Watch Out, Coke and Pepsi — Here Comes Wahaha

Wahaha, whose main products are milk drinks, bottled water and mixed congee, is the number one beverage company in China, with revenues of 11.4 billion yuan ($1.37 billion) and profits of 1.35 billion yuan ($162.7 million) in 2004. The company was started in 1987 by Zong Qinghou, its 60-year-old chairman and CEO.

Up until the year 2000, Wahaha was 100% state owned. That year, Zong bought out 55% of the government’s shares, kept 30% for himself, and allotted 20% to employees and 5% to senior management. 

As a young man, Zong spent 15 years on a farm before starting the company with two retired school teachers. Initially he made money by selling beverages and ice cream. Then in 1989 he founded the Wahaha Nutritional Food Factory in Hangzhou. Its main product – “Wahaha nutritional liquid” – was an instant success. In 1991, Wahaha Nutritional Food Factory and its 100 employees merged with a state-owned enterprise called Hangzhou Canning Factory. The company in 1996 set up five subsidiaries with the French giant Danone Group, a joint venture that attracted $45 million in foreign investment, but allowed Wahaha to retain all managerial and operating rights as well as the brand name Wahaha. In the last eight years, the company has established 40 subsidiaries in more than 16 provinces in China, and in 1998 launched its own brand, “Future Cola,” to compete against Coke and Pepsi. In 2002, Wahaha entered the children’s garment market.

Qinghou Zong recently talked with Wharton marketing professor Z. John Zhang at Wahaha headquarters in Hangzhou. Philip Wu, president of the Wharton Club of Shanghai, was also present at the interview.

Zhang: How did you get where you are? Could you share some of your experiences with others who might benefit from them?

Zong: I spent 15 years in the countryside, and then thanks to my mother, I went back to the city. I graduated only from junior high before going to work at a school-owned factory. I helped them create some new businesses such as electric fans and electro-watches. Had they followed my thinking then, the factory would have expanded. But the management wasn’t daring and resolute enough. At that time, I completely depended on my own judgment to do business. For example, Sichuan has a lot of silk; the silk industry in Hangzhou is very advanced. So I made money by purchasing silk in Sichuan and selling to Hangzhou. Another example: Back then aluminum ingot was in short supply. That gave me the opportunity to act as a middleman and profit from the price gap. My bosses thought it difficult to manage, but they also knew I was very capable. So they appointed me to be in charge of sales for a school-owned business. I had two retired teachers working for me and a desk in the office. One of my clients was Xiao Shan International Mansion. I sold ice cream for them on a commission basis. I made 100,000 yuan in the first year (1987). I also went into the business of processing oral medicines and made more than 700,000 yuan in the second year.

Later, people started to question the quality of those medicines, especially if they contained hormones. Meanwhile, I found that Chinese children — who usually don’t have any siblings due to the single-child policy — are too picky about their food. I wanted to develop a kind of oral medicine that could help stimulate their appetite. We invited a professor to do the research and development, and asked experts from around the country to offer advice. At that time, there was no health product specifically aimed at this market, even though China had more than 300 million children. I felt the potential was huge. It turns out that our strategy of focusing our products on children was right. Our Wahaha products sold very well in the market, and we made a lot of money — more than 7 million yuan in profit in the third year, and more than 20 million yuan in the fourth year.

Once we opened the market to the Wahaha products, we could hardly produce enough to meet demand. Competitors came in, and we realized that we would have to expand our production scale. In 1990, when we were still considered a small factory, we spent more than 80 million yuan acquiring a money-losing, state-owned enterprise. At that time, some people were criticizing us for overthrowing the state-owned economy. But we assured our managers that we would run a good business and keep people employed.

We expanded the Wahaha product offerings to include a kind of milk mixed with juice, which has become very popular with kids. Then we became a one-billion-yuan enterprise, with 200 million yuan in profit.

Zhang: Was Wahaha still a state-owned enterprise before 2000?

Zong: At that time, even I myself was state-owned. The nature of the enterprise actually is collective ownership, and the state doesn’t have one penny of investment. We operated very well in 1996. But a lot of foreign companies have come in since China opened up. So we thought if we only rely on ourselves to expand our scale and technology standards, our progress will be slow. We decided to get foreign capital. There were questions about why Wahaha wanted foreign capital when its profits were so good. Our decision was to co-operate with Danone in France: With one agreement, we got a capital injection of more than $40 million and introduced an advanced production line. Through such a move, Wahaha expanded its scale and improved its enterprise standards. It was a turning point for us.

Back then, it was five factories of ours — not the entire corporation — that were co-operating with Danone. The rate of return was high, with the investment recouped within two to two and a half years. As a result, Danone has wanted to expand its investment in us every year. Now we have more than 30 factories in which Danone has a stake, and they represent one third of the profits. The state-owned stake now is less than one third.

Initially, Danone also wanted to join us in managing the company, but there is a lack of understanding on their part about the market in China. Some foreign management styles are not applicable in China. They thought things should be done this way, but I thought things should be done that way. I understand the market, and I didn’t listen to them. For example, we initially had two pure-water production lines. I told them we should add seven more, but they said only two more were needed. In the end, we made a lot of money with the seven new lines. That made the foreigners happy. After a few more instances like this, they realized that our understanding of the market is more accurate and that we do things honestly. The key to both a human being and a business is credibility. After witnessing how well we have managed the business, Danone decided not to interfere. For a shareholder, what matters most is return on investment.

Zhang: Has Danone helped Wahaha expand into the European markets?

Zong: They have helped a little. The main products Danone has are bottled water, cookies and yogurt. Europeans don’t think the quality of the Wahaha fruit milk is as good. But the Danone yogurt expires only after seven days, which makes it difficult to market in China. And we are not able to use their distribution channels in Europe, either. So the help from them isn’t much.

Zhang: You might have felt a number of constraints when Wahaha was still a state-owned enterprise. What are things like now, after the stock capitalization?

Zong: Ever since Wahaha was created until now, I actually haven’t felt much constraint at all. I always do things according to my own thinking. Initially my way was quite controversial, but now the controversy is gone …. The managers know that I’m devoted to what I do, that I haven’t made any big mistakes, and that it’s hard work on my part. I don’t participate in any kind of meetings, and don’t knock on the managers’ doors. Gradually, they came to understand that I really am busy and have put all my heart into the enterprise. They have become more forgiving about my low-profile style.

Zhang: What does it take for a new entrepreneur to become successful? Is it just a matter of having a clear understanding of the market, while being persistent?

Zong: All these years, we have never exceeded our capabilities. We don’t do what’s beyond our reach. We have been very focused on our primary business. We have to be big in order to be competitive. There are some people who just can’t wait to expand as soon as they make some money. The result, however, is bankruptcy.

We have been focused on our primary business for more than a decade. We have started to diversify gradually only during these two years. We won’t diversify until we become competitive and until opportunities emerge. I think diversification depends on market demand, competitiveness and opportunities. Meanwhile, after a company reaches a certain level, it may have to diversify. At present, Wahaha has 16% of the market. It’s difficult for a 10-billion-yuan beverage company to expand further.

There are two problems facing the beverage industry right now: First, the consumption level is low in rural areas; secondly, Chinese people have different consumption habits (than do foreigners). People drink a lot of beverages in the summer, while Westerners drink them all the time – with meals or when they are at home. When Chinese people go back home, they drink tea and they make tea for guests. And they have soup with meals. During these two years, the supply in the market has grown faster than the demand, leading to a glut. So there is intense competition in the industry.

Zhang: You once said in an interview that the Chinese market is huge and you are still focused on the domestic market. I remember that the former Coca-Cola CEO once commented that a person needs to drink 64 ounces of water a day and of that amount, two ounces are from Coca-Cola. From that perspective, the market potential in China is still big, isn’t it?

Zong: The market potential in China is still huge, but it develops in stages. A company’s expansion must match the market demand. You should not expand too fast, and you should not lag behind, either.

Zhang: How do you keep your lead, given that there are so many competitors in the domestic market, such as Coca-Cola, Pepsi and others?

Zong: The competition is very intense nowadays, and we are attacked from all sides. There is a big rival for each brand. In the soda market, our main competitors are Coca-Cola and Pepsi. In terms of water, tea and juice, our competitors are quite diverse. Compared to those that haven’t established a brand name, our quality is higher; compared to international brand names, we have lower costs. In addition, with each season come different kinds of competition. Bottled water sells better in the summer than winter. Soda sees 40% to 60% of its sales in the winter, with the Spring Festival being the peak time. We compete according to seasons and our major competitors. We have a product aimed at each season, and no season is slow for us.

Zhang: How did you come up with the strategy of “attacking the city from the countryside?” Did you get that from Chairman Mao’s works?

Zong: The strategy was based on our market analysis. It’s only Future Cola that adopts the strategy, not other products. Our market analysis shows that Coca-Cola and Pepsi directly sell to retailers, and their customers have different tastes. If we competed with them in the urban markets, we definitely would be defeated. We found that they haven’t penetrated the second-tier markets in China. In addition, their advertising targets sellers, while ours is TV ads. We have lower costs, and as a result, it’s easy for our brands to enter the rural markets. That’s why we wanted to conquer the rural markets first and win the first-mover advantage. Once we are there, our taste becomes the standard and the most authentic. Now Coca-Cola is also expanding in the rural markets, but since it is late, the market is very challenging. We have a bigger share in the rural markets, but it’s very challenging for us to expand sales in the city.

Other Wahaha products were sold in the urban markets first, followed by the rural markets. But it has cost a lot in recent years to put our products on the shelves in supermarkets. The investment is big, while the return is small. For retailers who really want to do business with us, it requires them to put in three to four times their capital. For every one million yuan in sales, there’s four to five million yuan worth of investment beyond it. That has limited our ability to expand sales. Gradually, we are losing the urban markets to our competitors. But that doesn’t mean our products don’t sell in the city.

Wu: You spend most of a year investigating the market. I feel that the market is huge, and you can’t really learn anything from books. You started from scratch and built the Wahaha brand in such a big marketplace where there was a lack of order and a lack of understanding about your products.  Could you tell us what your experience has been?

Zong: I take one step after another. But I think, first of all, it takes prescience to succeed, meaning you have to understand both consumer behavior and retailers’ thinking. Your actions have to match that behavior. In addition, you need to have opportunities. Now, things are completely different than they were 10 years ago, and it’s much more difficult to do business. Back then, people didn’t know the concept of advertising. At the beginning, each time I went to a city, I could gain entry into its market with only limited advertising, like TV ads placed two or three nights a week. It’s impossible to do that now.

In 1996, when Wahaha teamed up with Danone, there was still more than 20 million yuan in bad accounts even though our products saw more demand than supply. To solve the problem, we established joint products. Because there was more demand than supply and retailers competed for our business, we asked the retailers to pay us first. At the same time, we offered them interest rates that were higher than the rates offered by banks. As a result, we secured capital and eliminated bad accounts. After a few years, retailers developed trust in us, and came to know that we have the capability and don’t lie.

First and foremost, it takes honesty and credibility to do business. You have to be honest with the retailers in order to have a lasting co-operation. They get their share of the profits at the end of each year. Incentives also helped me establish relationships with retailers. If they can make more money by doing business with you, they will be more willing to do business.

Zhang: Has employee ownership produced good results?

Zong: I don’t think employee ownership has produced any good results. That’s because even if employees get less in bonuses, they can get compensated with more dividends. So for the employees who have shares, they don’t even care if they don’t perform well and thus get lower bonuses. Now I’m thinking of rescinding employee ownership, although there is some difficulty in doing that. I am considering performance-based incentives, but that also is difficult. Thinking about those changes is one thing; implementing them is another. It’s better for things just to happen naturally; it’s not good to force them.

Zhang: “Wahaha” is a name that’s very easy to pronounce, both at home and abroad. Is that something that was done for a purpose?

Zong: Once a brand becomes well known, everybody likes it. Initially, some people didn’t like the name, saying it’s too limited to children’s products. Everything you do is bound to stir discussion. You have to use your own judgment instead of simply listening to others.

Speaking of the extension of the brand, initially the popular view was that Wahaha was a children’s brand. Now the brand is expanding, regardless of the product. Some people didn’t think it was a name suitable for bottled water, but now bottled water ranks number one in the country.  Today the general feeling about the Wahaha brand is: It conveys credibility, quality and affordability. Even children’s clothing can be named Wahaha.

Zhang: How is Wahaha’s business in the U.S.? What’s your expansion plan there?

Zong: We haven’t focused on that market. It’s others who come to us. I think it makes better sense to do trade in America instead of manufacturing. The U.S. has a very strong beverage industry. If I opened a factory there and tried to compete with those local brands, it would certainly be challenging. Marketing costs in the U.S. are also higher than those in China.

Zhang: How does Future Cola sell in the U.S.?

Zong: Ever since Future Cola entered the market, it’s been challenged by Coca-Cola. Once supermarkets owned by the Chinese that do business with Coca-Cola are threatened, they don’t dare to do any more business with Future Cola … We still mainly target the domestic market. Also, the Chinese government now doesn’t encourage exports because of export rebates. Local governments rely mainly on taxes. In the past, it’s only the central government that had to rebate export taxes. Now local and central governments share the rebate. That’s why they are not encouraging exports.

Wu: From your exhibit room, I saw that the management structure at Wahaha is very flat, with each manager in charge of one aspect of the company. Given that you do business across the nation, what kind of system do you use to select talent, and manage and motivate employees?

Zong: I have learned from some big enterprises’ experiences. Once they became big, they opened up factories everywhere, resulting in a lot of problems. Wahaha’s local branches are all in the charge of headquarters. So there is no big hole. It’s headquarters that decides how much money to allocate to local branches. Resources are also allocated by the supply department at headquarters. Salaries hinge on production level each month. We also have an auditing department that does audits once every six months.

All the branch managers are selected from within. Once they prove to be reliable, their main responsibility is to supervise production. It would be difficult to find a lot of qualified managers to be in charge of a company’s entire operations.

In addition, there is a sales department in each province, a branch manager in each district, and a client representative for each client. All orders have to be returned to the headquarters.

Zhang: I heard each time there is a job posting, a lot of people apply. Is it about 20 applicants per position?

Zong: The benefits of working at Wahaha depend on an individual’s seniority and contribution. That’s why our staffers want to advance. Each year we promote people based on their performance. I think we have to maintain a system so that employees are motivated. Otherwise, it would be like dead water.

Zhang: Looking forward, where do you see Wahaha five years from now? Do you have any plans?

Zong: I have a vague goal, which is to reach 100 billion yuan in production within five to ten years. Exactly what we would like to do depends on the changes in the market. The world is evolving constantly. We had two strategies at the very beginning: One was to produce only one category; the other was to focus on food, nutrition and medicines. We decided on the first strategy in the end. Now we’re in a different situation. Because we have acquired the capability, we will do whatever is promising. I am very keen about resource-related and environment-related industries. Given that there is a shortage of resources in China, we could develop quickly if we find any opportunities in this area. I don’t care about name. Doing business is to make money. Once you make money, you can contribute to society.

Zhang: Do you have a specific department within the company that specializes in finding opportunities for future growth? Where do you go to look for opportunities? And do you take a systematic approach in scouting for new opportunities?

Zong: We have a department whose responsibility mainly is to collect all the marketing information. Looking for growth opportunities mainly falls to me. There are a lot of people who come to me to discuss investment. I analyze those opportunities.

Wu: What’s the key to success?

Zong: I’ve kept making small but quick progress, to avoid risks. I don’t do things that are beyond my reach. Secondly, you have to keep innovating, even if it’s small innovation. Thirdly, you have to be honest and reliable. Otherwise, retailers won’t do business with you. Then you have to be advanced in every aspect, including technology and equipment. It’s also important to produce above-average profits. If others make five yuan, you must earn seven yuan. Then you are more competitive than others. Finally, you have to take care of your employees. Teamwork is key. My goal is that employees are afraid of me but they don’t hate me. You have to have authority; be demanding, but also open-minded.

Zhang: I do pricing research so I have to ask you this: What kind of pricing systems or principles do you have at such a big enterprise as Wahaha?

Zong: You have to base pricing on cost first. Then it’s the amount of profits you have to share with retailers. Then it’s whether or not consumers can accept your prices. We have standard pricing across the country.

Zhang: Do you have control over the profit margin?

Zong: I accept only what the market accepts. We have control over our counterparts through negotiations.

Zhang: Are your prices lower than Coca-Cola’s?

Zong:  We have lower costs than Coca-Cola, and so we have higher profit margins. The combined profits at both Coca-Cola and Pepsi are lower than ours. They have a bigger market share than we do. But our total profits are higher than theirs. We make everything ourselves. They send expatriates here to be managers. So they have very high labor costs.

Zhang: If Coca-Cola lowers its prices, would you follow suit?

Zong: No problem. It would lose money if it lowers prices. But there’s still room for us.

Wu: How mature is the beverage industry in China? How would you assess the consumption and production levels here?

Zong: The beverage industry in China is quite advanced compared to the rest of the world. China is ahead of Europe and the U.S., but may be behind Japan. That’s because the industry has lower profits in Europe and the U.S., and so innovation progress is slower there. Japan’s progress has also been slow during these two years. It only has a few new products due to low profits in the beverage industry in recent years. All the big beverage companies in China have introduced advanced equipment from abroad. So they have higher production standards and the most advanced products.

Zhang: Are beverage sales immune to economic cycles?

Zong: Beverages are consumed very fast, unlike some electric appliances that can be used for many years. As long as you manage well, beverage sales can be stable regardless of the economic situation. Consumers like beverages that can enhance their health, and that’s why we need to keep innovating.

Zhang: What are your views on reforming state-owned enterprises in general?