With a free trade deal Australia can win China's dairy market
Global demand for internationally traded dairy products is now dominated by China. Although Australia has benefited from this, with annual dairy exports to China now worth over A$500 million, the growth has been much slower than what New Zealand has achieved.
Latest New Zealand statistics to June 2014 show annual dairy exports to China of A$5.05 billion (NZ$6.05 billion). These exports have increased more than tenfold since 2008.
In part, this growth has been because New Zealand has had a free trade agreement with China since 2008. It has not just been the reduction in tariffs that has benefited New Zealand. Chinese companies saw the signing of the agreement with New Zealand as a clear signal their government was in favour of them doing business with New Zealand.
The New Zealand FTA was negotiated in less than three years, whereas Australia’s agreement has taken more than nine years and is still incomplete. The reasons for this are complex, but a key point is that New Zealand’s senior government ministers at that time had China networks going back more than 30 years. Also, in the 1990s New Zealand strongly supported China’s entry to the World Trade Organisation (WTO) when many other countries were less supportive. Subsequently, the bilateral free trade negotiations went remarkably smoothly.
There have also been elements of serendipity in the growth of New Zealand’s dairy trade with China. Chinese consumers have traditionally purchased milk in the form of whole milk powder. Also, since 2008 a shortage of locally produced fresh milk has been substituted with UHT (ultra heat treated) product from locally reconstituted whole milk powder. New Zealand has been the dominant global producer of this product.
Given that global demand for whole milk powder is dominated by China, and the supply side is dominated by New Zealand, there has been a natural coalescence. Other countries, including Australia, have their dairy processing facilities structured for the production of cheese, butter and skim milk powder rather than whole milk powder.
The Chinese demand for dairy products is now broadening. This is just one part of the huge transformation in Chinese society. Key drivers at the consumer level are increasing wealth, urbanisation, changing cuisine, and food safety concerns. The new opportunities are for consumer-ready products produced and packed in overseas countries to overseas standards.
Australia does not need an FTA to prosper from these emerging consumer opportunities. Indeed most of the competition will be from European countries and the USA who also do not have an FTA. But an FTA will undoubtedly help. Achieving the potential will require both capital and vision.
Even without an FTA, Australia has potential long-term advantages over New Zealand with these emerging opportunities. This is because the New Zealand industry, although expert at efficient production of commodities, is not well set up for large scale production of consumer-ready products.
New Zealand’s Achilles heel is that production is seasonal with a huge peak of spring production and almost nothing in the winter. This creates large inefficiencies in processing capacity, and is inconsistent with large scale production of perishable products.
New Zealand’s processing and marketing of dairy products is dominated by the farmer co-operative Fonterra. Quite simply, Fonterra has no available mechanism within its co-operative structure to acquire the capital that would be needed to transition from a commodity dominant focus to a fast moving consumer goods focus.
Safety opportunity, logistics challenge
Chinese consumers are particularly concerned about food safety. They do not trust their local companies, and seek products of guaranteed provenance produced and packaged in Europe, America, Australia or New Zealand.
Middle class Chinese spend nearly half of their leisure time online. They quickly surf the net to see whether or not products sold in China are the same as sold in other countries. China now requires Chinese language packaging, but apart from that, Chinese consumers want to know the product is identical and meets foreign regulatory standards.
One problem for Australian companies will be the complex logistics of distribution in China. In general, the supermarkets do not have centralised warehousing and distribution systems. Accordingly, without well-placed local partners, market penetration is a major problem.
Fortunately there are solutions. The key one is the use of online marketing. However, it is only the major brands that can make this work. The other option is for a diverse group of food companies, covering the spectrum of products, to market online together. That way, Chinese consumers could purchase all of their “Australian food baskets” from one source.
A number of Australian companies are currently developing markets in China for fresh chilled Australian milk. This will be challenging. The bigger opportunity is for UHT milk which has a shelf life of over six months without refrigeration. In Australia, UHT milk is widely regarded as an inferior product, but the Chinese do not see it that way. I have seen UHT organic milk from California selling for 42.9RMB (A$7.90) a litre in top-end Beijing supermarkets.
China’s dairy industry has its own challenges
The Chinese dairy industry itself is undergoing major change. The small dairy farmers are going out of business. In part this is because of a shortage of labour in the villages. The old farmers are retiring and the next generation is moving to the cities.
The new Chinese dairy industry is based on American style mega farms of 3000 to 5000 cows, with all the cows housed and fed with what is known as a “total mixed ration”. Under this system, the cows produce twice as much milk as pasture-fed cows in Australia and New Zealand. The big challenge is to obtain the feed at a reasonable cost. A lot of the hay is imported from the US.
Chinese dairy farmers receive prices for their milk that are close to twice that which New Zealand and Australian farmers receive. Local Chinese language industry sources are currently reporting farm gate prices of 4.3 RMB (A79c) per litre for average quality milk and at least 5 RMB (A91c) per litre for good quality milk. Despite this, Chinese colleagues report that dairy self-sufficiency has dropped from 95% to 78% since 2008. This creates great opportunities for Australian companies to produce cheese, UHT milk, and infant formula within Australia, then put it on a slow boat to China, and still be price competitive.
There are also considerable risks. Developing consumer awareness of Australian brands will be capital expensive. Also, the Europeans, and particularly the Germans, are there already. In the six month period to 30 June 2014, China Customs report that 142 million litres of fresh and UHT milk were imported into China. Forty percent of this came from Germany.
The perceived opportunities are so great that everyone is going to be there competing for market position. Many will get crushed in the rush. Only those who have either scale or a genuine differentiated product will survive. In amongst this, understanding China will also be critical.
Many will make the mistake of focusing on the Tier 1 cities of Beijing, Shanghai Guangzhou, and Shenzhen. This is where the competition is greatest. It should never be forgotten that China now has more than 150 cities with more than one million people.
Keith Woodford does not work for, consult to, own shares in or receive funding from any company or organisation that would benefit from this article, and has no relevant affiliations.
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