The sign in the Shanghai supermarket said: "You can trust the source." Bright Dairy, China’s fourth-largest dairy firm, wanted consumers to know that its products were safe.
When it emerged in September that chemically tainted milk powder made by Sanlu Dairy was responsible for the death of four infants and the hospitalization of thousands, China’s dairy industry was thrown into chaos. Sanlu had been covering up the high levels of melamine – a chemical used to artificially inflate protein readings – for months. Who else had something to hide?
On September 16, it was confirmed that infant milk powder products made by 22 companies had failed tests. As the days wore on, more brands and products, as well as exports of Chinese dairy goods, were implicated.
The companies at fault include Hong Kong-listed Mengniu and Shanghai-listed Yili, which between them control over a third of the dairy market. Of the two, only Yili is a major player in the milk powder segment, and the melamine levels in its products were far below those of Sanlu. But all of China’s dairy firms have been tarred with the same brush: The reliability of the prevailing industry business model has been brought into question.
"These firms are really just marketing companies that happen to do milk. No one cared about the quality of the milk on the farms while it was okay, but now that’s changed," said David Oliver, a Beijing-based dairy industry consultant.
For all the hype surrounding Mengniu’s state-of-the-art dairy farm in Inner Mongolia, the 3,000 cows in residence meet only about 1% of the company’s raw milk needs. According to David Peerless, an analyst with Evolution Securities in Shanghai, large-scale farms with more than 5,000 cows account for a further 10%, while 40% comes from mid-size farms. The remaining 50% is supplied by milking stations that source their milk from small-scale and individual farmers. The melamine seeped in through this highly fragmented part of the supply chain.
Peerless has been advising clients to sell Mengniu since the start of the year due to concerns that the stock was overvalued. His decision was partially influenced by supply chain issues.
"The stability of Mengniu’s supply has always been a challenging issue," he said.
Mengniu saw its stock plummet 65.8% on September 23 as trading resumed following a week-long suspension. As of mid-October, the stock was still down more than 50% from its pre-scandal level. The sliding stock price would appear to reflect waning consumer confidence.
A survey carried out by Beijing-based research firm All Media Count of 900 adults who buy milk found that 80% of the respondents have a more negative opinion of domestic dairy products as a result of the scandal. Sanlu was most readily associated with the problems, and over half of respondents who described themselves as Sanlu loyalists said they planned to desert the brand.
The results were more encouraging for Mengniu and Yili. Although these firms were strongly linked to the scandal, no more than a quarter of their loyalists intend to stop buying the firms’ products.
All is not lost
This sense of pragmatism was reinforced in comments made to CHINA ECONOMIC REVIEW during a tour of several Shanghai supermarkets in mid-October.
"I don’t have as much confidence in milk products as before, but I’ve been drinking milk for so many years and it’s not easy to it give up," said a 30-year-old woman surnamed Li, who was shopping at Lianhua Century Supermarket.
The bottom line is that dairy consumption in China is rising and the melamine scandal is unlikely to derail it.
Market research firm Euromonitor International put the retail value of the country’s dairy industry at US$17.9 billion in 2007. Prior to the outbreak of the scandal, it said the industry would pass US$20 billion in 2008 before reaching US$28.5 billion by 2013 as growth in the maturing market begins to moderate.
Yang Fan, an analyst with Euromonitor, said the scandal may knock two percentage points off industry-wide growth in the second half of the year, but he sees no reason to alter the 2013 projection.
Mengniu and Yili are so entrenched in the public consciousness that analysts expect them to retain the lion’s share of this expanding market, whether it is through organic growth or consolidation. The danger is that the companies, aware of their brand strength, will be content to ride out the crisis rather than address it.
Beyond posting reassuring notices in supermarkets and running public service-style announcements in TV ad slots, any meaningful PR strategy is tied to restructuring the industry as a whole. Taking over dairy supply chains – from cow to shop shelf – and tightening up quality control is neither cheap nor easy. This makes the government’s role in the process, as both an organizer and a champion of best practice, even more crucial.
"They have to be upfront and say this is where the problem comes from and this is what we are going to do to ensure it never happens again," said David Wolf, CEO of Beijing-based public relations consultancy Wolf Group Asia.
Wolf noted that the dairy firms have sought counsel from international PR agencies. He also identified two potential obstacles to progress: the lack of corporate accountability in China and the fact that many companies still pay little regard to corporate communications.
Although placing emphasis on quality comes at a price, it should ultimately pay off for China’s dairy firms. It gives them the chance to add a core value to their brands that doesn’t live or die by marketing and presentation.
"Right now, there is product parity for everyone in the industry – they are selling basically the same thing with the same quality risk," said All Media Count founder Mike Underhill. "There has been a flowering of new products, packaging styles and flavors as the firms try to differentiate themselves – but copycatting is very easy. Everyone thinks there is more diversity than there really is."