Comment - Spirits - Tequila: Is Diageo Left With the Scraps?

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Following a flurry of activity in the Tequila sector last month, has Diageo finally returned to the point it had previously reached when it handled Jose Cuervo? Richard Woodard compares then to now.

To shamelessly misquote Oscar Wilde: “To lose one Tequila brand, Diageo, may be regarded as a misfortune. To lose two looks like carelessness.”

A year after ending its relationship with category leader Jose Cuervo, the world’s biggest spirits company has now, thanks to that unexpected Suntory Holdings swoop for Beam Inc, also lost out on a potential bid for the number two brand, Sauza.

Is Diageo’s Tequila strategy in tatters?

The company itself would clearly say not. It has been patiently building luxury Tequila Don Julio in the US, adding 15% in 2013 to close the year at 230,000 cases, according to Impact Databank figures. In terms of focus, Cuervo’s loss has proven to be Don Julio’s gain.

Meanwhile, in the space of three weeks last month, Diageo has splashed out on not one but two more Tequila brands, DeLeón and Peligroso. But, neither of these are by any stretch big money signings: with its 10,000-case volumes and roots in southern California surf culture, Peligroso is the embodiment of “niche”.

So, what is the company up to?

There’s a clue in the DeLeón buy, which garnered more than its fair share of headlines thanks to the involvement of rap artist and producer, Sean 'Diddy' Combs. The acquisition of the brand, through a 50:50 partnership between hip-hop mogul and drinks monolith, is essentially a repeat of the deal they did with Cîroc vodka, back in 2007.

Compare the vodka and Tequila categories and the mists begin to clear. Cîroc was a response to Grey Goose, for which Bacardi famously paid over US$2bn in 2004. Fast-forward a decade and, while Grey Goose is up to nearly 4m cases a year, Cîroc has moved to well over 2m cases from a standing start in 2009. In other words, the Cîroc arrangement worked.

In Tequila, for Grey Goose read Patrón. The original luxury Tequila cleared 2m cases in the US alone last year, while building strong routes-to-market for future international growth. Any thoughts Diageo might have of buying it are effectively blocked, however, by the “significant” minority stake in Patrón that Bacardi bought in 2008.

So, just as Cîroc chases Grey Goose’s tail in the US luxury vodka market, so DeLeón is set to do the same behind Patrón in high-end Tequila. And, while Patrón has benefited in the past from the brand’s Hollywood connections, the involvement of Combs should ensure that DeLeón is seen at all the coolest parties from now on.

Diageo’s trio of high-end Tequilas, however, implicitly suggest a greater subtlety in the increasingly mature US Tequila market. The aim is to create a stable of complementary brands, all of which fulfil differing needs in the luxury market: Peligroso in the fast-growing super-premium (US$20 to $40) segment, Don Julio just above it and DeLeón at the top. Similarly, Peligroso’s association with action sports and presence in the burgeoning flavoured spirits segment (via a cinnamon variant) contrasts with DeLeón’s rooting in music culture.

There’s no way that Diageo’s Tequila threesome can, on their own, accomplish the company’s avowed long-term goal to regain leadership of the Tequila category in North America. But, that only matters if the company’s sole concern is case sales.

Diageo North America president Larry Schwartz has also said the company wants to regain the profits lost through Cuervo within two years. In the absence of a big-brand acquisition, tactical purchases are the best way to achieve this, focusing on value over volume.

That value question was a major part of the frustration the company felt with Cuervo, whose market share in the US has been steadily eroded in recent years.

Former Diageo CEO Paul Walsh was open in saying that the brand wasn’t fully “paying the rent” for being distributed by the company, and his desire to take control of it implied that, as brand owners, Diageo would do a better job of exploiting Cuervo’s profit potential than the Beckmann family.

So, is Diageo better off without Cuervo? Perhaps the best way to answer that question is to pursue the vodka analogy a little further. Having Don Julio, DeLeón and Peligroso ticks the Cîroc and Ketel One boxes, but can’t begin to match the volumes of Smirnoff.

The problem for Diageo – and this is where we came in – is that its volume options in the far smaller Tequila market are limited, to say the least. Cuervo’s gone and Sauza is about to be bought by a rival, while Patrón is part-owned by Bacardi.

What else is there?

Schwartz says the company’s goals will be accomplished by a mix of “organic growth, innovation and acquisitions”, so the Diageo Tequila masterplan may not yet be entirely complete.

But, while its three-pronged strategy may not have the scale of Tequila’s biggest names, it does have the potential to make handsome profits for Diageo shareholders. Oh, and handsome profits for the Beckmann family too, by the way – because they still own a 50% stake in Don Julio.

For Diageo and Tequila, it seems, it’s all about making the best you can out of a world that is far from perfect. And, for the moment, sacrificing scale in favour of margin and potential.

Sectors: Spirits

Companies: Diageo

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