"For so many years, the only opposition that we have had is ourselves. In our 30-year history, we have tried everything we can to go beyond our self and to satisfy the needs of our customers, "says Liu Chun Hai, Vice-President of Yili Group.
"Our core value is quality. Quality talks and that will never change.
"For Yili Group, we [look at consolidation] this way; as the leading enterprise of the China dairy industry, what matters most is the well-being and development of the industry. We support every policy so long as it is a positive for the well-being of the industry."
Paul Wang, vice-president of Mengniu Dairy Group adds: "The consolidation I think is going to be very good for dairy companies who have a certain skill level and capability to invest on the quality side, the system side and to benefit the government monitoring. There's so many small companies at present and it's not good for overall industry quality."
Already Mengniu has been proactive in bringing international investors into its fold. French dairy producer Danone and European food group Arla are the company's second and third-largest shareholders. It's a mutually beneficial arrangement with Mengniu looking to leverage the experience and technical capabilities of Danone and Arla while they stake their claim on the second wave of the "White Gold Rush".
"In China the farming business does not have the benefit of a long history, but in Europe they have done it for more than 150 years," says Wang. "They have a lot of experience accumulated, so we try to bring in those good ideas and experience to help us become a better company and build a better industry.
"Mengniu is making every effort to increase our capability through cooperation with major international companies. They have very good experience and long histories in the dairy industry. We are very interested in co-operating with them and they are very open with us in terms of sharing their technology, food safety capability, new product development and advanced technical skill."
The Inner Mongolian Government has signalled its support of one of the region's most important economic drivers. In 2009, 8 billion RMB was set aside to invest in the integration of the fragmented approach to dairy farming throughout the region.
Inner Mongolia is home to more than three million dairy cows. When the policy implementation began more than 90 per cent of the region's cows were being raised by farmers in their backyards.
A national-level laboratory was also setup to monitor products being produced by Mengniu and Yili.
Access to raw milk supply is an issue for the two champions as growth continues to be curtailed by the lack of sufficient domestic milk pools. Substantial investment has been earmarked to address this by the two companies, and the central and local governments.
"We have a dual strategy [for addressing milk supply]. In the domestic market, we are consolidating our raw milk bases. We now have more than 2200 farms and large scale, intensity farming is at over 90 per cent," says Liu.
"Our strategy at Mengniu is very similar to Yili. We are expanding our farm base as large as possible to better control costs across the supply chain. The best way to ensure a consistent supply of quality milk is to expand our own farm base," adds Wang.
"Once we attain the right scope - quality comes first and foremost as well as the ability to control that quality through continuous investment - then we can pay attention to scale. Instead of family farms which are very small and may have questionable quality, we are looking at industrial sized scalable farming."
At present, 94 per cent of Mengniu's milk is sourced from industrialised scaleable farms. That number is set to change to 100 per cent by the end of next year as investment in local milk pools escalates.
Says Wang: "The biggest growth will be in our own farms, which are growing very quickly By next year we are aiming to have an additional 100,000 milking cows on our own farms. It's a major part of our plan, and there is a significant budget for farm construction."
Farms owned and operated by Mengniu constitute the second largest supply of raw milk for the company. Milk continues to be sourced from suppliers in an arms-length business relationship, however the proportion acquired from these farms is dropping.
"For farms where we just have a supplier arrangement, we try to assist them on the technical supply and look to raise their standards and unify their supplies with those from our own suppliers," says Wang. "All of the farms who have a business relationship with Mengniu use raw materials from our recommended suppliers, ensuring that the best quality is available for those farms which aren't yet scalable sized farms.
"The supplies including feed and medicine are extremely important for food safety. Once the feed is controlled and their medical needs are taken care of, the food safety issues for the cow diminish substantially. There are also significant cost advantages as we are able to negotiate as a group and secure bulk supply arrangements. It's one way we are using our scalable policies to improve smaller farming operations."
By far the largest source of milk comes from farms in which Mengniu has become a shareholder to secure long-term supply.
Last year Mengniu increased its stake in China Modern Dairy from 1 per cent to 28 per cent at a cost of $468 million. Modern Dairy is China's largest milk producer by sales volume and had previously agreed in 2008 to sell all of its raw milk to Mengniu at a pre-negotiated price as part of a ten-year deal. By upping its stake in Modern Dairy, Mengniu secured a ten year extension on their existing deal - locking in the entirety of Modern Dairy's milk supply through to 2028.
Yili uses the same three channels as Mengniu to secure its milk supply. 20 per cent of that is from Yili's own farms and the remainder from arms-length suppliers and co-operatives formed by Yili and third party producers.
Both companies are also investing offshore to develop quality milk supplies. In New Zealand, Yili has invested $214 million in building an infant formula plant in South Canterbury in a deal that saw it agree to purchase Oceania Dairy Group in 2012. Yili took control in 2013 following approval from the Overseas Investment Office.
Both companies are also investing offshore to develop quality milk supplies. In New Zealand, Yili has invested $214 million in building an infant formula plant in South Canterbury in a deal that saw it agree to purchase Oceania Dairy Group in 2012. Yili took control in 2013 following approval from the Overseas Investment Office.
"In order to transform China's dairy industry into a more normal and professionally oriented sector which produces high quality dairy products, that's a very important factor."
Mengniu followed suit, securing its own New Zealand resource base through its acquisition of fellow Chinese dairy firm Yashili. At the time of the acquisition, Yashili was already well under way with its investment at Pokeno, south of Auckland where it is building an infant formula plant to produce 52,000 tonnes of product for export to China.
The significant international investments should go a long way to rehabilitating the reputations of the brands. Both Yili and Mengniu were front and centre when the 2008 melamine crisis decimated local processors. Both were implicated when their infant formula products tested positive for the industrial chemical and suffered considerable damage to their reputations.
If the new look Chinese dairy industry is to become the success that the government envisions, getting consumers and the public behind their national champions and generating confidence in domestically produced products is essential.
"People here are really sensitive about food safety and the government have issued many policies addressing this," says Liu. "When Chairman Xi Jinping visited Yili in February, he emphasized that 'food safety is on the tip of the tongue,"'
Chinese parents are among the world's most informed when it comes to dairy products - the upshot of the scandal-plagued industry and the one-child policy. They are familiar with the ingredients, quality and standards and have a deep-seated distrust of Chinese dairy.
"China's standard is already matching up with those internationally," says Wang. "I think the government is trying to be very clear about what is required from processors and manufacturers."
"They're defining very clearly what is required and expected when it comes to processing. They want to deliver the Chinese consumers a really good product, high in quality and produced under a transparent process to build up consumer confidence for Chinese dairy products".
"It is not that the standard is more strict than it was previously, it's just that some standards in the market haven't been followed. The standard of manufacturing will be implemented and monitored in major factories and the overall industry standard will rise across the board."
A host of new requirements are being introduced to raise standards of process industry wide. Mengniu will need to integrate its powder production facilities so that it all takes place at a single site, as transporting raw product is seen as exposing it to undue risk of contamination.
"The government has given us three years to change this, to ensure that there is no transport and our milk powder is produced as an integrated processes. There's just too many worries about pollutants during the transport process".
Securing the supply chain and cutting the middlemen from the system, which helped sow the seeds for consolidation in the first place, will go a long way towards restoring the integrity of the Chinese dairy industry. Such a dramatic change must inevitably be led from the top, and with the Government's resources helping support the National Champions, Yili and Mengniu are well on track.
* Alexander Speirs was supported by the Asia:NZ Foundation for his research trip to China with a journalism travel grant and received assistance from Air New Zealand and NZ Inc Ltd.
