Examination of Witnesses (Questions 280
- 299)
WEDNESDAY 21 OCTOBER 2009
LORD GRANTCHESTER
AND MR
GERRY SMITH
Q280 Mr Drew:
Can you just spell out for us the model that was set up and did
you try and change that model because of some of these inherent
financial difficulties?
Lord Grantchester: We tried at
the very end to change—
Q281 Mr Drew:
Spell out what the model was that the company was set up according
to.
Lord Grantchester: I just explained
that when a member left—
Q282 Mr Drew:
I mean the type of co-operative.
Lord Grantchester: That then crystallised
liability into a loan note and what we tried to do at the end
was to ask that all our equity—
Q283 Mr Drew:
What I am trying to get to is was there an inherent weakness in
the nature of the co-operative structure that the DFB had. You
obviously inherited this and it would be interesting to know whether
you tried to change any of it. Can you just spell that out.
Lord Grantchester: I just explained
that I did try to change it in terms of changing the balance sheet,
to strengthen the balance sheet from the liabilities side to an
asset side. One of the facets was to change the debt part of a
member who put in his equity as a debt and change it into the
normal process. If you think of a member investing in his company,
it should be an asset on the balance sheet and not a liability.
The Committee suspended from 4pm to 4.15pm
for a division in the House.
Chairman: There may possibly be a second
vote within the next few minutes. I will be ceding the Chair to
Mr Drew at twenty minutes to five.
Q284 David Taylor:
To obtain effective management of large co-operatives is quite
a challenge and if they are an agricultural co-op there are particular
difficulties that come in. The Scottish Agricultural Organisation
Society in their evidence said: "In large and highly capitalised
agricultural co-ops, the effectiveness of the Board in discharging
its responsibilities, and the effectiveness of individual directors,
require at least biannual evaluation".[8]
Was that a feature of life at this particular co-operative, Lord
Grantchester?
Lord Grantchester: Just to sort
of step back and then step forward again—
Q285 David Taylor:
Before your time, of course, and during your time.
Lord Grantchester: What I wanted
to get across was I do not think there was anything on the governance
side of how internally people fulfilled their responsibilities
in terms of the Board, the Council or management. I did say there
were aspects of the model that in hindsight came back to haunt
us towards the end, and I alluded to the way the investments were
put on the balance sheet, et cetera. Now we are coming to the
management of a farmer-owned business and you are asking me about
best practice to have a biannual evaluation. I am not sure I am
aware that it was ever best practice to have a biannual, or semi-annual,
or do you mean every two years, evaluation. We had an annual evaluation
of the Board that the Chairman did with his Board members, but
also as part of the governance all of the directors came up for
election every three years. There was an election of directors
by rotation. In terms of the management, at the time of the purchase
of ACC we were just a supplying co-op and the purchase of ACC
took us into processing and that was a different sort of management,
ie management managing the processing division.
Q286 David Taylor:
You were previously a director of Littlewoods Organisation and
Everton Football Club, I believe. Was this the first co-operative
with which you had been involved in your business life?
Lord Grantchester: The first and
only co-operative.
Q287 David Taylor:
So far or full stop?
Lord Grantchester: So far.
Q288 David Taylor:
You have had extensive experience on other boards and we have
talked very briefly in the session so far about training of farmer
directors. Do you think that they were particularly at a disadvantage
in the context of the DFB that you joined relatively late in the
day in terms of their commercial experience and the training that
they had received? What was your assessment on arrival? Was there
anything that you did in the remaining months leading up to the
collapse?
Lord Grantchester: The comment
I would make is most farmers do not have board experience. The
nature of the beast is that they tend to be sole traders or partnerships.
The structure of tax legislation favours that rather than companies
farming, but there are companies that farm. Generally speaking,
farmers do not have experience of board commercial life off their
farms, so that is a huge challenge for them. As time progresses
there is a huge gulf that opens from the farmer enterprise to
the board of the co-op. Succession planning to replace the farmer
board members on the board is a huge challenge to the organisation.
That is one feature, I would say, of farmer-owned businesses which
is tough for them.
Q289 David Taylor:
The National Farmers' Union told us that in their belief farmer
directors needed to be properly supported, trained, highly skilled
and have the ability to manage large and complex businesses. From
your description were any of those characteristics present amongst
the farmer directors?
Lord Grantchester: That is a huge
challenge to all farmer-owned businesses, not only to attract
entrepreneurs but attract entrepreneurs with experience to be
able to assess and direct accountable management.
Q290 David Taylor:
Returning to the earlier comments you were making a minute or
two ago about board effectiveness in discharging responsibilities,
what performance indicators would you identify briefly as being
core to any such assessment or appraisal of a corporate entity
or collective entity like a board?
Lord Grantchester: Could you just
repeat the question.
Q291 David Taylor:
What performance indicators would you be measuring to assess whether
or not a board truly was an effective collective entity?
Lord Grantchester: The chairman
in his role, the previous chairman to me obviously, undertook
this appraisal system and assessed the effectiveness of each director
at each Board meeting. He allocated around the Board various areas
of attention that he would like each Board member to try and input
into the business, expertise and interest. I think he did a fairly
effective job in keeping the Board assessed. We contributed, especially
on the HR side of things, in terms of the culture and changes
that were needed on purchasing ACC. All of these things were taken
in the Board. There were away days to assess things as well. There
was a constant challenge within the Board in terms of if ever
Board members felt out of their depth or in difficulties to give
them the advice and expertise in order to undertake their task.
From my experience, Dairy Farmers of Britain's internal working,
comparing it with other companies, did recognise that and tried
to rectify it to provide the back-up necessary. The farmer membership
were most insistent that in order to have farmer control there
had to be a majority of farmers on the Board. I would not say
I entirely went along with it but that was the very strong message
we were getting from members, to retain a farmer majority on the
board, but then because it gets very big and unwieldy you have
to make sure you have got all the expertise you need round that
board table.
Q292 David Taylor:
Looking back, if you had arrived at DFB nine or 12 months earlier
can you identify changes that you might have made that could have
headed off the eventual collapse of the co-operative?
Lord Grantchester: I do not think
there was anything at that stage. I will not get into the evolvement
of events that led to the collapse, but in the model that we were
advised from our Dutch colleagues, who have a very successful
model of co-operatives on the Continent working very effectively
for farmers, managing very big businesses exceptionally well,
no-one suggested there was anything fundamentally wrong with the
model. As you came into it later on there were aspects in setting
it up that did come back to haunt us.
Q293 Chairman:
I want to move on to analysis as to why the business ultimately
failed. The Committee recently received an email from Mr Paul
Fox who produced a succinct summary of why he thought the business
went wrong. He said: "The prime cause was the price paid
and the failure to assimilate ACC and generate sufficient cash
surpluses. This created an impossible burden of debt. In the period
following acquisition the Board's strategy was based on further
merger and consolidation and the Board and executive did not grasp
the management challenge which led to economic failure".
He concluded by saying: "The lesson to learn is that unless
a co-op has a strong market position and has historic reserves
of capital, it cannot compete effectively in the fierce UK market".[9]
Is that a fair summary?
Lord Grantchester: Paul Fox was
one of our field staff. He was a very good member of our field
staff and ran the Cheshire territory. It is a very fair assessment.
There may be bits which we wish to colour in. When he challenges
by saying that the Board failed to grasp things, we can perhaps
go over some of those points. His general assessment is not very
far wide of the mark.
Q294 Chairman:
It is very difficult from your point of view to help us through
the decision-making process that led to what went wrong. When
we look, for example, at the document that we referred to earlier,
Creating a New Force in the UK Dairy Industry, what is
quite remarkable about this is the lack of any numbers in it.
I think the only numbers I could find were about a market leading
network of 60 distribution centres and ISO 9002. There is nothing
to give us any indication as to what the commercial expectations
were. We heard earlier from the Co-operative movement that they
decided being in the dairy business was not central to their business,
so they had an existing facility through ACC to get rid of. It
would appear from those observations that you paid top dollar
for it. Why was everybody so confident that this could be made
to work, that you could be ruthlessly competitive in a fiercely
competitive market taking into account the kind of capital investments
that were being made by companies like Robert Wiseman, Müller,
many others? These people were investing big time in modern, efficient
dairy facilities, not trying to make do and mend with "second-hand"
old equipment. Why did you think you could pull the impossible
out of the hat and do that, whereas others were clearly spending
a very large amount of money on absolute purpose-built kit? Mr
Smith is smiling. Come on, Mr Smith, give us a birthday treat
and tell us what you think.
Lord Grantchester: I have got
a big amount to say on that, but I will let Gerry—
Q295 Chairman:
You start then. We will be fair to the Chairman, but I would love
to hear from Mr Smith because I could tell that was his moment.
His body language said, "I want to tell them everything".
Lord Grantchester: He is very
welcome to help the Committee but I will just give a general view.
At that time you will remember, along with me, the situation dairy
farmers were facing with the disbandment of the Milk Board and
then the successor body, Milk Marque, which was only allowed to
be a supplier in the milk chain. We all know it was then challenged,
for want of a better word, that it was manipulating the market
and had to split into three siblings, three young co-ops. You
will also recall that they did not inherit any finance from that
so they had to set themselves up from the start. It was against
a backcloth of people saying, "Is that the right model?"
I could compare that to the rail network where it is a very horizontal
stratospheric model. Everyone said, "This is not the right
model, we have to get back into vertical integration in a supply
chain". Why did we think it was possible? Because everybody
was saying this was what the dairy industry had to do to restructure
into a vertical co-operative from the farmers' point of view,
to re-engineer the supply chains to allow the farmer to not only
get nearer the market but to do it without subsidies, to use that
word. We had to respond to market signals. It was welcomed by
everybody, this vertical integration was very necessary. I have
got Neil Gwyn's quote here at the time of the ACC purchase.
Q296 Chairman:
For the benefit of the record, could you explain who Neil Gwyn
was?
Lord Grantchester: The NFU representative
on the dairy trade board. "This is a move which results in
the UK dairy farmer getting closer to the market place and is
welcomed by the NFU". You will also recall that Sir Don Curry's
Commission had been set up to see what he could do in order to
produce sustainable agriculture into the future. It was very much
against a backcloth of "These are the right things for farmers
to do". You then have to see what is available in the market
place. We have seen other companies go to the wall over the ensuing
years in this very tough market place. We have seen Amelca, which
was set up from scratch to get nearer to the market, with no market
presence at the time. It was not buying any business trade., It
had to fight its way into the market place. We identified we had
to purchase assets already out there in the market place to allow
us to begin to unfold this strategy for the benefit of the farmer,
who was not only a supplier but was now an equity provider. The
first thing to understand about co-ops is a very unusual aspect
of them is you have to do whatever you can to maximise that price
to your supplier, not minimise his price, so everything was then
judged on milk price. We have to go out, as you say, and assess
what is available in the market place, that you do not buy something
that comes back to haunt you with the best prospects you can and
what is available. Is it good enough? How much ought we pay for
it? What can we do with it? Is it going to do the job for us?
Quite rightly, the Board's assessment of Dairy Farmers of Britain
under the previous chairman was that we wanted to be in the fresh
market. We identified that as some protection from the world market
with the reduction of subsidies and world price was then deemed
to be the benchmark price which, as we all know, in international
agricultural economics has very big question marks over it. The
only sizable purchase available to us in the fresh market was
the ACC whereby of the product ranges that we bought in to secure
the assets 55 to 60 per cent was liquid dairy, so we identified
this was where we wanted to be. There were things about it that
we will come back to that made it extremely difficult, but at
the time it was welcomed by everybody as "This is the right
move to make, we can only buy what is available to buy".
Q297 Chairman:
Mr Smith?
Mr Smith: Thank you, Chairman.
It is difficult once he starts because he is so passionate about
the business, but I think everything he said is very relevant.
I come from a plc background, I have only been in the farmer co-operative
just over four years. There was nothing wrong with the strategy
or the vision that Dairy Farmers of Britain had. Just to remind
you, it was to be the number one farmer-owned milk business in
the UK, it was to be vertically integrated—and what that
meant was to be in charge of our own destiny—and, finally,
they wanted to pay a top quartile milk price, absolutely fantastic
strategy, nothing wrong with that. I think the demise of Dairy
Farmers of Britain was the way we went about delivering that strategy.
We have heard about the acquisition of ACC. That was one of the
factors that contributed to the demise. Chairman, I have got a
list that you can go through. Business is all about confidence.
The real reason for Dairy Farmers of Britain going into receivership
was that as farmer members lost confidence in us, our other suppliers
lost confidence in us, our financiers lost confidence in us and,
most importantly, our customers lost confidence and that was why
Dairy Farmers of Britain failed.
Q298 Chairman:
That is a very elegant summary. Being highly aware of the dairy
industry, as everybody was who was involved in the business—one
hopes so—you lost the confidence of one of your major customers,
as we heard earlier, because, if anything else, you could not
be the most important thing, be competitive. Secondly, your customer
in the shape of the Co-op was troubled, to say the least, by quality
of service issues and by the fact that you had the lowest farmgate
price. With such a clear ex-post analysis, why did anybody not
see that those were the ingredients that were to lead to downfall
when they were actually happening?
Lord Grantchester: First of all,
let me take that in two parts again. I will give you an overview
and then I am very happy for Gerry Smith to get into the finer
detail of how many minutiae of pence per litre it was. I would
like to get into the detail of the ACC purchase and I would like
to clarify perhaps various other lines of inquiry the Committee
have done and partial answers they have received. For example,
last week you asked about due diligence. I would like to put on
the record that the due diligence was vendor due diligence undertaken
by KPMG. As Dairy Farmers of Britain, we found it extremely difficult
when you had to ask questions to then find out answers that were
provided by KPMG. We were not able to undertake due diligence
ourselves, you could say did we know the right questions to ask,
because what we then found in the purchase of ACC was that there
were some very different aspects of it, none the least of which
is that the Co-op that had undertaken a quick restructure itself
to move assets about in order to sell to us. This landed us with
a potential huge tax liability. We spent £1 million on advice
to avoid that tax liability which would have been a further £6
million hit to the co-operative. We then found that there were
a number of commercial contracts that were uncompetitive and we
had to supply our competitors at very uncommercial prices. Then
we found that the way they operated was when a shop wanted supply
it picked up the phone and got it. We even began to question how
KPMG put the due diligence together as to where the profit of
one division stopped and the next division started. As I say,
we began to wonder because we had then to work out our own cost
plans of supplying milk from different dairies to different shops
and cost it all out as to what was the most effective way to do
it.
Q299 Chairman:
For clarification, effectively when you bought ACC you bought
an ongoing business with its obligations that you just described.
Lord Grantchester: In hindsight
what can seem naive is that we only had a three-year supply agreement.
In hindsight that was hopelessly too short because what then happened
was—and I am sorry to have to say—that at all times
we were also naive to think the Co-operative had a fellow co-operative
ethos. At all times in the negotiations with them they were very
slow, they would only put the price up even though the mechanisms
were available after there was a price rise in the consumer market
place.
Chairman: Before Mr Smith starts I am
going to cede the chair now to Mr Drew who will conduct the proceedings
to the end of this inquiry.
In the absence of the Chairman, Mr Drew was called
to the Chair
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