Page last updated at 00:30 GMT, Monday, 29 September 2008 01:30 UK

Why China's milk industry went sour

By Vaudine England
BBC News, Hong Kong

Chinese babies
Tainted milk has made thousands of Chinese babies ill

It did not take long for the euphoria of the Beijing Olympics to fade.

China's failure to produce good milk has killed at least four babies, and sickened many thousands of others.

Domestic and export markets in anything that might contain Chinese milk powder are stymied, and scores of dairy firms have gone to the wall.

The still unravelling saga has reduced China's reputation for food safety - and manufacturing integrity - to its lowest level in years.

Experts in the industry say the problems start at source - the cows.

Most farmers are poor and do not eat well - and neither do their cows. Average herds of just three to five cows are often kept in substandard, filthy conditions.

But bigger problems occur as the milk moves through the production chain.

Squeezed on price

The farmers have few means to monitor the quality of the milk they are producing. And their small business size gives them little ability to influence the market.

First they dilute the raw milk with water to increase its volume, often up to about 30 percent
Industry expert

The farmers have no bargaining power when they sell the milk to middlemen, who are usually independent and unregulated.

The farmers get squeezed on price yet are under constant pressure to produce more milk.

So in order to meet the booming industry's gulping demands, and to cope with the ever lower prices paid for raw milk to smallholders, the milk is bulked up.

Several experts on the Chinese milk industry say this is where the additive process begins.

Ins and outs

"First they dilute the raw milk with water to increase its volume, often up to about 30%," said one of several experts who spoke to the BBC on condition of anonymity.

The problem is that the dilution also lowers the nutrient content of the milk, especially its protein, and that lowers the price paid for the milk.

That is when the melamine comes in. A nitrogen compound, it makes the milk appear to have more protein.

Until now, no dairy was testing its milk for melamine, not just in China but across Australasia, with consequences that are now known to be fatal.

The scandal has spread around the world to wherever China has exported its milk-based products.

Several babies in Hong Kong have also become unwell.

Booming industry

Compounding the problems is the frantic pace of development in the dairy industry, which has been growing at the rate of about 30% a year until this year.

4 Chinese babies have died and 53,000 are sick
The crisis has been an indictment of China's food safety regime

Lack of modernisation and economies of scale make it impossible for farmers to meet demand.

The regulatory and watchdog bodies of government have failed to keep up.

After all, the dairy sector has grown from tiny to a worth of about $20bn in less than five years.

Experts say it is more difficult for farmers in the major milk areas of northern China where the industry is dominated by the huge Yili and Mengniu groups.

"These farmers are under enormous pressure to keep supplying, no matter what," said one of the industry experts.

Dysfunctional system

What has made it all so much worse, for parents, consumers and the foreign partners involved in Chinese dairy firms, has been the failings of China's political system in coping with the tragedy.

"We now know that Sanlu - the company where this all started - knew about their melamine problem in December last year, and they were sitting on it," said another source closely involved with the unravelling of the scandal.

As soon as Fonterra, New Zealand's dominant dairy company and 43% stake-holder in Sanlu, heard about the possible contamination, they sought meetings with their local partner.

That is when another chain of frustration began, as allegations circulated about huge delays in the company's admission of fault.

"If these allegations prove to be true then frankly I'm appalled this could go on," said Fonterra chief executive officer Andrew Ferrier.

"We're just deeply, deeply saddened and we wish there was something we could do and of course we apologise to Chinese consumers," he said.

'We will close you down'

Veterans of doing business in China defend Fonterra, explaining that as a minority partner, no foreign company can control events.

As head of the government I feel deeply grieved. But the most important thing is to draw a lesson from it
Chinese Premier Wen Jiabao

"If you're a minority partner in a joint venture and something goes wrong, you are always told late. Then if it's serious and you need the co-operation of your local partner the local government will stall you," one source said.

"You'll believe they are reporting things up the system but then it turns out that they're not. That's what happened to Fonterra," he said.

"Fonterra was misled by its local partner, stalled by the city government, and indeed threatened by that city government; they were told if you take this further we'll close you down," the source said.

Fonterra did take it further - it made sure its own test results were clear, that the paper trail of who they had contacted and when was clear, and decided they needed high-powered help.

New Zealand Prime Minister Helen Clark told the Beijing government, which then came down hard and fast on Sanlu. Staff there are facing jail terms, help has been promised to the victims and 22 other dairy firms have been censured.

Chinese Premier Wen Jiabao said in New York last week (23 September) that the key was to learn from the tragedy.

"As head of the government I feel deeply grieved. But the most important thing is to draw a lesson from it," Mr Wen said.

'Crude business'

"This has certainly been an indictment of the food safety regime in China, but it's important to note that the culprit here is the city government - they are the ones who blocked the information coming out, and tried to avoid a public recall of the product," one of the industry insiders said.

"The truth is, at the local level, which is where you are doing business in China, it is a crude business. Your regulator is the local government and your local partner is also often really, if not nominally, the local government," concurred another source involved.

For the future, these experts believe that foreign expertise in the dairy industry is needed - and wanted by the Chinese consumer - more than ever.


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