Mengniu is investing in its supply chain but has announced product contamination this year

Mengniu is investing in its supply chain but has announced product contamination this year

China. It's a market, as we all know, with potential. A market of over one billion consumers. A market where the middle class alone is 300m strong and, by some estimates, forecast to increase to 800m by 2025. And a market, where in the last week alone, three major food and drink multinationals have announced fresh significant investment.

Last Monday, our sister site just-drinks reported on Carlsberg's plans to build a new brewery in the south of the country. On Friday, US fast-food giant Burger King announced plans to open 1,000 more restaurants in China over the next seven years.

That same day, Nordic dairy giant Arla Foods unveiled a deal it hopes will multiply its sales in China by five times by 2016. Arla has operated in the country since 2005 when it formed a milk powder venture with local dairy Mengniu. A new agreement between the two companies will see Arla become a shareholder in Mengniu and both firms look to sell a wider range of dairy products in the country.

In many ways, Arla's new agreement in China ranks at least alongside its planned merger in the UK with Milk Link in strategic importance for the business. Just three weeks on from Arla's announcement that it plans to create the UK's largest dairy processor, it spoke of what it hopes will be a "breakthrough" for its namesake brand in China.

"Arla will be able to benefit right away from Mengniu’s strong nationwide distribution network, which is something that can take companies years to build up.  That’s important for competing in a dairy market that is projected to become the world’s largest by 2020," James Roy, senior analyst at China Market Research Group, told just-food.

However, investing in China, especially in its agricultural sector, carries risk. Concerns over food safety remain high, not least over the quality of dairy products, as demand among Chinese consumers continues to grow.

In December, Mengniu admitted producing milk containing excessive levels of a cancer-causing chemical. It blamed "mouldy and deteriorated" fodder and, with companies struggling to keep up with demand and facing a fragmented agricultural sector, it has proved very difficult to monitor all parts of the supply chain.

Roy said Mengniu "has been relatively less damaged" by food safety issues than some of its competitors and "enjoys a reputation as one of the stronger domestic dairy brands".

Industry watchers say China's food manufacturers are investing in their supply chain to reduce the prospect of contamination and, last Monday, Mengniu said it would build up to 12 dairy ranches this year to improve milk quality. The Chinese government, particularly after the melamine scandal in 2008, has moved to tighten regulations and step up inspections.

Nevertheless, food safety scares continue. Last week, Chinese dairy group Yili reportedly recalled infant formula containing "unusual" levels of mercury. The disclosure came in what China had billed "National Food Safety Week" to highlight the issue. And it was a week in which Wal-Mart also found itself at the centre of concerns over the safety of food sold in some of its stores.

"It will likely still take a long time to secure supply chain for its dairy products – issues like diluting milk with additives to inflate protein count have proven to be difficult to root out, as continued safety scares have shown. That is why the government has been so supportive of domestic companies cooperating with international companies to improve their own standards," Roy said.

Improving food safety and product quality is at the centre of Arla's fresh investment in China. Arla and Mengniu plan to set up a technological centre that will look to "provide expertise" on farm production, milk quality and traceability.

"Mengniu has an opportunity to use the JV to improve its own internal processes and put in place international-level best practices and show consumers that they are serious about safety," Roy said. "The cooperation will help Mengniu's reputation as being committed to safety, but in the meantime it will have to avoid scandals at all cost to avoid squandering the trust in its brand that it does have."

There is no denying China's potential and, with concern over food safety remaining high among Chinese consumers, the rewards for companies that demonstrate investment in quality control and that show public health is a priority will be very lucrative.

The deal between Arla and Mengniu has benefits for both sides. The appeal of targeting China's growing middle class with a range of dairy products has obvious appeal to Arla. An association with Arla and the use of the dairy giant's brand will no doubt improve Mengniu's reputation in the eyes of consumers who may have avoided the company's products after the food safety scare at the turn of the year. There is a perception among some Chinese consumers that multinational operators have tighter safety controls than local companies.

However, for all the apparent benefits of investing in China for Arla and for all the apparent work Mengniu is undertaking to shore up its supply chain, the investment is a risky one for the Danish-Swedish dairy group. Food safety remains a problem in China and for all the talk of a "breakthrough" for Arla's brand in the country, any scare or scandal could do it some serious damage.