Integrating spirits, wine and beer has proved problematic for major drinks groups over the years but expansionary moves by the two major Australian brewers, Foster's Group and Lion Nathan, suggest that the idea is once again being seriously considered. David Robertson reports.

Consolidation in the beer industry has been going on for years and Pernod Ricard's acquisition of Allied Domecq suggests the same is happening in spirits, but how far will the merger mania go? Will the drinks sector end up as a small handful of cross-category companies consisting of beer, wine and spirit divisions?

Wine, beer and spirits are all marketed and distributed in different ways which has made companies wary of trying an integrated approach, especially in light of earlier failed attempts at combining all three categories. However, the question of whether a cross-category model is workable is one that some of the world's biggest drinks companies are again understood to be asking, and they are looking to Australia for the answer.

The two largest drinks companies in Australia are (or were) brewers: Fosters and Lion Nathan. Both companies have spent the last five years buying wine companies to the extent that Fosters now has around 70% of its assets in wine.

Lion's wine division is much smaller but it is still about 11% of the company's assets. Fosters has also moved into spirits, launching the Cougar bourbon brand a few years ago. Fosters' ready-to-drink mixes saw volume growth of 34% in 2004 with Cougar up 53% and another brand, Black Douglas, up 30%.

Lion is now also eager to move into spirits and its new chief executive Robert Murray has admitted this will be an important area for the company. Lion is currently looking at whether it will launch its own brand or look for a joint venture with one of the big distillers.

A source at Lion admits that the company is "looking to become a cross-category player", which would mean that both Lion Nathan and Foster's domestic operations will cover the three major categories: beer, wine and spirits.
But will this cross-categorisation work?

Ready-to-drink spirit mixes, predominately bourbon or dark rum mixed with cola, are the fastest growing part of the Australian drinks market and Foster's move into this category certainly seems to be paying off.

Like Diageo's Bundaberg Rum brand, which sponsors the Australian rugby team, Cougar has used sport as one of its main marketing vehicles - a strategy that would normally be more familiar to beer marketers.

Fosters has also been able to use its beer distribution network with bars and nightclubs to get Cougar prominently placed. "Cougar's success is a case of supply push rather than demand pull," said a Lion Nathan source. "Foster's used its distribution power from beer to get Cougar noticed."

Lion also wants to use its beer-distribution and beer-marketing skills to launch a successful spirit brand. This is possible because half of all beer sales are to males aged 18 to 25 - the same consumers who are buying spirit mixes like Cougar, meaning that there is now more similarity between spirit and beer drinkers than ever. Beer and spirits do seem to mix after all.

But it wasn't so long ago that Fosters and Lion Nathan were insisting that wine was the obvious partner for a beer company. But the marriage of wine and beer has not been particularly successful and Foster's recent acquisition of Southcorp has been dogged by controversy. Many analysts think it is a bad move with Merrill Lynch recently damning the company's wine strategy as "doomed to disappoint".

Insiders at Lion Nathan admit that its A$400m wine buying spree has failed to make money. Some analysts are harsher; one said: "Lion has tried numerous expansionary moves over the past five to 10 years, near enough all of which failed."

One of the major problems is that wine is typically bought by more affluent and older people, not necessarily typical beer drinkers so there are, therefore, few marketing and distribution synergies.

And there is another problem with trying to create a cross-category model covering beer, wine and spirits. Strong retailers can use supplier merger and acquisition activity against them. Fosters is experiencing this following its Southcorp acquisition as Australia's dominant retailers, Woolworths and Coles, are believed to be threatening to drop brands unless some of the synergy benefits from the merger are passed on to them (and consumers).

Ron Sargeant, a drinks analyst with Morgan Stanley, said: "I think that the difficulty both Lion and Fosters will have is that one of the key synergies in mergers is distribution. The problem is that Australia has a highly concentrated retail sector, which will prevent distribution synergies being realised to any great extent." Other markets like UK and the US would see similar pressures, destroying much of the rationale for cross-category mergers.

Based on the evidence from Australia, beer companies can succeed in selling spirits (and presumably vice versa) but adding wine spoils the mix. Not that this has stopped either Lion Nathan or Fosters trying to make the beer, wine and spirits model work. "I've no doubt that Lion and Fosters [think they] can consolidate the beverage sector," said Sargeant. "Whether or not they can do it in a value enhancing manner remains to be seen."

Perhaps drinks companies should stick to consolidation within their own categories rather than risk destroying shareholder value in areas they aren't familiar with. For Diageo, that would mean abandoning its interest in Montana - a move that make many analysts in Australia happy.