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  1. Analysis
November 29, 2013

China briefing: Multinationals face shifting formula landscape

Multinational companies have dominated China's infant formula market but domestic companies are, with government support, looking to bolster their position with demand expected to remain buoyant. Wang Fangqing in Shanghai reports.

Multinational companies have dominated China’s infant formula market but domestic companies are, with government support, looking to bolster their position with demand expected to remain buoyant. Wang Fangqing in Shanghai reports.

Major food companies serving the Chinese dairy industry have told just-food how they see great opportunities emerging from oncoming China government reforms, many expected to be proposed next year.

One policy that could boost those in the sector would be easing China’s long-standing one-child policy. The decision was made by the Chinese leadership earlier this month in a bid to bolster the country’s future workforce and support the funding of its social services in an ageing China.

The potential impact of the policy change has been a subject of debate but Wang Dingmian, director at Guangzhou Dairy Industry Management Office, a provincial government food industry promotion agency, told Chinese media once the one-child policy is relaxed, the move could increase demand for Chinese infant formula by 20%. Demand is already rising fast. According to market researchers Euromonitor, China formula sales hit CNY78bn (US$12.8bn) in 2012, up 26% on 2011.

Anticipating the reform of the one-child policy, Chinese manufacturers have been shoring up their supply chains of raw liquid milk. In September, China Modern Dairy Holdings, China’s largest farming company and raw milk supplier, partnered with private-equity firm Kohlberg Kravis Roberts & Co. and a Beijing-based private-equity company, CDH Investments, to jointly invest US$140m in the next 18 months in building two dairy cattle ranches in Shandong province, between Beijing and Shanghai.

Leading Chinese dairy company Mengniu has also been preparing for market expansion. It is the largest shareholder in Modern Dairy, which has six China dairy farms in operation and two more under construction.

“Right now, about 94% of our raw milk is from large-scale industrial farming, and we expect it could reach 100% by 2015,” a Mengniu spokesman says, adding the company plans to invest CNY3.5bn in industrial farming in the following two years.

In June, Mengniu bought Hong Kong-listed infant formula firm Yashili International Holdings Co. for HK$12.4bn (US$1.6bn). Mengniu has significant existing milk and ice cream interests, but Oushi Mengniu, launched only this year, is its only baby formula. Yashili, however, has been selling formula for more than a decade in China and has a strong presence in south China.

Mengniu has also secured a European milk source for its baby formula manufacturing through an alliance with Danish dairy company Arla Foods. “Our baby formula Oushi Mengniu only uses milk source from north Europe,” the Mengniu spokesperson says.

Also in September, Mengniu’s major rival the Yili Group invested US$50m in the Hong Kong IPO of China Huishan Dairy Holdings Co., a farming company based in Liaoning province, in the north of China. Huishan has 45 farms in operation, producing more than 327,000 tonnes of raw milk annually.

Meanwhile, China is determined to restore its reputation on food safety, which was damaged in 2008, when the domestic dairy industry was almost paralysed by the melamine scandal. Mengniu, for example, is inviting Arla’s experts to help improve onsite management, quality control and food safety assessment using European Union standards.

In June, China’s State Council issued a formal notice, making it clear all formula manufacturers in the country have to use a quality control system as strict as the one used in drug manufacturing. It also banned repackaging. More importantly, it requires formula manufacturers to build their own farms to secure milk sources to help consolidate China’s dairy industry, which has more than 120 dairy companies across the country.

A consolidation plan has been drafted by China’s ministry of industry and information technology (MIIT) and is waiting for the approval from the State Council. According to the ministry, the plan aims to form three to five mega dairy companies by 2018. 

The most recent deal was announced this month when US-listed Chinese baby formula company Synutra International struck a deal to buy Youth-Base, a regional formula brand previously owned by Shanghai-based Newbaze Nutrition Dairy.

Synutra said it was attracted by the brand’s distribution in the wealthy Jiangsu and Zhejiang provinces, near Shanghai. The deal allows Youth-Base to keep its operation independent, but R&D and supply chain management, including milk sourcing and manufacturing, as well as quality control, will be taken over by Synutra.

A strengthening of China’s domestic formula sector will challenge multinational rivals, which, although they dominate the industry, particularly the premium end of the sector, are already under scrutiny.

In August, for example, six foreign baby formula manufacturers – Biostime International Holdings, Mead Johnson, Danone, Abbott Laboratories, FrieslandCampina and Fonterra – were fined a total of CNY670m by the Chinese government for fixing prices. In October, Japanese food manufacturer Meiji Holdings, also found guilty of price fixing but not fined, pulled out of China’s formula market, citing reasons as “intensifying competition and the rising cost of milk sources imported from Australia”.

However, Xu Feifei, brand strategy director at Shanghai-based consultants Labbrand, says stricter rules and growing competition also offered opportunities for multinationals.

Referring to the fines, she said: “Complying with China’s anti-trust law is a must. It may lower profits in a short term, but it also makes foreign brands more competitive facing Chinese rivals.”

However, Xu recommends foreign companies focus on selling into smaller cities or rural counties. “In a market as fragmented as China, distribution channels cannot be more important. As far as I know, many Chinese brands are already developing their network in these areas.”

Perhaps that is why Japanese baby food maker Wakodo, owned by food and drink giant Asahi Holdings, has recently partnered with Taiwan-owned noodle specialist Master Kong to set up a joint venture selling formula in China early next year.

Master Kong is a subsidiary of Taiwan’s Tingyi Holding Corp, which has a well-established nationwide distribution network in China.

Click here for the rest of just-food’s management briefing on China.

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