'Realities' to set in for a2 Milk in China as competition grows and an adult market beckons

Things could be about to get tougher in China for sharemarket darling a2 Milk. Photo / File

Things could be about to get tougher in China for sharemarket darling a2 Milk, with Chinese competition for the infant formula market cranking up and a forecast that within two years adults will be dipping into a growing pool of A2-type milk.

China marketing specialist Michael Norris of AgencyChina said at least six other infant formula producers are adding A2 milk to their China offerings, including foreign food giants Nestle and Danone, Nestle subsidiary Wyeth, and fast-growing Chinese dairy company Junlebao.

He expected A2 milk pools in China to grow and dairy companies to at last realise that many Chinese adults are lactose-intolerant, opening a whole new market for A2 milk, which he expects to kick off within 24 months with a performance/sports category.

This raised the question of whether A2 milk was on the way to commoditisation, with a consequent squeeze on price margins.

While New Zealand-founded a2 Milk led the category in China and had an advantage of being able to sell in stores, "some realities are going to set in" for the company, said Norris.

The a2 Milk website says it has product in 16,400 Mother and Baby stores in China. Norris said its competitors are restricted to selling online because they have yet to get the necessary registration for physical distribution.

He also noted a2's competitors had multiple product lines while the NZX- and ASX-listed company had only one infant formula line.

As research and strategy manager at AgencyChina, Norris said he spent a third of his time talking to Chinese consumers in their homes to get insights to help global clients differentiate their product in China's crowded market.

He believed a2 Milk could come under pressure to lower its prices a little. Its Chinese label infant formula costs about $20 more a tin than the next offer from Wyeth, he said. A2 Milk also offers an English-label infant formula.

"It may also find the need to go back to the R&D lab and come back with a new formula or increase the product line".

A2 says it has 6.4 per cent of the China infant formula market in dollar terms.

The company responded to a Herald invitation to comment on Norris' claims with a statement which failed to directly address most of them.

The statement, attributed to a spokesperson, said "competition in China is not new".

"We have been anticipating and preparing for increased competition in the market for some time. Our view is that China is an extremely attractive market and will continue to be. Also, the issue of competition from other A2 products in China is not new. Given this backdrop, particularly in the past two years, we are pleased with how we have performed.

"We consider our first mover advantage as the pioneers and experts in A2 protein knowledge, our single-minded focus, and our unique, modern and premium brand will continue to strengthen our brand position irrespective of existing and new entrants. Since 2000 we have been the only player making meaningful investments in scientific research and education of the differences between the A1 and A2 beta casein protein types.

"We will continue to evolve and connect with our consumers through communication programs to build our unique and modern brand proposition and our growing product portfolio."

The past six months have been bumpy for a2 Milk.

This month the Herald reported chief technical officer Phil Rybinski had left the company after just a year in the job. He was appointed by previous chief executive Jayne Hrdlicka, who in a surprise move stepped down in early December after just 18 months at the helm.

Geoff Babidge, largely credited with turning the company into today's multibillion-dollar business, is back as chief executive and managing director in an interim arrangement.

Norris is an Australian who has worked in China since 2017, and before that was a Prime Minister's scholar there in 2014. He said institutional investors ask him a lot about the potential commoditisation of A2 milk in China.

"My answer is I think the days of super fat margins in infant formula are gone. There will be more and more price convergence in the premium space.

"I'm not saying the premium price point will go away, but rather brands will converge around the same price bracket. And that will have some margin pressure."

Whether the "big shift" into adult products which he predicts for A2-type milk will create premium prices depends on how the Chinese A2 milk pool grows, he said.

"If they scale really quickly and there are abundant pools inside China then I think your big dairy players domestically, like Mengniu and Yili, will have a good crack at A2 at scale."

The pathways to premium dairy products in China are organic milk, A2, and goat and sheep milk, he said.

Geoff Babidge is back as chief executive and managing director in an interim arrangement. Photo / Supplied

"It's not just a competition within A2; all these different propositions are gaining good traction and around the same time. What is going to be the next mental shortcut for 'premium' in the mind of the Chinese consumer? That's the $64,000 question."

Norris said the Chinese domestic dairy industry was on the rise.

"When you see the stats or look at the infant formula market, you will find some of the international firms are losing ground relative to these Chinese domestic competitors who have more or less shrugged off the taint [contamination] scandal and are advancing in terms of quality and technical excellence."

Domestic companies getting savvier about marketing and distribution in China will drive up the cost of doing business there, he predicts.

"You'll be having to spend more to hire better staff and have to take all these initiatives and actions to be able to keep your position, let alone extend it."

Norris said two new Chinese companies in particular had enjoyed explosive growth in the infant formula market.

One was Junlebao, an A2 competitor, which offered "budget nutrition" and the other was Feihe, more premium and with no discounting, ever.

They both had "clean sheets" on food safety and their growth illustrated a growing acceptance of Chinese producers by Chinese consumers.

On his prediction there would be a market push into "general purpose" daily A2 dairy within two years, Norris said the extent to which lactose intolerance and stomach discomfort was a barrier to dairy consumption in China was not well-realised.

Development of the A2 market for senior consumers would be slower to kick off than the sports or "performance" market because dairy companies, especially foreigners, hadn't marketed well to the retiree bracket.

"But performance nutrition ticks all the boxes - it's high margin, there's a clear need for it ..."

Dairy companies in China, already exploring products for children up to pre-school age, would also realise that Chinese mothers wanted the right nutrition for their children up to puberty, he said.

"So the idea there is a more daily nutrition variance is coming through the market. It's just a question of how best to meet consumer need - is it fresh, is it UHT, is it family share like a milk carton? There are a few things to work out."