Agri Assignment Final

COFCO XINJIANG TUNHE CO., Ltd. CASE ANALYSIS

SUBMITTED BY DEEPIKA (P35121) DIVYA (P35126) KANIKA (P35140) SUMIT JHANWAR (P35193) VIVEK PILLAI (P35210)

Q 1. Make five forces analysis of COFCO. How these forces impact the company.

Porter’s Five Forces represents theoretical framework that is used for industry analysis and strategy development. Specifically, the five forces shaping competition within the industry consist of the intensity of rivalry among the competitors, the risk of entry of new competitors, the bargaining power of buyers, bargaining power of suppliers and the threat of substitute products and services

Fig-1 Potter’s five forces for industry analysis

China is one of the largest tomato producers in the world, but there is a large gap between China and foreign countries as for the tomato products aspect. The gap is mainly present in the following aspects: less varieties, poor quality, backward planting technologies, low machinery application level and single product variety. China’s tomato products generally

belong to preliminary processing and become raw materials of overseas developed countries, and the export price is on the low side.

COFCO Tunhe produced 50% of China’s total processed tomato-product output and 15% of the world’s output. Sales of tomato products accounted for 44% of the company’s revenues and 30% of its profits. Tunhe operated 22 tomato factories which produced 3 primary products- tomato paste, tomato powder and lycopene. It exported 90% of its tomato paste to 80 different countries including U.S., Italy, Russia, Japan, North Korea and the Middle East. Heinz Co., Nestle S.A., and Unilever N.V. were its top international customers. It also provided tomato paste to fast-food restaurant chains like McDonald’s and KFC. It also sold its own branded products to consumers in China.

1) Threat of new entrants – Entry into the industry is difficult given the high initial cost of plant and machinery. Also with world leaders of tomato processing like Tuhne and Chalkis already being present in the market, it will be very difficult for a new entrant to carve a market share for himself, he will have to incur extra cost on advertising and promoting his brand to attract international buyers.

But if someone can come up with a new technology or a new value chain which is cost effective as well as improves efficiency, it will give him competitive advantage helping him earn a better market share.

2) Rivalry among competitors- Xinjang Chalkis Tomato Products Company and Xinjang Tienye Company are COFCO’s main competitors which are owned by the Xinjiang Production and Construction Group (XPCG) which was an outgrowth of the People’s Liberation Army (PLA) who had taken control of the Xinjiang region in 1949. XPCG has been involved in infrastructure and industry development in the region and has some 1500 companies under it. It also maintains relationship with the local government.

Chalkis is the third largest tomato processing company in the world with a market share of 7.43% and annual production of 2.5 million (MT). With the financial backing from XPCG and established name in the tomato processing industry,

Chalkis possess a great threat to COFCO if it changes its working style by bringing in more professionalism.

3) Bargaining power of suppliers- The only raw material required by Tuhne is tomato so their biggest suppliers are 2,00,000 farmers from which it buys 2.2 million metric tons of fresh tomatoes in a year. In China Tomato growing was based on ‘Company + Farmer’ model. Farmers were organized under villages or farmer cooperative associations of 10-20 families whose representatives signed contracts with tomato processing companies.

Tomato was one of the least ruminative crop grown in the region, wheat and cotton being more profitable in terms of yield as well as price. Thus the processing company had to look at the prices of different crops in the previous year before deciding on the price to be stipulated in the contract.

In China land is owned by the government and the local agriculture bureaus act as intermediaries between the farmers and the business enterprise. The bureau strongly encourages the farmers to grow crops that would provide them with the highest profit.

Clearly the farmers have more bargaining power and that’s why they receive higher prices in the early and late stages of the processing season as well, even though the quality of tomato is not as high as that of the peak season.

4) Bargaining power of buyers- Key international customers of Tuhne include H.J. Heinz, Unilever N.V and Nestle S.A. etc. Apart from these it also sold in bulk to paste re-packers like South Italy’s Antonio Petti Fu, Saudi Arabia’s National Food, Tyseer and Russia’s Baltimore.

All the clients have annual revenues in billions of dollars and are involved in many other businesses like Unilever has 400 brands in home and personal care, Nestle is world’s largest food and beverage company and Heinz in involved in both backward and forward integration in the tomato industry.

As can be seen, the companies Tuhne is serving have such a reputation that any supplier will be willing to work according to their terms and conditions only to be associated with such giants. These companies dictate their terms in the form of the specific variety of tomato seed they want for their product, how it has to be harvested, processed and packaged. Also the traceability of the tomatoes to its farmer is a prerequisite with these company. On top of all this they buy the tomato paste at a very low price as compared to world standards.

As the product is undifferentiated the buyers can easily switch between suppliers according to price they offer suppliers. Clearly buyers have more bargaining power.

5) Threat of substitutes- The existence of close substitute products increases the propensity of customers to switch to alternatives in response to price increases (high elasticity of demand). As it is a raw material dominated industry, potential threat of substitute is quite less. Nonetheless it can be in the form of better variety of seed which has better features. Another source can be artificially produced sauce which is of lower cost. It can also be in the form of better and low cost packaging that adds substantially to the margin of the processor.

2. Why did Heinz outsource tomato paste procurement?

Heinz is a global food company based in USA with revenues of $9 billion in 2007. Heinz is known worldwide for its signature product line which includes Heinz ketchup, Classico tomato sauces, Ore-Ida frozen potatoes, Weight Watchers Smart Choice prepared foods and

AB brand soy sauces. Ketchup and sauces sold directly to customers and commercial enterprises like fast food joints, accounted for over 40% of the company’s revenues.

In the late 1990’s, Heinz began to shift its supply strategy for its branded tomato products like Heinz Ketchup as Heinz considered the reputation of its brand as its core asset. That is it had faith that customers will buy its products on the basis of the brand image it has created over the years. People will purchase ketchup on the basis of ‘Heinz’ being written on its bottle. The source of the contents inside this bottle was of secondary concern for the customer as long as Heinz was claiming it belonged to the Heinz group. Thus it decided to outsource more of the production of tomato paste rather than produce it in-house.

Its business with China particularly began in 1998 when a tomato supply shortfall occurred in California. As China was the third largest producer of tomatoes in the world having a share of 12% in processed tomato product output, Heinz thought it to be a good option as it also gave benefit of low cost. But it had concerned regarding efficiency of China farmers and therefore it started procuring from Chalkis the third largest tomato processing company in the world. But when it started doing business with COFCO Tunhe from 2005 onwards, it was really impressed as COFCO responded accurately to their specific requirements of seed, method, pesticide residue etc. In 2007 Heinz purchased 5% of its global paste requirement from Tunhe.

Q 3. What are the major risks for Heinz in procuring it from COFCO? How is it being addressed? Can Global GAP certification would be of use to COFCO and how? Ans. Heinz was outsourcing more of the tomato paste rather than producing it. The company thought that outsourcing does not matter unless the quality is ensured. So, for the tomato perspective Heinz decided to outsource it to China when a shortfall occurred in California. It formed a relationship with Tunhe, under COFCO management. Major risks undertaken were: 1. Mould and pesticide residue: Heinz revealed that Chinese were not that efficient in producing tomatoes as they were able to find out some mould and pesticide residues on some of the tomatoes. 2. Production capacity(1st year): the production capacity of the factories in Tunhe was not up to the mark. They were not equipped to manufacture high viscosity pastes, which resulted in production back-ups and hence, problem for Heinz.

3. Processing Delays (2nd year): In the second year of operations, Tunhe employed unused mechanical harvesters which resulted in in excess dirt entering the factory premises and created further processing delays. The processes undertaken were not automated which might result in faults and delays, which was a major concern for the Heinz. 4. Promotion of modern techniques had to be done which eventually increased their costs. The problem basically faced was because of the inexperience of Tunhe in complying with the international standards. Heinz adopted following methods in order to mitigate the risks: 1. Trainings were also imparted on improved, international standard processes. 2. Heinz pushed the government to change the current land system for producing more tomatoes. 3. The company encouraged Tunhe to procure lands and firm it according to Heinz’s international standards. Deep-till soil preparation, drip irrigation, IPM and mechanical sprayers were employed for consistency of process. 4. A lot of investment of time, energy and dollars had to be done by Heinz in order to help Tunhe to improve their production. GLOBAL G.A.P (Good Agricultural Practice) Fruits and Vegetables Standard:

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It covers all stages of production, from pre-harvest activities such as soil management and plant protection product application to post-harvest produce handling, packing and storing. This certification would help COFCO in covering all the flaws, present in the production process. Global Gap Certification is a strict procedure and it would help COFCO in maintaining international standardization & supply quality products to Heinz. It would also help to improve seed management, control of GMO products, site selection, field management, harvest management, personnel safety, environmental protection and other issues.

4. Why did COFCO integrate backward into seed production? What are the advantages of such a move?

Ans: To survive and stay relevant and competitive after opening up of the import export of food sector COFCO had to integrate backward- upstream in the supply chain as its customers began to establish direct relationships with their suppliers in China.

Of all the raw materials seeds were the most essential and important element in agriculture production. Tunhe had the aim of becoming most favourable supplier to its customers. The advantages of the backward integration for seeds are as follows: 1.

It is being able to provide high quality and customised variety of seeds to farmers such that they produce tomatoes with specific characteristics that Tunhe’s customers required for their particular products. For example , the company’s Japanese customers needed products with high lucopene content. Tunhe now produced 80% of the seeds its farmer used. 2. The ability to develop new seed varieties was also helped Tunhe to gain new customers. 3. By establishing seed research institute and partnering with well known tomato genetics suppliers they have ensured supply of high quality seeds for procurement desired quality of produce and thus reducing dependency on other seed producing organisation. Thus, it was wise to integrate backwards into seed production. 5. How would you describe the relationship between Heinz and COFCO? What are the expectations for each of them in the relationship? Are they hostage to each other?

Ans: The relationship between Heinz and COFCO is that of trust. Heinz has invested a lot of time, energy, and dollars in helping Tunhe improve. Their relationship has not yet been formalised though. COFCO TUNHE and Heinz reached the agreement on tomato demonstration project. 5.4 hectares of planting base was established in Hutubi County. Seeds from Heinz were introduced to local farmers. Heinz experts strictly guided them with planting techniques. Through the project, a total of 5,750 MT raw material was produced in 2006 on an average of 87 MT per hectare, 27 MT higher than the other planting regions. And the raw material met the Heinz’s requirement on producing HB products with high bostwick. Productive efficiency improved and local tomato industry in China upgraded after cooperation from Heinz.

Both Heinz and COFCO are dependent on each other. Heinz wants tomato paste for making Heinz tomato sauce and Heinz ketchup. Even though Heinz business is diversified to a certain extent, but its 40% revenues are generated from sauce and ketchup products only. So, ensuring regular supply of tomato sauce was the most essential aspect to keep its bottom line healthy.

Also, after facing crisis once in 1998, they needed a big supplier of tomato which can provide high volumes of tomato paste while ensuring higher quality standards. Taking all these considerations, they decided to partner with COFCO Xinxiang Tunhe Co. Ltd. as it was ranked second among tomato processing companies with 7.43% of world’s market share (2006). Also, being alow cost producer in a country with adequate climate for tomato cultivation supported by huge man power availability, Heinz could rely on COFCO.

Another fact in support of Heinz’s strategy to partner with COFCO Tunhe Co. Ltd. is that China’s per capita consumption of tomato processed product was very low.

All Heinz wanted was international standard tomato paste in huge volumes and COFCO was capable of doing so.

COFCO Tunhe Co. Ltd. lacked brand name credibility and Heinz core asset is its brand reputation. The brand building exercise could take years thus it is better for COFCO to partner with Heinz and create a win-win situation. Also, COFCO Tunhe Co. Ltd. got access to Heinz’s resources in terms of Heinz’s hybrid seeds, drip irrigation, deep till soil preparation method, integrated pest management and mechanical sprayers. This helped COFCO in increasing their agricultural productivity from 24 Metric tons to 48 Metric tonnes. Increase in cost was also there but in lower ratio which assured profitability. Thus apart from market access, COFCO had new technology in tomato production. Deal would also help in creating domestic market reputation.

6. How did COFCO turn around Xinjiang Tunhe after taking over the controlling interest? Is it really a strategic fit as claimed by the company? Explain. COFCO introduced a new work culture in Tunhe and brought in a culture of professionalism to all their businesses. Their aim was to achieve a decent life not only for the investors and shareholders, but also for those working in Tunhe. Communication with the customers in order to understand their specific requirements was not considered critical till then. They made sure that much effort was put in place to know the actual requirement of the customer rather than being concerned only about what price they could get from the paste. This required top managers who dealt with international customers to learn English as it was essential for proper communication. These two objectives were achieved by bringing in new personnel from other COFCO businesses into the senior management team, at the same time retaining high performers.

They were chosen with the prime focus on good enterprise management, especially in the processing industry, good administration, personnel management and good language skills. COFCO and Tunhe needed each other strategically. Being a trading company primarily, COFCO realized that they were losing their importance in the industry with the growing relationship between their export customers and suppliers. In order to remain relevant, they adopted a strategy of backward integration, moving COFCO upstream in the supply chain which was when they came across Tunhe. When we look into the history, China D’Long International Strategic Investment Co. had acquired a controlling interest in Tunhe in 1997. However their rapid expansion policies left the company in precarious financial shape which was when COFCO came along and acquired 37.2% stake in Xinjiang Tunhe, taking controlling interest in June 2004. While COFCO gave them the much needed vision on the way forward with better management and export management expertise, Tunhe was a high volume supplier which helped COFCO integrate and expand. This decision was strategically beneficial and essential for both the parties. While COFCO’s relevance was under question due to the introduction of new governmental policies which increased competition, in order to adapt to the changing external environment acquiring Tunhe or a good supplier was a matter of survival in the long run. They had the resources needed to support their decision as well as bridge the financial mismanagement in Tunhe caused by the wrong expansion decisions taken by D’Long. Thus in the overall picture, it can be viewed as a good strategic fit.