China’s Parents Crave Illegally Imported Baby Formula

China’s Parents Crave Illegally Imported Baby Formula

By Liza Lin and Julie Cruz on May 02, 2013

For Hong Kong customs agents, baby formula is the new heroin. On March 1 a law went into effect limiting the amount of powdered milk travelers can carry out of Hong Kong to two 2-pound cans each. Since then, more people have been arrested for smuggling baby formula than were caught all of last year with heroin and cocaine. As of April 23, border officials say they’d seized nearly 20,000 pounds of powdered milk and arrested 879 people, many of whom were part of a smuggling syndicate. In 2012, 420-plus people were arrested for smuggling illegal drugs through Hong Kong.

Many Chinese parents are desperate to get their hands on foreign-made baby formula after numerous food safety scandals in recent years. In 2008 at least 22 Chinese companies were found to have sold dairy products containing melamine, a toxic chemical that can make diluted milk appear to have a higher protein content. Six babies died as a result. In 2011, China’s largest milk producer, China Mengniu Dairy (2319), said in a statement that moldy cattle feed led to excessive toxin levels in its milk. Last year another large milk producer, Inner Mongolia Yili Industrial Group (600887), recalled formula tainted with mercury. “Chinese consumers are so frightened and so sensitive to safety issues with milk powder that they are willing to pay a higher premium than consumers anywhere else,” says James Roy, a Shanghai-based senior analyst at China Market Research Group. That willingness to pay has led to baby formula shortages in Hong Kong, where food safety standards are higher. The surge in Chinese demand has even hit foreign markets, where baby formula is often cheaper than in China. Over the past year, stores in Germany, the U.K., and New Zealand have put limits on all bulk purchases of formula, such as Danone’s (BN)Aptamil and Mead Johnson Nutrition’s (MJN) Enfamil.With a limited supply available on Chinese e-commerce sites, consumers’ next best choice is to buy those foreign brands domestically. This gives international baby products companies a golden opportunity to boost their share of China’s formula market at the expense of local rivals. Baby formula sales grew 29 percent last year, to 95.2 billion yuan ($15.4 billion), more than four times the size of the U.S. market, according to industry analyst Mintel Group. This year, China’s top five international sellers of formula—Danone, Nestlé (NESN), Mead Johnson, Abbott Laboratories (ABT), andWyeth (PFE)—will increase their total market share by 5 percentage points, to about 55 percent, China Market Research estimates.

Danone reported first-quarter sales growth that beat estimates as China safety worries helped drive a 17 percent jump in its baby food revenue. Nestlé reported that its first-quarter infant nutrition sales increased 10 percent, outpacing the company’s overall growth. Illinois-based Mead Johnson, which counts on China for 30 percent of its total sales, saw operating profit rise 12 percent, to $870 million, last year on revenue that grew 6.1 percent. Meanwhile, profits at Mengniu shrank 16 percent last year, to 1.45 billion yuan, as sales fell 3.5 percent. Food quality and safety incidents affected consumer confidence and sales, it said in a March 27 statement.

As foreign companies ramp up production in China, they’ll have to convince Chinese consumers that their formula is safe. While Danone says it buys the milk it uses in China from New Zealand, Nestlé uses a combination of local and imported milk and says it’s working to teach local Chinese dairy farmers better safety practices. Heiko Schipper, managing director of Nestlé’s Greater China food and beverage division, says she can understand why Chinese parents are so wary of local milk. “When you talk about the health of your baby, it’s very hard to say to people, ‘You are overreacting.’ ”

The bottom line: Local food scares have provided an opportunity for foreign companies to increase their share of China’s $15 billion market for baby formula.