Since the 2008 melamine crisis, China has undertaken a dramatic capital-fuelled strategy to achieve scaled farms and vertical integration within the sector. Average production has doubled since 2008, and in so many metrics, the industry improvement is staggering. China’s milk quality has really improved and average somatic cell counts are in line with European standards.

The consolidation has fostered two of the world’s largest dairy companies in Yili and Mengniu, both of which have achieved impressive levels of vertical integration, with between 30-40% of their milk coming from their own farms, and their aim is to continue to expand their herds and increase that proportion.

But the hubris of developing these dairy giants has created a highly imbalanced sector, where everyone has been in expansion mode, creating a herd structure with over 500 new mega-farms built from 2020 to 2023, in turn creating an output that far outstrips the demand for domestic dairy products in China.

The economy in China is growing, albeit at a slower pace than before, and finally, as the reality crystallises, some hard decisions are being made to try to get the industry back in kilter.

So how bad are things at the moment? Let’s put it all in context. China has approximately 5m milking cows and is producing around 41m tonnes (~40m litres) of fresh milk. According to a top executive from the top state-owned feed company, China has a stock of 18m tonnes of whole milk powder – which has been expensively processed from fresh milk from farms in China (Chinese whole milk powder is far more expensive than the top player in the market, New Zealand).

The top two Chinese processors have been stockpiling milk powder at a rate of between 10,000t-15,000t/day, which has led to an ‘overflow’ stock equivalent of at least six months of domestic milk output.

For private farmers, the crunch has been long and punishing. Culling cows was a first and easy step, but the price has bottomed out for culled cows and for many farms that are highly leveraged, having invested at the peak, the losses are significant.

Secondly, due to the terms of the milk supply contracts between processor and farmers, farmers need to either take care of 20%-30% of their own fresh milk (powder it or find a way to sell it), while dairy processors do not allow them to reduce their herd size and they must carry the excess market demand as they prepare for (hopefully) better market conditions.

Some Chinese farmers are dumping milk – some are giving it away. A video showing a milk truck in a small city in China’s northeast showed people queueing for fresh milk, where the farmer appeared to be offering 10l/person for free.

Risks and challenges

The onus on farmers to sell 20%-30% of their own milk each month is putting a huge strain on them and, ironically, is creating food safety risks and challenges that China has been specifically trying to move away from through its dramatic improvements. It’s not unreasonable to surmise that the increased risk is somewhat akin to what led to the original melamine crisis.

There is no end in sight for this downturn. Austasia, China’s highest-producing livestock company, has started to publicly sell pregnant heifers. China’s dairy farming industry will continue its painful reform, where capital markets, vertical integration and market demand will continue in a pull-and-push to find a new equilibrium.

In recent years, the conventional wisdom was to get big to survive, but more cows don’t automatically mean more profit, and now the industry is trying to find the right model for sustainable growth.