Voluntary Report - public distribution

**Date:** March 28, 2006

**GAIN Report Number:** CH6603

CH5615

**China, Peoples Republic of**

**Dairy and Products**

**Market survey of South China Dairy Products**

**2006**

**Approved by:**

![](media/image1.wmf)Keith Schneller

US ATO Consulate Guangzhou

**Prepared by:**

Lorilee Schultz

**Report Highlights:**

China's dairy industry is undergoing a "white revolution" as demand for
dairy continues to rise and extensive restructuring takes place on the
supply side. Dairy sales reached \$9.5 billion in 2005 and are expected
to grow rapidly as per-capita dairy consumption continues to rise. Fluid
milk sales are at the forefront of this growth, followed by ice cream,
yogurt and cheese. As demand increases, fierce competition among China's
1,600 processors has forced many local and international companies out
of the market. In 2005, the U.S. became the second largest exporter of
dairy products to China with sales of \$60.5 million.

Includes PSD Changes: No

Includes Trade Matrix: No

Unscheduled Report

Guangzhou \[CH3\]

\[CH\]

Table of Contents

I. Executive Summary 3

II\. China's White Revolution: The Growing Demand for Dairy 4

III\. Introduction to South China 5

IV\. Consumption levels in China: The Rural/Urban Divide 6

V. Dairy Product Profiles 7

> A. Fluid Milk 7
>
> B. Soy Milk 8
>
> C. Powdered Milk 8
>
> D. Yogurt 8
>
> E. Ice Cream 9
>
> F. Cheese 9

VI\. Product Price and Packaging 11

VII\. Consumer Buying Habits 12

VIII\. Fierce domestic competition drives out foreign investors 12

IX\. Local supply continues to grow 13

X. Labeling laws impact reconstituted milk 13

XI\. U.S. becomes second-largest exporter to China 14

XII\. Contact Information 15

Appendix: Effective Tariff Rates 16

South China Dairy Products Market Profile

**I) Executive Summary**

China's dairy industry is rapidly changing as demand for dairy continues
to rise and extensive restructuring takes place on the supply side.
Dairy sales reached US \$9.5 billion in 2005, reflecting a more than 70
percent hike since 2000. This growth is expected to continue at an
annual pace of eight to nine percent through 2010.

At just 13 kg, China has one of the lowest per-capita dairy consumption
levels in the world. Contrary to popular belief, it is low incomes, and
not lactose intolerance, that has traditionally been a detriment to
dairy product purchases. But rising incomes, changing lifestyles, higher
quality products and improved availability are helping consumption
levels to skyrocket. In fact, industry experts predict dairy consumption
could double in the next ten years.

Fluid milk is the leader of China's growing consumption habits. Retail
sales have expanded by 215 percent since 2000, reaching nearly \$4.1
billion in 2005. Growth in sales of milk powder is slowing, but ice
cream and yogurt sales continue to increase at a rapid pace. Sales of
cheese last year grew 18 percent over 2004 to reach \$49.7 million,
making it a small but rapidly emerging dairy market.

While demand is on the rise, China's dairy industry is also presented
with many challenges. Recent food safety scandals and continuing price
wars have plagued the industry and many of the country's 1,600
processors struggle to make a profit. International players have
experienced similar challenges, and have also found it difficult to tap
into China's intricate distribution networks.

New labeling laws may also impact the sale of several dairy products.
Effective October 1, 2005, "The General Rule on Labeling of Pre-Packed
Foods -- GB7718-2004" requires that all fluid milk products containing
reconstituted milk (as much of the country's yogurt, ice cream and even
UHT milk does) must state "reconstituted" and indicate percentages of
milk. Already, some European-branded yogurt products have had to drop
prices due to lower demand for their reconstituted products. Also,
pasteurized, non-UHT milk, is no longer allowed to be labeled as "fresh"
and can only be labeled as "pasteurized" or "pure."

The U.S. now ranks second in the world for dairy exports to China, with
sales of \$60.5 million in 2005. Sales volume reached 83,350 MT, up 12
percent from 2004. Strong U.S. exports are expected to persist, as the
devalued U.S. dollar and reduced dairy subsidies in the EU will also
continue to favor imports of U.S. products. China is now seventh largest
market for U.S. dairy products by value and ranks tenth in terms of
export volume.

**II) China's White Revolution: The growing demand for dairy**

China's dairy industry is undergoing a "white revolution" as demand for
dairy continues to rise and extensive restructuring takes place on the
supply side. Dairy sales reached US \$9.5 billion in 2005, reflecting a
more than 70 percent hike since 2000. This growth is expected to
continue at an annual pace of eight to nine percent through 2010.

Traditionally, dairy has not played a big role in Chinese diets,
especially in the south, and this is reflected in the country's low
consumption levels. In fact, at just 13 kg, China's per-capita
consumption of dairy products is one of the lowest in the world. It is
roughly one-third the Asian average of 35 kg, significantly lower than
the world average of 100 kg, and far behind the nearly 300 kg per person
consumption level of some developed nations. But it's growing fast.
Per-capita consumption has more than doubled since 1995 and analysts
predict it could double again by 2015. Multiple that additional 13 kg
per person by China's 1.3 billion people, and that's a lot of milk.

There are many factors contributing to China's burgeoning demand for
dairy. One of the most significant may be the rise in disposable
incomes, which have expanded twofold over the last decade. Thanks to the
favorable income elasticity of dairy products in China, a small growth
in income corresponds to a significant boost in consumption.

Consumers are also becoming more health conscious and are attracted to
the many positive attributes of dairy products. A larger share of the
public now values dairy as a good source of energy, protein and calcium.
While dairy sales are seeing across the board increases, some of the
biggest growth categories are reduced fat milk and products fortified
with vitamins and minerals.

The government likewise recognizes the importance of dairy in the
Chinese diet. As a result, it has initiated school milk programs aimed
at increasing consumption among children. These programs reached more
than 15 million students in 2005. It also has a military milk program
and recently aired a series of programs on state-run television focusing
on the benefits of dairy consumption.

These factors have helped transform the perception of dairy as a
supplemental food for the elderly and ill to an everyday staple for all
age groups. Also, many historical barriers to milk consumption have been
greatly reduced- namely, high prices, poor refrigeration and limited
production in southern coastal areas. The introduction of shelf-stable
UHT milk has been a tremendous boon to the industry, eliminating the
need for cold-chain distribution and facilitating the movement of fluid
milk from concentrated production areas in the north to population
centers in the south.

At the same time, prices are declining and cold-chain distribution for
fresh milk, yogurt and ice cream is slowly improving. A wide selection
of dairy products- including both fresh and UHT-preserved milk,
creatively flavored yogurt drinks, and a plethora of novelty ice creams-
is now available from supermarkets, convenience stores and home delivery
services in metropolitan areas across China. At home, more than 90
percent of urban households own refrigerators, providing the ability to
properly store high-quality milk and dairy products.

But other challenges hinder China's dairy prospects as well. For
starters, many Chinese are lactose intolerant. Although much debate
exists about the actual number, estimates show as many as 60 to 90
percent of Chinese people may lack the enzymes necessary to properly
digest milk and its products. But there is some belief that the
discomfort many older Chinese initially feel after drinking results
because they are not used to processing these enzymes, not having
regularly digested lactose since birth like many Westerners. A gradual
introduction of dairy into the diet and consuming easy-to-digest
products such as yogurt may help dampen the effects of this problem.
Young Chinese, for example, can be seen on the weekends enjoying various
dairy products including ice cream and flavored yogurt. Fruit smoothies,
which often include dairy ingredients, are also becoming increasing
popular with young people.

Recent food safety scandals have also shaken consumer confidence in
dairy products. Just in the last five years, rumors of reprocessing
expired milk, pre-dating products and adding water to milk have brought
the safety of many dairy products into question. Powdered milk infant
formula suffered especially hard following a case where several babies
died from malnutrition after drinking formula with no dietary value.
Crisis management following these scandals was slow and several major
companies suffered serious losses. In the future, crisis prevention and
brand management issues will be paramount to maintaining consumer trust.

# III) Introduction to South China

According to recent AP estimates, China is poised to become the world's
second largest retail goods market behind the United States by 2020. The
six-province region that makes up South China is home to 22% of the
nation's population, or 281 million people. Comprised of Fujian,
Guangdong, Guangxi, Guizhou, Hainan and Hunan provinces, South China has
long been at the forefront of the nation's rapid economic development.
In fact, it was the first region in China with liberalized markets after
reforms in the late 1970's.

Five Special Economic Zones (SEZs) -- free trade zones which allow and
encourage foreign investment and provide trade incentives -- exist in
the region: Shenzhen, Zhuhai and Shantou in Guangdong Province; Xiamen
in Fujian Province; and Hainan Island. These coastal SEZs along with the
industrial metropolis of Guangzhou all boast relatively high per-capita
incomes and growing populations of sophisticated, white-collar
consumers.

Guangdong Province's proximity to Hong Kong also contributes to the
growing modernization and westernization of its urban residents.
Historically, foreign products could not be imported directly to the
mainland. These goods often traveled through Hong Kong first.
Consequently, Guangdong's residents have long enjoyed high-end imports,
and supply chains from Hong Kong to Shenzen and Guangzhou are well
developed. As incomes continue to rise and the middle class continues to
grow in South China's coastal cities, the demand for premium goods is
expected to increase as well. Additionally, supply chains through
Guangdong and Fujian to locales farther inland are helping to modernize
cities such as Hunan's Changsha, where the market for high-end imports
is smaller but growing. As these supply chains improve, dairy product
availability will likely expand further into second and third tier
cities.

When it comes to dairy consumption, there are several characteristics
that set South China apart from the rest of the country. Actual dairy
consumption by both rural and urban households in the region is somewhat
less than the national average. This is likely due to differences in
traditional diets; also, comparatively high consumption levels in
Beijing and Shanghai have raised the national average.

Consumption of imported dairy products is quite high in south China. For
example, research from the Center for Agricultural and Rural Development
(CARD) indicates that roughly 66 percent of households in Guangzhou have
purchased imported dairy products, citing cost, availability and safety
as the major reasons for doing so[^1]. The same report revealed that
Guangzhou residents tend to buy more milk powder but significantly less
fluid milk than their Beijing and Shanghai counterparts. The study also
discovered that children account for a larger percentage of consumption
in Guangzhou households than their parents, a positive sign for future
dairy sales in the region.

**IV) Consumption levels in China: The Rural/Urban Divide**

![](media/image2.wmf){width="3.0in" height="2.2838582677165356in"}A huge
divide exists between urban and rural China, and understanding the
differences between consumers is a key issue for American exporters
wishing to penetrate the Chinese market. In 2004, the reported average
urban per capita income was US\$1163 (up 11.2 percent from 2003), while
the reported average rural per capita income was only US\$362 (up 12
percent from 2003). The similarity in growth rates is a promising sign
for the future development of rural China, but the fact that urban
incomes more than triple rural incomes testifies to city-dwellers' large
relative purchasing power.

As disposable incomes rise, consumers, both urban and rural, are
spending a smaller percentage of their income on food. In 2004, urban
consumers spent 28.8 percent of disposable income on food, compared to
31.4 percent in 2000. Over the same time period, food expenditures for
their rural counterparts have decreased from 36.4 percent to 35.1
percent. But because good meals signify prosperity in China, actual
spending on food and dairy products continues to rise.

Both urban and rural per-capita dairy consumption have experienced
explosive growth in recent years. Reaching 18.83 kg in 2004, per-capita
urban consumption increased 89.4 percent from 9.94 kg/person in 2000.
Over the same time period, per-capita rural consumption rose 86.8
percent from 1.06 kg in 2000 to 1.98 kg in 2004.[^2] While both rural
and urban per capita consumption increased at a similar pace
percentage-wise, there is still a huge gap in consumption levels.

# 

# TABLE 1: Urban and Rural Food Expenditures by Region

  -------------- ------------- -------------- ------------ ----------- ---------- ------------ -------------- ------------
  Region         Urban                                                            Rural\*                     

                 Per Capita    Per Capita     \% of        Per Capita  \% of Food Per Capita   Per Capita     \% of
                 Disposable    Food           Disposable   Spending on Expen-     Disposable   Food           Disposable
                 Income (USD)  Expenditures   Income       Dairy (USD) ditures    Income (USD) Expenditures   Income
                               (USD)                                                           (USD)          

  **National**   **1163.16**   **334.52**     **28.8%**    **16.34**   **4.9%**   **362.52**   **127.40**     **35.1%**

                                                                                                               

  Fujian         1379.68       419.09         30.4%        19.92       4.8%       504.86       173.89         34.4%

  Guangdong      1682.43       488.06         29.0%        15.73       3.2%       539.00       195.27         36.2%

  Guangxi        1072.84       336.68         31.4%        12.39       3.7%       284.60       129.33         45.4%

  Guizhou        903.96        279.07         30.9%        10.69       3.8%       212.54       93.13          43.8%

  Hainan         955.03        336.15         35.2%        10.51       3.1%       347.85       126.90         36.5%

  Hunan          1063.89       306.12         28.8%        12.16       4.0%       350.34       165.27         47.2%

                                                                                                               

  **South        **1176.30**   **360.86**     **30.7%**    **13.57**   **3.8%**   **373.20**   **147.30**     **39.5%**
  China**                                                                                                     

  Source: 2005                                                                                                 
  China                                                                                                       
  Statistical                                                                                                 
  Yearbook                                                                                                    

  \*Statistics                                                                                                 
  not available                                                                                               
  for rural                                                                                                   
  dairy spending                                                                                              

  1 USD=8.1 RMB                                                                                                
  -------------- ------------- -------------- ------------ ----------- ---------- ------------ -------------- ------------

There are several explanations for this disparity. Distribution is much
more limited in rural areas. Also, while roughly 90 percent of urban
households own a refrigerator, less than 18 percent of their rural
counterparts own the appliance. In urban areas, consuming dairy is
considered chic, healthy, and a sign of affluence. Therefore, it is not
surprising that the majority of Chinese dairy consumption takes place in
metropolitan areas, where the urban middle and upper classes comprise
the vast majority of the market for retail fluid milk sales. U.S.
exporters who want to introduce their products on the mainland may find
success most easily in the coastal cities of China. McDonalds, KFC and
Häagen Dazs are already experiencing great success in these areas with
sales of ice cream products.

**V) Dairy Products Profiles**

Dairy products in South China continue to evolve, responding to
consumers' ever-changing lifestyles. Health is a growing concern among
consumers, so it's no surprise that sugar free, low-fat, and vitamin and
mineral fortified products are quickly becoming popular. This report
summarizes trends among the biggest categories for dairy sales in China.

**Fluid Milk: The battle between UHT & "fresh"**

With a 215 percent increase in retail sales volume since 2000, fluid
milk is one of the fastest-growing dairy segments in South China. Sales
in 2005 approached \$4.1 billion. But the market for fluid milk is also
characterized by low margins and stiff competition. One of the major
ongoing battles is between UHT and "fresh" fluid milk products.

The majority of UHT milk is produced in the north tends to have a higher
gross profit rate because it benefits from a longer shelf life and
cheaper, easier distribution. Fresh chilled products are produced more
locally, as close proximity to major population centers eases
transportation demands of these perishable products. In South China,
northern UHT giants Yili and Mengniu have managed to capture a large
share of the fluid milk market, largely due to their vast distribution
and marketing resources.

Currently, UHT milk accounts for roughly two-thirds of all fluid milk
sales nationwide. But fresh milk has the potential to stage a comeback.
Consumers in South China traditionally value freshness and many are
switching to fresh milk as it becomes more readily available. This
advancement in availability and quality is a result of improved
cold-chain distribution channels.

Recently the marketing of fresh milk has caught a snag. On October 1,
2005, the government's "General Rule on Labeling of Pre-Packaged Foods
-- GB7718-2004" was put into effect. This law prohibits the labeling of
pasteurized, non-UHT milk as "fresh." Only raw milk can be labeled as
"fresh." Instead, non-UHT milk must be labeled as "pasteurized" or
"pure," terms that convey no image of freshness to Chinese consumers.
Some processors are fighting to change this regulation, but the future
of the law remains uncertain.

As a whole, the fluid milk market has benefited from consumers switching
from powdered to fresh milk. While the entire fluid milk market is
expanding rapidly, some of the biggest gains may come from reduced-fat
milks as consumers become more health-conscious. Newly introduced
low-lactose milk is also growing in interest.

**Soy Milk: A sizable but stable market**

With 2005 sales of over \$440 million, soy beverages compose a
significant portion of the dairy products market. In South China, many
consumers purchase freshly made cups of soy milk from street vendors for
a quick breakfast on the way to work. At the same time, many younger
consumers dislike the distinctive soy bean-like taste of soy milk and
opt for flavored soy drinks instead. As a result, companies like Bright
Dairy and putting more effort into developing new soy milk products.
According to Euromonitor statistics, sales over the next five years are
expected to increase at a stable pace of less than 5 percent each year,
significantly behind growth of other dairy products.

**Powdered Milk: Still a mainstay, but growth is slowing**

Sales of milk power reached \$1.6 billion in 2005. This signifies a 9.7
percent gain over 2004, and a total increase of nearly 50 percent since
2000. The long shelf life, low cost and ease of preparation make it an
attractive product for many consumers. However, the market for powdered
milk is relatively mature compared to other dairy products, and growth
is expected to slow over the next five years. Growth that does occur
within this category will be driven by the introduction of fortified
milk powders targeting the elderly, pregnant women and women.
Penetration into rural markets will also play a key role as more urban
consumers switch to fresh milk.

**Yogurt: Health benefits and fun flavors spur growth**

Another fast-growing product in China is yogurt. It has grown at an
annual rate of 23 percent since 2000, with the largest gains coming from
fruited and drinking yogurt. Sales in 2005 totaled \$582 million. Yogurt
is an attractive product for many companies, as the profit margin is
typically much higher than for fluid or powdered milk. It's also a much
harder market to enter, due to the advanced production techniques
needed. As a result, there is slightly less competition among yogurt
than many other dairy products.

As the yogurt market continues to expand, many new yogurt products are
introduced each year. Recent popular additions are fruited yogurts,
sugar-free yogurt, and bio-drinking yogurt. Bio-yogurt claims to improve
intestine function and aid in digestion. Many of these products are
especially popular among middle-class working women.

Fruited yogurt sells at a small premium to flavored yogurt. The most
popular flavors in 2005 were strawberry, peach, blueberry, pineapple,
orange, grape and aloe. Part of the attraction to aloe yogurt comes from
its high vitamin E content, which has been linked to better skin health.
This example illustrates the growing interest in multi-function health
foods.

**Ice Cream: Poster child for Chinese dairy consumption**

Ice cream can be found virtually everywhere in South China from
convenience stores to fast food outlets and from supermarkets to street
vendors, making it one of China's most visible signs of dairy
consumption. In 2005 alone, sales of dairy ice cream totaled nearly \$2
billion. Thanks to its strong economy and long, hot summers, South China
boasts the highest per-capita consumption of ice cream in the country.
Sales in the region have expanded by over 56 percent since 2000 and are
expected to gain an additional 40 percent by 2010.

No longer a seasonal treat, ice cream is now positioned as a year-round
snack food. Sales are exploding, and they're doing it one cone at a
time. Impulse buys of single-serving ice cream account for an
astonishing 98 percent of sales in this vast and growing market.
Although enjoyed by young and old alike, ice cream is especially popular
among China's single-child population. This demographic flocks to
freezer cases, spending one to two yuan (US 12-25 cents) for an ice
cream treat. It is clear that these cheap, convenient products are
favorites, as purchases of ice cream for 2 yuan or less account for
roughly 80 percent of total ice cream sales.

While inexpensive local brands dominate the market, premium
international brands enjoy a small but growing market among affluent
white-color workers in the region. The same is true for take-home ice
cream products. Take-home ice cream is a relatively new concept in
China, but its small demand is rapidly growing through supermarket sales
in big cities.

Traditional ice cream flavors like chocolate and vanilla are mainstays,
but trendy new flavors with fun names seem to spur sales. Recent
fashionable flavors include aloe, cappuccino, milk tea and various
fruits. Traditional flavors such as red bean are also common.

In addition to dairy ice cream, water "ice cream" is also very popular
with consumers, especially during the summer months. In fact, water ice
cream sales in 2005 totaled \$1.6 billion. While water ice cream sales
are expected to continue at a healthy pace, many consumers are switching
to more nutritious, higher-quality dairy ice cream.

**Cheese: A niche market with explosive growth**

Cheese is not a food found in traditional Chinese diets, and it has only
recently been made available on the market. Consequently, cheese is a
tiny market in China, with sales of just \$49.7 million in 2005. As the
Chinese become more familiar with cheese, largely thanks to exposure at
Western fast-food giants McDonald's, KFC and Pizza Hut, sales are
growing rapidly. In fact, 2005 sales jumped 18% from 2004, marking a 123
percent increase since 2000. Volume of cheese sales for the year reached
4,160 MT.

Despite this remarkable growth, cheese is still very much a niche
market. Per-capita consumption of cheese in China is about one-third of
a pound- less than one percent of U.S. cheese consumption. A big
challenge to marketing cheese is that many Chinese find it hard to
digest. There is also limited product availability, especially in rural
areas, and cold-chain distribution is relatively undeveloped.
Furthermore, many people simply don't know what to do with it.

Processed cheese currently dominates the retail market, while
unprocessed cheese is relegated to expatriate stores, high-end grocers
and select foodservice channels. Spreadable cream cheese makes up
roughly a third of this market; the rest is composed mainly of processed
cheese slices. Although most cheese is imported from Australia and New
Zealand, Chinese companies such as Bongrain Foods and Bright Dairy are
now offering cheeses locally produced, or at least locally packed. These
local products, marketed under the Pikifou and Bright labels, enjoy an
advantage in retail price and market presence. They are also taking the
lead in consumer education, a key to sustaining market growth.

Still a market in its infancy, there are many promising signs for
continued growth. Cheese continues to grow in popularity, especially
among urban young people who enjoy Western lifestyles. It is also making
strides among health-conscious consumers, particularly women looking for
an easy, tasty way to increase calcium and protein intake levels for
themselves and their children.

As demand continues to rise, opportunities will expand for cheese
importers. China has little experience in cheese-making and in most
cases lacks the expertise and high-tech equipment necessary for
production. Also, China's entry into the WTO has drastically reduced
import tariffs, making imported cheese more affordable to consumers.

**FIGURE 3**

![](media/image3.wmf)

\*Includes soy beverages, coffee whitener, flavored milk drinks and
condensed/evaporated milk

Source: Euromonitor

**VI) Product Price and Packaging**

Product packaging is very important to Chinese consumers. Food safety is
a major concern, as well as quality and freshness. Consumers demand
packaging that can deliver these characteristics but is also convenient.
Moreover, many Chinese consumers still prefer to buy single-serving
containers of dairy products like fluid milk, yogurt and ice cream,
despite cost savings from more bulk purchases. This is in line with the
Chinese custom of shopping daily and buying small quantities of food at
a time, resulting from a value for freshness as well as space and
storage constraints.

The table below summarizes price and packaging information from
convenience stores, neighborhood supermarkets and hypermarkets in and
around downtown Guangzhou. The table is merely meant as an overview of
some common dairy products in South China, and is by no means an
exhaustive or omniscient listing.

TABLE 2: Survey of South China Dairy Products

  ------------- -------------------------- ------------- ---------- ----------
  **Product**   **Packaging**              **Size**      **Price    **Price
                                                         Range      Range
                                                         (RMB)**    (USD)**

  ** **         ** **                      ** **         ** **      ** **

  **UHT Milk**  Tetra pack aseptic carton  250 ml        1.60 -     .20 - .40
                                                         3.20       

                Tetra pack aseptic carton  1 L           4.60 -     .57 - .84
                                                         6.80       

                                                                     

  **Fresh       Gable-top carton           200 ml        2.30 -     .28 - .43
  Milk**                                                 3.50       

                Gable-top carton           946 ml        6.50 -     .80 - 1.17
                                                         9.50       

                                                                     

  **Soy Milk**  Plastic Bottle             1.5 L         10.00      1.23

                                                                     

  **Powdered                                                         
  Milk**                                                            

  Unfortified   Plastic bag                400 g         12.20 -    1.51 -
                                                         15.50      1.91

  Fortified     Plastic bag                400 g         17.50 -    2.16 -
                                                         24.50      3.02

                                                                     

  **Yogurt**    Plastic bottle w/          650 ml        6.00 -     .74 - 1.17
                screw-top lid                            9.50       

                Individual plastic cup w/  150 ml        1.80 -     .22 - .37
                foil lid                                 3.00       

                                                                     

  **Ice Cream**                                                      

  Novelty       Individual cones, cups and 80 - 100 g    2.00 -     .25 - .99
                stick desserts with paper                8.00       
                or plastic wrapper                                  

  Domestic,     Plastic tub                250 g         4.90 -     .60 - 1.48
  Standard                                               12.00      

  Imported,     Cardboard carton           392 g         75.00 -    9.26 -
  Premium                                                95.00      11.73

                                                                     

  **Cheese**                                                         

  Processed     Individually-wrapped in    12            24.50 -    3.02 -
  Slices        plastic                    slices/250g   25.70      3.17

  Cream Cheese  Plastic tub or             250 g         22.00 -    2.71 -
                foil-wrapped in cardboard                29.80      3.68

  Imported      Plastic-wrapped block      250g          25.00 -    3.09 -
  block                                                  29.80      3.68

                                                                     

  **Butter**    Wax paper in cardboard box 227 g         6.80 -     .83 - 1.65
                                                         13.40      

                                                                     

  \*1 USD = 8.1                                                      
  RMB                                                               
  ------------- -------------------------- ------------- ---------- ----------

Price has long been a barrier to milk consumption, which is not
surprising considering the cost of dairy products relative to other
foods. In fact, while many foods in China cost less than half their U.S.
counterparts, dairy product prices in China are often similar or even
higher than those in the U.S. UHT milk, for example, costs roughly the
equivalent of \$3.00 per gallon. Fresh milk, on the other hand, is
usually more than \$4.00 per gallon. At about \$2.50 per gallon on a
reconstituted basis, powdered milk is the cheapest milk option. To put
some of the other products into perspective, cheese costs the equivalent
of over \$5.50 per pound, while butter is around \$2.50 per pound and
yogurt costs \$.75 cents to \$1.00 per pint.

**VII) Snapshot of Consumer Buying Habits**

CARD's dairy survey[^3] provides a good snapshot into the buying
patterns of the urban Chinese consumer. On average, today's consumers
purchase milk three times a week, buying four to five single-serving
packages at a time. Other packages are purchased less frequently,
roughly once or twice every two weeks. Households far away from city
centers or those with elderly residents buy more milk powder, while
yogurt is most popular with younger, well-educated consumers. Ice cream
is favored in households with children and younger parents.

Location of purchase is also important. In Guangzhou, roughly
three-fourths of residents make purchases of milk and yogurt in
supermarkets. Neighborhood grocery stores and home delivery also account
for a large percentage of purchases, with delivery points, schools and
street vendors playing a smaller but significant role in the
distribution of these products. Corner stores and street vendors are a
main purchase point for ice cream, while most cheese purchases occur
indirectly in western-style restaurants.

Although the link between school milk programs, media advertisements and
buying patterns remains unclear, research indicates that in-store
advertisements have been successful at boosting dairy sales.

## 

## VIII) Fierce domestic competition drives out foreign investors

In the late 1990s, China had only 700 dairy processors. By 2004, this
number more than doubled to over 1,600 as more companies entered the
market hoping to cash in on the country's escalating dairy consumption
habits. This plethora of companies has led to intense competition within
the industry. To date, three companies have emerged as leaders.
Inner-Mongolian companies Yili and Mengniu, combined with Shanghai's
Bright Dairy, enjoy a combined 42.36 percent market share. Still, price
wars continue to plague the incustry. A double-edged sword, this
competition has helped make dairy products more affordable to consumers.
It has also caused already small margins to quickly recede, forcing many
less efficient processors out of business. After the initial explosion
of dairy companies, extensive consolidation is expected in a
reconstruction of the industry.

Many foreign companies have also felt the squeeze. Eager to cash in on
the growing demand, multinational companies like Danone, Kraft,
Parmalat, Unilever and Friesland Coberco entered the Chinese market only
to retreat a short time later after heavy losses. Until recently, only a
few companies- Nestle, Mead Johnson and Wyeth- remained as major
players. But after a few years hiatus from the chaotic Chinese market,
some companies are coming back. In the second half of 2005, Fonterra,
Arla Foods and Danone SA have invested heavily in joint ventures with
some of China's biggest processors. Maintaining a successful position in
the industry will depend on access to developed distribution networks,
effective marketing, brand management and offering safe, high quality
products.

**IX) Local supplies continue to grow**

According to China's National Statistics Bureau, domestic milk
production reached 23.7 million MT in 2004. This is more than double the
domestic production in 2000, thanks to increased cow numbers and
improvements in production per cow. In 2004, China's 5.5 million dairy
cows produced an average of 4 MT per cow. Water buffalo also play a
significant role in milk production, yielding over 1 million MT of the
milk supply in 2004.

Agricultural experts say an ongoing national dairy technology-upgrading
project has greatly improved cow breeding and feeding efficiency. The
\$49 million dairy project, part of the government's 10^th^ Five-Year
Plan (2001-05), has made vast improvements to the industry. The project
has worked to overcome major obstacles to dairy industry development
such as shortage of well-bred cows, low feeding efficiency, the poor
quality of raw milk and a low technological level in dairy product
processing. The China Dairy Association estimates that in the coming
10-15 years, the domestic dairy industry will develop at an annual speed
of 6 to 9 percent.

The majority of domestic production takes place in the north and west
and near metropolitan areas such as Beijing or Guangzhou. Dairies in
Guandong Province were originally established to service the Hong Kong
Market, which provided much higher prices for liquid milk than the
mainland. Today, these dairies are producing more and more milk for the
local market. However, they struggle to maximize production efficiency
due to a lack of high-quality forages and the hot and humid climate of
South China.

**X) New labeling requirements for reconstituted milk products**

Much of China's yogurt, ice cream, and even UHT milk is produced using
reconstituted dry milk powder. In many cases, this powder can be
imported and used as the main ingredient in these products at a lower
cost than local raw milk supplies. Some powdered milk was even being
used in products labeled as "fresh." However, On September 18, 2005, the
State Council issued the "Notice of Strengthening Management on Fluid
Milk Production and Marketing" requiring that only raw milk is allowed
for pasteurized milk and strongly recommending raw milk for UHT milk.

On September 30, 2005, the Ministry of Agriculture (MOA) announced the
"Identification of Reconstituted Milk in Pasteurized and UHT Milk" to
serve as an industry test standard since there is no national standard.
The notice will likely keep some consumers away from reconstituted milk
because urban, wealthier Chinese pay more attention to health and they
prefer fresh products. This will force producers to adjust product
patterns to develop more value-added products such as flavored yogurt,
infant formula milk powder, adult functional milk powder or more
varieties of flavored UHT milk.

From October 15, 2005, producers should state clearly on labels
"reconstituted milk" and the percentage used in the ingredients list. It
requires that plants intending to use reconstituted milk for fluid
products should register prior production with local quality supervision
agency including the information on 1) imported or domestically procured
milk powder quantity, quality, place and name of milk powder plant; 2)
beginning date and length of production; 3) quantity of fluid products
with reconstituted milk and the percentage of each batch of finished
products and 4) marketing areas of fluid products with constituted milk.
Any change should be notified to the agency 15 days in advance. Without
registration, the Administration of Industry and Commerce will not issue
production license.

The new notice could lead to a decrease in milk powder imports because
most imported milk powder is reconstituted for fluid products,
especially after import tariffs for milk powder dropped this year. The
raw milk industry indicates that China imported 121,488 MT of milk
powder in 2004. If this powder is reconstituted (multiply by 8), the
volume would equal the same quantity of raw milk produced by 242,976
head of cows for an entire year, thus affecting the livelihood of many
dairy farmers. The U.S. is the third-largest milk powder supplier to
China's market with sales of \$12.6 million in 2005.

**XI) U.S. becomes second-largest dairy exporter to China**

In 2000, the U.S. ranked fourth in the world for dairy exports to China,
with annual sales of \$20.1 million. Since then, exports have more than
tripled to \$60.5 million in 2005, allowing the U.S. to surpass France
and Australia for the title of second largest dairy exporter to China.
Volume of sales reached 83,350 MT, up 12 percent from 2004. Over the
same time period, value of sales jumped 47.4 percent, marking a nearly
32 percent increase in unit price for U.S. dairy products.

With 13.2 percent of sales and 26.0 percent of volume, the U.S. is still
far behind New Zealand, who has market shares for sales and volume of
48.4 and 30.1, respectively. However, strong U.S. exports are expected
to continue, while dry weather in New Zealand and Australia limit
exports from the number one and number three exporters to China. The
devalued U.S. dollar, as well as quota production constraints and
reduced dairy subsidies in the EU, will also continue to favor imports
of U.S. products. China is now seventh largest market for U.S. dairy
products by value and ranks tenth in terms of export volume.

The total value of China's dairy imports rose 3.3 percent in 2005 to
reach \$460 million. At the same time, the quantity of imports totaled
320,000 MT, a decline of 7.7 percent over 2004. As domestic production
continues to grow, the future of dairy imports rests largely with public
demand.

####### Table 3: U.S. Dairy Exports to China

+-----------+---------+---------+---------+--------+--------+-------+
| **        | **Value |         |         | **%    | **     | **2   |
| Product** | (1,000  |         |         | Change | Market | 005** |
|           | USD)**  |         |         | from   | Share  |       |
|           |         |         |         | 2004** | (%)**  | **R   |
|           |         |         |         |        |        | ank** |
+-----------+---------+---------+---------+--------+--------+-------+
|           | *       | *       | *       |        |        |       |
|           | *2003** | *2004** | *2005** |        |        |       |
+-----------+---------+---------+---------+--------+--------+-------+
| ** **     | ** **   | ** **   | ** **   | ** **  | ** **  | ** ** |
+-----------+---------+---------+---------+--------+--------+-------+
| Fluid     | 0       | 0       | 2       | ∞      | 0.03   | 12    |
| Milk      |         |         |         |        |        |       |
+-----------+---------+---------+---------+--------+--------+-------+
| Powdered  | 4,546   | 9,123   | 12,646  | 38.62  | 5.37   | 3     |
| Milk      |         |         |         |        |        |       |
+-----------+---------+---------+---------+--------+--------+-------+
| Yogurt    | 16      | 35      | 25      | -28.4  | 1.75   | 11    |
+-----------+---------+---------+---------+--------+--------+-------+
| Whey      | 25,187  | 30,992  | 46,378  | 49.64  | 29.4   | 1     |
+-----------+---------+---------+---------+--------+--------+-------+
| Dairy &   | 421     | 12      | 36      | 190.75 | 0.11   | 16    |
| Butter    |         |         |         |        |        |       |
| Spreads   |         |         |         |        |        |       |
+-----------+---------+---------+---------+--------+--------+-------+
| Cheese &  | 487     | 912     | 1,471   | 61.3   | 5.57   | 3     |
| Curd      |         |         |         |        |        |       |
+-----------+---------+---------+---------+--------+--------+-------+
|           |         |         |         |        |        |       |
+-----------+---------+---------+---------+--------+--------+-------+
| *         | **3     | **4     | **6     | **4    | **1    | **2** |
| *Total:** | 0,657** | 1,075** | 0,558** | 7.43** | 3.20** |       |
+-----------+---------+---------+---------+--------+--------+-------+
| Source:   |         |         |         |        |        |       |
| Global    |         |         |         |        |        |       |
| Trade     |         |         |         |        |        |       |
| Atlas     |         |         |         |        |        |       |
+-----------+---------+---------+---------+--------+--------+-------+

# XII) Useful Contact Information

**Agriculture Affairs Office Beijing**

Maurice House, Agricultural Minister-Counselor

Embassy of the United States of America

No. 3 Xiu Shui Bei Jie, Jian Guo Men Wai

Beijing, China 100600

Phone: (8610) 6532-1953

Fax: (8610) 6532-2962

Email: <AgBeijing@usda.gov>

# Agricultural Trade Office

Keith Schneller, Director

China Hotel Office Tower, 14/F

Guangzhou, China 510015

Phone: (8620) 8667-7553

#### Fax: (8620) 8529-0703

Email: <atoguangzhou@usda.gov>

# Agricultural Trade Office 

Laverne Brabant, Director

Kerry Center South Tower

24^th^ Floor, Suite #2425

No. 1 Guanghua Lu

Beijing, China 100020

Phone: (86-10) 8529-6418

Fax: (86-10) 8529-6692

Email: <atobeijing@usda.gov>

# 

# Agricultural Trade Office

Ross Kreamer, Director

Suite 331, Shanghai Center

1376 Nanjing Xi Road

Shanghai, China 200040

Phone: (86-21) 6279-8622

Fax: (86-21) 6279-8336

Email: <atoshanghai@usda.gov>

**U.S. Dairy Export Council**\
Daniel Chan

PR Consultants, Ltd.\
Suite 436, Shanghai Center

1376 Nanging Xi Road

Shanghai, China 200040\
Phone: (86-21) 6279-8668\
Fax: (86-21) 6279-8669\
Email: [danielc@prcon.com](mailto: danielc@prcon.com )

**U.S. Dairy Export Council**

Sylvaine Siu\
PR Consultants, Ltd.\
Unit D, 14 Floor, Vulcan House\
21-23 Leighton Road

Hong Kong, China\
Phone: (852) 2833-5977\
Fax: (852) 2893-7538

Email: sylvaines@prcon.com

**Appendix I. Dairy Tariff Table**

  ---------------------- ----------- ------- --------- -------- ---------------
  Tariffs on Dairy                                              
  Products, Effective                                           
  January 1, 2005                                               

                                                                

                                     MFN     General   V.A.T    Effective Rate

                                                                (MFN & VAT) 1/

                                                                

  Fluid Milk             0401.1000   15.0%   40.0%     17.0%    34.89%

                         0401.2000   15.0%   40.0%     17.0%    34.89%

                         0401.3000   15.0%   40.0%     17.0%    34.89%

  Powdered Milk          0402.1000   10.0%   40.0%     17.0%    29.89%

                         0402.2100   10.0%   40.0%     17.0%    29.89%

                         0402.2900   10.0%   40.0%     17.0%    29.89%

                         0402.9100   10.0%   90.0%     17.0%    29.89%

                         0402.9900   10.0%   90.0%     17.0%    29.89%

  Yogurt                 0403.1000   10.0%   90.0%     17.0%    29.89%

                         0403.9000   20.0%   90.0%     17.0%    39.89%

  Whey                   0404.1000   6.0%    30.0%     17.0%    25.89%

                         0404.9000   20.0%   90.0%     17.0%    39.89%

  Butter & Dairy Spreads 0405.1000   10.0%   90.0%     17.0%    29.89%

                         0405.2000   10.0%   90.0%     17.0%    29.89%

                         0405.9000   10.0%   90.0%     17.0%    29.89%

  Cheese                 0406.1000   12.0%   90.0%     17.0%    31.89%

                         0406.2000   12.0%   90.0%     17.0%    31.89%

                         0406.3000   12.0%   90.0%     17.0%    31.89%

                         0404.4000   15.0%   90.0%     17.0%    34.89%

                         0404.9000   12.0%   90.0%     17.0%    31.89%

  Source: China Customs                                         
  ---------------------- ----------- ------- --------- -------- ---------------

[^1]: Fuller, Frank H., John C. Beghin, and Scott Rozelle. "Urban Demand
    for Dairy Products in China: Evidence from New Survey Data." Center
    for Agricultural and Rural Development, Iowa State University. Nov.
    2004.

[^2]: National Bureau of Statistics of China

[^3]: Fuller, Frank H., John C. Beghin, and Scott Rozelle. "Urban Demand
    for Dairy Products in China: Evidence from New Survey Data." Center
    for Agricultural and Rural Development, Iowa State University. Nov.
    2004.