China’s scandal-rocked dairy industry is changing, but the government’s goals remain uncertain

10.23.2013 17:57

China’s Dairy Market Policies Clear as Milk

The scandal-rocked dairy industry is changing, but the government’s goals remain uncertain

By staff reporters Qu Yunxu and He Chunmei, and intern reporter Huo Bingyi

Dairy operators pouring over the Chinese government’s latest industry-support policies and what speculators have been saying about future policy changes want to know whether the cup is full, half-empty or nonexistent. Clear answers are hard to find because mixed signals have been trickling out of the Ministry of Industry and Information Technology (MIIT), Ministry of Agriculture (MOA) and other policymaking agencies since last spring.The government in general wants to strengthen the Chinese dairy industry’s reputation and fend off competition from companies in Australia, Germany and other countries that have been grabbing market share since 2008.

That year, tens of thousands of children across China were sickened after drinking domestically produced baby formula intentionally laced with a plasticizer called melamine by dairy farmers seeking higher profits through faked protein counts. Health authorities said tainted milk powder killed at least six.

Shocked Chinese consumers shifted their allegiance to foreign baby formula, and the government directed Beijing Sanyuan Foods Co. to buy the bankrupt dairy at the center of the scandal, Sanlu Group, for 617 million yuan.

It appears further consolidation is among the government’s latest goals. Some industry watchers say Beijing is backing only the country’s largest, state-run dairies. But some government officials say they want to lift the industry as a whole without playing favorites.

Domestic media reported in mid-September that MIIT had picked five dairies to receive government subsidies worth a combined 30 billion yuan. The companies – Inner Mongolia Yili Industrial Group, China Mengniu Dairy Co., Heilongjiang Wondersun Dairy Co., Feihe International Inc. and Treasure of Plateau Yak Dairy Co. – were also reportedly offered special credit access.

The reports triggered disputes over whether the government should give preferential treatment to a “national team” of dairy firms at the expense of smaller players.

Some government officials later denied the media report. Gao Fu, an official at the MIIT’s consumer goods department, said on September 28 that the subsidies would not be company-specific but would go toward boosting domestic brands overall and improving quality control industry-wide.

Nevertheless, industry players have continued debating whether the government should build and finance a champion team. The five dairies named in the media report applauded the team approach, while other companies complained about its likely effect on competition and fears of disputes with countries that sell dairy products in China over what could be seen as trade protectionism.

Even while the debates were continuing, MIIT on October 18 handed the State Council a five-point plan outlining future government support for dairy industry consolidation. The government, it said, should provide subsidies, credit and land.

Goals and Controls

At the same time, MIIT and China Dairy Industry Association (CDIA) officials have rejected claims that Beijing wants a small team of nationwide dairies to control the industry. They’ve also denied reports that the government has already set up a special fund to support a handful of companies.

Business journalists and industry watchers expected these denials to be clarified or perhaps shoved aside September 28, when a dairy industry press conference was called in Beijing and organized by CDIA. Attending were officials from MIIT, MOA and the Ministry of Commerce (MOC).

The conference’s sole purpose, the journalists later learned, was to promote dairy products, none of them new, that are being sold by six domestic companies. Song Kungang, CDIA’s honorary chairman, called the products reliable and innovative. CDIA and MIIT officials said similar promotional events are planned for the future.

MIIT opened the door to policy changes May 16 by floating a plan aimed at raising the quality of domestic milk powder products as well as consumer confidence. Later that month, the State Council called for similar, quality-control action that would affect all baby formula products.

To achieve the goals of better and better-selling dairy products for children, the government has proposed dairy company consolidation and restructurings, as well as stricter oversight and management for the entire industry. Moreover, MIIT is one of nine government agencies that this year issued new quality control guidelines for dairy companies.

MIIT in particular has signaled interest in consolidating some of China’s 127 baby formula producers. Gao said the goal is to build a stable of 10 major players that would market high-end formula within two years.

Currently, Gao said, these 127 companies’ combined annual production capacity is nearly 600,000 tons. But only three in the group have a maximum output exceeding 30,000 tons.

Among high-end baby formula brands, Gao said, foreign companies control more than 75 percent of sales. The government wants to cut that portion to 30 percent by 2015 by building the 10-company team, which could enjoy combined annual sales of 2 billion yuan.

The nation’s chief economic planner, the National Development and Reform Commission, jumped into the fray in late June by launching a campaign targeting foreign dairies for price fixing. Six companies, including Mead Johnson Nutrition Co. and Hong Biostime International Holdings, were fined a combined 669 million yuan for violating China’s anti-monopoly law.

The ruling forced the foreign companies to cut prices in China. But the net effect, according to an industry source, was to make foreign-made milk powder even more attractive than domestic brands in the eyes of consumers.

About bambooinnovator
Kee Koon Boon (“KB”) is the co-founder and director of HERO Investment Management which provides specialized fund management and investment advisory services to the ARCHEA Asia HERO Innovators Fund (www.heroinnovator.com), the only Asian SMID-cap tech-focused fund in the industry. KB is an internationally featured investor rooted in the principles of value investing for over a decade as a fund manager and analyst in the Asian capital markets who started his career at a boutique hedge fund in Singapore where he was with the firm since 2002 and was also part of the core investment committee in significantly outperforming the index in the 10-year-plus-old flagship Asian fund. He was also the portfolio manager for Asia-Pacific equities at Korea’s largest mutual fund company. Prior to setting up the H.E.R.O. Innovators Fund, KB was the Chief Investment Officer & CEO of a Singapore Registered Fund Management Company (RFMC) where he is responsible for listed Asian equity investments. KB had taught accounting at the Singapore Management University (SMU) as a faculty member and also pioneered the 15-week course on Accounting Fraud in Asia as an official module at SMU. KB remains grateful and honored to be invited by Singapore’s financial regulator Monetary Authority of Singapore (MAS) to present to their top management team about implementing a world’s first fact-based forward-looking fraud detection framework to bring about benefits for the capital markets in Singapore and for the public and investment community. KB also served the community in sharing his insights in writing articles about value investing and corporate governance in the media that include Business Times, Straits Times, Jakarta Post, Manual of Ideas, Investopedia, TedXWallStreet. He had also presented in top investment, banking and finance conferences in America, Italy, Sydney, Cape Town, HK, China. He has trained CEOs, entrepreneurs, CFOs, management executives in business strategy & business model innovation in Singapore, HK and China.

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