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Source: Guotai Junan Securities Research
The dietary differences between China and the West determine the different status of milk in Chinese and Western diets. Through the channel research results on dairy sales in "The Spring Festival Consumption Exceeding One Trillion for the First Time: What New Trends and Opportunities?", it is not difficult to find: Even now, milk is still endowed by Chinese people with expectations of hope, health, and beauty.
The good impression Chinese people have of dairy products has not been fully projected onto dairy enterprises. If the development history of Chinese dairy enterprises is compared to a person's development history, the melamine incident is like their coming-of-age ceremony. Before the 2008 melamine incident, the development of the dairy industry was like a person's childhood and young adulthood, constantly breaking through bottlenecks to achieve development; after the melamine incident, the dairy industry suffered a huge blow and was finally forced to mature after the pain.
In the 2019 Central Document No. 1, implementing dairy industry revitalization and strengthening the construction of high-quality milk source bases were prominently listed. The Guotai Junan Food and Beverage Team, by reviewing the rise and fall of China's dairy industry from scratch over the past 38 years, attempts to uncover the next trend for revitalizing China's dairy industry.
01 1980-1998: "Milk" Not Yet Mature
Before 1998, China's dairy industry was still in a primitive stage, with a backward industry ecosystem and very slow growth. It was specifically constrained by two major bottlenecks:
First, insufficient raw milk supply, leading to a severe shortage of dairy supply and low per capita consumption.
Data source: FAO, Guotai Junan Securities Research
Second, rough product processing, no cold chain in distribution, and extremely backward production methods.
Before 1998, China's dairy industry had backward production methods, with manual milking and simple sterilization methods being common. Consumers purchased dairy products through glass bottle home delivery, which did not use 4°C cold chain transportation. The backwardness of production and transportation made it difficult to guarantee dairy quality.
Due to insufficient industry development Before 1998, China's dairy industry had extremely low concentration
Data source: Wind, Guotai Junan Securities Research
02 1998-2008: The Birth of Giants
In 1998, two events changed the fate of dairy products:
The first was the introduction of Tetra Pak equipment. Around 1998, some dairy enterprises, represented by Yili, began to introduce Tetra Pak equipment on a large scale, solving the problem of expanding to distant markets due to the lack of fresh-keeping technology, thus having the conditions to develop long-distance markets. Mengniu was established in 1999 and also used Tetra Pak pillow packaging to expand the national market. Yili and Mengniu were significantly more competitive than the small local dairy enterprises left over from the planned economy, and their process of expanding the national market was exceptionally smooth.
The second was overcoming the bottleneck of milk sources. Around 1998, some dairy enterprises, led by Yili, began to guide social resources to strengthen milk source construction, greatly alleviating the bottleneck of raw milk supply in the industry. The dairy industry has always had the saying "those who get milk sources get the world." Leading companies like Yili and Mengniu encouraged dairy farmers to expand scale by providing interest-free loans, and continuously improved cooperation with farmers, providing technical support. Benefiting from continuous milk source construction, the number of dairy cows in China grew rapidly.
Leading companies strengthen milk source construction China's dairy cow numbers grow rapidly
Data source: USDA, Guotai Junan Securities Research
It can be said that at this stage, the two bottlenecks were overcome, and domestic dairy enterprises began to develop rapidly. Seeing the vast market space for dairy products, various foreign and industrial capitals also entered, driving the rapid popularization of consumer education and significantly increasing dairy penetration. The rapid expansion of scale drove the entire industry into a period of high-speed growth. At this time, Yili and Mengniu seized the opportunity and overtook on the curve to become leaders.
In 2005, the second season of "Super Girl" swept the country. Anyone with memories of that entertainment history will not forget that the streets and alleys were looping a cute girl singing sweetly, "Sour and sweet, that's me." That summer, besides the girls who came out of "Super Girl," the fate of Zhang Hanyun, the third-place winner of the 2004 Super Girl, was also changed, and of course, their common sponsor—Mengniu.
As mentioned earlier, Yili and Mengniu became industry leaders at this stage. In comparison, Mengniu grew significantly faster than Yili, surpassing Yili for the first time in 2007 to become the industry leader. As a new industry recruit established in 1999, Mengniu's ability to come from behind was mainly due to the following excellent performances:
- Placing marketing at the core of strategy, proposing "market first, then factory," and quickly capturing the market with high-intensity marketing investment.
When Niu Gensheng founded Mengniu, he established that marketing was at the core of all work and creatively proposed the business approach of "market first, then factory." Unlike heavy investment in sales expenses, when facing the dilemma of lacking factories at the beginning, Mengniu did not choose to build or acquire factories but cooperated with poorly managed factories in regions like Heilongjiang for OEM processing, avoiding excessive investment in production capacity. From the beginning, Mengniu established the core position of marketing, quickly captured the market, and this became the most core reason for its rapid growth to become the industry leader.
- Product innovation leading the industry
At this stage, Mengniu's product innovation was divided into two situations:
- The first was developing new categories. For example, Telunsu, breakfast milk, and good night milk;
- The second was old trees with new flowers, developing new attributes for old categories. For example, Sour and Sweet Milk developed leisure attributes, expanded drinking scenarios, and sales increased rapidly.
In contrast, Yili's performance was relatively slow, not only in marketing methods but also in product innovation, which was relatively conservative. The tactical failure led to its revenue being surpassed by Mengniu, forcing it to give up the industry leader position.
Guangming, as the industry leader at the time, made strategic decision errors at this stage and was eventually surpassed by Yili and Mengniu.
First, there was a misjudgment of consumer demand, leading to a failure to focus on room-temperature milk, instead continuing to focus on low-temperature products. It did not consider that the primary requirement of consumers for dairy products was not high quality, but more convenient and cheaper Tetra Pak room-temperature milk products could better meet consumer needs, resulting in slow progress in expanding the national market.
Second, the intensity of channel sinking was insufficient. The company was slow in sinking channels to township areas, and its sales team came from big cities, lacking the "grassroots" genes for channel sinking. Constrained by this, the company's channel sinking pace lagged behind competitors.
In addition, the entanglement between Guangming and Danone for 15 years also consumed much of Guangming's energy. The company's rigid copying of foreign experience failed to meet consumer needs, becoming another important reason for its slow progress in expanding the national market.
Guangming's channel sinking progress lags behind Number of outlets significantly less than competitors
Data source: Wind, NetEase Finance, Guotai Junan Securities Research
Note: Data is from 2017
By 2008, the industry had reached a higher level of maturity, the leading positions were initially set, and an oligopoly pattern had formed. At this stage, Yili and Mengniu's revenues grew rapidly. However, due to misjudgment of industry development trends, Guangming's growth rate was significantly lower than competitors at this stage, eventually giving up the top position and becoming a regional brand. At this point, the ranking of industry leaders was basically determined, and the duopoly pattern of Yili and Mengniu had initially formed.
03 2009-2018: China's Dairy "9/11"
On September 11, 2008, the Oriental Morning Post was placed on newsstands in Shanghai as usual.
Just on the back of the slogan "Drink a pound of milk every day, strengthen Chinese people," the Oriental Morning Post, months after domestic media reported on "big-headed dolls," was the first to name Sanlu milk powder as causing illness.
The Ministry of Health investigation launched on the same day triggered the melamine incident that shocked China and the world.
Incomplete statistics of major melamine events from 2008-2009
2008.06 Sanlu Group received reports from consumers that infants developed kidney stones after consuming Sanlu milk powder and were hospitalized.
2008.09 On the 8th, media such as Gansu's "Lanzhou Morning News" first exposed the toxic milk powder incident under the name "a certain milk powder brand."
2008.09.11 The Oriental Morning Post first named Sanlu milk powder in reporting the illness-causing incident. On the same day, Fonterra notified the Chinese government of the melamine incident through diplomatic channels.
On the 15th, Sanlu Group publicly recalled problematic products, apologized to affected children and parents, and issued an apology letter.
2008.09 On the 16th, the State Council launched a Level I response for major food safety incidents and fully launched investigations, treatment, and rectification actions. The phased inspection results of the special inspection of infant formula showed that 69 batches of products from 22 milk powder manufacturers were found to contain melamine, including well-known brands such as Yili, Mengniu, and Guangming. In the national special inspection of liquid milk for melamine, some batches of products from Yili, Mengniu, and Guangming were found to contain melamine.
On the 17th, the public security organs decided to criminally detain Tian Wenhua, former chairman and general manager of Sanlu Group.
By the 26th, at least 15 countries and regions had imposed varying degrees of bans and recalls on Chinese dairy products.
2008.12 The Shijiazhuang Municipal Government held a press conference and officially announced that due to severe insolvency, Sanlu Group had been applied for bankruptcy liquidation by creditors.
2009.01 The first-instance judgment of the Sanlu problematic milk powder criminal cases was announced in the Shijiazhuang Intermediate People's Court, with former Sanlu Group chairman Tian Wenhua sentenced to life imprisonment.
Data source: Sohu News, NetEase News, Guotai Junan Securities Research
The main reason for the melamine incident was that before 2008, industry leaders prioritized marketing above all else, neglecting upstream milk source construction, resulting in raw milk production being unable to meet downstream market demand.
Raw milk supply lagged before and in 2008 Raw milk production growth rate lagged behind dairy production growth rate
Data source: China Dairy Yearbook, Guotai Junan Securities Research
Note: Liquid milk production is significantly lower than raw milk mainly because some raw milk is made into dry dairy products (such as milk powder)
We believe that the direct impact of the melamine incident on the industry is mainly reflected in the following aspects:
In the short term, in 2008, the dairy industry's revenue and profits fell sharply, with widespread losses among enterprises, and the industry was in dire straits. After the melamine incident, consumer trust in the quality and safety of domestic dairy products fell to freezing point.
In 2008, dairy industry enterprises Revenue and profit growth declined sharply
Data source: Wind, Guotai Junan Securities Research
In the long term, under the situation of consumer distrust of the domestic dairy industry, large enterprises could still reshape consumer trust by strengthening expense investment, promotional publicity, and other means, while imported milk took advantage of the import concept to seize the market. In contrast, small and medium-sized enterprises had weaker brand power, found it difficult to gain consumer favor, and their market share was gradually eroded by large enterprises and imported brands. After small and medium-sized enterprises exited the market, most of the gaps were occupied by leaders, and the duopoly of Yili and Mengniu continued to strengthen.
04 Three Strong Players Stand Together After the Darkest Hour
Under the heavy pressure of the melamine incident, COFCO and Mengniu hit it off, with the former taking over Mengniu in 2009 and becoming its largest shareholder. After the transaction, COFCO, together with Hopu Fund, held 20% of Mengniu Dairy's equity, becoming its largest shareholder.
Mengniu's COFCO era can be roughly divided into three parts: the Yang Wenjun era (2009-2012), the Sun Yiping era (2012-2016), and the Lu Minfang era (2016 to present).
Major events in Mengniu Dairy's development history from 1999 to 2018
1999 Niu Gensheng, then vice president of Yili Group, resigned and founded Mengniu. Niu Gensheng found a dairy enterprise in Heilongjiang for OEM processing, concentrated a large amount of funds on marketing, and confirmed the asset-light path of "building the market first, then the factory."
2000 Due to lack of funds, Mengniu leased Tetra Pak liquid milk production lines through third-party financial leasing and put them into production. The first Tetra Pak pillow was successfully launched, and Mengniu entered a period of rapid growth. Top international investment companies Morgan, CDH, and Actis jointly injected more than 26 million US dollars into Mengniu at one time, the largest financing received by the domestic dairy industry at that time.
2002 Entered the Hong Kong market.
2004 Listed in Hong Kong, becoming the first mainland dairy enterprise to be listed overseas.
2005 The "Happy China Mengniu Sour and Sweet Milk Super Girl" annual competition swept the country. Taking advantage of this, Mengniu carried out integrated marketing, and the revenue of Sour and Sweet Milk soared, significantly increasing brand awareness.
2009 Yu Xubo, president of COFCO Group, took over Mengniu Group. In the same year, Mengniu entered the world's top 20 dairy companies.
2010 Mengniu spent 500 million to acquire Junlebao.
2011 Mengniu's sales were overtaken by Yili.
2012 Yang Wenjun stepped down as president, succeeded by Sun Yiping, and Mengniu fully entered the COFCO era.
2013 Sun Yiping adjusted the organizational structure from a business division system to a linear functional system. Externally, it established a joint venture with Danone to expand low-temperature product business.
2014 The dairy industry merger and reorganization plan was implemented.
2015 Began channel reform to promote channel flattening.
2016 Lu Minfang succeeded Sun Yiping as president of Mengniu. Implemented the "deep distribution" strategy to strengthen competitiveness in channels.
Data source: Sohu News, NetEase News, Guotai Junan Securities Research
In 2016, Lu Minfang succeeded Sun Yiping and became the new president of Mengniu. He previously worked at Danone and Yashili, with rich experience in the dairy industry.
After taking office, President Lu began to adjust the company, mainly focusing on the following aspects:
- Re-adjust the company's organizational structure from a linear functional system back to a business division system to improve operational efficiency of each department and respond to rapid market changes.
- On the basis of Sun Yiping's channel structure adjustment, begin to use deep distribution to promote channel sinking and seize the market in third- and fourth-tier cities.
- Strengthen expense and resource investment, increase brand exposure through sponsoring the World Cup and other means, and strengthen brand promotion.
- Focus on reforming weak parts, assisting Modern Farming to develop downstream liquid milk products, and Yashili to carry out supply chain and channel reforms.
At present, the measures taken by Lu Minfang have achieved good results. Modern Farming and Yashili both achieved significant turnaround in 2017, and liquid milk and other products also grew steadily. It is expected that Mengniu will continue on its current path, and the gap with Yili is expected to narrow, and the industry duopoly pattern will continue.
Unlike Mengniu, Yili's shareholder composition and senior management team remained relatively stable during this stage. Pan Gang was in his prime, and under his leadership, Yili did outstanding work in these ten years, successfully overtaking Mengniu to return to the industry leader position and widening the gap. During this period, Yili mainly carried out work in the following aspects:
Incomplete statistics of major events of Yili from 2008 to 2018
2009 Yili became a senior sponsor of the Shanghai World Expo and launched the "World Expo Standard" project.
2011 Yili's sales exceeded Mengniu's, regaining the industry leader position.
2012 Yili became the designated nutritional dairy product for the Chinese sports delegation at the 2012 London Olympics.
2013 Yili's Oceania production base was officially approved.
2014 Yili launched an employee stock ownership plan and entered the global dairy top 10.
2016 Yili launched stock option and restricted stock incentive plans.
2018 Kantar Consumer Index released the "2018 Global Brand Footprint Report." Among them, Yili topped the list of the top ten brands most chosen by Chinese consumers for the second consecutive year.
Data source: Sohu News, NetEase News, Guotai Junan Securities Research
Management incentives and employee stock ownership plans progressed smoothly, and the mechanism issues were ultimately straightened out. Yili had previously attracted widespread attention because the management MBO was unsuccessful, and ultimately former chairman Zheng Junhuai was imprisoned for this matter. After Pan Gang took office, he continued to promote reforms. The company finally launched management equity incentives in 2006, an employee stock ownership plan in 2014, and another equity incentive plan in 2016. With the exercise of options by management led by Pan Gang and their continuous increase in holdings in the secondary market, their shareholding ratio gradually increased. As of now, Chairman Pan Gang holds 3.88% of the shares. If not considering the Shanghai-Hong Kong Stock Connect, he is the company's second largest shareholder. Other core executives such as Zhao Chengxia, Liu Chunhai, and Hu Liping are also among the top ten shareholders. The straightening out of the mechanism laid a solid foundation for the company's rapid development.
The "Weaving Net Plan" promoted channel sinking, and the strongest FMCG channel was gradually built. Yili began to promote the Weaving Net Plan in 2006, focusing on channel sinking. After years of channel construction, Yili now has more than 5 million terminals, and the strongest FMCG channel has gradually been built.
In 2008, in coordination with channel sinking The number of sales personnel increased
Data source: Company announcements, Guotai Junan Securities Research
Benefiting from channel sinking Yili's penetration rate is significantly higher than peers
Data source: Kantar Consulting, Guotai Junan Securities Research
Reducing expenses, increasing prices, and improving net profit margin, with the protection of economies of scale, the industry leader position is stable. Facing slowing industry competition, in 2010 Yili proposed the "double improvement" work, emphasizing improving expense efficiency and net profit margin, marking the company's shift in expense investment thinking and reducing investment in vicious competition expenses. After entering the mature period, as the industry leader, the company's economies of scale began to show. Since 2010, although the company's sales expense ratio has gradually declined, the absolute value of sales expenses is still significantly higher than competitors except Mengniu. Under economies of scale, it is almost impossible for small enterprises to overtake through expense investment, and the company's industry leader position is stable.
Jumping out of the vicious circle of one-sided emphasis on marketing, focusing on strengthening weak links in the industry chain. At this stage, Yili began to correct the previous policy of marketing above all else and focused on repairing weak links in the industry chain, mainly reflected in:
1. Strengthening milk source construction
After the melamine incident, the company began to strengthen upstream milk source construction. On the one hand, it continued to promote the dairy cooperative model to maintain and develop relationships with dairy farmers; on the other hand, it used its own resources to strengthen the construction of large-scale pastures. In addition, the company also implemented the global weaving net plan, laying out milk source bases in New Zealand to ensure sufficient raw milk supply.
2. Strengthening production capacity construction
After the 2009 melamine incident, the company accurately grasped the market gaps caused by the shutdown of Sanlu and the exit of small and medium-sized enterprises, actively built new production capacity. In 2012, the company began planning a new round of production capacity construction and completed a private placement to raise funds in 2013. The key reinforcement of weak links such as milk sources and production capacity laid a solid foundation for the company's growth.
In contrast, Guangming, after recognizing its gap with Yili and Mengniu in brand building and channel sinking, began to pursue high product power, trying to compete through product differentiation. The most typical example is Mosilian, which opened a new field of room-temperature yogurt after its launch in 2009. Consumer awareness continued to increase, and revenue maintained high growth.
Benefiting from the company's focus on high-end products strategy, the company's gross profit margin was significantly higher than competitors during this period, and the "small but beautiful" operating model was once widely recognized.
Benefiting from focusing on high-end Guangming's gross profit margin was higher than peers for a long time
Data source: Wind, Guotai Junan Securities Research
After Guangming launched Mosilian, the leaders Yili and Mengniu did not immediately launch similar products but observed the room-temperature yogurt category for a period. After Mengniu launched Chunzhen in 2013 and Yili launched Ambrosial in 2014, both increased advertising investment and used their strong channels for national promotion, with obvious economies of scale. Affected by this, Mosilian suffered a huge blow. In 2015, its growth rate fell from 100% to negative, and it has been difficult to make major breakthroughs since then.
Leaders copy, and Mosilian's growth rate slowed significantly in 2015
Data source: Euromonitor, Guotai Junan Securities Research
Although other new products were excellent, they were also difficult to compete with the high-intensity resource investment of leaders. During this period, although the company's expense ratio was higher than competitors, under the disadvantage of economies of scale, its absolute resource investment was smaller than competitors, making the promotion of new products relatively difficult. Under the disadvantage of economies of scale, the strategy of leading with products to seize the market was difficult to succeed.
In November 2018, an article titled "Save Guangming" spread across the internet, expressing concerns about the sharp decline in Guangming's performance in 2018. Later, Guangming responded with an article titled "Believe in the Power of Guangming":
In the first three quarters of 2018, Guangming Dairy's performance declined, mainly due to the fierce competition in the dairy market and poor sales of room-temperature dairy products. However, Guangming Dairy's star products such as Youbei high-quality fresh milk, Zhiyou full fresh milk, and Rushi pure fermented milk have been recognized by consumers, with gratifying growth and high market share.
After a decade of turmoil in the dairy industry, Guangming, as a century-old enterprise, has successfully attracted a large number of dairy consumers, including young people, through the brand stickiness brought by high-quality products. They have sustained feelings and trust in Guangming.
However, as Guangming promised in its response, how to regroup after ten years, rebuild trust, and meet the diverse needs of different consumer groups is a question that Chinese dairy enterprises, including Guangming, must consider.
The above content is excerpted from the securities research reports already published by Guotai Junan Securities, "Breaking Bottlenecks to Open High Growth, Yili and Mengniu Come from Behind" and "Price Increases Become an Important Driver of Industry Growth, Leaders Hard to Shake." For specific analysis content (including risk warnings), please refer to the full report. If there is any ambiguity due to excerpts, the full report shall prevail.
New Distribution will hold the 2019 (5th) FMCG + Internet Conference during the Chengdu Spring Sugar and Wine Fair from March 16 to March 18. This conference will focus on the topic of "Breaking the Game" and conduct in-depth discussions with many brand owners, supply chain service providers, distributors, and retailers.
Compared to previous conferences, this summit will be fully upgraded. In addition to the original topics such as channel innovation, city distribution logistics, and distributor transformation, it will also add multiple parallel forums such as new marketing cases, IP + FMCG empowerment, community group buying, and innovative retail. Through three days of ten high-density and high-quality expert sharing and exchanges, we believe that every brand owner and distributor can learn the latest business models, expert opinions, and implementation methods, find new tools and methods for their own breakthrough in 2019, and return to the track of high-speed growth.
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