Research in Focus - Challenges Facing Diageo in Spirits

In a recently-published global briefing 'Diageo in Spirits', Euromonitor International’s  senior alcoholic drinks analyst Jeremy Cunnington takes a look at what are the challenges facing Diageo in spirits as the new CEO Ivan Menezes takes charge.

Integrating new acquisitions

Major purchases for Diageo have been a bit like London buses - nothing comes along for a long time and then three come one after the other, starting with Mey Içki in Turkey in 2011, Ypióca in Brazil in 2012 and, at time of writing, a pending deal for United Spirits in India.

The two companies that have already been acquired seem by all accounts to be integrating well and there are early signs that the Mey Içki acquisition is providing the required platform for Diageo’s international brands. However, the huge challenge will be United Spirits. 

The Indian company will be a huge and complex organisation to integrate. At the end of its 2012 fiscal year (March), United Spirits employed 6,200 staff (around 25% that of Diageo) and had 29 manufacturing sites. Diageo will also have to take on ten facilities leased from third parties and another 50 with which United Spirits has contracts. This compares with Diageo’s 106 facilities globally.

It will also have to deal with United Spirits’ lower profitability compared to its rivals, and falling share of the market. Key brands are focused at the lower end of the market, while United Spirits has been losing share since its 2010 peak to smaller and more dynamic players.

Underperforming brands

One of the legacies of Diageo’s pre-economic crisis focus on the mature markets of Western Europe and North America is that a number of its large strategic brands are in decline, notably Baileys and J&B. Meanwhile, some of its other brands are being weighed down by their mature market focus, most notably Smirnoff, which, despite rapid growth in the emerging markets of Brazil and South Africa, is being held back by stagnation in the US and the UK.

Many of these brands were already struggling for growth in these markets before the economic crisis. The current economic difficulties have merely exacerbated the decline, especially for J&B with its over-reliance on Spain. 

Due to the universality of blended Scotch, J&B’s problem can - and will - eventually be fixed by a focus on other fast-growing markets, for example in Latin America and the Middle East and Africa. Baileys’ problems are more difficult to address. Cream-based liqueurs, which the brand dominates, is not a universal category and requires the education of consumers in those markets. While the company has had success in expanding the brand’s presence in emerging markets, most notably China and Russia, its volumes are still relatively small and so more needs to be done.

Gaps in brand portfolio

Diageo’s current acquisition spree has focused more on addressing geographical rather than category weaknesses, thus leaving gaps in the company’s portfolio. 

The most important gap, in Cognac, is the one that is the most unlikely to be filled in the foreseeable future. While it has an interest in Cognac with a 34% stake in Moët Hennessy, that will not transfer into sole ownership anytime soon, with majority owner LVMH unlikely to sell one of its most profitable divisions. 

The acquisition of Jose Cuervo would have filled the gap in its portfolio for a major Tequila brand. The breakdown in negotiations may just be temporary but, in the meantime, it lacks a major brand to even distribute. While its Don Julio brand can fill part of the gap, it is still too small for a company the size of Diageo. 

Diageo also lacks a super-premium Bourbon. These, along with flavoured variants, are key growth drivers in the US market and are becoming increasingly important in the larger export markets. While Diageo has its Bulleit brand, it is relatively small and so the company could do with a larger name in the category. One such brand, Maker's Mark, could come into play should its parent company, Beam Inc, be a target in the next round of industry consolidation.

Geographical weakness

In 2007, 74% of Diageo’s spirits volumes were sold in mature markets, although the picture looks better if one includes its beer volumes, which were focused on Africa. Nevertheless, the company’s focus was on high value 'Western' markets and even then at the exclusion of some major ones, such as Germany. 

Some of that weakness has been rectified with sustained investment that started prior to 2007, especially in its weakest region of Asia Pacific. Its position has been greatly helped by its emerging market-focused acquisitions, which, when the United Spirits purchase is completed, will see an almost complete reversal of the company’s mature versus emerging market split.

Diageo's weakness in emerging markets is relative to the strength of its mature markets and, in both Latin America and the Middle East & Africa, Diageo is the most advanced of all international players. Nevertheless, it could do more in these regions, as the Ypióca acquisition showed. 

The company is still weak in Eastern Europe, relying on third party distributors in all markets except Russia and Poland. The rest of its Central & Eastern European markets have annual volume sales of just under 1bn litres, which, while declining in overall terms, offer growth opportunities for international spirits categories such as whiskies.

As Diageo addresses these issues it will have to be wary of its rivals. Pernod Ricard has been focusing on broadening its geographical footprint in Africa and Latin America through more organic growth. Pernod is not alone, with many other companies such as Brown-Forman, William Grant & Sons and Edrington Group also focusing on these regions. They will also look to exploit any weakness Diageo shows, leaving Mr Menezes with some tough challenges ahead.