China’s food industry barely existed as recently as the 1990s, and it is still a slapdash collection of thousands of small, low-tech, under-capitalized companies that produce little value added and mostly serve local markets. In China, everything has to happen overnight, but the process of sifting and consolidating companies to build a strong industry that interfaces effectively between farms and consumers takes time. Will Chinese officials and consumers have the patience to wait for a strong food industry to take shape?
An August 2013 survey of Heilongjiang Province’s food industry provides an interesting snapshot of the difficult process of creating a food industry in an urbanizing society. Heilongjiang is in China’s far northeast, bordering Russia. It is more lightly populated than most of China, has large expanses of forest and grassland and is China’s leading producer of grain and second-largest dairy producer. Because of its relatively clean environment, it is a leading producer of “green” and organic food. It is China’s leading producer of grain and soybeans, and its rice is known for high quality. Heilongjiang has a large network of state farms that were set up to populate areas along the border when Mao was worried about a Russian invasion.
The survey’s stated purpose is to support Heilongjiang’s transition from an agricultural province to a food province by administering questionnaires to 860 food manufacturers and making onsite visits in August 2013. The survey included “above-scale” (over 20 million yuan or $3.3 million in gross income) companies as well as small businesses that are usually excluded from industry statistics.
Rapid Expansion
The survey respondents reported red-hot growth. The value of output grew 26.7 percent for above-scale companies but only 10 percent for small ones in the first half of 2013. Asset value grew 15 percent for above-scale companies and 23 percent for small companies. Income and profits were also up 23 to 30 percent. This pace of growth is surprising considering that China’s economy was not especially vibrant in 2013.
The rapid expansion of companies partly reflects a consolidation process as the industry transitions from a highly dispersed structure of numerous extremely small businesses to fewer, larger companies. (The survey didn't track how many companies went out of business.) Of the 1500 food companies in the province, only 15 have over 1 billion yuan ($160 million) in assets. The survey says there are only 20 “large” companies and 97 medium ones. Most companies began as family businesses, make low-end products, are low-tech, labor-intensive, and use crude management practices. Companies produce “blindly” without knowledge of the market, turn out copycat products, compete with each other for resources, and engage in “disorderly” competition.
Lack of Financial Intermediation
It’s unclear how such rapid expansion is being financed. The report characterizes food companies as chronically short of capital. They are described as having large debts (the average debt-asset ratio is 50 percent), yet most individually-operated companies are barred from borrowing money because they have no assets they can mortgage. Many companies have few fixed assets, as they rely on rented factories and equipment. The report says small village rice mills can’t borrow because collective land can’t be mortgaged. Companies have cash flow problems since they must purchase raw materials in a concentrated period of time and process them throughout the year.
The report cites figures on investment in Heilongjiang’s “green food” industry which indicate funds for expansion are generated from internal sources. “Green food” is a uniquely Chinese (i.e. vague) food certification that might be called semi-organic, an initiative that originated with the province’s state farm system in the 1990s to boost confidence that food products are free of pollutants and chemical residues. Investment totaled over 16 billion yuan ($2 billion) and rose more than 20 percent in 2012. The provincial government has long endorsed “green food,” but just 140 million yuan of investment came from the government. Bank loans accounted for just 630 million yuan. Foreign investment in Heilongjiang’s “green food” industry totaled 3.3 billion yuan. Most funds for green food investment were internally generated, totaling 11.8 billion yuan, but there is no clue as to where this money came from. All but the largest companies are barred from formal equity markets, and venture capital is in its infancy. This capital may have been savings of company bosses, earnings from real estate or other ventures, or raised by selling shares to friends and relatives.
The report's authors point out that financial support is a systemic problem and companies need to start by building credibility with potential lenders and investors. Their recommendation that companies increase the transparency and openness of information gets to the heart of why financial intermediation is broken in China. Other recommendations for offering new financial products tailored for food companies, improving loan guarantees, and finding new ways to aggregate capital will go nowhere as long as companies routinely lie about their financial status and keep multiple sets of books. The absence of trust between investors and managers may be a reason why most Chinese companies are family-run, dominated by a big boss and his cronies, and fail to grow into large organizations.
Nuanced Role of State Ownership
Many outsiders think all Chinese companies are tools of the state and are flush with cash from subsidies and bank loans, but the reality is more nuanced. State ownership is more important in "heavy industry" sectors like steel, automotive manufacturing, and rail transport that were considered the commanding heights of the economy during the planned economy era. The food industry had no state-owned behemoths during the centrally-planned economy period, so private companies have a big role in the food industry (but there are a number of companies that descended from municipal or provincial food supply systems in the era of central planning).
According to the report, only 81 of Heilongjiang’s 1,147 “above-scale” food companies are state-owned or collective companies. None of the 7,000 “below-scale” enterprises are state-owned. However, the survey of “nonpublic” companies includes a number that are at least partially state-owned: a COFCO-owned ethanol plant (the biggest company surveyed with 2 billion yuan in assets); Beidahuang, a company front for Heilongjiang’s state farm system; Jiusan, the most prominent state-owned soybean processor; and a meat company that originated as a state-run slaughterhouse.
The report suggests that the Chinese government's policy support for the food industry is insufficient. However, the report lists a number of programs that benefit food companies, including the 20-year-old "green food" industry, and notes the creation of industrial parks and industry clusters has propelled the industry's growth. The ethanol industry--which accounted for the largest food company in Heilongjiang--has been heavily dependent on subsidies since it was started 10 years ago. The Heilongjiang report recommends including the food industry in the province's five-year plan and giving companies favorable land, tax, and loan policies. Support should be tilted toward "backbone" companies with priority for "green food," said the report's authors.
No R&D
An August 2013 survey of Heilongjiang Province’s food industry provides an interesting snapshot of the difficult process of creating a food industry in an urbanizing society. Heilongjiang is in China’s far northeast, bordering Russia. It is more lightly populated than most of China, has large expanses of forest and grassland and is China’s leading producer of grain and second-largest dairy producer. Because of its relatively clean environment, it is a leading producer of “green” and organic food. It is China’s leading producer of grain and soybeans, and its rice is known for high quality. Heilongjiang has a large network of state farms that were set up to populate areas along the border when Mao was worried about a Russian invasion.
The survey’s stated purpose is to support Heilongjiang’s transition from an agricultural province to a food province by administering questionnaires to 860 food manufacturers and making onsite visits in August 2013. The survey included “above-scale” (over 20 million yuan or $3.3 million in gross income) companies as well as small businesses that are usually excluded from industry statistics.
Rapid Expansion
The survey respondents reported red-hot growth. The value of output grew 26.7 percent for above-scale companies but only 10 percent for small ones in the first half of 2013. Asset value grew 15 percent for above-scale companies and 23 percent for small companies. Income and profits were also up 23 to 30 percent. This pace of growth is surprising considering that China’s economy was not especially vibrant in 2013.
The rapid expansion of companies partly reflects a consolidation process as the industry transitions from a highly dispersed structure of numerous extremely small businesses to fewer, larger companies. (The survey didn't track how many companies went out of business.) Of the 1500 food companies in the province, only 15 have over 1 billion yuan ($160 million) in assets. The survey says there are only 20 “large” companies and 97 medium ones. Most companies began as family businesses, make low-end products, are low-tech, labor-intensive, and use crude management practices. Companies produce “blindly” without knowledge of the market, turn out copycat products, compete with each other for resources, and engage in “disorderly” competition.
Lack of Financial Intermediation
It’s unclear how such rapid expansion is being financed. The report characterizes food companies as chronically short of capital. They are described as having large debts (the average debt-asset ratio is 50 percent), yet most individually-operated companies are barred from borrowing money because they have no assets they can mortgage. Many companies have few fixed assets, as they rely on rented factories and equipment. The report says small village rice mills can’t borrow because collective land can’t be mortgaged. Companies have cash flow problems since they must purchase raw materials in a concentrated period of time and process them throughout the year.
The report cites figures on investment in Heilongjiang’s “green food” industry which indicate funds for expansion are generated from internal sources. “Green food” is a uniquely Chinese (i.e. vague) food certification that might be called semi-organic, an initiative that originated with the province’s state farm system in the 1990s to boost confidence that food products are free of pollutants and chemical residues. Investment totaled over 16 billion yuan ($2 billion) and rose more than 20 percent in 2012. The provincial government has long endorsed “green food,” but just 140 million yuan of investment came from the government. Bank loans accounted for just 630 million yuan. Foreign investment in Heilongjiang’s “green food” industry totaled 3.3 billion yuan. Most funds for green food investment were internally generated, totaling 11.8 billion yuan, but there is no clue as to where this money came from. All but the largest companies are barred from formal equity markets, and venture capital is in its infancy. This capital may have been savings of company bosses, earnings from real estate or other ventures, or raised by selling shares to friends and relatives.
The report's authors point out that financial support is a systemic problem and companies need to start by building credibility with potential lenders and investors. Their recommendation that companies increase the transparency and openness of information gets to the heart of why financial intermediation is broken in China. Other recommendations for offering new financial products tailored for food companies, improving loan guarantees, and finding new ways to aggregate capital will go nowhere as long as companies routinely lie about their financial status and keep multiple sets of books. The absence of trust between investors and managers may be a reason why most Chinese companies are family-run, dominated by a big boss and his cronies, and fail to grow into large organizations.
Nuanced Role of State Ownership
Many outsiders think all Chinese companies are tools of the state and are flush with cash from subsidies and bank loans, but the reality is more nuanced. State ownership is more important in "heavy industry" sectors like steel, automotive manufacturing, and rail transport that were considered the commanding heights of the economy during the planned economy era. The food industry had no state-owned behemoths during the centrally-planned economy period, so private companies have a big role in the food industry (but there are a number of companies that descended from municipal or provincial food supply systems in the era of central planning).
According to the report, only 81 of Heilongjiang’s 1,147 “above-scale” food companies are state-owned or collective companies. None of the 7,000 “below-scale” enterprises are state-owned. However, the survey of “nonpublic” companies includes a number that are at least partially state-owned: a COFCO-owned ethanol plant (the biggest company surveyed with 2 billion yuan in assets); Beidahuang, a company front for Heilongjiang’s state farm system; Jiusan, the most prominent state-owned soybean processor; and a meat company that originated as a state-run slaughterhouse.
The report suggests that the Chinese government's policy support for the food industry is insufficient. However, the report lists a number of programs that benefit food companies, including the 20-year-old "green food" industry, and notes the creation of industrial parks and industry clusters has propelled the industry's growth. The ethanol industry--which accounted for the largest food company in Heilongjiang--has been heavily dependent on subsidies since it was started 10 years ago. The Heilongjiang report recommends including the food industry in the province's five-year plan and giving companies favorable land, tax, and loan policies. Support should be tilted toward "backbone" companies with priority for "green food," said the report's authors.
No R&D
Few of the Heilongjiang food companies have any significant research and development capacity and most have none. Only 14.5% of companies surveyed had "research organizations," and 29% reported a "shortage of technical personnel." The report recommends that companies should have closer relations to universities and research institutes, and they should share resources by setting up industry R&D centers.
Again, more fundamental problems hinder R&D. First, there are few experienced technical personnel to start with in an industry in its infancy that tends not to attract the brightest bulbs in the pack. One company bought advanced equipment for testing vegetables but left it sitting idle because no one knew how to operate it. Companies have no funds to support R&D and bosses looking for immediate riches are not interested in investments in R&D that will pay off years in the future, if at all. Even if a company does discover an innovation it will immediately be copied or stolen, preventing the company from reaping returns on its R&D investment.
Instant Industry Champions?
The province has also attracted foreign companies like Nestle and Coca cola, and China's government and industry officials view these multinationals with trepidation. Many of these multinationals emerged from a similar sifting and shake-out process when North America and Europe urbanized during the 19th and 20th centuries. Chinese officials want domestic companies that can compete with these companies in the 21st century, but they don’t want to wait decades for their own companies to evolve and grow through an organic process. They see big, strong multinationals and presume that being big is what makes them competitive when it's actually their competitiveness that makes them big.
With a Chinese food industry spinning its wheels in a low-tech, copy-cat rut of vicious competition, systemic problems prevent industry champions from emerging. The temptation of government officials is to play Frankenstein by trying to create big industry champions by throwing money at them to give them the hardware accoutrements of big, successful companies. However, the lack of effective internal management that made multinationals what they are today will result in wasted resources, disappointment, and seething rancor.
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