By now, anyone who follows events in Israel closely knows two seemingly unrelated facts.
First: More than 200 Israeli companies are listed on NASDAQ, the largest electronic-screen based stock exchange. This is more than any country outside of North America, earning Israel the title “Start-Up Nation.”
Second: The massive social justice protests in Israel this summer began with a boycott of cottage cheese after the price rose to 8 shekels for 250 g. This is equivalent to $4.55 for the standard American 16 oz container of cottage cheese. Compare that to $2.99 for 16 oz of organic cottage cheese at Whole Foods, hardly American’s discount grocer.
So what is the connection?
Israel’s economy is humming along. Unemployment is an enviable 6 percent. But, that low unemployment rate veils some serious problems. First, labor force participation is low. In the Haredi (ultra-orthdox) sector, men typically are subsidized by the government to study until age 35. In the Arab sector, only 17% of women work outside the home. Second, Israeli costs of security are huge. Besides a defense budget that amounts to 7% of the Gross Domestic Product, labor productivity is implicitly taxed by a need for men to serve 4 weeks a year in the reserves. And, the ongoing cost of the cadres of private security guards represents a further tax on productivity.
In most households, two adults work. Israeli taxes are high. The VAT (value added tax) of 16% is charged on everything—food, rent, clothes, cars, day care. Individuals also pay a progressive income tax of 10-45%. About 50% of household income typically goes to rent. (In the US, experts advise that no more than 25-30% of income should go to mortgage payments or rent.) Daycare costs another $850-1000 a month per child under school age. Public transportation costs are rising; gas prices are exorbitant. Buying an apartment requires a large down payment that most people can’t amass, especially because rents have risen 15-25% in the last two years. Mortgage rates are tied to inflation—there is no “30 year fixed” in Israel. Education—including “free” public K-12 education–is increasingly expensive with parents required to buy books and find money for any “extras” like required school trips. So this well-educated workforce is working hard and yet can’t see any way to create a secure future for themselves and their children.
Meanwhile, Israeli millionaires and billionaires are being created every month. Not by the old formula of winning at LOTTO (the government run state lottery) but by winning the new, capitalist lottery—the start-up-to-buy-out lottery.
Here are the steps to winning the new lottery: 1) Be brilliant: have a great idea, especially one that solves a business problem; 2) Be practical: make the idea concrete by creating a product that embodies the idea; 3) Be entrepreneurial: show that there is a market for the product by creating a viable company; 3) Get bought out: sell the company to a private investor, a bigger company or go public on the stock market; 4) Get out: most early entrepreneurs receive financial incentives to stay with the start up for a few years after the buy-out to help take the product to the next stage but then disengage themselves from the company they helped create; 5) Repeat.
Kibbutzim dream the start-up-to-buy-out lottery like everyone else, but on a bigger scale. They need to — all the members of a kibbutz community depend on its financial success.
Some kibbutzim have been remarkably successful. For example, Kibbutz Ramat Rachel has turned its unique location on the edge of Jerusalem into its gold mine. It had a brilliant idea: all Israelis wish they could replicate parts of the classic kibbutz lifestyle. It created the product: pastoral recreational facilities open to the public for a fee, highly regarded daycare and after-school care facilities based on the traditional kibbutz model, and old age nursing care. It marketed these products plus a kibbutz style hotel, all close to downtown. More recently, it built a complex of ten beautiful modern medium rise apartments on its former agriculture lands in Talpiot. So far, the kibbutz is keeping its hand on the management of this empire, in part because what they offer is “kibbutz hospitality.”
Location is not typically the path to success for kibbutzim, often located in the country’s periphery. In fact, the most startlingly successful example is Kibbutz Shamir, located near the Lebanon border. According to Wikipedia, Kibbutz Shamir produces “honey, honey-based toiletries, and advanced optical products.” Shamir Optical developed high quality progressive lenses and has been an innovation leader, with factories in Israel and Thailand. It went public and was listed on NASDAQ. Now Essilor International, the French optical giant, has acquired 50% of Shamir Optical for $130 million. That’s $220,000 for every adult and child living on the kibbutz.
Buy-outs don’t need to be limited to high tech products. The traditional kibbutz products aren’t high tech. The story of cottage cheese, or dairy more generally, is the story of how agricultural kibbutzim and moshavim have joined the buy-out bandwagon.
Anyone who has spent time in Israel knows that Israeli dairy products are wonderful. This is especially remarkable because cows are supposed to thrive and produce the most milk in places with cool climates, like Wisconsin and Northern Europe. But the cows with the highest milk production per head anywhere on Earth live in Israel and especially on Kibbutz Yotvata in the hot, arid Arava region of southern Israel.
Yotvata kibbutz member Ori Chorazo had a brilliant idea: figure out how to breed a cow that would thrive in the desert. He made it practical: starting with 4 cows in 1962, he developed a unique breed. Being so isolated from the rest of Israel, the kibbutz needed its own dairy to process its milk to sell in Eilat. He convinced the kibbutz to open a dairy, proving that the concept was viable. What resulted was a brand known for unrivaled quality. Ori tragically died in an auto accident, but his idea more than survived. It made Yotvata a powerhouse in the Israeli dairy industry. In 1997, Kibbutz Yotvata sold 50% of its dairy business to Strauss, an Israel-based international food conglomerate. Yotvata was first of the major Israel’s dairies to make the transition to corporate ownership and also the one that remains most closely associated with the company after the transition.
Today, the Strauss Health (formerly Strauss-Elite Dairies) produces the Milki, Sky, Gamadim, Symphony and Dany brands as well as the Dannon products sold in Israel, through a partial ownership agreement. Most of the seemingly “independent” brands in the Israeli dairy case, including the Yotvata brand, come from Strauss, now Israel’s second largest dairy company.
Tara Dairy originated in Tel Aviv as a cooperative for processing milk from family farms in Nahalat Yitzchak. The families eventually sold their land for more valuable uses and the dairy eventually moved out of town but continued production with milk purchased from kibbutzim and moshavim. In 2004, Tara Dairy, Israel’s third largest, was purchased outright by Coca Cola Israel. Since then, Tara has acquired Gilad Farms, formerly the fourth largest Israeli dairy and the only one focused on the Haredi market. (Gilad shuts down completely on Shabbat and has a more stringent Cholav Yisrael kashrut certification.) It also acquired the fifth largest dairy, Tzuriel, which specializes in goat’s milk products.
All along, the number one dairy in Israel has been Tnuva, the cooperative of over 680 kibbutzim and moshavim. If you thought it is still owned cooperatively, don’t be too hard on yourself — a survey conducted after the cottage cheese boycott began showed that over 40% of the Israeli public think the same thing. But they are wrong. In 2007, Apax, a British private investment firm, purchased 77% of Tnuva. The kibbutzim and moshavim continue to provide milk to the dairy, but they turned over management and marketing to outsiders.
In just ten years, the Israeli dairy industry was transformed from a market with seven major family-run and cooperative dairies to one with only three dairies, all run by large corporations.
Tnuva is the dominant firm in Israel’s dairy industry and especially in cottage cheese, where it provides about 70% of the market. In fact, cottage cheese is so tied to Tnuva that in the Spring 2011, Tnuva rolled out a national advertising program — billboards with an abstract pastoral scene, an abstract graphic design of a small house, the Hebrew word “cottage,” and the Tnuva logo. Economics 101 teaches us that firms don’t advertise generic products like cottage cheese unless they control the market. Tnuva controls Israeli cottage cheese.
In June 2011, Tnuva-Apax raised the price of cottage cheese to 8 shekels for 250g. But then, all hell suddenly broke loose. The cottage cheese boycott, the first protest of the Summer of 2011, was born. Consumption dropped 58% almost overnight and Tnuva ultimately rolled back the price. Today, in an attempt to lure consumers back to cottage cheese, several grocery chains are running “2 for 10 shekels” specials. That’s about $2.80 for 17 ounces, which would be no great bargain in the US.
Tnuva’s miscalculation sparked a protest movement. After the cottage cheese boycott came the medical residents’ strike for more pay and fewer hours, then the tent city rent protests, then the parents’ stroller marches for daycare cost reform, and then the mass marches with general calls for Social Justice.
The start-up-to-buy-out game usually makes Israelis better off because Israel is small and the world is large. An Israeli has a great idea, develops a superior product, employs well-educated, skilled Israelis to make it, and then sells it internationally on a small scale. An international company buys the Israeli company and crank up the scale of production in Israel and abroad. More product gets exported. A few Israelis get very rich. Israelis working for the firm usually stay employed. Israel as a country gains and no one in Israel is hurt because the money comes from outside.
Dairy is different. The dairy products produced in Israel are mostly consumed by Israelis. And Israelis don’t have other options.
The Israeli dairy industry is protected by sky-high tariffs. That’s why Dannon licenses with Strauss to make its product in Israel. It can’t pay a 170% tariff on imports and offer a product at anything like a competitive price.
Historically, these astronomical tariffs made sense. During the British mandate, Israeli dairies could hardly gain a foothold because the British dairy products were dumped in Palestine. The new Israeli government protected the nascent dairy industry. It worked. A dairy industry second to none developed.
But a protected infant industry can become a mature monopoly or cartel. These monopolies and highly concentrated industries need to be watched vigilantly and regulation may be necessary.
Maybe Tnuva as a cooperative of cooperatives was a benign monopoly that recognized its social responsibility to its customers and its nation. But, Tnuva owned by an international investment firm is surely not. Cottage cheese prices have come back down for now, but unless the government does something, they will creep back up.
This is not an indictment of kibbutzim and moshavim for doing what they must do to win the start-up lottery and keep their heads above water. Thousands of people depend on these collectives to survive. Instead, it is an indictment of an economic philosophy that “privatized” the economy while keeping high tariffs in place, and then let monopolies and cartels develop without regulating local products for which there are no good substitutes.
In the US and Europe, it took over a year for the antitrust authorities to evaluate and approve Essilor’s purchase of Shamir Optical to determine that it would not have anticompetitive effects on prices. In Israel, the Israeli Antitrust Authority apparently took no notice when Apax purchased Tnuva, Coca Cola took over Tara, Gilad and Tzuriel, and Strauss merged with Elite and then went into partnership with Yotvata and Dannon. Instead, it seems that the Israeli government just cheered another start-up-to-buy-out “victory”. No thought was given to the fact that maybe these investors would “milk” the Israeli consumer.
It took until July 19, 2011, in response to a Knesset committee inquiry, for the new Israeli Antitrust Authority Director General David Gilo to issue a statement saying, “The dairy market could be a candidate for being declared a cartel. This is a market of three firms and many entry barriers, but we need to thoroughly analyze it to see whether its conditions justify it being declared a cartel.” In other words, no analysis has been done up until then.
But cottage cheese is not the real problem. It is just the canary in the coalmine. The real problem is that Israelis need a way to buy an apartment, educate the kids, and put food on the table without having to win the start-up-to-buy-out lottery.
Israelis have now been awakened to the fact that their economic lives are untenable. But to fix it, they have to understand how an economy that is humming along can still be so broken that average person sees no prospects for a better tomorrow.
The Israeli government needs to understand that “the start-up nation” isn’t a miracle solution that can lift the whole country if, as a result of buy-outs, Israelis have to pay monopoly prices. It must start paying attention to the problems that international buy-outs can create in local markets. It isn’t just an economic issue; it is an issue of social justice.