a2 Milk's climb to the top

Jayne Hrdlicka is the CEO of The a2 Milk Company. She was appointed last July, and came from Jetstar where she was the CEO, the Qantas subsidiary, and has been running a2 Milk now for 12 months or so.

It's a very interesting business and it's obviously been having huge success lately; it had a big first half result, and the shares have been climbing spectacularly.

In fact, I think that when she took over it was $8, now it's $16, and it's a billion dollar company easily now, and obviously booming sales into China is the main reason for that. 

Let's talk to Jayne Hrdlicka about what she's doing and what she's focusing on.

Jayne, obviously you started as CEO at a2 Milk last July.  When you started, what did you think of the Daigou channel for sales?

Well, I'd done a fair amount of homework, Alan, before joining the company, and had a few months off between jobs to deepen my understanding of the business and its various channels to market.  I was pretty impressed that the company had embraced such an entrepreneurial channel and done that in quite a structured and disciplined way, because they recognised that it reaches an important segment of the consumer population in China, so I was intrigued to learn more and very impressed with the approach the company had taken to such an important consumer channel.

How much of your sales are through Daigous?

We don't disclose the specific volumes through individual channels.  We have a multichannel strategy into China.  The Daigou channel's an important piece of the puzzle.  It's an important part of the consumer mix and it's an important part of our business.

Is it more than 50 per cent into China?

A very big part of our business is product going from Australia into China, and that's easy to see through our numbers.  We don't disclose how much of that's going through Daigou.

Right, fair enough.  You've come to a view about how sustainable that is, because I get the feeling, looking at your presentations and so on, that you're really focusing on what you're calling the Chinese labelled product that you're selling into stores in China.  Is that a fair comment?  Am I right to think that?

No, I don't think you're right to think that, Alan.  What we're basically saying is we have a multichannel strategy into China.  We've spent quite a lot of time in the last eight or nine months really getting close to Chinese consumers, talking to mothers, talking to young parents, understanding the basis of their decision-making, what's important to them in a brand, what channels they use, why they use those channels, and then stepping back from it and saying, okay, how's the market segment, and where does our brand resonate best, and what do we need to do across the mix of channels to ensure that we're building our brand for the long-term in China?

That reaffirmed multichannel strategy's important, that reaffirmed that the Daigou channel's also really important, so is cross-border eCommerce and that the English label and China label products that we sell into consumers in China, the combination of those two products is also really important.

We have real clarity now, Alan, on what matters to consumers, the mix of channels that they use, why and why those channels are important, and that just reaffirms a mix of things for us, but it clearly says, in my view and in the company's view, that the Daigou channel is not going away.  It's been around for a long time.  Some say it's been around for centuries.  It's been an important part of consumers being able to reach products, access products that are available around the world that they might not otherwise be able to find on sale in China.

There's a level of competence that comes with being able to do that.  It's been around for a long time.  Now it leverages eCommerce and so it's much more easy to access and it remains an emotionally important channel.

Obviously one of the factors about the Chinese market is the regulatory uncertainty that exists.  Do you think that the Daigou channel is more or less certain in a regulatory sense?  Because there's so many people doing it and it's such a broadly-based popular way to go about it, do you think you're more vulnerable in that channel or less so?

Look, I think all channels to market into China are important and each has its own set of challenges, and the regulators are a critical part of our business in every market in the world. What I'd say, the latest round of regulation sought to do two really important things.  One, ensure that consumers were protected, and two, ensure that the fair share of tax that should be paid in those transactions was being paid.

The consequence of that is that it probably accelerates the pace at which the corporatisation of Daigous take place, because it makes it easier for the big guys to have the infrastructure to the big players who've sort of aggregated smaller Daigous.  It makes it easier for them to manage the infrastructure and the regulatory requirements relative to the smaller guy. 

Smaller guys can still do it, but it makes a little bit easier for the big Daigou players, and as a consequence of that, the smaller players will look at a mix of different options in how they reach consumers, their consumers and their loyal following in China.

The other thing, I notice that there's somebody else started up selling a2 protein milk.  Can you see competition issues on the horizon?

Well, we've been facing quite a lot of competition from some of the very biggest companies in the world, Alan, and it is only drawing attention to the very special brand that we've built, so we see competition in lots of different corners.

It is great for us because it will encourage us to continue to lift the bar and redefine what great looks like, which we'll continue to do, and it draws to the fundamental premise around a2 Milk, and we think that's good for consumers, and that's good for the category, and it's good for our shareholders.

You were saying that you've learnt a lot about the Chinese consumer and what they want and how it works.  Can you give us a sense of what you have learnt about that?

Well, what we've learned is, I think you learn every time you go out and talk to your consumers, that staying close to them is really, really important at making sure that we've built our business to deliver what matters to them.

Chinese consumers are different to Australian consumers, they're different to Americans and they're different to Europeans, they're different to Thai and Singaporeans.  They're a very unique customer group, and it's quite clear that that's a market that is going to continue to change at a rate of knots.  Consumers have lots of choice, and retailers are working hard to innovate.  Retail innovation in China is running at the fastest pace I've seen anywhere in the world, and it's really impressive the pace of technical innovation and technology as a backbone, digital backbones to improve customer experiences.

What it's done for us, Alan, is help us understand that if we want to play in China for the long-term, then we need to invest in China for the long-term, and we need to invest in our organisation capability in China and more broadly to ensure that we can be the sort of business that we have the potential to be in the eyes of our consumers.  It's given us a lot of confidence to invest.  We announced at the half year that we would be investing significantly more in the second half in marketing and in organisation capability, and we've done exactly that.

I was at Macquarie Conference a couple of weeks ago and I announced there that in FY20 we would continue to invest more in marketing and more in organisation capability, people, infrastructure, technology.  We would continue to do more of that in FY20 as we aggressively build our business for the future.

In the presentation to Macquarie you said you've got 5.7 per cent market share in China.  Firstly, can you tell us what that's a percentage of, and secondly, what do you think you can achieve in terms of market share in China?  Do you think you can get to 10 per cent?

So, 5.7 per cent is consumption share, so it's consumption of the total market, which is a very impressive number.

The total infant formula?

Total consumption of infant formula, yeah.  Total consumption of infant formula.

Right.

And we've done quite a lot of analysis, Alan, to get a handle on what we think the best metrics are to understand how we're doing in China, and we land on Kantar market share as the best metric, if you look at it on a moving annual total basis, because it sort of smooths out any aberrations in the numbers, so that's definitely the best metric in the category.

We're very pleased with the progress that we've made, and we're very confident about the strength of our brand, and we're clear about what we need to go do to deliver against our potential.  We're not saying what we think great looks like, we think we're doing well and we think we've got a lot of room left for growth. 

I'm quite clear with investors to say we have three priorities.  The first is core products, existing products in core markets.  Second priority is new products in core markets against core consumers.  And the third priority is new markets and/or going after different consumer groups in core markets.  We're being really focused in how we go about doing that because we think there's so much potential remaining in the current products in our core markets of China and the US.

Just to focus on the US.  You're in over 10,000 stores there now, you've got growth of more than 100 per cent in the US.  Obviously, they're different markets, but do you think there's as much potential or something like the same potential in the US as in China?

Well, the US market we continue to think is an important market.  It is performing well.  We're doing some work right now to figure out how big can we be and how fast can we get there?  The product is reacting exactly that way we'd want it to react in market, the consumer data's excellent, we're pulling consumers from across the category and bringing consumers who've left dairy back into dairy, which is great, and the passion and loyalty behind the brand once a consumer's exposed to it's very high. 

We're very confident in our ability to build a good business in the US.  Exactly how big it can be is an open question.  It's a very competitive market, so we are punching above our weight and enjoying the challenge.

Could I just focus now on the supply side of things?  You've got a contract with Synlait to supply the product.  That's an exclusive contract for ANZ and China.  A couple of things about that.  It doesn't mention the United States there in describing that.  Is that because it's not exclusive for the United States?

We don't divulge details of our contracts because there's commercial in confidence.  The relationship with Synlait's a strong one.  We continue to work together on new products innovation and new market opportunities.  We also have a strong relationship with Fonterra and a commitment to work with Fonterra through other markets in the region both with infant formula as well as other aspects of our supply chain.  We're working with them on ingredients and we've also launched fresh milk with them in New Zealand.

Does Fonterra have a2 cows like Synlait does?

Yeah, Fonterra has a mix of farmers in their cooperative and many of them have isolated a2 cows in their herds and are working with us to manage those herds in a constructive way against our policies, and they're excited to be a part of the a2 family. 

Because your Synlait contract is five years from July 2018, so, I guess, presumably you have to renegotiate it in 2023.  You're working with Fonterra.  Is that kind of an insurance policy in case it doesn't work out with Synlait after that?

Synlait's been a great partner of the a2 Milk company from the beginning of our days with infant formula, and they'll continue, I'm confident, to be an important partner for us over time.  Fonterra brought different mixes, skills and capability, given the breadth of their manufacturing capacity, and the different sorts of things that they can do from a technical standpoint.  They play different roles for us.  There'll be some overlap, I'm sure, over time, but at the moment they're playing quite different roles.

Are a2 cows only in New Zealand, or have we got some here?

We definitely have some here, and the a2 milk that's sold in every grocery store across Australia is coming from cows, a2 cows, in the region that the milk's being sold.  The same thing is true in the US, the a2 fresh milk that we sell in the US comes from US a2 cows.  The product that we sell in the UK comes from a2 cows that we have identified and are taking milk from in the UK.

Right, okay. 

There are a2 cows everywhere, you just have to find them.

Yeah, right.  I'd assumed that you were reconstituting that milk.  I've obviously got that wrong.  Right, so are those cows owned, or does that stuff come through Synlait and Fonterra, or that's a different set of deals, supply deals?

Those are different relationships, yeah.

Yeah, right, I see, so the Synlait and Fonterra deals are for infant formula.

No, the Fonterra relationship does support fresh milk into New Zealand.  The Fonterra relationship also supports ingredients that we use for a mix of things, as well as infant formula.  Both companies are obviously very capable producers of infant formula.

Yep.  Thanks very much, Jayne.  Great to talk.

Yeah, pleasure.

That was Jayne Hrdlicka who is the CEO of The a2 Milk Company.