Nestle has fallen into a dilemma. Although Nestle still holds the top spot in China's instant coffee market, its reduced market sensitivity and unsuccessful new product launches and acquisition integrations (Yinlu and Hsu Fu Chi) are dangerous signals in the FMCG industry.

The world's largest food company, Nestle, is tasting the bitterness of coffee in the Chinese market.

After five years, Nestle has changed the entire packaging of its instant coffee. The classic coffee color has been replaced with bright red. Salespeople have stacked these new products into small mountains in supermarkets and used the usual promotional tactics. However, in March of this year, to support the launch of these new products, Nestle destroyed 4 million tons of instant coffee at its Dongguan coffee factory. "About 30% of that was product recalled for repackaging," said a former Nestle employee.

What troubles Nestle even more is that not only instant coffee, but also ready-to-drink coffee, chocolate wafers, candies, cooking products, pet food, and the acquired Yinlu and Hsu Fu Chi businesses have all seen varying degrees of decline. In the rapidly changing consumer goods market, Nestle failed to foresee that e-commerce would quickly broaden consumers' horizons and shopping radius.

Over the past five years, Starbucks and others introduced freshly ground coffee, which in turn gave rise to café culture. This market segment has seen a compound annual growth rate of 38.6%—Chinese consumers, who are extremely eager for new things, clearly believe that Starbucks represents a more globalized lifestyle.

Nestle's performance has already reflected this passivity. In 2014, its sales in China were 660 million Swiss francs (approximately 4.448 billion RMB), a year-on-year growth of 0.3%, compared to 29% the previous year. Nestle is clearly aware of the problems in its Chinese business. In its 2014 annual report, Nestle specifically mentioned, "In China, we need to realign our product lines to adapt to the ever-changing Chinese consumers." For a large, century-old European company, this is not easy.

Profit First

Nestle, from Switzerland, is a "financially driven" company. To ensure sufficient profits to reward shareholders, Nestle meticulously calculates financial returns and profit margins for everything from major strategic layouts to minor new product launches. This approach is commendable in mature markets, where it has a century-old brand foundation in Europe, but in the Chinese market, where new brands emerge endlessly, price wars are common, and consumer loyalty is low, this approach appears passive.

"Nestle requires a 50% gross margin for its brands; European companies cannot understand China's small-profit, high-volume approach," said a former Nestle salesperson. "But Nestle products are not luxury goods; consumers cannot accept such a high price difference."

Nestle underestimated the aging speed of its existing brands—instant coffee, ice cream, and chocolate candies—which were once considered fashionable by Chinese consumers but are now often classified as "unhealthy foods." Especially in the last five years, Chinese consumers have shown great enthusiasm for healthy foods and high-end imported new brands.

Misjudging the market was the beginning of KitKat's failure, and the long-standing reliance on a distributor-based sales system has slowed Nestle's perception of market changes.

The distributor system is a common distribution method in the retail industry. FMCG companies like Nestle and Procter & Gamble manage channels this way. When the market is a seller's market, i.e., supply is less than demand, Nestle can smoothly deliver products to consumers through large distributors and sub-distributors without building its own distribution system. This allows Nestle to free up costs and energy for more R&D, marketing, and nurturing new brands.

However, as the market expands, within the longer chain formed by outsourced distribution, Nestle gradually loses its keen sense of the market.

For Nestle, retailers and distributors have different payment terms and bargaining power. Supplying to retailers like Walmart involves a credit period of about three months, and whether payment is received on time depends on the retailer's cash flow and allocation. But supplying to distributors is different; they must settle accounts with Nestle immediately upon purchase.

Therefore, the distributor system not only saves upfront distribution costs but also brings in cash flow. This is a factor that financially driven companies value more.

About ten years ago, FMCG companies like Procter & Gamble and Unilever changed their channel strategies, adopting a direct supply approach for large retailers like Walmart to gain first-hand terminal data, leaving only small sales channels to distributors. Nestle did not follow this change. No one dared to easily shake Nestle's distribution system, as its successive CEOs needed a good financial report. Currently, Nestle still connects with Walmart through distributors.

A self-managed sales team can better execute in-store activities at the terminal and can more quickly feed consumer feedback back to the company.

Nestle's "finance-first" business philosophy reinforced the existing distribution system but also gradually distanced Nestle from consumers.

Multi-brand Management Conflicts

For large multi-brand companies, operating brands independently can also maintain direct communication channels between brands and consumers. Nestle is not without experience in this regard. Due to different sales channels, a few brands like Wyeth, Professional Catering, and Nespresso report directly to global headquarters, and their sales systems operate independently.

But for other brands, especially non-global brands acquired by Nestle, they are all accommodated within Nestle China's sales system. This system classifies instant coffee, cereals, candies, pet food, etc., as dry goods under one sales team, and assigns another sales team for professional catering mainly targeting restaurants and office buildings.

This is a cost-minimizing approach for sales, but as a result, brands with small sales volumes, especially new brands, find it difficult to grow. "Coffee is a 10 billion yuan business; why would I spend so much effort managing a 100 million yuan cereal business?" For salespeople, sales volume means bonuses.

The pet food brand Purina was once one of Nestle's most successful business units in China. In 2007, Purina's sales in China reached 300 million yuan, with a market share higher than Mars' pet food. But then, a new executive took over and merged Purina's sales system into the dry goods system. At that time, Purina's sales accounted for only 1% of Nestle's dry goods sales, and the dry goods salespeople had no energy to specifically take care of Purina, so its competitive advantage gradually disappeared.

Now, Nestle has almost withdrawn from Purina, and the brand's annual sales have dropped to tens of millions of yuan.

Without successfully introducing new brands, Nestle expanded its scale through localized mergers and acquisitions—a common practice in its global market. Since 2011, Nestle has successively acquired local beverage brand Yinlu and candy brand Hsu Fu Chi. But in China, the integration has not gone smoothly.

Yinlu initially made achievements in the peanut milk segment, but because beverage categories have higher profit margins and larger volumes than food categories, competitors like Master Kong, Daliyuan, and Jinmailang followed, forcing their way into the market with very low prices and additional entry fees.

At the terminal, Yinlu could only fight back by increasing promotional efforts. In the wholesale market, it lowered the price of a box of peanut milk from 41.5 yuan to 40.5 or 40 yuan, sacrificing about 1 yuan per box in old stock handling fees for Nestle.

Competition in this segment is intensifying. More imported and regional products are joining the national market through the internet. This does not include new brands that have succeeded based on e-commerce platforms. A sales representative for Yinlu in the northern market said his sales target this year was reduced by 200,000 yuan, but it is still difficult to achieve.

Nestle opened an e-commerce platform in 2012, but its focus was on transferring its offline products to the e-commerce platform rather than using it to try launching new products—this clearly did not fully utilize the opportunities brought by e-commerce.

In fact, after the acquisition, Yinlu and Hsu Fu Chi's marketing autonomy was weakened. Nestle not only connected their IT systems and supply chains but also managed them uniformly according to Nestle's production processes and quality standards, and sent brand management personnel, with brand investment costs also following Nestle standards.

Maintaining the independence of acquired brands while effectively managing them—Nestle has always strived to balance the two. After acquiring Wyeth in 2012, Nestle did not integrate Wyeth. Because Nestle headquarters believed that "Wyeth's success today is due to its own corporate DNA," Nestle has a calm European culture, while Wyeth's culture is American: aggressive and results-oriented.

These two milk powder businesses are still in competition. Except for senior management who can communicate, ordinary employees are not even allowed to call each other's companies. As a result, Wyeth's performance climbed from fourth to first in the milk powder industry.

Seeking Change in a Dilemma

Nestle has fallen into a dilemma. Although Nestle still holds the top spot in China's instant coffee market, its reduced market sensitivity and unsuccessful new product launches and acquisition integrations are dangerous signals in the FMCG industry.

Nestle China urgently seeks change!

In 2014, for the first time, a local manager was appointed as Chairman and CEO of Nestle (China) Co., Ltd. Unlike his foreign predecessors, Zhang Guohua from Hong Kong had served as a marketing executive at FMCG companies like P&G and Coca-Cola, and it was he who led Wyeth to overtake its competitors. But for Nestle, what matters more is Zhang Guohua's insight into consumer needs.

In 2006, he was the first in the industry to invite "Daddy" Jacky Cheung to endorse milk powder, rather than the usual mother image used by peers. Years later, consumers whose children have grown up still remember the Wyeth brand because it understood that new mothers "actually hope that fathers also participate in caring for the baby."

However, the market is changing rapidly, and the difficulty of Zhang Guohua's reforms has increased. Nestle's high-growth areas—milk powder and professional catering—are facing pressure from local competitors. Foreign brands like Wyeth, Abbott, and Mead Johnson are becoming homogeneous. At the same time, they also face pressure from local competitors like Beingmate, Synutra, and Biostime, which are more flexible in China.

Nestle has the strictest compliance standards among foreign companies. This makes it passive when facing "flexible" competitors in the Chinese market. In Europe, to encourage breastfeeding, milk powder companies are prohibited from advertising milk powder for children under one year old, and any promotional activities such as going to hospitals to contact new mothers and distributing samples would be severely fined. But Nestle's Chinese competitors still direct more promotional information to mothers of newborns under one year old.

By May 1 this year, Zhang Guohua had been in office for one year. Nestle did not respond to interview requests. According to insiders at Nestle, in addition to vigorously expanding local talent, Zhang Guohua also wants to strengthen Nestle's nutrition business, making "products that originally seemed less healthy become healthier." This adjustment is because Nestle's existing product structure can no longer keep up with China's consumption upgrade trend—which means upgrading existing products and launching new ones.

The sales system remains the top priority. Zhang Guohua clearly does not want to repeat past mistakes; as soon as he took office, he promoted the establishment of a direct sales team. Currently, Nestle has reached a direct supply agreement with RT-Mart, and negotiations with Walmart are ongoing. More hypermarkets will be added to Nestle's direct supply list in the future.

For Zhang Guohua, this is a "last stand." Foreign giants no longer hold the rules of the game in China's consumer goods market; internally, Zhang Guohua also faces the unshakable power of foreign executives—the European corporate style will not change.

For Nestle China and Zhang Guohua, 2015 will determine their future fate.

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Excerpt from "Terminal Visit and Sales General Model" September 10, 2015 20:00--21:00 Long press the QR code below to register, 9.9 yuan for the course.