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  1. Analysis
July 29, 2008

Dairy giants face hurdles tapping into China

China’s expanding dairy sector offers substantial growth potential for international dairy groups, many of which have already established a foothold in the country. However, writes Mark Godfrey from Beijing, progress has been slower than might have been predicted with local companies proving to be stout competition, while new legislation introduced this year will increase the cost of entry for international groups.

China’s expanding dairy sector offers substantial growth potential for international dairy groups, many of which have already established a foothold in the country. However, writes Mark Godfrey from Beijing, progress has been slower than might have been predicted with local companies proving to be stout competition, while new legislation introduced this year will increase the cost of entry for international groups.


China offers international food groups growth potential across a wide range of sectors, but now it also presents foreign dairy companies with a business opportunity they dared not dream would emerge, a growing milk and dairy products market. It appears dairy consumption is finally taking off in the People’s Republic.


International dairy companies, including Danone, Nestlé and Fonterra, have identified China as a significant growth opportunity and have established a presence in the market. However, in spite of a regulatory system which is actually quite open to foreign investment, so far they have made relatively slow progress in their attempts to capitalise on the expanding Chinese milk and dairy products sector.


There could be number of explanations for this, not least of which is the sheer strength of local competition and the resolve of local players not to let foreign companies muscle their way in. Also, anecdotal evidence suggests local farmers are generally more keen to deal with locally-owned dairy processors than with foreign-backed groups.


Furthermore, multinationals have not always had a smooth ride in managing joint ventures, as underlined by Danone’s much publicised problems in China. Moreover, legislation introduced this year relating to the minimum capital requirement for inward investment looks set to increase the cost of entry for international investors.


However, according to Nick Debnam, partner in chief for consumer markets at KPMG China, from a regulatory standpoint the Chinese dairy market has so far been relatively open to inward investment. “There are very few policy-related limitations,” he says. Australian and New Zealand suppliers are particularly well placed, Debnam explains, pointing to a free-trade agreement signed between China and New Zealand in April this year. The deal has been welcomed by New Zealand dairy producers, who will benefit from lower tariffs on dairy imports. “China is keen for more free-trade deals,” Debnam adds.
 
Local firms, however, still dominate the Chinese milk market, of which UHT products make up the large majority. Based in Inner Mongolia, Mengniu took a 17% share in value terms in 2007 according to Euromonitor. Danone is number five in the drinking milk segment, with a 4.5% value share, followed by Nestlé in sixth place with 2.1%.
 
But the good news is that milk consumption is on the rise among Chinese consumers. However, while overall milk retail value sales jumped by 21% year-on-year in 2006 to US$6.5bn, the bulk of that rise was still observed in UHT, which accounted for US$5bn of total sales according to Euromonitor figures. Pasteurised milk sales rose by 8.9%. In 2007, UHT sales reached 5.7m tonnes, compared to 2m tonnes of pasteurised product. Drinking and spoonable yoghurt sales hit 1.2m tonnes and 0.7m tonnes respectively.
 
While multinational groups may have struggled to bed down with local joint venture partners, foreign groups have gained a significant presence in the powdered milk segment, which includes infant formula. According to Shanghai-based research group Access Asia, Nestlé leads the market with an 18% retail value share, though this dropped from 19.2% in 2005. Local brand Yili expanded its share from 14.1% to 16.2% in the same time period while third-ranked player Dumex has gone from 12.3% to 16%.
 
Jiang Min, of the Qingdao Murray Goulburn Dairy Company plant in the southeast coastal city of Qingdao, tells just-food that his Australian-backed company is concentrating its infant formula sales on the east coast and in the western metropolis of Chongqing. A 15% price premium over competing brands is sustainable, Jiang says, because consumers are drawn to the perceived quality of the company’s imported Australian milk powder.
 
The company, says Jiang, will in future also be targeting the adult and sports nutrition drinks sector from 15 representative offices opened across the country, while its 8,000 sq m processing plant will double in size by January 2009. Prices, however, will be under pressure, with the Australian drought tightening milk supplies. “We’re paying twice the price that locals are paying for their milk,” Jiang explains. Marketing will be key to growing sales, he adds. “Our biggest challenge is that Chinese consumers don’t know us.” That’s why the firm is investing in national TV advertising.
 
While Mengniu and Yili dominate in milk sales, some 700 smaller firms have done well by exploiting regional knowledge, particularly in the yoghurt segment. Euromonitor figures show Hunan Taizinai leading number two and three players – Bright and Mengniu respectively – in yoghurt (drinking and spoonable) while Danone takes fifth place.
 
Nevertheless, China’s keenness to consolidate and build brands means investment and technology is needed form abroad. But foreign players err by thinking they can come in and dictate to local firms, says Wang Huai Bo, an industry veteran who works as a consultant to Mengniu and sits on the board of the China Dairy Association. Chinese local government officials rather see foreigners as a source of investment and technology for a controlling Chinese partner. “Foreigners are welcomed by local governments because they want money to develop their own industries and product lines,” says Wang. “They don’t want their local companies’ products to be taken over.”
 
Yet, China’s long-awaited Food Safety Law – expected to come into force this autumn – might promote such consolidation. Its stipulations for higher hygiene and production standards of dairy processors will “benefit foreign brands in particular,” notes Nick Debnam. “They will already have these standards in place but smaller local companies who can’t afford to upgrade will have to merge or close.”
 
China, which has targeted milk production of 28m tonnes by 2012, compared to 25m tonnes currently, suffers from a quality problem, Wang Yue Jing adds. “There’s a glut of low-quality milk,” he explains. Milk meeting Government standards of 3.2g of protein per 100ml is rare in the market, Wang points out.
 
However, new regulations were passed this year aimed at improving the quality of local milk output. In future, investors must have access to a “stable milk supply”, according to a Government document entitled Opinions on Promoting the Sustainable and Healthy Development of Chinese Dairy Industry. New investors must also have net assets of at least twice the capital required for a project and total assets must be three times the amount of funding required.
 
The new regulations, which could represent another obstacle for international dairy firms looking to invest in China, are “fair and necessary”, Wang Huai Bo claims. The Government’s new restrictions will “prevent blind investment”, Wang says. “Before this, newcomers didn’t consider the market needs and what competition might already be there.” The rule on milk supply similarly “discourages waste of resources”, he adds.
 
Multinational companies investing in any emerging market will always have to deal with such an evolving regulatory landscape but, with demand for dairy soaring in China, there will be plenty of growth for the world’s dairy giants to milk.

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