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Diageo Fires Back in the Next Round of the Whiskey Wars

http://www.fool.com/investing/general/2014/03/26/diageo-fires-back-in-the-next-round-of-the-whiskey.aspx

Brian Shaw
March 26, 2014

Brown-Forman (NYSE: BF-B), owner of the Jack Daniels brand of Tennessee whiskey, is hoping to maintain the recently imposed state government requirements for what beverages can be labeled "Tennessee whiskey." The rules are quite specific, including the requirements that the mash be comprised of at least 51 percent corn, aged in new charred oaks barrels, filtered through maple charcoal, and bottled at a minimum of 80 proof. Given this support of the existing law, it should be a surprise to no one that this is the exact process that Jack Daniels has used for years to grow its brand to over 11 million cases in 2013.

Upon further consideration, lawmakers are starting to question whether these requirements are too restrictive.  In particular, there are questions regarding the requirement to use new barrels, which can cost around $600 per barrel as noted by state Representative Bill Sanderson; this added cost can restrict entrepreneurs from launching new brands of Tennessee whiskey.  

 A recent decision has been made by Tennessee House and Senate committees to postpone the review of the law until the summer, making changes to the current restrictions unlikely for another year. Meanwhile, Brown-Forman sees a different reason behind the upcoming the pressure to review the law this summer: lobbying from global spirits giant Diageo (NYSE: DEO)

A war or words
Brown-Forman has been vocal in its attempts to protect the law that gives Tennessee whiskey legal protection against new competitors. Jeff Arnett, the master distiller at the Jack Daniel's distillery in Lynchburg, Tennessee is not shy about his opinion on the potential dilution of the law:

"It's really more to weaken a title on a label that we've worked very hard for... As a state, I don't think Tennessee should be bashful about being protective of Tennessee whiskey over, say, bourbon or scotch or any of the other products that we compete with."

Given the direct linkage that Brown-Forman has made to Diageo in this effort to weaken the meaning of "Tennessee whiskey," Diageo was of course compelled to respond. In a forceful press release, Diageo referred to Brown-Forman as "anti-competitive" and "protectionist" while emphasizing its support of a "return to flexibility, innovation and entrepreneurship." As a final shot at Brown-Forman, Diageo turned the logic that new barrels are required for premium whiskey against Brown-Forman by reminding the world that Brown-Forman's Early Times brand does in fact use previously used barrels.

Aside from monitoring the back and forth of this soap opera, there really aren't any valid reasons for this restrictive law other than the corporate interests of Brown-Forman and other distillers that plan to meet the state's current requirements and hope to keep competitors out. 

Competitive environment
Perhaps more importantly, the changes to this law aren't likely to have a profound impact on the current competitive environment. Amongst Tennessee whiskey distillers, Diageo's George Dickel brand is in a distant second place, with roughly one percent of the case volume of Jack Daniels.

So what is this war of words really all about? In reality, the real objective for Brown-Forman in the process of getting the law passed last year and defending it today is the hope to market a more-exclusive "Tennessee whiskey" label as a premium product. This has little to do with Jack Daniels vs. George Dickel, and everything to do with the positioning of Jack Daniels within a spectrum of brands in an industry that has been seeing strong growth at the higher end in recent years. 

The ability for Brown-Forman to market Jack Daniels as a premium product is an important aspect of the fight for market share with Beam's (NYSE: BEAM) Jim Beam bourbons. During the company's most recent earnings release, Brown-Forman credited its strong performance on the strength of the Jack Daniels brand, which grew sales 10% over the previous year; the company hopes to continue this success by emphasizing the premium nature of the Tennessee whiskey label.

While the fourth quarter was solid for Brown-Forman, the company is trying to solidify its competitive position due to the fact that it is competing with larger companies including Diageo and Pernod-Ricard. Following the recently approved acquisition of Beam by Suntory,