A2 Milk has grown rapidly to become one of New Zealand’s largest companies by market capitalisation, with a key factor in its expansion being the success it has had selling its infant formula in China – benefiting from the appeal of its use of A2 milk proteins, which are reputed to be more digestible than the standard a1 proteins.

At the end of February 2018 everything in the corporate garden was looking particularly rosy. A2 Milk had just reported a record half-year profit, firmly based on  surging demand for its infant formula in China (direct sales in China more than tripled during the period) which appeared to be showing no signs of stopping – or indeed slowing. The company comfortably beat market estimates and heralded its result as a vindication of a business strategy that has seen it succeed where others have struggled.

Moreover, it was also able to announce the signing of a supply deal with the world’s biggest dairy producer, its compatriot Fonterra, to provide milk, powder and formula as well as distribution and sales support for new A2 markets in Southeast Asia and the Middle East.

It was a shock then – both for the company and the markets – to hear the news that Nestle was to launch its own A2 infant formula under its Illuma brand – Illuma Atwo Stage 3 formula – a move it stated was a response to a ‘rapidly growing and constantly changing consumer market’, adding that it is the first infant formula to combine a major saturated fatty acid in human milk and A2 type beta-casein, designed to support babies’ digestive comfort.

The stock market was the first to react, with the share price of A2 Milk falling sharply in the wake of the announcement. The concern – and the reason for the sharp drop in its share price – is that Nestle, with its considerably greater global experience would be able to grab a significant slice of the Chinese A2 pie.

However, A2 Milk itself remains upbeat and has responded robustly to the market’s concerns. Its position appears to be firstly that the market for A2 infant formula will grow exponentially as a result of the entry of such a global giant, and secondly that if it does, it is A2 Milk itself, rather than Nestle, that will gain most benefit. It noted that A2 Milk is the only company engaged in the sourcing, processing and marketing of solely a1-protein-free dairy and nutritional products in global markets. A2 Milk also pointed out that would-be competitors might struggle to promote a clear and unambiguous message about the benefits of the new A2 formula, whilst at the same time continuing to include a1 protein in most of their product range.

Although per capita rates are among the lowest in the world, in absolute terms, the Chinese infant formula market is the world’s largest with a volume of 340,150t according to GlobalData, now well ahead of both the US and the total market in western Europe. There is a continuing perception among mothers in China, despite various safety scandals, that baby milks are the only type of commercially prepared baby foods necessary for a baby’s nutritional needs. Value growth has advanced at 79.1% in nominal terms since 2010, pushing sales up to 75.8 billion Chinese yen (US$11.4 billion) in 2016 with rising average prices resulting from the fact that consumers are increasingly opting for premium brands as manufacturers steadily develop new improved formulations to raise prices and increase margins.

Nestle has emerged from a huge pack of infant formula manufacturers in China to lead it – a position it has held relatively unchallenged for a number of years. However, the margin of leadership is small – in the order of six percentage points in 2016 – and this is a sector which is constantly evolving. Nestle has evidently decided that the popularity of infant formula using A2 protein is likely to be a long-term trend and has taken steps to ensure that it is not left out in the cold. Should it prove successful, it seems likely that other multinationals active in the market may also look to move into the segment. A2 Milk remains bullish about its abilities to hold off these giants of the industry and certainly it currently controls much of the supply chain – perhaps yet again there may be an example of a regional David managing to beat the Swiss-based Goliath.