Continental Restructure Keeps Diageo’s Spirits High

Diageo is heading into the second half of 2015 in proactive mood after a summer period of restructurings, partnership changes, regional drives and corporate social responsibility efforts.

The London-headquartered, global alcoholic beverage manufacturer has long targeted emerging markets outside of its core European operation in which to grow the worldwide brand, with Africa - from its South African base - a pivotal facet of the Company’s recent successes.

Growing as a consequence of careful strategic and organic expansion, complemented by a series of significant global mergers and partnerships, the business - whose brands include Smirnoff, Guinness, Baileys and Johnnie Walker - is best known as being the world’s largest producer of spirits; a factor which has led to the Company’s most critical decision of the past three months.

The termination of Diageo PLC’s partnership with Heineken NV in South Africa was largely said to be as a result of the business’s strive for more control in what is becoming an increasingly lucrative southern African market.

While this is undoubtedly the case, the subsequent restructuring that is set to occur is also an indication of the growing spirit market share on the continent; outweighing a tougher battle for beer dominance among the likes of SABMiller and Anheuser-Busch InBev.

Flying solo in SA

In Africa, Diageo’s strategy has always been to saturate the market as much as possible with its globally prominent brands, accelerating the growth of the wider sector and securing its own sector dominance in the process.

Utilising local expertise across its operations, the reputation that the Company has formed has certainly paid dividends, making mergers such as the one with Heineken an appealing proposition for other global manufacturers looking to enter the region.

Diageo’s footprint in Africa further emphasises this attraction; bridging southern, eastern and western markets to cover all gateways from the surrounding European, North American and Middle Eastern admirers.

It is for these reasons that Heineken NV may be a little less satisfied by the premature breakup announced by Diageo PLC in July of this year, three years ahead of the previously agreed termination date in 2018.

“We now believe that Diageo has the necessary scale to move to the next stage of growth,” was the rallying cry of Chief Executive, Ivan Menezes, bringing to an end an 11-year relationship.

The logistics of the decision comprised the sale of its 42.25 percent stake in the holding of the Diageo-Heineken-Namibia Breweries (NBL) portfolio, selling a respective 15 and 25 percent stake in its Namibian and Gauteng breweries, but buying the remaining stake in the merger’s marketing unit.

 A sign that Diageo feels it can go it alone in Africa? Perhaps, but Jeff Milliken who will now run South Africa’s operations moving forward, has made no bones about the fact that Heineken’s focus on beer diverted attention away from where Diageo has always been most successful.

“We were feeling it's time to move to the next stage of growth where each of the JV partners can pursue their own commercial agendas independently; Diageo focusing on spirits...and Heineken and NBL on beer," he was quoted as saying at the time of the announcement.

When looking at the facts and figures it is not all too surprising, considering Diageo’s leading 40 percent market share in South Africa’s spirit industry, with the Company more than strong enough to sustain such prominence independently.

However, following more than 10 years of leveraging the capabilities of one of Europe’s leading producers, the significance that this decision symbolises may well have evident repercussions elsewhere on the continent, with the restructuring emanating into areas far beyond South Africa.

East African potential

Setting the tone in the south, it is arguably going to be the east that follows suit most proactively in reassessing its approach and driving more forcefully into the market.

The region specifically is one of Diageo’s top five global markets with liquor sales doubling over the past two years as a consequence of the Company’s adherence to local consumer trends and resources.

Known as the cheapest global brand in Kenya specifically, its name isn’t always hailed by local independent retailers, but that won’t phase a Company as reliant on the market as Diageo is.

While the wider Group’s year-on-year operating profits at the end of June reported a 0.8 percent fall, this was in the midst of a six percent rise in Africa, epitomising the significance that the continent has for the business at present.

This aligns with a general migration into Africa for the spirits industry which sees the region as a largely untouched market, open to the best - or cheapest - proposition.

In Kenya, Pernod Ricard SA is taking the fight to Diageo, labelling the continent as the new Asia, but the latter still holds a narrow lead virtue of its existing ownership of East African Breweries Limited (EABL).

The majority shareholding of EABL is currently the vehicle for Diageo’s second key area of focus in the region, earmarking Tanzania as a country yet to be perfected, following a 51 equity acquisition of Serengeti Breweries Limited in 2011.

“When the merger was granted we had expectations for business and market development,” Chief Executive Officer, Charles Ireland told Bloomberg Business at the end of July. “Four years down the line the market hasn’t developed as we expected. The business has taken longer to respond. The FCC thought we are under-investing, but we are really serious about the success of Serengeti.”

Amid an investigation from Tanzania’s Fair Competition Commission, Ireland continued: “The Tanzanian business will have a positive return at some point in the near future. We have made some modest capital investment in modernising the brewery and we are positive that the business will respond very well in 2016.”

Long-term growth

The key to any large mulitnational’s success in new and emerging markets is the ability to foster a local influence and feel to the company. By becoming a continent-wide enterprise, Diageo has achieved that; forming a potent combination with its already world-leading offering and its subsequent ability to drop prices where necessary.

In-keeping with local regulations and internal CSR initiatives however, the Company also continues to evolve the way in which it  creates wealth for the continent; embracing efficient production and packaging techniques where possible, enhancing access to clean water in surrounding communities via its pan-African Water of Life programme, and utilising local suppliers and personnel throughout its operations.

Being conducted primarily in the less mature eastern and western markets, peripheral activities like these are a clear mirroring of the way in which Diageo has expanded in the past, into the likes of North America, Latin America and the Caribbean, and is indicative once again of why the Company feels as confident as ever in its abilities to conquer Africa all by itself.

Over the past year, net sales have dropped across Europe and the three aforementioned - now emerged - markets, as well as in Asia Pacific. Meanwhile, African sales continue to soar; headed by its stronghold in South Africa and increasingly being complemented by its supporting cast to the east and west.

 “Our participation strategy is clear by market and category. We are focused on our core and have a more proactive approach to our portfolio,” Menezes said of the worldwide Group’s performance back in July. “We sold Gleneagles in the year, and since the year end, have sold the shares USL owned in United Breweries and we restructured our South African operations to focus on spirits and monetise investments worth £125 million.”

Jeremy Cunnington, senior alcoholic drinks analyst at Euromonitor International added in an interview with the drinks business: “While there have undoubtedly been errors in judgement such as slowness in developing a high-end bourbon, spirits is a long game and judgement should not be rushed.

“Short sighted solutions such as divesting its beer operations would only make the situation worse in the long-term by depriving Diageo of a major platform for long-term growth in Africa, which is potentially one of the most dynamic regions for spirits in the future.”

And it seems that Diageo agrees. With the south ticked off and projects in the east and west well underway, the Company’s assault on Africa will not only be welcomed with open arms by a parched and curious spirit consumer market, but may well continue to be Diageo PLC’s safety net in what would have otherwise been a calamitous past 12 months.