Tim Morris Firms are turning New Zealand ingredients into finished, shelf-ready products ready for sale in world markets.Tim Morris
From bulk products in Synlait's warehouse to infant formula on Chinese supermarket shelves.
Arguments over "adding value" have been the hardy perennial of any discussion of the New Zealand food industry for longer than I have been alive. On one side of the discussion are the academics, armchair experts and opinionated observers calling for the large farmer-owned co-operatives to "add value." On the other side are industry insiders who claim it's harder than it looks OR someone tried that once and failed OR there's no money in it.
Having spent my misspent youth working in retail in the market (in the US, in this case) selling to consumers (remember them?) I can see both sides. Yes, we should turn our wonderful raw material ingredients into finished products people actually want (when was the last time you put bulk milk powder in your shopping cart?), but yes, it is a lot harder than the armchair experts think.
This conflict could go on practically forever with no resolution in sight, if not for one problem...
Almost unnoticed by the two sides, quietly in the background the solution has emerged. A strong and growing group of firms have emerged in New Zealand and just got on with the job of doing it. The visionary pioneers of the wine industry, mostly immigrants, led the way. Turning dry, hungry Marlborough sheep country into branded bottles of wine taking shelf space in the UK from France is almost the definition of value-added.
But a wide range of products have followed, including chocolate, sugar confectionery, biscuits, manuka honey, muesli bars, soups, ice cream, jams and jellies and infant formula, to name just a few of the larger examples of emerging food exports. Firms that stand out as leaders include Comvita, Tasti, Griffins, Whittaker's, Healtheries and Barkers. These firms are turning New Zealand ingredients into finished, shelf-ready products ready for sale in world markets. Of these emerging growth areas, the one that most clearly paints both the opportunity and the challenges in New Zealand's value added future is infant formula. The industry is an interesting microcosm and one of the best examples of the country's ongoing move up the value chain. There has been significant investment in the industry over the past decade - in the order of $900 million to $1 billion and exports continue to grow. While the future is full of opportunities, there are clouds on the horizon, particularly in China.
Infant formula is one of the most complex foods in existence. It is an engineered food designed to mimic human breast milk as closely as possible. Infant formula sits on the dividing line between food and pharmaceuticals, indicated by the fact that the industry has historically been dominated by major pharmaceuticals firms, such as Abbott.
From a business point of view, infant formula is a highly attractive activity, as it is highly profitable. Mead Johnson (global #3 in the category) makes twice as much profit as Fonterra on 20 per cent of the sales. This profitability comes from product complexity, economies of scale, patents and other intellectual property, the importance of doctors in the sales process, global regulations (such as bans on advertising) and widespread government market intervention (for example, two-thirds of all US infant formula is bought by the government.
This defensibility has led to a highly consolidated global market dominated by a handful of multinational companies. Almost all markets are structured and include three or four of the global leaders, maybe a dying regional brand, and niche products, such as organic and goat.
The industry is currently undergoing terminal consolidation with the multinationals playing a game of musical chairs until stopped by competition authorities. Recent major deals include Nestle buying Pfizer's infant nutrition unit for US$11.9 billion in 2012 (Pfizer having itself bought Wyeth) and Danone buying Numico/Nutricia for 12.3 billion euro in 2007 (Numico itself being the result of a decade plus industry roll-up). To put these numbers in perspective, Fonterra has a current market capitalisation of US$8.7 billion.
The main exception to this ongoing consolidation is China, which is similar to developed markets 100 years ago. In China ,a wide range of players compete including all the major global multinationals, the major local dairy firms (Mengniu, Yili, others), regional start-ups (BeingMate, Biostime and others) and a huge range of smaller firms.
Much, if not all, of the current action and excitement in the New Zealand infant formula industry can be seen as a result of this situation in China.
New Zealand was there at the beginning, with Glaxo ("The food that builds bonnie babies") part of GlaxoSmithKlein which had been founded near Palmerston North in 1904 to make infant milk products. But we missed our chance and the firm soon left for London.
However, New Zealand has a long history of being a key supplier of dairy ingredients to the industry. We are the largest exporter of milk powder in the world (and have been among the top five exporters for the past 50 years). All major infant nutrition firms in the world buy raw materials from New Zealand. For example, Abbott recently disclosed that its plant in Guangzhou, China uses 100 per cent NZ milk.
Until the early 2000s, New Zealand only produced a small amount of infant formula, with Danone marketing Karicare primarily in the decidedly sleepy domestic market.
Firms are turning New Zealand ingredients into finished, shelf-ready products ready for sale in world markets, says Tim Morris.
Things began to change in 2003 when Fonterra invested in upgrading its capacity to produce and pack more complex dairy-based nutritional powders. This was followed five years later by the signing of the New Zealand-China Free Trade agreement in 2008 and the "lucky" accident of the Chinese melamine milk scandal later that same year which suddenly accelerated already growing Chinese demand through the roof.
Since then the New Zealand infant formula industry experienced rapid growth. Westland, Synlait, Sutton Group (now under Danone's ownership) and New Image now also manufacture bulk infant formula powder. More recently three of the four largest dairy companies in China -- Yili (greenfields), Mengniu (greenfields), and Bright (Synlait) -- have invested in infant formula plants in New Zealand. At the same time, the Dairy Goat co-operative has quietly been pursuing a successful niche strategy building on the unique properties of goat infant formula.
The availability of bulk infant formula in New Zealand has led to the rapid emergence of a canning/contract packing industry. This in turn -- in combination with the "Wild West" conditions in the Chinese market -- led to the emergence of a huge number (100+) of smaller "pure play" firms selling and marketing infant formula from New Zealand. However the Chinese Government has begun "taking steps" to bring order to the market. In August 2013, the Chinese Ministry of Industry and Information Technology indicated it aimed to reduce the number of manufacturers to 3-5 firms with revenues exceeding CNY50 billion (US$8 billion) by 2018. Earlier this year China radically changed its regulations and began requiring factory certifications, effectively leaving the huge number of New Zealand infant formula labels without a market. Just last month four Chinese government departments -- the China Food and Drug Administration, the Ministry of Industry and Information Technology, the National Development and Reform Commission and the Ministry of Finance -- issued a statement saying they will consolidate the market by providing funds and tax incentives to chosen companies for mergers and acquisitions. The future looks set to be a battle between the multinational leaders and the primarily Chinese newcomers for control of Asia.
Returning then to the perennial question of the New Zealand food industry: "Can we add value?" Infant formula has shown us that, to borrow a slogan from Barack Obama,"Yes, we can." All it takes it a lot of hard work and more than a little luck. But it has also shown us that the "value-added" world beyond container quantities of ingredients is a tough, highly competitive place without simple solutions. All of the elements of the business mix -- quality, scale, logistics, innovation, service, sales & marketing and branding -- must be working and, even then, success is not guaranteed.
In addition, like people, industries and countries have to learn new skills and, as anyone who has tried to learn a new language can tell you, this takes time. The good news is, the transition is happening now, the platform for the future is already visible in the export statistics -- $2.5 billion of processed foods (including infant formula), $1.3 billion of wine and $40 million of spirits. These are the export products of the future, destined for hypermarkets and restaurants of Asia. It will take 20 years or more of hard work to fully realise the potential. Let's stop talking, recognise the job in hand, and get on with it.
Tim Morris is a director at Coriolis. All of Coriolis' recent work on the future of New Zealand's food exports, including their infant formula report, can be read at www.coriolisresearch.com.