Authors: Zhao Jingchuan, Sun Yitong, Nick Torres Corporate & Commercial Group KWM
The Administrative Measures for the Registration of Product Formulas of Infant Formula Milk Powder (the “Measures for Formula Registration”) have played a vital role in the rectification and supervision of the infant formula milk powder industry in China as well as in the integration and development of the milk powder industry since October 1, 2016. Based on our practical experience in infant formula milk powder industry and insight into regulatory trends, this paper briefly introduces the characteristics, development and impact of China’s formula registration system on manufacturers.
“Past Lives” and “Present Lives” based on the Formulation Registration System
Prior to the implementation of the Food Safety Law (2015), China implemented a record-filing system for the product formulas of milk powder. During this period, many manufacturers used the formula as an important marketing tool to out-perform their competition. Blinded by greed, manufacturers deceptively made minor changes to the same nutritional ingredients in the formula, labeled the same formulas differently, and charge different prices to sell these products through varies channels and seize control of a larger market share. According to statistics during that period, there were 2,000 different types of formulas in only 103 manufacturers, and the number of formula in some individual enterprises exceeded more than 180. The proliferation of formula not only made the ratio of formula ingredients lack sufficient scientific confirmation, but also had a negative impact on the safety and reliability of infant formula milk powder, directly harming the interests of consumers.
Entering the era of registration system, infant formula milk powder’s industry entry barriers have greatly increased. Firstly, according to the formula registration procedures, enterprises applying for the formula registration must be the manufacturers of the infant formula milk powder, with corresponding research and development, production and inspection capacities as required by law. Secondly, the product formula itself must possess a sufficient scientific and safety basis. Furthermore, each enterprise must not exceed nine product formulas under three formula series. In other words, an enterprise can only register at most three formula series including phase one (0-6 months), phase two (6-12 months) and phase three (1-3 years), and an enterprise can only register a maximum of three formulas for each formula series. The law shall also apply to overseas infant formula milk powder manufacturing enterprises, whose products are exported to China.
As of July 10, 2020, the State Administration for Market Regulation (“SAMR”) has approved a total of 1311 infant formula milk powder products for 166 enterprises, including 998 domestic products manufactured by 115 domestic enterprises and 313 imported products manufactured by 51 overseas enterprises.
Characteristics of the Formula Registration System
Based on the aforementioned legislative background, the formula registration system sets up a capability threshold similar to the general “registration” or “license” system. At the same time, the formula registration system also has unique characteristics and rules.
- Formula Registration Certificate Follows the Circulation of a Plant Rather than an Enterprise
Although the product formula’s registration of infant formula milk powder is applied for in the name of the enterprise, the formula is in essence closely integrated with the factories producing the formula milk powder.
As illustrated in the figure above, under the general licensing system, the license is usually granted under the name of an enterprise. If the factory’s assets are sold to a new enterprise, the license, in principle, would remain under the name of the original enterprise and would not transfer with the factory, and then the new enterprise would need to apply for a new license. Therefore, in order to obtain a license through a merger or acquisition, it would usually be necessary to adopt an equity acquisition structure. However, under the formula registration system, based on the existing registration requirements, regulators (the SAMR) are more concerned that in an equity acquisition there is no substantial change in the facilities and processes of factories. According to our discussions with the relevant executives in practice, in theory, an asset transaction can achieve the acquisition of formulas, that is, the acquirer could obtain the registered formulas through the acquisition factory as an asset deal, and after the acquisition, the name of the applying enterprise would be changed in accordance with the asset transfer agreement.
- Formula Registration Certificate Shared by a Different Wholly Owned Subsidiaries of the Group
Under the Measures for Formula Registration, wholly owned subsidiaries, which have acquired the registration and production license of the product formulas of infant formula milk powder, may use the product formulas of infant formula milk powder registered by another wholly owned subsidiary within the same group company. Allowing different wholly owned subsidiaries of the group to share the formula registration certificate can be used in different factories of the group to arrange the production capacity rationally to improve production efficiency.
- Feasibility of Contract for Production of a Third Party Factory
As previously mentioned, the registration of factory formula is associated with branding and labeling. As a general principle, the factory shall not be an original equipment manufacturer factory (“OEM”) and manufacture infant formula, unless the OEM factory registers the infant formula to be produced under its own name. In this case, the Principal will authorize the OEM to use the Principal’s brand and recipe and then the Principal will sign an exclusive sales agreement with the OEM.
The Regulatory Trend for Dry and Wet Composite Process
The production of infant formula milk powder is divided into wet method, dry method and dry-wet method composite process. Due to the following characteristics, dry and wet composite process have gradually become the mainstream production process of infant formula milk powder, and consumers are also more inclined to choose the products made under this process.
- Wet process. The raw and fresh milk is mixed with various nutrient elements in liquid state and then dried to make finished product. The wet process makes all kinds of nutrient elements evenly distributed, but there is a risk of nutrient elements could be destroyed in the drying process, and the production cost is high.
- Dry process technology. The raw milk powder is mixed with various nutrient elements in a dry state and made into a finish product. The dry process is simple and convenient, easy to adjust and low cost, but the uniformity of nutrient elements is relatively weak, and the taste of the product is inferior to that of wet process.
- Dry and wet composite process. Dry-wet composite process combines the advantages of the two processes, but the production process is also the most complex.
According to our knowledge, the following possible regulatory trends exist in the dry-wet composite process:
- Labeling Requirement: At present, there is no clear requirement for marking the base powder and its source on the product label. However, Article 42 of the Circular of the State Administration for Market Regulation on Seeking Public Comments on the Measures for the Supervision and Administration of Food Labels (Draft for Comment) stipulates that “If raw milk, raw milk powder and other raw materials are stated on labels or instructions of infant formula milk powder, specific places of origin and countries of origin shall be truthfully stated.” In addition, infant formula milk powder made from base powder shall be labeled with “base powder” in the list of ingredients, and the original base powder ingredients shall be labeled in parentheses in descending order of the dosage added. The measure is expected to be officially enacted next year.
- Co-location Requirement: Currently, wet process and dry process are allowed to be completed in different factories, that is, factories are allowed to use imported base powder or the base powder produced by factories owned by the same group company but not in the same factory. Due to the problems of low freshness and nutrient loss during long-distance transportation of base powder, regulators are considering further improvement of the process requirements. The possible trend is that the wet and dry parts of the dry-wet composite process will have to be produced in the same factory area around 2024.
According to this requirement, if the dry and wet composite process is not in the same factory area, it is also necessary to clearly mark the base powder in the product ingredient table. Due to consumer preference, the marketing and sales of milk powder products clearly labeled as base powder are likely to be affected.
In order to respond to the above regulatory requirements and trends, some manufacturers of infant formula milk powder have begun to lay out their manufacturing sites, including planning to build a new or merged dry and wet process compound plant (in the same plant area) to meet the production capacity supply under the new requirements. When formulating plans for production capacity expansion and process upgrading, manufacturing enterprises need to fully consider their own demands and industry regulatory requirements. For example, if a manufacturer is considering to acquire an existing factory that meets the regulatory requirements (which is shorter than the period of building a new factory), the manufacturer should consider how it would gradually replace the registered formula of the original factory with its new formula, how to avoid idle production capacity, whether to adopt a contracted operation or a commissioned production during the transition period, etc.
We have extensive experience in the acquisition and operation of infant formula sector. If you have any questions, please feel free to contact us.