John Pearce's key risk focus at Fonterra is milk

Milk might not seem to be a particularly risky commodity. But for Fonterra Co-operative Group Ltd., milk is at the heart of the key risks that John Pearce, Fonterra's general manager, policy and risk, must manage.

Milk is what the Auckland, New Zealand-based dairy processor deals in, making business continuity one of the enterprise's major challenges.

Mr. Pearce points out that there are two parts to Fonterra's business. There is a commodity side that comprises dairy products, such as milk powder, sold mainly to other food manufacturers around the world, he said.

“We also have a strong brand presence, particularly in Australia, Asia and in Chile, selling dairy products under a variety of brand names,” he says.

Business continuity is a particularly important concern for Fonterra, he said.

“We have to process enormous volumes of milk,” said Mr. Pearce. “At peak, we need to process around 80 million liters of milk a day just in New Zealand, and the problem is you just can't turn that flow off. If you have a major loss, you've got to find somewhere for the milk. It's not environmentally acceptable to dump milk, so we have to find alternative processing options wherever possible. As a result, business continuity is a key element of our manufacturing planning. Our business continuity plans are directly linked to the business objectives and associated risks.”

In addition, Fonterra has an arrangement with the farmers that if there's a force majeure event—an event beyond the control of both parties—and “we can't take the milk, then we will pay the farmers for the milk,” said Mr. Pearce. “The difficulty when you couple that with the fact that milk is an environmental pollutant, you can only dump milk for a very limited period of time. Once you've exhausted that time period, you then have to dry the cows off, and that means you're losing milk for the rest of the season. So your business interruption number goes from a relatively small number to a really big number very quickly.”

He said Fonterra is looking at strategies to mitigate that risk.

Mr. Pearce said Fonterra partially funds the risk through insurance. That's complicated, he said, because Fonterra's business interruption insurance is built around the loss of a single site, and Fonterra has other milk processing plants to deal with milk flow if a single site out of Fonterra's 28 manufacturing plants in New Zealand is not running.

“There are three sites whereby if they stop operating, we can't deal with the milk flow,” he said. “So those sites are quite unique and they cost us a lot in terms of business interruption insurance, because we're insuring that milk for the year. For all of the other sites, there are strategies in place to change product flow, and to change what we make.”