China spirit - How Diageo reinflated the baijiu bubble - Part II

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In a visit to the home of Diageo's Chinese spirit brand, Shuijingfang, news & insights editor Andy Morton looks back at the fall - and subsequent rise - of baijiu, and shows how the company is learning from past mistakes to help shape the Chinese white spirits' future. Here's part two of Andy's story - part one can be found here.

During its tenure, Diageo has grown to better understand Shuijingfang, the Chinese people and their culture

During its tenure, Diageo has grown to better understand Shuijingfang, the Chinese people and their culture

Future hurdles

What does the future hold for Diageo and its Shuijingfang journey? As CEO Ivan Menezes says: "The baijiu category is enormous in China". According to Bernstein, bajiu accounts for an incredible 28% of global spirits sales and 39% of global spirits volumes. It is only fitting that the world's biggest spirits producer by net sales has a stake in it. 

Nine-tenths of those huge volumes are at the value end of the category, but the upper end is where the money is, and it is here that Diageo is chasing the margins that helped propel Moutai's share price increase. Moutai's EBIT margin, says Bernstein, stands at a very attractive 73%.

Shuijingfang, however, is a small figure in a market dominated by some very large players.

According to Bernstein research, in 2015 Moutai posted US$4.6bn in annual net sales, putting it just ahead of Beam Suntory. Second-biggest baijiu producer Wuliangye Yibin was on $3bn, just shy of Brown-Forman's total net sales. Yanghe was next - just behind LVMH - on $2.5bn, while further back sat Luzhou Laojiao, China's fourth-biggest baijiu producer by net sales with US$1bn a year, about the same return as Remy Cointreau.

In comparison, figures from market research provider Euromonitor show that last year Shuijingfang had a 0.2% share by volume of the super-premium local spirits category in China.

As a brand, Shuijingfang also has a shorter history than its rivals. Go to the Shuijingfang visitors centre in Chengdu - tucked behind a nightclub cluster named after a famous Hong Kong entertainment district - and you'll be shown old baijiu pits that date back 300 years. Yet, these pits, in which the grain used to make baijiu is fermented under a layer of yellow mud, were not making Shuijingfang all those years ago. Indeed, the brand as we know it only came into being in the 1990s, when the mainstream brand Quanxing was given a makeover.

Shuijingfang also has the potential handicap of being a foreign-owned brand in an industry that, for the past five centuries of baijiu production, has been proudly domestic. It may be no coincidence that Diageo is the only multi-national spirits producer with baijiu in its portfolio (though Brown-Forman has a "co-operation agreement" with Wuliangye). 

The complexities of either building a brand or buying one of baijiu's zhongguo mingpai (famous Chinese brands) are widely-considered to be too difficult to overcome. Diageo's supporters, of course, would argue that the company has done exactly that in other countries - in Brazil, it owns the cachaça Ypioca, while in Turkey it controls Mey Icki, itself owner of Yeni Raki, the best-known version of the country's national aniseed spirit.

Speak to Chinese consumers, however, and they argue that baijiu is different; that foreigners cannot understand the centuries of history behind the spirit. Diageo, they suggest, has bitten off more than it can chew.

"I don't really understand why Diageo invested in Shuijingfang," says former Shuijingfang employee Wang Yong*. "The baijiu business is different to whisk(e)y and other spirits businesses. You can just sell whisk(e)y to supermarkets and to pubs and restaurants. For bajiu, it's different. The most important thing is the Chinese consumption behaviour, especially for high-end products. That behaviour depends on the relationship people have when they drink baijiu or are treating friends and business partners. It is different to Europe. If you only use the system that sells whisk(e)y to sell baijiu, it doesn't work."

In a bid to make it work, Shuijingfang is focussing on a new type of consumer in the baijiu market - youth. Traditionally the liquor of business and government, baijiu has failed in the past 20 years to capture the attention of the newly-monied 20- to 35-year-old crowd. However, according to Shuijingfang's board secretary, Tian Jidong, the company is developing new blends that it hopes will appeal to younger consumers wary of baijiu's typically-53% abv. And, as China's cocktail scene takes off, Shuijingfang has also created baijiu cocktails to encourage newcomers to give the spirit a try.

Furthermore, says Tian, when it comes to convincing young Chinese people to drink baijiu, time is on the industry's side.

"When the younger generation step into society, they will follow their leaders in the business occasion and they will drink baijiu," Tian told just-drinks in an interview at Shuijingfang's headquarters in Chendgu. "It happens naturally; we don't have to push it very hard."

These comments were echoed by Shuijingfang rival Wuliangye. Speaking earlier this year to just-drinks at Chengdu's Food & Drinks Fair, China's biggest spirits and wine exhibition, company marketing director Liao Bing said the new generation may have fallen for "foreign liquor", but tradition - and national pride - will see them return.

"As time goes by, the new generation will go back to Chinese spirits, especially as our country becomes stronger and stronger and they become more proud of being Chinese," Liao said. "Also, we are doing more to attract younger consumers. Because we cater to different generations, that's what gives baijiu such a bright future."

Meanwhile, in the UK, Diageo CEO Menezes told just-drinks that Shuijingfang is "resonating with a younger consumer".

"We're confident we have an exciting growth engine in the baijiu category which really no other multi-national company has - this is a real advantage for us in China," he said.

Meanwhile, smaller, more agile producers are also working to attract the next generation of baijiu consumer, and products such as Baijiu Bubble, a sparkling RTD-style drink, are appearing. A single-serve drink that sells for CNY30 (US$4.50), Baijiu Bubble costs more than double the equivalent size of the popular Bacardi Breezer flavours, but it has a light bulb inside that can be turned on and off. The variant subsequently has great appeal for nightclubs or karaoke rooms, two of China's biggest drinking occasions.

Elsewhere, the Youyuan company, launched last year in Chengdu, creates customisable baijiu bottles for people looking to impress friends or business partners. Larger producers already offer this service, which ties in with personalisation trends among young Chinese, but where a big producer would require a minimum order of 1,000 bottles or more, Youyuan's minimum is just five.

Mutual learning

The baijiu market has changed considerably since Diageo first partnered with Shuijingfang, and will continue to do so as the partnership enters its second decade. And, as with all relationships, both sides have learned from each other.

"Diageo has gotten to know Chinese white spirit better and better," says Shuijingfang's Tian. "They know how to manage Chinese people, Chinese products and Chinese culture, so the conflicts become smaller and smaller, both between the leadership and regular staff. Meanwhile, staff get to know the culture of Diageo better and better. It's getting smoother."

The deepening ties have meant another evolution at the Chinese company, but perhaps not one that is to everyone's liking. Asked if Diageo still likes to have a lot of meetings, Tian gives a quick laugh. "We have even more now," he says.

*Wang Yong's name has been changed

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