SHANGHAI - Danone has just closed its Shanghai yogurt plant, Nestlé says it's going to shut down its local ice cream factory and Pepsico has sold off 24 bottling plants in China. What is shaking up foreign food and beverage giants inside the world's No. 2 economy?

Danone, the French dairy giant, says it wants to concentrate on developing its Bio brand, where margins are high. But after the failure of its Chinese joint ventures, the company is operating alone, and its sales and marketing channels are far behind the competition. In the Guangzhou yogurt market, for example, Danone has a 12% share, but is forced to ship in products from faraway factories in Shanghai or Beijing. To arrive from the factory to the supermarket can take nearly one week, which is already half of processed yogurt's typical shelf-life.

Just two days after Danone ceased production in Shanghai, Nestlé, an even larger food industry rival, confirmed that it would stop selling ice cream in eastern China, and shut down its Shanghai factory. The company didn't give a specific reason for the closure, but industry analyst Liang Mingxuan of CI Consulting said the Swiss firm was struggling to compete with local peers.

"In the past few years both Nestlé"s ice cream business and Danone's yogurt business have been squeezed by dairy giants Yili and Mengnui," he said.

The Chinese spent 31 billion yuan ($4.9 billion) on ice cream in 2011, according to consultancy Euromonitor, but Nestlé"s share of the market was around 3%, less than half of Unilever's, and far behind Yili and Mengniu, which have 17% and 15% respectively.

With Nestlé"s market share flat, the company has struggled to match its rivals' economies of scale, a problem aggravated by the location of its factories – one up north in Tianjin and the other down south in Guangzhou.

The Shanghai problem

It's significant that, when they chose to make cutbacks in China, Nestlé and Danone both singled out their Shanghai operations.

"There's almost no suitable land", said Gao Jianfeng, a management consultant with BOGO Consultants, who recently advised a foreign client looking for a location to build a factory near Shanghai.

"A lot of the land seems like wasteland, but, when you make enquires, you find that it all belongs to someone," he added. Gao noted that the owners of the leaseholds (Note: businesses are not allowed to actually buy land in China; local governments only sell long-term leases) are often businesses from Zhejiang, Jiangsu and the Yangtze River Delta.

Gao says that the lack of land is the biggest problem for businesses in the area. Those determined to operate there must either settle for one of the tiny plots available or pay for land from another business that already owns the leasehold.

Another problem for businesses eyeing Shanghai is the operating costs, with labor, logistics and raw materials coming at a premium over the Pearl River Delta, central and western regions.

"The lack of land makes it hard for Nestle and Danone to build new plants and expand their production capacity," said Gao.

Many coastal cities, including Shanghai, had previously drawn foreign manufacturers with tax breaks, but changes to the taxation code have put an end to these incentives. "Shanghai is focused on developing the service, high-tech and advanced manufacturing industries," said Chen Yao, of the Chinese Academy of Social Sciences.

The government's fiscal policies are expected to reflect these new priorities, further marginalizing the city's food factories and prompting the owners to shift inland. "Shanghai is no longer suitable for traditional manufacturing," concludes Gao, the management consultant.

But that point of view isn't universally accepted, and market analyst Li Baojun, says that Shanghai factory owners have another option aside from moving inland. Li says that some firms are keeping their higher-cost operations in the east, but upgrading the products produced in those plants.

As an example, he cites Nestlé, which may have shed its ice cream business in Shanghai, but has just bought 60 percent of Xiamen-based food company Yinlu, and 60 percent of candymaker Hsu Fu Chi.

Along with their moves inland and upmarket, foreign food makers are paying much closer attention to their supply chains, in light of recent food scandals in China. "In the past, it was enough to have a lead in production and sales channels," said one investor. "Now they're also very concerned about whether a company has its own sourcing and production base … and whether it has a system to trace any quality problems."

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