Made in China, Eaten Everywhere

Problems with Chinese-manufactured food have gained international notoriety over the last decade. In 2008 alone, thousands of children in China were sickened by baby formula that was contaminated by melamine. Consumers in Japan fell ill after eating imported Chinese dumplings tainted with high levels of insecticide. Other internationally prominent incidents have involved fish, vegetables, mushrooms, eggs, rice, and wheat protein.

As Chinese firms have claimed a larger share of the global food market, food safety problems have garnered increasing international attention as unsafe products have resulted in illness, death, and mistrust. However, lower costs and the need for supply chain diversification have made the creation of a “China strategy” a competitive necessity for multinational food companies.

So how can these firms reduce the risk of Chinese-made food? This paper is a synopsis of research conducted as part of Kellogg’s Global Initiatives in Management program into the challenges facing multinational companies that source food in China. The research examined several supply chain models that may be used to maintain better control of food products. How well companies can adopt and implement such models has implications for the broad range of firms in this sector, inside and outside China, and global consumers alike.


The Problem

The food safety failures mentioned above are significant. In 2006, China accounted for 12 percent of all agricultural trade. Though most exports go to neighboring Asian countries, the country exported $4 billion of food products to the US in 2007. Most observers anticipate that China’s share of the world food market will continue to grow for the foreseeable future.

Safety failures are attributable to breakdowns in China’s food supply chain—problems typical of developing countries. But because China’s food products reach so many, it’s critical to understand and address these issues. Among the contributors: the inability of many farmers and small companies to implement international food-safety standards, though the growth of larger food brokers is mitigating this problem; significant fragmentation and poor documentation, resulting in diminished traceability of agricultural products; a poor distribution network and system of oversight for perishables (especially raw meat; 79 percent of retailers don’t monitor product temperatures during shipping); high pesticide and pollutant contamination of agricultural products.


Food Market Background and Trends

An understanding of China’s cultural and regulatory legacy is essential to fully appreciate the food-safety challenges that the country now faces:

Complex Regulatory Structure. The rapid growth of China’s food export has outpaced the ability of the Chinese government to ensure the safety of its product. The central government has 10 agencies responsible for overseeing food and drug safety at the national level, with overlapping responsibilities and little effective hierarchy. There are also innumerable local and regional agencies that perform similar functions. The State Food and Drug Administration (SFDA) was created in 2003 to oversee and coordinate the other food and drug safety agencies. The creation of the SFDA has not, however, had the intended effect of reigning in Chinese food regulation, and the agency has instead fallen into a position alongside other agencies in the cadre of organizations that constitutes China’s convoluted food and drug control system. Regulatory and enforcement issues have led to widespread corruption in both the corporate and government sectors. In 2007, the former head of the SFDA, Zheng Xiaoyu was tried and executed on charges related a scandal involving tainted cough medicine that led to dozens of deaths in several countries.

Multinational companies that are committed to being successful in the Chinese market need to invest in developing relationships with central and local government organizations. At a central level, companies have the opportunity to shape the government’s agenda for new food safety regulations and enforcement mechanisms. All the multinationals interviewed for this study have strong ties with the Ministry of Health, the Ministry of Commerce, and the General Administration of Quality Supervision, Inspection, and Quarantine (AQSIQ). Companies such as General Mills and Tyson play an informal advisory role in government issues related to food safety regulation, education and enforcement. Relationships with government organizations are also formalized through training programs and knowledge sharing visits for government representatives, such as Cargill’s food safety training program with AQSIQ and high-visibility corporate citizenship initiatives, such as Ecolab’s support of the Beijing Olympics and Coca-Cola’s water conservation efforts in China. At a local level, governments have the ability to open doors for doing business and aid in protection of intellectual property.

Consumer Preferences. The Chinese market can be split into two broad segments: affluent consumers and mainstream consumers. Historically, most Chinese consumers preferred buying foods in wet markets where they could touch and sample them; in this context, safety is a secondary concern. But the rise of the affluent segment has led to changes in expectations: 95% of Chinese consumers ranked food safety as very important in 2007, up from 73% in 2005, and market research indicates that they’re more willing to pay premiums for safe products.

Chinese Food Market Opportunities and Threats. The relatively low level of development of the Chinese consumer market and food retail industry has presented Chinese companies with a number of opportunities and threats. Opportunities include:

· Rapid market growth with relatively low investment

· Exponential market share growth – without having a strong brand awareness

· Arbitrage opportunities and high uncertainty – lack of public information on market activities coupled with the high uncertainty about the changes in the market place give market players who have superior information networks an opportunity to monetize their knowledge.

Threats include:

· Product failure due to insufficient food manufacturing expertise – some Chinese food companies are still catching up on the application of good manufacturing practices and best practice food safety procedures

· Competition from newcomers – without a strong brand or operational capabilities, and without having established barriers to market entry, a new entrant can take over the market if its value proposition is superior

· Economic incentive to cheat – as long as the market is highly fragmented and there are no dominant players, companies will have a very high incentive to cut corners; the upside reward of dominating the market is much higher than the downside risk of losing the existing market position for smaller companies. Over the long term, however, such a strategy can have devastating consequences, not only to the company’s survival, but also to consumers, when cutting corners yields unsafe products

· Overreliance on trade and government relationships and lack of market transparency – many local players have longstanding relationships with food producers, brokers, and the government, especially those who are partially owned by the government. While these relationships are often vital to the success of the company, they can turn into a liability when the company’s performance doesn’t meet expectations. For example, a company that produces poor-quality and potentially unsafe food can continue to prosper in China, whereas similar behavior in the US would likely prompt such a negative backlash of public opinion that the firm may be driven out of the market. In China, local government officials are often evaluated based on the economic performance of their municipality or region. When quality or safety issues come into conflict with cost concerns, an incentive may exist to look the other way. Thus, product failures can be overlooked and, due to lack of market transparency, they can grow exponentially to reach catastrophic dimensions, as was the case in the melamine-contaminated milk scandal.

Chinese food companies have traditionally been successful in serving the mainstream market, but have had a hard time matching the value proposition of multinational food companies in the affluent consumer segment. Chinese companies need to invest in years of marketing to develop a premium food brand, and furthermore, their local market knowledge advantage relative to foreign competitors is mitigated by the demands of consistently offering high quality food products and implementing a comprehensive food safety solution. This reality is reflected in the separation between Chinese companies who cater to the export market and those who serve the local market. There are very few examples of Chinese companies who are successful in both markets, largely because of the strategic tradeoffs inherent between offering high quality products and being low-cost.


Multinationals’ Food Supply Chain Models

Multinational firms can customize their China-focused strategies and supply chains to realize benefits over local players including strong brands, scale and supply-chain advantages, and “high share of voice” in dealing with China’s government, because the government wants to encourage foreign investment. Yet several factors often prevent multinationals from capitalizing on these advantages. Among these: failure to adapt strategies specifically to China (e.g., copying business models from home countries), unrealistic expectations of short-term Chinese revenues, and insufficient nimbleness relative to local players.

In order to effectively manage the safety of their sourcing activities in China, many multinationals have adopted one or more of the following three supply chain management models.

Fully Integrated Model. This model is preferred when a specific ingredient is critical to a company’s operations (e.g., represents a large percentage of material costs) and comes from a fragmented supplier base and/or has high potential for contamination. Because producing the ingredient internally may be costly, many firms opt for a fully integrated model. Tyson is an excellent example of full integration.

Tyson China began primarily as an importer of chicken feet and cattle hides from the United States. The company started producing inside of China by purchasing a large scale production facility. As part of the purchase, Tyson had to invest heavily to ensure the safety of the food that was coming from the plant. Once the Tyson name is used on a product, the same safety rules and precautions apply in China, or any other country, as they do in the U.S. This quality allows Tyson to charge a 20% premium over unbranded competitors in China.

Tyson found that the main challenge in expanding production locally is not building large scale facilities and ramping up production, but rather ensuring the product quality and safety during each step of the process. Given the importance of quality and safety for the Tyson brand, the company chose not to allow any outside hands on any part of the process, starting from the input materials. Tyson even produces the chicken feed from local corn and soybeans. The company builds and owns the farms where the corn and beans are produced. Heinz, General Mills, and Frito Lay have instituted similar supply-chain practices in China for tomatoes, corn, and potatoes, respectively.

Supplier Relationship Model. Short of maintaining control over the entire supply chain, firms can use strong relationships to educate local suppliers and enhance safety-related processes. For example, multinationals can provide knowledge, dedicate personnel to suppliers, and ask suppliers to adhere to rigorous inspection protocols. Cost advantages can be achieved, despite the additional expenses engendered by these measures, through large-scale operations driving economies of scale, especially for food items exposed to fewer risks (e.g., spices). Many large players have developed comprehensive vetting processes for new suppliers; General Mills uses employee turnover, capital investment history, and training program information to assess suppliers. Sourcing managers serve as initial quality filters for potential suppliers. Multinationals often use a variety of factors to evaluate potential suppliers in China, including previously existing relationships with other multinationals, indicators of financial viability, and the attitudes’ of supplier management toward change and improvement.

Because the cost of establishing new relationships is high, multinationals will continue to devote substantial resources to maintain these relationships. Coca Cola inspects all potential suppliers for its three Chinese bottlers and stipulates that purchases can only be made from approved suppliers. Coca Cola also employs a “three strikes” policy for suppliers, breaking the relationship after repeated infractions. Management of these relationships typically requires adding organizational elements, such as General Mills’ dedicated Supplier Quality Audit team, in order to help multinationals fill China’s regulatory void for food safety.

Outsourcing Model. Some companies hand off responsibility for controlling food safety in China to a third party, partly to compensate for their knowledge gaps regarding the Chinese market. For example, Ecolab provides food companies assessment, training, auditing, and quality assurance using Ecolab-developed systems. The firm contracts with many companies to provide food safety products and services across all of the customer’s locations. For instance, Aramark retained Ecolab to help them manage food safety when Aramark won the catering contract for the Beijing Summer Olympics in 2008.

While this solution may be costlier than the other alternatives, the outsourcing party typically brings significant local food safety expertise and may have the tools and resources in place to implement food safety programs on a large scale in a short time frame. Thus, a firm that is looking to build a large-scale operation in China in a very short time may be able to rely on an outsourcing partner to put food safety processes and procedures in place with suppliers or with the local organization.


The Future of Food Safety in China

In late 2008 the US opened its first international Food and Drug Administration office in China to strengthen collaboration between the FDA and China’s ASQIQ. Today China is revamping its food-safety laws, now a top priority. A new Food Safety Law passed in February 2009 includes elements such as a new Food Safety Commission, a reduction in food-safety agencies to five, and nationwide risk monitoring, testing, and recall systems.

These reforms are contributing to a brighter future for China’s food industry. Yet multinationals must continue to move cautiously in sourcing Chinese products. Best practices include elements of the fully integrated, supplier relationship, and outsourcing models presented here. Players should match models carefully to their own capabilities, resources, and goals, recognizing that the choices they make will have clear consequences for their costs, product quality, reputations, and ultimately the consumers they serve.