What do China’s latest dairy market regulations mean to exporters of dairy ingredients?

By Nicolas Pechet and Thomas McDonald

Consumers around the world would not be familiar with the dairy brands from companies such as China Modern Dairy, Mengniu Dairy, Panda Dairy or Yili Group, but they are aggressive competitors to Nestle and Danone for shelf space in China.

China is a high-growth market for international dairy products. In the first two months of 2014 for instance, imported milk powder sales in China rose by 79.3% from a year ago.

New regulations seem to further alter the playing field for milk powder brands in favor of major foreign companies, which together made up 54% of the Chinese market in terms of sales revenue in 2013.

A recent state-sanctioned release announced on May 1 said “from now on, nonregistered offshore production of dairy food may not be imported.” This immediately barred all but 41 foreign makers of infant milk formula from selling in China and opened up precious shelf space in grocery stores in the intensely competitive infant formula market. This appears to give foreign brands the chance for greater market penetration in China, but also raises several key questions.

Are Chinese regulations set to favor local producers in the long term?

There is reason to believe that the increased regulation by Chinese authorities is ultimately meant to create greater opportunities for local brands. Historically, other highly lucrative industries in China previously dominated by foreign players have seen market interventions by the central government in favor of local businesses. The Chinese National Development and Reform Commission has seen to it that domestic companies are being encouraged with financial incentives and access to political backing while foreign companies have to navigate targeted regulations and restrictions.

Sanyuan for instance, has secured RMB 10 million (US$1.6 million) in financing by a local municipality. Beingmate has made strides to develop its marketing channels and restructure its business in order to strengthen its market position. Local dairy producers are no doubt ambitious and have their eye on capturing greater market share.

These new regulations help to give both foreign and local brands a chance to capture market share but for the time being, the memory of the 2008 melamine incidents in China and favorable laws for domestic dairies help bolster Chinese consumers’ preference for foreign dairy brands.

Will the regulatory framework in China help improve food safety?

Foreign companies have gone to great lengths to ensure consumer safety for their products in China. Nestle, in an effort to manage quality, has been consolidating its farms in China from 18,000 to just a few. In order to successfully make this transition, the company runs three demonstration farms and educations courses for farmers, has an institute for dairy farmer training and provides credit and funding for expansion to interested farmers.

In the case of local producers, the NDRC with the Ministry of Industry and Information Technology has allocated RMB 30 billion (US$4.75 billion) of credit access for a small handful of local dairies in order to drive consolidation and increase quality control.

Amendments to China’s Food Safety Law are expected this year that will place stronger regulations on food manufacturers and distributors, not just on their operations but also their supply chains. Greater scrutiny of dairy companies and on the execution of national laws by local governments can be expected, which will hopefully improve food safety in this sector.

Are foreign or Chinese companies better positioned to increase market share?

Both foreign and local companies hold valuable cards that will allow them to capitalize on the recent market changes. Foreign companies, known for quality assurance, will be able to leverage the current demand for their products over local brands. Local companies will be able to leverage their relationships with local distributors, suppliers and logistical operators to lay claim to the newly available shelf space in a timelier manner.

The dairy market is being driven by brand confidence and the new regulations do not address that. Thus, with the exception of a slight consolidation, the new regulations are set to favor foreign dairy importers until public confidence in local dairy producers grows.

Nicolas Pechet is managing director and Thomas McDonald is an analyst at Global Intelligence Alliance, Shanghai, China. Global Intelligence Alliance is a strategic competitive intelligence and advisory group formed in 1995 when a team of competitive intelligence specialists, management consultants, industry analysts and technology experts came together to build a suite of customized solutions ranging from outsourced market monitoring services and software, to strategic analysis and advisory.