Dairy prices rise as supply shrinks

Most of the farms have signed contracts with dairy companies as their suppliers, but in the face of runaway milk prices, farms do not honor their contracts and companies also scoop supply originally designated for others.

"Forget about contracts, forget about taking what's not yours, whoever offers the highest price gets the milk," said a milk farm manager in Inner Mongolia.

In the wake of the 2008 milk scandal, authorities encouraged companies to build their own supply base to better monitor the quality of raw milk. Yet without sufficient funding and land, the country's goal to supply 70 percent of milk from farms operated by companies by the end of 2011 did not materialize. The rate is less than 40 percent.

While large-scale proprietary farms are yet to become major suppliers of raw milk, domestic dairy producers are quickly losing their individual milk farmers, whose number has declined by 600,000 from 2008 to 2012 and is expected to lose another 10 to 20 percent this year.

This is largely due to a sector-wide reshuffle carried out after the scandal with an aim to weed out unqualified individual dairy farmers.

The move has created a shortfall of 4 million tons of raw milk supply, or half of the domestic dairy production capacity, according to Song Liang, senior analyst with the Distribution Productivity Promotion Center of China Commerce, a Beijing-based think tank.

"Individual milk farmers will continue to be a major supplier for dairy producers for a long time, so protecting their interests and giving them more incentives to encourage dairy cow rearing is the key to ease the current tight supply," said Huugjilt, secretary general of Dairy Association of Inner Mongolia.

To truly transform the country's dairy industry, companies should grant equal attention to building their own supply base as they do to production, according to Gu Jicheng, secretary general of the Dairy Association of China.