Brand cocktail

Diageo’s merger of its UDV spirits and wine operation with Guinness is driven by a belief that drinking habits are changing to focus on brands rather than product types. But the strategy change is a risk, mixing two previously incompatible mar

The consequences of mixing the grape and the grain are well known to drinkers the world over. But the prospect of a nasty hangover has not prevented global giant Diageo from merging its UDV spirits and wine operation with Guinness to create the world’s largest branded drinks group.

The architect of the move, Diageo chief executive John McGrath, is so confident of its success that he is handing over control to former Pillsbury chief executive Paul Walsh four months earlier than expected.

But Walsh and his new global management team will have their work cut out convincing investors that the merger makes sense, despite claims that it will save £130m a year in management costs.

One City analyst says: “There is little enthusiasm for this merger. Spirits and beer are completely different markets. Spirits are low volume and high margin, while beer is the exact opposite.”

Since Guinness and Grand Metropolitan merged three years ago to form Diageo, the company has struggled to convince investors that there are significant synergies to be had from housing Burger King and Pillsbury under the same roof as Guinness and UDV.

Earlier this month, against a backdrop of flat sales in the US, Diageo admitted defeat and announced the £7bn sale of Pillsbury to rival General Mills and set in motion the divestment of Burger King.

Walsh, who will take over the reins at Diageo in September, has attempted to square the circle of the widely differing beer and spirits market by referring to changing tastes and market conditions. “People are making choices based on occasion, not product type. They are thinking less of beer, wines and spirits. Rather, they are reaching for brands.”

The new focus on brand-led marketing – and the anticipated bias towards UDV – is reflected in Walsh’s choice of Rob Malcolm as president of global marketing, sales and innovation for Guinness UDV (MW last week).

Malcolm joined UDV last year from Procter & Gamble, where he helped launch Sunny Delight in Europe. He was appointed to the top marketing role in the new company ahead of seasoned spirits marketer Colin Fell, head of global marketing at Guinness.

Kevin Baker, of global drinks analysts Canadean, believes Diageo’s strategy will signal a change in the way companies approach the alcoholic drinks market.

“Diageo is ahead of the game. Consumers are increasingly selecting a drink from a much wider repertoire of alcoholic beverages for any given drinking occasion,” Baker says.

“Consumer choice is no longer simply between a Budweiser or a Holsten Pils.

“These brands compete not only with each other, but also with Martini Metz, Hooper’s Hooch, Bacardi Breezer or Red Bull and Vodka. These drinks compete for the same drinkers and the same drinking occasion.”

Baker expects Diageo to seek further beer acquisitions to bolster its portfolio. “It is likely to look at other bottled beers. Grolsch would fit nicely as a premium product. It wouldn’t necessarily want anything too mass market.”

The launch late last year of Guinness Draught in a Bottle, which is specifically designed to capture the “high value adult drinking occasions”, so successfully exploited by Smirnoff Ice, offers a clue to UDV Guinness’ direction.

But for many observers there is a question mark over Guinness’ suitability as a platform for youth-oriented brand extensions. And any talk of the brand as being just another “ready-to-drink beverage” is certain to have purists weeping into their stout.

“The black stuff” has always performed well in Ireland, the US and the UK but is little more than a niche product in many other markets, despite attempts to export Irish pubs – lock, stock and bar staff – to far-flung locations.

But it remains a unique product. Even Guinness marketers believe it takes customers at least three samples to acquire the taste.

If Guinness didn’t exist, it is unlikely any modern marketing department would invent it. One insider says: “Guinness has a particular culture. It is run, essentially, by Guinness zealots. The commitment to quality on the ground is legendary.

“The big question, for Diageo, is how to retain that focus, when Guinness becomes just one of eight brands.”

UDV, with 17,000 employees worldwide and an operating profit last year of £967m on a turnover of £4.9bn, is likely to dominate the new company. By comparison, Guinness has 13,000 employees and recorded an operating profit last year of £273m, on a turnover of £2.2bn.

Each tier of management in the new company is likely to be selected by their immediate superiors, pitting Guinness people against their UDV opposite numbers.

An industry observer says: “Morale must be rock-bottom at Guinness at the moment. Diageo is talking about getting its strategy together before it begins acquiring more spirits brands. But there is a danger it will take its eye off Guinness.

UDV domination

“The organisation is likely to be dominated by senior UDV people, because Guinness is never going to be a truly global brand. It could well lose the passion and commitment which has driven it for decades.”

However, another former Guinness insider believes the merger makes sense and is long overdue. “When Guinness bought Bell’s and then United Distillers, the beer and the spirits businesses were always kept apart.

“There are potentially massive sales synergies. The number of sales points are much less than they were ten or 15 years ago. In the pub trade and in the take-home trade, you are selling to far fewer points of negotiation,” he says.

Under the new regime, management will focus on four major markets – the US, UK, Spain and Ireland – which together deliver 60 per cent of Diageo’s operating profit from alcohol.

It will concentrate its considerable marketing muscle on eight global priority brands – Johnnie Walker, Baileys, Smirnoff, J&B, Cuervo, Tanqueray, Malibu and Guinness.

Diageo is prepared to plough unprecedented amounts of cash into marketing its core brands – this year’s £100m global Johnnie Walker campaign makes it one of the most heavily advertised consumer products in the world.

Global spirits growth

Finance house Merrill Lynch believes the prospects for growth in the global spirits market are the best for a decade, with category leaders such as Johnnie Walker and Smirnoff stealing market share from second place brands.

But food and drinks brands remain out of favour with investors. Diageo’s top brands performed poorly in Interbrand’s recent survey of brand values, with Johnnie Walker dropping from 55th place to 67th, losing six per cent in value, to £1.5bn.

Smirnoff also dropped down the rankings from 51st to 62nd, despite gaining six per cent in value, to settle at £2.4bn. Meanwhile, Guinness fell from 59th to 73rd place, losing three per cent of its value.

A lot will hinge on the battle for Seagram’s spirits portfolio, which is likely to come down to a straight fight between Diageo and Allied Domecq.

UDV already holds 23 per cent of the market share by value – more than double its nearest competitor, Allied. Yet if it is able to scoop up some of Seagram’s key brands, such as Martell Cognac or Chivas Regal, it could achieve total dominance of the global spirits market.

But even without the extra clout of the Seagram brands, Diageo’s rebirth as the world’s largest beer, wine and spirits group will be enough to give its rivals sleepless nights.

Speculation about the future of Diageo’s food divisions – Pillsbury and fast-food chain Burger King – has been mounting since the group’s interim results in February.

Diageo reported a fall in half-year profits from £972m to £755m in the six months to December 1999 on sales of £6.6bn.

At the time, incoming chief executive Paul Walsh claimed Pillsbury and Burger King were an integral part of Diageo and would be retained. But the group has acted quickly to set the wheels in motion to sell both companies within three years.

Pillsbury – with brands including Haägen-Dazs ice cream, the Old El Paso Mexican range and Green Giant – has long been viewed by analysts as an unprofitable millstone around Diageo’s neck.

The company has lost patience with Pillsbury’s poor performance in the low-growth US food sector and is selling two-thirds of the business to US giant General Mills.

General Mills Рwhich has interests in Europe, including a joint venture with Nestl̩ to make products such as Shredded Wheat under the Cereal Partners banner Рhas bought Pillsbury for $10.5bn. Diageo will initially retain 33 per cent of the new company, but is expected to offload those shares within two years.

Burger King made a profit of £185m last year, but observers say Diageo’s decision to float 20 per cent of the business on the New York Stock Exchange now, and the rest by 2003, is overdue.

Analysts say the chain would have been hived off in one go, but for outstanding tax liabilities from the merger of Guinness and GrandMet.

Recent departures by senior Burger King figures suggest the writing has been on the wall for a while. Chief executive Dennis Malamatinas quit suddenly in June to take up a post at online travel service Priceline.com, the US online retailer of cut-price goods.

Diageo said Malamatinas wants to spend more time in the UK. He will be responsible for bringing Priceline to European markets.

Burger King North American president Paul Clayton left the company in January to become chief executive of natural fruit juice and soup chain Jamba Juice.

Burger King UK and Ireland marketing director Lorraine Thomson has also quit, to join Internet portal Excite Europe as marketing director (MW June 22).

Malamatinas’ shoes are being filled by Guinness head Colin Storm until a permanent replacement is found, while Burger King has yet to appoint successors to Clayton and Thomson.

Ian McCawley

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