Frost: We need to make Scotch ‘durable’ in China

David Frost, CEO of the Scotch Whisky Association, speaks to Becky Paskin about the category’s future in Asia.

David Frost says that although Scotch has been impacted by China’s slowdown, producers should seek durability

Ask a diplomat a question and you’ll get a diplomatic answer. After all, you wouldn’t expect anything less from a man who spent 25 years with the British Foreign and Commonwealth Office, most recently as Britain’s most senior trade policy official within the Department for Business, Innovation and Skills.

But for all his cautious fence-sitting over Scotland’s independence referendum and reluctance to divulge his whisky preference – “which I choose depends on the circumstances and my mood”, he says – David Frost, incoming CEO of the Scotch Whisky Association (SWA), is the ideal man to fight for the Scotch industry’s future.

Frost joined the SWA in January this year following the departure of Gavin Hewitt, who oversaw a decade of global growth and increased investment in the industry. After spending most of his career with the FCO, Frost’s interest was piqued by the opportunity to make a real difference. “I wanted a change of direction,” he explains. “Working in government is often fascinating but can be frustrating – as a civil servant you are always advising others, and never acting yourself. I wanted to work in an environment where I could use my knowledge more directly to the commercial and economic benefit of the UK – which this job certainly does.”

His experience working in foreign trade policy gives Frost an advantage in his battle to tear down some of the formal and informal barriers to the category’s growth, particularly in those emerging markets that present high yet untapped potential.

Trade barriers

“As 90% of Scotch whisky is exported, the biggest difficulty is that most markets have trade barriers of some kind,” he says. “Less so in the EU because we benefit from a single market, but elsewhere there are changing rules and regulations to deal with. If we can get rid of some of these barriers it will make for a real difference. Specifically it’s in places like India where both the potential market and the difficulties of doing business there are so great; if we can get rid of some of these barriers it will make for a real difference.”

The largest issue in India, for Scotch and all international spirits, is the government’s ball-breaking 150% import tariff on wines and spirits, a long-running problem that’s been painstakingly negotiated as part of the India-EU free trade agreement (FTA) for the past seven years. While lowering the tariff would make imported spirits much more affordable to Indian consumers, the government is concerned sales of domestically-produced wines and spirits will falter. According to reports, the most recent offer made by India was to slash the duty rate to 40%, but Frost is hungry for more.

“We’d like to see a 0% tariff,” he insists, adding that some other countries around the world, such as the EU, US and Taiwan, charge no import duty for Scotch. “That said, we always have to be realistic about the glide path, and a tariff that does not massively distort the economic decisions that companies make is where we’d like it to be.”

While India’s high import tariff limits the prospects of Scotch in the region, Frost says other markets in Asia are “pretty good”

Prospects in India

But despite the regulatory hurdle, Scotch whisky is enjoying solid growth in the country, with exports up 11.5% by volume and 4% by value during 2013. There is clearly already strong demand driven predominantly by India’s rapidly emerging middle classes. “Even despite the 150% customs tariff, high levels of excise duty in some states, the preference for local products in parts of India and the regulatory complexities in different states, Scotch is still growing by double-digit figures,” Frost says. “Imagine what we could do if these barriers weren’t there?” Frost believes a 0% tariff is “extremely realistic” once FTA negotiations resume following the Indian government and EU Parliamentary elections this month.

Elsewhere, one particular market causing a different kind of stir among Scotch producers is China, where volume declined by almost 30% to £51 million last year, dropping the market out of the SWA’s top 20 export destinations. While Frost attributes the severe drop in part to “the spike slowdown in growth”, he agrees the results are “to a large extent due to the restrictions on gift giving and general austerity measures in government”. The policies are clearly having an effect on both Cognac and Scotch volumes, with the most aspirational brands hit hardest, leading many to ask just how long will the China catastrophe last? “It’s hard to tell, you have to be an expert in Chinese policy to give a clear answer to that,” Frost says, before bleakly adding, “it’s gone on longer than most of us thought.”

Need to broaden out in China

So does he have any advice to impart? “One thing this situation is illustrating is that over time we need to broaden out the market in China. In the long run we need to get beyond our reliance on gift giving and distribution in nightclubs, as we have done elsewhere in Asia. We need to make the category a bit more durable and that’s what our member companies have in mind, but it takes time to do that. There’s no question the middle class in China is growing massively – this is going to be a growth market – but you’ll see fluctuations around spend for a bit.”

In the meantime, Frost sees the overall prospects in Asia as “pretty good”, despite value declines of between 3-15% in almost all priority markets, including Singapore, Taiwan, Japan and South Korea. “Taiwan is interesting because they have grown so quickly in the last decade or so, and although our figures show exports to Taiwan have fallen, we understand through people in the market that the deliveries have actually risen,” he explains. “There is actually a hub effect going on here, and the prospects in Taiwan, and other South East Asian markets remain pretty good.”

“Pretty good”, however, pales in comparison to the 19-38% growth rates from a handful of emerging markets in Eastern Europe and Latin America, and off strong bases too. Their expanding middle classes are developing a penchant for western brands, and with minimal barriers to trade, Scotch is thriving in countries like Poland, Brazil and Mexico, even becoming one of the biggest British exports to the latter.

Frost has identified Africa as an important region for growth in the Scotch industry

Africa is emerging priority

“We’re simply seeing what you’d expect in an emerging market where the middle class is growing. All things being equal you’d expect to see the Scotch imports mounting and that’s what’s happening now.” In Latin America particularly, Frost is also excited in anticipation of the effect the new FTA between the EU, Colombia and Peru will have on Scotch volumes come the end of 2014. “The prospects are looking good, from relatively low levels,” he remarks.

But one region with a developing middle class and long history of British trade that is absent from the SWA’s top 20 export markets, is Africa. Although the mature market of South Africa appears as the sixth largest for Scotch by value, generating £163.5m for the industry, Frost views the remainder of the continent as an emerging priority for the category. “We identified Africa as a growth region a couple of years ago,” he says. “The region has had a long enough period of stability and growth that we’re beginning to see an emerging middle class in parts. In Nigeria and Kenya last year, exports were still at quite low levels but growing really fast at 42% and 62%, so of course we’d like to get onto that.”

One slight difference in the region – call it an advantage if you will – is that Britain is still the leading European exporter to much of Africa, a position not necessarily enjoyed by the UK in Asia or Latin America. “Taking advantage of Britain’s presence is something we need to capitalise on in Africa while we still have it,” Frost declares, referring to the possibility that Scotland and the UK may part ways in the near future, depending on the outcome of the Scottish independence referendum on 18 September. A “Yes” vote would see Scotland become a separate entity from not only the UK, but the EU as well, with whom Scotch is registered as having a GI, until such time it can reapply for membership.

Question of independence

Currently, the Scotch industry benefits from international trade promotion by over 200 foreign British embassies around the world, but should Scotland become independent, the number would drop to just 70. “We’d like to understand a bit more about how the Scottish government could do the same job as a network of 200,” Frost says. “If there were to be a ‘Yes’ vote I’m sure we’d work extremely closely with the Scottish authorities to continue being successful, but at the moment we see several risks because it’s a change of status.” Despite the question marks hanging over Scotch’s future as a British product, Frost says the category’s global development “will continue for many years yet”.

“Scotch’s success is driven by growth overseas, mainly in emerging markets, and as the middle class in those countries expands, so will demand for Scotch,” he predicts. “There may well be fluctuations around a trend but we’re pretty confident that trend will continue upwards. Look at the huge sums being invested by the industry – £2bn over the next few years – it’s clear they are confident too.”