Having exported milk powder to China for some time, the New Zealand dairy co-operative Fonterra has moved into local production with a major investment in one of the country's leading dairies. Dominique Patton spoke with Philip Turner, Fonterra's general manager of government and trade for Asia, about the company's plans for the Chinese market.

New Zealand dairy co-operative Fonterra is known as the world's biggest exporter of dairy products but the company is increasingly looking to expand its overseas production as a route to growth. And nowhere can this be more clearly seen than in China.

Having exported milk powder to China for many years, the company took the decision two years ago to invest in local production, acquiring a 43% stake in Shijiazhuang SanLu, one of the country's top four dairies.

The move reflects both the enormous potential of the Chinese dairy industry and the company's ambitions for the market, says Philip Turner, Fonterra's general manager of government and trade for Asia.

"We accept that we can't continue to rely on exports out of New Zealand to meet our needs for growth but instead we have to go beyond borders and into local markets," explains Turner, adding that "we see China as the most exciting dairy market in the world". 

China's food industry is growing rapidly but no segment has seen the same level of growth as the dairy sector, which has risen from a virtually non-existent industry 20 years ago to one with major national brands and a significant amount of international investment. But with little tradition of dairy foods in China, even local analysts did not expect to see domestic production ramping up so quickly to the point where many are now talking of the country being a net exporter of dairy products.

"The idea seems incredible given the scale of Chinese dairy production just 20 years ago. Major dairies are now exporting. Three or four years ago no-one would have believed that possible," says Turner, adding that like most observers, Fonterra has been caught out by the speed of growth of the industry. 

It is some testament to the growth of the dairy sector that its progress is even outstripping China's impressive economic growth. "Consumption is already growing faster than GDP at 12% to 15% each year and production is growing even faster," Turner points out.

However, the question is whether this can be sustained, he adds. China's land prices are rising and pressure on water supply is already severe. But with imports of milk powders on the decline for the last two years - partly due to high world prices but also because of the strong growth in domestic production - international dairies know they need to be based inside the country if they want to be sure of benefiting from the industry's growth.

The result has been a flurry of investment in local players, including Fonterra's investment in SanLu. "We have serious ambitions for SanLu to become a leading dairy company but it will require a further step up," says Turner.

SanLu is not yet seeing the astonishing sales growth of leading dairies Mengniu and Yili, both based in the vast grasslands of China's Inner Mongolia region. Last year, Mengniu reported a 50% rise in sales for its first half. Both have invested heavily in marketing and promotion of their brands, using highly innovative advertising to capture a national consumer base.

"SanLu is behind that kind of growth but it is a very solid company with a strong reputation," says Turner, without disclosing precise figures.

SanLu distributes to around 600 cities but is still considered a regional player. But this could change under Fonterra's management. The New Zealand dairy is currently setting up a dairy farm to help SanLu meet increasing demands for high-quality milk and premium nutritional products in China.

The quality of milk in China is still unreliable owing to poor farm hygiene and water quality. This will not change on most farms which typically own an average of ten cows. However, there is an emerging trend for major dairy companies, such as Mengniu, SanYuan and Nestlé, to set up large collective farms and Fonterra is aiming for the same kind of quality control with its plan to open a dairy farm this October. It has already bought 3,000 cows and identified the land. It is currently negotiating with local authorities for a lease.

"We're keen to build the cow to customer operation that we already have in New Zealand and Australia," says Turner. "Like others, we find getting the right volumes of milk at the right quality is a serious challenge. But quality is going to be critical to drive the company forward, especially when you're talking about branded premium products."

With incomes in China rising rapidly, consumers are stepping up quickly through the pyramid of dairy consumption, he adds. This means that those living in the first tier cities (Beijing, Shanghai and Guangzhou) have largely moved away from consuming milk powders, and even UHT milk consumption has begun to decline. Instead they are looking for fresh milk and more processed products like ice cream and yoghurts.

This means there is already a sizeable market for added value products and Fonterra's first major change at SanLu has been to set up a premium brands division in Beijing to market a new range of products that will include its Anmum brand sold elsewhere in Asia for pregnant women and new mothers. Fonterra says it plans to back the range with significantly increased marketing investment.

"Our objective is to be a leading dairy company in China," says Turner. "We're satisfied with where we have got to date but you can expect us to expand quite aggressively."

Fonterra is not expecting an easy ride in this high-growth market which not only faces the challenge of low-quality milk and food safety risks but also tough competition, led by Chinese dairies in particular. But it cannot ignore the appeal. "It doesn't really compare with any market in the world," says Turner. "You don't see growth figures like that anywhere else. This makes it very special."