Exploding watermelons, toxic peanuts, and contaminated rice are just some of the food hazards that routinely bedevil Chinese consumers. The risks of contamination are particularly far-reaching in the case of milk, since more than 70 percent of Chinese mothers rely on baby formula rather than breast milk to feed their babies. Longstanding concerns regarding unsafe milk in China came to a head in late 2008, when the Chinese authorities accused more than 20 domestic producers of selling milk adulterated with melamine. Six infants died and more than 50,000 babies were hospitalized. In 2011, regulators closed more than 400 dairy farms for violating sanitation and certification standards.
Growing numbers of Chinese families have responded by shunning domestic infant formula in favor of imported brands. That’s creating challenges for both local and multinational companies selling dairy products in China. The country’s largest dairy producer, China Mengniu Dairy, on June 18 announced a HK$12.5 billion ($1.6 billion) deal to buy Yashili International, a local infant-formula maker. The deal makes sense because “the government is trying to consolidate the industy,” Guosen Securities analyst Todd Yang told Bloomberg News. The goal is to “better monitor both upstream and downstream food quality.”
China Mengniu isn’t the only company positioning itself to benefit from China’s renewed focus on fixing its troubled food supply. To see how one multinational is handling the challenges, consider Nestlé, the world’s biggest food company. Like almost all other big foreign companies selling dairy products in China, Nestlé relies on imported milk powder for its infant formula. For other dairy products, however, Nestlé stands out for meeting its raw material needs by buying fresh milk from Chinese farmers. Domestic sourcing of milk can yield a significant cost advantage, build the local supplier ecosystem, and prepare the ground for the day when Chinese parents start trusting local milk as reliable enough for their babies.
That’s no easy task. Nestlé’s milk collection is concentrated primarily in northeast China, where, as in much of the country, the dairy sector is very fragmented: More than 18,000 farmers supply Nestlé with a daily average of 100 liters (about 26 gallons) of milk. Given this structure, there are many points where milk can become contaminated, so Nestlé utilizes what it calls a “factory and farmers” model that eliminates the middleman. Farmers bring milk directly to a network of Nestlé-owned collection centers, none more than an hour’s distance from the farm, where a computerized system samples, tests, and tags each batch of milk. To reduce further the risk of contamination at the source, the company provides farmers with continuous training and assistance in cow selection, feed quality, storage, and other areas.
Now Nestlé is implementing a more ambitious strategy to transform its milk supply chain by collaborating with local governments, banks, and investors to accelerate the consolidation of China’s dairy farms. Fewer, larger, and professionally managed dairy farms will have more reliable quality and use land and labor more productively. Nestlé is building a new institute to upgrade the training that staff at larger and more professionally managed farms need. Around the institute, Nestlé is building three demonstration farms with thousands of cows. For farmers who want to increase their scale, Nestlé is providing credit guarantees to finance purchases of more cows.
The Nestlé case offers five important lessons.
First, build visibility into and control over the supply chain. Know your suppliers and, as much as possible, their suppliers, too. Without end-to-end visibility and control, you run the risk of being blindsided along any of a number of dimensions—product quality and safety, environmental damage, safety and health of workers, and theft of intellectual property, to name just a few.
Second, ownership is not a necessary requirement for control of the supply chain. Visibility into and control over the supply chain dramatically reduce the need to own the supply chain. Capital is always a scarce and costly commodity. Like Nestlé, most companies are generally better off investing their capital in downstream activities that offer greater opportunities for differentiation and thus higher returns.
Third, be proactive in providing training and assistance to ramp up the capability of your suppliers. In strategic markets such as China, it’s critical for you to ensure not just short-term but also long-term success. Like Nestlé, global companies can leverage their knowhow and scale to help accelerate the upgrading of their suppliers’ capabilities.
Fourth, prefer and, if possible, try to create more consolidated (but not monopolistic) supply chains. Greater consolidation means fewer suppliers as well as fewer links in the supply chain. As a direct result, there will be fewer points which need to be monitored and where things can go wrong. Also, bigger suppliers are likely to be more professionally managed, to be more productive, and to offer greater potential for collaborative innovation.
Finally, believe in and practice the concept of “shared value.” Nestlé is very clear that it wants a long-term collaborative partnership with its suppliers. More than once, the company has unilaterally increased the price it pays to dairy farmers to help them cover the rising cost of feed and to give them an incentive to boost milk supply the following year. Without a win-win mindset, long-term partnerships are impossible.