Milking China’s demand for dairy
China’s unquenchable thirst for high quality imported dairy produce, particularly baby and infant formula, has triggered an “extraordinary furor” amongst the established dairy industry and shrewd prospectors seeking lucrative potential investments, according to industry commentator Paul O’Brien.
Mr O’Brien, who is a Regulatory Analyst, Writer and Editor at Chemlinked (Reach24H), said that China’s regulatory and legislative “iron curtain” was the challenge for these would be investors in accessing China’s market.
Mr O’Brien said a number of key factors had precipitated China’s huge demand for imported dairy (particularly infant formula).
Changes in domestic demand and supply issues
The recent change in China’s family planning policy allows Chinese couples to have a second child (under certain conditions). This has created a baby boom. At the same, safety concerns emerged in the domestic market triggered by some well-publicised food safety scandals such as the melamine scandal.
New dairy safety regulations in China were introduced and require all foreign and domestic dairy manufacturers to undergo CNCA audit prior to dairy product being saleable or gaining entry into the China market.
There was a clamor by domestic Chinese buyers to find CNCA audited overseas manufacturers. Mr O’Brien indicated that Chinese investors were seeking to invest in brands with a strong reputation for food safety.
China’s government looking to address market balance and trade deficit
Mr O’Brien said the most likely factor to change in the China market will be the improved integrity and reputation of domestically produced infant formula.
“This is the Chinese government’s ultimate goal and it is attempting to achieve this end using a twofold strategy, firstly by controlling the influx of foreign produce and secondly repairing the reputation and increasing the quality of domestic produce,” Mr O’Brien said.
Mr O’Brien identified the main strategies the Chinese government is implementing to achieve this.
First of all, the Chinese government has created some technical barriers to trade. New regulations make it a lengthier and more difficult process for foreign dairy produce to gain market entry into China.
Secondly there was a pattern of “natural selection by regulation”. Mr O’Brien said this was a term he coined to describe a common regulatory strategy adopted by the Chinese government to cull the industry by removing the weakest domestic manufacturers and only allowing the fittest to continue. The Chinese government has instituted very stringent domestic dairy regulations with the aim of consolidating milk manufacturing into the hands of China’s larger more reputable dairy companies. These regulatory selective pressures target China’s smaller, financially unstable domestic dairy manufacturers forcing them to modernize, amalgamate or close. This also has the knock on effect of allowing greater control over pricing.
How are domestic interests faring at the moment in comparison to foreign competitors?
Mr O’Brien said foreign companies held the lion’s share of the Chinese dairy products market, boasting over 60 per cent of the dairy market in China.
“However, China’s economic climate is changing,” Mr O’Brien said.
“Inflation has meant that consumers are feeling the pinch and looking to find ways to save money,” Mr O’Brien said. “Foreign milk powders retail at a significantly higher price than domestic produce, usually in the region of 30 to 40 per cent more expensive, a fact domestic producers are keenly aware of and eager to exploit,” he said.
“Several major domestic and foreign companies including Dumex, Erie, San Yuan Yubo and Abbott have made price reductions ranging from 3 to 50 per cent,” Mr O’Brien said. “These recent price reductions have been completely market driven with no coercion from government,” he said.
Are the price reductions a sign of things to come?
The Chairman of China’s dairy industry advisory body recently told reporters that milk formula companies in China would have to cut prices due to the increasingly fierce market competition.
Mr O’Brien said this situation had been in the making since the “production license renewal” and “domestic milk mergers restructuring plans”were instituted and was “very likely the early signs of an impending price war”.
“While foreign brands are still in the ascendancy and those with solid reputations are likely to sustain a sizable market share, for those would be investors still sitting on the fence it is advisable to strike while the iron is hot and not wait for the market to reach saturation point,” Mr O’Brien said.
From 2008 to 2012 milk prices in China have seen a steady year on year increase of 10 per cent, according to Mr O’Brien.
“This rapid inflation was unlikely to be sustainable and what we are seeing now is likely the inevitable bursting of the bubble,” Mr O’Brien said. “International giants are not excluded from these pressures, reflected in Abbotts 10 per cent price cut on its flagship formula range and Dumex’s more modest 3 per cent reduction on its “Ying Yang” product range,” he said.
Domestic low cost retail models
Mr O’Brien said that just two months before the June price cuts, dairy company Junlebao, China’s newest entrant to the infant formula market, preempted the price reduction by entering the market with an unprecedented low price, retailing their single pot infant formula (900g Specifications) for only 130 Yuan. This price is two or even three hundred Yuan cheaper than many of its rivals.
“The move has generated huge interest in the industry and certainly started its marketing campaign with a bang,” Mr O’Brien said. “The timing of the move was not a coincidence and more likely based on savvy market forecasts,” he said.
Mr O’Brien said Junlebao’s low cost model utilised the low cost marketing strategies (online and mobile sales platforms) he had written about in previous blog posts, allowing the Company to pass these savings onto the consumers and enter the market with enticingly cheap products.
“The most interesting aspect of this strategy is that according to Junlebao Chairman Sammy Liu net profits will still range between a healthy 3 to 4 per cent,” Mr O’Brien said.
The Fonterra false recall has created opportunities for other exporters into China
Mr O’Brien said that before 2013, China’s imports from New Zealand milk powder accounted for 70 to 80 per cent of total imports. However, since the Botulism product recall incident, Europe’s milk exports to China have surged.
“Companies such as Danone, Wyeth and other first-tier manufacturers are keen to take up the slack and have begun marketing in earnest,” Mr O’Brien said. “New Zealand milk powder export prices reduced from $ 5,005 / ton in February 2014 down to $3,877 at its lowest point in May,” he said.
“In addition to the Botulism incident there are other reasons for the price reduction such as an increase in global milk supply, a general economic downturn in the Asian Pacific region and outstanding raw material supplies remaining after over purchasing during the spring festival seasonal demand,” Mr O’Brien said.
Profit margins faltering but demand increasing
Mr O’Brien said data showed that despite prices dropping, Mr O’Brien said the overall demand for imported milk powders was still increasing.
“Imported price fell from an average of 44000 yuan / ton in April 2013 to 34,000 yuan / ton in April 2014 (down 22.7 percent) while domestic prices decreased by 21.9 per cent in the same period,” Mr O’Brien said.
“From April 2013 to 2014, research institutes reported an increase of 69 per cent in foreign imports (an annual increase of 500,000 tons ) bringing the total import volume to some 1.2 million tons,” Mr O’Brien said. “With the upcoming cessation of EU quotas and the largest proportion of audited and CNCA accredited dairy manufacturers cleared for import to China coming from Europe, it is likely that prices will take a further hit post 2015 when European supplies increase and production capacities are geared up,” he said.
Mr O’Brien said the likely extent of the impact on prices was still unclear.
“What new investors should realise is that high priced infant formula is likely to be the sole purview of established companies like Danone’s Dumex and Abbott,” Mr O’Brien said. “Adopting lean marketing and sales strategies is a feasible way to keep profits high and continue to reap the benefits of China’s markets,” he said.
Paul O’Brien 保罗 is a Regulatory Analyst, Writer and Editor at Chemlinked (Reach24H)