Chinese Dairies Face a Worsening Crisis

http://online.wsj.com/article/SB122176474691453271.html
SEPTEMBER 19, 2008
Slow Response to Tainted Formula Fans Consumer Fears
By LORETTA CHAO
Shijiazhuang, China
As China's baby-formula scandal widens, the country's multibillion-dollar dairy industry is reeling. Consumers, wary of domestically produced milk, are flocking to buy foreign formula and other products, and shares of the country's largest dairy companies are plunging.
A dairy scandal is sweeping through China. Milk dealers have been arrested and government officials fired as milk powder laced with melamine has poisoned more than 6,200 babies and killed 4. WSJ's Loretta Chao reports. (Sept. 19)
So far, 22 companies -- including Olympics sponsor Inner Mongolia Yili Industrial Group Co. and Mengniu Dairy Co., which supplies milk to Starbucks Corp. in China -- have been linked to melamine contamination in baby formula. More than 6,200 babies have fallen ill, many with kidney problems that could lead to permanent damage. On Thursday, the state-run Xinhua news agency reported a fourth death connected to the problem.
Farmers say they haven't heard anything about what might happen to their cows or their milk, which many are throwing away because of slumping demand.
The contamination extends beyond formula to liquid milk, authorities have found. Melamine is an industrial compound used in nonfood products. Its addition to milk can make milk appear to contain more protein to help pass quality testing.
Melamine was found in eight of the 30 Yili products sold in Hong Kong. The government has said it will continue its investigations and provide free medical care to victims.
In this city southwest of Beijing, home of Shijiazhuang Sanlu Group Co., the first company implicated in the scandal, anger is running high among farmers who are being forced to pour their milk into rivers because they have no buyers. Sanlu had been a trusted brand prior to the discovery of high concentrations of melamine. Sanlu, which is 43% owned by New Zealand dairy company Fonterra Co-operative Group Ltd., hasn't responded to repeated requests for comment.
Reuters
Customers return tainted milk powder at a supermarket in Hefei, Anhui province.
Until now, dairy sales in China had been booming. According to market researcher Euromonitor International, revenue from milk-formula rose to $3.1 billion in 2007 from $1.4 billion in 2003, while revenue from other dairy products grew to $17.9 billion from $8.8 billion in the same period.
Liu Jinhu, an analyst for Sealand Securities in Shenzhen, said that if Chinese dairy companies want to avoid being overtaken by foreign counterparts they will have to rebuild their supply chains and practice better corporate responsibility. The milk-powder scandal "might become a watershed for China's dairy industry to find its rebirth," he said. In the long run, it will lead to consolidation and a shuffling of the industry, he said.
Anger is growing that it took Sanlu and local government officials more than a month to report the problem. In a broadening investigation, 12 more milk and melamine dealers were arrested and authorities are looking for others, Xinhua said Thursday, reporting that some of those arrested confessed to buying large quantities of melamine and adding it to milk they resold.
"I will never believe in domestic brands," said Gao Jie , a 22-year-old resident of Pinggu, a Beijing suburb, through sobs. She brought her one-year-old son to the hospital last week because of a fever, and later learned that he had stones in both kidneys after drinking Sanlu formula for half a year. "It's so heartbreaking ... he was clinging to me the whole time in the hospital. And he didn't even have the worst of it; there were screaming children everywhere and some were urinating blood and others were vomiting," she said. She is one of many parents now talking to lawyers about potential class-action lawsuits.

Many travelers are buying imported formula in bulk in Hong Kong and bringing it back to neighboring Shenzhen, border officials say. Retailers plan to stock more multinational brands, but say some parents won't trust even imported brands if they're sold in Chinese stores. Imported formula is more expensive, and out of the price range of many.
Ding Zongyi, head of the Chinese Medical Association's child health professionals committee, says a crisis was "bound to happen" with such poorly regulated supply chains and without proper reporting methods or the ability to trace problems if they occur.
New York-based Bristol-Myers Squibb Co.'s Mead Johnson Nutritionals baby-formula unit, which sells formula in China, uses a "batch code" system to track its raw materials and products. Spokeswoman Gail Wood says traceability is the key factor that's missing with formula makers who use locally produced milk. Mead Johnson sources milk from New Zealand, Australia and elsewhere for its formula sold in China. "Each tank [of milk] is given a vendor number, and that number gets forwarded to every person that buys it. Mead Johnson requires to know, down to the can, [which] tank helped produce [which] can," Ms. Wood says.
Farmers in Shijiazhuang say there's no such system in their county, where there are at least hundreds of cows producing milk for sale.
The dairy industry is a competitive and low-margin business. Farmers sell milk to local dealers who in turn sell it to companies like Sanlu. Authorities say it was the dealers who added melamine to the milk.
The affected companies are scrambling. On Thursday, Yili said in a statement that it has set up a hotline for parents, and that it plans to donate several hundred million yuan annually over five to 10 years to help modernize the industry and develop systems to ensure product quality.
A Starbucks spokeswoman in Shanghai said customers have approached store employees with concerns about the milk used, which is from Mengniu. In a statement early Friday, the company said it decided to stop using the milk as it works with Mengniu to determine its safety. The Starbucks spokeswoman added that is the Mengniu milk the company uses is a high-grade line that hasn't been implicated thus far. The coffee company is in the process of looking at other possible suppliers.—Kersten Zhang, Gao Sen and Sue Feng in Beijing and Bai Lin in Shanghai contributed to this article.