Source: Beijing Business Today; Authors: Qian Yu, Wang Xiao

After five years, Danone once again tastes the "flavor" of owning a local infant formula factory.

Recently, a Beijing Business Today reporter noticed that Murray Goulburn Dairy (Qingdao) Co., Ltd. (hereinafter referred to as "Qingdao Murray Goulburn") has undergone multiple changes, including a change in equity structure where Qingdao Murray Goulburn is now wholly owned by Danone. This means that after five years, Danone once again has the "flavor" of owning a local infant formula factory.

Industry insiders say that since the implementation of the "New Formula Registration Policy," acquiring formula-registered dairy companies is currently the most convenient channel for foreign dairy companies to enrich their registered formula brands, which is also the purpose behind Danone's 100% shareholding in Qingdao Murray Goulburn.

After the acquisition, Danone is expected to complete an omni-channel layout including offline physical distribution, domestic e-commerce sales, and cross-border e-commerce, which will help further explore the Chinese market and enhance its competitiveness in the industry.

-01- Acquiring Local Milk Powder

On May 31, a Danone spokesperson told a Beijing Business Today reporter that Danone had reached an agreement with Australia's Saputo Dairy Australia (SDA) to acquire 100% of the shares of SDA's Qingdao Murray Goulburn (Murray Goulburn Dairy (Qingdao) Co., Ltd.).

Qingdao Murray Goulburn was established in February 2000, with a business scope including production, processing, and wholesale of infant formula milk powder and dairy products (30% of products exported).

By checking business registration information, the Beijing Business Today reporter found that Qingdao Murray Goulburn has undergone multiple changes. The sole shareholder (initiator) changed from Saputo Dairy Australia Pty LTD to Danone Asia Pacific Holdings Pte. Ltd, with a subscribed capital of USD 5 million, and it is now a limited liability company (wholly foreign-owned).

At the same time, the legal representative changed from Richard Charles Wallace to Li Peng, who also serves as chairman and manager. Other key personnel changes include Wang Yanqi and Tang Fei as directors, and Fan Ping as supervisor.

In fact, this is not the first time Danone has owned a milk powder factory in China. Previously, Danone produced and sold Dumex brand milk powder products in China and achieved the number one market share in the domestic milk powder market. However, in August 2013, Dumex was implicated in the "Fonterra botulism incident." Although it was later proven to be a false alarm, the brand image was damaged, and performance in China declined. In 2014, Dumex's sales were 1.319 billion yuan with a net loss of 771 million yuan.

In December 2015, Mengniu Dairy and Yashili jointly announced that Yashili and Danone had reached an acquisition agreement. Danone sold all equity of Dumex China for HKD 1.23 billion to Yashili, which was controlled by Mengniu. At the time, the transaction was seen as Danone offloading a burden.

Industry analysts believe that with the divestiture of Dumex in China, Danone's milk powder business footprint in China shifted from "mainly composed of local and international brands" to focusing on its international brands. Five years after selling the Dumex brand to Yashili in the Chinese market, Danone, through the full acquisition of Qingdao Murray Goulburn, once again owns a local infant formula factory, which has become a golden brick for Danone to knock on the door of China's vast consumer market.

-02- Aiming for Formula Registration

The industry generally believes that the main reason for Danone to restart local milk powder production in China is the implementation of new regulations on milk powder formula registration.

After Danone sold the Dumex factory in China, the newly implemented "Measures for the Registration of Infant Formula Milk Powder Product Formulas" on October 1, 2016, stipulated in Article 9 that infant formula milk powder and special medical purpose formula food produced domestically or exported to China must obtain registration certificates according to law. Each production factory may have no more than 3 formula series and 9 product formulas in principle, with each formula series including infant formula (0-6 months, stage 1), larger infant formula (6-12 months, stage 2), and toddler formula (12-36 months, stage 3).

For brands that failed to pass formula registration after the implementation of the "New Formula Registration Policy," their milk powder products are not eligible for sale in offline stores in China and can only rely on cross-border e-commerce platforms and personal channels such as daigou (purchasing agents).

Therefore, although many overseas milk powder brands have many formula products, they have to reluctantly give up and cannot register all formulas one by one. For example, Danone's Karicare Gold series can only enter the Chinese market through cross-border shopping channels.

Dairy expert Song Liang said that although there is no total quantity control for formula-registered products, with increasingly strict supervision, dairy companies have generally felt that formula registration progress has been slow in recent years. Therefore, acquiring formula-registered dairy companies is currently the most convenient channel for foreign dairy companies to enrich their registered formula brands.

"Taking over Qingdao Murray Goulburn means Danone fully controls a milk powder factory that already holds the 'passport' for Chinese milk powder formula registration," said an industry insider.

It is reported that the formulas of three infant formula milk powder products of Qingdao Murray Goulburn have passed registration, with the product name "Maiqile" covering stages 1-3. The formulas were approved as early as November 2017, and they are domestic milk powder produced in Qingdao.

Regarding the reasons for acquiring Qingdao Murray Goulburn, a Danone spokesperson also told a Beijing Business Today reporter, "This investment is an important milestone for Danone's development in China and a key step for Danone to develop infant formula production in China. Through this transaction, Danone will further enrich its product range in the Chinese market and, with its professional experience in the global infant formula field, better serve Chinese consumers."

-03- Filling Channel Shortcomings

The "2020-2026 China Infant Milk Powder Industry Market Competition Status and Market Supply and Demand Forecast Report" released by Zhiyan Consulting shows that the global infant formula market size will grow from USD 59.1 billion in 2018 to USD 95 billion in 2026, with a compound annual growth rate of 6%. In 2019, China's milk powder industry market size was 175.5 billion yuan, a year-on-year increase of 8.4%, with a compound growth rate of 8% over the past five years. It is predicted that the compound growth rate of the milk powder industry from 2020 to 2023 will be 7%.

With the market expanding, Danone is further betting on and exploring the Chinese milk powder market. In February this year, Danone's 2019 performance report showed that annual sales increased by 2.6% year-on-year to EUR 25.3 billion (approximately RMB 192.9 billion). As Danone's second-largest market, China accounted for about 10% of its sales in 2019. Roughly estimated, Danone's sales in China last year were about 19.3 billion yuan, of which about two-thirds came from the professional special nutrition business where milk powder is located (estimated at about 12.8 billion yuan).

However, for Danone's milk powder business to continue its rapid growth in the Chinese market, there are still some prominent issues to be resolved, first and foremost the channel issue. "China's infant formula industry has reached a stage where 'channels are king and terminals win,' and major infant formula companies are competing for full-channel dominance," said an industry insider.

According to Danone CFO Cécile Cabanis at the 2019 financial results meeting, factors affecting milk powder business growth in 2020 include not only China's population growth and the epidemic but also registration. Previously, Danone's newly developed milk powder products were ready to be launched in channels directly controlled by the company. However, due to the "pause button" on the registration process, the launch of some of Danone's high-end milk powder new products was delayed compared to expectations.

Song Liang said that relatively speaking, population growth and the epidemic are objective factors and uncontrollable; registration is something companies can actively act on and is controllable. Acquiring a local factory with registered formulas means connecting to domestic offline physical sales channels and domestic e-commerce channels. Coupled with cross-border e-commerce and personal daigou channels that existed before having registered formulas, Danone is expected to achieve an omni-channel layout, which is conducive to exploring the vast first- and second-tier city markets and the sinking markets of third- and fourth-tier cities and below.

Currently, the market share of infant formula brands in China shows a pattern of coexistence of foreign and domestic brands. Nestlé's market share rose from 13.9% in 2016 to 14.1% in 2018; Danone's market share rose from 8.1% in 2016 to 9.5% in 2018; Feihe's market share rose from 5.1% in 2016 to 8.6% in 2018.

"Against the backdrop of fierce competition in the Chinese milk powder market, Danone's sense of crisis has always been high." In the view of Bao Yuezhong, an expert in fast-moving consumer goods new retail, while doing a good job in the sinking market, how to combine online channels to meet the uninterrupted shopping needs of infant parents has become the key to the continued expansion of foreign milk powder brands. How to further integrate online and offline in the future is also a key point for Danone to achieve performance breakthroughs.