Dairy giant Fonterra is expected to have control of its supply chain in China. But is that reasonable given the extraordinary amount of consumer fraud in that country?

Fonterra has launched an internal probe into the fraudulent sale of 300 tonnes of its bakery products in China that had passed the expiry date.

It is not alone in facing problems with distributors in China. Zespri became engulfed in a double invoicing scam involving one of its distributors. All multinationals face these problems.

The dairy company said yesterday: "Fonterra provides guidelines to the customers we sell products to directly on how expired or damaged product should be managed in a responsible way and we expect these to be adhered to. In this case, it seems the issues have occurred much further along the supply chain, not with a direct customer."


But that may not be strictly on point when the linkages between one of its distributors and those "much further along the supply chain" are probed.

Jiawai's former general manager, Minggang Liu, has been singled out as the prime culprit - the alleged mastermind of the expired bakery product scam who has been arrested in Shanghai as part of a 19-strong ring.

I've met the personable Liu before.

In fact, in April I invited him - on the suggestion of a New Zealand-based consultant to the New Hope conglomerate - as one of my guests to a business luncheon in Shanghai during the Prime Minister's visit.

The intention was to learn more about the increasing activities of New Hope and Jiawai in New Zealand.

If Liu was already feeling the heat from the Shanghai authorities' raids of various entities selling the expired Fonterra-originated product, he wasn't showing it.

He talked knowledgeably about Fonterra and was well known to several of the Shanghai-based New Zealand dairy players at the luncheon. But within weeks he had resigned as general manager of Jiawai for "personal reasons".

The term "personal reasons" is frequently used euphemistically in China if business people step down when under investigation for alleged frauds or embezzlement.


This was the case with the charismatic Guo Benheng, who led Bright Dairy & Food's $82 million investment in Synlait Milk after the global financial crisis scared off New Zealand investors.

This expired dairy product fraud does raise questions for Fonterra.

Fonterra's president of NZMP for Greater China, Teh-Han Cho, said late yesterday the company had entered into an authorised distributor agreement with Jiawai in March 2016.

"It is our understanding from reports that part of the current investigation in China relates to Fonterra product that a former Jiawai employee may have onsold to others prior to our contract with them," he added. "Because we aren't part of the official investigation we have very limited access to the real facts and need to be overly cautious.

"As a result we've suspended Jiawai's status as an authorised distributor."

Extraordinarily enough, even though the alleged scam involves expired Fonterra product, the company has not had official notification of the inquiry as it is not a part of it. It found out through Chinese media reports on Sunday.

Nor does it have any information about which products are involved in the investigation - whether the so-called expired "bakery products" are whole milk powder/skim milk powder, butter, cheese or other bakery products. Or even whether they were marketed under Fonterra brand names after the expiry dates.

It has been assumed the expired product was whole milk powder. If so, the expired product was roughly equivalent to 0.1 per cent of Fonterra's milk power exports to China in 2015.

As Professor Keith Woodford wrote this year: "The 2015 calendar year was indeed a quiet one for China's milk powder imports, with whole milk powder imports declining to 347,000 tonnes after purchasing 619,000 tonnes in 2013 and 671,000 tonnes in 2014. Nearly all of this whole milk powder came from New Zealand."

Piecing together exactly what has occurred in China is complex and made harder by the web of interwoven companies.

But from the various Chinese news and official statements - and some press statements subsequently issued by Jiawai and its parent company yesterday - the scenario goes something like this.

Jiawai bought bulk Fonterra bakery products to distribute in China for food manufacturing by other companies. When it was clear the bakery products had reached expiry date, or couldn't be used for food manufacturing because the expiry date was approaching, they were onsold to another company by Liu for use in animal feeds to reduce Jiawai's losses.

(Note that this has subsequently been disputed by Fonterra, which suggests the sales may have occurred before it opened a supply arrangement with the New Zealand company in March.)

Where it gets complex is that another "family company" that Liu previously founded and retained linkages with then bought some Fonterra expired product off the animal feed company. Liu's family company then onsold the expired product to various other entities which repackaged it and sold it online as if it was viable material that was still within the expiry date.

Since Shanghai authorities announced the result of their investigation, Jiawai and New Hope's parent has joined the chorus of condemnation over Liu's alleged actions. The Chinese conglomerate has also moved to take control of its distribution supply chain in China, taking over management of Liu's family company. It is not clear whether the Chinese conglomerate has all along held an investment in the Liu family group.

What they have stressed is the importance of food safety, saying "the interests of consumers cannot be violated".

They have strongly condemned Liu's "personal violations" and said they now have full responsibility for the company.

It is clear that if Fonterra has supply chain issues, then so does the Chinese conglomerate.

It is notable that it is Fonterra's name used in the official statements but that Liu's bosses and overseers are not mentioned.