The question of how China feeds its people has long fascinated observers. In a country with 21% of the world's population but only 10% of its arable land and water resources one quarter of the world's per capita average, logic states that foreign trade can play a key role in food supply. And in today's market, companies that find a way to do this can expect large commercial returns.
China's food industry is making the journey from fragmentation to consolidation, like other sectors of its economy. This has in turn spawned a clutch of dominant food chain players that combine local knowledge, brand awareness and efficient distribution. Their target market is obvious: an urban population that is expected to number 800 million by 2020.
While the urban-rural income disparity remains huge, city dwellers reaping the rewards of an economy growing by around 9% a year form the backbone of a consumer class that has cash to back up its dining demands. With increasing affluence, these demands are changing.
"We are seeing a considerable growth in demand for meat, milk and fruits, processed foods and convenience foods," said Vaclav Smil, distinguished professor at the University of Manitoba, Canada and author of China's Past, China's Future: Energy, Food, Environment.
While China's cereals consumption has fallen steadily from 210 kg per capita in 1990 to 168.2 kg in 2002, meat consumption more than doubled over the same period, reaching 51.7 kg per capita. The United Nations' Food and Agriculture Organization (FAO) figures also show a similar percentage rise in milk consumption, rising from 5.2 kg to 12.5 kg per capita between 1990 and 2002. Vegetable consumption leapt from 99 kg to 257.1 kg per capita over the 12-year period.
"Just look at the calorie intake of Taiwan versus China – it shows a startling difference in intake per person," said Gregg Hunt, senior trader at Chicago-based Fox Investments and a former grain purchasing agent for China's state-run agricultural import and export group. "If income in China reached Taiwan's level there would be a massive increase in consumption. It just shows how far China can go."
Keen to export
Foreign farmers are keen to help China meet these rising demands. "Adding 50-100 million to this middle class would put tremendous pressure on the food supply and I personally don't think that China is prepared to meet that increase on its own," said Jeff Beal, a farming consultant for Strategic Marketing Services in Rockford, Illinois. "The additional demand will have to be met by suppliers from outside."
China's wheat import demand, which saw 7.26 million tonnes split 40%-35%-25% between producers from the US, Canada and Australia in 2004, varies in accordance with the domestic harvest. The one area where there has been solid upward momentum is soybean imports, which have risen from 795,000 tonnes in 1995 to 20.23 million tonnes in 2004, 50% of which came from the US with the remainder divided more or less equally between Argentina and Brazil.
With soybeans primarily used in vegetable oils and livestock feed, Beal believes that changing consumer demand will maintain this growth. For similar reasons, he says it is "inevitable" that China – already the world's second-largest corn consumer – will become net importer of the crop, with South America the ultimate beneficiary of this increasing demand.
"Over the next three to five years the US will benefit greatly from rising Chinese imports," he said. "But over the next seven to 15 years, it will be countries like Brazil that gain. It is developing an extra 200 million acres of productive land, which is equal to all the arable land in the US used for corn, wheat and soybeans."
With land intensive crops, the long-term pattern appears to be one of China boosting imports of grains and putting more emphasis on production of labor intensive commodities such as fruit and vegetables – better suited to a country in which 40% of the population works in agriculture. The crop share of total primary production fell to 50% in 2003 from 65% in 1990, while growing domestic demand for meat and dairy has seen China consolidate its position as the world's number one livestock producer.
But changes within the sector indicate how increased wealth is stimulating calls for greater quality and variety. Pork production rose 98% between 1990 and 2003, but this figure is dwarfed by the 402% increase in beef production alongside increases of 306% and 234% for poultry and mutton respectively. Milk production rose 289% over the same period.
Rise of the machines
In its November report on China's agricultural policy, the Organization for Economic Cooperation and Development (OECD) made a series of agricultural policy recommendations aimed at boosting rural incomes and standard of living. However, secure land tenure is seen as the key to encouraging farmers to invest in their land so as to boost productivity and diversify into other areas and to meet demands for better quality and a wider variety of produce. (See: Fight for the right: farmers and land security).
Increased mechanization suggests that China's farmers are slowly accepting the concept. That, plus one of the highest rates of fertilizer use in the world, has seen productivity rise. In this way, the government hopes to counterbalance the continued rural to urban migration that, at the current pace, will see 70-100 million workers leave agriculture between 2000 and 2010.
But there are those who doubt China's ability to sustain production given the increasing strain on land and water resources that comes with it. "It is a disaster in the making," said the University of Manitoba's Smil. He cites the continuing losses of top-quality arable land, shortages of irrigation water, the enormous waste of nitrogen fertilizers and excessive monoculture cropping as the major threats to the country's agriculture sector.
China's industrial-led growth is taking place at such a fast rate, conflict between farmers and factories is inevitable in regions where certain natural resources are dwindling. The government announced last month that 1.6 billion tones of soil were lost in 2004 due to erosion, which a Water Resources Ministry report blamed on "over development and unreasonable construction projects."
Soil erosion fuels desertification, which is particularly severe in China's drought-ridden north. The problem is a simple one: agriculture is responsible for 70% of the country's water consumption, but 65% of cultivated land is located north of the Yangtze River – which is home to just 20% of China's water resources. A huge south-north water diversion project, that will see three giant canals carry water from central and southern rivers, is being touted as the solution. The US$62 billion project – nearly twice the cost of the Three Gorges Dam – is due to be completed in 2050.
Referring to the environmental problems posed by increased agricultural activity, the OECD report argued that improvements were ultimately dependent on "substantial reallocation of land resources away from land intensive toward labor intensive products, and on reallocation of labor from agriculture to non-agricultural activities."
Carry on consuming
Imposing reform on China's massive agricultural sector is likely to be a long and tortuous process, but on the consumption side of the country's food industry, changes have been taking place quickly. In fact, the Chinese appetite for retail therapy is so strong, an upturn in consumption-led growth is expected to start propping up the economy as companies in several sectors feel the consequences of industrial over capacity and reduce fixed-asset investment.
"We believe that consumption will remain the most resilient segment in the economy," said Fan Cheuk Wan, head of China research at ABN AMRO. "We are positive about underlying consumer demand momentum because of the very solid and sustainable disposable income growth. A new middle class has emerged in the major cities, offering a new growth driver for high-end consumer products."
In this way, Chinese consumers are not only demanding more meat products but better quality meat products, which means that country-wide processing companies such as People's Food are moving up the product scale in order to capture more value. "We are seeing a growth in demand for fresh pork and low-temperature products, usually popular with European consumers," said People's Food spokesperson David Tsoi. "People's taste has upgraded and they want products that are fresher and taste better."
Typically, high-temperature meat products – sausages and ham that are cooked at sufficiently high temperatures to not require cold storage – have been popular with Chinese consumers. But the principal growth driver is a quality-conscious class of urban consumers, stimulating an increase in sales of fresher produce. The company didn't even offer low temperature meats until 1999.
None of the top three meat processors, Yurun, Shuanghui and People's Food, enjoys more than a 2-3% market share but a UBS report in December concluded that the sector was further along the road to consolidation than the dairy, beer and wine sectors. The reason for this is that meat-processing is inextricably tied to the development of the supermarket phenomenon: cold storage facilities offer an alternative to the markets. A growing number of people prefer to take their pork chops off the shelf rather than off the spike (See: Pile it high, sell it cheap: the supermarket phenomenon).
"Traditionally, most of the pork people consume is slaughtered locally and sold fresh at market," explained Tsoi. "But an increasing number of consumers find that our chilled fresh pork tastes better. As people have got more affluent, they are more concerned about quality than price."
As a result, products bearing the People's Food Jinluo brand now command a degree of consumer loyalty and respect, a key ingredient to the company's overall success.
"With a vast market, which straddles different provinces and takes in different consumers with different tastes and preferences, having a sustainable national brand is a critical factor to your success," said ABN AMRO's Fan.
Establishing a good brand in China is a problem for foreign companies across the product scale, even in areas where a degree of western chic might seem to be a selling point. "With products like red wine, you'd be hard pushed to find Chinese people who had not lived overseas who could name some foreign brands," said Denise Chai, head of regional consumer research at Merrill Lynch.
Multinational corporations (MNCs) such as Coca-Cola, Pepsi and Nestle came to China early and successfully launched product lines. But later entrants into the market are up against established domestic brands as well as a host of major players from Japan, Taiwan and South Korea. Mengniu Dairy Co. is a good example of effective brand building in a growing market sector.
Founded in 1999 by three former employees of China's largest state-owned dairy, Mengniu achieved huge public exposure by sponsoring the popular TV talent show "Super Girls." The company has overtaken the likes of Shanghai Bright Dairy & Food and Sanyuan Food and is now going head to head with Yili Group to become the country's largest dairy firm. Revenues increased 37% during the first half of 2005 reaching US$585.6 million.
"You can match Mengniu's marketing campaigns with its continuously innovative brand-building ideas," said ABN AMRO's Fan. "We can expect food and beverage companies to spend even more money on advertising and promotion in order to expand their market positions."
Having a brand that is a good seller in western markets doesn't guarantee a breakthrough in China, though. McDonald's had to engineer a change in eating habits to get the Big Mac into Chinese hands (See: They're lovin' it: fast food moves forwards) and similar efforts are being made to wean people onto breakfast cereals. In this way, Fan questions the suitability of some western brands to the Chinese market. "The MNCs do not have the right food products to launch in China," she said. "If you want to introduce a western-style food, you have to overcome the cultural barrier because the eating culture in China is unique. It can't be changed overnight."
In a country where the dried noodle is king, the world's largest noodle producer, Nissin Foods of Japan, has only enjoyed limited success. It was used to producing high quality instant noodles for the Japanese market but was unable to transplant its business model to China – people just weren't prepared to pay a premium for a better product. On the other hand, Taiwan noodle producer Tingyi has become the dominant player in the Chinese market and the good performance of its Master Kong brand has been put down to insight into the kind of product consumers want.
"Due to the common eating and drinking habits shared by people in Mainland China and Taiwan, it is easier for Taiwanese food and beverage companies to develop the right products for the Chinese market," said Fan.
What Tingyi also has is a network of 341 sales offices and 72 warehouses serving 3,908 wholesalers and 61,065 direct retailers. For a foreign company looking to enter China, the financial commitment required to establish a distribution network may be just too great. Coca-Cola has invested US$1.1 billion in the country since 1979 and, while China now represents 3.8% of the company's global sales volume, it contributes less than 1% of global revenues.
Play the long game
Coca-Cola is able to invest in the long term growth of the Chinese market but for smaller companies looking to target a niche market for luxury goods, this strategy is out of the question. However, this means good business for the host of domestic firms that specialize in distributing high-end foreign products (See: Posh nosh: tapping into the luxury market).
The other viable entry strategy – to those that can afford it – is acquisition. "It is the most cost effective way for an MNC to enter the Chinese market," said Fan. "We are likely to see more of this." There will always be ambitious domestic companies willing to exchange shares for capital investment, but foreign investors have come and gone in waves over the years as sectors of the naturally fragmented food market have edged rather than galloped towards consolidation.
During the 1990s, China's dairy market was targeted by major players such as Nestle, Kraft, Groupe Danone and Parmalat. By the early 2000s, they had either scaled back their involvement or left the market completely. Now, though, foreign activity appears to be making a comeback. Danone boosted its stake in Shanghai Bright Dairy & Food Co to 11.55% in November, having already gone from 3.85% to 9.7% in March. This was followed by Fonterra, the world's largest dairy products exporter, paying US$107 million for a 43% stake in Shijiazhuang San Lu Group.
This rediscovered optimism is tied to the growing demand for dairy among affluent Chinese – Euromonitor International predicts that retail dairy sales will rise 55% to be worth US$7.9 billion by 2009. While in the past large dairy firms were accused of simply pushing western brands on an uninspired Chinese public, now they are doing their homework: Danone has spent US$3 million on a research and development center for fresh dairy products in Shanghai.
Access all areas
For Fonterra, the investment in San Lu provides a ready-made platform from which the New Zealand company can sell nationwide: there is no need to spend time building relationships with local suppliers and retailers. However, Fonterra China's General Manager Patrick Kwok is keen to stress that the deal is about more than just access to a network that reaches 600 cities.
"San Lu's distribution network is one of its major competitive advantages but these advantages exist along the whole supply chain – in product and brand value, relationships with central and local government and relationships with farmers," he said. The bulk of Fonterra's US$141 million a year China business is focused on milk powder and food ingredients. But the company plans to diversify in order to meet the expected growth in demand for consumer dairy products such as cheese and desserts.
As to which name these products would be marketed under, Kwok said the branding strategy was something the two parties "will have to discuss", though he emphasized that the relationship is built on the long term exchange of multinational expertise for local knowledge. "We are not using San Lu as a just a vehicle to develop our own brands, we want to help its business grow," he said. "By a joint venture we mean a joint venture and we have made a long term commitment."
Perhaps this is just as well. As the big dairy firms discovered to their cost last time round, success will only come to those who are patient. Consolidation and commercialization are figuring ever more strongly in China's food market but the road is likely to be a bumpy and circuitous one.
Foreign firms first have to ask themselves whether their high-end products will appeal to consumers; then they have to decide what to do if one of the ever more savvy domestic operators produces an equally good version at lower cost. At the same time, though, they can rely on marketing and management wizardry that has proved effective in the world's most competitive markets.
With the Chinese diet creeping towards westernization, perhaps it is case of when, not if, their products become successful and their brands are lodged in the psyche of a potentially huge consumer base. The major players are aware that, as long as they stay the course, the rewards will be significant.
"Everybody knows the consumer market in China is the biggest growth market in the world," said ABN AMRO's Fan. "The Chinese consumer is used to spending almost half of their income on food and beverage items so this is a lucrative market that every global player wants to explore."