Challenges and Transformation in China’s Food Chain December, 2018 Introduction 3 Challenges 4 Highly fragmented produce and crop production 5 Highly fragmented livestock farming and meat processing 5 Highly fragmented dairy production 8 Input-driven agricultural growth 8 Resource scarcity and environmental protection 10 Low efficiency and productivity 11 Import dependency 14 Limited cold chain capacity 16 Fragmented restaurant and retail sectors 17 Food safety management and food fraud vulnerability 19 Complex regulatory and enforcement structure 20 Urbanisation, social media, rising urban income and rural welfare 21

Transformations 21 Dairy 23 Pork 30 Crops 33 Cold chain 36 Chain restaurants 37 Groceries and e-commerce 38 Online restaurant ordering and delivery 39 Traceability 40 Food fraud 41 Harnessing e-commerce and new business models to improve 42 supervision and enforcement

Keys to success 43 Introduction

After four decades of rapid growth, China is one of the world’s largest producers and consumers of food and agricultural products. The country is now the world’s largest producer of pork, mutton, fish, fruits, vegetables, wheat, tea and eggs. It is the second largest producer of chicken meat, and the third largest producer of milk and beef. The growth launched by Deng Xiaoping’s “Reform and Opening” has vastly improved nutrition and quality of life for China’s consumers, while raising income for hundreds of millions of China’s farmers.

But the speed of production growth, increasing complexity of supply chains and highly fragmented industry structure have created food safety and quality challenges for regulators.

With 230 million farms,1 China’s agricultural sector is incredibly fragmented and difficult to supervise; the vast majority of farms are too small to fully benefit from industrial farming methods, modern technology and agricultural best practices. This is changing, however, as corporations and investors build some of the world’s largest livestock operations and reforms of the rural land rights system enable consolidation of farmland.

With approximately eight million restaurants,2 supervision of the retail end of the supply chain is also difficult. At the same time, China’s two leading online restaurant delivery platforms now use the most advanced technology in the world to sell and deliver meals from millions of restaurants to hundreds of millions of customers. These well-funded platforms are enabling tighter supervision and enforcement of food safety and quality regulations, and are creating possibilities for automated, accurate and granular traceability on a massive scale.

Not only does China’s food supply chain encompass enormous contrasts between the traditional and the modern, but the continuing speed and scale of its transformation is truly historic.

This report will cover the major challenges faced by China’s food and agriculture sectors, take a detailed look inside the many areas of its ongoing transformation, and outline some keys to success for companies looking to enter or grow in China’s food sector.

1 2017 China Agriculture Yearbook 2 China Cuisine Association, China Catering Industry Development Report (2018)

3 || Challenges and Transformation in China’s Food Chain Challenges Challenges: Highly fragmented produce and crop production

China had 230 million farms in 2016, with an average of assigned to each rural household small, but it is often split 0.6 hectares of arable land. In contrast, the EU has 11 among several non-contiguous plots. A 2003 study found million farms with an average size of 16 hectares, while the that, on average, each rural household’s land was split US has only 1.6 million farms with an average size of more among 5.7 separate plots of about 0.1 hectare apiece4. than 100 hectares 3. This structure is largely due to China’s This further fragmentation was brought about when the system of rural land rights, the Household Responsibility HRCS was launched in the 1980s. Plots of farmland were Contract System (HRCS), where each rural household is assessed and assigned quality levels. Households within a assigned non-transferable rights to specific parcels of commune were then often assigned equal amounts of land farmland. Not only is the average amount of farmland from each quality level in order to ensure fair distribution.5

Number of farms with arable land6 Average arable land per farm (hectares)7

230 million 102

16 11 million 1.6 million 0.6

China EU-28 US China EU-28 US

Challenges: Highly fragmented livestock farming and meat processing

China’s livestock sector is also highly fragmented. Nearly China has nearly 21 million farms that raise broilers 43 million farms raise hogs, compared to 2.2 million in the (chickens raised for meat), compared to 2 million in the EU EU and only 56,000 in the US. About half of China’s hogs and only 33,000 in the US. Most of China’s broilers come come from farms that produce fewer than 500 per year from small and medium-sized farms that produce fewer while in the US, 90% of hogs come from farms that than 50,000 per year. By contrast, more than 95% of US annually raise more than 5,000.8 broilers come from large farms that produce more than 200,000 annually.9

Farms that raise pigs for slaughter10 Farms that raise broilers11

42.6 million 20.5 million

2.2 million 2.2 million 56 thousand 33 thousand

China EU-28 US China EU-28 US

3 2017China Agriculture Yearbook; 2017 China Land, Mineral and Ocean Resources Statistics Bulletin, Eurostat, 2012 USDA Census of Agriculture 4 Rural 2003, as referenced in Li G. K .and Zhong F. N., 2006.,“Farmland fragmentation, labour utilization and farmers’ income”, Chinese Rural Economy, (4): 42-48. (in Chinese) Economy Research Center of the Ministry of Agriculture, 5 中国共产党新闻网，《农村基本经营制度：理论评价与现实选择》, 10 Dec 2013, http://theory.people.com.cn/n/2013/1210/c40531-23800719.html 6 2017China Agriculture Yearbook ; Eurostat; 2012 USDA Census of Agriculture 7 2017China Agriculture Yearbook ; 2017 China Land, Mineral and Maritime Resources Statistics Bulletin; Eurostat, 2012 USDA Census of Agriculture 8 2012 USDA Census of Agriculture; Eurostat; 2017 China Animal Husbandry and Veterinary Yearbook; National Hog Production Development Plan (2016-2020) 9 2012 USDA Census of Agriculture; Eurostat; 2017 China Animal Husbandry and Veterinary Yearbook 10 2012 USDA Census of Agriculture; Eurostat; 2017 China Animal Husbandry and Veterinary Yearbook 11 2012 USDA Census of Agriculture; Eurostat; 2017 China Animal Husbandry and Veterinary Yearbook

5 | Challenges and Transformation in China’s Food Chain China produces and consumes about half of the world’s In 2015, the top eight slaughterhouse companies pork. Pork production is fragmented not only at the farm accounted for only about 10% market share13 and the top level, but also the corporate level. In 2016, the top 10 hog 50 slaughterhouse enterprises only accounted for only farming companies accounted for only 5.8% of all hogs 18% market share.14 produced.12 Meat processing is also highly fragmented.

Market share of top 10 hog producers Market share of top 8 pork processors 16 (by owned breeding sow inventory)15 (by total hogs slaughtered)

100%

40% 80%

30% 60%

20% 40%

10% 20%

0% 0% China EU US China EU US In 2016, China had more than 11,000 designated hog According to the Hog Slaughtering Management Rules slaughterhouses, i.e. slaughterhouses licensed according issued by the State Council, only designated to national food safety, biosecurity and environmental slaughterhouses can slaughter hogs; but the Rules include protection standards. The combined annual capacity of two exceptions: individuals in rural areas can slaughter these designated slaughterhouses was about 1 billion hogs for their own consumption, and local governments hogs, according to estimates from various government can authorise small-scale slaughterhouses for areas that sources.17 Of these 11,000 designated slaughterhouses, are not served by designated slaughterhouses. only 10% were fully mechanised, only 20% were partially Only 307 million hogs,19 about 45% of China’s 2016 hog mechanised, and the remaining 70% were manual.18 There production, were slaughtered in designated were fewer than 3000 “scale” slaughterhouses (i.e. slaughterhouses. These statistics indicate that the average slaughterhouses with annual capacity of 20,000 or more capacity utilisation for designated slaughterhouses was hogs.) China’s leading hog farming and meat processing only about 30%. The remaining nearly 400 million hogs companies are aggressively expanding modern produced in 2016 were slaughtered privately or at facilities slaughterhouse capacity. that likely did not meet national government standards for food safety, biosecurity and environmental protection.

Hog slaughterhouse mechanisation Utilisation of designated slaughterhouses and (% of designated slaughterhouses)20 total hogs slaughtered in 201621

100% 10% Fully mechanised

20% Partially mechanised

Manual 1 billion 50% 0.7 billion 70% 0.3 billion

Total designated hog Total hogs Hogs slaughtered in 0% slaughterhouse slaughtered designated Designated hog annual capacity slaughterhouses slaughterhouses

12 张广安, 在2017年5月16日-17日召开的第五届全球猪业论坛暨第十五届（2017）中国猪业发展大会，养殖‖中国猪业发展报告发布, http://www.sohu.com/a/141938624_785860 13 WattAgNet.com; USDA Livestock Slaughter 2015 Summary; China Animal Husbandry and Veterinary Yearbook 14 WattAgNet.com; China Animal Husbandry and Veterinary Yearbook; National Hog Production Development Plan (2016-2020), Apr 2016 15 Successful Farming, “What You Need to Know About China’s Swine Industry”, 12 Jan 2018; China Animal Husbandry and Veterinary Yearbook; WattAgNet.com; National Hog Farmer, “Get Acquainted with Global Mega Producers”, 7 Jun 2017; Eurostat; USDA Quarterly Hogs and Pigs 16 WattAgNet.com; China Animal Husbandry and Veterinary Yearbook ; Eurostat; USDA Livestock Slaughter Summary 17 中国环境科学研究院、中国肉类食品综合研究中心、中国轻工业清洁生产中心,《屠宰与肉类加工工业水污染物排放标准（征求意见稿）》编制说明, Nov 2017; 张凤,《生猪屠宰管理中存在的问题及对策》, 河南畜牧兽医（综合版）, 2016,37(10) 18 《屠宰与肉类加工工业水污染物排放标准（征求意见稿）》编制说明, Nov 2017 19 2017 China Agricultural Yearbook 20《屠宰与肉类加工工业水污染物排放标准（征求意见稿）》编制说明, Nov 2017 21《屠宰与肉类加工工业水污染物排放标准（征求意见稿）》编制说明, Nov 2017; 张凤,《生猪屠宰管理中存在的问题及对策》, 河南畜牧兽医（综合版）, 2016,37(10); 2017 China Agricultural Yearbook

6 | Challenges and Transformation in China’s Food Chain The fragmented structure of the livestock and processing industries makes it difficult to control biosecurity risks. China’s pork industry has been plagued by extreme market fluctuations, with price increases triggered by epidemics, subsequent overinvestment, oversupply and price drops.

According to the Dalian Commodities Exchange, the four major cycles since 2003 involved swings of 65%, 183%, 113% and 83%.22 Recent measures to control the spread of African Swine Fever, including restrictions on the transportation of live hogs and closing of some live markets, have resulted in price spikes in regions of net pork consumption and price drops in hog producing regions where outbreaks have occurred. These market swings make investment risky, and are especially perilous for small-scale livestock farmers.

China live hog price fluctuations (CNY/100g)23

25

20

15

10

5

0

22 Dalian Commodity Exchange, “Live Hogs Industry Expects Futures to Help on the ‘Hog Cycle’ Problem”, 01 Aug 2017, http://www.dce.com.cn/DCE/Media_Center/Exchange%20News/6052631/index.html 23 MARA; USDA

7 | Challenges and Transformation in China’s Food Chain Challenges: Highly fragmented dairy production

China’s dairy production is also highly fragmented. In averaging 11 cows per farm. In contrast, the US had 42 2016, China had more than 1.3 million dairy farms, thousand farms, with an average of over 220 cows per farm.24

Number of dairy farms25 Average size of dairy farms (number of cows)26

1.3 million 419

223

42 thousand 11 thousand 11

China US New Zealand China US New Zealand

Challenges: Input-driven agricultural growth

Since 1980, China’s major crop production has tripled but Pesticide use has more than doubled since 1991,27 and farmland has increased by only 10%. Growth was largely China’s farmers use about five times the amount of driven by increased factor inputs such as pesticides and pesticides28 per hectare as farmers in the US. chemical fertiliser.

Pesticide use 1991-2015 Pesticide use per hectare of arable land (tonnes)29 (kg/hectare)30

14 1.8 12

10 1.2 millions 8

6 0.6 4

2

0.0 0 China US France Germany United Kingdom

24 2018 China Dairy Data Report 25 2018 China Dairy Data Report 26 2018 China Dairy Data Report 27 National Bureau of Statistics 28 FAOSTAT 29 National Bureau of Statistics 30 FAOSTAT

8 | Challenges and Transformation in China’s Food Chain The use of chemical fertiliser quadrupled between 1980 and 2010,31 and China’s farmers use more than three times the amount of chemical fertiliser per hectare as farmers in the US. 32

Chemical fertiliser use 1980-2016 Chemical fertiliser use per hectare of arable land (tonnes)33 (kg/hectare)34

500 60

50 400

40 300

millions 30 200 20

100 10

0 0 China EU US 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 2016

China’s livestock industry consumes far more antibiotics antibiotics residues in meat products, excessive or than the US or Europe. According to a 2015 research improper use of antibiotics increases the risk of epidemics report, China used an estimated 80 thousand tonnes of among livestock from antimicrobial resistant superbugs, as veterinary antibiotics in 2013,35 compared to about 15 well as antimicrobial resistant zoonotic diseases that could thousand tonnes in the US and about eight thousand be transmitted to humans. Excessive antibiotics usually tonnes in Europe.36 In addition to the risk of excessive end up in waterways via agricultural waste.

Estimated veterinary antibiotic consumption in 2013 (tonnes/year)37

80

60

40 thousands

20

0 China US EEC

31 National Bureau of Statistics 32 World Bank 33 National Bureau of Statistics 34 World Bank (nitrogen, potash and phosphate fertilizers) 35 Chinese Academy of Sciences, 《科学家获取首份中国抗生素使用量与排放量清单》, 11 Jun 2015, http://www.cas.cn/cm/201506/t20150612_4372924.shtml 36 European Medicines Agency, Sales of Veterinary Antimicrobial Agents in 26 EU/EEA Countries; US FDA, 2013 Summary Report on Antimicrobials Sold or Distributed for Use in Food-producing Animals 37 Chinese Academy of Sciences, 《科学家获取首份中国抗生素使用量与排放量清单》, 11 Jun 2015, http://www.cas.cn/cm/201506/t20150612_4372924.shtml; European Medicines Agency, Sales of Veterinary Antimicrobial Agents in 26 EU/EEA Countries; US FDA, 2013 Summary Report on Antimicrobials Sold or Distributed for Use in Food-producing Animals

9 | Challenges and Transformation in China’s Food Chain Challenges: Resource scarcity and environmental protection

Resource scarcity and pollution are two of the biggest challenges faced by China’s agricultural sector. China produces a quarter of the world’s food with less than 10% of the world’s arable land38 and only 7% of its fresh water.39 China has less than 0.1 hectare of arable land per capita, compared to nearly 0.5 hectares per capita in the US.40

Arable land per capita (hectares/person)41

China 0.1

EU 0.2

US 0.5

80% of the country’s fresh water resources are in the Yangtze River and the South, but about 70% of its farmland is in the North.42 This requires massive irrigation 70% from underground aquifers and China’s enormous south- of China’s farmland to-north aqueduct. China’s irrigation efficiency index is is in the North. about 0.53,43 meaning that almost 50% of water is lost in delivery, compared to only 20-30% water loss in mature economies.44

As consumers’ income has grown, their diets have shifted 80% towards animal products. Per capita meat consumption of China’s water resources grew from less than 21 kg per year in 1991 to more than are in the South. 50 kg per year in 2016.45 While pork and chicken account for most of this, beef and mutton consumption have been growing 3-4 times more quickly than pork.46 Excessive use of chemical fertilisers has caused both soil acidification and water pollution.49 Rapid industrialisation Production of animal products generally consumes more has also have caused water pollution. According to a water per calorie than crops and produce, due to the report published in 2017 by the Ministry of Environmental quantity of animal feed that must be cultivated. According Protection, more than 60% of underground water sources to estimates, producing one calorie of pork or chicken surveyed were “bad” or “very bad”, and 30 of 60 major meat is estimated to require 4-7 times more water than lakes were polluted.50 producing a single calorie of cereal crops; producing one calorie of beef requires about 20 times more water than Industrial pollution has also contributed to soil producing of one calorie of rice.47 As meat consumption contamination. According to a national survey on soil increases, so will the demands on China’s scarce water quality published in 2014 by the Ministry of Environmental resources. Protection and the Ministry of Land and Resources, 19% of arable land surveyed exceeded national soil pollution Animal waste from livestock farming is a major source of standards; cadmium, nickel, copper, arsenic, mercury, water pollution. While pork meat production has grown to lead, DDT and polycyclic aromatic hydrocarbons were more than 56 million tonnes per year, pig farming produces cited as major contaminants.51 more than 600 million tonnes of excrement annually.48

38 Li Wei, “Accelerate Transforming Agriculture and Bring New Driving Forces for Safeguarding Food Security and Food Safety”, 16 Dec 2015,text from speech to the China Food Security & Food Safety Strategy Summit, http://www.drc.gov.cn/zjsd/20151216/4-4-2889567.htm 39 Lamb, Cate, “How Should Business React to China's Water Crisis?”, 21 Jul 2016, World Economic Forum, https://www.weforum.org/agenda/2016/07/what-china-s-new-approach-to-water-means-for-business/ 40 World Bank 41 World Bank 42 Zhang Zhengbin and Xu Ping, “Governance of Food and Water Security in China, with Reference to Farming in Northwest Areas”, in Food and Water Security, ed. U Aswathanarayana (CRC Press, 2007) 43 National Agriculture Modernisation Plan (2016—2020), Oct 2016 44 Li Wei, “Accelerate Transforming Agriculture and Bring New Driving Forces for Safeguarding Food Security and Food Safety”, 16 Dec 2015, text from speech to the 3rd China Food Security & Food Safety Strategy Summit, http://www.drc.gov.cn/zjsd/20151216/4-4-2889567.htm 45 OECD 46 OECD 47 Mekonnen, M.M., Hoekstra, A.Y., Ecosystems (2012) 15: 401, https://doi.org/10.1007/s10021-011-9517-8 48 National Hog Production Development Plan (2016-2020), Apr 2016 49 Ministry of Agriculture, 农业部关于印发《到2020年化肥使用量零增长行动方案》和《到2020年农药使用量零增长行动方案》的通知, 18 Mar 2015 http://jiuban.moa.gov.cn/zwllm/tzgg/tz/201503/t20150318_4444765.htm 50 Ministry of Environmental Protection, 2016 Report on the State of the Environment in China, Jun 2017, http://www.mep.gov.cn/hjzl/zghjzkgb/lnzghjzkgb/201706/P020170605833655914077.pdf 51 Ministry of Environmental Protection and Ministry of Land and Resources, National Soil Pollution Survey Report, Apr 2014, http://www.zhb.gov.cn/gkml/hbb/qt/201404/W020140417558995804588.pdf

10 | Challenges and Transformation in China’s Food Chain Challenges: Low efficiency and productivity

China’s agricultural production is still inefficient compared soy, which has become China’s largest agricultural import. that of the US and the EU. The following examples from China’s average feed conversion ratio (i.e. the amount of pork, dairy and staple crop production illustrate some of feed required to produce an additional kg of growth) is the many factors involved. higher than that of farms in the US and Europe.

In recent years, the average production cost for hogs in China lags in the number of pigs weaned per sow per year China has been approximately twice that of the US.52 Feed (PSY), another measure of productivity. Other factors often accounts for more than 60% of production costs.53 contributing to production costs include cost of piglets, China corn prices are much higher than in the US, and as labour productivity, genetic quality, veterinary expertise China’s industry shifts from household production to scale and farm management. farms, hog farming is increasingly dependent on imported

2016 pork production cost Estimated feed conversion Average pigs weaned per sow estimate (CNY/kg)54 ratio on scale farms per year (PSY) estimate56 (kg feed/kg of weight gain)55

27.5 3.0 25.7 16.1 2.8 2.7 11.4 17 7.7

China EU US China Germany US China EU US

52 2017 China Animal Husbandry and Veterinary Yearbook, AHDB Pig Cost of Production in Selected Countries 53 National Hog Production Development Plan (2016-2020) , Apr 2016 54 2017 China Animal Husbandry and Veterinary Yearbook; AHDB Pig Cost of Production in Selected Countries 55 China Animal Agriculture Association, Annual Report on Development of Swine Industry in China (2016) 56 2017 Company reports; 2016 AHDB Pig Cost of Production in Selected Countries

11 | Challenges and Transformation in China’s Food Chain China’s dairy industry also faces cost and efficiency countries — especially New Zealand, the largest source of challenges. In recent years, China’s raw milk prices have China’s dairy imports. generally been higher than those of most dairy exporting

2017 raw milk price (CNY/litre)57

6

5

4

3

2

1

0 Argentina Uruguay Chile New Zealand USA EU Brazil Russia China Japan

As China’s dairy production shifts from household farms to commercial scale farms, the industry is becoming more 2017 raw milk yield per dairy cow (litres/cow/year)58 dependent on commercial feed, which is more expensive in China than other major dairy countries. 12 10 Productivity per dairy cow is lower than most major dairy 8 producing countries. Factors contributing to productivity 6 per cow include genetic quality, farm management skills,

thousands 4 feed and feeding techniques (e.g. TMR), dairy farm 2 facilities, veterinary care, etc. 0 Fragmented cropland hinders mechanization, resulting in labour intensive farming. Economic development and industrialization have increased the cost of labour, while enticing workers to move from the countryside to the cities. The rural labour force is decreasing and aging while labour 2007 to 5.3 in 2016 for China’s three main staple crops costs are rising.59 (rice, corn and wheat) but labour cost per mu rose by more than 240%. In spite of a 13% increase in yields during the According to the NDRC’s annual Agricultural Production same period, the NDRC report indicates that production of Costs and Returns Compilation, the average number of these three staple crops, on average, became unprofitable person-days of labour per mu of farmland fell from 8.7 in in 2016.60

Average profit margin and labour cost as a % of market price for staple crops (corn, wheat and rice)61

50%

40%

30% Labour Cost / Value of harvest (%) 20% Profit / Value of harvest (%)

10%

0%

-10% 2009 2010 2011 2012 2013 2014 2015 2016

57 2018 China Dairy Data Report 58 2018 China Dairy Data Report 59 State Council Development Research Center, Agricultural Economies of Scale Development Working Group, “China Agriculture Economies of Scale Development and Problems”, 13 May 2016, http://www.chinareform.org.cn/Economy/Agriculture/Report/201605/t20160513_248889.htm 60 NDRC, China Agricultural Production Costs and Returns Compilation 2012 & 2017 61 NDRC, China Agricultural Production Costs and Returns Compilation 2012 & 2017

12 | Challenges and Transformation in China’s Food Chain Challenges: Import dependency

After the melamine incident of 2008, China’s overall dairy much of which is imported. Prior to 2008, China’s alfalfa output growth slowed and production began shifting from imports were practically zero. In 2015, China’s dairy and small household farms to dairy cooperatives and large livestock farms consumed 3 million tonnes of quality scale intensive dairy farms. While small farms often raise alfalfa, of which 1.2 million tonnes were imported. With or gather their own forage and feed, larger scale growth in the number of scale livestock farms, China’s operations depend on commercially purchased feed, which demand for quality alfalfa is expected to reach 6.9 million is more expensive. In China, large scale dairy farms tonnes by 2020, of which 90% will be for dairy farms.62 require significant amounts of alfalfa and other forage,

Alfalfa and other forage products imports (tonnes)63

1.8 1.6 1.4 1.2 1.0 0.8 millions 0.6 0.4 0.2 0.0 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017

While growth in domestic raw milk production slowed after supplied 80% of the 2008-2015 increase in dairy 2008, demand for dairy products continued to increase and consumption. The government aims to maintain a self- imports grew dramatically. According to the National Dairy sufficiency ratio of 70% or greater for dairy products.64 Industry Development Plan (2016-2020), import growth

Dairy imports (tonnes)65

1.2 Whey Whole milk powder Skim milk powder 1.0

0.8

millions 0.6

0.4

0.2

0.0

62 National Alfalfa Production Development Plan (2016-2020), Dec 2016 63 UN Comtrade Database 64 National Dairy Industry Development Plan (2016-2020), Dec 2016 65 UN Comtrade Database

13 | Challenges and Transformation in China’s Food Chain As larger scale livestock farms have begun to displace soybean consumption.66 China now accounts for more small household farms, China’s livestock industry has than 60% of global soybean imports.67 become dependent on commercial feed, a significant China has a self-sufficiency ratio of only 32% for edible portion of which consists of imported soy beans and soy vegetable oil. It is the world’s largest importer of vegetable meal. Soybeans are also used to produce oil and other oil, and one of the largest importers of oilseeds.68 food products for human consumption. In 2017 China relied on imports to supply more than 85% of domestic

Soy imports (tonnes)69

90 80 70 60 50 millions 40 30 20 10 0

In spite of growing pork imports during recent years, China of China’s total pork consumption.70 Measures to control is practically self-sufficient for pork products. Pork imports and prevent African Swine Fever outbreaks, e.g. grew from less than 500,000 tonnes in 2011 to over 1.6 restrictions on transporting hogs and pork products, could million tonnes in 2016 but total imports peaked at only 3% cause demand for imports to increase again in 2019.

Pork imports (as % of consumption)71

3.0%

Pork imports as % of consumption 2.5%

2.0%

1.5%

1.0%

0.5%

0.0% 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017

66 MARA, 《做强大豆产业推动区域经济发展 – 对黑龙江省大豆产业现状的分析与思考》, 27 Jun 2018，http://www.moa.gov.cn/xw/qg/201806/t20180627_6153261.htm 67 UN Comtrade Database 68 中华人民共和国厦门海关，《1-9月厦门关区食用植物油进口量价齐升》, 26 Oct 2017, http://www.customs.gov.cn/xiamen_customs/491078/491080/491082/1190157/index.html 69 UN Comtrade Database 70 UN Comtrade Database 71 UN Comtrade Database

14 | Challenges and Transformation in China’s Food Chain Challenges: Limited cold chain capacity

Most of China’s agricultural products do not enter the cold chain. According to the China Cold-chain Logistics Development Report, only 22% of China’s fruits and vegetables, 34% of China’s meat, and 41% of China’s aquatic products entered the cold chain in 2015.72 In Europe and the US, 95-100% of these products enter the cold chain.73 China’s per capita cold chain capacity lags behind the US. In 2017, China’s per capita refrigerated warehouse capacity was less than 30% that of the US.74

% of agricultural products distributed via cold chain75 Refrigerated warehouse capacity per capita (m3)76

China US, EU, Japan 100% 0.3

75% 0.2 50%

0.1 25%

0% 0.0 Fruits & Meat Aquatic China Western Europe US vegetables products

Fresh meat still accounts for the vast majority of retail meat 2016 retail meat sales value by product type77 product sales in China, compared only about 20% in the US. This reflects a number of factors: traditional preferences for fresh meat, limited cold chain capacity, and 100% an underdeveloped meat processing sector. 21% The large proportion of fresh meat in retail sales limits the 75% average shelf life of meat products to less than a week and requires that live hogs, (rather than chilled, frozen or 79% otherwise processed meat products), must be shipped 50% from hog producing areas to pork consuming areas. This exacerbates the biosecurity risks of a pork industry that lacks vertical integration and is based on small farms and 25% slaughterhouses. The biosecurity challenges of a fragmented pork industry structure have been apparent in the recent measures taken to prevent an African Swine 0% Fever epidemic. China US Fresh Cooked meats Cooked meats (counter) (packaged) (counter)

Chilled raw packaged Chilled raw packaged (whole cuts) (processed)

Ambient Frozen meat

72 China Cold Chain Logistics Association, China Cold-Chain Logistics Development Report (2016) 73 NDRC, Agricultural Product Cold Chain Development Plan (2010-2015) 74 China Cold Chain Logistics Association, China Cold-Chain Logistics Development Report (2017); USDA, Capacity of Refrigerated Warehouses 2017 Summary 75 China Cold Chain Logistics Association, China Cold-Chain Logistics Development Report (2016); NDRC, Agricultural Product Cold Chain Development Plan (2010-2015) 76 China Cold Chain Logistics Association, China Cold-Chain Logistics Development Report (2017); 2018 GCCA Global Cold Storage Capacity Report; USDA, Capacity of Refrigerated Warehouses 2017 Summary 77 Globaldata, Meat Market in China: Snapshot to 2021; Globaldata, Meat Market in the United States: Snapshot to 2021”

15 | Challenges and Transformation in China’s Food Chain China’s cold chain logistics industry is highly fragmented. Cold storage market share for the largest cold storage According to the China Cold Chain Logistics Development companies in China, Western Europe and the US80 Report, China’s top 10 cold storage companies accounted for only 10.5% of the cold storage market by revenue in 2016.78 In the US, the top four cold storage and logistics 35% companies account for more than 35% of the market.79 30%

25%

20%

15%

10%

5%

0% China (top 10) Western Europe US (top 4) (top 10)

Challenges: Fragmented restaurant and retail sectors

According to the China Cuisine Association, China has are chain restaurants.83 Of China’s total retail restaurant more than eight million restaurants;81 less than 1% of sales during the first six months of 2018, 77% were these are chain restaurants.82 In contrast, the US has attributed to enterprises whose annual revenue was less fewer than 700,000 restaurants of which more than 40% than CNY 2 million.84

Number of restaurants85 Number of chain restaurants86

8 7 250 6 200 5 4 150 millions 3 thousands 100 2 50 1 0 0 China EU-28 US China US

Supervision and enforcement over eight million restaurant management practices, and also a lack of national cold locations is an incredibly difficult job for the government. chain distribution capabilities for restaurants’ raw materials The low penetration of chain restaurants implies a low and other supplies. level of standardisation for food safety and quality

78 China Cold Chain Logistics Association, China Cold-Chain Logistics Development Report (2017) 79 IBIS, Refrigerated Storage in the US, Nov 2017 80 China Cold Chain Logistics Association, China Cold-Chain Logistics Development Report (2017); 2018 GCCA Global Cold Storage Capacity Report; IBIS, “Refrigerated Storage in the US”, November 2017 81 China Cuisine Association, China Catering Industry Development Report (2018) 82 National Bureau of Statistics 83 IFMA 2017/2018 Foodservice Insights Library 84 National Bureau of Statistics, “Total Retail Sales of Consumer Goods in June 2018”, 19 July 2018, http://www.stats.gov.cn/english/PressRelease/201807/t20180719_1610962.html 85 China Cuisine Association, China Catering Industry Development Report (2018); Eurostat; IFMA 2017/2018 Foodservice Insights Library 86 National Bureau of Statistics, 2017 Statistical Yearbook of China Chain Stores and Retail Trade and Catering Services; IFMA 2017/2018 Foodservice Insights Library

16 | Challenges and Transformation in China’s Food Chain Number of chain supermarket locations87 Number chain supermarket locations in China88

80 45 70 40 60 35 50 30 25 40 20 housands housands t 30 t 15 20 10 10 5 0 0 China US 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016

China has lower penetration of chain supermarkets and Market share of top 5 grocery store brand hypermarkets, with just over 40,000 chain supermarkets owners(including hypermarkets, warehouse (including hypermarkets, warehouse club stores, discount club stores and discount stores)91 stores) compared to more than 80,000 in the US. This implies a greater consumer reliance among Chinese consumers on traditional markets, restaurants and smaller, independent, retail shops. The number of chain supermarket stores in China has fallen from its peak in 50% 2012. 40% China’s supermarket sector (including hypermarkets, warehouse club stores, and discount stores) is also 30% fragmented, with the top five brand owners combining for approximately 10% market share,89 compared to more 20% than 50% in the US.90 10%

0% China US

87 National Bureau of Statistics, 2017 Statistical Yearbook of China Chain Stores and Retail Trade and Catering Services； IFMA 2017/2018 Foodservice Insights Library 88 National Bureau of Statistics, 2017 Statistical Yearbook of China Chain Stores and Retail Trade and Catering Services 89 Euromonitor, “EMIS Sector Capsule: Grocery Retailers in China”, Dec 2016 90 IBIS, Warehouse Clubs and Supercenters, Dec 2017; IBIS, Supermarkets and Grocery Stores, Jul 2018 91 Euromonitor, “EMIS Sector Capsule: Grocery Retailers in China”, Dec 2016; IBIS, Warehouse Clubs and Supercenters, Dec 2017; IBIS, Supermarkets and Grocery Stores, Jul 2018

17 | Challenges and Transformation in China’s Food Chain Challenges: Food safety management and food fraud vulnerability

Preventing harmful contamination, ensuring constant China’s food industry also has considerable food fraud temperature control and conducting proper food vulnerability. Food safety management is focused on preparation on a large scale requires effective preventing accidental contamination and temperature implementation of best practices and technology from farm abuse, but food fraud is intentional adulteration or other to fork. With the growing scale of China’s farms and food deception that is specifically designed to avoid detection companies, and the increasing complexity and geographic by consumers and quality assurance teams. China’s reach of its supply chains, sophisticated food safety and markets are fiercely competitive; producers and traders of operational management are required. food and agricultural commodities generally operate on razor thin margins. This pressure creates economic China’s leading companies and farms have made great incentive to use cheaper, inferior ingredients as progress in this area, but many small and medium size substitutes, or to use illegal additives to enhance attributes operators still have room for improvement. that determine pricing.

Seven types of food fraud

Dilution Mixing a liquid of high value with a liquid of lower value.

Substitution Replacing an ingredient of high value with an ingredient of lower value.

Concealment Hiding the low quality of food ingredients or product.

Mislabelling Placing false claims on packaging for economic gain.

Unapproved enhancements Adding unknown and undeclared materials to food products to enhance the quality attributes.

Counterfeiting Copying the brand name, packaging concept, recipe, processing method etc. of food products for economic gain.

Grey market production/theft/diversion Sale of stolen or excess unreported product.

Highly fragmented agriculture, logistics, processing, retail to confirm the accuracy of declared ingredients and and restaurant sectors make it difficult to prevent locations of origin. China’s fragmented agriculture sector undeclared, substandard or illegal ingredients from making and food industry, as well as the fragmented nature of their way into the food supply chain. It can be challenging local regulation and enforcement, make this risk difficult to control.

18 | Challenges and Transformation in China’s Food Chain Challenges: Complex regulatory and enforcement structure

With China’s enormous population, geographic size and The National Food Safety Law of 2015 assigns oversight diversity, economic complexity, and rapidly changing of food production and trading to the China Food and Drug economy, it is inevitably challenging to find the optimal Administration, which was folded into the newly formed division of responsibilities between different departments SAMR in 2018. National food safety standards are at the central government level, and equally challenging to formulated by the NHC jointly with the SAMR. The NHC, divide responsibilities between national and local SAMR and MARA are responsible for jointly developing government bodies. limits, testing methods and procedures for pesticide and veterinary drug residues in foods. Testing procedures for At the national level, food safety and quality responsibilities livestock slaughtering are the responsibility of the MARA are divided among the State Administration for Market and the NHC. The SAMR and MARA are responsible for Regulation (SAMR), the National Health Commission establishing a coordinated farm-to-table food safety (NHC) and the Ministry of Agriculture and Rural Affairs traceability system. (MARA). The National Food Safety Law covers food production and trading, while the National Quality and Safety of Agricultural Products Law covers primary agricultural products.

province-level national administrative government Mainland 1 34regions China government 334 2,851 administrative prefecture-level county-level structure92 administrative regions administrative areas

China has 34 provincial-level regions, 334 prefecture-level sharing mechanisms. Local governments determine the administrative regions, and 2851 county-level responsibilities of their local Food and Drug administrative regions.93 It is very difficult to ensure Administrations (FDA) and other government departments, consistency of local measures, regulations and and are responsible for incorporating food safety work in to enforcement, and it can take time for local implementation local budgets and planning. Local governments are of policy and guidance from the central government. responsible for implementing accountability systems for the supervision and administration of food safety.94 The Local county-level and above governments are responsible agricultural department of local governments are for food safety supervision and management in their responsible for planning, budgeting, leading and respective jurisdictions, including the establishment of coordinating agricultural product safety and quality whole process food safety management and information supervision and administration work.95

92 Ministry of Civil Affairs，中华人民共和国行政区划简册2018 93 Ministry of Civil Affairs，中华人民共和国行政区划简册2018 94 Food Safety Law of the People’s Republic of China 95 Agricultural Product Quality Safety Law of the People's Republic of China

19 | Challenges and Transformation in China’s Food Chain Challenges: Urbanisation, social media, rising urban income And rural welfare

China’s urban population has increased from about 580 million in 2006 to more than 790 million in 2016, and now makes up nearly 60% of the total population.96 Urban consumers require a much more complex supply chain than rural residents, making it much more difficult 80% of consumers said they for those consumers to verify the quality, authenticity are not satisfied with food and source of their foods’ ingredients. At the same time, 80% safety in China online media has increased public awareness of food safety and food fraud incidents. According to the China Daily, 80% of respondents to a 2014 survey “said they are not satisfied with food safety in China”, while 60% “said food companies have performed poorly in food safety.” 97 60% of consumers said food Urban per capita disposable income has increased from companies had performed CNY 6,280 in 2000 to CNY 36,396 in 2017,98 driving 60% poorly in food safety in China increased demand for quality and variety of food. During this time, China’s per capita consumption of meat increased from 38 kg/year to over 50 kg/year, with mutton and beef growing the fastest.99

Rural per capital income, however, was only CNY Urban and rural disposable income per capita (CNY)101 13,432 in 2017.100 Rural Urban Migration of the working age population to the cities has 30 led to a “hollowing out” of rural communities. The rural population has fallen from nearly 810 million in 2000 to 20 about 590 million in 2016.102 Meanwhile, the percentage of the rural population that is older than 65 is projected thousands 10 to increase from 9% in 2008 to 22% in 2030 compared to an increase from 7% to 15% in urban areas.103 0 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017

Rural population 1997-2016104 People aged 60 and over as % of total rural and urban population 105

800

750 20% Rural Urban 700 18% 16% illions 650 m 14% 600 12% 550 10% 2000 2005 2010 2016

Because rural land is collectively owned, rural residents assigned farmland fallow, and many grow crops as only a cannot sell their farmland. They often cannot move secondary occupation. Those who continue farming are because they would lose their land rights and their social vulnerable to risks such as weather, crop and livestock benefits. Some rural households leave all or parts of their diseases and volatility in agricultural products markets.

96 National Bureau of Statistics, China Statistical Yearbook 2017 97 China Daily, “Dissatisfaction With Food Safety Pervasive, Survey Finds”, 25 July 2014, http://www.chinadaily.com.cn/china/2014-07/25/content_17920201.htm 98 National Bureau of Statistics, 《中华人民共和国2017年国民经济和社会发展统计公报》, 28 Feb 2018，http://www.stats.gov.cn/tjsj/zxfb/201802/t20180228_1585631.html 99 OECD 100 National Bureau of Statistics, 《中华人民共和国2017年国民经济和社会发展统计公报》, 28 Feb 2018，http://www.stats.gov.cn/tjsj/zxfb/201802/t20180228_1585631.html 101 National Bureau of Statistics 102 National Bureau of Statistics 103 World Bank, Fang Cai, John Giles, Philip O’Keefe, The Elderly and Old Age Support in Rural China, 2012 104 National Bureau of Statistics 105 China Population Statistics Yearbook 2006, China Population & Employment Statistics Yearbook 2017

20 | Challenges and Transformation in China’s Food Chain Transformations

21 | Challenges and Transformation in China’s Food Chain China’s food sector has some areas that appear to have changed little from 20 or 30 years ago, but in other areas China now has the world’s most advanced technology and largest facilities. Driven by government policy and a wave of investment, the food sector is at the midpoint of a comprehensive transformation, the speed and magnitude of which is unprecedented.

The current transformation of China’s food and agriculture sectors involves modernisation, industrialisation, standardisation, consolidation, vertical integration and information technology. The government is promoting large scale companies with national brands that are accountable for safety and quality, offer differentiated products, and can compete with foreign products. The government is promoting growth in the processing stage to create more opportunities for economic growth and a greater range of consumer products.

The challenges summarised above are well-known to both regulators and industry leaders. While daunting, it is a sign of great progress that the focus of government, industry and consumer concerns has long moved beyond food security (i.e. ensuring sufficient food quantity) to food safety, quality, and sustainability.

22 | Challenges and Transformation in China’s Food Chain Transformation: Dairy

Dairy has been a primary policy focus, largely due to role it Enabled by the introduction of UHT processing, investment plays in child nutrition and the importance of food safety in and rising consumer income, China’s raw milk production food and beverages made for children. In 2006, Prime grew by more than 300% between 2000 and 2008. After Minister Wen Jiabao said “I have a dream that every the melamine incident of 2008, however, domestic raw milk Chinese person, especially children, can drink one jin of output growth slowed and the policy focus shifted to quality milk per day.” (note: one jin = 500 g)106 and safety.

Bovine milk production 1980 – 2017 (tonnes)107

40

35

millions 30

25

20

15

10

5

0 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017

In 2008, China had more than 2.59 million household dairy farms (i.e. farms with more than 100 cows) has increased farms, of which nearly 2.5 million had fewer than 20 dairy from only 20% in 2008 to 53% in 2016, while the number cows and nearly 2 million of which had fewer than 5 dairy of professional dairy cooperatives has grown from just over cows.108 Nearly half of all raw milk was extracted by hand. 2,000 in 2008 to more than 16,000 in 2016. Since then, the government has taken steps to improve The National Dairy Industry Development Plan (2016- quality and safety, including the creation of thousands of 2020) aims for further progress by 2020, with emphasis on professional dairy farming cooperatives and dairy modernisation, industrialisation, vertical integration and a production zones, where household farmers’ dairy cows more concentrated industry structure. can be housed together and milked mechanically. The percentage of China’s dairy cows belonging to scale dairy

Number of professional dairy % of dairy cows on farms with Mechanised milking111 farming cooperatives109 more than 100 dairy cows110

16,037 70% 95% 99% 53% 10,182 51% 2,097 20%

2008 2012 2016 2008 2016 2020 2008 2015 2020 (planned) (planned)

106 China Daily, 25 Feb 2006, 《温家宝：让每个中国人每天都能喝上一斤奶》, http://www.chinadaily.com.cn/hqsy/2006-04/25/content_578567.htm 107 2018 China Dairy Data Report 108 2012 China Dairy Data Report 109 National Dairy Industry Development Plan (2016-2020), Dec 2016; 2017 China Dairy Industry Quality Report 110 National Dairy Industry Development Plan (2016-2020), Dec 2016; 2017 China Dairy Industry Quality Report 111 National Dairy Industry Development Plan (2016-2020), Dec 2016

23 | Challenges and Transformation in China’s Food Chain The number of small household farms has decreased by province each have 40,000 cows,113 more than any dairy about 50% since 2008, while the number of farms with farm in the US or Europe; and there are plans to build the more than 1000 dairy cows has grown from 112 in 2002 to world’s largest dairy farm, with 100,000 cows, in nearly 1,500 in 2016.112 The Bengbu dairy farm in Anhui Mudanjiang, Heilongjiang province.114 province and the Saibei dairy farm in Hebei.

Dairy farms with fewer than 20 cows115 Dairy farms with more than 1,000 cows116

2.5 million 1,479

1.2 million 706

112 2008 2016 2002 2009 2016

112 China Dairy Data Report 2012 & 2018 113 Modern Dairy Holdings Ltd. 2018 Interim Report 114 China National Radio,《中俄将在黑龙江建全球最大牧场 饲养10万头奶牛》, 15 Jul 2015，http://news.cnr.cn/native/gd/20150715/t20150715_519219613.shtml 115 China Dairy Data Report 2012 & 2018 116 China Dairy Data Report 2012 & 2018

24 | Challenges and Transformation in China’s Food Chain The modernisation of the dairy industry is also helping to largest dairy farm company has already achieved a yield of increase the efficiency of China’s dairy production. China’s 9,900 kg/year, and several farms have achieved yields of average annual dairy cow yield is about 60% that of US more than 12,000 kg/year.118 dairy cows, but there has been consistent progress during The use of total mixed rations (TMR) is one factor that the past decade. China’s average yield has increased from contributes to productivity and efficiency. The share of 3890 kg/year per cow in 2005 to 7000 kg/year in 2017,117 scale dairy farms in China using TMR increased from 30% and the government plans to achieve average productivity in 2008 to 80% in 2016.119 of 7500 kg/year by 2020. Yield growth will accelerate as large modern farms increase their market share; China’s

China’s average dairy cow milk production (kg/year)120 Share of scale dairy farms using TMR technology 121

7,500 80% 6,200 4,760 3,891 30%

2005 2010 2016 2020 (planned) 2008 2016

China’s raw milk production is not only fragmented in consolidated sectors of China’s food industry. The top terms of the number and size of dairy farms, but also in three processors account for more than 40% market share, terms of the companies that own dairy farms, with the top compared to only about 15% in the US;122 making this the three dairy farming companies accounting for less than 7% best stage of the supply chain from which to drive of China’s raw milk production, compared to about 50% in improvements to quality and safety throughout the supply the US. Dairy processing, however, is one of the most chain.

Market share of top 3 raw milk producers123 Market share of top 3 dairy processors124

50% 50%

40% 40%

30% 30%

20% 20%

10% 10%

0% 0% China US China US

117 China Dairy Data Report 2012 & 2018 118 2018 China Dairy Data Report 119 National Dairy Industry Development Plan (2016-2020), Dec 2016 120 China Dairy Data Report 2013 & 2017; National Dairy Industry Development Plan (2016-2020), Dec 2016 121 National Dairy Industry Development Plan (2016-2020), Dec 2016; 2017 China Dairy Industry Quality Report 122 2018 China Dairy Data Report; IBIS 123 2018 China Dairy Data Report; IBIS 124 2018 China Dairy Data Report; IBIS

25 | Challenges and Transformation in China’s Food Chain The consolidation is in ongoing. While revenues for scale formula milk powder manufacturers fell from 145 to 100, dairy companies (i.e. companies with annual revenue of largely due to the elimination of companies with poor CNY 20,000,000 or more) increased from CNY 143 billion production conditions, low safety and quality assurance in 2008 to 359 billion in 2017, the number of scale dairy capabilities, or obsolete production capacity.125 companies fell from 815 to 611. The number of infant

Number of scale dairy Total revenue of all scale Number of enterprises that enterprises126 dairy enterprises (CNY billions)127 produce infant milk formula128

815 359 145

611 100

143

2008 2017 2008 2017 2008 2017

In 2015, the first D20 summit was convened in Beijing, quality and innovation. Having a well-known brand bringing together 20 leading Chinese dairy companies, increases a company’s financial incentives to invest in food comprised mainly of dairy processors, but also including safety and quality management in order to reduce the risk leading dairy farming and feed enterprises. Vice Premier of an incident that would destroy brand value. Wang Yang called on the companies to “make quality the The emphasis on consolidation and vertical integration will top priority for manufacturing operations, foster product improve traceability and accountability for food safety brands, build company prestige, and aspire to build management covering the whole supply chain. consumer trust in domestic dairy products”.129 The Government policies encourage or require dairy companies all signed the “Beijing Declaration” which called processors to build their own raw milk production bases or for the D20 companies to put quality first, pursue a brand to take controlling stakes in dairy farming companies. A strategy to strengthen overall competitiveness, commit to prime example of the trends towards consolidation and earnest self-regulation and fulfilment of social vertical integration, China’s second largest dairy processor responsibility, and take the path of integrated industry has spent more than USD 2 billion on acquisitions since development.130 The D20 Summit is now convened 2014,131 and has built up a 38% stake in the country’s annually, and encourages the largest Chinese companies largest dairy farming company in order to better control its to take control of their supply chains and drive raw milk supply.132 improvements to quality, safety and competitiveness. The government’s National Alfalfa Production Development The government’s emphasis on building national dairy Plan (2016-2020) plans to double the production of quality brands aims to overcome a perceived consumer alfalfa to feed cows on scale dairy farms, drive further preference for foreign brands; but strong brands can bring vertical integration and enhance national self-sufficiency. other benefits as well. With the ability to charge premium prices, strong brands incentivise differentiation based on

125 Ministry of Agriculture, 从严监管 全面提升乳品质量安全水平——关于《全国奶业发展规划（2016-2020年）》解读, 11 Jan 2017, http://jiuban.moa.gov.cn/zwllm/zwdt/201701/t20170111_5428445.htm; National Dairy Industry Development Plan (2016-2020), Dec 2016; 2018 China Dairy Industry Quality Report 126 National Dairy Industry Development Plan (2016-2020), Dec 2016; 2018 China Dairy Data Report 127 National Dairy Industry Development Plan (2016-2020), Dec 2016; 2018 China Dairy Data Report 128 National Dairy Industry Development Plan (2016-2020), Dec 2016; 2018 China Dairy Data Report 129 Xinhua, “Chinese Vice Premier Wants Better Dairy Industry”, 18 Aug 2015, http://english.agri.gov.cn/news/dqnf/201508/t20150819_26307.htm; 农民日报,《中国奶业D20峰会在北京召开》, 19 Aug 2015, http://jiuban.moa.gov.cn/zwllm/zwdt/201508/t20150819_4795588.htm 130 Xinhua, 《中国奶业D20企业联盟 北京宣言》, 18 Aug 2015, http://www.xinhuanet.com/food/2015-08/18/c_128141825.htm 131 China Daily, “Chinese Dairy Labels Evolve Into Big Brands”, 23 Oct 2017, http://www.chinadaily.com.cn/business/2017-10/23/content_33596728.htm 132 http://www.moderndairyir.com/en/aboutus_milestones.htm

26 | Challenges and Transformation in China’s Food Chain Infant formula milk powder is the most tightly regulated Infant Formula Milk Powder Production Enterprises, issued dairy product, with the government setting more specific in 2013, stated that infant formula milk powder goals for consolidation, branding and vertical integration. manufacturers who use fresh milk as a raw material must By 2020 there will be 3-5 companies earning more than have self-built self-controlled milk production bases and CNY 5 billion in revenue from infant formula milk powder; make progress towards obtaining all of their raw milk from and the top 10 domestic brands will account for 80% dairy farms in which they own a controlling share.134 market share.133 The Rules for Control and Oversite of

Infant formula milk powder market share in 2020 (planned)135

All others Top 10 Chinese brands 20% 80%

In addition to guiding the transformation of the dairy sector, According to the Teng Jiacai, the erstwhile head of the the government has been conducting extensive safety and CFDA, “The dairy industry is an indicator for modern quality testing throughout the supply chain. During the work is the breakthrough point and the key to efforts to years 2009-2016, the Ministry of Agriculture conducted strengthen food quality and safety.”137 In China’s food and quality and safety tests on more than 170,000 batches of agriculture sectors, the dairy industry is leading the way raw milk for quality and safety, including more than 26,000 towards consolidation, vertical integration, quality batches in 2016. In 2016 they also conducted 11,000 improvement and national brands. Other sectors of the inspections of milking stations and 8,200 inspections of food industry are moving in the same direction. dairy transport vehicles. The CFDA conducted food safety tests on 2,532 batches of infant milk formula and 3,318 batches of other dairy products.136

133 National Dairy Industry Development Plan (2016-2020), Dec 2016 134 《婴幼儿配方乳粉生产企业监督检查规定》, 3 Dec 2013, http://www.gov.cn/gzdt/2013-12/03/content_2540737.htm 135 National Dairy Industry Development Plan (2016-2020), Dec 2016 136 2017 China Dairy Industry Quality Report 137 国家食品药品监管总局副局长 滕佳材, 从严监管 全面提升乳品质量安全水平—关于《全国奶业发展规划（2016-2020年）》解读, 11 Jan 2017, http://www.moa.gov.cn/hdllm/zbft/zgxknnxdqdys/xgxw/201701/t20170111_5428445.htm

27 | Challenges and Transformation in China’s Food Chain Transformation: Pork

China is following a comprehensive strategy to transform for modern biosecurity, veterinary care and waste its massive pork industry; key themes include increasing management. The number of farms producing more than the scale of farms and slaughterhouses, vertically 50,000 hogs per year has grown from 12 in 1999 to more integrating supply chains, and improving genetics, than 300 in 2016.140 With land in short supply, companies biosecurity and veterinary practices. are finding new ways to build large-scale farms: on Yaji Mountain in Guangxi province, a pig breeding farm is The number of small household hog farms (farms that already operating several 8-story sow barns, and is produce fewer than 50 hogs/year) has been steadily building a 13-story sow barn (the world’s tallest). In total, decreasing, falling from over 80 million in 2007 to about 40 the farm will house 30,000 sows and produce 840,000 million in 2016.138 Pollution and epidemic control measures piglets per year. The ventilation, waste management and are further reducing that number. In 2015 the government biosecurity systems are among the world’s most issued the Water Pollution Control Action Plan, which advanced.141 required provincial governments to designate areas near sensitive water supplies as off-limits to poultry and While China’s top 10 companies produced only 5.8% of livestock farming. By the middle of 2017, provincial and the country’s hogs in 2016, this was a significant increase local governments had designated nearly 50,000 areas over a mere 3% in 2015.142 China’s largest hog producer where poultry and livestock farming are prohibited, plans to increase its output from 17 million hogs in 2016 to covering more than 600,000 square kilometres. More than 27.5 million hogs in 2019143 and aims to achieve 10% 200,000 poultry and livestock farms were closed as part of market share in the future.144 Consolidation is happening this effort.139 at a rapid pace as small farms close down and large companies invest in new capacity. At the same time, the government has been encouraging the construction of large scale livestock farms, equipped

Farms producing fewer than 50 hogs/year145 Farms producing more than 50,000 hogs/year146

80 million 311

40 million 96 12 44

2007 2016 1999 2004 2009 2016

Efforts to modernise the pork sector also address the use 13th Five-year Plan, China aims to ensure that livestock of antibiotics and feed additives. In 2016, the government antibiotics are properly used and that the indexes for issued the Plan to Address Antibiotics in Livestock, Poultry livestock medicine residues are basically in line with Codex and Aquatic Production, Forbidden Chemical Compounds, Alimentarius standards.147 and Excessive Veterinary Drug Residues. According to the

138 China Animal Husbandry and Veterinary Yearbook 139 环境保护部,环境保护部通报2017年上半年《水污染防治行动计划》重点任务进展情况, 24 Aug 2017, http://www.zhb.gov.cn/gkml/hbb/qt/201708/t20170824_420319.htm 140 China Animal Husbandry and Veterinary Yearbook 141 Agweb, “China Pork Producer Adds More, Taller High-Rise Hog Hotels”，14 May 2018, https://www.agweb.com/article/china-pork-producer-adds-more-taller-high-rise-hog-hotels/; Reuters, “China's Multi- Storey Hog Hotels Elevate Industrial Farms to New Levels”, 14 May 2018, https://www.reuters.com/article/china-pigs-hotels/rpt-insight-chinas-multi-storey-hog-hotels-elevate-industrial-farms-to-new-levels- idUSL3N1SI1Y3 142 搜狐，养殖‖中国猪业发展报告发布, 17 May 2017, http://www.sohu.com/a/141938624_785860 143 Reuters, “China's Top Pig Farmer Pushes into Meat Processing as Pork Prices Lose Sizzle”, 17 May 2017, https://www.reuters.com/article/us-china-pork-guangdong-wens-idUSKCN18D0CT; 温氏食品集团股 份有限公司投资者关系活动记录表, 11 May 2017 144 温氏食品集团股份有限公司投资者关系活动记录表, 4 Sep 2018 145 China Animal Husbandry and Veterinary Yearbook 146 China Animal Husbandry and Veterinary Yearbook 147 13th Five-year Plan, Mar 2016

28 | Challenges and Transformation in China’s Food Chain China’s pork production costs are much higher than the US ratio. While the national average PSY is only about 17, or the EU. Larger scale farms should help to reduce the some large scale farms have already achieved PSY of cost difference. While commercial feed and commercially 30.148 bred piglets are more expensive than those of household As the scale of China’s hog and breeding farms increase, farms, scale farms have lower overall costs due to labour the average cost of labour and piglets should decrease. productivity. The results of a 2015 NDRC study on hog The National Hog Production Development Plan (2016- farming costs are shown in the graph below. With better 2020) encourages leading pork industry companies to build farm management, including biosecurity, veterinary care, hog farms near prime corn growing regions, and to feeding and genetics, China’s leading large scale vertically integrate hog farming with feed production, producers will continue to improve their efficiency, as breeding, fattening and slaughtering operations. reflected in measures such as PSY and feed conversion

Estimated cost of raising one hog on Estimated PSY on different farm types in China different farm types in China (CNY/hog)149 (pigs weaned/sow/year)150

Others Labour Piglet Feed

1,800

1,500

1,200 24 900

600 15

300

0 Scale farm Household farm Household farm Leading large scale corporate farm

148 Company reports 149 NDRC 150 Company reports

29 | Challenges and Transformation in China’s Food Chain The government has also been driving consolidation in Not only does the government plan to have larger scale primary processing by actively culling manual and partially farms and slaughterhouses, but the National Hog mechanised slaughterhouses.151 The number of designated Production Development Plan (2016-2020) also aims to slaughterhouses has fallen by nearly 90% since 1998, while standardise farming and processing, and to have “dragon the number of “scale” slaughterhouses (i.e. those that head” companies integrate slaughtering, processing, slaughter more than 20,000 hogs per year) has grown from delivery and sales. about 2,000 in 2008 to nearly 3,000 in 2016.152

Designated hog slaughterhouses153 Scale slaughterhouses (capacity of at least 20,000 hogs/year)154

100 thousand 2,937

2,000 11 20 thousand thousand

1998 2008 2016 2007 2016

In China pork is mostly sold as warm fresh meat. The Modernisation of the pork industry extends to the financial government’s plan aims to increase the market share of markets. The China Securities Regulatory Commission chilled fresh meat and processed meat products, (CSRC) approved the Dalian Commodity Exchange’s implementing a strategy of “branded slaughterhouse application to launch live hog futures trading. Live hog companies, accelerate upgrading meat product categories futures should help large producers and processors and premium pricing for premium quality.”155 manage the risk of price fluctuations.159

There are already many examples in the market of trends In the Opinions on Accelerating the Advancement of towards vertical integration and increasing scale of farms Recycling of Livestock Farming Waste the State Council and processing enterprises. In 2017, China’s largest has also issued targets for improving the management of producer of live hogs announced plans to establish a livestock farm waste, with an emphasis on treatment and vertically integrated “farming, slaughtering and processing, recycling. By 2020, the government aims to recycle 75% of central warehousing, distribution and delivery, chain retail livestock manure for organic fertiliser or power generation, store” business model.156 The company plans to build more up from 60% in 2015.160 100% of large scale livestock than 5,000 retail outlets in southern China.157 At the same farms will have sewage treatment facilities in place by time, China’s largest producer of swine and poultry feed is 2019, and 95% of all scale161 poultry and livestock farms expanding to become one of China’s largest hog will have livestock sewage treatment facilities in place by producers, and is also expanding into processed meat 2020.162 Achieving these targets will reduce water and soil operations.158 contamination, reduce dependence on chemical fertiliser and provide additional sources of renewable energy.

151 Ministry of Commerce,《全国生猪屠宰行业发展规划纲要（2010-2015）》内容解读, 11 Jan 2010, http://sczxs.mofcom.gov.cn/article/Nocategory/201001/20100106737046.shtml 152 Ministry of Commerce,《全国生猪屠宰行业发展规划纲要（2010-2015）》内容解读, 11 Jan 2010, http://sczxs.mofcom.gov.cn/article/Nocategory/201001/20100106737046.shtml; China Animal Husbandry and Veterinary Yearbook 2016 153 Ministry of Commerce,《全国生猪屠宰行业发展规划纲要（2010-2015）》内容解读, 11 Jan 2010 http://sczxs.mofcom.gov.cn/article/Nocategory/201001/20100106737046.shtml; Ministry of Environmental Protection, 《排污许可证申请与核发技术规范农副食品加工工业—屠宰及肉类加工工业（征求意见稿）》 编制说明， 27 Dec 2017 http://www.zhb.gov.cn/gkml/hbb/bgth/201801/W020180103397741432613.pdf 154 Ministry of Commerce,《全国生猪屠宰行业发展规划纲要（2010-2015）》内容解读, 11 Jan 2010, http://sczxs.mofcom.gov.cn/article/Nocategory/201001/20100106737046.shtml; China Animal Husbandry and Veterinary Yearbook 2016 155 National Hog Production Development Plan (2016-2020), Apr 2016, http://www.moa.gov.cn/nybgb/2016/diwuqi/201711/t20171127_5920859.htm 156 Guangdong Wens Foodstuff Group Co., Ltd., 2016 Annual Report 157 Reuters, “China’s Top Pig Farmer Pushes into Meat Processing as Pork Prices Sizzle”, 17 May 2017, https://www.reuters.com/article/us-china-pork-guangdong-wens-idUSKCN18D0CT; 南方日报讯,《 温氏要 建5000家销售门店，等于再造一个温氏》, 30 Sep 2016, http://www.xinm123.com/html/pig/20160930439968.html 158 Reuters, “New Hope Joins China’s Hog Expansion Frenzy Even as Pork Prices Sink”, 29 Aug 2017, https://www.reuters.com/article/us-china-agriculture-companies/new-hope-joins-chinas-hog-expansion- frenzy-even-as-pork-prices-sink-idUSKCN1B91BA 159 Dalian Commodity Exchange, 《用生猪期货熨平“猪周期”》, 12 Dec 2018， http://www.dce.com.cn/dalianshangpin/xwzx93/jysxw/6087704/index.html 160 National Agriculture Modernisation Plan (2016-2020), Oct 2016 161 MARA defines scale farms as larger than the following: Hog farms with inventory of 300 or annual production of 500, dairy farms with more than 100 cows, cattle farms with inventory of 100 or annual production of 50, sheep farms with inventory or annual production of 100, egg farms with more than 2,000 hens, broiler farms with a flock of 5,000 or annual production of more than 10,000. Local government definitions may vary. http://www.moa.gov.cn/zwllm/zcfg/flfg/201706/t20170627_5728780.htm 162 State Council,《 国务院办公厅关于加快推进畜禽养殖废弃物资源化利用的意见》, 27 Jun 2017, http://www.moa.gov.cn/zwllm/zcfg/flfg/201706/t20170627_5728780.htm

30 | Challenges and Transformation in China’s Food Chain Transformation: Crops

China’s crop production is highly fragmented, with an in the Midwestern farms of the US, while China’s average of 0.6 hectare of farmland assigned to each of mountainous regions might be better suited for a different more than 230 million rural households. The government approach, e.g. one village farmer takes over the operation aims to consolidate farmland into larger plots to improve rights of neighbouring farmers’ land. efficiency, quality and production through modernisation Consolidation of farmland will facilitate further and industrialisation. modernisation. The National Agriculture Modernisation The transformation of horticulture is progressing much Plan (2016-2020) aims to have 40% of China’s arable land more slowly than that of China’s dairy and meat sectors. farmed by “appropriate scale” operations by 2020, This is largely due to the HRCS system of agricultural land compared to 30% in 2015.168 The 13th Five-year Plan aims rights management under which farmland land is to increase mechanisation of the ploughing, planting and collectively owned by the commune, and the rights to harvesting of major crops from 63% in 2015 to 70% in specific plots of farmland land are assigned to individual 2020, including a target of 500 counties that will households.163 demonstrate mechanisation of the entire agricultural process.169 When implemented in the early 1980s to replace communal farming, this system unleased massive growth. But it now hinders the consolidation of farmland that would enable modern, standardised, industrial farming.164 At the % of crops harvested mechanically170 same time, the system provides a social safety net for hundreds of millions rural residents. To protect this vulnerable population, China’s policymakers have taken a cautious approach to reform. As urbanisation continues to shrink the rural population and economic growth provides new opportunities for non-farm employment, reforms have 70% slowly begun to be implemented. 63%

China is unbundling the three types of rights associated with farmland under the HRCS: ownership rights (which belong to the commune), contract rights (which assign land to a specific household), and operating rights (the right to 2015 2020 (planned) farm the land).165 Rural households can transfer operating rights and collect income through various structures, including leasing, cooperatives, exchanging operating % of arable land farmed by appropriate-scale rights for one plot of land for the rights to another plot of operations171 land, or exchanging operating rights for equity in an agriculture business. Operating rights can also be mortgaged.166 Rural residents can earn wages from other employment while continuing to collect passive income from their land rights.

By the end of 2016, the rights to about 32 million hectares 40% of China’s arable land had already been transferred under 30% various local systems.167 Different approaches to consolidation will be appropriate for different regions. The large flat expanses of land in Heilongjiang, for example, are amenable to the large scale, industrial methods used 2015 2020 (planned)

163 State Council《关于完善农村土地所有权承包权经营权分置办法的意见》, 30 Oct 2016, http://www.gov.cn/xinwen/2016-10/30/content_5126200.htm 164 State Council《关于完善农村土地所有权承包权经营权分置办法的意见》, 30 Oct 2016, http://www.gov.cn/xinwen/2016-10/30/content_5126200.htm 165 13th Five-year Plan, Mar 2016; State Council《中共中央 国务院关于深入推进农业供给侧结构性改革 加快培育农业农村发展新动能的若干意见》, 31 Dec 2016 166 State Council《关于完善农村土地所有权承包权经营权分置办法的意见》, 30 Oct 2016, http://www.gov.cn/xinwen/2016-10/30/content_5126200.htm 167 2017 China Rural Property Rights Transfer Transaction Market Development Report 168 National Agriculture Modernisation Plan (2016-2020), Oct 2016 169 13th Five-Year Plan, Mar 2016 170 National Agriculture Modernisation Plan (2016-2020) , Oct 2016; 13th Five-Year Plan, Mar 2016 171 National Agriculture Modernisation Plan (2016-2020) , Oct 2016

31 | Challenges and Transformation in China’s Food Chain Local land reform pilot projects have only begun during the harvesters in China has nearly doubled since 2006, past few years, but there are already signs of reaching a total of 1.14 million in 2016, indicating increased modernisation progress in the initial figures from the 2016 mechanisation.172 The area covered by greenhouses and agricultural census. The number of agricultural businesses large polytunnels increased from 81,000 and 465,000 surpassed 2 million, up from only about 400,000 in 2006. hectares, respectively, in 2006 to 334,000 and 981,000 Of the more than 2 million agricultural businesses, 900,000 hectares in 2016.173 are agricultural cooperatives. The number of combine

Number of agricultural Number of combine Area covered by greenhouses and large businesses174 harvesters175 polytunnels (hectares)176

Greenhouse Large polytunnels

1.2 1 0.6 1.1 2.0 million million 0.8 million

0.4 millions 0.6 million 0.4 0.2 0 2006 2016 2006 2016 2006 2016

Average irrigation efficiency coefficient180

0.60 0.55 0.50 0.53 0.45

2005 2010 2015 2020 (planned) 2030 (planned)

Modernisation of horticulture also includes environmental 2005 to 0.53 in 2015.177 The 13th Five-year Plan aims to protection and efficient use of natural resources. increase the cropland using high-efficiency water- Policymakers have long included targets for improving conserving irrigation by 6.7 million hectares,178 and the irrigation efficiency. There has been significant and steady National Sustainable Agricultural Development Plan (2015- improvement during recent decades, as indicated by 2030) aims to achieve an overall irrigation efficiency China’s irrigation coefficient improving from 0.45 in coefficient of 0.55 by 2020 and 0.6 by 2030.179

172 Xinhua, “Census Shows China Moving Towards Scale Farming”, 15 Dec 2017, http://www.xinhuanet.com/english/2017-12/15/c_136829064.htm 173 2016 National Agricultural Census; 2006 National Agricultural Census 174 Xinhua, “Census Shows China Moving Towards Scale Farming”, 15 Dec 2017, http://www.xinhuanet.com/english/2017-12/15/c_136829064.htm 175 Xinhua, “Census Shows China Moving Towards Scale Farming”, 15 Dec 2017, http://www.xinhuanet.com/english/2017-12/15/c_136829064.htm 176 2016 National Agricultural Census; 2006 National Agricultural Census 177 National Agriculture Modernisation Plan (2016-2020), Oct 2016; Central Government of the PRC, 《我国大力发展节水灌溉 力争农业用水10年零增长》, 28 Nov 2011, http://www.gov.cn/jrzg/2011- 11/28/content_2004606.htm; National Sustainable Agriculture Development Plan (2015-2030), May 2015 178 13th Five-Year Plan, Mar 2016 179 National Sustainable Agriculture Development Plan (2015-2030)，May 2015 180 National Agriculture Modernisation Plan (2016-2020), Oct 2016; People’s Daily, 我国大力发展节水灌溉 力争农业用水10年零增长, 28 Nov 2011, http://www.gov.cn/jrzg/2011-11/28/content_2004606.htm; National Sustainable Agriculture Development Plan (2015-2030)，May 2015

32 | Challenges and Transformation in China’s Food Chain Pesticides and chemical fertilisers have contributed to the in 2015 and total chemical fertiliser use began to decline in massive growth in crop production during the past 30 2016. Statistics from the FAO and World Bank also years, but have also resulted in residues on agricultural indicate declining usage. According to the FAO database, products, water pollution, soil acidification and soil China’s pesticide usage per hectare of cropland fell from hardening.181 In 2015, the Ministry of Agriculture issued the 14.8 kg in 2014 to 13.1 kg in 2015. According to the World Action Plan for Zero Growth in the Application of Pesticide Bank database, China’s chemical fertiliser consumption by 2020, and the Action Plan for Zero Growth in the per hectare of arable land fell from 567 kg in 2014 to 506 Application of Chemical Fertiliser by 2020. Government kg in 2015. statistics indicate that total pesticide use began to decline

Year-on-year change in total pesticide usage Year-on-year change in total chemical fertiliser usage 1993-2015 (%)182 1982-2016 (%)183

14% 15% 12% 10% 10% 8% 5% 6% 4% 0% 2% 0% -5% -2% 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 2016

The government aims to strengthen the connection increase by 40 million mu by 2020, a 40% increase over between livestock farms and farms that grow feed for 2014. The government aims to increase quality alfalfa livestock. It is encouraging meat and dairy companies to production to support growing numbers of large-scale dairy build large scale livestock farms near corn, soy and alfalfa farms, as well as growing beef and mutton production. growing regions, and to vertically integrate into large-scale According to the National Staple Oilseed Production feed production through investment or contract farming. Development Plan (2016-2020), China aims to increase its In the various plans covering the period of 2016-2020, self-sufficiency ratio for edible vegetable oils from about China aims to increase production of those crops where it 32%184 in 2017 to 40% by 2020. This will be accomplished has the greatest import dependencies. The area planted mainly by increasing the area planted with soybeans, with soybeans, used mainly for hog feed and edible oil, will rapeseed, and peanuts.185

Edible vegetable oil Soybean planting area (mu)186 Quality alfalfa planting area (mu)187 self-sufficiency ratio (%)188

140 8 40% million million 32% 100 million 3 million

2014 2020 2015 2020 2017 2020 (planned)

181 Ministry of Agriculture, 农业部关于印发《到2020年化肥使用量零增长行动方案》和《到2020年农药使用量零增长行动方案》的通知, 18 Mar 2015， http://jiuban.moa.gov.cn/zwllm/tzgg/tz/201503/t20150318_4444765.htm 182 National Bureau of Statistics 183 National Bureau of Statistics 184 中华人民共和国厦门海关，《1-9月厦门关区食用植物油进口量价齐升》, 2017年10月26日， http://www.customs.gov.cn/xiamen_customs/491078/491080/491082/1190157/index.html 185 National Staple Oilseed Production Development Plan (2016-2020), Feb 2016 186 National Staple Oilseed Production Development Plan (2016-2020), Feb 2016 187 National Herbivorous Livestock Industry Development Plan (2016-2020), Jun 2017 188 中华人民哦你共和国厦门海关，《1-9月厦门关区食用植物油进口量价齐升》, 26 Oct 2017， http://www.customs.gov.cn/xiamen_customs/491078/491080/491082/1190157/index.html; National Staple Oilseed Production Development Plan (2016-2020), Feb 2016

33 | Challenges and Transformation in China’s Food Chain Transformation: Cold chain

While China’s per capita cold chain capacity has not yet caught up to that of the US or Europe, it is growing quickly. Total refrigerated warehouse capacity has increased from 55 million cubic meters in 2012 to 119 million cubic meters in 2017.189 Refrigerated truck shipping increased from 54 billion kilometre-tonnes in 2012 to 100 billion in 2016. In 2009, only 4%, 13% and 21% of China’s fruits & vegetables, meat, and aquatic products were distributed via the cold chain. By 2015, those rates had increased to 22%, 34% and 41%, respectively.190

Along with increasing capacity, the 13th Five-year Plan % of agricultural products distributed via cold chain191 includes objectives for establishing industry cold chain standards and replacing obsolete vehicles and equipment. 2009 2015 Capacity growth and capability upgrades will be driven by 40% industry consolidation in upstream agriculture and processing, and by consolidation of the downstream retail 30% and restaurant sectors. As livestock farming and slaughtering become more intensive and concentrated on 20% a small number of large scale facilities, their enormous output will need to be shipped to large factories for further 10% processing or packaging, and then on to distant urban consumers via temperature-controlled distribution hubs. 0% Fruits & vegetables Meat Aquatic products As chain enterprises account for an increasing share of China’s restaurants and convenience stores, they will rely on a smaller number of large manufactures to produce standardised products and raw materials, and to distribute 3 192 those to thousands of outlets in their regional or national Refrigerated warehouse capacity (m ) network. 120 E-commerce is also driving cold chain capacity. Online retailers are developing national markets for agricultural 100 products and foods that often originate from a limited geographic area. For example, the China Daily reported 80 that a leading e-commerce platform was building out its 60 cold-chain capabilities for delivering cherries produced in millions Yantai, Shandong Province to more than 200 cities in 20 40 provinces and regions. A courier company that serves e- 20 commerce platforms built a cold chain beginning in Maoming, Guangdong Province in order to deliver fresh 0 lychees to distant consumers within 72 hours.193 2012 2013 2014 2015 2016 2017

189 China Cold Chain Logistics Association, China Cold-Chain Logistics Development Report (2017) 190 China Cold Chain Logistics Association, China Cold-Chain Logistics Development Report (2011 & 2016) 191 China Cold Chain Logistics Association, China Cold-Chain Logistics Development Report (2011 & 2016) 192 China Cold Chain Logistics Association, China Cold-Chain Logistics Development Report (2017 & 2018) 193 China Daily, “Online Giants Upgrade Cold Chain Systems”, 7 Jun 2017, http://www.chinadaily.com.cn/business/2017-06/07/content_29646635.htm

34 | Challenges and Transformation in China’s Food Chain Transformation: Chain restaurants

Retail continues to be transformed by the growth of 2022, with a focus on increasing the share of its restaurant chains, e-commerce grocery sales and online restaurants in third and fourth tier cities to 45%. Their restaurant delivery platforms. stated targets include 75% delivery hub coverage.194 A leading international coffee chain announced plans to During 2017-2018, several major restaurant chains increase the number of its outlets in China from 3,300 in announced aggressive expansion plans. A leading global May 2018 to 6,000 by 2023 and increase the number of fast food hamburger chain announced plans to increase cities covered from 141 to 250 during that same period.195 the number of its stores in China from 2,500 to 4,500 by

Number of chain restaurants196

25

20

15

thousands 10

5

0 2008 2009 2010 2011 2012 2013 2014 2015 2016

In addition to cold chain capabilities, the continued growth of chain restaurants will increase standardisation and the use of technology for food safety and quality management throughout the supply chain. With so much investment in scale, these organisations have significant financial motivation to prevent food safety failures and protect the global reputation of their brands.

194 “McDonald’s Announces Growth Plan for China Following Completion of Strategic Partnership with CITIC and Carlyle”, 8 Aug 2017 http://www.mcdonalds.com.hk/content/dam/hongkong/English/about_us/press-releases-new/pdf/2017/Website_20170808%20Aug%208%20McD%20Press%20Release__Eng_FINAL.pdf 195 “Starbucks first-ever China investor conference highlights store growth in its fastest growing market”, https://news.starbucks.com/press-releases/starbucks-china-investor-conference 196 National Bureau of Statistics

35 | Challenges and Transformation in China’s Food Chain Transformation: Groceries and e-commerce

The growth of traditional supermarkets/hypermarkets has slowed during recent years, but e-commerce grocery sales are increasing quickly.

Although growing, online sales only accounted for about 5% of 2017 grocery sales in China; but this is sure to 198 increase significantly during the coming years. Estimated value of fresh food e-commerce transactions 197 To meet demand for quick delivery of groceries, e- in China (CNY) commerce giants are building physical grocery stores that also serve as hubs for local delivery. China’s leading e- 150 commerce platforms have announced plans to build more than 1,000 brick and mortar fresh food stores during the next five years. Shoppers can order fresh products online 100 for delivery within 30 minutes, or they can visit stores in person.199 billions

China’s leading e-commerce platforms are also working 50 closely with major hypermarket and supermarket chains, and forming shareholder relationships between parent companies.200 While growth in traditional in-store sales has 0 2012 2013 2014 2015 2016 2017 slowed for supermarkets and hypermarket chains, the large stores can also serve as convenient hubs for quick fulfilment of online grocery orders; their distribution and cold chain infrastructure form a strong foundation for growth in online retail ordering and delivery. the merchants who use their platforms. 3rd party ecommerce platforms must have food safety departments As online grocery sales grow, e-commerce platforms offer that inspect those merchants’ activities and information. If new and powerful tools to monitor the food supply chain violations are detected, the 3rd party platform must stop and enforce food safety laws. China’s retail e-commerce is the violation and report to the local FDA. For serious dominated by a few of the world’s largest and most well- violations, the platform must promptly cut off services. 3rd funded technology companies. The national reach of the party platforms must register merchants, create files and leading e-commerce retail platforms, combined with collect the relevant information, including information about cutting-edge technology, is helping regulators to address their food safety staff. Merchants’ licenses and permits the challenges associated with China’s highly fragmented must be prominently displayed on their activity pages. 3rd retail sector and the fragmented nature of local FDA party platforms and merchants who sell food online are regulation and enforcement. responsible for the truthfulness of food safety information The Measures for Online Food Safety Violations (Order published online. Local FDAs are empowered to conduct 27), issued by the CFDA201 in 2016, requires these e- random checks by ordering food online, and can access commerce platforms to take an active role in supervising transaction records.

197 电子商务研究中心，2017年度中国网络零售市场数据监测报告， http://www.100ec.cn/zt/17wlls/ 198 Forrester, “The State of Global Online Grocery Retail”, 20 Mar 2018 199 China Daily, “JD to Open Over 1000 Fresh Food Stores”, 4 Jan 2018, http://www.chinadaily.com.cn/a/201801/04/WS5a4deb83a31008cf16da51d9.html; Shanghai Daily, “Alibaba Plans to Enhance O2O Services”, 12 Jun 2018, https://www.shine.cn/archive/business/it/Alibaba-plans-to-enhance-O2O-services/shdaily.shtml 200 Techcrunch, “Walmart sells Yihaodian, its Chinese E-commerce Marketplace, to Alibaba rival, JD”, 21 Jun 2016, https://techcrunch.com/2016/06/20/walmart-sells-yihaodian-its-chinese-e-commerce- marketplace-to-alibaba-rival-jd-com/ 201 In 2018, most food safety related functions of the CFDA were moved to the newly formed State Administration for Market Regulation. Local FDAs, e.g. provincial and county FDAs, continue to have local regulation and enforcement responsibilities.

36 | Challenges and Transformation in China’s Food Chain Transformation: Online restaurant ordering and delivery

The most dramatic transformation has been the The scale, sophistication and penetration of these emergence of China’s mobile online restaurant ordering platforms is far ahead of similar platforms in the US or and delivery apps. Ele.me and Meituan Dianping have a Europe. To illustrate this, we compare the largest online virtual national duopoly after Ele.me acquired China’s restaurant delivery platforms in the US and China; each of number three platform, Baidu Waimai. These platforms are which has approximately 50% market share in its own backed by China’s largest tech giants, as well as major country. In 2017, the largest online restaurant delivery international private equity funds. platform in China had 250 million users and 2.7 million restaurants, compared to only 15.6 million users and 85,000 restaurants on the largest platform in the US in 2018. The largest online restaurant delivery platform in China delivered 14.5 million orders per day in 2017, compared to about 420,000 orders per day for the largest US platform in 2018.202

One of China’s largest online restaurant US largest online restaurant delivery platforms (2017) delivery platform (2018 Q2)

250 million Active users for food orders 203 16 million

14.5 million Meal orders per day 204 420 thousand

2.7 million Restaurants using the platform 205 85 thousand

In spite of their enormous reach, online restaurant delivery restaurant location. 3rd party platforms must sign a food platforms still only account for only about 5% of China’s safety agreement with each restaurant that uses their total restaurant/catering industry revenue;206 this is platform. predicted to grow to 10% by 2020.207 Online restaurant Order 36 also sets national minimum requirements for ordering platforms in the US only account for about 3% of restaurants that do business through online ordering and restaurant sales in the US.208 delivery platforms. Any restaurant business that sells food The Measures for Supervision and Administration of Food online must have a physical store, and the safety and Safety in Online Catering Services (Order 36) became quality of food sold online must match that of the food sold effective on 1 January 2018. 3rd party online restaurant in the restaurant. Restaurants must establish a raw delivery platforms must have full time food safety material control system, and must only purchase raw management departments; and must monitor and conduct materials from qualified suppliers. They must check random inspections of the restaurants that use their certificates and invoices, and must conduct and record platforms. They are required to examine the restaurants’ acceptance inspections for food raw materials. They must operating permits and licenses and to confirm that regularly conduct maintenance, clean and inspect relevant truthfulness of the information on those documents, e.g. equipment and facilities.

202 China Sharing Economy Development Annual Report (2018)； 2017 美团，外卖发展研究报告 , http://new.qq.com/omn/20180112/20180112A10IB5.htmlh；”Grubhub Reports Record Fourth Quarter Results”, 8 Feb 2018， “Grubhub Reports Record Fourth Quarter Results”, 8 Feb 2018 https://investors.grubhub.com/investors/press-releases/press-release-details/2018/Grubhub-Reports-Record-Fourth-Quarter-Results/default.aspx 203 China Sharing Economy Development Annual Report (2018), “Grubhub Reports Record Second Quarter Results”, 25 Jul 2018, https://investors.grubhub.com/investors/press-releases/press-release- details/2018/Grubhub-Reports-Record-Second-Quarter-Results/default.aspx 204 China Sharing Economy Development Annual Report (2018), “Grubhub Reports Record Second Quarter Results”, 25 Jul 2018, https://investors.grubhub.com/investors/press-releases/press-release- details/2018/Grubhub-Reports-Record-Second-Quarter-Results/default.aspx 205 2017 美团，外卖发展研究报告; “Grubhub Reports Record Second Quarter Results”, 25 Jul 2018, https://investors.grubhub.com/investors/press-releases/press-release-details/2018/Grubhub-Reports-Record- Second-Quarter-Results/default.aspx 206 China Daily, “China’s Food Delivery Market Grows 23% in 2017”, 22 Jan 2018, http://usa.chinadaily.com.cn/a/201801/22/WS5a6564e3a3106e7dcc135bf7.html 207 China Cuisine Association,《引领餐饮外卖健康发展，开拓网络服务大市场——2017首届中国餐饮外卖大会在京成功举办》, http://www.ccas.com.cn/Article/HTML/108326_4.html 208 IFMA 2017/2018 Foodservice Insights Library

37 | Challenges and Transformation in China’s Food Chain Transformation: Traceability

While traceability is difficult in China’s large, fragmented implemented their own traceability measures, Shanghai is food and agricultural sectors, progress is being driven by one of the more stringent examples. Companies in both technology and regulation. Shanghai must upload information to a municipal platform that collects information and enables the government to According to article 42 of China’s 2015 National Food rapidly investigate food safety problems. By 2017, the Safety Law, system covered 25 types of food and agricultural Food producers and traders shall establish food products.209 safety traceability systems pursuant to provisions of this Law to guarantee traceability of foods. China Aligned with the “implement by category” principle, many encourages food producers and traders to use product-specific traceability initiatives have been launched information technology to collect and retain during the past 15 years, often focusing on vegetables, production and trading information and establish food meat or dairy products sold within a municipality. Some safety traceability systems. national product-specific initiatives have focused on products with elevated food safety risks and food fraud The FDA will work with the Ministry of Agriculture and vulnerabilities. The Standards for Infant Milk Formula relevant departments to establish a coordinated Powder Production Company Food Safety Traceability traceability system for food safety that covers the Records, issued in 2015, contains very detailed record- whole process. keeping requirements, including product R&D and In 2017, the CFDA issued the Provisions for Establishment formulation, raw and supplementary materials of Food Safety Traceability Systems by Food Producers management, production and processing, finished product and Traders. This document assigned food producers and management, sales management, risk information traders with the primary responsibility for food safety collection and product recalls. In 2016, the government traceability systems. It stipulated minimum requirements issued the Food Safety Traceability Guidance for for recording and documenting specific information by Producers of Edible Vegetable Oil, addressing another companies involved in food production, trading of food and product that was historically vulnerable to adulteration and agricultural products, and food service, as well as those fraud. involved with transportation, storage and distribution of The most exciting developments in traceability have been food. The requirements are detailed, but are mainly limited driven by e-commerce. The two major e-commerce food to one-up, one-down traceability. safety regulations have strict information retention Because of the diversity of company scale and technical requirements, including technical capabilities for data capabilities, the Provisions stipulated principles of backup, failure recover, reliability and security. Order 27 “implement by category” and “avoid a one-size-fits-all requires e-commerce platforms to keep transaction data approach.” until six months past the product’s shelf life, or two years if there is no shelf life. Order 36 requires online restaurant In line with the “avoid a one-size-fits-all approach”, deliver platforms to maintain detailed records, including the provincial FDAs are encouraged to formulate measures food name, delivery person’s name, time of order, time of and conduct pilot projects tailored for local conditions. Of delivery, and delivery address for at least six months. the several provincial and municipal governments have

209《上海市食品安全信息追溯管理办法》; 上海新闻晨报，《食品安全专家解释了上海市食品安全法规，以及上海市肉类、奶制品、酒类等可追溯性体系的改进提升》， 14 Mar 2017， http://newspaper.jfdaily.com/xwcb/html/2017-03/14/content_14515.htm

38 | Challenges and Transformation in China’s Food Chain Transformation: Food fraud

One of the biggest challenges in stopping food fraud, most targeted and specific food fraud regulations. It anywhere in the world, is the lack of specific regulations defines 10 specific illegal acts of food safety fraud, that clarify what is illegal and which government agency is specifies the penalties for each, and for each act assigns responsible for enforcement. In 2017 the CFDA issued the enforcement responsibilities to a specific government draft Measures to Handle Acts of Food Safety Fraud. If body. enacted, the Draft Measure would be one of the world’s

10 illegal acts of food safety fraud210

1. Food product fraud 2. Food production and trading fraud 3. Labelling and instructions fraud 4. Food product advertising fraud 5. Information fraud 6. Food inspection and certification fraud 7. Permit application fraud 8. Information filing fraud 9. Report fraud 10. Providing false information to regulators

Another challenge in stopping food fraud, anywhere in the governments to step up inspections of the most world, is that law enforcement officials often do not give problematic categories of companies and their advertising, priority to investigating and prosecuting it. To address this, to increase sample testing, and to increase cooperation China’s State Council issued the Plan to Address Food with media to encourage the public to report suspected and Health Food Fraud and False Advertising in 2017. The violations. plan targeted five types of violations. It directed local

Five targeted violations in 2017-2018211

1. Unlicensed production, trading and importing of food and health food products 2. Labelling of food and health food products, and health food products with false information or claims 3. Illegal marketing and fraudulent sales using the internet, conference marketing, television shopping, direct sales, telemarketing, etc. 4. Unapproved health food advertising and fraudulent food and health food advertising 5. Other acts of food and health food fraud and false advertising.

210 CFDA, Measures to Handle Acts of Food Safety Fraud (Draft for comments), Feb 2017 211 China State Council, Plan to Address Food and Health Food Fraud and False Advertising, Jul 2017

39 | Challenges and Transformation in China’s Food Chain Transformation: Harnessing e-commerce and new business models to improve supervision and enforcement

Physical supervision over supply chains that include more Online restaurant ordering mobile app users in China217 than 200 million farms and more than 800 million restaurants and retail stores on the retail end is incredibly difficult. But with the world’s largest and most advanced mobile e-commerce and delivery platforms, China is a world leader in harnessing new technologies to improve food safety monitoring, enforcement and traceability, as well as food fraud prevention. 322 million Order 27 and Order 36 have been issued at the national level, but local governments are largely responsible for 194 million enforcement and drafting of specific measures that are 104 appropriate for local conditions. million

The Shanghai Municipal FDA is cooperating with the 2015 2016 2017 online restaurant delivery platforms to establish hotlines on which the city’s 30,000 delivery drivers must report unlicensed restaurants, businesses operating without a licensed physical restaurant, unsanitary restaurants or any government can guide supervision and enforcement at the other illegal activity.212 Nationally, more than a million national level. delivery drivers are connected to the world’s largest mobile e-commerce platforms. Currently e-commerce is most visible at the retail consumer end of the supply chain. But the two largest China has a mobile internet population of 753 million213 online restaurant platforms have launched e-commerce and this is expected to increase to more than 1 billion by platforms that facilitate transactions between restaurants 2020.214 China’s mobile payment penetration has reached and their raw materials suppliers. 70% of all mobile internet users,215 and the number of users who ordered meals using mobile apps increased As e-commerce moves up the supply chain, and integrates from 104 million in 2015 to 322 million in 2017, an increase production, processing, distribution and cold chain of more than 200% in only two years.216 services, China’s food chain could become one of the world’s most closely monitored and supervised in the With only a few giant e-commerce platforms dominating world. the online grocery and restaurant sectors, China’s

212 China Daily, “Shanghai Requires Food Delivery Staff to Report Unlicensed Restaurants”, 29 Mar 2018, http://www.chinadaily.com.cn/a/201803/29/WS5abcaf1da3105cdcf6515229.html 213 China Internet Network Information Center, Statistical Report on Internet Development in China (Jan 2018) 214 Meituan Dianping Application Proof, 25 June 2018 (p.102) 215 China Internet Network Information Center, Statistical Report on Internet Development in China（Jan 2018） 216 China Internet Network Information Center, Statistical Report on Internet Development in China（Jan 2018） 217 China Internet Network Information Center, Statistical Report on Internet Development in China（Jan 2018 & Jan 2017）

40 | Challenges and Transformation in China’s Food Chain Keys to success

41 | Challenges and Transformation in China’s Food Chain ,

China's food sector is exceptional in its size, complexity, • Government incentives: Much of the ongoing food and speed of change. The following are some keys to industry modernisation and industrialisation is policy success for companies that aim to enter the market or driven and supported by subsidies and incentives. In grow their operations. order to stay competitive, companies that invest in new capacity or other upgrades must be sure to identify all of the subsidies and incentives that are available. • Mobile strategy: E-commerce is growing fast and • Supplier management: Companies must design and smartphones have become the channel of choice for implement sophisticated supplier management programs young members of the middle class. Be sure to make that are tailor-made for their China operations. They this a key focus of any China retail strategy. need to be familiar with all of the suppliers and service • New e-commerce capabilities and tools: Invest in providers in their supply chain. Companies must develop capabilities to take advantage of China’s unique e- an understanding of their suppliers’ financial conditions, commerce platform capabilities for food safety and and must ensure that relationships are win-win. quality management, supply chain management, • Traceability systems: Traceability is very challenging in traceability and data analysis. China, but companies are responsible for the • Agricultural modernisation and industrialisation: establishment, effectiveness and continuous Anticipate and ensure strategic alignment with the policy improvement of their systems. They should integrate changes and modern technologies that are changing the traceability systems with their ERP, fully utilise the latest way that food is produced in China. During the next ten e-commerce platforms’ capabilities, and have a strategy years these will drive step-change improvements in cost to meet both current and future requirements for each of and resource efficiency. their product categories, distribution channels and locations. • Cold chain and distribution: China’s farms and processing facilities are changing from small scale to • Food fraud: Fraud methods and targets are constantly large scale. Chain restaurants and e-commerce are changing. With fiercely competitive markets, millions of delivering standardised products to consumers all over small players and the availability of chemical and the country. Scale operations at both ends of the supply pharmaceutical inputs, food fraud vulnerability chain must ensure that their supply chains have assessment and mitigation strategies must be sufficient cold chain capacity and distribution continuously updated. infrastructure. • Food safety culture: Food industry executives cannot • Vertical integration: Growing companies at every stage take food safety culture for granted. Companies must go of the supply chain must take control of their suppliers, beyond traditional training and standard operating distribution and retail through vertical integration. This procedures. They must instil strong values among front- can reduce food safety and quality risks, improve line staff through constant leadership engagement. With traceability, strengthen accountability and reduce rapidly evolving business models, high levels of M&A vulnerability to food fraud. activity, and fast growth, companies must make deliberate efforts to define and build a strong Foreign companies operating in • Risk management: organisational culture. China’s food sector cannot merely apply the risk management approaches used in other markets. The • Food safety due diligence: Investors need to go risks in China are much more complex and are beyond traditional financial due diligence, and evaluate constantly evolving. Large companies and brands will be the technical capabilities, management practices and held accountable for any food safety or quality failures food safety risks of target companies. that occur in their supply chain, whether upstream or • Quality reputation: Companies must work hard to build downstream. a reputation for quality and sustain consumer trust. • Regulatory compliance: National and local Chinese consumers are increasingly aware of food safety governments are constantly updating regulations in order and quality issues, especially via information gleaned to protect public health, build trust and adapt to new from social media. technologies and business models. Companies must go beyond the letter of the law and work closely with local regulators to improve food safety wherever they have This report was written by Brian Marterer of PwC operations. China.

42 | Challenges and Transformation in China’s Food Chain PwC helps companies to deliver safe quality food from growing and profitable businesses. Our Food Supply & Integrity Services team can help your company overcome the evolving challenges of China’s food sector. We combine food industry expertise with capabilities in risk management, internal controls, supply chain, strategy, compliance, capital markets and M&A. Contact us

Amy Cai China and Hong Kong Priority Services Leader +86 (21) 2323 3698 [email protected]

Samie Wan China and Hong Kong Food Supply and Integrity Services Leader +852 2289 2019 [email protected]

Wenjing Cao PwC China Food Supply & Integrity Services Partner +86 (10) 6533 7026 [email protected]

Brian Marterer PwC China Food Supply & Integrity Services Senior Manager +86 (10) 6533 8756 [email protected]

This content is for general information purposes only, and should not be used as a substitute for consultation with professional advisors.

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