Click 'Read Original' for details. This article is from the WeChat public account CBNweekly2008, republished with permission. More and more fresh milk from Wei Chuan, Meiji, and New Hope is being neatly displayed in the glass cases of tea shops, indicating that dairy companies have found a new business. Every 'Lian Nuan Chu Cha' tea shop prominently places 3 to 4 cartons of 950ml Meiji fresh milk on the beverage preparation counter to signal that the brand uses fresh and safe tea ingredients. "What tea, milk, fruit, and other ingredients a tea shop uses are now key factors defining the tea brand," an employee of Lian Nuan Chu Cha told CBN YiMagazine. Displaying and promoting the ingredients used has become a common industry practice, "especially for tea shops with an average product price above 20 yuan." Fruits are a typical example. For instance, Nayuki's tea drink 'Ba Qi Yang Mei' highlights that each 'Dongkui' bayberry is as large as a ping-pong ball. In the fiercely competitive tea market, product homogeneity has long been an unavoidable issue. With a survival rate below 20%, tea shops must find ways to create distinguishable flavors in similar products to break through the competition; otherwise, they may easily become one of the four out of five shops that close. According to the '2019 China Beverage Industry Development Trends Report' released by Meituan-Dianping, China's tea market fully exploded in 2018. By the third quarter of 2018, the number of freshly made tea shops nationwide reached 410,000, a year-on-year increase of 74%. Bai Xiufeng, Dean of Meituan-Dianping's Catering Institute, described 2018 as the 'first year of China's new-style tea drinks,' because most of the growth came from consumers substituting regular beverages and the demand for 'healthy tea drinks.' Since milk tea products still dominate the tea business—Meituan-Dianping's report lists 9 out of the top 10 recommended drinks for 2019 that involve dairy ingredients such as fresh milk, flavored milk, and cheese—the biggest change in tea shops, driven by consumers' desire for healthier options, has been the gradual upgrade of dairy ingredients. Over the past 30 years since the 1990s, tea shops (initially mainly milk tea shops) have gradually transitioned from using milk tea powder primarily made of flavors, colors, and non-dairy creamer to using pasteurized fresh milk with short shelf life, high transport and storage requirements, and good nutritional value, as well as imported foreign milk. The pace of this industry-wide change has peaked in the last three years. This naturally means a surge in production costs for new-style tea shops, but the shift in market demand has also brought new business opportunities for dairy companies. Before tea shops began prominently displaying branded milk in their stores, some large companies had already sensed the upcoming market changes. Between 2015 and 2016, several leading customers of Fonterra in the southern market proactively proposed exploring cooperation for product upgrades. "We realized then that this was not an isolated case; the entire consumer base was starting to demand higher quality in tea drinks, such as upgraded milk fat," said Ruan Jianhua, Vice President of Fonterra's Foodservice Division in Greater China, in an interview with CBN YiMagazine. This New Zealand-based company is one of the world's largest dairy producers, with nearly 40 years of experience supplying butter, cream, various cheeses, and liquid milk to the catering and bakery channels in China. Milk cap tea is one of the landmark products that marked the industry's leap from non-dairy creamer to real milk fat. According to Meituan-Dianping data, consumers' preference for 'milk caps' in freshly made tea drinks has far surpassed the once-popular and widely accepted 'pearls' (tapioca balls). The popularity of milk cap tea has created new opportunities for dairy producers. The main ingredients for making milk caps are cream and cheese, which place higher demands on raw materials compared to traditional milk tea. Tea shops must maintain stable supply and quality, forcing them to seek dairy suppliers with more stable production capacity and channels. In this regard, established players clearly have a first-mover advantage. In 2012, when Heytea founder Nie Yunchen opened his first tea shop, he chose Anchor's cream cheese and whipping cream—brands well-known in the baking circle—to develop cheese milk caps, considering product performance stability, application range, and taste. According to the report 'The Path to Quality Selection in China's New-Style Tea Industry' released by CBN Weekly in 2018, leading tea brands such as Heytea, Nayuki, and Sexy Tea all chose established dairy brands like Anchor as their ingredient suppliers. Beyond raw material quality, established dairy companies can also provide customized services based on tea-making processes. For example, one chain tea shop client had nine different types of machines for whipping milk caps. Anchor's team developed standardized procedures for each machine and adjusted them according to different store conditions. "From capturing industry insights, introducing catering trends, to recipe development, and providing integrated services for clients' back-of-house SOPs and front-of-house promotions," said Ruan Jianhua. Anchor is one of Fonterra's brands. Currently, most tea brands in the market consider innovation and R&D as one of their core competitive advantages, with new product launches on a quarterly or even monthly basis becoming the norm. However, consumers may not know that what determines the new milk tea flavors they will drink next month is not just the tea brand, but also the dairy companies. For example, behind the once-trending milk cap hotpot, the push from dairy companies wanting to 'add milk to everything' played a part. "From simple tea with milk cap, to adding milk cap on fruit, to adding ice cream on top of the milk cap, we are also developing an application of adding milk cap to beer," Ruan Jianhua told CBN YiMagazine. Before milk cap products became widely popular, Fonterra had already co-developed new applications of butter and cheese in the tea sector with some tea brands. Even the beloved milk cap is set to be transformed by dairy companies for efficiency reasons. In the past, the whipping of cream was mainly done manually, but different people's hand-whipping results varied, easily affecting the consistency of the product's taste. Ruan Jianhua explained that they subsequently developed and launched a milk cap paste product to replace the traditional process of whipping cream to make milk caps. "While making drinks in the back kitchen becomes more efficient and convenient, quality control of tea drinks can also be better guaranteed, and it can even help tea shops reduce labor costs to some extent," Ruan Jianhua said. Dairy companies are trying to replace the traditional process of whipping cream to make milk caps with milk cap paste products. The enthusiasm of dairy companies for the tea market stems from huge market opportunities. For example, in recent years, Fonterra's B2B business in China, targeting catering, bakery, and tea channels, has maintained high double-digit annual growth. According to Ruan Jianhua, "a significant portion of the additional growth indeed comes from tea drinks," but besides leading brands like Heytea, Yidiandian, and Nayuki, this high growth is also supported by a large number of small and medium-sized tea shops emerging nationwide. These tea shops are often scattered across streets and alleys from first-tier to third- and fourth-tier cities, making channel penetration challenging. The current pace of change in the tea market is as follows: "Basically, every six months, a batch of brands and stores in the tea market is replaced. You must have deep and broad channels to reach new players in the market in a timely manner," Ruan Jianhua said. To keep up with this pace, dairy companies have to move faster. In the early days, Fonterra's channel network mainly relied on a few general agents and fewer than 60 distributors. After a round of power consolidation and redistribution, it has now developed a network of over 100 distributors. Combined with a growing in-house sales team, Fonterra has expanded its channel network from fewer than 40 cities to over 300 cities, supplying products to more than 100,000 tea shops under over 20,000 tea brands. Currently, these small and medium-sized tea shops account for an estimated 70% of Fonterra's overall B2B business volume, far exceeding the 30% from leading brands. Whether it's the year-on-year increase in the number of tea shops or the investment community's enthusiasm for new-style tea brands, both signal that the 'pie is growing.' According to Fonterra's market observations, the B2B market capacity for dairy products achieved double-digit growth in the past year, attracting more competitors to enter. At the same time, the explosive growth in the tea market has also inspired many traditional dairy companies to rethink their product strategies. Local Chinese dairy companies are gradually realizing that developing B2B business could bring new growth points. New Hope Dairy regularly holds an annual 'Milk Fan Festival' as a fixed part of its brand marketing. In January this year, New Hope Dairy's subsidiary Nanshan Dairy cooperated for the first time with several new-style internet-famous tea shops, including Hunan-based MAMACHA, providing them with 24-hour fresh milk, Chuxin yogurt, and other main products as in-store display materials. The result was that this cooperation brought New Hope a considerable, even exceeding expectations, volume of sales. Although this attempt was still at the brand and marketing level, New Hope quickly became convinced that the tea channel has greater business expansion potential. A month after that event, New Hope formally established a New Retail Innovation Department within the company, starting from scratch to focus on developing B2B business. "By this time, New Hope understood that some people, though not direct consumers of fresh milk or yogurt, are likely the target audience for milk tea and coffee. The milk you produce doesn't have to exist only in the form of fresh milk or yogurt; it could be ginger milk curd, latte coffee, salty milk tea, or even a bakery's homemade yogurt. So this is a potential market waiting to be developed," Li Li, an industry insider close to New Hope Dairy, told CBN YiMagazine. Before the establishment of the New Retail Innovation Department, New Hope had explored B2B business expansion through its sales department. For example, cooperation with Haidilao and Hema Fresh's 'Daily Fresh' was achieved during this period, but mainly for OEM products. In the future, it is reported that New Hope plans for its B2B business to focus more on capturing and satisfying consumer consumption scenarios, as well as customized production for new product development for different channels like tea shops. After making this decision, the company directly transferred its former product director from the marketing department to head the New Retail Innovation Department's business and product development. Recently, one of the department's tasks has been to study how to improve the stability of fresh milk foaming in coffee. "To meet the specific needs of B2B clients down to a single drink, you have to consider not only the sterilization process and freshness of the fresh milk, but also whether the product presentation is stable, whether the taste is smooth, and the sensory perception of whether it tastes good. Each of these requires dedicated R&D personnel for specialized research," Li Li explained. Although the upgrade of dairy ingredients has to some extent raised the production cost of drinks, more and more dairy companies joining the B2B business layout has also given tea shops more choices, improving overall production efficiency while lowering the threshold for product innovation and new product development. This means greater control over the supply chain and greater possibilities for enhancing brand and product competitiveness. In 2018, the whipping cream sold by Fonterra in the Chinese market could make 500 million cups of milk cap tea. In 2017, that number was 200 million cups. For both foreign and local dairy companies, this is a signal worth getting excited about for the entire industry. (At the interviewee's request, 'Li Li' is a pseudonym.) Staff reporters Wang Yiyue and Liu Pingting contributed to this article.