China's dairy industry will double in size, to nearly $20 billion, by the decade's end, McKinsey research finds. More important, changing consumer tastes, retail modernization, and the country's increasing affluence will transform competition in this nascent industry and likely usher in a wave of consolidation—a transformation that could be mirrored in other product categories across China. The findings for the dairy industry suggest that foreign companies considering their prospects in China have a window of opportunity because they bring much-needed capabilities in areas such as product development, branding, and channel management.

To map the contours of China's dairy industry—the largest in Asia after Japan's—and to predict its likely evolution, we studied consumption patterns and consumer preferences in more than 150 Chinese cities and towns.¹ This effort, together with our experience with clients in China's retail sector, highlighted three important findings.

The first is the rate at which China's consumers are adopting the purchasing habits of their Asian neighbors and seeking higher-value-added products such as milk beverages, cheese, and yogurt. Today these products account for one-quarter of China's dairy consumption, compared with nearly 60 percent of Japan's (Exhibit 1). This proportion will change as Chinese incomes rise; indeed, we expect...