The Chinese consumer increasingly avoids domestically produced dairy products if they can afford imports, and for good reason. So why did a Danish multinational just buy a strategic stake in China’s biggest milk products company?
Would you buy milk from this guy?
In 2008, infant formula adulterated with the industrial chemical melamine killed 13 babies in China and made more than 6,200 ill. Since then, foreign producers have seized up to 80% of the Chinese formula market.
Dumex, a subsidiary of Groupe Danone (DANOY, quote), leads the pack with a 17% market share, followed by Mead Johnson (MJN, quote) and Nestle (NSRGY, quote), according to CIConsulting in China. Nestle paid $11.9 billion in April to buy Pfizer’s (PFE, quote) baby food division, largely to gain market share in China.
Last week, Denmark’s privately owned Arla Foods, maker of Lurpak butter and other well-known European brands, unveiled a different strategy: buying into China Mengniu Dairy Co. (CIADY, quote), the largest Chinese milk producer by volume. Arla paid $289 million for a 5.9% stake, making it Mengniu’s biggest shareholder except state holding COFCO Corp.
Mengniu is not immune from its industry’s quality control problems or the Chinese consumer distrust that they breed. Even as Arla was announcing its share purchase, Hong Kong-based Mengniu was weighing whether to cut off an ice cream supplier in Inner Mongolia after an intern posted photos showing a garbage-laden environment on the internet.
Yet the market cautiously welcomed Arla’s move anyway. Mengniu’s shares jumped 11% on the news before subsiding toward the end of last week.
The acquisition is driven by compelling logic. Imported milk powder is two to three times more expensive than domestic product. The Chinese consumer is finding the extra cash to protect their babies, but native brands like Mengniu remain dominant in everyday purchases.
Rather than compete with the local giants, Arla aims to make Mengniu more reliable by consulting with the company on milk source management and production quality control. Mengniu hopes that the stamp of European healthiness will give it an edge over Chinese competitors like Inner Mongolia Yili Group, the top dairy provider by revenue. Yili recently issued a recall of baby formula tainted with excessive levels of mercury.
“By cooperating with one of China’s most popular brands, Arla has access to the huge consumer pool already established by Mengniu as well as its milk source, farms and processing,” says Wan Ge, an analyst at consulting firm ChinaVenture.
The Arla-Mengniu partnership will be closely watched by other multinationals mapping their strategy for China, and investors wondering about the competitiveness of other Chinese consumer goods providers.
The Chinese consumer at this point strongly prefers foreign brands if the price difference from domestic is relatively small, says Tony Nash, managing director for Asia at U.S.-based consultant HIS. A case in point is hair products. Global icons occupy 75% of the Chinese market, led by Procter & Gamble (PG, quote), with close to 60% on its own, and Unilever (UL, quote).
Milk and other food products are different though. They account for a much bigger slice of Chinese consumer budgets, and the price differential to imports is higher. Count on multinationals with a strong foothold to keep building Chinese sales. But “Made in China” may not be a derogatory phrase forever.
