June 26, 2014 12:00 am JST

India and China, headaches and hope

KEN MORIYASU and TAKAFUMI HOTTA, Nikkei staff writers

Nestle's new R&D center is based inside the premises of Hsu Fu Chi's headquarters in Dongguan, China.

DONGGUAN, China/MUMBAI -- Nestle's 33 factories in China employ 53,000 people. Its joint venture confectionery factory in Dongguan, Guangdong Province, breaks more than one million eggs every day. The scale of its China operations is overwhelming, and is now second only to the U.S. market in terms of sales.

     But it is not without risk. The slowdown in China is apparent in much of the data that Nestle's decision-makers see. How does the world's largest food company steer this massive ship through these rough waters?

     "When you look at China, you notice that growth in consumer goods is happening at the very top and the very bottom," said Nandu Nandkishore, executive vice president of Nestle and zone director for Asia, Oceania, Africa and the Middle East. At the bottom, people are emerging from poverty and moving into the consumer class, as millions of people move from farms to cities under the encouragement of the Chinese government.

     "At the same time, there is an even more accelerated movement from the middle class to the affluent class happening across emerging cities," he said. These two clusters, according to Nandkishore, have very different requirements when it comes to purchasing. "The people at the top are looking for global products and services, saying I want the same Gucci bag as other people have, or I want to drink the same Nespresso that George Clooney is drinking in the commercials. Meanwhile, the emerging consumers need a lot more localization of food, in terms of price, nutrition and taste," he said. Nestle calls it a polarization within China.

Catering to the wealthy

The 56-year-old, India-born board executive member was in Dongguan in June to address the bottom half of the polarization. In 2011, Nestle paid roughly $1.7 billion to acquire 60% of a Chinese confectionery company called Hsu Fu Chi. Three years on, Nandkishore was at Hsu Fu Chi's main factory in the southern city of Dongguan to open a new research and development center, as a board member of the company and a Nestle executive. It will combine Hsu Fu Chi's knowledge of Chinese pastry treats and traditional snacks with Nestle's state-of-the-art science and technology "to tailor our products to meet local consumer needs and preferences," Nandkishore said at the opening ceremony.

     Hsu Fu Chi is not exactly a sexy company. It produces around 900 products ranging from chocolate, candy, pastry, jelly and pudding to sachima, a traditional Chinese snack made from eggy puffs, sticky syrup, berries, nuts and raisins. The million eggs cracked daily are for these pastries. The treats are inexpensive, and hardly known outside China. Yet Hsu Fu Chi boasts an army of 10,000 sales staff and 138 sales branches spread across Greater China. Simply put, Hsu Fu Chi is strong in China, and that was more than enough for Nestle to make the purchase.

The new R&D center cost Nestle around $10 million and will have 30 scientists tasked with improving quality, taste and safety of the products. Betty Chan, the scientist heading the chocolate section, worked at Nestle's Product Technology Centre in the British city of York as part of the chocolate and wafer team before recently returning to Dongguan. "I want to apply what I learned in the U.K. to the chocolates that Hsu Fu Chi makes," she said.

     Nestle believes that improving food safety and upgrading its ingredient, could provide an advantage for Hsu Fu Chi and even allow them to command higher prices. "What is unique in China is the concern for food safety. Consumers are looking for food that is more natural, better for health and has less additives. They are quite willing to pay extra for better food," John Cheung, chairman and chief executive officer of Nestle China explained at a press conference.

     Nandkishore also explained Nestle's strategy for the affluent. At the top of the polarized market are people looking for global products as a way to define their identities as global citizens, he said. "We are looking at the possibility of taking our premium green tea KitKat from Japan and making it available across the globe." Nestle already does this with its single-serve coffee maker Nescafe Dolce Gusto, providing the same machine under the same name everywhere.

A long time in India

In India, Nestle operations focus on the poorer consumers. In mom and pop kirana stores where locals buy daily food and household goods, Nestle products are available in small quantities. There are 3.7 million outlets, including kirana, across India that sell Nestle products. In a Mumbai kirana, a single packet of Nescafe coffee sells for two rupees, or 1.6 cents. A packet of the extremely popular Maggi instant noodles goes for 10 rupees. "Maggi is our best-selling product," says a kirana owner.

     Supermarkets in India also host a variety of Nestle products including beverages, confectionery and dairy products.

     Nestle's relationship with India dates back to 1912, when it began importing and selling condensed milk in India. It built its brand through offering quality goods at affordable prices. It has eight factories that produce food specifically developed for the local market. Ruchika Gupta, a mother of two kids keeps a stock of Nestle Everyday Dahi in her refrigerator. Dahi means yogurt in Hindi. "It is nutritious and helps," said Gupta. The product has been adjusted to suit local tastes.

     However, the heavy focus on the lower income sector and not enough attention to wealthier consumers could be weighing on Nestle's growth potential. Nestle India's net profit for the year ended December 2013 was up by 5%, a significant slowdown compared to the near 20% growth up until 2011. Sales have also stumbled to single-digit growth, down from near 20% increases in previous years.

     "Nestle has focused on lower-end merchandise as per capita sales of Nestle India is still much lower than in other countries. So Nestle needs high-value-added new products," said a local analyst, Manish Sonthalia at Motilal Oswal Asset Management.

     India's Sensex index has risen about 20% in the past six months. Nestle India has not joined this wave, losing 10% during the same period. The market has not been soft on Nestle. The company could well adopt its two-pronged China strategy to India. "The strength of Nestle is the ability to straddle both the needs of the affluent and the emerging consumers," said Nandkishore.