China’s new baby milk scandal to trigger tighter cross-border e-commerce rules

An escalating counterfeit scandal on infant formula has triggered panic among consumers, dealing a blow to China’s baby formula industry. Analysts say unregulated sales channels, in particular e-commerce channels, may be one of the key reasons behind the high frequency of counterfeits, which could cause considerable damage to brand names. Chinese authorities have also signalled tighter regulation of e-commerce channels for baby formula, which could boost domestic operators that mainly rely on offline channels and business-to-consumer (B2C) flagship stores in the medium to long term. Foreign milk brands still seen as superior years after China milk scandal The country’s food safety regulator – China Food and Drug Administration (CFDA) – confirmed on Wednesday that a baby formula factory has produced more than 17,000 tins of fake Similac and Beingmate milk powder by repackaging cheap but conforming products with counterfeit labels. Similac is a popular formula line under New York-listed Abbott Laboratories while Beingmate is one of China’s largest baby formula producers. The CFDA didn’t clarify whether other brands were involved in the counterfeiting, but said the bogus products have already reached the market across the nation and an investigation is under way to track them. It also urged consumers “not to panic” and claimed the counterfeits have no “(food) safety risks”. The scandal followed a surprise announcement by Danone Nutricia last week that it had stopped supplying Karicare baby formula in China. Although Danone Nutricia did not give any reasons for the exit, analysts said the brand has been suffering a sales decline ever since its involvement in the botulism contamination scare in 2013. A rising number of Karicare knockoffs in the market only made matters worse. Unregulated distribution, in particular e-commerce channels, may be behind the surge in counterfeits, according to Song Liang, a senior dairy analyst at a research institute under the Ministry of Science and Technology. Along with the rapid growth of cross-border e-commerce (CBE),Chinese consumers with an appetite for high-quality foreign baby formula – seen as safer than domestic peers – have turned to overseas purchases on the internet rather than them from local franchised stores. Consumers, however, lack knowledge about the credibility of products purchased via CBE. “It’s a major challenge to regulate cross-border e-commerce, in particular counterfeiting that uses cheap but conforming baby formula products from other brands,” Song added. In addition, some domestic distributors of popular foreign brands turn to unofficial manufacturers when they cannot get enough orders from official producers in overseas markets, and they have little control over the quality of these products obtained through unofficial channels. The counterfeit scandal could cause major damage to popular and high-quality formula brands in the industry, such as Abbott and Beingmate, as the look-alikes divert established brands’ revenues, disrupt the pricing of genuine products, hurt brands’ reputations and impact future sales, Song said. Shenzhen-listed Beingmate, one of China’s largest baby milk powder producers, has suffered two consecutive years of revenue declines. Last year, the company reported a 10 per cent drop in sales to 4.5 billion yuan. In 2014, Beingmate’s revenues fell 17 per cent from the previous year while net income slumped 90 per cent. In reaction to the latest counterfeit scandal, Beingmate urged consumers in a Wednesday statement to purchase baby formula from authorised sale channels, including franchised stores and official e-commerce shops. China milk antitrust probe may be step towards consolidation Nevertheless, the scandal may put further pressure on the Chinese authorities to launch a regulatory overhaul of the industry and tighten regulations on distribution channels, including those on e-commerce platforms, analysts said. Morgan Stanley says the Chinese regulators have already signalled an intention to further regulate CBE with respect to baby formula. The CFDA recently filed a notification with the WTO’s Committee on Technical Barriers to Trade that both domestic and imported infant formula will be subject to registration with the regulator. Currently, the majority of infant formulas sold via CBE lack required CFDA approval or proper Chinese labels. “The new rule shows the government’s intent to escalate the regulation towards all infant formula sold in China. Thus we think it is likely that cross-border e-commerce will also need to comply with the new regulation,” says a note by Morgan Stanley analysts. In the near term, the tighter regulations may have a negative impact on baby formula producers as sellers would need to clear non-compliant inventory ahead of the full implementation. However, in the medium to long term, it will benefit domestic operators, including Chinese and foreign brands, that mainly rely on offline channels and B2C flagship stores, as low-priced foreign products via CBE will be wiped out of markets and many smaller players may have to cease operation under the stricter new regulation. Among potential beneficiaries listed in the A-share market, Morgan Stanley named Yashili and Beingmate, citing factors such as limited exposure to cross-border e-commerce channels and potentially greater market consolidation triggered by the new rules.