Friday, August 28, 2015

Living with Giants - Lessons from Industry Organisation

Bigger is not Necessarily Better

Management consultants McKinseys were the advisors behind the creation in 2002 of the mega-cooperative, Fonterra.  Owned by dairy farmers, the new organisation was intended to consolidate New Zealand's dairy processing, exploit its export strength, diversify its output, and move it up the value chain.  This all looked good while increasing demand in China in particular sustained increasing output and prices, especially given that  Fonterra accounts for around one third of global dairy trade.   

But price escalation was never going to be sustained in what is essentially a commodity market.  Consequently,  over-production and cyclical pressure on consumer demand have seen a rapid collapse in prices, and increasing questions over Fonterra's performance.

Commodity Trading Still

There are no surprises here. We have seen a series of collapses in New Zealand's commodity sectors over the years. Where are industry giants New Zealand Forest Products and, in the meat sector, Waitaki New Zealand Refrigerating today? Where are those former behemoths of the pastoral sector, Borthwicks and Fletchers? Dominance of a sector all too often carries the seeds of its own destruction. Even that giant of the IT sector, Google, has reset itself as a cluster of smaller, more focused entities.

Fonterra was meant to drive the innovation that would increase the value of dairy exports, to reduce its dependence on commodity sales.

Its biggest innovation appears to have been the Global Dairy Trade an auction platform it established in 2008 that has become the benchmark for world dairy prices. It is no more than an instrument of the commodity trade, though. It simply confirms the cyclical nature of the market - and leads the race to the bottom. 

In fact, dairy prices have gone nowhere over the past decade. Those that have sunk capital into the sector on the back of the promise of "white gold" have seen poor returns, insufficient in many cases to cover the costs of their capital. This is especially the case for those that purchased or extended farms in the boom years.

Global Dairy Trade Price Index

What Went Wrong?

Industry commentator, Tony Baldwin, identifies five factors behind this indifferent performance.  These are detailed in his NZ Herald piece today. In summary:
  • The organisation remains producer-driven rather than consumer-focused;
  • It misunderstands its own strengths and weaknesses and therefore where it needs to address its role (and value) in the supply chain,;
  • It has confused roles and objectives;
  • As a cooperative it is capital constrained;
  • It has effectively misdirected capital into lower value volume production capacity rather than into higher value product development.
Not everyone will agree with this diagnosis, but the outcomes speak for themselves.  Whatever the vision was for Fonterra, the architects surely were not looking for more of the same - volatile commodity trading writ large?

The Lessons for City Organisation

So what's this got to do with city matters?  Everything.  Fonterra is another example of the fallacy of thinking big when it comes to reforming organisations. 

When Auckland municipalities were amalgamated in 2010 I suggested that large organisations are slow moving and resist change as internal relationships and established ways of doing things dictate their responses to changing external conditions.  Consolidation was the wrong response to whatever was wrong with Auckland.

Nothing I have seen since leads me to change my mind. And the comparison with large industrial organisations holds.

Think about it: 

Producer Driven
The new Auckland City remains focused on shaping the city according to a particular brand of planning. No room for innovation there as  the architects of Auckland draw on precedent from elsewhere to fulfil a vision of more people in less space. Intensification was a keyword in dairying as larger herds became established but that did nothing for the consumers of dairy products or, really, for the sustainability of the New Zealand economy. Citizens in Auckland are now faced with a future closer to the crowded cities of the past than the open city that could define our future.

Role Confusion
The role of Auckland Council has become one of dictating rather than  enabling, of shaping rather than servicing, and of participating in an unwinnable auction based on contrived city indices rather than facilitating and supporting a competitive private sector or housing the community in a sustainable manner.

Capital Constrained
Ultimately councils are constrained by their population and population expectations. Whatever form city taxes take, there is a limit to the capacity of citizens to fund current and future development.

Increasing the indebtedness of future generations to fund assets through debt is an option - an option that sours if the underlying population expectations fail to materialise. On that score, it is probably worth reviewing the volatility of the global dairy trade index when thinking about just how much debt it is sensible for the Auckland Council to take on. We need to acknowledge the uncertainty around our population projections - an uncertainty exacerbated in the short-term by unsustainable increases in housing costs.

Misdirected Capital
Time will tell - but intensification of the population requires highly expensive investments in public transport if the city is to continue to function without extreme congestion.

In due course this will constrain the investment that might be made in making Auckland as a whole (and not just as a CBD-centric conurbation) a more attractive place to live in. What will define a successful city must include reliable and quality services, green spaces, and ready access to community and recreational amenities across the board. 

Where to From Here?
Can Auckland get away with its mantra-based path to intensification as a means of creating a liveable and competitive city?  I think not.

Can the current structure deliver?   Not, I don't think, without a radical overhaul. 

And if there are any immediate lessons we might take from the Fonterra and Auckland City examples - bigger is not necessarily better. Oh, and choose your advisors carefully.

Wednesday, August 12, 2015

Too little, too late: finally fronting Auckland's housing problems

Singing an old song
It’s hardly worth blogging about the Auckland housing crisis any more.  It’s an old song few people wanted to hear in the past. Now everybody’s singing it. Today’s comprehensive coverage by the New Zealand Herald neatly highlights the ultimate contradiction – how can Auckland be one of the most liveable cities in the world when it is one of the least affordable?

When the problem of where to put our growing population could have been relatively easily solved 20 or so years ago, planners were stuck in an eighties groove promoting Plan A - a city contained within strict boundaries against the clichéd chorus of “no more sprawl”.

The idea of urban sprawl was – and still is – used to raise an image of ever-expanding, continuous development of monotonous housing and crowded roads swallowing pristine bushlands and a pastoral cornucopia.  From this it was a short step to damning all and any greenfield development that might have kept the housing market functional, offered opportunities for smart urban design, and made new communities viable –and liveable.

Even though geography, economics, and preferences favour a city in which employment can disperse and urbanisation can take place on greenfields divorced, if necessary from high cost legacy infrastructure, we put up the shutters and were blind to the consequences and costs of a high density, high rise alternative.

The tide has turned 
The resulting shortage of affordable housing has finally risen to the top of the Government agenda. The Minister of Housing and even Auckland Council are starting to push the boundaries and look at options for a realistic city footprint.   Initiatives include extending the capacity of hinterland villages and towns , identifying areas well suited to urbanisation on or beyond the city edge, and tackling the thorny issue of how to re-form swathes of the existing urban area to accommodate greater density. 

It’s a sign of our past failures, though, that these initiatives necessitate bypassing the Resource Management Act and leapfrogging the fraught process of translating the Auckland Plan into a meaningful statutory planning document.

But things will get worse before they get better. 
The Council still estimates a shortfall of 25,000 dwellings in 2018 compared to 15,000 today.  The Productivity Commission estimates an even greater 32,000 shortfall and says another 13,000 homes would be needed annually just to cater for growth.    Whatever the number turns out to be, it will swamp the best we have achieved, a peak of 12,000 dwellings consented in 2005, and a long-term average of little over 7,000 a year. 

Unfortunately, it's no longer just a numbers game.  We have procrastinated to the point that we are now faced with an enduring structural problem in a housing market that will be marked by increasing reliance on offshore capital, a lift in long-term rental tenancies, and ultimately a slowdown in population growth as the city loses its appeal.

Do we have the capacity?
It’s no longer just a question of releasing land for development.. 

One problem is that we have let our investment in infrastructure fall behind.  That can be solved with time, funded by more rates increases, foreign capital, or, better perhaps, the municipal infrastructure bonds long promoted by advocate of affordable housing Hugh Pavletich. 

But don’t expect any early boost given the small size of the civil engineering sector in New Zealand, and, like new housing, don’t expect it to be achieved without a solid injection of foreign capital.

We may also lack the capacity to ramp up residential construction and in trying to do so increase the risks around the quality and cost of building houses.  The challenge for the building sector will be to achieve levels of productivity not enjoyed since 2004 while boosting building personnel, and promoting a more competitive materials sector.  Without gains in these areas, Auckland may need twice the builders it had in 2014 simply to reach an annual target of 13,000 new homes, let alone make a dent in the existing shortfall.  

Finally, and fundamentally, prices have reached the point that the traditional drivers of new demand, the first home buyers, are effectively excluded from the market.  Incomes have simply not kept pace with house prices.

The flow-on effects are insidious
The consequent shift to a housing market dependent on investors funding new stock rather than occupants raises a new set of uncertainties (including a divisive populist reaction against offshore investors, as if their presence is a cause and not a result of a housing shortfall contrived by poor planning).

For a start, we have an insufficiently developed rental sector to provide tenants the degree of security necessary to underpin education, health, and career . Without a strong institutional and regulatory framework, rental housing is a second best solution for families, undermining commitment to community and increasing mobility. While that may not worry the young and transient, it is not conducive to family formation, household stability and savings, or strong communities.

A high rental population tends to be associated with high labour turnover, lifting the cost of employment and undermining in particular businesses that employ the less skilled.  At the same time, higher salaries and wages are needed to compensate for high cost housing (and commuting) in Auckland, boosting the cost of the professional and management services to the corporate and government sectors.

Can we afford the bubble to burst?
Auckland's distorted housing market contains the seeds of its own destruction that no amount of fiddling with macro-economic settings will now resolve.  And even if some twenty years too late we take the brakes off land supply, prices are unlikely to fall quickly and quietly enough to restore order as we knew it, if only because of the costs that have become embedded in the construction sector and are likely to be amplified if demand for development outruns the capacity of the market to supply it.

And if we could drop prices sufficiently to bridge the affordability gap we risk bursting the bubble.  Highly mortgaged householders will find themselves without equity and banks without collateral. The social and economic consequences and the fiscal and political impacts would be grim.

On the other hand, we may no longer have a say.  As the rock economy encounters softening commodity prices, falling consumer confidence, and a weakening labour market, expect that pillar of economic activity – the Auckland housing market – to encounter its own rocks. A weaker economy could burst the bubble without any supply side response.  On the other hand, global deflation and a low New Zealand dollar could prop up a bubble market for a little longer, exacerbating the problem in the long run. 

Will the market simply slow down as people move out or stop moving in?

There are other scenarios that might just ease the pain and slow the market.

For example, the trickle of households exiting Auckland (which has exceeded any gains from the rest of New Zealand for over twenty years) could turn into a torrent .  Detached housing, lack of congestion, and ready access to amenities underpin the growing attraction of secondary cities and towns.  Retirees have known this for a long time, and the potential to cash up their Auckland home for two or three times the cost of a better dwelling in a smaller city or town is likely to boost the momentum as increasing numbers of baby boomers retire.

And despite loose talk of zombie towns, employment and entrepreneurial opportunities are out there to complement the lifestyle opportunities associated with small town living. 

And we can expect many more families to make the move.  A return to the regions and a slowdown in gains from international migration as excessive house prices and lagging infrastructure diminish Auckland’s liveability may be sufficient to lower the city's temperature.

Retreat of the baby boomers?
We also need to think about what will happen to the stock of baby boomer housing 10 or 20 years out. While we can incorporate the ageing of the population into naïve demographic projections, do we really know how their behaviour might shape the housing market ten or twenty years hence?

Only a minority might move out of Auckland, but that will have a significant impact on the housing market.  Many more may opt for the convenience, comfort and security of retirement villages.  That, and a little natural attrition along the way, should see the options for suburban revival increase as the large houses of the 1950s and 1960s are recycled or replaced, increasing residential capacity in existing suburbs.
Add to that the changing household characteristics in an increasingly diverse Auckland– including more multi-generation families occupying larger individual dwellings, more sharing among non-family members and households – and the numbers game might change substantially.

So what do we plan for now?
Of course, either of these scenarios – a bubble burst or a market moderated – creates another problem.  What do we do with all our plans and projected spending predicated on another million Aucklanders – or thereabouts – by 2041.  How should we revise the massive spend proposed for transport infrastructure that assumes that the growth of the past decade is somehow inevitable over the next?  And how do we maintains the conceit that as much as 70% of it might be contained within the existing built-up area?   And pay the debt that we are accumulating on the basis of growth assumptions that we were never ready for and are consequently unlikely to be fulfilled?

It’s time to think about Plan B; Plan A has clearly failed the city.