However, when the market was once again buoyant, he claims his stock allocation was reduced – meaning he made less money – as a2 Milk pushed tins of formula into cross border e-commence.
Brand awareness remains strong for a2 Platinum in China, the biggest infant formula market in the world – valued in the region of $26 billion.
But Mr Zhang says a2 Milk has lost sight of the power of the smaller daigou which helps propel brand loyalty with mothers amid a rise in nationalism of locally made products.
Smaller rival Bellamy’s in 2016 also sought to bypass this important channel to market, and it nearly went under.
“This is critical to renewing a brand’s consumption life cycle. In order for a brand to succeed, the brand, channel and consumer must be in vertical equilibrium,” Mr Zhang told The Australian Financial Review.
“If you disadvantage those who create value for your brand then there is a problem.”
The recruitment channel (such as daigou) has traditionally been closest to the consumer in China. These small businesses and distributors are on the front line to discuss the brand and educate consumers who recommend brands to new users.
Mr Zhang is clear the recruitment channel of daigou didn’t simply disappear in a vacuum but because the trade became less profitable.
“A brand’s success requires an appropriate pricing structure,” Mr Zhang says.
“If a brand floods the market to further increase top-line sales to the point the retail price on e-commerce channel is lower than the wholesale cost to the recruitment daigou channel – there is no incentive to promote the brand.”
A2 Milk boss David Bortolussi is expecting 2022 sales to be higher than the $NZ1.21 billion achieved in fiscal 2021 – underpinned by China and English label formula growth in the second half. But the company is also having to overcome China’s low birth rate to grow.
Two years ago a2 Milk shares were nearly trading at $20 per share. They are now sitting at about $4.50 each. Since taking the helm in February 2021 Mr Bortolussi moved swiftly to address excess infant milk formula inventory last year.
I have told Australian Financial Review that daigou channel still plays a critical role in new user acquisition and brand development but hinted that Mr Zhang was unwilling to exclusively commit to deal with a2 Milk – without directly commenting on his allegations.
“During the past year, we have increased our direct engagement with the daigou community, provided more marketing support and seen an increasing number of daigou representing our a2 Platinum brand,” he said.
“Consistent with our growth strategy communicated to the market last year, we are simplifying and delaying our English Label infant milk formula distribution network. In doing so, we are evolving our distribution network towards partners willing to commit to more exclusive, transparent and performance-based arrangements, and we are pleased with progress to date.”
According to Citi analysts consumer preference for domestic brands continues to increase in China and the perception of quality of foreign brands has deteriorated since last year.
But despite a rise in Chinese nationalism, international formula brands are still popular with Chinese mothers. Often local brands can sell for over 500 RMB with hefty 70 per cent plus profit margins, and can be less affordable than imported brands.
“We are seeing on the ground that cost of living is having a material impact on the consumer’s purchase behaviour, particularly after the pandemic,” says one sector source.
Amid COVID-19 restrictions in China, and stock imbalance in the market, Mr Zhang took the opportunity to centralize his businesses through an app “AZ Global” – so his army of recruiters could work from home. He operates like a franchisee system.
the [daigou] channel is the shoe for the brand…. Just because there are shinier and prettier shoes, it doesn’t mean they will fit your feet size.
— Wen Jun Zhang
Previously he had merchants buying from Coles and Woolworths, but faced issues with his slew of smaller buyers no longer operating here in Australia due to long-time COVID-19 travel restrictions.
With the consolidation online his recruiters were able to continue to support infant formula brands.
Mr Zhang says he has a proprietary end-to-end technology that supports his business via recruitment channel with detailed data and visibility.
“Without [cost effective] recruitment, it is difficult for an infant formula brand to be sustainable and competitive in China,” he says.
According to Mr Zhang, a “recruiter” is someone who achieves sales despite tough market dynamics, while a “reseller” can only sell when the market demand is strong.
Mr Zhang started his business with just $30,000 in about 2013-2014. He was on the hunt for an infant formula brand to introduce to Chinese parents since Bellamy’s was already more established. About a year later he began working with a2 Milk.
The pair have both gained from the relationship: at its 2019 peak, China contributed to 40 per cent of a2 Milk’s sales.
Mr Zhang grew his business to turnover about $500 million a year and owns 11 warehouses in Australia, New Zealand and greater China.
The a2 Milk board – led by David Hearn – has been concerned about its primary exposure to just one significant customer in China – Mr Zhang. But a2 Milk still reverted to that relationship, which now appears to be irreconcilable.
While Mr Zhang’s relationship with a2 Milk was headed south, his relationship with the smaller rival Bubs Australia was getting stronger.
In March entities associated with his AZ Global penned an equity incentive deal with Bubs.
Mr Zhang says the daigou channel must be respected.
He recalls telling Peter Nathan, the former head of a2 Milk’s China business, that “the channel is the shoe for the brand, the feet. Just because there are shinier and prettier shoes, it doesn’t mean they will fit your feet size. It can cause injuries and doesn’t make you walk or run better”.