguire: Well, the route of members being allowed to invest fixed capital that doesn't have to be repaid, that would improve our position.
Q722 Chairman: Because the Continental counterparts, again just to be clear, you are saying that the bulk of their capital has come because of retentions over a very long period of time, which has given them their war chest to do whatever they are going to do?
Mr Maguire: That's right, and those capital sums, for example with Fonterra, are tradable so if a member wants to release some capital he trades it. It's not the Fonterra business that has to repay capital to him, so Fonterra can get on doing its business without having to worry about repaying the members.
Q723 Chairman: So when you say the debt is repayable, they have got an instrument saying, "Fonterra owes me £10,000," and they can take that, I presume, to a bank who will pay them out at discount?
Mr Maguire: Similar to the way the stock market works, they can trade it.
Q724 Chairman: Right. So there are people who will buy that paper knowing effectively, in the case of Fonterra, that you have got a global dairy player, a big strong business? In other words, they are looking at it almost as a corporate bond, are they not?
Mr Maguire: Yes, that's right.
Q725 Chairman: Because they are saying it is quality paper?
Mr Maguire: Yes.
Chairman: There is no element of default likely to come on it. Dan, you wanted to com in?
Q726 Dan Rogerson: Just briefly, one of the restrictions is £20,000, that is it, and over and above that it is counted as borrowing?
Mr Maguire: Yes.
Q727 Dan Rogerson: Is there a period in which the coop has to pay that back, or is it open-ended?
Mr Maguire: Well, it depends whether the member retires from milk production. There is a set period over which that would be paid. In our case it is five years after retirement. Over a period of five years we would repay that money.
Q728 Chairman: Can I just be clear, because we have debated around the bill that is before the House, or the measures before the House and the alternatives. If you had a clean sheet of paper and you said, "Right, I've got a one-off opportunity to help with our capital raising," I get the impression that for you capital at the moment is not a problem?
Mr Maguire: At the moment it is not a problem, no, but it could be in the future.
Q729 Chairman: Let us say, hypothetically speaking, you saw a great opportunity and you wanted £50 million and you thought, "Do we really want to go back to the banks again?" and you had a clean piece of paper to design a model to raise it, have you got any thoughts as to what would be on the piece of paper?
Mr Maguire: Well, if we could operate the same as a plc in terms of being able to tap into a range of markets would be ideal, but realistically that is not possible, so realistically the funds will have to come from members and from banks.
Q730 Chairman: Can I just be very clear? Because of the constitution of a coop there is no way that you could create a minority class of equity? In other words, I can understand that the members own the business, but let us say the business is worth £500 million for argument's sake if it is going to go on the market and it is sold. So you have got some kind of equivalent of a market capitalisation for it. There is no way you could create a class of share that would say, "Well, okay, we'll sell 10 per cent of it. In other words, 10 per cent anybody can buy, they can invest in it, they will get a dividend and we'll create some kind of market for that paper"? Is that theoretically possible?
Mr Maguire: It is theoretically possible and it is something that we have looked at, so it is something that I wouldn't rule out for the future, but First Milk is very young in its development. It's not at this stage in a position to be attractive to outside investors, but we certainly wouldn't rule that out in the future. It is possible.
Q731 Chairman: Are there any examples from the Continent where "novel" forms of capital raising that you have observed have been carried out?
Mr Maguire: There are many examples, yes. Dairy Farmers of America have corporate bonds, they have substantial amounts of dollars in corporate bonds, so there are examples throughout the world.
Q732 Chairman: So if I have understood you correctly, the cooperative model as such does not inhibit using the same array of market possibilities that a plc would have. The message clearly from you is that you are a young business and at this moment in time some of those alternatives would not be compatible with where you are, the market would not view you with much comfort, and I suppose at the end of the day it could cost you more to try and raise capital by these other means than by going to straight bank finance?
Mr Maguire: You have summed it up pretty well.
Chairman: Right. Okay. It is just that, again coming back to why we are doing this report, is there anything we need to be saying to the Government, because that is where ultimately our report goes, that says, "Look, the cooperative model weaves its way through various parts of agriculture and production in the United Kingdom. It is a model which is well supported by people who want to trade in that way, but they are up against it and therefore as a government what should you be doing to assist this model to grow and strengthen against a background where, in the case of Dairy Farmers, that particular enterprise failed?" and it is sort of picking out from that piece of analysis whether the problem was intrinsically because it was a coop or whether it was other factors. I think we are beginning to see that. Okay. Let us move on then to David.
Mr Drew: I would have been asking some questions of Mr Yates about communication, but he was so forthright in explaining the nature of the problems I did not think there was any point, and the Chairman did not call on me anyway, so we will fast forward on that without much ado!
Chairman: I apologise for that.
Q733 Mr Drew: I am just interested in how First Milk works. How would you sum up your communication strategy in keeping your members informed of what you are doing?
Mr Mustoe: I think it is pretty good. I think it is improving. We are attempting to make communication swifter. For instance, historically we have always viewed printed material as a way of doing it, letters, newsletters. We are now into the digital age so we now communicate by text, emails and recorded messages. That actually allows us to get to members quicker. It also saves us money. We have a members' dedicated website which is kept right up to date, a weekly bulletin which includes not only First Milk but UK and global industry news, a monthly newsletter, annual meetings around the country with all our members and they are all invited to it, quarterly discussion groups in local areas, and an annual AGM, so I think we actually are pretty open and pursue it quite vigorously and in an orderly manner.
Q734 Mr Drew: If you were to want to make changes, is one of the areas that you are forever reflecting on how much information the members can handle, but more particularly on your side what level of confidentiality you should, if you like, disclose on the basis that one of the apparent problems with Dairy Farmers of Britain was there were people who did want to spill the beans but there were all sorts of reasons why it was difficult to do so, not the least of which not everybody was telling apparently the whole truth all of the time? How do you cope with that issue?
Mr Mustoe: I think in normal times it is not an issue. Where you come up against a big acquisition then that is where the rubber hits the road and I am sure there are lots of examples of openness that have gone wrong, because everybody has a best friend they want to tell, and so it goes on. I know there have been examples of that in my short time, but you just have to make a judgment and at the end of the day the final point is when a deal is done members have got to be aware of the ramifications of that deal. They have got to be aware of the risk and they have got to be aware of the potential upsides, and I think as long as you are open about that without disclosing commercial confidences then I think that has to suffice and I think it is appropriate.
Q735 David Lepper: The NFU, and indeed the Minister in his evidence to us, talked about the importance of developing dedicated supply chain arrangements between the retailers and the farmer suppliers and the Coop group have told us that at the time they were negotiating with DFB they made just such a suggestion about developing a pool, a farmer pool of suppliers. DFB didn't seem to want to know, according to the Coop group.
Mr Mustoe: You mean dedicated to a particular retailer? Yes, we do have an example.
Q736 David Lepper: Yes. What is First Milk's view about that?
Mr Mustoe: We do. We have, through Wiseman, a dedicated pool of, I think it is 176, or something like that, isn't it, of farmers -
Mr Maguire: Farmers, yes.
Mr Mustoe: -- who are teamed up with Tesco. We have got other discussions going on along that whole structure with other retailers. I cannot tell you which ones at the moment, but that is an ongoing process and I think it's certainly a way that we will continue to go and I think the industry will.
Q737 David Lepper: Are there no longer term dangers in that for the suppliers in terms of the control that the retailer might have?
Mr Mustoe: The retailer has ultimate control now. That's not going to change whichever system it is. It comes back to my four points about performance - the right product, the right service, those are the things on which you are judged.
Q738 Mr Williams: I was going to come back to your four issues. Not included in those four was developing a loyal supply base. Now, we have heard today from Mr Yates about a dividend and then an increase in the price of milk. People are involved in cooperatives, or whatever, to maximise the return on their efforts really. They invest their time, their money, whatever, in producing milk and they want a good return on it. How do you decide what return your members should get and basically is that good enough then to generate the loyalty that you need really if you are going to supply your retailer clients?
Mr Mustoe: I think the return is never good enough is the sort of position I think a lot of the farmers would take, and I understand that because it is very important to them, but there is one principle and it comes back to this awful, boring fact on the way that you run your business. If you don't earn it, you can't pay it, and that is the issue. So you have to maximise the earnings by running the business in the best possible way. We have just recently all been aware of the terrible weather and the fact that milk has had to be thrown away because the milkers are unable to get it. We announced this week that we are compensating dairy farmers at the milk price that they would normally receive for December and January because we think it's the right thing to do. Not everybody has taken that view in the industry, but I think that's where a cooperative comes into force. I have to say we have also said that in the event that we get this kind of weather in the future then we are not going to be able to do it, so we would advise members to take insurance, and some have already done that anyway, which is provided by NFU Mutual and places like that at reasonable cost, but we felt this time it was particularly important to support our members in a difficult time and therefore we have agreed to pay compensation.
Q739 Chairman: Could I, Mr Maguire, just probe you on one small point? One of the issues that were raised with us was that when you have the tension, the amount of money that a farmer, if you like, puts in through that route is deemed by the tax authorities to be income and therefore they end up paying tax on it. Do you think that is a fair way to deal with that money where effectively technically it is income because it is a withdrawal from a payment that the farmer would have received but in reality he can't do anything with the money, he hasn't got it? It's a bit like making a contribution to a pension. You get tax when it comes out as income on the way out, but it goes in tax free on the way in.
Mr Maguire: Yes, I think it is rather unfair in the way it is treated and you asked earlier were there any recommendations that your group could put forward in terms of supporting coops, and that would certainly be one to relax, the tax considerations, because we certainly think it is unfair that the notional income that a farmer gets is actually taxed on it, so he is not getting the cash because it is a deduction from his milk price, and yet he is expected to pay, and does pay, a tax on it. I think to rub salt in the wounds, the Dairy Farmers of Britain guys who lost out are unable to claim those tax credits back for money they never received and tax that they had to pay. So I think that is particularly unfair.
Chairman: Gentlemen, thank you very much indeed. Thank you for sparing us extra time. I think your insight, if you like, from the cooperative standpoint of somebody who was not involved in what happened to DFB has been particularly valuable because we were anxious to hear from a coop which had traded successfully as opposed to, sadly, one which eventually went out of business. So thank you very much for the perspective that you have brought us and for sharing your experiences with us. We appreciate it. Thank you.