Lesson 3 Overview
•
This week we address the issue of Consumer Protection in our reading of Chapter 24 of The Legal
Environment of Business (10th Ed.).
The federal agencies discussed in Chapter 24 “Consumer Protection: are the Federal Trade Commission, The
Food and Drug Administration, and the Consumer Product safety Commission. There are significant sanctions
these agencies can bring down on offenders who fail in their duty to treat consumers fairly in the marketplace.
These agencies enforce and publish regulations concerning statues such as the Federal Trade Commission Act,
The Food, Drug and Cosmetics Act, and the Consumer Product Safety Act.
The Mandatory Assignment 24-3 “Spotlight on McDonald’s -Food Labeling” in the Business Case Problems at
the end of Chapter 24 is a good segue into your consideration of how management, Chinese regulatory
authorities, the Chinese judiciary, consumers and the international community reacted and dealt with a lifethreatening health issue from contaminated milk in the Sanlu Case.. Note the tension between management and
Chinese government officials and the consumers.
First MANDATORY ASSIGNMENT
MANDATORY ASSIGNMENT — Briefly answer the questions in 24.3 “Spotlight on McDonald’s – Food
Labeling” (p. 530) based on your reading. Post your answers in the Discussion Thread. with your opinion on
whether the Nutrition Labeling and Education Act is an appropriate response to the issue of food labeling for
children? If not, how should it respond? Also answer the questions asked on the Mandatory Assignment
Template: Should the law be amended to improve it? If yes, how? Is theh law satisfactory? If yes, briefly
explain why you think it is satisfactory.
Your second Mandatory Assignment is to write an analysis of the Sanlu Case. The Sanlu Case is posted
below along with guidance on how you should write your analysis.
Read the Sanlu case at least twice. First, get the overall situation and read again to become more
familiar with the facts.
Each time you read the case, take notes and identify in a time line the facts, the decisions that were
made, and by whom.
Use the template in Law Assignments for your answer. Discuss the following:
(1) How the Chinese government and judicial system responded to the situation and the
response of the international community; and
(2) Give your opinion on whether you believe the Chinese government’s regulatory and
judicial responses were adequate to protect the consuming public in China and
consequently buyers of the milk product in other countries.
S
w
9B09M077
SANLU GROUP AND THE TAINTED MILK CRISIS1
Francis Sun wrote this case under the supervision of Professor Shih-Fen Chen solely to provide material for class discussion. The
authors do not intend to illustrate either effective or ineffective handling of a managerial situation. The authors may have disguised
certain names and other identifying information to protect confidentiality.
Ivey Management Services prohibits any form of reproduction, storage or transmittal without its written permission. Reproduction of
this material is not covered under authorization by any reproduction rights organization. To order copies or request permission to
reproduce materials, contact Ivey Publishing, Ivey Management Services, c/o Richard Ivey School of Business, The University of
Western Ontario, London, Ontario, Canada, N6A 3K7; phone (519) 661-3208; fax (519) 661-3882; e-mail [email protected].
Copyright © 2009, Ivey Management Services
Version: (A)2009-10-07
The government said Sanlu was to blame; Sanlu said the cow farmers were to blame; the
cow farmers said the cows were to blame; the cows said the grass was to blame; and the
grass said its mother was to blame. . . .
— Black humor circulated widely in China in the wake of the tainted milk scandal.
In late summer of 2008, a tainted milk scandal unfolded in China and shocked the world. Lethally high
levels of melamine, an industrial chemical that could cause kidney failure, were detected in infant formula
being sold in the market. Sanlu Group Inc. (Sanlu), the core firm in the scandal, had manufactured a
product containing melamine that was 5,125 times higher than the European Union (EU) safety limits. The
scandal swept through the Chinese dairy industry, which was valued at RMB122 billion (US$18 billion) in
2007. All over the world, Chinese dairy products were recalled and banned. By December 2008, the
official numbers of victims included more than 290,000 infants sickened, 51,900 hospitalized, 11 suspected
deaths and three officially confirmed deaths.
On January 22, 2009, the Intermediate People’s Court of Shijiazhuang city, Hebei province, sentenced two
managers of Sanlu’s raw milk suppliers to death. Four Sanlu executives — Chief Executive Officer (CEO)
and Chairwoman Tian Wenhua, Vice Presidents (VPs) Wang Yuliang, Hang Zhiqi and Wu Jusheng —
were charged with producing and selling fake or substandard products. Tian was sentenced to life
imprisonment, and the others received sentences of five to 15 years. Tian was ordered to pay a fine of
RMB24.7million (US$3.6 million). Despite the bankruptcy of the company as a legal entity, Sanlu was
also fined RMB49.4 million (US$7.3 million).2
1
This case has been written on the basis of published sources only. Consequently, the interpretations and perspectives
presented are not necessarily those of Sanlu Group or any of its employees.
2
“Sanlu Group Criminal Cases Reached Verdict,” Xinhuanet, January 23, 2009, http://news.xinhuanet.com/legal/200901/23/content_10705325.htm, accessed on January 23, 2009.
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SANLU GROUP
The Road to Becoming the Top Dairy Producer
On February 16, 1956, 18 farmers in suburban Shijiazhuang city pooled 32 milk cows and 170 milk goats
to form a collective milk plant for handling milk storage and basic milk processing. They named their
3
group “Happiness Dairy Production Collective.” This collective was the predecessor of Sanlu Group.
Thanks to several generations of hard-working employees, the company successfully survived the political
turmoil (i.e. the Cultural Revolution) and steered itself into the reform era in China. Since the early 1980s,
and throughout China’s rapid economic growth that created a huge consumer market, Sanlu had continued
to diversify its dairy products. Sanlu employed nearly 10,000 people, and was one of the largest employers
in Shijiazhuang, the capital of Hebei province.
Sanlu’s success was inseparable from one particular individual, CEO and Chairwoman Tian Wenhua. In
1986, Tian first initiated the program of combining cow ownership and cow raising to solve the problem of
raw milk shortage. At the time, China had just started its economic reform, and the shortage economy
dating back to the planning era still prevailed. Because any activities other than pure farming were
considered a “capitalist tail,” raising cows were prohibited in rural areas. By combining cow raising and
milk processing in its daily operations, Sanlu assumed the roles of both a farmer and an industrial
producer.
As consumer demand for dairy products increased along with economic growth and improved living
standards, Sanlu’s integrated model couldn’t catch up with the ever-growing market. Raw milk supply
became a bottleneck for expanding output capacity. Tian was often embarrassed by not being able to
4
satisfy a friend’s request for a 500-gram milk quota.
Tian revolutionized the industry by convincing villagers to raise cows and sell raw milk back to Sanlu, as
epitomized by the slogan “cows going to villages, and milk coming back to cities.” She nicknamed those
villages as the first section on Sanlu’s production line. By 2003, Sanlu’s raw milk supply was relying on
more than 160,000 heads of cows being raised by villagers.
From the very beginning, some questioned whether these ill-managed and less-monitored “first sections”
would supply substandard raw milk to Sanlu. What happened later proved that such worries were not
unwarranted. Due to misalignments of interest between Sanlu and the cow raisers, disputes frequently
erupted regarding the milk quality and the price. Because these villagers supplied a large portion of raw
milk that was necessary for Sanlu’s expansion, the company could fill the supply gap only by sacrificing
quality in exchange for quantity.
Since the 1990s, Tian had launched multiple rounds of successful acquisitions, labeled as “low-cost
expansions.” Three of those major acquisitions were made in 2006 alone. In February 2006, the group
opened a dairy plant in Tangshan (a city in Hebei, near Beijing) with an annual output capacity of 200,000
tons of formula milk powder. In April 2006, Sanlu acquired a liquid milk production base in Weifang, in
Shandong province, which was capable of producing 300,000 tons of liquid milk every year. In October of
the same year, the company invested in production facilities with an annual capacity of 100,000 tons of
5
lactic acid bacteria drink and yogurt in Xinxiang, Henan province.
3
Diyi Caijing Daily, Oct. 10, 2008, http://news.sina.com.cn/c/2008-10-10/012716425723.shtml, accessed on Oct. 10, 2008.
“Reinvestigating Tian Wenhua and Her Sanlu Model,” Sanlian Life Weekly, November 3, 2008, pp. 82–87.
5
Ibid.
4
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9B09M077
Powdered milk had been Sanlu’s strongest product line since 1983, when it introduced the first infant
formula product in China. By 2007, Sanlu had been exceeding all other competitors for 15 consecutive
years, with a market share of more than 18 per cent. Its market share ranked second for yogurt and third for
6
liquid milk. In 2007, Sanlu’s total sales reached the benchmark of more than RMB10 billion (US$1.36
billion), a 5.3 per cent growth over the previous year (see Exhibit 1). Tian was considered one of the most
successful entrepreneurs in China for her role in building up the company. She was named deputy chair of
the China Dairy Industry Association and elected to the National Committee of the Chinese People’s
7
Political Consultative Conference.
Sanlu prided itself on its stringent quality control by boasting extremely rigorous test procedures for its
products. On September 2, 2007, Sanlu was featured in “Made-in-China,” a special episode of the CCTV
program Quality Reports Weekly. In the program, Sanlu claimed that it carried out more than 1,000 tests
before sending a product to the market. Numerous Sanlu products passed regulatory standards three times
8
in a row and were thus exempted from routine inspections from the government.
In 2007, the Chinese Ministry of Commerce awarded Sanlu the titles of “the Most Competitive Brand” and
“the Renowned Brand in China.” Forbes ranked Sanlu number one on its list of top Chinese dairy
enterprises. The China Brand Asset Assessment Center estimated that Sanlu’s brand assets were valued at
approximately RMB15 billion (US$2.19 billion). In the same year, China’s State Council bestowed the
prestigious “2007 National Science and Technology Progress Award” on Sanlu for its innovative infant
formula and related techniques. In August 2008, one month before Sanlu was shut down for criminal
charges, CCTV and dozens of other media promoted Sanlu as “the national brand that had changed
9
Chinese people’s life in the past 30 years.”
Partnership with Fonterra Co-operative Group
In December 2005, Sanlu signed a joint-venture agreement with the New Zealand dairy firm Fonterra Cooperative Group (Fonterra). The joint operation was formally launched on June 15, 2006. In this
partnership, Fonterra acquired a 43 percent stake in Sanlu at the price of RMB864 million (US$107
million), allowing Sanlu to control the majority equity (56 per cent). Under the agreement, a senior
Fonterra manager joined Sanlu’s senior executive team, and three Fonterra representatives also joined the
seven-member board of directors.
Fonterra was the largest marketer of dairy ingredients in the world, exporting dairy ingredients to 120
countries. Fonterra had total revenues of NZ$12.3 billion (US$8.5 billion) in 2005 and was worldrenowned for its production, processing and sales of dairy products. Fonterra exported more than 90 per
10
cent of its total production.
The joint-venture deal represented the largest investment by a foreign dairy company in China. At the time
of signing the joint venture contract with Fonterra, Sanlu declared it would invest RMB3 billion (US$439
million) in further expansions over the following three years, with the aim of forming a national industrial
network.
6
Sanlu Group website, http://www.sanlu.com, accessed on Nov. 19, 2008.
Ibid.
8
Ibid.
9
“Special Focus”, China Dairy, Issue 9, 2008, pp. 3 –7.
10
“Media Release”, Fonterra Company website, www.fonterra.com, accessed on Nov. 20, 2008.
7
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9B09M077
The significance of the joint venture was best captured by remarks made by executives of both parties
11
during an earlier signing ceremony at the prestigious Diaoyutai State Guest House in Beijing. According
to Tian:
Sanlu has become a famous Chinese brand. We have accumulated extensive experience in
new product research and development (R&D), operational management, sales and
marketing, and maintained a robust and sustainable growth momentum for many years.
Fonterra is an acknowledged leader in dairy production with extensive management
experience, world-class R&D teams, and advanced marketing skills.
I believe the co-operation between Sanlu and Fonterra is significant to the development of
the Chinese and global dairy industry. It signals that Sanlu has taken the first crucial step
towards the objectives of reaching the world-class level and developing Sanlu into a global
leader in the dairy industry.
Fonterra CEO Andrew Ferrier emphasized that the investment reflected Fonterra’s confidence in the future
of the dairy industry in China:
Over the past 20 years, Fonterra has been the number one exporter of dairy ingredients to
China. We have been impressed by the spectacular growth in consumer demand for dairy
products in China and the way Sanlu has grown strongly to meet this demand.
From a marketing perspective, Fonterra Brands Managing Director Sanjay Khosla said that the investment
was the logical marketing strategy for Fonterra in China:
We will complement our existing importing and consumer businesses in China by
partnering with a successful local company that has access to local fresh milk supplies.
The joint venture would draw on the respective strengths of Fonterra and Sanlu. It is a
professionally managed company that has a good track record for growth. It has an
established sales and distribution network reaching more than 600 cities in China.
The partnership did not affect the operational structure of Sanlu. The business scope of the joint venture
continued to be manufacturing, marketing and distribution of consumer dairy products within China.
Throughout 2006 and 2007, as expected by both parties, the joint venture had been on the track with its
original goal of achieving a high level of competitiveness and profitability.
THE SCANDAL
In late 2007, sporadic consumer complaints and media reports began to emerge, blaming tainted baby
powder milk for a number of cases of infant kidney failure12 (see Exhibit 2). Some of these cases had a
confirmed link to products from Sanlu, which had been China’s number one seller of baby formula for 15
11
All citations are from Fonterra Co-operative Group Ltd., “Fonterra and Sanlu Reach Joint Venture Agreement”, press
release, December 2, 2005, assessed on Nov. 20, 2008.
12
“Sanlu Received Consumer Complaints as Early as End of 2007,” Hebei Youth Daily, September 23, 2008,
http://news.sjzcity.com/2008/6131.shtml, retrieved on June 20, 2009.
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9B09M077
consecutive years and had accounted for more than 18 per cent of the Chinese baby formula market in
2007.
In response to more and more similar consumer complaints, on July 1, 2008, Sanlu launched an
investigation into infant kidney failures that were allegedly linked to its infant formula. The company sent
16 batches of samples to the local governmental food safety regulator for testing of the ingredients. The
results showed that all of the 16 samples contained melamine.13
Melamine is a chemical often used to manufacture a type of flame-retardant plastic, which is commonly
used in the manufacture of countertops and dry-erase boards. Melamine is nitrogen-rich and is sometimes
illegally added to food products to increase their protein level. Melamine is also used in cattle feed.
Melamine is known to cause renal and urinary problems in humans and animals when it reacts with
cyanotic acid in the body. If taken by humans or animals in a large quantity or over a prolonged period,
melamine can damage urinary and reproductive systems. The common symptoms of melamine poisoning
14
are kidney stones and kidney failure. The use of melamine in food production is universally banned.
On August 1, 2008, Sanlu’s board of directors, led by Tian, held its first meeting to discuss the
contamination of baby formula and dairy products.15 The board decided to cover up the incident and to
check the products in stock for melamine content. The board decided not to halt production. The firm filed
a report to inform the local government that its products were contaminated with melamine and asked the
government to help investigate possible contaminations of the raw milk sources. On the same day, some
government officials visited Sanlu and applauded its decision. They did not ask the company to stop
production.16
After the government officials’ visit, Sanlu held another board meeting on August 13, 2008, deciding that
the company would (1) continue to sell products in stock with a melamine level of less than 10 milligram
per kilogram (mg/kg), (2) withhold temporarily inventories with a melamine level of more than 10 mg/kg
and (3) replace items in the market that had high melamine levels with products that contained
approximately 20 mg/kg.17
On September 11, 2008, the Health Ministry of China announced that a lethally high level of melamine
was detected in infant formulas being sold in the market, including those made by Sanlu. The following
day, the government ordered Sanlu to halt production and to recall and destroy all unsold products. The
authorities reportedly seized 2,176 tons of Sanlu’s inventory and ordered the firm to recall another 9,000
tons from the market.18 On September 15, local police arrested four individuals and detained 22 suspects
for adulterating melamine into the milk source. In the follow-up moves, Tian and three other executives
were arrested and a number of government officials at the central and local levels were removed from their
office (see Exhibit 2).19
Court investigations indicated that, from October 2007 to March 2008, the dairy industry faced extreme
shortages of raw milk. Dairy firms started a new round of fierce competition for raw milk that drove the
13
“Tracing the Sanlu Poisonous Milk Powder Case,” Xinhua Net, January 4, 2009, accessed on Feb. 22, 2009.
World Health Organization, “Q & A on Melamine,” http://www.who.int/csr/media/faq/QAmelamine/en/, accessed on April
25, 2009.
15
Fonterra Media Release, “Statement by Fonterra CEO Andrew Ferrier to Media Conference,” September 15, 2008.
Source: www.fonterra.com, accessed on Nov. 20, 2008.
16
The Melamine in Court. By Tian Lei. Nanfengchuang Magazine, Issue 2, 2009, pp. 56-58.
17
“Tracing the Sanlu Poisonous Milk Powder Case, Xinhua Net, January 4, 2009, accessed on Feb. 22, 2009.
18
“China to Destroy 10,000 Tons of Tainted Baby Formula,” Xinhua, September 15, 2008.
19
Yanzhao Dushi Bao, September 23, 2009, pp. 1.
14
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9B09M077
price as high as RMB3.6 (US$0.51) per kilogram. When the price reached RMB3 yuan (US$0.43), Sanlu
found that it could not afford to pay for the raw milk, yet its major suppliers insisted on a higher price. To
keep production running, Sanlu agreed that its suppliers could adulterate the raw milk with water under the
condition that the protein level be maintained at 2.8 grams per 100 grams level.20 Geng Jinping, a supplier
who was later executed in the Sanlu case, added approximately 434 kg melamine-rich “protein powder” to
some 900 tons of raw milk at his milk station.21
On September 16, 2008, China’s General Administration of Quality Supervision, Inspection, and
Quarantine (GAQSIQ), which was the Chinese equivalent to the U.S. Food and Drug Administration
(FDA), released test results based on 491 samples of baby milk powder sold by 109 companies. The results
indicated that all 11 samples from Sanlu failed the melamine test, and one recorded the highest level of
contamination among all samples, at 2,563 mg/kg or parts per million (ppm), despite the EU safety limit of
only 0.5 ppm melamine content in food. Samples obtained from 21 other companies were also found to be
tainted (with concentrations ranging from 0.09 to 619 ppm), including samples from all top five dairy
22
brands in China, such as Mengniu, Yili and Bright Dairy.
China’s top dairy firm that survived the scandal impeccably was Beijing-based Sanyuan Dairy (Sanyuan),
which later acquired the bankrupted Sanlu. Sanyuan owned and operated 27 large-scale farms in Beijing
and their more than 35,000 heads of milk cows. This integrated model accounted for more than 80 per cent
23
of its raw milk and guaranteed the quality of raw milk supply.
The number of tainted milk victims soared. On September 17, 2008, Health Minister Chen Zhu stated that
tainted formula had sickened more than 6,200 children, and 1,300 newborns remained hospitalized due to
24
kidney failure. In early December 2008, Xinhua reported that the Ministry of Health revised the numbers
to more than 290,000 sickened, 51,900 hospitalized, 11 suspected deaths and three officially confirmed
deaths.
The official figures were likely to be understated because deaths without an official verdict might not be
counted. For example, the eight-month-old daughter of Li Xinquan, a peasant from Runan County, Henan,
died on September 10, 2008, as the result of long-term intake of Sanlu’s baby formula, but was not counted
as a victim. The family was denied compensation because she died one day before “9-11,” the official date
25
on which the government labeled the Sanlu scandal as a criminal case.
Sanlu’s joint-venture partner, Fonterra, played a significant role in uncovering the scandal. During Sanlu’s
August 1, 2008 board meeting, Fonterra representatives Bob Major, Mark Wilson and Patrick Kwok
reportedly disagreed with the decision to cover up the incident, but their minority position on the board
failed to stop the decision. On September 5, 2008, these representatives notified the New Zealand
government about Sanlu’s decision and asked for help in dealing with it. Three days later, the prime
minister of New Zealand, Helen Clark, deputized Tony Brown, New Zealand’s ambassador to China, to
26
alert Beijing directly. The series of actions was believed to have prompted the Chinese government to
investigate and thereafter disclose the scandal.
20
“Investigation into Sanlu’s Poisonous Milk Powder,” Xinhua, January 4, 2009.
“Sanlu Criminal Cases Reached Verdict,” By Zhang Jingyong. Xinhua, January 23, 2009.
22
“Products from 22 Dairy Firms Contain Melamine”, Yanzhao Dushi Bao, September 17, 2009, pp. 4.
23
“Credit, Quality, and Trust”, by Niu Liping. China Dairy, October 2008, pp. 15-16.
24
“Twelve More Arrested in China’s Tainted Milk Scandal,” Associated Press, September 18, 2008.
25
“The Melamine in Court”, by Tian Lei. Nanfengchuang Magazine, Issue 2, 2009, pp. 56-58.
26
“New Zealand Alerted China to Tainted Milk, PM Says,” South China Morning Post, September 16, 2008, pp.A4.
21
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9B09M077
REACTIONS TO THE SCANDAL
Domestic Reactions
The tainted milk scandal had directed the Chinese public’s fury and resentment toward the involved dairy
firms. Long queues of consumers formed outside the offices of Sanlu and other dairy firms, demanding
product returns and refunds. Hundreds of thousands of consumers filed law suits against Sanlu. Most
interesting were the consumer reactions on the Internet.
Internet hackers broke into the Sanlu website and, using a play on words, changed the name “Sanlu Group”
to “Melamine Group,” which was made easier because Sanlu Group (三鹿集团) and “Melamine Group”
(三聚氰胺) both started with the same Chinese character (三). To Sanlu’s list of “famous products,”
hackers added “Melamine.” Internet users also vented their anger with hundreds of millions of messages
on bulletin boards and blogs.
Celebrities who had endorsed dairy products in media advertisements were also mocked in images to
which digitally modified words had been added. For example, the words of actress Deng Jie in an
advertisement were paraphrased from something like “Sanlu, trustworthy and smart choice” into “Sanlu,
step-mother’s choice,” and her profile was changed to a petrified statue (symbolizing a kidney stone). Text
messages expressing anger and black humor, such as the blame game cited in the opening to this case,
were widely circulated among cellular phone users.
In late September 2008, the disclosure of an official’s speech diverted the public anger toward political
leaders. In a speech reportedly delivered in August 2008, Zhu Yonglan, the director of the Special Food
Supply Centre at the State Council and Central Government Offices, disclosed that her office was set up in
27
2004 to source high-quality organic food for top political leaders. The existence of Zhu’s office stirred up
growing resentments that the country’s leaders were not even troubled by the food security turmoil faced
by Chinese citizens. Ordinary consumers started to question whether the government ever intended to be
serious about the food safety issue.
International Reactions
As expected, the melamine scandal led to worldwide bans on Chinese dairy products from China’s
28
neighboring Asian countries, and from Africa, Europe and the Americas. In Canada, for example, the
four largest manufacturers of infant formula testified to the federal government that they did not source
milk ingredients from China. Mengniu strawberry yogurt, the only Chinese dairy product on Canadian
market, which was distributed only in Alberta and Saskatchewan (and without English or French
29
trademarks), was recalled by its importers for possible melamine contamination.
On September 25, 2008, the EU announced a ban on all imports of baby food containing Chinese milk and
called for tighter checks on other Chinese food imports. Netherlands and the French authorities ordered all
27
“Amid Milk Scare, China’s Elite Get Special Food,” by Anita Chang, CNBC, September 24, 2008,
http://www.cnbc.com/id/26873844/for/cnbc, retrieved on September 23, 2009.
28
“China Tainted Milk Crisis Triggers Global Recalls,” USA Today, September 23, 2008,
http://www.usatoday.com/news/world/2008-09-23-3519812911_x.htm, retrieved on September, 23, 2008.
29
“Mengniu Strawberry Flavour Sour Milk Beverage May Contain Melamine”,
http://www.inspection.gc.ca/english/corpaffr/recarapp/2008/20081015e.shtml, accessed on September 22, 2009.
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30
Chinese dairy products to be removed from store shelves. Meanwhile, the European Food Safety
Authority (EFSA) warned that children who consumed large quantities of biscuits with high milk content
could theoretically be consuming melamine at more than three times the prescribed EU safety limits (0.5
mg/kg of body weight).
In the United States, the FDA issued an advisory on September 12, 2008, regarding the possibility of
contaminated milk powder being sold in specialty markets serving the Asian community in the United
States, while assuring consumers that no formula approved for sale in the United States was made in
China. Later, the FDA issued a general alert against all finished food products from China, noting that
official information from a number of nations indicated a wide range of melamine contamination in many
31
products. To further cope with the surge of contaminated food incidents in China, the FDA set up, for the
32
first time, overseas inspection bureaus in Beijing, Guangzhou and Shanghai in November 2008.
The World Health Organization (WHO) referred to the incident as one of the largest food safety events it
had dealt with in recent years. The WHO decried that such deliberate contamination of foods intended for
vulnerable infants was deplorable. In a press conference, WHO official Peter Ben Embarek said that the
milk contamination was clearly not an isolated accident; instead, it was a large-scale activity intended to
33
deceive consumers purely for short-term profits.
BACKGROUND OF THE SCANDAL
Chinese firms did not operate in a vacuum. Their activities were affected by both the industries to which
the firm belonged and the larger community in which it resided. Sanlu alone could not have caused a
scandal with such a magnitude. Apart from the mistakes and wrongdoings within Sanlu, numerous other
factors had also play a facilitating role in the scandal, including the structure of the dairy industry,
government regulations on food safety, the political climate and all the social and cultural transformations
that had accompanied China’s recent economic development.
The Chinese Dairy Industry
When the People’s Republic of China (PRC) was established in 1949, the dairy industry in China was
relatively small, with an annual total output of more than 200 metric tons. The first three decades of
economic development raised the dairy industry’s output to almost 1,000 metric tons. However, in the next
three decades that followed China’s massive economic reform in 1978, the economy grew by more than 10
per cent annually. The growing affluence of Chinese consumers, their rising awareness of and demand for
nutritional intake and rapidly expanding commodity distribution channels together created a huge market
for dairy products. Strong demand stimulated more investments in the industry, making China one of the
major dairy producers in the world (see Exhibits 3, 4 and 5).
Unlike most other countries where dairy farming occupied vast prairie lands, China’s very conventional
farming sector used a unique operational chain (see Exhibit 6). Due to the lack of prairie lands, more than
30
“EU Bans Baby Food with Chinese Milk,” CNN News, September 25, 2008.
“FDA Import Alert,” November 12, 2008. http://ftn.fedex.com/news/NewsBulletinDisplay.jsp?url=111808〈=en,
retrieved on September 22, 2009.
32
“U.S. Opens Food Safety Office in China after Scares,” CNN.com, November 19, 2008. Retrieved on April 28, 2009.
33
“China’s Melamine Milk Crisis Creates Crisis of Confidence,” VOA, September 26, 2008,
http://www.voanews.com/english/2008-09-26-voa45.cfm, accessed on September 22, 2009.
31
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80 per cent of the dairy cows in China were raised by small farmers in their backyard (see Exhibit 7). Each
herd typically comprised fewer than 20 cows. Average milk production per cow was 30 per cent lower than
the world average.34
One media report painted an even murkier picture.35 According to this source, most Chinese dairy farmers
were poor and did not eat well — neither did their cows. The average herd of just three to five cows was
often kept in substandard and filthy conditions. The two major dairy firms in the Inner Mongolia region,
Mengniu and Yili, relied on small-scale farms for more than 90 per cent of their raw milk supplies and
constantly paid two-thirds of the normal price to purchase milk that failed quality tests.36 These two firms
purchased substandard milk despite having invested millions in state-of-the-art facilities in a region that
prided itself on its vast grasslands and produced more than one-quarter of China’s milk.
Chinese safety standards required that fresh raw milk be processed immediately after being extracted from
cows and then be kept at a prescribed low temperature. Due to lack of capital and operational scale, most
backyard farmers had neither the necessary processing and refrigeration equipment, nor access to modern
and large-scale processing facilities, which were concentrated in the major cities. After years of fierce
competition, processing facilities became even more concentrated, making it virtually impossible for
dispersed backyard farmers to send fresh milk directly and immediately to dairy plants.
This dilemma was seen as a lucrative opportunity by some villagers who had easy access to funding and
established “milk stations” to connect the supply chain. As shown by the picture in Exhibit 8, a small
vehicle was used by farmers to transport fresh milk to the bigger tank truck owned by a milk station. The
truck traveled to individual cow f