Diageo (DEO -1.48%) is huge and it knows how to move distilled spirits all around the globe. Bourbon is growing at a record pace and is just barely tapping its global market potential. Diageo knows this and understands that its best opportunities for growth are in emerging spirits (Bourbon) and emerging markets (India). That's why it recently bought more of the Diageo of India, United Spirits, and why it plans to plunk down around $115 million to construct a 1.8 million proof gallon distillery and six barrel storage warehouses in Kentucky over the next three years.
One of Diageo's chief competitors, particularly in the world of American whiskies, is Brown-Forman (BF.A -1.57%) (BF.B -1.84%). At the end of 2013, it also announced plans to invest $100 million to expand its operations in Lynchburg, TN -- adding whiskey production and storage capabilities to meet the rising global demand for its flagship Jack Daniel's Tennessee Whiskey. The expansion will increase its capacity by 15 to 20%. Brown-Forman moved about 11 million cases of Jack Daniel's in 2013, while Diageo's top bourbon, Bulleit, only sold about 600,000 cases.
Diageo hopes to reach the one million case mark this year. Only a few bourbons or Tennessee whiskies reach this level each year, including Jack Daniel's and Jim Beam (6 million plus) at the multimillion mark. Only Evan Williams (Heaven Hill), Wild Turkey (Campari) and Maker's Mark (Suntory/Beam) sell between 1 to 1.4 million cases per year.
Investing for growth
Larry Schwarz, President, Diageo North America, stated that the "proposed investment in Shelby County, in the heart of Kentucky bourbon country, will cement our commitment to expanding our share of the American whiskey category." Basically, the American Whiskey category includes two kinds of whiskey, Bourbon and Tennessee Whiskey, which almost qualifies as bourbon except it's made in Tennessee (not Kentucky) and charcoal-mellowed.
In the press release, Diageo pointed to two trends that drove its investment decision. First, bourbon is growing faster than any other spirits category in the U.S. Its value climbed 14% over the last 52 weeks. Secondly, global demand for bourbon in the super-premium price segment increased by a compound annual growth rate of 24% over the last three years.
What's driving the growth
Diageo also pinpointed two areas that were creating momentum for bourbon -- "flavor innovations" and "consumer demand for premium brands with authenticity." Diageo has long positioned its best-selling bourbon, Bulleit, as an authentic craft bourbon. However, its marketing strategy -- detailed in a previous article -- has walked a fine line between its huge size and its positioning in the bourbon market as "authentic." Authenticity is usually a quality associated with smaller distilleries and breweries -- not the market leader.
Rankling bourbon enthusiasts
Days before Diageo's announcement, one of the most popular voices in the bourbon industry, Chuck Cowdery, started a scathing blog about Diageo with these words: "The way Diageo presents its 'Orphan Barrel' whiskeys is an insult to American whiskeys and the people who drink them."
Cowdery went on to lament the fact that Diageo isn't emphasizing the "interesting true histories" of some of its newer premium bourbons, but instead "made up a front company to sell them, coined some jokey names, and designed some retro-style packaging, all of which is silly and belittling to the ostensibly fine bourbon inside."
The he said something that made most bourbon enthusiasts cringe. He played the "flavored vodka" card, accusing Diageo of being a "scotch company treating American whiskey like flavored vodka." Ouch.
Diageo cares about growth, not bourbon
Could these remarks by bourbon enthusiasts derail Diageo's efforts to make greater inroads into the bourbon market? Possibly. Will they stop the company from growing its overall revenue and profit? It's very unlikely.
The truth is that Cowdery is right. Diageo is a scotch (Johnny Walker) and vodka (Smirnoff) company first and foremost, and a bourbon company (Bulleit) way on down the line. Johnny Walker is the top-selling Scotch in the world and Smirnoff is the best-selling premium vodka across the globe.
Scotch also represented 29% of Diageo's net sales in 2013 and vodka made up 12%. By comparison, the whiskey category, which also includes Canadian, Irish, and American whiskies, made up only 7%. Diageo does not include any American whiskeys in its "strategic brands," which it defines as "having broad consumer appeal across geographies" and comprise around two-thirds of Diageo's net sales.
It does include Canadian and Irish whiskies, so that tells you that American whiskies, like Bourbon, are way down the totem pole when it comes to Diageo's overall strategies. So while bourbon enthusiasts might be a little put off by Diageo's inauthenticity, this should not really affect its bottom line. In the end, Diageo's successful foray into North American whiskies will result from domination of new markets across the globe. That doesn't mean that it shouldn't be smarter about how it is perceived by bourbon enthusiasts, but this is not where Diageo generates most of its revenue or profit.
Bourbon fool or foolish investor
So all things considered, the new distillery is a small piece of the pie for Diageo and one that will not make or break the company. Diageo's goal is likely to sell enough Bulleit over time to bring it to the level of a "strategic brand," but that is a long-term concern -- maybe five to 10 years out. Bourbon is glaringly absent from its current vast portfolio and once you get past Jack Daniel's and Jim Beam, the global American whiskey market is wide open.
Also, the new distillery, at 1.8 million gallons, will be the smallest major producer distillery in Kentucky. So Diageo is not trying to hit a home run, it's simply trying to get on base with this move and position itself for the future if the boom in bourbon keeps building across the globe.
