Rearing China’s babies – an Irish opportunity?

One of the major drivers of global dairy prices has been China. Rising incomes of currently low-income consumers are driving the growth and demand is expected to grow by 15% every year for the next five years. Infant formula is expected to grow by 20% per annum, while UHT milk is expected to grow by 10%.

Dairy accounted for 70% of Ireland’s total exports to China last year and was worth €268m. Infant formula accounted for 75% of dairy exports to China and this grew by 37% in 2013. The largest dairy export is the Wyeth “Illuma” brand which sells in the super premium infant formula category.

Dairy product consumption in China remains polarised – urban residents consume 90% of all dairy products, which shows there is great potential for growth in rural areas.

China’s dairy consumption is expected to increase by 38% by the end of 2022. Such is the potential that if China’s dairy consumption was to increase from 10kg/person to Japanese levels of 60kg/person, China would consume an extra 70bn litres of dairy.

Declining self-sufficiency

This year, Chinese dairy production is expected to reach 36bn litres – making it the third largest milk-producing country after the US and India. The industry is being directed to build larger vertically integrated corporate farms which can have up to 14,000 head. Despite this, 50% of the milk is still supplied from farms with less than 100 head.

But despite year-on-year production growth, China’s self-sufficiency in milk has been declining. In 2008 China was 95% self-sufficient – today, due to the rapid market growth, that has reduced to 80%.

Incremental local supply is also coming at a very high cost due to the reliance on imported feed. Chinese farmgate milk prices are among the highest in the world at 50c/litre, meaning it costs up to 50% more to produce milk in China than in the USA or the EU.

Largest dairy importer

China imports 9 million tonnes liquid milk equivalent (LME) per year, almost double that of the next largest dairy importer – Russia. Last year it absorbed 16% of the world traded part of dairy.

It imports 123,000t of milk powders, with the majority (79%) coming from New Zealand due to a free trade agreement between the two countries.

The US and EU are major suppliers of whey to China. It imported about 430,000t last year with volumes bound for China’s infant formula market.

The US (Mead Johnson, Abbott, Wyeth) accounted for half of this. France (Danone) was the next largest supplier (14.9%), while Ireland accounted for 3.3%.

The dairy industry is also consolidating rapidly.

Emerging Chinese players are focusing on securing safe supply in China and are backward investing into corporate dairy farms (Abbott and Fonterra). Companies are also tying up supply (Arla and Mengniu) and acquiring offshore suppliers (Beingmate and Kerry Group).

Food safety in China remains a fundamental issue for consumers and an increasing focus for the Government. Major scandals in both 2004 and 2008 damaged the trust in locally produced dairy products. Firstly, in 2004, nutritionally substandard milk led to deformities in children. Then, in 2008, melamine was intentionally added to milk to artificially increase the measured protein content. Such scandals have shifted middle- and high-income consumers toward imported products and in particular infant formula, where it achieves up to four times the European price. Therefore, China’s demand for imported infant formula continues to increase and grew 34% last year.

The local industry is seen as unsafe, prices of imported formula are seen as too high, leading to huge suitcase imports and the government wants viable local players. Since 2008 the regulation environment in China is getting quite strict and complicated. There are now 12 government regulation agencies involved in infant formula.

The government is forcing local consolidation, attempting to stamp out monopolistic pricing and cracking down on suitcase trade. And since May this year, it has required overseas infant formula plants to register.

The Chinese government is seeking to break the consumer reliance on imported “branded” product, which currently accounts for 60% of the market. They wish to form about 10 large milk powder groups with more than €254m in revenues by the end of this year. The authorities have simplified the approval process of domestic formula companies through taxation, fiscal and financial support.

This is a crowded market with all the global brands and dairy companies present. The market is extremely fragmented – the largest player, Mead Johnson, has just a 10% share, while the top five have a combined 41% share.

Developing brand Ireland in China a huge challenge

The sheer scale of population in China and its dominance of the global traded market for dairy commodities means the country exerts a huge amount of influence on the global dairy market.

A small change in China’s demand and supply balance can have a large impact on the global market and therefore commodity prices.

From an Irish perspective, it is a market that presents a number of challenges as well as opportunities.

Aside from its distance away, China is a vast country and developing a successful distribution network is a major challenge for any company.

The most successful dairy products that we export from Ireland have traditionally been cheeses and butter. However, there is little demand for these products in China because they are not part of the traditional Asian diet. Instead, the market requirement is for infant formula and UHT milk.

Another challenge for the Irish dairy industry is developing the brand Ireland image in this country. Most people in China have never heard of Ireland. In a country with the size and population of China, it will be a massive undertaking to successfully develop the reputation of safe and sustainable Irish food.

However, the forecasted growth and the high premiums that can be achieved in China means that it is not a market we can ignore. It will always be a destination for Irish infant formula, mainly due to the three multinational companies – Abbott, Danone and Nestle – who have operations in Ireland.

The free trade agreements that New Zealand and now Australia have with China give those countries an advantage over Irish products. However, as China seeks to diversify its dependence on New Zealand dairy this may present an opportunity for Ireland. It looks like this will most likely be on a business-to-business platform.

As China takes more off our large international competitors, Irish dairy processors may be able to find a greater return from traditional markets that have been overlooked by the large players.