This article was first published in Caijing Magazine (ID: i-caijing). Against the backdrop of an industry downturn, Tsingtao Brewery's revenue and net profit have declined for two consecutive years, while China Resources Beer and AB InBev have grown against the trend. Among the three giants, Tsingtao's market share gap with China Resources has widened, and its brand premium is weaker than AB InBev's. (A common industry view is that compared with China Resources Beer, which has always used low-end products to compete, Tsingtao's advantage lies in quality and brand. However, compared with AB InBev, it is clearly inferior, with limited brand premium potential. Photo/VCG) China's beer market is a game among giants. According to Euromonitor International, in 2016, the combined market share of the top five players in China's beer industry was 73.3%, with the top three being China Resources Beer, Tsingtao Brewery, and AB InBev. In 2014, China's beer industry entered a downward cycle. Over the following two years, Tsingtao's market share fell by 0.8%, while China Resources Beer and AB InBev each grew against the trend by 2.0% and 1.9%. Along with the decline in market share, from 2015 to 2016, Tsingtao's revenue fell by 4.87% and 5.53% year-on-year, respectively, and net profit fell by 13.92% and 39.09% year-on-year, respectively. In the first half of 2017, Tsingtao's sales volume grew by 2%, while China Resources Beer and AB InBev grew by 2.9% and 2.7%, respectively; Tsingtao's revenue grew by 2.15%, while China Resources Beer and AB InBev grew by 3.7% and 9.1%, respectively. Euromonitor International predicts that China's beer market will continue to shrink at a rate of 2% per year, with sales volume in 2021 expected to be nearly 1.6 billion liters less than in 2009. Although there is debate among beer industry insiders about this forecast, overall, with an aging population and consumption divergence, the future of beer consumption is indeed not optimistic. If the industry dividend disappears, the market will test companies' endogenous growth. For beer companies, the path to profitability is either to increase market share or to upgrade product structure. However, Tsingtao is inferior to China Resources in the former and to AB InBev in the latter. A Gap Hard to Close Tsingtao Brewery Co., Ltd. (600600.SH/00168.HK, hereinafter "Tsingtao") was once China's largest beer company. After being surpassed by China Resources Beer (Holdings) Co., Ltd. (00291.HK, hereinafter "China Resources") in 2006, the market share gap between the two has widened. Over the past 20 years, China's beer industry has experienced rapid development from supply shortage to market saturation. In this process of territorial expansion, the competition was on "quantity" rather than "quality." The raw materials and production process for beer are not complex: water, malt, and hops are the basic ingredients, and malting, mashing, fermentation, and packaging are the main steps. Before the trend of consumption upgrading emerged, almost all Chinese beer companies produced industrial beer of American origin. Industrial beer is made by adding cheap grains (such as rice) and additives like syrup to the basic ingredients to minimize cost and maximize production. For a long time, the competitive barriers in the beer industry were focused on scale and channels, not products and brands. Tsingtao's loss of initiative in market share is partly attributed to changes in corporate leadership. Peng Zuoyi, who served as president from 1996 to 2001, saw the opportunity for low-cost acquisitions in the beer market and took the lead in completing Tsingtao's nationwide strategic layout. However, before he could digest and integrate the acquired companies, he died suddenly of a heart attack in 2001. Facing 41 acquired companies and a series of problems such as increased costs and insufficient funds, the new president Jin Zhiguo decided to slow down expansion and shift to lean management. The direct impact on Tsingtao was that its business logic changed from "bigger and stronger" to "stronger and bigger." A regional general manager at China Resources Beer told Caijing that Tsingtao only resumed aggressive acquisition expansion after China Resources acquired Sichuan Lanjian Brewery in 2007, securing 14 breweries at once. The years of silence in between gave China Resources the opportunity to overtake. According to annual reports, in 2006, China Resources Beer had nearly 50 breweries in mainland China and sold 5.3 billion liters, while Tsingtao sold only 4.5 billion liters. Since then, China Resources Beer has become the top beer seller in China. In June 2012, Jin Zhiguo resigned citing personal health reasons, and former president Sun Mingbo took over as chairman. In the following four years, Tsingtao's market share in the southern region continued to decline. In 2013 and 2014, revenue in South China fell by 1.18% and 7.25% year-on-year, respectively; in 2015, revenue in South China and Southeast China fell by 10.21% and 12.32% year-on-year, respectively; in 2016, revenue in South China and Southeast China fell by 14.90% and 38.69% year-on-year, respectively. According to Euromonitor International, the market share gap between China Resources Beer and Tsingtao was 5.8% in 2012 and widened to 8.4% in 2016. A former product director at Tsingtao told Caijing that the loss of the southern region was partly related to the departures of Jin Zhiguo and Yan Xu, as this market was built from scratch by Yan Xu. Yan Xu, former marketing president of Tsingtao, left in January 2011. During her tenure, Jin Zhiguo relied heavily on her to expand the southern market using the "key account" model, which was controversial internally because most domestic beer companies used the "intensive distribution" model. The key account model involves selecting distributors with large consumption scale and good performance in a region and authorizing them to control the terminals; intensive distribution, on the other hand, means the company itself takes on market management, terminal promotion, and other aspects, weakening the role of distributors. Before joining Tsingtao in 1998, Yan Xu served as deputy general manager at Zhujiang Beer and was familiar with the southern market. In 2001, Tsingtao's South China revenue was 1.549 billion yuan, and by 2010 it had grown to 4.185 billion yuan. After Yan Xu left, Sun Mingbo concurrently served as marketing president. A former regional manager at Tsingtao told Caijing that after Sun Mingbo took over, he preferred the intensive distribution model. Currently, Tsingtao's marketing approach combines both, known as the "key account + micro-operation" model. According to the 2017 interim report, Tsingtao's South China revenue grew by 0.28% year-on-year, initially halting the decline; Southeast China, however, saw a 45.78% year-on-year decline due to organizational restructuring. According to the third-quarter report, from January to September 2017, Tsingtao's revenue and net profit grew by 1.5% and 1.6% year-on-year, respectively. Although performance has stabilized and rebounded, another weakness of Tsingtao—the composition of its market share—has little chance of changing. According to the 2016 annual report, nearly half of China Resources Beer's revenue came from the eastern region, with the central and southern regions each accounting for about a quarter; Tsingtao, on the other hand, derived more than half of its revenue from Shandong Province, followed by about 16% from North China. This means that any setback in Shandong would have a significant impact on Tsingtao's overall performance. A regional general manager at China Resources Beer told Caijing: "We are determined to win Shandong. In fact, if we just take 10% of the market share, Tsingtao will be unable to bear it." A Brand Still in Need of Improvement According to industry experts, the future contraction of China's beer market is mainly due to two factors: on the one hand, the number of mainstream beer consumers is declining. According to the National Bureau of Statistics, China's birth rate was 33.59 per thousand in 1970, falling to 21.06 per thousand in 1990 and 14.03 per thousand in 2000. On the other hand, with consumption upgrading, sales of substitutes such as premixed drinks, wine, and spirits (represented by whiskey and brandy) are rising. From 2010 to 2015, China's imported wine sales grew from 46 million liters to 538 million liters. Moving products toward the mid-to-high end is the future growth point for Chinese beer companies. Tsingtao's brand strategy is "Tsingtao as the main brand, Laoshan as the second brand." In recent years, it has launched a series of high-end products under the main brand, such as August, Hongyun Dangtou, Classic 1903, and Pure Draft. According to the annual report, in 2016, these high-end products accounted for about one-fifth of total sales volume. A common industry view is that compared with China Resources Beer, which has always used low-end products to compete, Tsingtao's advantage lies in quality and brand. However, compared with AB InBev (NYSE: BUD/LSE: 0RJI, hereinafter "AB InBev"), Tsingtao is clearly inferior, with limited brand premium potential. Many industry insiders believe that Chinese consumers have not yet formed absolute brand loyalty to local beers and still choose based on consumption habits and channel convenience. In random interviews by Caijing, consumers also said they do not consider Tsingtao a mid-to-high-end beer, only feeling it is better than most domestic brands; only imported beers can be considered mid-to-high-end. A former product director at Tsingtao said that China Resources Beer and Tsingtao push their high, medium, and low-end products through the same channel, but AB InBev uses two systems. When promoting high-end products, AB InBev uses a separate team to break into local high-end hotels, high-end clubs (such as KTVs), and key accounts (KA, such as Walmart and Carrefour), with the door-opener being AB InBev's international brand recognition. In contrast, Tsingtao derived only 2.28% of its revenue from overseas in 2016. AB InBev has been a beneficiary of consumption upgrading in China's beer market. From 2012 to 2016, its market share in China grew from 11.6% to 16.2%, an increase of 4.6 percentage points. In comparison, China Resources Beer and Tsingtao saw increases of only 3.9% and 1.3%, respectively. According to official reports, during the 2017 Tmall "Double 11" event, the top three beer brands by sales were all from AB InBev: Budweiser, Harbin Beer, and Corona. AB InBev's main product structure in China is: low-end products Harbin Beer and Sedrin Beer, mid-end Budweiser, and imported high-end beers such as Corona and Hoegaarden. In contrast, Tsingtao's product system lacks depth—because it had promoted the main brand "Tsingtao" during the expansion phase and emphasized its high-end positioning in recent years, Tsingtao lacks a national low-end brand. According to a former regional manager, Tsingtao had previously tried to launch low-end products such as Tsingtao Ice and Tsingtao Dayou, but the results were unsatisfactory. So from 2014, Tsingtao decided to make Laoshan Beer its national second brand to compete with Snow Beer and Harbin Beer. However, as a regional brand, Laoshan Beer cannot form competitiveness in a short time; it is currently only visible in Shandong and Hebei, and is difficult to promote elsewhere. After Anheuser-Busch, the parent of Budweiser, acquired Harbin Beer in 2004, it set the goal of making it a national brand. In 2016, Harbin Beer's market share in China was 6.4%, while Laoshan Beer's was only 3.0%. The reason Tsingtao's top management has been hesitant about defining product tiers may be that nearly half of Tsingtao's market share is in Shandong, making it easy for its own brands to cannibalize each other. In the competition for mid-to-high-end products, Tsingtao is also at a disadvantage due to its own mechanisms. During the previous merger and acquisition expansion phase, China Resources Beer adopted a "brand consolidation" strategy, using the Snow brand to integrate newly acquired brands. Currently, China Resources Beer's main product structure is: low-end Snow Beer, mid-end Snow Brave the World, and high-end Snow Pure Draft and Snow Facial Makeup. A former regional manager at Tsingtao told Caijing that although the retail unit price of Tsingtao Classic and Snow Brave the World is around 6 yuan, they use different distribution methods. When Tsingtao pushes products from channels to terminals, it often offers a rebate of 6 yuan per case of 48 yuan, and if the merchant agrees to an exclusive store (brand monopoly), an additional 10 yuan is rebated, so the terminal effectively gets a case of beer for 32 yuan. In contrast, China Resources Beer often directly gives the terminal a case for 28 yuan with no additional conditions. The industry describes Tsingtao's approach as "stacking," meaning it focuses more on terminal management such as shelf display and exclusivity; China Resources Beer's approach is "giving," with the main indicator being shipment volume. The former regional manager said: "China Resources' terminal profit is so high that we simply cannot compete." The result of backward channels is not a reduction in sales revenue, but that consumers rarely see the product, making it difficult to form brand awareness. The large number of employees is considered one reason for the different distribution methods. Tsingtao has many employees and processes, leading to high costs and limited room for profit sharing, and frontline staff feel constrained in their work; China Resources Beer and AB InBev, with relatively fewer employees, directly adopt the simplest method—managing by shipment volume. A regional general manager at China Resources Beer told Caijing that Tsingtao currently relies mainly on manual labor for loading and unloading in Shandong Province, rather than commonly using logistics equipment such as pallets and forklifts. A former regional manager at Tsingtao confirmed this. Tsingtao did not respond to this. A former product director at Tsingtao said that personnel adjustments involve various relationships and are not easy. Change requires deep restructuring; if done well, there's no problem, "but if something goes wrong, who can bear the responsibility?" An Uncertain Future On October 12, Tsingtao announced that its second-largest shareholder, Japan's Asahi Group Holdings (hereinafter "Asahi Group"), was studying the transfer of all or part of its shares. Asahi Group bought 270 million H-shares of Tsingtao in 2009, holding a 19.99% stake. On November 14, Asahi Group CEO Naoki Izumiya told CNBC that the reason for selling Tsingtao shares was the realization that further expanding market share in China was very difficult, and beer market growth had slowed. This is considered a good opportunity for industry consolidation. Many industry insiders said that the acquirer would be one of China Resources Beer, AB InBev, or Carlsberg, with China Resources Beer being the most likely. Whether Tsingtao chooses to buy back shares depends on the terms of the agreement signed with Asahi Group. It is a consensus in the industry that China's beer market will become further concentrated. A regional general manager at China Resources Beer said that the current profit of the beer industry is around 10 billion yuan, even less than that of bottled water. A case of Tsingtao beer earns about 1.17 yuan, and a case of China Resources Beer earns only 0.75 yuan. When he entered the industry in 1998, there were over a thousand breweries in China; after more than a decade of competition, only one to two hundred remain. Only by further increasing concentration, even if a case costs one yuan more, will companies' lives improve. He Xiaoqing, senior partner at Kearney and head of the retail and consumer goods practice in China, told Caijing that the previous merger and acquisition expansion model in China's beer industry was relatively crude, and the future should learn from 3G Capital's experience and develop in a lean model. 3G Capital is one of the largest investment institutions in Latin America and the lead investor behind AB InBev's acquisition of SABMiller. Their integration of acquired companies is not simply merging sales data, but introducing new management systems, cutting sales and operating costs, and reshaping corporate culture. Currently, the net profit margin of domestic beer companies is less than 5%, while AB InBev's global net profit margin has exceeded 10%. In addition to making up for shortcomings, Chinese beer giants also face a new competitive force. Even AB InBev, which holds a 44% market share in the United States, was impacted by craft beer in 2016. There is no unified international definition of craft beer, but it is certain that no artificial additives are added during the brewing process, and it typically uses ale fermentation (top fermentation), with longer fermentation times and shorter shelf life. According to Euromonitor International, craft beer in the United States will grow at a compound annual growth rate of 11% in the future. Zhou Jingsheng, founder of imbeer, is one of the earliest people in China to come into contact with craft beer. He resigned from NetEase Technology Center in 2011 and successively founded the imbeer website, bar, and brewery, and co-hosted the Beijing Homebrew Association and Master Cup events. Pointing to a beer classification chart, he told Caijing: "Chinese people have been drinking light lager (Lager, bottom fermentation) for over 20 years. Why can't we drink some good beer?" Zhou said he hasn't made much money in seven years of entrepreneurship. Now more and more people like craft beer, but the scale is still small, a typical niche market. Some foreign companies have also seen opportunities in the Chinese market. In 2013, Germany's URBRU Beer Group invested 260 million euros in Handan, Hebei, to build Asia's largest production base, with all equipment in its production workshop from Germany's Krones AG, specializing in producing authentic German beer made from water, malt, hops, and yeast. For these new forces, the biggest difficulty is opening up sales channels. Li Qing, president of URBRU (China) Beer & Beverage Co., Ltd., told Caijing that in the past year, they have been "beaten black and blue" by domestic beer giants on the channel side. Fang Gang, who previously worked at Tsingtao and later resigned to provide marketing consulting services for beer companies, is well known in the industry. In his view, Chinese people will drink more and more craft beer, but it will take time to cultivate. When Caijing mentioned these future challenges to Yuan Lu, former board secretary of Tsingtao, her response was that China's beer market is large enough and it will never be dominated by one player, and she is not worried about Tsingtao's survival space. -END-