Contaminated Milk Sours China's Dairy Business

Farmers and milk distributors have been devastated by the contamination scandal, the recall, and bans on Chinese dairy products

For farmer and migrant worker Dong Lizhong, dairy farming was supposed to be his golden ticket out of a factory job. Instead, his dairy business has been shattered by the contaminated milk crisis. Melamine, a chemical additive used to make plastic, was discovered in the milk supply of China's third-largest dairy, Sanlu Group, after babies mysteriously developed kidney stones. To date, four infants have died, and at least 53,000 have fallen ill from drinking contaminated baby formula.

China's four largest dairy companies, accounting for nearly half the country's milk market, have pulled their products off shelves. More than 20 countries, including France, India, and South Korea, have already banned not just dairy products from China but also candies and cookies. "This is a disastrous setback. I estimate that it will take one or two years to rebuild confidence in dairy products," says Luo Yunbo, dean of the College of Food Science & Nutritional Engineering at China Agricultural University.

The local milk-collection station in Tongye village, Hebei province, stopped buying milk on Sept. 14, just as the cows were entering their peak milking period. Farmers continue to milk their cows at the stations, but they now take the milk home to drink themselves or "feed the cabbages"—pour the milk in their cabbage fields. Dong estimates that he has already lost $1,461, or a quarter of his annual income last year, in expenses to feed his 20 dairy cows corn and fresh grass. Some of his neighbors are suffering even more. "Unless someone starts buying milk, we're going to see a lot of cows being slaughtered very soon," he says.

Cutting Corners

For the past five millenniums, China has not had a tradition of drinking milk. But as the country has grown wealthier over the past three decades, the domestic dairy industry has taken off. No one has benefited from this trend more than China's two largest dairy companies: China Mengniu Dairy and Inner Mongolia Yili Industrial Group. At the same time, scores of entrepreneurs—from dairy farmers to milk-collection station owners to milk distributors—jumped into the dairy market to make their fortune. The fierce competition within China's dairy industry encouraged some to cut corners to make the quick buck, regardless of the consequences.

As Mengniu and Yili expanded at breathtaking speed, especially after Mengniu sold shares in Hong Kong four years ago, their ability to supply milk has barely kept up with demand. China is projected to consume 25 million tons of milk this year, putting its dairy market ahead of France or Germany, according to KPMG. In their quest for more raw milk, Mengniu and Yili have expanded outside their base in the northern province of Inner Mongolia and set up milk production facilities in other parts of China. Not surprisingly, most of the quality problems in milk have been found in dairy farms in Hebei and Inner Mongolia provinces, where the competition for raw milk supplies has been the fiercest.

Most dairy farmers in Hebei province traditionally sold their milk to milk-collection stations established by local heavyweight Sanlu. In recent years, new privately owned milk-collection stations to buy raw milk for Mengniu and Yili started popping up next to existing stations. These new entrants captured raw milk supplies by offering dairy farmers slightly higher prices. "This competition broke the rules. As milk buyers fought over milk supplies, their standards for quality fell," says Roger Liu, vice-chairman of American Dairy (ADY), a Heilongjiang province-based powdered milk company.

Additives to Boost Protein

Also, many of the milking stations do not have the equipment to test milk for additives. At the Nanxincheng station, 16 households bring their dairy cows in the area to be milked in the red brick farmhouse. The farmers hook up the cows up to a milking machine, which pumps the milk directly into a big vat. "They didn't test the milk here. They sent it to Sanlu for testing," says Du Yanjun, a government inspector who has been posted to monitor the Nanxincheng station after the contamination crisis broke.

The milk is collected from the stations and shipped by middlemen to big dairy companies like Sanlu, which would do their own testing and grading. It now appears that unscrupulous middlemen commonly add melamine into the raw milk to increase protein levels in their milk samples, so their milk would be graded higher. However, ingesting melamine can also cause kidney stones or kidney failure, especially in infants.

Matthew Estes, president and CEO of BabyCare, had looked into switching from Australian and New Zealand sources of milk for the company's infant-formula business in China. BabyCare did extensive testing of possible suppliers and realized it could not locate a suitable supplier in China. "We couldn't the find quality that met our standards. We chose to not sell rather than take the risk," he says.

Pleading for Reimbursement

After numerous attempts to cover up mysterious ailments in babies who drank Sanlu baby formula, the company finally issued a public recall of 700 tons of baby formula. Since then, Beijing has fired several senior officials connected with the scandal including the chairwoman of Sanlu Group; the mayor of Shijiazhuang, the city where Sanlu is based; and the head of China's food and product quality agency.

Yet there remain limits to what the Chinese government can do to resolve this crisis. Since Sept. 12, more than 200 Sanlu powdered milk distributors from across the China have descended on Sanlu's headquarters in Shijiazhuang. They all recalled an initial batch of Sanlu baby formula from supermarkets and stores shortly after the scandal broke. However, Sanlu will not reimburse them for the recalled formula. Sanlu told them that their capital has been frozen by government investigators. They have come to Shijiazhuang to plead for reimbursement before their distributorships go bankrupt.

One Sanlu distributor from Jiangsu province, Li Zongyuan, has already bought back $44,000 worth of powdered milk. He estimates that his customers still have $29,000 worth of products still sitting on store shelves, but is unable to buy it back until Sanlu reimburses him for the recalled products he has already bought back. "Some of the stores with their own trucks have brought the products to our warehouses and demanded that we take it back and refund their money," he says. "We have no money."

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