For Comvita, an unofficial "grey" channel into China has played a big part in its success.

The company, New Zealand's biggest manuka honey maker, has enjoyed a dream run for years, based on strong offshore demand - particularly from China.

Cracks in that performance started to emerge last year, when the company reported tough trading conditions in the first four months of the year to June.

Sales were significantly lower than in the prior year, resulting from a slowdown in the New Zealand and Australian informal channels into China.


Making things worse, unfavourable weather means Comvita now expects its net profit to be just $5m to $7m, compared with $18.5 million in the 18 months to June 2016.

It's not the only company to hit a snag in the so called "daigou" channel - Chinese for "buying on behalf".

The slowdown has hit other manuka honey producers and played a part in the spectacular fall of Tasmania-based infant formula company Bellamy's.

Health supplements company Blackmores has also suffered from problems in the grey market.

Comvita chief executive Scott Coulter says the company has benefited from the unofficial channels, which it has used to build its brand in China.

For Comvita, the simplest unofficial channel has been through Chinese tourists buying product at a gift store or airport, helping the brand to build its reputation.

Enter the daigou

"Comvita's brand has been built largely on the daigous and on the people who come and visit New Zealand," Coulter says. "It's been a great springboard."

The people behind daigou are generally small-time businesspeople operating outside the normal export/import channels, buying small amounts of product from wholesalers and posting it to China. They vary in size, sophistication and complexity. Some - complete with their own warehouses - turn over millions of dollars a year.


Last April, the Chinese authorities moved to level the playing field by introducing an 11.9 per cent duty on the daigou channel. Coulter says demand slowed following the introduction of the duty.

Comvita also exports to China through the formal channels, using a Chinese distributor. "It goes through customs, it is released to the market, and then we sell it." That formal channel attracts a 17.5 per cent tax - China's equivalent of GST.

Just as it clamped down on daigou, China also signalled that it would also change the rules on dietary supplements - pills and capsules - through a registration process known locally as Big Blue Hat.

Most of Comvita's exports to China are honey, which is regulated as a food and is a simpler prospect than dietary supplements.

Big business

"So you had a really big business going of exporting into China of small parcels that did not attract any tax," says Coulter.

"The Chinese - and we would think the same - put a tax on this commerce because it had become very large."

Chinese authorities also introduced limits on how much infant formula or honey returning tourists could bring into the country.

"The net effect of those changes has been that the grey channels have slowed down," says Coulter.

"While Comvita was not directly affected by the dietary supplements rule changes, most of the people that we sold to also sold dietary supplements, so there was a big buildup of product at the border.

"The whole system slowed down and it has taken some time to get it back its feet."

Where now?

"The Chinese are pushing the market into more formal channels, although they do recognise that the e-commerce trade and the grey market is a significant and important part of developing their own economy," Coulter says. "They like the fact that high quality foods coming in helped their own companies to become more competitive from a quality perspective.

"Our view is that having business on the ground in China is an important part of our future. We embraced the daigou channel and it definitely had its place, but over the long term we are building a business in China that will sell our product."

Comvita last year placed some 2 million shares with China Resources Ng Fung, taking the Shenzhen-based Chinese food giant's stake from less than 5 per cent to around 9 per cent.

Coulter says partnering with China Resources - which has 4000 supermarkets in China - is an opportunity to increase its distribution in the republic.

The company is now "well set up" to sell to Chinese consumers.

"Certainly it's not the easiest place to trade, but it is certainly not the worst either, and the Chinese welcome product that is of high quality," Coulter says.

Manuka Health

Manuka Health NZ, the second biggest manuka honey producer, also acknowledges the grey channel's role in its success. The unlisted company's chief executive, John Kippenberger, says exports have been growing at 25 per cent a year, and the grey channel played a big part in that.

"Without a doubt it is an important part but there are a lot of other countries and geographies around the world that are continuing to do very well too," he says.

Kippenberger says the 11.9 per cent duty did slow business, as has talk of further regulation.

"When they came out with those announcements, the whole daigou channel was full of stock," he says. "Manuka honey and dietary supplements were caught up in the cross border system into China.

"When the Chinese Government started talking about regulation change, it put the brakes on that channel to a degree.

"We have now started to see that bottleneck of that large amount of stock start to work its way through the system," he says. Kippenberger expects sales to recover this year.

Chinese authorities have also talked about reviewing the manuka honey sector in New Zealand, as they did with infant formula in this country. "We think that will be positive for the industry," he says.

Formula implosion

Bellamy's, the Tasmanian infant formula company that was once the darling of the Australian share market, has endured a spectacular fall from grace, thanks in part to issues in the grey channel.

Part-way through December, the Australian and New Zealand dairy company A2 Milk, which has itself enjoyed a strong run, began to get caught up in the negative sentiment surrounding Bellamy's.

And in the big league, New Zealand co-operative dairy giant Fonterra has acknowledged there are people who buy its products from overseas supermarkets or specialty stores, then resell to consumers in China through online markets.

Fonterra's line is that it encourages consumers to buy its products through official channels.

In contrast, A2 Milk engages with the daigou channels and remains supportive of them.

The company, which this week announced a bumper first-half profit, said it continued to trade strongly based on strong demand for its formula.

"The outstanding aspect of our half-year performance was the continuing growth in A2 Platinum infant formula in both Australia and China, through a multi-channel strategy involving a combination of local distribution, e-commerce and overseas shopping - daigou - traders," it said.

Peter Nathan, A2's chief executive for Australia and New Zealand, said there was more to the infant formula market than A2's smaller competitors took into account.

"There has been a lack of appreciation from the broad market about the difficulty of successfully launching in the infant formula market," he said in a conference call for this week's result.

"There was a broad view that it was quite straightforward and that all you needed to do was have a product sourced from Australia or New Zealand and you would largely be successful, which has proved to be anything but the case.

"The depth of understanding required to use the daigou, and the other grey channels, has simply not been appreciated by the broader market," Nathan said.

The grey channel

• Success in China, with its 1.3 billion consumers, is the holy grail for any business.

• For many, the "grey" channel - or daigou - offers manufacturers a toehold.

• The typical daigou trader buys product from a retailer or wholesaler, packs it up into a parcel or a small pallet, and sends it to China for on-sale.

• It's been estimated that there are 40,000 daigous, operating with varying degrees of sophistication and scale, in Australia alone.

• The daigou trade has been big in Australasia - first for infant formula, followed later by manuka honey and health food supplements.

• Until last year, daigou traders could send product to the People's Republic and effectively circumvent a 17.5 per cent value added tax - China's version of GST.

• The trouble began when Chinese authorities slapped a 11.9 per cent tax on incoming daigou product last April.

• The daigou trade has played a big part of the success stories of small and not so small producers, and has been important to manuka honey producer Comvita.

• Trouble in the daigou channel has had a big impact on the earnings of a handful of second-tier stocks, here and across the Tasman, many of which had become high fliers because of hot demand from China.

• Among them, Bellamy's has endured a spectacular fall from grace, while Comvita has taking an earnings hit, as has dietary supplements company Blackmores. Alternative milk company A2 Milk - a strong advocate of the daigou channel - has emerged unscathed.

• The daigou experience has forced many companies to re-think how they do business in the People's Republic.

Bellamy's - what happened?

Bellamy's, once the darling of the Australian share market, was one of a handful of stocks that rocketed up on demand for infant formula.

The stock debuted on the ASX in August 2014 at A$1.30.

Investors bought into the hot demand story, taking the stock to a record A$14.99 by August last year.

Trouble began to surface later in the year when the company said it had experienced "temporary volume dislocation" in its China sales channels, which are adjusting for regulatory changeover.

Bellamy's share price slumped, and they were later suspended from trading at the company's request.

In a business update in January, the company said its revenue and profitability had been hit by lower-than-expected demand for its infant milk formula, which had also led to increased inventory levels, excess ingredients and shortfall payments to suppliers.
Bellamy's said it had responded by amending a key manufacturing contract with Fonterra and implementing measures to reduce production and better manage inventory.

Trade in the company's shares has since resumed, but chief executive Laura McBain has left the company.

Boardroom infighting has ensued, involving Kathmandu founder and Bellamy's investor Jan Cameron's attempts to oust the company's independent directors.

To top it off, Bellamy's faces a class action suit from disaffected shareholders.

Trade in the company's shares has since resumed, and the stock was last quoted at just A$4.80.

According to one market source, many players - Bellamy's included - did not understand the relationship between the cross border e-commerce channel and the daigou.

"What happened with Bellamy's was that they ended up selling a lot of product to traders who could not actually move it."

Before April, there was significant momentum for online platforms JD.Com and T.Mall, which allow anyone to open a store.

"Then there was the new tax in April - some of them became less competitive and could not move the product through the customers they thought they could. Some of them dumped product on the daigou market and collapsed the price," says the source.

"Those daigous who were previously making money were no longer making money because they had bought product at a higher price, leading to a backlog of inventory.

"Once they started to collapse the price, the likes of Bellamy's lost its attraction ... if the brand loses it lustre, in the eyes of the daigou, then they jump off and move to something else."

He says Bellamy's mismanaged the channel "to a significant extent".

"If you are a small and unsophisticated player, it would be easy to get sucked into the vortex because China is a complex market and the end user is only a couple of steps (in the process) away," he says.

"When you are in a sweet spot, everyone wants to buy your product ... you might end up selling to others who may or may not have a legitimate end user to sell to ... if they can't make a quick dollar, they will dump it."

Harbour Asset Management analyst Oyvinn Rimer says problems in the daigou channel are one of a number of issues facing Bellamy's.

"If you don't service that demand well, then they can turn on you quite quickly."