The announcement from SABMiller that it would focus solely on small-scale M&A deals in China was billed as the end of the party. The big breweries were finally calling time on an era of multi-million dollar acquisitions through which they had tried – and in some notable cases failed – to make their mark on the Chinese market.
But this change in tack says far more about the state of the sector than it does the ambitions of the world’s second-largest brewer. There are simpy precious few investment targets still up for grabs – phase one of the brewery sector’s slow crawl toward consolidation is complete.
"There are no big players available apart from Beijing Yanjing, which is the second or third largest," said Alice Hui, an analyst at DBS Vickers. "But it doesn’t seem to want to team up with any foreign investor at the moment."
As the potential targets have been crossed off the list, the asking price of those still open to offers has gone up. In January, InBev bought Fujian Sedrin, China’s eighth-largest brewery, in a US$738 million deal that works out as US$95 per hectoliter of annual capacity. SABMiller is said to have set a limit on its China bids of US$25-30 per hectoliter, which saw it lose out in the battle for Harbin Brewery, China’s fourth-largest, last year when Anheuser-Busch paid US$694 million at US$65 per hectoliter.
But in a market still enormously fragmented and blighted by oversupply, the return on these millions of dollars spent is negligible. Despite being the largest beer consumer in the world with sales of 29 million hectoliters in 2005, China has yet to become a prime commercial market. "This is a game of waiting," said Nomura analyst Wu Rui. "Most of the international players planned to wait even before they got in. The Chinese beer market is estimated to grow 5-7% a year over the next few years, which might be the highest rate in the world."
It is this potential – in the form of urban dwellers with rising disposable incomes and a huge but still not fully tapped rural market – that has drawn the top breweries to China. "If you go back to 1980, China was the number 33 country in the world for beer, with a market the size of Chicago’s," said Steve Burrows, CEO of Anheuser-Busch International. "Now it is bigger than the third-, fourth- and fifth-largest markets in the world combined. There is low per capita consumption, so if it increases to match the levels in Japan and Korea, the market will double in size."
With most of the top 10 domestic players having secured foreign investment, from here on in consolidation is likely to be slow and methodical. Hui of DBS Vickers points out that in 1998, the three leading breweries accounted for just 10%; the figure now stands for about 33%.
But it will take time and effort for these major players to acquire or eliminate the several hundred small-scale operators still in existence. Many of these breweries were opened and maintained at the behest of self-conscious local authorities; they have never made profits and simply cannot compete in a truly commercial environment.
Unless Beijing Yanjing is subject to a takeover by a new foreign investor, Anheuser-Busch, SABMiller and InBev are going to be the overseas players driving the next stage of sector reform. These brewing giants have been present in China for over a decade – Anheuser-Busch first invested in Tsingtao in 1993 and now has a 27% stake, while SABMiller joined forces with China Resources Breweries in 1994 and has 49% – but they have had to tailor their strategies in order to survive.
"When the foreigners came in last time they were looking at the market potential but the market just wasn’t ready," said DBS Vickers’s Hui. "There was a big price difference between local and imported brands." The flood of foreign investment in the mid-1990s soon turned into a mass exodus when the companies found their premium, own-brand products weren’t selling. Fosters abandoned its joint venture in 1999 with losses totaling more than US$125 million and Becks left the market soon afterwards in similar circumstances.
The only foreign beer to make significant progress in the China market is Anheuser-Busch’s Budweiser, produced at a brewery in Wuhan which was bought by the US company in 1995.
Explaining his company’s success, Burrows identifies three key areas: strong marketing, product quality and a network of 186 wholesalers 70% of whom work with no other alcohol-related firm apart from Anheuser-Busch. "While Chinese beer is a lot better than it was 10 years ago, improvements can still be made," he said. "We brew Budweiser in China in exactly the same way as we do elsewhere."
Yet Anheuser-Busch’s China strategy has always been twin-pronged: its investment in Tsingtao is likely to be more profitable than organic expansion for the time being at least. "The chances are rare for foreign brands to seriously challenge domestic players, as economy lager has taken the lion’s share of the beer market in China," said Lucia Pan, a research analyst at Euromonitor International. "Even though industry trends do show that brewers are turning to standard or premium lager for more profit, economy lager may still turn out to be dominant."
With this understanding of the power of low-cost domestic brands has come an appreciation of the peculiar qualities of the China market, particularly its strong regional focus. This has taken Carlsberg out into the west of the country – where per capita consumption is well below the national average and competition from foreign-invested rivals is minimal – with acquisitions in Xinjiang, Tibet, Gansu and Yunnan. Similarly, InBev’s purchase of Fujian Sedrin leaves it more or less unchallenged in the fast-growing southeastern province.
Pick of the bunch
But it is Anheuser-Busch’s stake in Tsingtao that is the pick of the bunch, as the Shandong-based brewery is China’s one genuine nationwide beer. Indeed, it was at Tsingtao’s instigation that Anheuser-Busch took over the Harbin Brewery.
"For some reason SABMiller had failed to keep its partner happy but, because of the way it came up, Tsingtao couldn’t participate in the auction," said Burrows. "They firmly believed in the value of Harbin so we bought it – it offers a strong northeast position that would otherwise have gone to a competitor."
There are already plans to integrate Harbin with Tsingtao, which gives Tsingtao the opportunity to expand into the northeast of the country, where it is currently poorly represented, and gain an edge on rivals in the consolidation battle. Also working in Tsingtao’s favor is its efficient distribution network, based on a system of wholly-owned sales companies that supply customers directly.
Not only does this enable the company to maintain a high standard of service, it also allows it to respond quickly to changes in demand. The overcapacity in the sector arises from companies not being able to do this effectively, boosting output to try and expand market share but then failing to shift the supply to the places where it is needed. "Overcapacity has always been a problem and that is why the price competition is so intense," said Hui of DBS Vickers. "It all comes down to how they give out discounts and run promotions outside the normal price system."
Consolidation should gradually deal with the overcapacity as the large players introduce better supply chain management. They will also force down costs to boost their profit margins in the mass market and, at the same time, force smaller and less efficient operators out of business.
But the key to making money lies in catering for the ever more refined tastes of the urban dwellers rather than drawing rural drinkers away from the spirits counter. The conversion from budget goods to quality brands across the consumer sector is what the foreign brewers have been waiting for. While demand for their products will grow at the top end of the market, it is through their investment in and support of domestic firms that the foreign players are more likely to hit pay dirt.
By developing mid-range products domestic brewers can expect to tap a market equipped to generate both sales volume and profits. Local branding is just as important as this focus on quality. A recent industry report by Nomura notes that "one of the key essences of brand differentiation is the perception of point of origin", arguing that the pride people feel for their "local brew" poses significant barriers to entry.
While foreign marketing savvy can pay off in the long term, the distribution challenges presented by China’s fragmented market suggest that Anheuser-Busch will need more than the 30 years it took to push its brands to number one in the US. This view is supported by Anheuser-Busch’s Burrows, who backs a premium Tsingtao product to score bigger with Chinese drinkers than anything the overseas players have to offer.
"If they think a foreign brand is going to take over the Chinese beer market, they are going to be disappointed," he said. "It will be a very long time before Budweiser, Becks and Heineken become dominant in China – I don’t think there is any market in the world in which a foreign brand has a dominant position."