Immediately after the holidays, in two weeks’ time, Tnuva Food Industries is slated to take center stage in two important events.
The first is a mammoth initial public offering at an estimated company valuation of NIS 10 billion - high by any standards, much less for a manufacturer of staple food items.
The second is a hearing with the Agriculture Ministry's price supervisor, Uri Zuk-Bar, whom Tnuva will attempt to persuade not to place two of its products - 38%-fat heavy cream and 5%-fat soft, white cheese (“gvina levana”) under price controls.
The Prices Committee, a joint body of the agriculture and finance ministries, determined that Tnuva’s profit margin on the pair “far exceeds the bounds of reasonable profitability." In other words, Tnuva is having a field day with exorbitant markups on the items.
There’s good reason to think there’s a connection between these two nearly concurrent events. That is, that Tnuva’s NIS 10 billion valuation is due not only to outstanding management but also to exploiting a captive market to its fullest advantage. The suspicion is that Tnuva's profit margins are higher than they would be in a truly competitive market, mainly because Israel's dairy industry at all stages is far from competitive.
Tnuva has already been declared a dairy monopoly due to its 50% market share. The three large dairies together – Tnuva, Strauss and Tara – control more than 80% to 90% of the market. Strauss, too, has been declared a monopoly in dairy desserts (refrigerated puddings).
An analysis by the Agriculture Ministry's research division in May 2011, one month before the start of the so-called cottage-cheese protest, termed Israel’s dairy market "an oligopolistic competition of differentiated products," explaining that "creating a variety of products is one of the ways for competitors in a market to reduce the competition among themselves." In other words, each dairy grabs a lead niche and is careful not to disturb the others in theirs.
Tnuva, the largest of the three, seems to have an especially tight grip on the market. seems especially tight. Zuk-Bar examined the profitability of just 12 different dairy products, all of which were released from price controls during the past decade, in order to determine whether the price controls should be restored due to excessive profit margins. His researchers concluded that "unreasonable profitability" was indeed an issue for some of the items.
"Unreasonable profitability," as defined in 1996 by a government committee, is a markup exceeding 12%. While the precise figures from Zuk-Bar’s review were not made public, in order to protect Tnuva’s commercial confidentiality, the fact that the price supervisor chose to intervene implies that the markup was much higher.
The two items for which excessive profits were found have nearly identical counterparts, namely long-life cream and 9%-fat soft white cheese, which were not singled out for excessive profits. But no one doubts that if profits were excessive for one they were also excessive for the other. The supervisor didn't bother proposing price supervision for these as well, since monitoring the price of one product – the anchor product – is enough to restrain the price of similar items. By that logic, four of the 12 products examined presumably earn excessive profdits for Tnuva.
The price supervisor also noted, in a press release, that very high profit margins – apparently the highest among the 12 tested products – were found for three hard cheeses on the list: Sliced and packaged Tal Ha'emek, Gush Halav and Gilboa cheeses.
These cheeses should actually have been the first to be put back under price controls, but the supervisor chose not to, arguing that it was enough for the main, anchor product, hard cheese sold by weight, to be under price supervision and adding that if necessary price controls would be restored for the packaged sliced cheeses. In other words, these three hard cheeses are already under supervision because they are sold at deli counters at a controlled price of NIS 40 a kilo. For some reason shoppers insist on buying the same cheese, prepackaged, for NIS 60 to NIS 80 per kilogram.
This confounding behavior is confusing to officials. In any case, it means excessive profitability was found for seven, not two, of the 12 Tnuva products examined.
It should also be noted that until two years ago two additional items on the list of 12 were being sold at excessive markups - 5%- and 9%-fat cottage cheeses. Their prices were reduced after the consumer protests that adopted their name, and have remained at the lower levels. Indeed, the supervisor found profit margins on them to be reasonable now.
So Tnuva learned its lesson with respect to two products on the list but not seven others. Of the Tnuva products that were checked, in practice 58% - 75% prior to the cottage-cheese protests - generated excessive profit margins. Perhaps that helps explain Tnuva's IPO market value.
All 12 products are staples, commodities sold in large volume, as are the 10 basic products, such as milk in plastic bags, that are still subject to price controls. Tnuva and Israel’s other two big dairies sell hundreds of other products, including refrigerated puddings, whose markups aren’t being monitored. The government assumes there’s no need because they are under more competition. But in light of Strauss’ classification as a dairy-dessert monopoly and the (non)competitive culture of the big three, this confidence seems misplaced.
The proof is that even Tara Dairy, which is growing rapidly with its new Noam plant, is choosing to focus on the quality of its products (such as the minimal use of preservatives) rather than their price.
The government is largely responsible for this situation. If Tnuva is an official monopoly, is it any wonder that it allegedly exploits its monopolistic position in every way possible? Any other monopoly would do the same, so the real problem is the very existence of a monopoly in such an important product category.
It is precisely because of this market failure that the government must open the dairy sector to competition by removing import duties on dairy products in general and hard cheeses in particular. But the government, despite the cottage-cheese protest and mounting evidence that dairy prices have remained quite lopsided, prefers to surrender to the farmers’ and dairies’ lobbies and leave the duties in place. We're all paying the price.
Tnuva said that since it faces a hearing on this subject it can't respond to any questions on the matter. The company also said its profit margin of 5.3% is fair, comparing it to those of Strauss (4%) and Osem (8.7%).
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