Coinciding with the publication of Diageo's first-half results, this month's just-drinks interview is with Andrew Morgan, president of Diageo's European operations. Morgan took the opportunity to explain to Dean Best why amid a very positive group performance, the European division has failed to shine.

Diageo may be firing on all cylinders in North America and across much of Asia of late, but Europe is proving a tougher nut to crack for the UK-based drinks giant.

Last week, the world's largest beverage alcohol firm posted a set of robust first-half results. CEO Paul Walsh toasted an 11% jump in profits from Diageo's North American business, thanks to strong spirits sales. Diageo's Scotch portfolio, meanwhile, was the main driver for some notable growth in markets such as South Korea and Latin America.

Europe, however, is giving the company something of a headache. Profits in the six months to the end of December were flat, as falling sales in the UK offset a rosier picture in continental Europe. Moreover, Andrew Morgan, president of Diageo's European operations, sees the company's difficulties in the region continuing for at least another year.

"I'm not happy that we didn't grow profits in the first half," Morgan tells just-drinks at Diageo's HQ in the heart of London. "We'll continue to find it quite tough in the second half and then look to start growing our volume and sales value more in the next financial year."

Morgan has led Diageo's European operations since the company restructured its business on regional lines in 2004. A UDV veteran, he presides over a region that, according to Diageo's first-half results, accounts for a third of the company's sales and over a third of its operating profit. As such, even for a company as global as Diageo, improving its European performance is key to its long-term health.

And central to that improvement will be Diageo's moves to revitalise sales in the UK. Diageo's sales in the UK fell 9% during the first six months of the year. A declining spirits category in the UK on-trade dampened the first-half performance, while the ongoing consumer shift from on- to off-premise hurt sales of Guinness in particular.

"There are a number of things impacting our performance in Great Britain (GB). The main thing I think is the on-premise," Morgan explains. "That's mainly down to consumption moving toward being more associated with food. Some of the stuff we're working with now is how we get spirits consumed more around the meal occasion."

Andrew Morgan

Leaving aside the reluctance of pub-goers to drink a gin and tonic or a Baileys with their meal, it is Diageo's decision to stand firm on the pricing of its spirits brands, particularly in the off-trade, that has been a key factor behind its problems in the UK. Morgan admits Diageo has been unwilling to cede too much ground on price. "In observing what's happened in recent years, particularly at Christmas in the off-trade, we feel that some of the pricing is inconsistent with our premium brand positioning on our spirits brands," he says, pointing to previous Christmas promotions on Baileys, where a litre of the Irish cream liqueur would be on sale for "less than GBP10 (US$19.53)".

He adds: We did draw something of a line in the sand in terms of what we were prepared to support with the retailers this Christmas, and it cost us volume."

Diageo's stance in the face of mounting discounting pressure from retailers was a brave one, especially during the key Christmas period. What's more, as the sales of Diageo's spirits stable in the UK fell, Pernod Ricard benefited, enjoying a bumper festive period.

However, Morgan is insistent that Diageo's strategy is correct. "We knew we'd lose some significant volumes but as far as I'm concerned this is the right thing to do for the brands. This is about the health of our brands for the long term."

Morgan says Diageo plans to use discounts "wisely" to bolster off-trade sales in the UK. For instance, it has tweaked the price of Smirnoff to stave off competition from value brands. "We're constantly working with what is the right sweet spot on price between brand image and our ability to generate volumes," he says. "We'll probably do that better over the next year than maybe we did at Christmas this year."

But Morgan concedes the UK market - which accounts for "close to a third of our European sales" - will remain "quite challenging". "I don't expect us to be in any kind of turnaround mode in the second half," he says. "We may see some improvement in volume and sales trends but I'm not looking for that to significantly flow through to the bottom line and we've got a smoking ban coming up in July, so it's going to be quite challenging in GB."

Looking across the English Channel, Morgan is more upbeat. Diageo saw spirits sales rise 6% in Europe - excluding Russia - during the first half. Moreover, Morgan says that "an awful lot of our market units are growing at 10, 20%".

Last year, Diageo merged its hubs in northern and southern Europe and created a single business unit, based in Paris, for the continent. The move seems to be paying off.

Continental Europe - a business unit that does not include Iberia or Russia - has now just about overtaken GB in sales terms as the largest segment within the European division. Morgan points to strong growth in a number of countries, including Greece, Poland and, notably, Italy, where a number of drinks multinationals - including Campari, Pernod Ricard and Carlsberg - have reported problems.

"We are managing in continental Europe to meet the premiumisation trends that are occurring there," Morgan says. "There seems to be, in markets like Germany and Italy and France and Benelux, every readiness in consumers to pay more for quality and great brands."

Spain, however, remains problematic for Diageo. The company said sales in Iberia - which also covers Portugal and the Canary Islands - were down 3%, due to an identical decline in the Spanish spirits market as a whole. Morgan says: "Spain is not the spirits market that it was. Again, the on-premise was down and Scotch declined about 5% or 6% last year. I'm looking in Spain to get more price discipline and get a better channel mix in terms of our profitability going forward."

Diageo deserves credit for its performance on the continent after recent warnings of "subdued" European markets. A crucial task now is to drive profits in Europe to help match growth elsewhere around the world. Morgan remains upbeat about the company's prospects. "In the medium term, we will look to grow the bottom line in Europe and I'm confident we can."