China's dairy industry is expanding fast but there will inevitably be casualties as inexperienced investors scramble to lap up the cream.
Last month, some 30,000 Shanghai schoolchildren were given the opportunity to buy a 200ml container of flavoured milk for Yn1.25 – just half the price charged in the local shops. They could choose between five varieties, each adorned with a different Looney Tunes character. The milk is supplied by Harbinbased Wandashan, one of China's largest dairies. The flavourings, along with the Daffy Duck, Bugs Bunny and Tweety Bird images, are licensed from China Premium Food Corp, the US-based partner in the project. The manufacturers are participating in a scheme that gives them tiny operating margins but access to an important and fast-growing market.
China Premium, a subsidiary of Bravo Foods International, is not an investor in Wandashan, having recently rejected this means of entering the Chinese market. Back in the mid-1990s, the company formed a joint venture to sell pasteurised milk products with Chinese partners, including the Ministry of Agriculture. However, unable to agree on a number of issues, such as product development and marketing, it pulled out of the partnership.
Undeterred, China Premium shifted its investment to regional dairies, including one in Hangzhou. "We rushed into small dairies. There was still no common vision," admits Jeffery Tarmy, general manager of China Premium Food Corp (Shanghai). Finally, China Premium decided to abandon its dream of selling fresh milk through a joint venture and launched the current business model, in which it is only an agent for the flavoured ingredients. So far, it looks to be a success, though the early travails of this small US-based company serve as a warning to other investors in China's dairy industry. With milk consumption growing by 25 per cent annually, however, foreign and domestic investors continue to pour in.
Pick a big name in the dairy industry and it is likely to have already invested in a Chinese dairy. According to Chinadairy.net, the website of the China Dairy Industry Association, there are 45 Sino-foreign dairy ventures, involving 12 of the top 20 dairy companies worldwide. While no statistics on total investment are available, dairy giants Nestl? Parmalot and Danone are all big players in China, and foreign-invested companies now account for 28 per cent of the industry's total output.
Danone's investment in Shanghai Bright Dairy & Food Co is a good example of what both sides stand to gain from joining forces. In 2000, Danone took a 5 per cent stake in Bright (diluted to 3.85 per cent after Bright's listing). Bright is China's largest dairy, with 25 per cent of the market, including 11 per cent of the yoghurt market. In 2001, it reported a profit of Yn1.2bn, on revenue of Yn3.5bn. Danone's investment also gave it valuable foreign management expertise.
There are two essentials for success in China's competitive dairy industry, according to Tarmy. "Know-how and money are what you need to make it," says the former consultant. As for money, Bright recently raised Yn980m in a listing on Shanghai's domestic A-share market which, according to the prospectus, will be used to build a yoghurt production centre. As part of the investment agreement, Bright gained control of two of Danone's mainland yoghurt factories, which it then merged. The Danone yoghurt factories didn't perform that well at first, according to Haitong Securities analyst Ding Pin, though she adds that the investment should give Danone access to Bright's local market knowledge and its sales network.
China's dairy market has huge potential. Per capita milk consumption in China, although just over 7kg a year compared with more than 100kg in most Western countries, has grown steadily over the past decade. In 1990, per capita annual consumption for all kinds of dairy products was only 4.4kg, and total output 4.75m tonnes. By 2000, consumption had risen by 68 per cent to 7.38kg and output was up 93 per cent to 9.19m tonnes, according to Dairy Industry Association figures. In 2001, output rose 12 per cent to 10.3m tonnes. Until very recently, the total comprised almost exclusively yoghurt, powdered milk and UHT milk. But new cooling technologies and improved distribution networks mean fresh milk is the fastest growing sector in China.
The government is playing its part in boosting dairy consumption. Besides the school milk programme in Shanghai, Beijing is running advertisements promoting milk as a healthy drink. In June, a vice governor of the central Hunan province called for a plan to encourage people to drink more milk, and to guarantee the availability of good milk. These promotions seem to be working, with milk often the preferred beverage of young Chinese professionals out for dinner at fancy restaurants.
Peripheral industries are also benefiting. In August, Germany's Westfalia Landtechnik won one of its largest ever orders, for 15 milk carousels valued at m4m, from the Fujian Changfu Group. And at a dairy convention held in Beijing one year ago, 40 per cent of the exhibitors – made up of 29 local and 10 foreign companies – got 50-100 "serious inquiries", according to the organiser of the show, Messe Dï¿½sseldorf China. One Hong Kong exhibitor said it had received orders worth Yn6m.
But investors and suppliers to China's dairy industry should beware – like most sectors, the dairy industry is still littered with inefficient stateowned enterprises. Many are tiny – 90 per cent of China's 1,500 milk product enterprises have a daily output of less than 100 tons, according to China Daily. And like any industry in China that shows rapid growth, the dairy sector is attracting investors helter-skelter, often with little regard for strategy or quality. "There is so much investment going on – there is huge expansion and the industry is in turmoil. Companies are manoeuvring and a lot of newcomers are coming in, many of them non-dairy people," says the general manager of a Sino-European dairy venture.
Although dairy consumption may be soaring, China's manufacturing capacity still outstrips demand. Meanwhile, the country's WTO entry means tariffs on imported dairy products will be reduced by 2006 – the current rates of 25 per cent for powdered milk, 42 per cent for yoghurt, 44 per cent for butter and 43 per cent for fresh milk will fall to 15 per cent, 34 per cent, 36.7 per cent and 34.8 per cent respectively. Starting up or modernising a dairy operation requires huge capital investment in machinery, pastureland and cows. But, with competition growing, some creditors may be left empty-handed. "Unfortunately, the cake isn't big enough at the moment," says the general manager of the joint venture. "In the next 12 to 18 months, there will be some nasty crashes."
However, good opportunities can still be found and the big names continue to invest. Nestl?has been negotiating to buy control of Diequan Dairy from the government of Eryuan county, in southwest Yunnan province. However, according to a report, talks broke down in September because the offer price was deemed too low. Nevertheless, smaller players like China Premium are finding their niche.
"There are some very, very good companies," says the European general manager. "The large, purely Chinese companies are run very well – it is in the smaller plants, where maybe people jump on the bandwagon, that there may be some problems."