UNCORRECTED TRANSCRIPT OF ORAL EVIDENCE To be published as HC 971-iiiHouse 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 Geoffrey Cox
Mr David Drew
Mr James Gray
Patrick Hall
Miss Anne McIntosh
David Taylor
Mr Roger Williams
________________
Memorandum submitted by The Co-operative Group
Examination of Witnesses
Witnesses: Mr David Messom, Director of Food Retail, and Mr Philip Hardman, Group Counsel, The Co-operative Group, gave evidence.
Q190 Chairman: Good afternoon, ladies and gentlemen. Welcome to our further evidence session on our inquiry into Dairy Farmers of Britain. At the outset may I start with an apology. Occasionally, with the vagaries of Parliament we suddenly find ourselves bereft of a quorum. For example, Dan Rogers, one of our members, is in a debate on Equitable Life; another colleague is also on another select committee and they have another urgent meeting this afternoon. Currently we have a quorum, and so I have taken the decision that we should start with evidence from the Co-operative Group, but I am afraid we will have to postpone the evidence of Lord Grantchester and Mr Gerry Smith. Could I apologise publicly for the disruption this has caused. Mr Smith, if I might be so bold as to acknowledge, as this is your birthday, perhaps this was not the present you were hoping for, but we would very much like to hear from you again and we will invite you to come and join us, but I do not want to start an evidence session which, effectively, we cannot conclude. Without further ado, let us welcome Mr David Messom, the Director of Food Retail for the Co-op. You must be going to say some very controversial things, Mr Messom, because I see you are accompanied by the Group Counsel, Mr Philip Hardman. You are both extremely welcome. The demise of Dairy Farmers of Britain was obviously a very sad event, particularly for the members. Part of it, obviously, was associated with the relationship they had and then did not have with your good selves, and we will explore that in a little bit more detail, but perhaps we could start, Mr Messom, with your own overview as to why you thought DFB failed. Your organisation has very considerable experience in the dairy industry both, at one time, as a supplier and processor and as a very significant retailer of dairy products. You are in an ideal position to give us some commentary on why you thought DFB failed.
Mr Messom: My personal view is that you could argue that they paid too much for the ACC business originally which they acquired from the Co-operative Group. I think there was a lack of investment between 2004 and 2009 to make the business more efficient and they were, effectively, competing in a market that had some very efficient processors of milk, and I think that is exemplified by the fact that effectively they were paying their farmer members one of the lowest farmgate prices and yet were struggling to remain competitive with competitive cost prices in that market. Therefore, effectively they were an inefficient processor in a very competitive market.
Q191 Chairman: I am right in saying that Associated Co-operative Creameries, to which you have just referred, was your business before you sold it? Just refresh my memory: why did you get out of dairy? Why did you stop being a dairy producer and processor?
Mr Messom: To correct the record, I am the Director of Trading, if you like, the buying side of the Co-operative Group. It was not my personal decision. The only dealings I had with ACC was as a supplier to me, but it was the Group's intention to get out of production generally. Over a number of years the business had systematically removed itself from production. It used to have a tea factory and a canned goods producing factory and the Board's decision at the Co-operative Group was that its future lay, as far as food was concerned, in retailing and not actual production and, therefore, that was part of an on-going process over a number of years.
Q192 Chairman: The reason I am asking the question is to try to establish whether or not it was a viable profitable processing business. In other words, you did not get out because you could not make it pay.
Mr Messom: No, it was a profitable business at the point in time that we got out of it, but it was, if you like, one of the last production businesses that the Group was exiting from.
Q193 Chairman: Bluntly, your exit from dairy was because it was not a core function of your business.
Mr Messom: Correct.
Q194 Chairman: When you came to sell ACC was Dairy Farmers of Britain the only serious bidder, or did it attract attention from a wider group of people within the industry?
Mr Messom: As a customer of ACC---
Q195 Chairman: Mr Hardman is obviously warning you about something.
Mr Messom: No, I can answer the question, but I think Philip Hardman would be better to answer that.
Q196 Chairman: Carry on, Mr Hardman.
Mr Hardman: Thank you, Chairman. I was directly involved at the time, and we conducted, I think, what you would loosely describe as a controlled auction. Most of the major players at that time expressed a degree of interest in acquiring it. As the process matured, Dairy Farmers of Britain, who were, I think, the most competitive of the bidders from the start, pretty well became the preferred bidder and we proceeded to consummate a transaction with them in the summer of 2004, but they were by no means the only party who expressed what we took to be a genuine interest in the business we had to sell.
Q197 Chairman: I do not expect you to disclose confidential financial matters about others who are not the subject of this inquiry, but when you talk about Dairy Farmers of Britain being the most competitive, is that a polite way of saying they were the ones that offered the most?
Mr Hardman: Yes, they did.
Q198 Chairman: Was their margin, over the others, a significant one? When you saw the price they were offering, did you go, "Wow, what a deal. We can't say no to that", or was it that they just crossed the line a little bit ahead? Just give me a feel.
Mr Hardman: No, I do not think we were ever saying, "Wow, we can't say no to that." They certainly led the field from the start. There was certainly one other player in the market that moved into, internally, what we regarded as a sort of shortlisting phase, though I do not think either that party or Dairy Farmers of Britain were ever aware we had that internal shortlist, and Dairy Farmers of Britain bid the most.
Q199 Chairman: By a significant amount? Was it another ten million more or something? As I say, I do not want you to break the confidences of what others bid.
Mr Hardman: In selecting Dairy Farmers of Britain at the end of the day, they had clearly won the competition that we had run. There were a number of reasons for that than purely the money on the table. We thought they had the safest harbour for all our employees, or all bar a very small number of them at the most senior management levels, and the fact that they were a co-operative business clearly, from our point of view, was reassuring.
Q200 Chairman: Did they tell you how they were going to pay for it?
Mr Hardman: I think we were privy to some of their financing, not least because in the closing moments of the process we conducted with them we had to step into the frame and provide part of the financing for them in the short-term. Part of their bank financing, I think, for some reason or other, was delayed at the eleventh hour and we provided several million pounds to ensure, effectively, that they could still complete the transaction as we intended in the middle of August.
Q201 Chairman: Basically, it was a bank-funded operation.
Mr Hardman: I am sure there was some member funding in there as well, but there was certainly a considerable slice of bank funding.
Q202 Mr Cox: It is clear that you had no real doubts about the long-term viability of DFB having taken over ACC, because you granted them a new contract to supply considerable quantities of milk in August 2007, did you not? Does it follow from that you had no concerns at that point?
Mr Messom: No, in 2007 they had demonstrated over the three-year period a very good record in terms of service and supply, extremely good service and supply, I would say, and therefore we did an open and honest tender, again, in 2007 and they won it fairly and squarely in terms of the vast majority of that milk. The only part of the business they did not retain was the south-west part of the business, which went to Robert Wiseman.
Q203 Mr Cox: On that subject, I understand you gave written contracts to your dairy suppliers. Is that right?
Mr Messom: Yes.
Q204 Mr Cox: Is that unusual in the market place, or is it something that is pretty standard?
Mr Messom: I would have thought it was fairly standard. In terms of own-brand supply agreements, I would say the majority of the retail trade would give written agreements. Certainly it is commonplace.
Q205 Mr Cox: You were going to brand the milk Co-operative milk, were you?
Mr Messom: Yes.
Q206 Mr Cox: This was for an own brand.
Mr Messom: It was.
Mr Cox: I see. Thank you.
Chairman: We want to talk in a few minutes about the tendering process, and we will come on to that. It is an issue that naturally follows from that, but we will wait until we get there. I would like my colleague, David Taylor, to take up the questioning on that subject.
Q207 David Taylor: I am sorry I am a little late, Chairman. I hope what I am about to ask has not been covered to any great extent. There was no public announcement that DFB had been unsuccessful in securing a new contract with the Co-op Group during the month of March, and it was in fact April before that happened. Why did that happen?
Mr Messom: It was mainly because the Co-operative Group acquired the Somerfield business on 28 February, and it was our view that we wanted to have a look at what Somerfield's cost pricing was and also what their agreements were, because up until the time we purchased that business we did not know what contractual arrangements they had with their milk suppliers. It could have been a situation that when we acquired the Somerfield business the end of their supply agreement with their milk suppliers could have well been within a matter of weeks and, therefore, we may have had to combine the business very quickly. As a result, it did not. When we got into the Somerfield business and saw what they were doing, their contract with their suppliers runs through to 2010. Therefore, having looked at the business, looked at the pricing to make sure that we had got what we considered to be a competitive quote versus what Somerfield were currently paying, then we were able to make the announcement and, obviously, we discussed it with Dairy Farmers first.
Q208 David Taylor: At what point did it become absolutely clear to the Co-op Group that DFB was in significant difficulties?
Mr Messom: Significant difficulties, I think probably towards the end of March. We had had concerns and discussions with them towards the end of 2008 because it was starting to come out in the public domain, on websites and in various journals, that Dairy Farmers were having some financial difficulties, and the fact that they then announced towards the end of 2008, beginning of 2009 that they were going to close their Fole and Portsmouth dairies started to signal to us that there could be an issue and certainly security of supply was something that we were very concerned about.
Q209 David Taylor: It is difficult for us at this juncture to try and identify which event was followed by which decision. Were you influenced in your decision not to award the new contract by the fact that you had heard of the significant difficulties of DFB, or had you already come to that conclusion without any knowledge at all of the problems that it was facing?
Mr Messom: No, obviously we were aware of the difficulties. In a true commercial tender process they were not the most competitive. Even forgetting whether they were having financial difficulties or closing dairies, just on a straight financial basis they were not the most competitive, and we gave them every chance to come back and see if they could improve their offer to retain that business, foregoing the fact that they were having difficulties in terms of closure of factories, et cetera.
Q210 David Taylor: Had they passed that first test about being there, or thereabouts, in terms of price, are you saying that it is at that point that media speculation and the industry's reports might then still have meant that you would not award the contract? They were there on price but you were unsure about their future. Is that how it might have panned out?
Mr Messom: If they had been competitive, I think we would have awarded part of the business to them irrespective of the situation, and so they could have still continued supplying some of our milk, but probably we would have split the business.
Q211 Chairman: I want to pick up on a point you have raised there. This tendering process: you were talking about the competitive nature of their prices. Obviously they were competitive up to the time when it came to renew their contractual arrangements, but what is not clear from your evidence is how much they were out by. Was it a significant sum? Was it some pence per litre, or fractions of pence per litre? In the nicest sense, how hard-ball was the Co-op at playing with its suppliers? You buy Somerfield, who have got a reputation for value. You are in the value business, and it is a highly competitive business for selling liquid milk on the high street. How hard were you being with them?
Mr Messom: It was a fair and honest process. It would be remiss of me, seeing as this is a public hearing, to quote figures, because we have obviously got confidential prices with our current suppliers, so it would be the wrong thing for me to say.
Q212 Chairman: At the risk of upsetting my colleague Mr Taylor, could I pursue why I am asking this question. The people who were in DFB had some knowledge of the way that the dairy industry was going. There are lots of charts that are published in the public prints about the price of milk that is being paid to farmers, and I presume those things are accurate. You would think that a company that was already supplying you, and indeed others in the high street, would have had some idea of what a competitive bid was. I appreciate that publicly you may not be able to tell me the difference, but was it a question of fractions of a pence per litre or was it a question of some big difference? I am trying to establish why it is that they were so far out in pricing to secure the contract for what effectively was one of their most important customers and one where, as a result of losing that business, they went out of business.
Mr Messom: We are talking in terms of millions of pounds difference. One of the concerns we had and, as part of the tender process, was we were trying to recognise that the farmgate price and Dairy Farmers of Britain during the tender process made it very clear that, were they to retain the business and almost having to match their cheapest competitor, that money would have had to have come from the farmer. They were already paying at that moment in time their member farmers one of the lowest prices in the industry. That would have driven it even further down, and that was a concern to us, because effectively we would then have contributed to farmers probably going into a loss situation themselves.
Q213 David Taylor: That leads me into the penultimate question I have to put. You said that, effectively, and I paraphrase, DFB was offering the lowest farmgate prices. Why then, in your assessment, were they not able to put in the lowest bid for the contract? What was the problem?
Mr Messom: Because the situation was they were not as efficient a processor of milk as their competitors.
Q214 David Taylor: That was an inefficiency to an extent that the advantages of having the lowest price were lost entirely, and you said to the Chairman, I think, that the gap was pretty significant. We are not talking about fractions of a penny here, are we?
Mr Messom: No, we are not talking of that at all.
Chairman: I would like, Mr Messom, to request you to write in confidence to the Committee with that information. We would like to know what it is. Obviously, we respect the confidence you share with us, but I think we need to get some clear steer of what the order of magnitude was between where DFB ended up, because, obviously, it is a fairly fundamental decision that they were not able to be competitive in your terms compared with others.
Q215 Mr Cox: There has been a public comment, has there not, that there was 2.9 million difference?
Mr Messom: Yes, that is on the record.
Q216 David Taylor: My final question then. I am a Co-op MP and I take it as part of my basic attitude that I want other Co-op MPs and other Co-op elected members of local authorities and, indeed, social and the commercial co-operatives to succeed. I want them to be important and to have an expanding role within communes within society. The Co-op Group have said that it is "proud of its co-operative ownership, structure and identity". How do you square that with the fact that you then pulled the plug on a fellow co-op, which might have survived had you had faith in them, rather than what some people would see as abandoning them at too early a stage?
Mr Messom: I take you back to November 2007 when in actual fact we talked to Dairy Farmers of Britain wanting to get into farmer pools and wanting to form a long-term relationship with this organisation. They would not do that, they did not want to do it because they wanted to be fair to all members and they felt that the Co-operative Group, wishing to pay more to those dedicated farmer pools, would disadvantage certain of their members. It is not as if we had not tried to, if you like, form a longer-term relationship, and at one stage we actually gave them an addition of two pence per litre more than we needed to have done over and above the price increase, which was to the cost of over £4 million to the Co-operative Group, to assist them in their continued trading with us.
Q217 David Taylor: Are you saying you did that because they were a co-operative; if it was a commercial organisation that you would not have given that extra two pence?
Mr Messom: I cannot possibly comment on what we would have done at that particular time.
Q218 David Taylor: No-one is expecting you to take wholly uncommercial decisions, but the fact that someone bidding for a contract from you is a co-operative, are you suggesting that might play a small part in the final decision as to whether they were allocated that contract?
Mr Messom: It may play a small part, but at the end of the day I have a responsibility to the Co-operative Group, and to the CRTG or the Co-operative societies, to ensure that they are getting a price on Co-operative brand milk at a commercial price, enabling them to compete in the market and continue to keep their employees in business and Co-operative shops open throughout the country.
Q219 Chairman: Mr Messom, the two pence you talked to, is that the two pence that is mentioned in paragraph 11 of your written submission?
Mr Messom: No, that is a separate one. At the time we were starting to talk to them about a farmers' pool as a gesture of our commitment to want to do this and we started to pay them two pence extra, which they were then accruing if we started it, because certain farmer members would need some funding up front to bring their farms and processing places up to the standard that would be required and, therefore, it was really our responsibility to ensure that that money was in place before we started it. That was a gesture from us to make that happen, but that is not the two pence that I was talking about.
Q220 Mr Cox: I do not quite understand your evidence. Forgive me, Mr Messom. You have said one or two things that, on the face of it, may strike one as contradictory. First, you have told us that you were concerned that the farmgate price was the lowest and you appeared to imply one of the reasons why you began to think of pulling out of a relationship with the DFB but, on the face of it, by pulling out, you were making things far worse for the farming producers, were you not?
Mr Messom: In hindsight, yes, that is what has actually happened, but my number one concern, which I have said earlier, is to ensure that the Co-operative Group and their societies got a competitive price on milk.
Q221 Mr Cox: I hear that, and that is really what I was coming to, because at one point to my colleague Mr Taylor, you were suggesting that you had made a £4 million decision that was, so to speak, at least partially influenced by the fact that you were having solidarity with another co-operative. Yet, on the other hand, you retracted from that and said the main decision is commercial. I fully understand that, but do you think it is possible that the signals that were being received by Dairy Farmers for Britain, at least for some part of the run-up to the disaster that happened, was that another co-operative, namely yours, would stand by Dairy Farmers of Britain and would tend to have solidarity with them and, therefore, they were likely to be the preferred option?
Mr Messom: No, I think it was very clear right from the outset of the tender process. We set it out in very clear terms to every single supplier that was tendering, that really we were looking at four aspects: price was just one, security of supply was the second one, service level, whoever got the contract, to make sure that we had 100 per cent availability, and the fourth was the farmgate price.
Q222 Mr Cox: What is the small residual part that is played by the fact that you were purchasing from another co-operative?
Mr Messom: I think, had we had all those four factors being met equally between two organisations, at that point in time our preference in terms of supporting a fellow co-operative would have come into play.
Q223 Mr Cox: This gesture you made of £4 million, how was that influenced by the existence of the fact that DFB was a co-operative?
Mr Messom: As I said, I do not know, if I had been in the same situation with a commercial organisation, whether we would have done the same or not, but we felt it prudent at that moment in time. We recognised that Dairy Farmers of Britain were in a situation in which they were paying their farmers less than the market, they were seeking price increases from us above the market level and we felt it prudent to give them something towards what they were looking for. They were asking for more than we gave them.
Q224 Mr Cox: Do you not think that might have sent the signal that they were being treated favourably because they were co-operatives and, thus, they might expect such treatment in future?
Mr Messom: No, I think the signal we sent was that we wanted them to certainly continue to give us the service and make sure that our milk supply was retained right the way through to the end of the contract.
Q225 Chairman: Could we pursue this. Paragraph 22 of your evidence makes clear what the tender criteria were - you have just enunciated them - but up to that time you had a continuing commercial relationship with Dairy Farmers of Britain, so they must have been doing a reasonably good job. I notice that in paragraph ten, for example, you talk about the award of the contract in 2007. You observe, however, in November 2007 DFB failed to produce two of the four lines agreed. I would be interested to know why they failed on that. Was that the kind of factor that affected this question of the service level?
Mr Messom: Yes. Clearly, Dairy Farmers of Britain were looking to widen their customer base and were wanting to increase the range of products that they sold to the trade, and we spoke to them about it. We are ever trying to improve the range of products in our stores and, therefore, they talked to us. We wanted to move from a branded product to our own brand in that particular instance, and we tendered for the business with them, talked to them about it and we developed those products together. Unfortunately, when we came to the seasonal period of that year, they were unable to supply two out of those four products.
Q226 Chairman: There is regular dialogue between a supermarket and its supply chain. That is part and parcel of what you do. Did you put a shot across their bows at any stage during the contract that was running to say, "Look, if you guys carry on like this, your chances of renewal aren't going to be very good"?
Mr Messom: We did have what you would say are commercial discussions on that sort of basis.
Mr Hardman: Might I just add to that. The report from Pricewaterhouse Coopers in August, who clearly reviewed the board minutes of Dairy Farmers, says that, I think, from the end of summer 2008 they were starting to have misgivings about their ability to retain contracts. I think we can deduce from that that must have been because the relationship we had with them was causing them at least to reflect.
Q227 Chairman: I accept that entirely, because I have read the same thing as you have, but I was interested from your point of view. Your dairy buyers are sitting there thinking, "By God, this lot are a sham. They are not doing what they are supposed to be doing. We had better have a word with them." My next question is: what was their reaction when you told them they were not performing properly? Did they say, "Oops, yes, you are absolutely right", or did they give you a lot of excuses? Obviously, if we are looking for the reasons why they went out of business, part of it is not understanding what the customer wants.
Mr Messom: I think it was on the lines of, "Yes, we realise we have let you down. These are new products to us. We have perhaps bitten off more than we can chew", and, as a result, we did not pursue other areas of trying to expand the range of products that they could supply to us.
Q228 Chairman: To sum-up, they would have been very aware of your misgivings during the first contractual period and, if they had had anything about them, they would have been perceptive enough to have recognised that was going to affect their chances in the next contractual negotiation?
Mr Messom: But I would also say that, in terms of standard liquid milk, they gave us an exceptionally good service. It did not affect the core of the business; it was only these new products that we were trying to develop with them that they let us down.
Q229 Chairman: Coming back to the question I started with, it was the level of service agreement on the core products which influenced your perception of the company, not their service on liquid milk.
Mr Messom: Correct, and on service level from Dairy Farmers of Britain, throughout the contracts they have been exceptionally good.
Q230 David Taylor: You opened a new
distribution centre at
Mr Messom: We did.
Q231 David Taylor: Was it an unfortunate
coincidence that at the very same time you lowered the price to DFB for
supplying milk in the South East? Was it
linked to the opening of
Mr Messom: That we lowered the price?
Q232 David Taylor: Yes?
Mr Messom: They bid on the contract
tender process in 2007. The specific
South East was one of our lots and we asked for quotes from all of the parties
that tendered for it for both direct-to-store delivery and through the distribution
centre, and they put that price in, but there were no promises made that any
supplier for the South East would go through our distribution centre. There was nothing in any of the documentation
and there was nothing in any of the discussions that we had with any of the
suppliers that there was a guarantee that we would move that direct-to-store
product into our new
Q233 David Taylor: How much notice was there given to DFB of the change, or how long a period was it before the reduced price came into effect?
Mr Messom: I am not quite sure I understand in terms of the reduced price. We did a new contract in 2007, which they secured, and they continued to supply our stores in the South East on a direct-to-store basis from the start of that contract in August 2007.
Q234 David Taylor: I think the Receiver's report said that, according to DFB board minutes in July 2008, DFB pulled out of the South East Co-op stores, comprising about 50 million litres of milk, as a cost increase that they were seeking was not accepted. Is that true?
Mr Messom: Yes. Effectively they came to us and said that, by and large, they were losing money supplying our stores in the South East on a direct-to-store basis.
Q235 David Taylor: And they were paid 15 pence a gallon more to do that, or thereabouts.
Mr Messom: Yes, that is the deal that
was done. If they supply product into
one of our distribution centres, then there is a 15 pence differential versus
delivery direct-to-store, and they came to see us and said, effectively, they
were losing money on our South East business and they really gave us three
options. One was would we put them into
Thurrock into our distribution centre in the South East or, effectively, they
needed a price increase, which we could not afford to give them because it was
totally out of line with where the market was, or would we find another supplier
to supply the South East stores with milk.
We considered it. We could not
put them into
Q236 David Taylor: Is it unusual to have written an overall contract for supply which allowed DFB to pull out of supplying the South East Co-op stores?
Mr Hardman: I am not sure that is the contract. We did write. I think, to be clear here---
Q237 David Taylor: Clearly the opt-out was allowable.
Mr Hardman: David, I am sure, will correct me if I am wrong, but I think the position here is that a contract that DFB had entered into in 2007 they were finding, in respect of some of the deliveries, was becoming unsustainable from their point of view. They approached us with a number of proposals that they felt would make it sustainable. I doubt whether any of that was anticipated by the contract. This was not a question where we were asking them to lower a price that they had previously agreed; this was the opposite to that: "Can we have a higher price to the one that has previously been agreed because, otherwise, this is an unsustainable part of the country for us." I think we would have been able to hold them at the contract price to the full two-year contract life, but from the proposals they put to us we accepted that they could walk away, as they saw it, to cut their losses.
Q238 David Taylor: It was not that the contract allowed an opt-out, it was just that you conceded a contract variation.
Mr Hardman: We were happy to assist them in this way.
Mr Messom: In the interests of continuity of supply of milk to our stores. That was the fundamental problem.
Q239 Chairman: I notice in paragraph 33 of your evidence you say, "However, strong corporate governance within any co-operative business is essential with open and honest communication to stakeholders, including members, about the organisation's business plan delivery and market place position." Because you have a close relationship with all your suppliers, you will gain a view, as you have just given us an indication, in commercial terms about your view of Dairy Farmers. Did you make any assessment about their strengths in the content of paragraph 33 in terms of deciding whether or not they were a well organised body that had good communications with members? Did you ever look at any of those aspects?
Mr Messom: We looked at the aspects of how they did business with us and how they serviced our stores. We did not go into the detail of how they communicated to their farmers or how they particularly ran their business, and we tend not to do that. I am aware, for instance, that previously you have had experience in Northern Foods. I would not presume to understand how Northern Foods work internally; I am more concerned about our relationship with Northern Foods and how they would supply us. I do not think it is our remit to get involved in the internal workings of each supplier.
Q240 Chairman: The reason I was asking the question, though, (and it comes back to this issue about security of supply) is because part of the reason that you gave for Dairy Farmers being incapable of renewing their contact were two matters: (1) straightforward competitiveness with reference to the price, and (2) quality of service, and to address some of those issues might have raised matters of what were their future investment prospects.
Mr Messom: Understood; yes.
Q241 Chairman: If you are then looking at the business, when you work out the strengths and weaknesses of a supplier I would have thought (and it would be reasonable) that you might have to come to a conclusion as to whether, in fact, it was a well run business or not, because part of who you want to do business with is, are they going to be there tomorrow?
Mr Messom: It is a fair comment. Yes, that would be regular dialogue with all companies in terms of every one of our suppliers' future, what they are investing in plant; and they gave us reassurance at regular meetings that I had with their sales director and managing director that they had got big plans for continued investment in their plants to continue to improve efficiency, and everything they were saying to us was in a positive way that they were there for the long run and they were going to be a very sustainable supplier to the industry.
Q242 Chairman: You had no reason whatsoever to doubt the veracity of those statements.
Mr Messom: Once we get into a situation
where in the public domain conversations were being had in terms of
Q243 Chairman: Going back to the answer to the first question, when I asked you why you thought it had folded you gave as one of the answers the price that they paid for ACC.
Mr Messom: Yes.
Q244 Chairman: Did you form that judgment with the benefit of hindsight? Sometimes when people sell things you sort of breathe a huge sigh of relief and think, "How the hell have we got away with that one? I do not know where they are going to get the money for it, but, jolly good, they are the customer, thank you very much, I will take the money. I am not going to say anything publicly about it", but privately you might well have started to ask yourself the question, "We got more than we expected. How on earth are they going to do it?" Did that kind of internal dialogue ever happen within your organisation?
Mr Hardman: To speak to events at the time, I think you recognise when you go through a process like this that nearly every bidder is in a different place in the life cycle of their organisation. Dairy Farmers of Britain were at the start of a strategic plan to vertically integrate their business as far as they could and to grow it significantly and at speed, and they obviously went through several acquisitions following the ACC one, none of them of the same sort of dimensions. I think we sent you the leaflet that the chief executive put out on the morning of completing the ACC deal.
Q245 Chairman: This confident, glossy publication.
Mr Messom: Indeed.
Q246 Chairman: This is the one: "Creating a new force in the
Mr Messom: Absolutely.
Q247 Chairman: Written in glowing terms. It is interesting to read it with the benefit of hindsight.
Mr Messom: Absolutely. Events could have turned out completely differently, in which case he would have been heralded as having done a fantastic deal and what a snip. At the time did we think they were paying a good price? We thought they were paying a good price. Was it justifiable to them? It must have been; otherwise they would not have paid it.
Q248 Chairman: I do not want to get into the business of double-guessing what was in their minds; I am in no position so to do. I think what I am interested in from the professional standpoint of people who have been in the dairy industry as long as you have is really to get a view (and, bearing in mind they do not exist any more, feel free to be straight with the Committee), to try and understand whether, from a professional point of view, you felt the kind of commercial decisions they were making were sensible, well-founded, or there were times when you were thinking, "God, I do not know whether I should have done that. If I was in their position, I would be thinking twice about it."
Mr Messom: I think at the time, although I have to say I am on the trading side and I was not on the ACC side of the business, I do not think there was discussion internally of what you are alluding to in terms of, "Cor, we have got away with it", or whatever. There was none of that discussion at that moment in time. I think there was pleasure that we had actually exited our last food production unit and that we were now out of all food production. I would argue, or say, that certainly my view that I thought they had paid too much was one of hindsight, but it was not discussed at the time.
Chairman: Gentlemen, thank you very much indeed for assisting us with our inquiries and also for the very helpful written evidence and other material that you have sent us. We look forward, in confidence, to receiving the further details on the subject of the price differential. Thank you very much for contributing. It so happens that things do not always work out as you have planned. Having announced that Lord Grantchester and Mr Smith were not going to give evidence to us, we are now in the fortunate position of being 25 minutes away from the vote and with sufficient members to start that inquiry. I am going to take the heroic decision that we do reverse the decision we made earlier and invite the next two witnesses to come forward and start the process. From the Committee's point of view, it is easier that we take the evidence now than it would be to postpone it. Could we change witnesses and move on. Apologies again for any further change in the programme but at least you know it is live and not recorded!
Witnesses: Lord Grantchester, a Member of the House of Lords, Chairman of the Board, and Mr Gerry Smith, former member of the Executive Team, Head of the Liquid and Milk Division, Dairy Farmers of Britain, gave evidence.
Q249 Chairman: Having now fast-forwarded the situation, could I formally welcome Lord Grantchester, who was the Chairman of the Board of Dairy Farmers of Britain when, sadly, it ceased trading. I think, as he will no doubt tell us, he was not there for the duration of the life of the business but accepted the responsibility towards the end of the company's life. We are grateful to Mr Gerry Smith, who is a former member of the Executive Team, who was the Head of Liquid and Milk Division. Mr Smith, I understand that you joined Dairy Farmers shortly after the decision was made to purchase ACC, so you were not part of that decision-making process. Is that right?
Mr Smith: That is true, Chairman. I joined in November 2004.
Q250 Chairman: You are both very welcome, and my apologies again for the slight disruption of the situation. Lord Grantchester, I think there may be one or two things you wanted to say to the Committee by way of an opening statement. Normally we do not like those kind of things, because people use it as an excuse to bang on and use up time, but I know you will be succinct. If you want to take perhaps two or three minutes to give us the benefit of your thoughts, we will then start our questioning.
Lord Grantchester: Thank you, Chairman. I was only going to open the debate by saying
that the whole Board and the whole company of Dairy Farmers of Britain really
regret the outcome to both its staff and the supplying membership of the
situation. It was a very regrettable
decision. A lot of people have either
lost considerable sums of money or their livelihoods. It has been a very upsetting time for a lot
of people and we welcome very much the Committee's inquiry into the situation
as to what lessons can be learned and look forward to the outcome being a very
positive response. I am sorry to be
pausing for breath. I did come in at a
very late stage in taking the position of Chairman, but I have been a long time
in the dairy industry. I have been a
dairy farmer in my own right on a dairy farm in
Q251 Chairman: Could I persuade you both to speak up. Unfortunately, sometimes the acoustics and amplification in these committee rooms is not always what it would be and it would be, I think, helpful to all of us if you could do that. It is a bit like accepting, Lord Grantchester, the poison chalice in a game of pass the parcel, if I do not mix my metaphors. You happened to pick up the chairmanship in what, arguably, was the saddest part of the cycle of DFB. Why did you do it?
Lord Grantchester: Chairman, I have a big affinity, having been in the business of producing milk, with fellow dairy farmers. I joined the Board of Dairy Farmers of Britain to try and help the small farm, the family farm, to have a sustainable future. I have been involved, as you know, at a political level in all the machinations that have been going on with both farmer supplies in the subsidy area and also OFT inquiries, milk boards, milk marques and we have scars across our backs. I thought I could perhaps try to help and support farmers through their own business and at the end it was Dairy Farmers who were pulling together to try and restructure the business for the benefit of the members and its staff.
Q252 Chairman: What was state was the business in when you took over?
Lord Grantchester: Obviously, it was under severe pressure. We can go back over how it came to be under severe pressure, but it was under severe pressure, and we took the decision that we had to reduce our cost base very substantially and yet supply the same customers that we had. We were going to have the same returns into the business but cut our costs very considerably in supply from what was then three dairies instead of five liquid dairies. This was an entirely incredible strategy to have at that time because we were not doing anything different that we were doing in terms of supplying customers but we were reducing our cost base very considerably.
Q253 Chairman: For the record, when did you take over?
Lord Grantchester: It was the beginning of November 2008.
Q254 Chairman: The beginning of the end had been identified.
Lord Grantchester: The beginning of the end, or the end of the beginning. Yes, we had a severe challenge in front of us, one that I felt I could help bring to the company, to its staff and to the members, to achieve a sensible and profitable restructure.
Q255 Chairman: Can you give us some indication of the respective roles of the Board of the company, the executive team and the members of the Council and perhaps just explain to us what was the relationship between these three parts of the decision-making process? For example, how did communications run up and down the co-operative? In the case of the farmer members of the Board, what kind of professional advice, independent of those employed as full-time executives, did they have access to and in what ways were the membership involved, if at all, in the decision-making process of the business?
Lord Grantchester: There are a lot of detailed questions seeking very detailed answers in your supply of questions there. Can I just say as an overall comment to the Committee, along with Stephen Oldfield, who is submitting and answering this very same question, I concur with him, there were no governance issues which in any way led or abetted any outcome, or downfall, or poor performance of the business. There were no governance issues. That is the overall point I want to get across. I can answer your very detailed questions. Yes, all board members and Council members went through extensive training periods and were provided through EFP with booklets and courses that they underwent in order to make them aware of all the responsibilities that they had in their respective roles - that was all followed up - and, as the business developed, members of the Board also went underwent training programmes in order to help clarify and help them in their roles. For example, risk management was one which the Board identified as something we had to be very careful of and mindful of, but board members went on special management courses in addition to the general ones in terms of the role of directors, finance and non-finance directors, and strategic direction courses. All these were undertaken by board members and, in fact, there was an annual appraisal of board members whereby we discussed openly how things were going, what any of the board members felt they needed to spend more attention doing, and this was in conjunction with the other non-executive directors which the previous Chairman recruited to strengthen the Board.
Q256 Chairman: When it came to, for example, the major decision to invest in ACC, would the members of the Board have been wholly reliant on the executive officers of the company for advice and information about this purchase, or did they have access to any external advice?
Lord Grantchester: If any board member felt that he was not getting the right advice through the Board, he would make the Chairman aware of that and ask for that advice to be provided. This always happened; it was always provided. There was never a time when any Board director sensed that his request was being denied and that, therefore, he would have to go and seek extra outside guidance to help him in his decision, and that is nothing different to any other board I have been a member of.
Q257 Chairman: This is a difficult question, bearing in mind when you took over, but are you aware when these major investment decisions were being made, both the purchase of the ACC creameries at the outset and other assets and then, subsequently, the decisions that were made with Project 523, the rationalisation process, of any kind of input from external advisers to the Board or not?
Lord Grantchester: There was considerable outside expert advice provided to the Board at all times throughout the company's history.
Q258 Chairman: By whom?
Lord Grantchester: By the various skills required, either corporate financial advice in terms of purchases, strategic considerations, also in terms of any other accountancy advice, and, of course, at the end, insolvency advice. The Board were most mindful of their duties and made sure that they took the appropriate advice.
Q259 Chairman: When you talk about corporate finance advice, for example, you started life with a consortium of four banks which eventually got down to one. Was the advice that was available outwith the banking group? For example, did you have a City adviser who was able to help the company with external commentary, both on financing and the nature of these big investments?
Lord Grantchester: There was considerable debate about when and if to bring in, as you call it, City financial advice. We had the best advice we felt we could afford at the time, and one of those was when, and if, and at what cost it is appropriate for the company to take on when it then went into, as you say, very considerable weighty advice.
Q260 Chairman: I appreciate it may be difficult at this stage, but if you have access, or somebody can assist us, it would be quite useful to know, when some of these earlier key strategic investments were being made, who was providing this independent external advice to members of the Board, because, clearly, the company had it own financial advisers. Was it Smith & Williamson?
Lord Grantchester: Solomon Hare started it and then they merged to become Smith & Williamson, and that was the advice given to the Board.
Q261 Chairman: So there was nothing in addition to that.
Lord Grantchester: Nothing in addition to that.
Q262 Chairman: Did DFB have any kind of governance charter? If so, what kind of information did it contain?
Lord Grantchester: Yes, in the formation of
Dairy Farmers of Britain, in the merger of Milk Group and Zenith, this was one
of the models, along with the co-operative, as supplied, directed and advised
to by us by the co-operative movement from
Q263 Chairman: Can you help us in terms of who decided what in terms of the big investments which DFB had to make during its trading life? What is not clear to us is who had, if you like, the decision-making power. Was there any need to refer key decisions to the members, was there any kind of accountability to members, votes by members, in relation to major investments, or did the farmer Board have to make reference to the Council? Give us a commentary on how it worked.
Lord Grantchester: As I said at the beginning, there were no governance issues (which meant we had those covered by our own internal documents, memorandum and articles) of how it all operated together, what the various roles of the respective parties were, the shareholder body and, as with any other company, you have in your memorandum at what level it needs investor approval, shareholder approval. We were no different from any other company in that there was a level that was required to have a Council vote, and the ACC was one such level that required a Council vote.
Q264 Chairman: You waved from the back a copy of the document entitled Creating a New Force in the UK Dairy Industry: Background to the Acquisition of ACC by Dairy Farmers of Britain. As far as I can see, the document is not a financial document, it is a sort of glossy which tells us how wonderful life is going to be as a result of purchasing this thing. I presume this document went to the members.
Lord Grantchester: Indeed.
Q265 Chairman: Bearing in mind the members had to put their £20,000 in and some of them were already investing through loan arrangements their own capital and the well-being of the business that sold their milk was at stake. Did the members have any say - yes or no - in the decision to buy ACC?
Lord Grantchester: Of course they had a role to play in the decision of purchasing ACC.
Q266 Chairman: But there was no member vote.
Lord Grantchester: I will definitely check, because it is a long time ago, but my recollection is that there was a member vote endorsing the purchase of ACC and, in fact, the Board went to considerable trouble going round the country to the various regions explaining it all to them in order to produce that meaningful vote from the membership. I will submit to the Committee the actual date of when that vote happened.
Chairman: That would be very helpful. David Drew.
Q267 Mr Drew: What I could do with is a feel for the decision-making process. Some of the criticism that may have reached our doors on an informal basis has said that the Council was quite an unwieldy body, and it may have been apparently a very democratic body, but it was not great body for making a decision. Is that a fair criticism of the structure of DFB?
Lord Grantchester: I do not think that is a fair criticism, calling it an unwieldy body. Any commercial organisation is accountable to its shareholders. What Dairy Farmers of Britain tried to do, which was subsequently changed, was not have AGMs which were open to all members because, as everyone knows, in commercial operations they can then become very disruptive with one or two people at the back of the room. We had a one-removed shareholder body called the Council in which the shareholders, ie the dairy farmers, voted for their Council members in each region to represent their views in Council. Far from being unwieldy, it was not a general body with an AGM, it was first an 80-member Council that then was reduced, to reduce costs as our membership base was declining, to a 60-member based Council body.
Q268 Mr Drew: Were there occasions when the Council voted against the Board per se?
Lord Grantchester: There were times when the Council voted against the Board.
Q269 Mr Drew: Can you give us an example?
Lord Grantchester: In March 2009, not to refinance the company.
Q270 Mr Drew: And that started to pre-empt the slide.
Lord Grantchester: That is just one example.
Q271 Mr Drew: That was a pretty crucial example.
Lord Grantchester: I can explain everything about that vote. You ask me was there a time, and that immediately comes to mind because, once you are in that situation where any organisation votes against the advice of its Board, it has to then seriously think what it is doing about its board members. Are they the most appropriate board members, if it is not carrying out what the body of the co-op, for want of a better word, has just decided? It put me in the very difficult position: how do I stand if what we are advising our members to vote is then rejected by that body?
Q272 Mr Drew: Were you satisfied that the members of the Council were, if you like, representing the membership; that truly was the view of the membership; that they did not want to refinance the company?
Lord Grantchester: We will come back to all the refinancing angles of it. If the general question is: was I happy that the Council represented the views of the farmers, I would most emphatically say yes.
Q273 Mr Drew: Was there a governance charter? How did this all hold together in terms of the Board, the Council, the individual shareholders?
Lord Grantchester: At the time of the merger, the two bodies coming together, Milk Group and Zenith, had a merger committee and there was a merger board of both boards that went through and set the rule book and published and agreed a whole set of memoranda - it was quite a thick document - that said exactly what the various powers are and what can happen under what circumstances.
Q274 Mr Drew: With the benefit of hindsight, were there things you would have done to the charter to clarify any of the structural arrangements or the decision-making processes?
Lord Grantchester: In hindsight, I think it was an excellent volume that set how the matters of Dairy Farmers of Britain were to be decided and conducted in a very fair and commercially competent angle.
Q275 Mr Drew: To summarise then, there was not a structural weakness in the organisation, as far as you were concerned, that contributed to the financial failing.
Lord Grantchester: There was not any structural weakness. There were model weaknesses, which is slightly different.
Q276 Mr Drew: What do you mean by that?
Lord Grantchester: The model of a co-operative set-up.
Q277 Mr Drew: You would say there was a problem with the---
Lord Grantchester: With the co-operative model, but not the actual internal who can do what under what circumstances and what powers they have. That was very adequate for the circumstances we were in, but the model of what is a co-operative and how does it work in the modern world---
Q278 Mr Drew: Can you say a bit about that?
Lord Grantchester: Yes. What I would say about that is what became very difficult is, because post the Milk Board era and Milk Marque (and we can touch on all sort of facets about that) the modern style co-operative was that members were no longer happy on the model that was, for want of a better word for describing it: you paid your entrance price to join and when you left you got your entrance price back and whatever had happened in the middle was left for the future; and this is the same model of building societies, if you remember a gentleman of the demutualisation era, where everybody was suddenly saying, "I am a member. I want that in my name. I want to bag it for myself", and we use the expression "carpet-baggers". Partners were not willing any more to invest into something called "the Board", however you might like to describe it, and then at end of the day see that investment, maybe for the future, for not their families, maybe other families, who knows. When they retired they did not get any of that investment back.
Q279 Mr Drew: Can you spell out the model, so we are all absolutely clear?
Lord Grantchester: This did become a very big burden on us, because when a member left it then crystallised a long-term liability into a loan note that had to be repaid in ten years; so he could get his money back. It was deemed a benefit and an advantage of this new style co-operative and here we were being all things to all men; when a dairy farmer invested in his own company he got his money back when he retired. Towards the end, that became a huge strategic burden to us because, when that member left, it crystallised the long-term liability that had to be repaid to him. If I can just finish the point, what company out there, when it asks for equity, then can face a shrinking equity base and still be able to exist?
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
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". 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, twice a year, 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 a rotation of directors. 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 farmer-owned 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 comes from the farmer body of the co-op to then replace the farmer board members on the board and that is a huge challenge to the organisation. That is one feature, I would say, of farmer-owned businesses which is tough for them, that they do not generally have off-farm board experience.
Q289 David Taylor: The National Farmers'
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 have 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 put on 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. We had 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
Lord Grantchester: Paul Fox was one of our field staff. He was a very good member of our field staff and ran through the territory there. 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 reduce 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
Board of the dairy co-ops. "This is a
move which results in the
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
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. If we were not able to get at 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 difficult aspects of it, none the least of which is the Co-op that had then gone into a quick restructure itself to move assets about in order to sell this to us which 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 they 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 naïve is that we only had a three-year price 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 naïve 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 marketplace.
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
Q300 Mr Drew: Mr Smith, you were about to leap into action and we will be pleased to hear what you have got to say to back up the Chairman's perspective.
Mr Smith: I think it depends what you want to cover, Mr Drew. Do you want to cover in my view the reasons for the demise of Dairy Farmers?
Q301 Mr Drew: Do, please.
Mr Smith: I suppose I was fortunate that I joined the business in November 2004 following the acquisition of ACC so I was not part of the due diligence exercise but, in my view, there was no doubt that we paid too much for that business. We acquired old assets and I would argue that they were the oldest assets in the dairy industry. Those assets required significant investment to bring them up to standard. You read the PwC report, £20 million was invested in those dairies following the acquisition of ACC. I think it took us some time to understand what we had actually purchased. I would argue ---
Q302 Mr Drew: Could I interrupt you at that. Why? ACC were a fairly transparent organisation. I will declare an interest, I am a Co-operative member. I know a bit about ACC. It was not the reason I did not take part in cross-examining them, but there would have been some nervousness on my part because of what I have known previously. It was known that there were some difficulties just in terms of capacity, competitiveness and effectiveness in the marketplace, so why was it such a shock when things started to appear in terms of future evaluation that you did not quite buy what you thought you bought?
Mr Smith: I did not get involved in the liquid side of the business until around about the summer of 2005. I was asked by the Board to go and investigate, together with some colleagues, the performance of that business, so we had actually had the business from August 2004 and a black hole was discovered in the summer of 2005. We analysed the business in some detail in the summer of 2005 and personally I came to the conclusion that we had not made any profit in that business since we acquired it. I think it was not until we appointed ---
Q303 Mr Drew: Your predecessor had not picked this up?
Mr Smith: No-one had picked that up until the summer of 2005.
Lord Grantchester: To interject there a minute, we did not find that the company had the mechanisms to help us find the answers as to what was going on. We had to go in to analyse the business that we had purchased ourselves as to where in the supply chain what was the cost of going to one dairy, to another dairy. These things were not readily available in the company, we had to go about setting up all those knowledge bases and trying to understand how the supply chain worked, we had to do that. That is why to a certain extent it was not there, that it took that amount of time for Gerry's team to then be able to have the tools to analyse the business.
Q304 Mr Drew: That is a fairly fundamental weakness. If you do not know whether you are a making a profit or loss, most businesses would be in some difficulty.
Mr Smith: I would suggest that it was not until we appointed a new finance director to look after the liquid side of our business that we discovered we had an issue. You have to remember that we acquired the business in August 2004 and our financial year was March 2005. When you acquire a business sometimes you acquire a very strong balance sheet with it, so the true performance of the business sometimes is not known until you prepare your own budget.
Q305 Mr Drew: I know that neither of you was around but who did the due diligence on the actual takeover of ACC?
Lord Grantchester: KPMG.
Q306 Mr Drew: What action have you taken against KPMG in the sense that at least you could question them whether their due diligence was suitably rigorous?
Lord Grantchester: As I said in my earlier comments, we did wonder ourselves and we did formulate a claim against ACC.
Q307 Mr Drew: I know that, but that is the formal thing. There must have been an informal reckoning that this was not what you thought it was.
Lord Grantchester: Correct.
Q308 Mr Drew: That is for the record, yes?
Lord Grantchester: Correct.
Q309 Mr Drew: Could we move on because I am aware that we have got to try and get to the end of this session. Just so that we are absolutely clear, the membership of the new organisation got to vote on a number of key parts of the creation of the business and, in particular, obviously the takeover of ACC was ratified by a vote of the membership.
Lord Grantchester: Correct.
Q310 Mr Drew: What about the dairies at Lincoln and Bridgend that were also acquired? There was a clear vote on this.
Lord Grantchester: There was no vote on
Q311 Mr Drew: It was referred to the Council. Could the Council have called for a vote of all the members? Just so I am clear, if they were either abdicating responsibility or felt the Board was over-egging the pudding, acting unilaterally, the Council could have said, "Let's have a vote", but they chose not to.
Lord Grantchester: They chose not to challenge the decision. It was explained to them that there was not a formal necessity to have a vote. It was explained to them.
Q312 Mr Drew: Finally, moving tack slightly, can you spell out exactly what this Project 523 is. I think I know what it is but it has come up on a number of occasions. What was it and what was the impact of that in terms of the wider remit to change the nature of the organisation?
Lord Grantchester: Once again, if I can provide the backcloth to it I am very happy for Gerry Smith to come in because it was his task to restructure the business. You will have heard that under 2007 we renegotiated the contract with the CRTG group successfully. As I have hinted, there were problems in the relationship from the very start but it was a successful renegotiation. What I would say is that the negotiation in 2007 was very prolonged and protracted. It took us a lot of time, well over the year end, and caused us problems in refinancing and problems for the auditors to sign off the accounts. The Co-operative were very protracted in their negotiations. I would like to contrast that with the 2009 negotiations that were the entire opposite. We re-contracted with ACC during 2007 and we then found problems that ACC in their evidence earlier highlighted in the supply to the south-east which I would say was because we did submit different prices as direct to store or through their RDC network. Thurrock were promised to come on-stream but Thurrock did not come on-stream at the right time such that Dairy Farmers of Britain then had to underwrite £6 million of extra costs that in negotiations were not meant to be our costs. That was the background to why the south-east was walked away from because we were being asked to commit to an uncommercial contract.
Q313 Mr Drew: There was no tit-for-tat in this inasmuch as the Co-operative Group had already announced that it was removing you as a key supplier?
Lord Grantchester: That is 2009.
Q314 Mr Drew: Yes.
Lord Grantchester: I just want the Committee to understand what is meant by commercial or not. You will understand one of the difficulties of learning about the business that Gerry Smith has alluded to is that it was also the convenience sector, which was where our customers were, the Co-operative Group and others in what is called the middle market. You will recall that the OFT allowed big supermarkets to come into the convenience sector and the supermarkets restructured their supply base in 2005 from three suppliers down to two. Those tenders were not available to us. They were very lucrative contracts to the big three players. We were in the convenience sector which they could marginally cost and we could not marginally cost our fundamental customer. The competitors could marginally cost our customer against us which made it extremely difficult for us operating in that market to be able to "compete" because it was at very marginal costing because we did not have behind us other contracts which we could rely on to provide us with a sustainable price for our members. Our members were already identifying very severe weaknesses. The co-operative then came under the pressure of departing members and I have highlighted to you the crystallisation when that went on our balance sheet such that it became extremely difficult when the credit crunch landed in 2008 with the consumer trading down, with major supermarkets seeing that the trading down resulted in a growth of the discount sector, to then announce, "We are going to be the biggest discounter". That was the backcloth to us losing money and I then identified pressures that came on the business and we had to part company with our previous chairman by mutual consent. I was asked to step in and to then quickly have to rationalise this business, as I said earlier, to keep the customers we had but to reduce our cost price by going through three dairies rather than five. At this stage I will pass over to Gerry Smith to clarify this 523 Project.
Q315 Mr Drew: If you could do that very succinctly, Mr Smith.
Mr Smith: Just going back to 2005 when we discovered we were losing money, we embarked upon a major cost-cutting exercise. We took about £15 million of cost out of the business. We were still facing significant inflation in this business. When we got to 2008 we were still losing money despite all the good things we had done. We had improved product quality, the service levels, and customer confidence at that stage was pretty good. The 523 Project was a radical rationalisation of our assets. In the two budgets that we had presented to the Board in the previous two financial years we had considered reducing our dairies from five to four or to three. Just to give you the background: Dairy Farmers of Britain is a sales-led business, so if we say we are going to sell 800 million litres of milk to our customers we need to have assets to accommodate that sales demand. In essence we never sold 800 million litres. We built up our asset infrastructure to cope with that level of sales and we were selling 500 million. So we had an asset utilisation, which is the rate of your sales to your capacity in the five dairies, which was at 58%. Our competitors were close to 80%. This is a commodity business, it is all about being a low cost producer, and you cannot be a low cost producer if you have an asset utilisation of 58%. We had too many dairies. We put our paper to the Board and the executive team, which the Board accepted, which was to radically look at the asset base and reduce our dairies from five to three. At the same time we were looking to reduce our depot network significantly. This project was all about taking £28 million of cost out of the business. It reduced our dairies from five to three, as I have said, and reduced our depot network from 25 to 17. It had a cash cost associated with doing it, and that was our redundancy costs, of just over £5 million, but what it did was it took the business from significant loss to being profitable in the financial year 2009-10. From April 2009 this business was going to make money. That is it in summary. In essence we actually delivered that plan. You will have noted on page 27 of PwC's report that they say: "Despite the significant initial cash outlays primarily relating to redundancies, and delivery of Project 523 on budget, the planned cash and profitability improvements did not materialise in the remaining Liquids business". I have had various discussions with Stephen Oldfield on that comment and I think he now accepts it is factually incorrect.
Q316 Mr Drew: Are PwC prepared to reword that?
Mr Smith: They are prepared to alter that report. The reason I am stressing that, and I think it is quite important, is in April and May of this year the liquids part of Dairy Farmers of Britain made a profit of £1.5 million. Project 523 was a complete success. We had radically transformed the business from losing money to making money. Unfortunately, as I said earlier, we lost the confidence of our customers. The project had been delivered on time and on budget and, in fact, our cash costs came in at £2 million less than we had forecast. The confidence had been lost. The project was more than successful. You asked John what he could have done if he had become Chairman earlier. If we had carried out the 523 Project 12 months earlier we may still have been in business.
Q317 Miss McIntosh: How do you respond to the charge that it was a flawed business plan?
Mr Smith: The 523 business plan?
Q318 Miss McIntosh: Your whole business plan.
Mr Smith: I think PwC actually analysed the 523 business plan on behalf of the bank and they did their sensitivities. The actual performance during April and May showed that the plan was not flawed.
Q319 Miss McIntosh: Obviously I represent a number of farmers who lost access to the milk market with the demise of DFB. I understand a number of farmers did place substantial amounts of money with DFB as an investment, a sort of pension scheme and they will not be refunded obviously. Have they just lost that money?
Lord Grantchester: We will come back to this later on. To take you through it step-by-step, the implementation time of 523 with our financing of it, and so on, has to be analysed and, as Gerry says, what led to the loss of confidence. As you rightly say, it then resulted in losses to unsecured creditors. We can take it now if you like as to where it then goes but at the end I would like to come back to what I could perhaps suggest to the Committee, the lines of inquiry they could take up to mitigate that loss of farmer members. I would like to come back to that at the end.
Q320 Mr Drew: Can I take us now to what Mr Smith has been talking about, the loss of confidence of the customers, and try and tease out the reaction of the Board to the two issues in hand, one of which was the loss of the Co-operative Group. One of the questions is why did you only bid for two out of the five of the contracts that the Co-op Group had on offer. Was that because you did not think you would stand a chance of picking them all up or were you already beginning to read the runes and think, "The Co-op Group have lost confidence in us"? We will talk about Tesco in a minute.
Lord Grantchester: I would like to come back to the general restructuring cost and what they had on the general marketplace.
Q321 Mr Drew: You only bid for two of the five lots from the Co-op Group.
Mr Smith: Yes, that is correct. We bid for two of the lots and offered to do
the Welsh business for them, but that was part of a bigger lot and could not be
accommodated. The reason for that was
that Dairy Farmers of Britain was very efficient at producing milk and
distributing milk from the dairy direct to the customer's RDC - regional
distribution centre. We were very good
at that, very efficient. We were as
efficient as anyone else in the industry.
What we were not so efficient at was distributing it from the dairy
through our depot network direct to store, straight to the Co-op store. We were not good at that. Comment was made earlier in the Co-op
evidence about Dairy Farmers of Britain walking away from some business and,
quite rightly, David mentioned that we enjoyed a 15 pence a gallon premium for
direct to store business, but in essence it cost us 45 pence to deliver that
milk. For every pint of milk we were
delivering direct to store in the market we were losing money. That was why we decided to go for two of the
sections, one of which was direct to store delivery, the RDC delivery, which we
were very efficient at, and the other was organic. We had a good organic milk pool and it was an
opportunity to sell that through the Co-op.
Q322 Mr Drew: From what we have read and what was said previously presumably there was some attempt by the Board to rectify the situation. There must have been informal contact - that is what Mr Smith is alluding to - with the Co-operative Group to see if there was any way in which you could resurrect the relationship.
Lord Grantchester: I think there is a patch here I would like to go back over that you are skipping over, if I may, which is to take you through the winter that led to that loss of confidence of customers and the Co-operative Group were not the only one. I would like to say in terms of our 523 plan then which we put to the banks and HSBC, our bankers, to help fund, you will have to remember and think that we were financed by HSBC on what was called "asset-backed lending", ABL lending. That was on a different basis from the relationship lending whereby the cash flows of the business are smoothed by finance from the bank. We were not financed in that way, we were only financed on assets which were either cheese stocks, invoice discounting or a myriad of the asset-backed lending regime that then meant we went to the bank to say, "We want to restructure our business into profit". They then asked for an IBR, Investigative Business Review, which they asked PwC to do on their behalf. Through the winter of 2008 and coming through Christmas into 2009 they undertook that review and once again you could say were we naïve. We assessed that we could not afford to continue losing money while that investigative review went on. We had to grab the nettle and restructure, albeit we had not finance from that in place other than trying to persuade HSBC to finance it. The investigative reporting accountants, PwC, advised the bank not to finance it. That is very crucial for the Committee to understand because then you are going to ask me what did we do about it. The answer to that was we then had to try and find alternative forms of finance and there are only limited alternative forms of finance. One is you go to our Government, as all other industries do, the car industry or whatever, and try to get the restructuring cost paid by Government. As you well know, David, the Government is trying to see what it can do to help businesses through this credit crunch. At our time of going they were all very, very responsive to me to see what they could do to help; unfortunately we did not have in place at that time the instruments that are now available in terms of helping businesses through that time. We all remember the announcements that were made in February of what Government could do to help companies restructure. The flesh on the bones of those proposals then took longer to come through, they were not available to us to use at the time and I can give the Committee, if you want, chapter and verse on everything that happened with the Redundancy Service and what was in BERR and what was Defra in terms of making it all available. That finance was not available to us. It then happened that because of our communications and dialogue with our bankers, HSBC, they had to finance it because otherwise then, in terms of their creditor position, the whole thing was getting very difficult. The other alternative was that, while they were financing some of those finance costs, what else is available is you have your membership. In the re-financing of the business we went through a process under advice from our advisers on re-financing through the membership. There was then a third strand to what we should then do which was we were then asked by the bank, HSBC, to endorse their appointment of PwC to sell some assets to reduce our debt. Let me clarify, the appointment of PwC was - as in your other investigations - with a duty of care to the bank. As the Chairman of Dairy Farmers of Britain, I was faced with the position of the bank, HSBC, saying to me, "We want you to engage PwC with a joint duty of care". I did not think that in all honesty I could sign a contract with a joint duty of care, I want the Committee to understand that. We retained our advisers to advise us, the Board, while PwC set about their task on behalf of a duty of care to the bank. The process of all of that, putting assets up for sale, then meant you were challenged in the marketplace by everybody saying, "You better look after your suppliers because they're up for sale. What's going to happen? Who's going to be supplying you if you sell that business to somebody else? Do you want that person supplying you if they sell it to somebody else? By the way, they may not be there for Christmas. How are you going to have milk in your stores for Christmas?" These were all challenges the business was having to face during that period. That general challenge was then publicised very unfortunately everywhere on websites and people seemed to take joy in trying to find fault with the situation, which then meant that customers got extremely nervous and a customer who is extremely nervous wants to put his supply out for re-tender again.
Q323 Mr Drew: Could we move on very quickly to the Tesco situation. In a sense I suppose our criticism that we would voice is why did you not strike a tougher bargain with Tesco? Certainly why did you not have some traction over them in terms of their ability to wriggle out of the contract, because once they went you were in serious difficulties? Why did you not ask for a more onerous arrangement so that you tried to lock them into this? Let Mr Smith start because presumably you were dealing with this.
Mr Smith: Yes, I was. I was dealing with the Co-op tender and Tesco.
Q324 Mr Drew: Also with Tesco's?
Mr Smith: Tesco did not walk away from
any contract. Tesco have been, and
continued right to the end to be, very supportive of Dairy Farmers of
Britain. When we closed two dairies in
Fole and
Q325 Mr Drew: You do not think you could have sought more of a guarantee that eventually when they did go they could have been held to their handcuffs, if you like, that they really needed to stay with you?
Mr Smith: I think the market dynamics changed significantly.
Q326 Mr Drew: By that time it was all too late.
Mr Smith: Local Choice was a premium
product with everything else that was happening in the
Mr Drew: Roger, I want to move on to receivership.
Q327 Mr Williams: In March 2009 ---
Lord Grantchester: Mr Drew, there are some other aspects of that which I think should be on the record but I know you have to move on.
Q328 Mr Drew: I do think it is important. Very quickly then, Lord Grantchester.
Lord Grantchester: I want to say that, in terms of the strategy of where we were going, we identified that we had to move out of the convenience sector and try to get in with more better payers, the supermarkets and Tesco's are the number one supermarket in the country. The only way we could get in there with their contracts was on a new brand, a new product which was on the back of the consumer identifying food miles as an issue and wanting local supply. Tesco's identified us as the best people. They also identified us as backing the family farm and the commercial angles of their strategy in terms of helping local communities. We had a very strong relationship with them to bring through this new brand and, as with any new brand, it had its teething problems, it took longer to develop. We invested; they invested behind the brand. Unfortunately, it did not come on, as Gerry has hinted, because of the credit crunch and the consumer downtrading away from the premium end of the market. Tesco's were entirely supportive of Dairy Farmers of Britain.
Mr Drew: Let us move on to receivership.
Q329 Mr Williams: In March when it looked like the co-operative would go into receivership you talked to Jane Kennedy, the Minister, about matters. What contingency planning did the Board do with the aim of maintaining the milk supply chain?
Lord Grantchester: Once again I am sorry, Mr Drew, to step back a bit from that question, which I will answer, in saying because of the inevitability of receivership and the various ways we were trying to finance our restructuring costs, the membership then came under the severe challenge of having to re-finance the business at the end of March on the back of asset sales of the business. It was a very close call, all the things we asked them to do in terms of changing the balance sheet from debt to equity, in terms of changing their loan investments into equity and then re-financing the business. Where we were in the process was not an ideal time in the process. I was putting PwC under a lot of pressure to clarify the liquid division because there was a lack of clarity. The liquid division was a severe challenge to the membership, "What are you asking us to re-finance? What is the position of that business now? Where is it?" Lack of clarity on the retail business meant that it was a very close call and members really wanted to support the business, it was a vote of 40/60 in favour. As close as it was, then it was lost, so the business was in crisis of not being able to continue in business with this challenge of not being re-financed. Then the Board had to be aware very critically of its responsibilities to all the creditors with a major responsibility being to the secured creditor, HSBC. To come to your question, sorry, could you please ---
Q330 Mr Williams: What contingency planning did the Board have to maintain the supply chain?
Lord Grantchester: Yes, once again we went to talk to HSBC and HSBC agreed to finance the business through to the beginning of June to then assess what assets could be sold to bring down debt, what it then meant to get it back in within facilities. Part of the ABL part of it was that as you were selling assets you had fewer assets against which to borrow, so fundamentally it was a very difficult race to operate in. The contingency planning that was done was right at the time of asking our equity providers to re-finance the business and the Co-op wanted to announce that we had lost the contract. What would that do to the confidence of our equity providers in the business when our major customer was saying, "We don't think we want to do business with you". We have to be very careful about what we say now in those negotiations of how they went with our major customer. They wanted to announce it the same week as I was having to ask our equity providers to re-finance the business. That was impossible. We then had to ask the Co-op for an audience to go through with them how are we going to migrate our supplies from us to your new suppliers such that our members will not lose out in terms of what they have lost subsequently in terms of milk cheques by going into negotiation with their suppliers, they have a third supplier. To migrate supplies across whereby their milk supply could move across to new suppliers and not lose any money meant the new suppliers had to finance that gap with loans that they repaid over a length of time. This was a model that was conducted when Westbury went bankrupt some years earlier, the new suppliers took on the supplies, financed the farmers' supplies through it and then the farmers slowly paid it back. That was the contingency planning that was happening at the last minute up to receivership.
Q331 Mr Williams: At the time all this was happening, as you say the Government was putting forward proposals to support a lot of businesses that were in trouble because of the credit crunch, you had an offer to go and meet with the North West Development Agency which could have investigated any opportunities like that but you turned that down. Why did you turn it down?
Lord Grantchester: We did not turn it down. It was part of PwC's brief to find buyers and they were in charge of doing it. It was not our place to go through that process and try to do negotiations between the RDA and some of our members who maybe wanted to reinvest through one of those schemes of the RDA. That was for them to do, not part of our company's accountability and responsibility.
Mr Smith: If I could just come in there. For a period of time I did lead a potential management buyout team of the Blaydon Dairy and we did take advice in the north to see what financial assistance was available to us. They were very supportive but the timescale we were working to was just too tight.
Q332 Mr Williams: If Dairy Farmers of Britain had gone into receivership at the end of March or beginning of April would it have had enough money to pay producers for the milk that they had supplied during March?
Lord Grantchester: Throughout that period we were breaching our banking covenants with HSBC because of the extra restructuring costs that we were taking on with our banking facilities, so we could not do anything without the support of HSBC. HSBC were very supportive of the company and wanted to support a soft landing, if I may use that expression, throughout this time. It was their decision to try to trade the situation through because, as Gerry has just said, the business was now restructured and making profits. It was not part of our planning to have the outcome that subsequently happened.
Q333 Mr Williams: You say you were breaching the covenants all the time and yet Mr Smith said that the restructuring cost £2 million less than had been budgeted for. What was the reason for the breaching of the covenants?
Mr Smith: The covenants were for the total business, not just the liquid side of the business. We were carrying very high cheese stocks at the time and it was taking a lot of cash to fund that stock. We were in breach of our covenants on cash.
Q334 Mr Drew: Let me just be very clear on this because one of the accusations that is thrown our way is if there had been some fancy footwork in terms of some of the dates then at least some of the farmers would have got their milk cheques, whereas obviously there is an issue. I know you could argue because of the way in which the receivership was delayed that meant some people did get their milk cheques. It is this game about who knew and who received help. Can you just give me a heads-up on that?
Lord Grantchester: Can I clarify that there were no preferential suppliers in terms of some farmers receiving milk cheques and some farmers not receiving milk cheques. The Board were most mindful of their responsibilities at that time to assess that they were not wrongfully trading. At that time we had the support of the bank and also had facilities until June. We also identified that the position was not worsening. The advice to the Board was that we could still continue and we wished to continue because the spring flush was coming whereby we knew with the surplus milk that is traditionally is in the marketplace in April, May and June, the supplying members could be at a severe disadvantage. We wanted to trade through that period with the support of the bank.
Q335 Mr Drew: So you would defend the timetable literally in terms of the time element of it?
Lord Grantchester: The timing of it was at the beginning of June, because of the different circumstances that were then happening, the Board identified that the creditor position was worsening and we were very mindful not to be wrongfully trading. We had a primary duty to all the creditors equally, although obviously secured creditors have preferential treatment. We then asked the bank to call in receivers because we had no other option. We were acting quite appropriately according to the advice received that the creditor position was then fundamentally changing.
Q336 Mr Drew: We must pull stumps there. Can I say that what has been said is on the record and must remain as said, but if there are things that have been unsaid, and certainly we have got some very specific questions we will put to you in writing, you can respond in writing because we have to go and do other things, as I am sure you realise.
Lord Grantchester: I do realise. In terms of the end, lessons learnt, there were a few things I was going to make the Committee aware of. Can I supply them to you in written form?
Q337 Mr Drew: That would be very useful.
Lord Grantchester: There is something out of this that I would like to point you in the direction of that could be extremely helpful to the members who, along with the staff, have suffered terribly out of this process.
Mr Drew: That would be very helpful. The clerk will be writing to you with some quite specific questions which we have not managed to fit in this afternoon. Thank you for coming and being so frank with us.