In a turn of events in the Chinese dairy market, dairy majors such as Nestle, Danone, Dumex, Wyeth, and Abbott have reason to be concerned as lesser-known dairy brands such as China Modern Dairy, Mengniu Dairy, Panda Dairy, Yili Group, and others are to be the recipients of a stimulus designed to increase their market share.
The new regulation, announced in mid-June 2014, is likely to impact foreign brands’ current share of over 60 percent of the milk powder market in China, valued at a total of USD 9.75 billion as of 2013. The policy states that the target for local Chinese brands is set to be 80 percent of market share by 2018, a drastic change from the status quo.
Both the National Development and Reform Commission and the Chinese FDA formulated the release by the State Counsel, which came out on June 13. It laid out specific elements of the policy as well as targeted outcomes, including:
- Just under USD 10 billion in bank funding over the next few years;
- A push for a consolidation in the industry to 10 major companies, inclusive of “three to five heavyweights;”
- Simplified processes for M&A activity;
- Land allocation for dairy farms;
- Stricter regulation for both local and foreign companies;
- Mergers and acquisitions to be completed by 2015; and
- Local brands to account for 65 percent of market share by 2015 and 80 percent by 2018.
The plan to reverse the trend of foreign market leadership in the China dairy market is bold and may not be possible as health is still the main priority—not only for Chinese citizens but also regulators. The success of the government-sanctioned initiative will depend not only on government support, but the ability of local companies to address sourcing and tractability-to-source issues, as well as problems associated with scaling up. Logistics for example, is an ongoing problem for all dairies in China.
New Legislation Success?
Two problems have plagued Chinese dairies in the past, this new legislations addresses one of them.
- Safety: Foreign dairy producers in China have increased their market share by 30 percent in the last five years, primarily as a result of safety issues associated with local brands. This new mandate does not directly address this.
- Scale: Foreign brands have long had the advantage of importing to the Chinese market and economies of scale advantages provided by sheer scale of operations. Nestle has been able to train farmers on farming best practices and address sourcing issues more effectively than smaller local competitors.
Will Food Safety Improve in China?
Foreign companies have gone to great lengths to ensure consumer safety for their products in China. Nestle, in an effort to manage quality, has been consolidating its farms in China from 18,000 to just a few. In order to successfully make this transition, the company runs three demonstration farms and educations courses for farmers, has an institute for dairy farmer training, and provides credit and funding for expansion to interested farmers.
Quality assurance is a highly complex undertaking in China. Chinese authorities have flagged issues such as tractability-to-source, hygiene, and process technology as important aspects for government approval, yet replicable solutions to these have yet to be found. For the medium term, it does not seem plausible to completely address these concerns in China.
Positioning Foreign Companies
The dairy market is currently driven by brand confidence. New legislation gives reason to believe local dairies will be making a move to improve quality and volumes in the future, but neglects to address buyers’ confidence in Chinese dairy products.
The push for Chinese companies to consolidate is likely to lead to a wave of restructuring of upstream processes. While the total number of companies will be reduced in this process of consolidation, it is also expected that a quarter of all Chinese dairy producers will bow out of the market. Foreign brands are advised to move quickly to secure new contracts with distributors, retailers, and marketing platforms.