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The Big Read
Drinks industry: Low spirits
From the Financial Times of Tue, 23 Dec 2014 19:03:19 GMT
Scott Sneddon, site operations manager at Diageo Plc's Glenkinchie distillery, poses for a photograph with a glass of single malt whisky in the company's ageing room in East Lothian, Scotland, on Tuesday, June 18, 2013. Diageo Chief Executive Officer Paul Walsh will step down in July, almost 13 years shaping the company into the world's largest distiller and hand over the reins to his chief operating officer Ivan Menezes. Photographer: Mike Wilkinson/Bloomberg *** Local Caption *** Scott Sneddon©Bloomberg

The Spotted Pig, a Michelin star gastropub in New York’s trendy west Village, is heaving. The walls, adorned with enough pig memorabilia to keep any farmer happy, hem in a lively after-work crowd. But it is not just the food that attracts the young drinkers to this part of Manhattan. Walker Chambliss, the bartender , says that whiskies and bourbons have become “extremely popular” in the city in the past few years.

“They [brown liquors] are being marketed towards a younger demographic of ‘hipsters,’” he says. “That’s why whiskey bars are such a big trend now, especially in Brooklyn.”

Brown spirits have seen something of a revival in the US over the past two years after falling out of fashion for more than a decade. And it is younger drinkers, mainly in their twenties, who are forcing that change. They, and the generation of millennials who will soon reach the legal drinking age, will shape new drinking habits and as a result the priorities for the industry in coming years.

But whether it be the bars of New York, London, Shanghai, Lagos or Moscow, the world’s biggest global spirits groups are finding they have to work harder to capture those new drinkers.

Despite improvement in the US market, it has been the toughest year in a decade for some of the biggest names in the $117bn global spirits business as growth in emerging markets stalled.

“After years of growth,” says Ivan Menezes, chief executive of Diageo, the world’s biggest distiller, “the industry is facing a number of wider economic challenges and tougher trading conditions in both emerging and more developed countries.”

Diageo, whose top brands include Johnnie Walker Scotch, Smirnoff vodka and Guinness, this year suffered its first fall in operating profits in nine years. While profits at rival Pernod Ricard, distiller of Absolut vodka and Chivas Regal Scotch, fell for the first time since 2008.

End of the party

Until last year, the international groups were partying in emerging markets where the thirst for branded spirits was in full swing. The world’s rising economies compensated for austerity-hit consumers in North America and Europe, who spent more time at home than in bars during the recession and traded down when they bought drinks.

Spirits chart

While emerging economies enjoyed high rates of economic growth, the greater wealth pushed more people into the middle class and minted fresh millionaires, keen to demonstrate their newfound status by buying more expensive drinks, usually western brands.

“In emerging markets, once annual income hit $6,000, the aspiration to drink Johnnie Walker comes in — it becomes an affordable luxury,” says Mr Menezes.

But that party came to an abrupt end in 2013, as economic growth slowed sharply in countries important to the drinks industry, including Brazil, Venezuela, Russia and China. The slowdown in China was compounded by a government clampdown on conspicuous consumption and corruption.

This meant state officials no longer dared be seen with $2,500 bottles of ultra-premium cognac like Louis XIII. Rémy Cointreau, which makes the cognac and is the most heavily-dependent on China of the global drinks groups, saw its profits fall by almost half in the financial year to the end of March.

With these emerging markets no longer enjoying the same degree of economic growth and continued stagnation in Europe, the only bright spot in 2014 has been North America. “The US is the emerging market right now based on what’s going on in the world,” says Larry Schwartz, North America president at Diageo.

Despite its maturity, the US remains the world’s most profitable spirits market accounting for 7 per cent of global drinks sales, but 21 per cent of profits. Its resurgence means distillers are renewing their focus on the continent.

“Although the US is mature, the population, especially of Hispanics, is growing, per capita alcohol consumption is creeping up and long-term premiumisation trends are strong,” says Trevor Stirling, analyst at Bernstein Research.

“Premiumisation” is a clunky term but it has become the most important word in the lexicon of spirits businesses. The name of the game is to increase profits by persuading consumers to fill their glasses with more expensive alcohol each time they drink.

This is especially important in areas of the world where people are already drinking relatively large amounts, such as Europe, and where health and social welfare concerns militate against selling more volume.

The US’ size and profitability mean that trends there travel out to other regions — as the craft beer movement has shown, where the growth of microbreweries has taken market share off the big brewers. That trend has been replicated in Europe, with speciality and craft beers the fastest-growing segment of the market.

Vodka shot

The resurgence of whiskey in the US has come at the expense of mainstream vodka, though it remains the most popular spirit, accounting for one in three drinks against one in four for whiskey. (Whiskey made in the US and Ireland is spelt thus, but it is always Scotch whisky — as in the film, Whisky Galore.)

Spirits chart

The biggest vodka brands are also suffering as a result of a proliferation of newcomers to the market, such as Tito’s, an artisanal brand that has now reached industrial scale.

Sales of both Pernod’s Absolut and Diageo’s Smirnoff fell in the financial year ending in June 2014. Pierre Pringuet, Pernod’s chief executive, says: “There are several hundred new entrants into the market, 99 per cent will not survive, but the problem is, they do take market share.”

For the first time in two decades, sales of whiskies outpaced those of vodka in the US in 2013, growing by 4.5 per cent, while vodka grew by 2.7 per cent, according to Bernstein Research.

It may seem surprising that a drink favoured by a millennial’s grandad should have become trendy. But as Alexander Smith, editor of International Wine and Spirits Research magazine, says: “The next generation want to differentiate themselves from their parents and baby boomers [in the US] have been drinking vodka and beer. They are almost inspired by nostalgia for their grandfathers’ generation, particularly with the revival of the classic cocktails in popular television shows hailing back to that period.”

The fastest-growing whiskies are American: Kentucky bourbons — such as Jim Beam and Maker’s Mark — and Tennessee whiskey, including Jack Daniel’s, as well as Irish whiskey, dominated by Pernod’s Jameson. American whiskies account for about half the volumes sold in the US, Scotch is 17 per cent and Irish whiskey is small, with 5 per cent.

They have followed vodka in using flavours for a broader appeal that has also drawn in women drinkers. Jack Daniel’s Tennessee Honey, this year became the first flavoured whiskey to sell 1m cases only three years after its launch in 2011.

The company hopes to replicate that success with the launch this year of cinnamon-flavoured Tennessee Fire, one of a number of labels spawned by the huge success of family-owned Sazerac’s Fireball, which has grown from 50,000 cases to 2m in five years.

Scotch has also benefited in the US from “premiumisation” as a result of increased demand for single malts and high quality blends. But volume growth has been less spectacular relative to American whiskies, mainly because flavours are not allowed under the definition of Scotch.

David Frost, chief executive of the Scotch Whisky Association, the Edinburgh-based industry body, says: “The whole point of Scotch is that it has gone through a rigorous process and it doesn’t have a flavour mixed in with it.”

Some Scotch brands have exploited a loophole that allows them to add flavours but only if they call the alcohol a “spirit drink”.

Pernod Ricard ventured into this for the first time this year with its Ballantine’s Brasil drink which is a mixture of its scotch and lime peel, which it promotes as representing “a fusion of the traditions of Scotland with the passion of Brazil”. Laurent Lacassagne, chief executive of Chivas Brothers — Pernod’s Scotch whisky business — says there is a balance to be struck between appealing to new consumers while avoiding the risk of compromising the core Ballantine’s Scotch brand.

“Flavours in spirit drinks will open whiskey brands up to a different type of consumer, such as women, as well as appealing to a new generation,” he says. “But we have to do it in a very premium way in order to uphold the high quality credentials of our brands.”

One reason for the caution is that the proliferation of flavoured vodkas, though instrumental to the spirit’s rapid growth, is now blamed for its slowdown.

Bacon, bison grass and bubblegum flavoured vodkas were rounds that some drinkers were happy to miss.

So far whiskey producers have been restrained. “Arguably flavours might eventually hurt whiskey and the segment could fall into the vodka trap of flavour proliferation,” says Mr Stirling.

Tony Conigliaro, owner of The bar with No Name in London’s Islington district, has built a drinks lab in his establishment to produce new concoctions.

The award-winning bartender and mixologist notes a changing nature in the new generation of drinkers. “People are more likely to be adventurous in what they drink, which is why the scene is so much more sophisticated now compared to the early 1990s.”

Even spirits that had been “lowly in stature”, such as tequila and pisco are now in demand. “We are getting better quality esoteric ingredients. There has also been a massive resurgence of gin over the past few years because many of the classic drinks used it, especially in the prohibition era. Now people are looking back and trying them out.”

Disloyal

The downside in mature markets of such experimentation is that having converted a consumer to a brand, their loyalty can no longer be taken for granted as in the past when people tended to stick with a label.

“Consumers are drinking from a wide repertoire — we know the days of drinking Johnnie Walker for life are over,” says Mr Menezes. “Our goal is to make sure that Johnnie Walker figures in the top two or three drinks you’d think of.“

This is less of a problem in emerging markets where rising populations provide a natural source of growth as more people cross the legal drinking age. Here the goal is to get people to switch from local drinks to global brands.

New products are also essential to maintain interest and celebrity association is a big draw. Diageo this year launched Haig Club whisky in a partnership with retired footballer David Beckham. Though it has a $60 a bottle price tag, it is aimed at younger drinkers with an appeal also to women and China as key target markets.

Mr Menezes says: “The holy grail is getting spirits drunk with meals. If The Haig Club is successful with meals in China, it will take away from cognac and [the Chinese spirit] baiju.”

There are signs that next year will be better. Mr Pringuet says: “We now expect a gradual improvement in China.”

The big distillers will be making a toast to that.

Additional reporting by Anna Nicolaou in New York



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