BEVERAGES: China’s Thirst Collision

Like other consumer sectors in China, China’s beverage market has grown rapidly in recent years. In fact, it is one of the world’s fastest growing consumer sectors, posting a CAGR (compound annual growth rate) of 19 percent over the last fi ve years. Domestically, the beverage industry is the second-fastest growing sector after dairy. In absolute terms, China’s beverage consumption is estimated to have reached 33 million tons in 2005 or 25 liters per capita. This compares to the world average of 55 liters, Korea and Taiwan’s 90 liters and Japan’s 135 liters. With continued economic growth in China on the back of low per-capita consumption, higher incomes and urbanization, it is expected that the beverage industry will continue to expand at an annualized rate of 15 to 18 percent for the next two to three years.


Overview
China’s drink sector is comprised of four major sub categories—namely bottled water (37 percent by volume), carbonated drinks (21 percent), ready-to-drink tea (18 percent) and juice and juice drinks (14 percent). Other drinks include energy drinks, milk beverages and plant-protein drinks (basically soy drinks). Key drivers for China’s beverage industry include income growth, urbanization and a greater awareness of health issues. Among these, health is becoming a bigger consideration for consumers in larger areas in their choice of soft drinks. As such, the consumption of noncarbonates, or functional drinks—namely juice and juice drinks, non-carbonated bottled water and ready-to-drink (RTD) tea—is expected to grow more quickly than that for carbonated soft drinks by five to 15 percent. The latter is likely to grow at a slower pace of five to six percent.




Bottled water
China is the largest market for bottled water in Asia, and ranks among the top 10 markets in the world with a production volume of 14 million tons. The market is currently growing about 20 percent annually as consumers become more health conscious and more companies purchase bottled water for their offices. However, growth is gradually declining because of the high-penetration rate in urban areas. Due to relatively low-entry barriers, about 70 percent of the sector is controlled by local players, which includes Chinese and Taiwanese companies. Market share is more evenly split among the top players with Wahaha (16 percent by volume), Nongfu Spring (10 percent), Coca Cola (seven percent) and Tingyi (six percent).

JuiceThe four major sub-categories of beverages in China are at different positions in their life cycles, and form the structure of the industry. Juice and juice drinks are in the high-growth stage; bottled water and ready to-drink tea are between the growth and mature stages, while carbonates are approaching the mature stage. The juice and juice drinks category registered the highest level of annual growth in the past three years—year-on-year growth was 28 percent in 2005 (estimated), 29 percent in 2004, 27 percent in 2003, and 23 percent in year 2002 (driven by rising health consciousness and the introduction of modern bottle technology). With China’s per-capita consumption of juice and juice drink at just one liter, compared to the world average of seven liter and 16 to 19 liters in Japan and Singapore, the potential for growth in the consumption of this category of drinks in China is huge. Over half of the juice and juice drinks consumed in China are diluted juice drinks (up to 24 percent juice). This market is dominated by Uni-President (32 percent by volume), Tingyi (20 percent) and Coca Cola (20 percent). At the same time, competition is heating up as consumers drink more nectars (25-99 percent juice) and pure (100 percent) juice. Foreign investments in these two sub-sectors are also increasing as consumer preference shifts gradually to premium drinks with higher juice content. This trend was highlighted recently when France’s Danone acquired a 22.18 percent stake in China’s major juice producer Huiyuan.

RTD tea
RTD-tea production has been registering slower growth in recent years of approximately 20 percent every year, hitting 3.5 million tons in 2005. This sector is dominated by three companies, Tingyi, Uni-President and Wahaha, which together enjoy the lion’s share of the market (over 85 percent). Tingyi’s fl agship product, the Master Kong series, lead the sector with nearly half of the market share, but other players including Uni-President and Wahaha are trying to expand their market recognition. Competition in the market is intense as major players fight for a bigger market share. However, the situation has stabilized somewhat, especially in the big cities; so this segment has since passed its fast-growing stage. It is expected that Tingyi and Uni-President will continue to dominate the market because of their competitive advantages, namely their established brand names, fi rm control over distribution channels and strong new-product development capability.






Carbonates
Comparatively, the average growth of the increasingly-saturated carbonate segment has been far slower than the industry average. From 1999 to 2005, this segment expanded eight percent compared to the 19 percent growth posted by the industry. This segment is dominated by Coca-Cola and Pepsi, with a combined market share over 70 percent. The remaining 30-percent market share is held by domestic brands including Future Cola by Wahaha and Jianlibao by Jianlibao. Under the virtual duopoly of Coke and Pepsi, new players are deterred from entering this segment. Hence, growth in carbonates is expected to come from a higher penetration into rural markets where consumption of carbonates is still low.

In all, the industry remains quite fragmented. While there are a number of heavyweights—like Coca-Cola, Pepsi, Uni-President, Wahaha, Tingyi and others—that dominate their respective segments, there is an additional 800 local beverage producers operating throughout the Mainland. That fact indicates that consolidation is the direction the industry will soon move towards, driven by the leading players’ intention to seek further geographic/product penetration, economies of scale and a better control over distribution.


Market conditions
Amid this fast growth, industry players are facing deteriorating profi tability. Increasing raw-material prices, higher operating costs, and declining selling prices primarily driven by the competition, have created a margin-squeeze for many soft-drink processors. From 1999 to 2005, the average sales price (ASP) for water dropped about 20 percent, 15 percent for RTD tea, 10 percent for juice and five percent for carbonated drinks. Cost-wise, sugar price and PET-chip prices rose over 200 percent and 50 percent respectively from 2004 to earlier this year. Meanwhile, distributors are also gaining power.

The expansion of organized food retail outlets has been a prime catalyst for the growth of China’s soft drink market due to the fact that the great majority of soft drinks are sold through off trade or retail channels. Therefore, expect downside pressure on the margins for softdrink processors to persist going forward. Key players are increasingly required to differentiate their offerings and invest heavily in advertising to remain competitive in the market. To win the battle, brand image and new product development will be the key success factors amid greater competition. In the short-medium term, premium, higher-margin products (like 100-percent fruit juice and functional drinks) will be the major growth driver for the soft drinks industry in China.



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