Is Big Really Beautiful? - Changing Fortunes in the Chinese Beer Market.
China was meant to be the world's great, untapped drinks market. Despite its fragmented nature and low margins, beer companies believed the global trend for consolidation would deliver returns worthy of their vast investments. But as Rupert Dean reports, many now question the wisdom of their previous actions.
As consolidation sweeps the drinks world, through beer, soft drinks spirits and wine, much is written on the causes behind the phenomenon that has seen the big get bigger and the small almost disappear.
Commentators in China are now starting to question the benefits of this rush to get bigger through acquisition
The size of modern retailers, the need for power-packing marketing budgets and globalisation are all common themes in any analysis of the hectic pace of M&A activity. However, when it comes down to it, studies of consolidation almost always come back to the balance sheet. And a careful look at many industries in several global markets illustrates that as consolidation has occurred, both profits and the economies of scale of the companies involved have improved.
What is interesting about the Chinese beer industry is that as it has adapted to the new market economy, prompting foreign investment and consolidation, many beer companies anticipated a similar reaction to their company profit sheets, some even believed the transition would happen in a much shorter timeframe given the rapid pace of modernisation.
However the reality is somewhat different, as despite the substantial upheaval over the last two decades, several industry commentators in China are now starting to question the benefits of this rush to get bigger through acquisition.
Many factors complicate the issue in China, not least of which is the ongoing discussions for an agreement on China's entry in to the World Trade Organization (WTO). Without resolution, this issue continues to cause concern to China's domestic brewers about their future strategic direction and has hastened the implementation of their acquisition strategies. The lack of an agreement has also not benefited the international joint venture partners, as the stability they require is dependent on reaching a deal.
This WTO merry-go-round coupled with the belief that a company's size is directly proportional to its potential success in the Chinese market, goes a long way towards explaining the hasty acquisitions strategies which characterize this market.
Many industry players believed that in the future, the Chinese market could only support ten large national brewers. It was also a common suggestion that this industry consolidation would bring about an element of price control and economies of scale that currently do not exist.
At the time of China's open door policy in the late 1980s, regional breweries dominated China's major cities and the international companies were soon rushing through the door to establish joint ventures and consolidate their market share through aggressive marketing strategies. By the mid 1990s, the domestic beer market had changed considerably, with foreign companies such as Budweiser, Foster's, Becks and Lion Nathan gaining share at the top end of the market, with only Tsingtao of the domestic brewers regarded as premium.
But since 2000, and despite the success of international brands such as Budweiser and Heineken, it is now the two major domestic breweries of Tsingtao and the Beijing Yanjing Beer Group that currently appear poised to make the considerable gains in market share.
Tsingtao itself has undergone a major strategic change in the last three years. Always considered the premium Chinese beer, the company originally believed in focusing on the export market. But since 1999, it has refocused attention on the domestic market and has engaged in an aggressive mergers and acquisitions strategy, buying up regional brewers and failed joint ventures in the east of the country (Carlsberg in Shanghai last year for US$18m), helping to regain footholds in the domestic market once lost to the international brewers.
The Tee Yih Jia Food Manufacturing of Singapore was the latest to announce a partnership with the Tsingtao Brewery and its brewing operation in Fujian. Tsingtao will pay US$18.5m cash to acquire 51% of the venture, with Tee Yih Jia controlling the remaining stake. As with a few of the other partnerships, the brewery will now be managed by Tsingtao and renamed Tsingtao Brewery (Fuzhou) Co.
Yanjing Group together with Tsingtao accounts for between 10-15% of the domestic market.
Also vying for the title of China's largest producer is the Yanjing Group in Beijing, who together with Tsingtao accounts for between 10-15% of the domestic market, and the Huarun Beer Group, which currently has around 4%.
The Yanjing Group is currently concentrating more on the northern and western provinces and acquisitions regional brewers there in its empire-building strategy.
The Huarun Beer Group are the relative newcomers, backed by the Hong Kong Huarun Group and are employing similar tactics. Huarun has set up companies in the Tianjin Municipality, Sichuan, Jilin, Liaoning and Anhui provinces and last week announced plans to purchase three beer companies in Suzhou, near Shanghai.
All of this is happening in a market where 17 billion litres of beer are consumed annually, so there are plenty of spoils to go around, provided, that is, everyone has the margins, the cash flow and the profits to sustain their business operations. Yet herein lies the major issue.
"Price wars are first of all murder and eventually suicide"
Li Guirong, Tsingtao chairman
One of the major complaints in the past ten years, often heard from foreign companies investing in joint venture enterprises in China, is the business environment of low margins, heavy price cutting and the fragmented nature of the market. This has often been cited by many of those international companies forced to pull out of China as the major reason for their exit from the market.
However, this is a problem that is now blighting the domestic brewers, such as Tsingtao, as their chairman, Li Guirong recently explained. "Price wars are first of all murder and eventually suicide," he said, before going on to emphasize that Tsingtao would no longer get involved in these business wars.
Other problems have also hindered the three large domestic brewers in their aggressive strategies, including over zealous local officials who use their influence to help the small regional brands and brewers from the advances of the nationals.
One ploy employed by the officials is to insist that when acquisitions occur, local staffing levels remained unchanged under the new owners, thus directly affecting the predicted beneficial economies of scale.
And although the three large domestic brewers have targeted many of these small brewers, the acquisition strategy does fail at times. In these instances the big brewers have simply tried to compensate by attempting to extend their influence over the regional distribution system by offering free delivery trucks to distribution partners and other giveaways, resulting in destructive, painful price wars.
Of course this response has not gone down too well with the stock markets in Shanghai and Hong Kong, the very people who are funding this merger and acquisition strategy. They are now questioning whether the perceived advantages of a greater control over prices and increased economies of scale can ever be realised by industry consolidation.
Of the international brewers that have remained, there is still optimism for the future in China. One such company, Lion Nathan (constantly rumored to be pulling out), has factories in Wuxi and Suzhou, close to Shanghai, and also owns the brewing and selling rights for Becks in China.
However, it has underutilised capacity and Lion chief executive Gordon Cairns admitted last month that after its failure to find a brewing partner in China, LN was now proactively considering its options to overcome this problem, including looking at other products to produce.
With the restaurant, bar and nightclub scene continuing to develop along Western lines and the recent announcement of Beijing as the host city for the 2008 Olympics, the opportunities for growth are endless, even if a favourable WTO agreement cannot be reached.
But, what the domestic beer companies must decide, is how to best leverage their market presence to gain more control over pricing, margins, and greater economies of scale. Is an acquisition strategy and the resulting larger company sizes really the answers to these problems? Or should these brewers be concentrating more on building up the strength of their own individual brands to achieve their goals.
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