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% percent 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 2 to 2.5 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’s 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 the 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 1 million yuan in sales, there’s 4-5 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: Just now your secretary told me 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 plac