Will China’s gifting clampdown damage international spirit sales?

Distillers’ jangling nerves have temporarily dampened the sound of clinking glasses in China, but no one is taking their eyes off the long-term prize.

The future looks bright for international spirits in China

Did you really think it would be that simple? Like all the best films, China’s plot is twisting like an Olympic contortionist in 2013, faced with a slowing economy and the well publicised government clampdown on ‘gift giving’ and hedonistic banqueting by officials.

High-end local baijiu players Moutai and Wuliangye have seen their stock price tumble. Pernod Ricard has raised some concern about slowing Scotch sales, and even the Cognac surge has softened.

But don’t be fooled by those relishing the prospect of an alternative ending to China’s story. Sales of imported spirits are still growing. Longer-term, Chinese consumers appear willing to expand their repertoires, and distillers remain committed to extending their reach in the country.

Emerging categories are beginning to chip away at the duopoly of blended Scotch and Cognac. “We know there’s a slowdown, but we are seeing double-digit growth in the single malt category,” says James Maxwell, regional director for Asia at Pernod Ricard’s Chivas Brothers.

Single malt minority

The group, which is enjoying success across Asia with The Glenlivet, estimates China’s market for single malt Scotch is a relatively tiny 75,000 cases, but expanding by 15% year on year. It’s notable that a relatively new arrival on the scene, Beam Inc, singles out Laphroaig single malt as a key growth brand there.

“Chinese consumers like to stand out from the crowd,” says Maxwell. It’s easy to get kudos “if you can drink something not seen or heard of before”.

He says that duty-free, in particular, is helping to showcase new drinks. “Chinese people are travelling more, and not just in the region. Those that are travelling are being exposed to a wider variety of brands and the younger generation are often Western-educated”.

Combine this inquisitiveness with a burgeoning middle class that, according to McKinsey analysts, will mean private consumption of goods contributes 51% of China’s GDP growth by 2030, up from 27% in 2010, and the scene is set for distillers to flourish.

That said, it’s still early days. International spirits only account for 2% of the overall market by volume. Diageo’s MD for Greater China, Joseph Tcheng, points out that vodka, for instance, is only 5% of international spirits volumes in China, and sales are only rising in low single digits. “We are seeding our vodka portfolio of Smirnoff, Ketel One and Cîroc in the modern on-trade,” says Tcheng.

If vodka has some yards to make up, spare a thought for gin. “We’ve done well with Beefeater 24, which really dials up botanicals from the region, such as Chinese green tea,” says Maxwell. “[But] ultimately, we’ll have a more difficult time in China with gin.”

China’s growing cocktail culture is providing an entry point for international brands

Tequila opportunity
There is greater excitement around Tequila, albeit the market is only equivalent to 28,000 nine-litre cases, according to Euromonitor. “Tequila is a mixable drink that goes with anything and the Sauza brand can easily appeal to the local consumers,” says Beam Inc’s country manager for China and Hong Kong, Ivan Ong. John McDonnell, international president and group COO at Patrón Spirits, says he sees “significant potential” for high-quality, 100% agave Tequilas among well-travelled and affluent Chinese consumers.

“The demand is most definitely there,” he says, but adds that distillers should be prepared to play a long game in China. He is doing just that with the Patrón XO Cafe brand. “We’ve introduced a completely new spirit into a predominantly brown [imported] spirit market, and we know it will take some time to build. This isn’t a volume play.”

More generally, a fledgling cocktail culture in hotel bars from Shanghai to Shenzhen offers a route into China for several spirits brands. “In tier one and two cities, the bar scene is becoming ultra sophisticated,” Maxwell says. “Unless you’ve got a blow torch, you’re not a molecular barman.”

Distribution frameworks
Growing numbers of smaller industry players see opportunities amid the conspicuous affluence of the biggest cities. “It’s an obvious market for any spirits company,” says George Rowley, MD of La Fee absinthe owner BBH Spirits. “If we can crack it, we’ll get some space before people tunnel in behind,” he says, having begun shipments of absinthe to the country via De Vere Fine Wines & Spirits, which also distributes Chase vodka. “Our primary market is cocktails,” he adds.

Distribution is perhaps the most pressing concern in China for all players. It’s tough for the little guys, says Rowley. “The big companies own the gateways. We don’t have the advantages of multinationals. You have to trust a lot in who you meet and what they say they’ll do.”

For larger distillers, the distribution challenge is about penetrating so-called tier three and four cities. “Moët Hennessy Diageo has continued to expand its sales force and now covers over 100 cities in China including lower tier cities,” says Tcheng.

Pernod Ricard, meanwhile, has “solid distribution” in 110 of the approximately 170 Chinese cities housing more than one million people. Shipping the spirit is only half the battle in smaller cities, however. “There’s still a huge amount of education to be done,” says Maxwell. “Some research suggests consumers struggle to tell the difference between a Scotch whisky, an Irish whiskey and even a Cognac.”

Consumer education of spirits is proving tricky in China’s on-trade

Clearer whisky descriptors
At legislative level, the Scotch Whisky Association is seeking to follow-up a Geographical Indication for Scotch in China by lobbying for tighter rules on what constitutes generic whisky, including a ban on adding flavourings. Some argue consumer education is made harder by the retail landscape. “Most foreign spirits are still glugged in nightclubs and bars, which is rarely conducive to appreciating the subtle aromas of a top single malt,” says Johnny Roberts, regional director for Asia at Berry Bros & Rudd Spirits.

In the off-trade, meanwhile, he adds: “It’s a shame that you don’t really have an independent retail channel in China. In Singapore or Hong Kong, there’re more family-run stores that have more of a vested interest [in selling high quality spirits and educating consumers].”

Looking ahead, ecommerce is clearly a channel all consumer goods firms must consider, with China’s overall online retail sales rising by 66% in 2012 to RMB1.3 trillion (£125bn), according to China Internet Network Information Center. Maxwell also says home consumption is flashing brighter on Chivas Brothers’ radar.

The meal occasion
For Berry Bros’ Roberts, though, a key question remains: “How much will international brands break into the Chinese restaurants?” Both Diageo and Pernod Ricard want more Scotch in this channel, currently the preserve of baijiu, beer and a splash of Cognac.

Diageo’s Tcheng believes the firm’s control of baijiu maker Shui Jing Fang might offer inroads in the “meal occasion” over the longer term, even if “we do not see much synergy in terms of distribution at present”.

Some believe imported spirits may get an opportunity as baijiu bears the brunt of a government banquet ban, although Deutsche Bank analysts warn that Western spirits cannot avoid being “caught in the crossfire” and that visibility is extremely low.

In general, Euromonitor analysts see baijiu as the old-man drink of China. Younger consumers would rather look west, they say. Concrete figures on baijiu are hard to find, but this trend may well lead to greater consolidation in the sector, with producers who remain increasingly looking to premiumise. One only has to look at cachaça in Brazil and vodka in Russia for potential precedents.

In the short term, international distillers are monitoring the austerity sub-plot in China intensively. Rémy Cointreau is most exposed, with 40% of group net sales from China, estimates Deutsche Bank, adding that the figure for Pernod Ricard is 10%, and Diageo 3%.

“China is still an emerging market, and it can be very volatile,” says Maxwell. “We’ve just got to brace ourselves for a little bit.”