First the Chinese government has been an advocate of milk drinking to its population and actively promotes the benefit of drinking milk. Second, the successful rollout of UHT milk in Tetrapak’s pillow and brick packages (a packaging which can be stored for up to 180 days without refrigeration) which allows dairy producers such as Mengnui and Yili surrounded with dairy farms in Inner-Mongolia to distribute this UHT based milk and dairy products throughout China. Finally there has been the rapid growth of the average income per capita in the urban areas that made the milk purchase affordable. The sales of dairy product has expanded by 14.8% over 2000-2005 with Mengnui, Yili and Bright Dairy accounting for 63% of the total market share. The market is segmented into the categories of UHT milk, fresh milk, yogurt drink and ice cream.The strong growth in UHT segment (38% market share) will continue to outperform other categories, from 64% of the liquid milk volume in 2005 to 71% in 2008, implying a 24% CAGR for the period for UHT milk and a 13% 2005-2008 CAGR for pasteurized milk.

         The entire industry is undergoing a consolidation that is reshaping the following four major areas:

1. The Consumer Side: Milk and other dairy products are becoming a part of Chinese daily diet and the Chinese consumers have become more aware of the nutritional value of liquid milk. Such demand is evident in the high priced market entrant TeLunSu branded UHT milk by Mengnui (retailing at US$2.47 per liter) and some of the so called Organic milk brands such as YuanZhen (retailing at US$2.5 per liter) and GuiYuan (retail price of US$ 3.37 per liter) and pasteurized fresh milk WonderMilk (retail price of US$3.64 per liter). The quest for quality and safe food that prompted the organic revolution in the U.S also made the Chinese consumers wanting the same. The imported products with high prices cause the innovation from the domestic market to supply the premium food products to meet the demand. This shift in consumer awareness and value is fundamental for healthy industry growth.
2. The Supply Side: The maturing liquid milk market makes modern dairy farming necessary because the need for better quality and higher efficiency.The antiquated farming method to provide raw milk from families in small villages no longer makes economic sense when quality becomes first consideration. Fontera, Mengnui, Yili and Bright Dairy are building mega farms to mitigate this eminent problem to overcome the inherent poor, unsanitary and unsafe milk supply issues. Their business model had been based on collecting milk from farmers for processing and distribution in the past. On 4/11/07 prime time news, Central Television Station aired a milk blending incidence at Shaanxi Province’s YangLing city, the collection station employees used whey and peptide powder, other additive to mix with milk collected from farmers to increase volume, content values and decrease bacteria count. This report has prompted stern investigation by the Chinese State Department and Agricultural Department and exposed an important health concern to the Chinese consumers. Is the milk source healthy. How are the standards met. Why can’t the dairy companies stop the inferior supply from coming into the milk stream.Is the finished product safe. This is a century old problem that exists in Chinese agriculture and will require major effort from the government and the industry to make incremental improvement. The “Three Agriculture Policy Initiatives” for the current Five-year Government Policy Planning Period (2006-2010) again shows the determination of the central party to support this issue. Such action is evident in many areas such as the government sponsored AI programs, dairy cow purchase program, and lower interest rate loan and the recently enacted Cooperative Law.
3. The Distribution Side: The cold storage delivery is becoming more available in the first tier cities in China (Beijing, Shanghai, Guanzhou, Shenzhen, and Tienjing) and growing in many second tier cities, enabling fresh pasteurized milk to be sold in the modern supermarkets, hypermarkets and convenience stores. The UHT products are distributed into 2nd and 3rd tier cities and the countryside creating more sales demand. Better logistic information also enhances product marketing cycle to gain competitive edges. Mengnui and Yili have built processing plants strategically around first tier cities to provide better, faster and cheaper logistic of their dairy product lines.
4. The Category Side: Yogurt drinks are popular and promoted as trendy & healthy drinks to the younger crowd and as an alternative for lactose intolerant consumers.Pasteurized milk is again in focus for its better nutritional value; as the disposable income increases causing demand for a better quality of life. The aggressive price cutting among the competitors to gain entry market shares margins in the low priced liquid milk has lead to slimmer margins and induced vicious cycle on the supply side.Thus, as the dairy industry in China goes through consolidation (more than 1 million dairy cows had been slaughtered in 2007), the dairy companies have turned to more value-added products. The diversification of product mix ranges from homogeneous nature of plain milk to more flexibility of flavor, taste, packaging, and other functional selling points so the companies are able to target different consumer bases and earn better margins.Additionally, the pattern of China’s consumers’ dairy consumption may also evolve and move up to higher-value-added products such as fermented yogurt, flavored milk drinks, non-powdered ice cream and cheese.According to Euro monitor, these products are more expensive than plain milk and accounted for only 18% of the total dairy consumption value in China in 2005, compared with 36%-62% in neighboring Asian countries.