Chinese consumers can expect higher dairy prices in December because of a shrinking supply of raw milk from the country's fragmented milk farms.
Most domestic dairy companies put up prices last week, ranging from five to 20 percent. This was mainly in the low-end milk market.
Milk profits are usually thin and are sensitive to price volatility. The price of premium products and milk powders are largely unaffected as high profit margins are able to absorb rising costs.
Analysts have ruled out any price-fixing by major diary companies and instead blame an ongoing shift involving individual raw milk suppliers.
Up until now, domestic dairy companies source most of their raw milk from individual dairy farms. This exposes companies to volatility in supply markets.
The upward pressure on retail prices has not shown any signs of weakening since it begun to increase in July. Statistics from China's Ministry of Agriculture showed that the average price of raw milk has risen for 14 straight months to reach 3.96 yuan per kg in November, up 18.9 percent from the same period a year ago.
Dairy producers told Xinhua that the price of raw milk has shot up to the 4-5 yuan range.
"From a cost perspective, raw milk at 4 yuan is reasonable, but now it's up to five or even six, and that's out of control," said Yao Haitao, vice president of Inner Mongolia-based Mengniu, China's largest dairy producer.
Yu Guangjun, head of the economic institute of Inner Mongolia Academy of Social Sciences, said the recent price hike marks a hiatus from price wars in the past, when dairy producers competed for market share by cutting retail prices.
Yu said the practice hurt dairy farmers. Some sought to reduce production costs by adding additives to milk to boost protein readings.
Such practice led to the milk powder scandal in 2008, when melamine-tainted infant formula powder killed six infants and sickened thousands of others. It also brought down one of China's largest dairy companies Sanlu.
But the current price hike does not benefit milk farmers either, as a premium goes to intermediary milk farms. They source raw milk from farmers and resell it to dairy companies.
According to Yuan Yunsheng, secretary general of the Hebei Dairy Association, these intermediary farms have made a fortune.
Most of the farms have signed contracts with dairy companies as their suppliers, but in the face of runaway milk prices, farms do not honor their contracts and companies also scoop supply originally designated for others.
"Forget about contracts, forget about taking what's not yours, whoever offers the highest price gets the milk," said a milk farm manager in Inner Mongolia.
In the wake of the 2008 milk scandal, authorities encouraged companies to build their own supply base to better monitor the quality of raw milk. Yet without sufficient funding and land, the country's goal to supply 70 percent of milk from farms operated by companies by the end of 2011 did not materialize. The rate is less than 40 percent.
While large-scale proprietary farms are yet to become major suppliers of raw milk, domestic dairy producers are quickly losing their individual milk farmers, whose number has declined by 600,000 from 2008 to 2012 and is expected to lose another 10 to 20 percent this year.
This is largely due to a sector-wide reshuffle carried out after the scandal with an aim to weed out unqualified individual dairy farmers.
The move has created a shortfall of 4 million tons of raw milk supply, or half of the domestic dairy production capacity, according to Song Liang, senior analyst with the Distribution Productivity Promotion Center of China Commerce, a Beijing-based think tank.
"Individual milk farmers will continue to be a major supplier for dairy producers for a long time, so protecting their interests and giving them more incentives to encourage dairy cow rearing is the key to ease the current tight supply," said Huugjilt, secretary general of Dairy Association of Inner Mongolia.
To truly transform the country's dairy industry, companies should grant equal attention to building their own supply base as they do to production, according to Gu Jicheng, secretary general of the Dairy Association of China.
