Examination of Witnesses (Questions 160
- 179)
WEDNESDAY 14 OCTOBER 2009
MR GORDON
BROWN, MR
PETER PEARSON
AND MR
JOHN GREGORY
Q160 Chairman:
Who did the due diligence?
Mr Brown: You are speaking to
the directors, are you not, in a week's time?
Q161 Chairman:
I just wondered if you happened to know.
Mr Brown: The directors are responsible
for it. Was it Smith & Williamson? I am not entirely certain.
Q162 Chairman:
Okay.
Mr Pearson: Chairman, on the due
diligence, one of the points that came up at the meeting that
PwC had in Bolton was somebody asked about the due diligence,
and I am just a farmer so I do not know common practice, and it
is apparently common practice that due diligence is only carried
out by one of the parties and the other parties accept it, but
that is something you would have to get clarification on.
Q163 Chairman:
We will. We will make a note of that. That is something we will
probe the directors about.
Mr Pearson: I think if you asked
Stephen Oldfield he would give you the same reply.
Mr Brown: Dairy Farmers of Britain
had a subsequent difficulty in that the vendor was their largest
customer once we had bought the business, so there was a difficulty
in the relationship there, do you sue your largest customer.
Q164 Paddy Tipping:
Was that part of the reason for the fall-out with the Co-op then?
Mr Brown: Yes. If we had just
left well alone in 2004 ACC would have been bought by one of the
majors and that business would have been rationalised into it.
We knowingly held that process up because what we wanted to do
was become one of the majors ourselves and that was, in effect,
our ticket to the game. We would then use that as a foothold and
do a deal with one of the majors. That was the strategy and it
failed.
Q165 Paddy Tipping:
Does that purchase reflect badly on the management of the company?
If you are looking at why a company goes wrong often it is the
management. How did you rate the management?
Mr Brown: Well, as farmers we
contributed £60 million in capital to the business and in
addition there were final milk cheques and it has all gone. I
think that answers the question.
Mr Pearson: Chairman, if I can
just come in on that. To be fair, if you looked at all the information
available at that moment in time, and certainly we have got some
recent information from August 2009, the margins that people were
getting increased the closer you got to the consumer. One of the
reasons that I stayed with DFB against all consultants' advice,
and they turned out to be right, was that I believed the milk
industry would get more competitive as technology improves production
and globalisation encourages that production to move to areas
that have low costs. The only way I could see that we could survive
as a family was to increase the margin obtained back to the farm.
The theory at the time was that you moved closer to the consumer
and as you moved closer the margins went up. To my mind, and I
know I am not alone, the purchase of ACC enabled us to go on that
one step. You have to remember that Amelca in our area failed
because they had a modern factory but no market place; we had
bought the market place. I think there were some things in that
purchase that were kept from the producers. It turned out that
some of the sites were only leased and I think you would have
to clarify with the directors but I suspect that in the agreement
those sites had to be put back in a certain order and paid for
by the members. Looking forward, and you probed Gwyn on factors
relating to the other co-ops, and certainly this gentleman asked
how you could change the governance of the co-ops in order to
drive the business forward, I am not sure I agree that there is
any difference between a co-op structure and a plc but they both
have to be profit orientated. One of the things that was lacking—and
it may have been left over from the Milk Marketing Board because
you have to remember that a lot of staff moved from the MMB, which
was a monopoly, through to Zenith and the other companies—was
they had not got that drive that possibly an individual has. Certainly
there was an ethos within the Co-op at Llandyrnog that DFB had
difficulty with in getting rid of some of the staff and that took
two and a half years. They appeared to us as the Council that
all the time they were trying to rejuvenate this company and as
Stephen Oldfield has pointed out £144 million was spent in
capital costs, acquisitions and various other things to try and
streamline that business. You also have to remember that some
of the companies you are competing with have dedicated supplies
which are more profitable than others, in other words the liquid
milk market, and those companies also rely on the co-ops to supply
what they are not getting direct off the farmer, so they only
supply 80% and the other 20% comes from the co-op. There are all
sorts of issues within the industry that are a disadvantage. The
lady across here asked about Denmark and New Zealand, maybe it
was in Stephen Oldfield's presentation, and 90% of the producers
in Denmark supply to Arla, so they are both virtual monopolies,
although there is some problem in New Zealand where I think Fonterra
is trying to get an equity stake because it has almost got too
big. There are problems when co-ops get too big, but we are not
at that stage in the UK I have to say.
Q166 Paddy Tipping:
Mr Gregory, you are a bit detached from this. Why do you think
DFB went down?
Mr Gregory: My opinion, and what
Peter and Gordon were speaking about, is that it all stems from
the purchase of ACC. We saw that as an independent outsider. We
spoke to our area manager who was responsible for our raw milk
purchasing and said that as a customer we were not very happy,
we did not think it was a good idea and he said, "Yes, it's
going to be a good thing, it's going to be good for the market
place as well". "Hopefully it will be successful but
we think you are buying a bad egg" was the comment. What
has progressed from there is the fact that the management was
kept on from ACC and you had a company which was not profitable,
which was not making good margins, not necessarily run by the
best of people and they had inherited this management but quite
a few had been sidestepped, let go and gone and worked for competition
taking confidential information on customers, pricing and stuff
like that which should never have happened.
Q167 Paddy Tipping:
Mr Pearson told us that the fact it was a co-operative structure
did not matter, that was not a contributory factor. Do you all
agree with that?
Mr Brown: I would agree with that.
It was not the reason why DFB went bust. It was a bit of the problem,
I do not want to disregard it completely. You mentioned with the
NFU about 20,000 and it is true there was a £20,000 limit
on capital but how DFB got round that, and how the other co-ops
get round it, was by having loan notes instead. You can get money
off of members, the bigger problem is in terms of getting outside
capital into the business. I would suggest that DFB had a bigger
problem in terms of getting outside capital into the business
and the business model was bad.
Q168 Paddy Tipping:
Both you and Mr Pearson were on the members board at—
Mr Pearson: The Council, not on
the board.
Q169 Paddy Tipping:
You must have been pretty fed up that you were not getting the
proper story.
Mr Brown: We were. As I say in
my written evidence, I did not expect the purchase of ACC to suddenly
make everything right. When you buy a business in any industry
it takes time to sort it out. I thought three years would be about
right but it later turned out, and this was kept from us, there
was a £7 million a year margin erosion when the three years
came to an end with CRTG, the Co-operative retail group, and we
were not doing well but we had that £7 million buffer. Once
that £7 million went, and that was in the summer of 2007,
that was when DFB really got onto its death spiral because it
coincided with a time of high commodity prices. From a point where
we could be fairly safe and think, "We're always going to
be better off than the people who are turning milk into cheese
and powder" it came to a point where everyone could do better
than us and that was when members started to leave. When you have
got a rapid exodus of members from a co-operative it is just like
hoisting a big red light above you and everyone can see it. No
matter what the directors or the executive said, the business
was in trouble.
Q170 Mr Cox:
Do you not think that there is a fundamental problem about farmers'
co-operatives, and I am very strongly in favour of them, that
there seems to be a problem potentially, not in all perhaps but
in some and, Mr Pearson, you spoke about the culture, that because
you have got a whole lot of shareholders essentially who are farmers,
who are busy producing, what you do not have is what you would
have with a plc. You do not have the kind of external scrutiny
from shareholders from a wide range of walks of life who are interested
in one thing, which is the bottom line. Farmers are busy milking
and they do not have the time sometimes to devote to the kind
of scrutiny that other shareholders might.
Mr Brown: I would have thought
the people who ought to have been doing that were the farmer directors.
They were paid £24,000 a year each, and in some cases more
than that, to give up their time to keep tabs on things.
Q171 Mr Cox:
Why just farmer directors, were there not other directors?
Mr Brown: There were and the non-executive
directors were paid a good deal more. There is always a suspicion
if you are non-executive directors that you are there for yourself.
I would never have thought that of the farmer directors because
they are from the farming community and collectively, if you speak
to the five or six farmer directors, I would imagine they have
lost possibly over half a million pounds between them because
they are quite big milk producers. They have lost a lot of money
and their reputations are finished over this matter. Those were
the people who saw what was going on in the business, or should
have seen what was going on, and yet they went ahead with the
purchase.
Q172 Mr Cox:
Is it not possibly because they are committed to this entity of
the co-operative and there is a lot of sentiment involved in it
in a hardnosed way that a company might not be?
Mr Brown: Some months ago between
January and February of this year I asked one of the directors,
"Do you think you were suffering from group thinking?"
and I think they were. I did not realise that at the time. When
you look back with a bit of hindsight, it is only in the last
year or so that—
Q173 Mr Cox:
What do you think of the NFU's idea of independent evaluation?
Mr Brown: Who would they be and
what would they do? It is difficult. To let someone in to know
that amount of information, the DFB has gone, it is not going
to affect the DFB.
Q174 Mr Cox:
I mean for a model for the future.
Mr Brown: I am all for scrutiny
of public companies as a potential investor in them. It looks
like I am going to be press-ganged into joining First Milk with
a retention of 0.3 pence per litre from 1 November and I do not
want to see that go the same way as my half pence a litre went
with DFB. I am all for scrutiny of what First Milk are doing.
Q175 Chairman:
Can I just ask about the democratic processes within the Council/board
of director relationship. Were there ever any matters put to a
vote to the Council?
Mr Brown: Yes.
Q176 Chairman:
ACC purchase being one?
Mr Brown: In the Articles of Association
of DFB no purchase greater than £15 million could be undertaken
without the consent of the farmer Council.
Q177 Chairman:
Coming back to your point, how was the farmer Council advised
of this? You were critical of the due diligence.
Mr Brown: Yes.
Q178 Chairman:
Normally if some company is going to buy an asset you would have
a very comprehensive assessment, financial accounting and everything
else to say whether it is a good deal or a bad deal. How was that
communicated to the Council?
Mr Brown: It came to us in June
2004. We had a Council meeting and the board and executive asked
us to lift the safety catch in effect. We said, "Why do you
want to do this?" and they said, "We can't tell you".
Philip Moody was giving a presentation. You are aware who Philip
Moody is?
Q179 Chairman:
You are going to tell us.
Mr Brown: Philip Moody was a non-executive
director of DFB. He is an accountant, corporate finance specialist
and partner in Smith & Williamson.
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