Annie Chang, Karan Kumar, Natalie Kwan, Amy Lau, Sara Pan, Daniel Strong, Christopher Swenson, and Christopher S. Tang
June 10, 2013
In Shenzhen city, you may not find someone selling you a fake Rolex but you will find many street vendors selling Mead Johnson or Nestlé infant formula smuggled from Hong Kong, the United States, Australia, the UK, or New Zealand. This (illegally imported) infant formula is not cheap. Each 0.8 kg tin can of formula is sold at US$ 38.8, which is 46% above the retail price in Hong Kong. Knowing 17 million babies are born in China each year and Chinese parents are willing to spend money on their children, the market for infant milk formula is huge, representing 23% of the US$41 billion global market.
Even though the total supply of milk formula is sufficient, and even when foreign-owned producers such as Danone and Nestlé are experiencing double-digit growth in their locally produced formula, concerns about the safety of local milk have led to a sharp increase in demand for imported formula among urban middle-class households. As demand for imported formula exceeds supply, price gouging is not uncommon – a 0.8 kg can of imported formula is sold as high as US$56 in 2013 (which is over 100% above the average retail price in other countries). The shortage of imported formula created a frenzy around the world as Chinese went overseas to purchase infant formula – some for personal use and many for resale in the black market (Figure below). This shopping frenzy has created shortages in Hong Kong, which triggered the Hong Kong government to impose a new law in February 2013 that allows each person to carry no more than 2 cans of infant formula and violators are subject to a US$64,000 fine and two years of jail time.
As the black market for imported infant formula is huge in terms of demand and profit margin, one wonders why established supermarkets in China such as WalMart (US), Carrefour (France), Tesco (UK), Metro (Germany), RT-Mart (Taiwan), and China Resources (China), or online stores such as T-mall and Yihaodian, would not stamp out this kind of illegal trade, especially when Chinese parents are frantically looking for imported infant formula after the milk scandal in 2008.
Should these retailers import and sell infant formula directly so as to compete with the black market? There are three problems with this idea. First, it will alienate the existing distributors and local producers (including those foreign-owned producers in China). Second, the import tariffs can be substantial even though the Chinese government has reduced the tariffs for importing milk formula from 20% to 5% in 2013. Third, it may offend the Chinese government by discrediting their efforts in improving food safety.
So, what can these retailers do? Instead of direct import, retailers can consider a couple of ideas to compete with the black market of imported formula. First, a retailer can purchase imported milk formula through an intermediary without creating unhappiness along the supply chain. For example, a retailer operating in China can purchase imported formula from a Chinese partner such as Funton Holdings who acquired an Australian milk factory Bonlac in 2013. Second, a retailer can foster partnership with foreign-owned producers in China so that these producers can import the formula on their behalf. For example, online retailer T-mall is fostering a partnership with Danone and Nestlé for direct sales of infant formula. Perhaps this partnership can be extended to imported formula in the near future. This is only a short-term solution.
To stamp out the black market, the Chinese government should reduce the import tariffs of infant formula to zero. This way, there is no way that the black market can beat the efficient supply chain that major retailers have established. The real question is: will the Chinese government lower the tariffs permanently and let the free market compete?