Click the image for details. A few days ago, while pondering COFCO Packaging's investment in JDB, I took the opportunity to review Mengniu. My impression was that Mengniu had been thoroughly beaten by Yili, but the review revealed that Mengniu's revenue is only somewhat behind Yili's (2016: Yili revenue 60.6 billion yuan; Mengniu 53.8 billion yuan), still on the same scale. So the question arises: since revenues are still on the same scale, when exactly did Mengniu start to seem far inferior to Yili? ✦ 1. Mengniu vs. Yili: Overtaking and Being Overtaken To discuss this, we must first talk about the story of overtaking and being overtaken between Yili and Mengniu. Yili is China's earliest dairy company, listed on the Shanghai Stock Exchange in 1996. In 1999, Niu Gensheng, aged 41, was the vice president of Yili Group. He had strategic differences and conflicts with then-chairman Zheng Junhuai. Niu Gensheng resigned and, on August 18, 1999, founded Mengniu with nine other initiators. At that time, the dairy industry leader was Yili. Mengniu started from zero; if ranked, it would have been after the thousandth place. Probably no one imagined that one day Mengniu would surpass Yili. But in just 4 years, Mengniu entered the top three in the dairy industry. In 1999, Mengniu's sales were only 40 million yuan, followed by an astonishing growth curve. In 8 years, by 2007, Mengniu's sales exceeded Yili's. This remarkable growth was achieved, first, thanks to favorable timing: the liquid milk market expanded dramatically with the rise in per capita income and government support. In 1998, per capita annual liquid milk consumption in China was less than 6 kg; by 2007, it had grown to 28 kg. But more importantly, it was due to human factors: Mengniu's keen market sense. Mengniu was adept at seizing market hotspots to enhance brand influence. In October 2003, when China's first astronaut Yang Liwei went into space, Mengniu was the sole sponsor, earning the label "China Astronaut's Special Milk." In 2004 and 2005, Super Girl became immensely popular, and Mengniu seized this marketing opportunity; its Sour Milk ads became household names. At this time, Yili was clearly slower in brand marketing. From Yili's annual reports, it wasn't until 2005 that Yili incorporated brand building into its annual operating plan. Imagine if Yili had been more astute; with its resource advantages, the space marketing opportunity would likely not have been taken by Mengniu. However, although Yili was less market-savvy than Mengniu at this time, its backend layout was solid, such as investments in milk source base construction and logistics distribution networks. After Zheng Junhuai's troubles, 36-year-old Pan Gang became chairman in 2005, and Yili began to focus on strengthening brand building. 2008 was a key turning point: the melamine incident broke out. Mengniu lost 950 million yuan in 2008, while Yili lost 1.7 billion yuan. At that time, Mengniu's sales scale was larger than Yili's; why was Mengniu's loss significantly lower than Yili's? Yili's 2008 annual report showed inventory write-offs of 885 million yuan and inventory impairment provisions of 238 million yuan, which together exceeded Mengniu's loss. Why didn't Mengniu have such large-scale inventory write-offs? Perhaps a post on Zhihu could provide some explanation. In the FMCG sector, distribution channels are a lifeline. Additionally, Yili became aware of brand building: it became the sole dairy sponsor of the 2008 Olympics and the sole senior dairy sponsor of the 2010 World Expo. Through these two major events, Yili expanded its brand influence. From 2009, Mengniu's growth rate began to lag behind Yili's. In 2011, Yili's revenue surpassed Mengniu's, returning to the top position in the dairy industry. In 2012, Mengniu was again embroiled in a food safety incident, widening the revenue gap. The profit gap was even larger, which is why today Mengniu's market value is only half of Yili's. ✦ 2. Mengniu: Being "Harvested" A comparison shows that although Mengniu's revenue was surpassed by Yili, Mengniu didn't fall behind to an absurd level. Why is the net profit gap so large? First, look at gross margins. From 2006 to 2016, excluding the special period of 2008, gross margin trends basically aligned with milk prices. From 2010 to 2013, there was a major cycle of soaring raw milk prices, and both companies' gross margins hovered downward. In 2014, raw milk prices fell, and with product structure upgrades, gross margins quickly recovered. However, clearly, Yili's gross margin has always been higher than Mengniu's, and with the downward trend in raw milk prices, the gap in gross margins between the two has become more pronounced. Accounting policies may have some impact, but not to this extent. In fact, comparing Mengniu and Yili's products, the prices of comparable products are basically the same, with very small differences. The reason for this gap is likely related to Yili's logistics distribution network. As mentioned earlier, while Mengniu was deeply cultivating the market, Yili was laying out milk source bases and logistics distribution networks in the backend. That is, Yili has its own logistics distribution network, which can be leveraged more effectively as scale expands. Mengniu, on the other hand, uses third-party logistics, and part of Mengniu's product transportation costs need to be shared by distributors, so Mengniu must compensate distributors appropriately in the ex-factory price. Looking at the combined three expense ratios, Mengniu originally had an advantage, but since 2013 it has risen rapidly and basically caught up with Yili. Looking at net profit margins, Mengniu is several points lower than Yili. Even in 2016, after adding back the 2.2 billion yuan goodwill impairment, the net profit margin was still significantly lower than Yili's. So it can be seen that the key divergence in profits between Yili and Mengniu occurred in 2013. What year was 2013? It was a year of major transformation for Mengniu. In June 2011, Niu Gensheng resigned as chairman of Mengniu's board. In 2012, another founding initiator, Yang Wenjun, resigned as executive director and president, and Sun Yiping took over, marking the official takeover of Mengniu by the COFCO faction. Afterwards, in 2013, Mengniu pursued two lines: internationalization and industry consolidation. On the international front, it introduced Danone as the second-largest strategic shareholder; on industry consolidation, it increased its stake in Modern Dairy to become its largest shareholder, and horizontally acquired a controlling stake in Yashili to fill the gap in milk powder. But tragically, for upstream Modern Dairy, raw milk prices fell continuously from 2014, leading to a sharp decline in performance and eventually losses. Yashili also suffered: raw milk prices plummeted, competition in the infant formula industry intensified, and its performance was equally poor—so poor that Mengniu had to impair 2.25 billion yuan of goodwill in 2016, causing Mengniu's second loss since 2008. Having two troubled assets naturally affects other businesses, as they at least divert management attention. Therefore, the key point where Mengniu was left behind by Yili in profits and market value is that Mengniu was "harvested," and in this regard, Yashili was the most beautifully executed harvest. ✦ 3. How Yashili Harvested Mengniu Mengniu and Yili's business structures are mainly divided into three segments: liquid milk, milk powder, and cold drinks (ice cream). Liquid milk has always been Mengniu's strength. Although Yili's revenue scale surpassed Mengniu's in 2011, in liquid milk, due to another safety incident in 2012, the gap narrowed; Yili only surpassed in 2015, and in 2016 Mengniu caught up, making the gap small again. The key gap lies in milk powder and ice cream. Let's skip ice cream and focus on milk powder. Mengniu only started developing milk powder in 2005, while Yili began in 2000. Mengniu never succeeded in this area; since 2013, milk powder revenue has been mainly reported under other items and is not significant. If you can't build it yourself, acquire one. Coincidentally, the national level was also calling for industry consolidation. So Mengniu set its sights on Yashili. On June 18, 2013, Mengniu issued a takeover offer for Yashili at HK$3.50 per share. Before the offer, Yashili's shareholding structure was as follows: After the offer, Mengniu's stake in Yashili reached 89.82%, with public float only 10.18%. Since Yashili maintained its listing status, this public float did not meet requirements, so Mengniu sold some shares at HK$3.50, eventually holding 76.58%. That wasn't the end. On October 31, 2014, Danone participated in a private placement of Yashili with cash of HK$4.39 billion at HK$3.70 per share. After completion, Mengniu's stake was diluted to 51.04%, and Danone held 25%. After these maneuvers, Yashili's shareholding structure became what it is today. The original major shareholder, the Zhang family, saw its stake reduced to only 6.39%. And the subsequent monthly K-line trend of Yashili's stock price was as follows. This wave can be described as a beautiful harvest, harvesting not only Mengniu and COFCO but also the international giant Danone. No one is to blame. Mengniu desperately needed an acquisition to fill its milk powder shortfall. As for Danone, its business entry into China had been bumpy. In 2013, it got together with COFCO and became a strategic shareholder of Mengniu. Mengniu wanted to do milk powder, and Danone also had the Dumex brand and needed channels to expand. Both sides were eager to build up the Yashili platform. Unfortunately, raw milk prices took a sharp downturn from June 2014, and both were harvested. ✦ 4. Yashili: What to Do with It After Mengniu and Danone came in, they injected their milk powder businesses into Yashili, such as Mengniu's Oushi Mengniu, Danone's Dumex China, and Arla organic milk powder, while stripping out Yashili's non-milk powder businesses. This left Yashili with a very clean milk powder shell, with products covering high, mid, and low ends. But the industry was sluggish, and Yashili's performance kept declining, eventually losing 320 million yuan in 2016. Mengniu and Danone were left staring at each other after being harvested. In 2016, Mengniu reassessed its milk powder business and impaired 2.25 billion yuan of goodwill. However, in 2017, Mengniu sold part of its stake in Modern Dairy and issued a strange convertible bond (convertible into Modern Dairy shares), but its stake in Yashili remained unchanged. This means the upstream can be let go for now, but milk powder still needs to be done. As mentioned above, from a revenue perspective, the gap between Mengniu and Yili is key in milk powder. Judging from Mengniu's current leader, Lu Minfang, there is no reason for Mengniu to abandon Yashili. From his resume, Lu Minfang is not from the COFCO faction but came from Danone. Before becoming president of Mengniu, he served as president of Yashili. It's unlikely he would set aside a business he once ran. In August, the most exciting event for the dairy industry was the announcement of the infant formula registration list. The first batch was announced on August 3, with the longest list of 89 (currently seven batches have been announced, totaling 192), and Yashili alone secured 21 spots. The infant formula registration system is somewhat like capacity reduction; for companies that can retain production capacity, this is certainly good news. Additionally, in terms of channels, since the list was previously uncertain, distributors faced significant uncertainty and were extremely cautious in stocking, preferring to clear inventory entirely, which affected sales and profits in the milk powder industry. Once this uncertainty is removed, channels can be laid out and goods can be stocked. Domestic milk powder companies have evolved considerably after past food safety pains. From the implementation of the infant formula registration system, it's clear the government intends to support the domestic milk powder industry. As for Mengniu's intentions, it is highly likely to allocate resources to this business in the future. If milk powder grows, Mengniu has the best chance of returning to the top position in the dairy industry. ✦ Conclusion Due to some biases, I haven't paid much attention to Yashili or Mengniu. With the departure of Niu Gensheng and other original management, and food safety incidents, I always felt Mengniu was failing and far behind Yili. This review revealed that the gap between Mengniu and Yili is not as large as imagined; perhaps the difference is just a Yashili. Of course, if Niu Gensheng could return, the gap might be closed faster. After the new leadership of COFCO Group took office, Mengniu also underwent a new round of personnel changes. The most notable was that Mengniu founder Niu Gensheng appeared on the list of Mengniu's Strategy and Development Committee. Although not returning to the front line, this change reflects the new COFCO leadership's emphasis on the team. Click the image for details. The 3rd (CFIC) China FMCG + Internet Conference will be held in Chongqing in October 2017. At this conference, New Distribution has invited 1,000+ distributors, 500+ brand owners, 200+ B2B platform founders, and 100+ investment and financing institutions to participate. The theme of this conference is New Forces, New Ecosystem. We will invite well-known domestic B2B industry experts, mentors, and B2B platform founders to discuss the following topics:
How can the FMCG industry leverage B2B to achieve new growth opportunities
How to build the new supply chain behind new retail
How can intra-city logistics help B2B achieve leapfrog development Highlights of this conference: The industry's first "2017 China FMCG B2B Industry Competitiveness White Paper"
Case sharing of excellent transforming and upgrading distributors
Conference + Exhibition upgraded, Hall 6 Internet Technology Exhibition strengthens matchmaking
Alibaba Retail Link, GLPS Finance, Eternal Asia Supply Chain, Best Store Plus, Yijiupi, Unilever, Hitech Technology, Yunmei Media—leaders from various fields will deliver keynote speeches and share pioneering views. October 17-18, 2017 Chongqing International Expo Center Registration is now open. Long-press the QR code below or click "Read Original" to register. Early bird tickets before September 15 enjoy a 30% discount! Add friend with note "Conference Registration" Click the links below to review the highlights of the 1st and 2nd FMCG + Internet Conferences: 2016 "FMCG + Internet" Summit Forum 2017 (2nd) China FMCG + Internet Conference Click the links below to review the highlights of the 1st and 2nd FMCG + Internet Conferences: 2016 "FMCG + Internet" Summit Forum -END-