Scotch whisky industry in ‘prolonged slowdown’

With shipments down for the first time in a decade, Scotch whisky is facing strong headwinds, yet confidence remains high among producers.

Analysts have claimed the Scotch whisky industry is in the midst of a “prolonged slowdown”, but producers remain optimistic

*This article was initially printed in the November 2014 issue of The Spirits Business magazine

This month the world’s most famous footballer will be raising a toast to the Chinese. Images of David Beckham armed with a dram of Haig Club – Diageo’s single grain whisky in its blue, aftershave-like bottle – will be splashed across billboards, print and online to launch the new brand in China.

It comes at a difficult time for Scotch with Chinese imports down 35% in value in the first half of this year according to the Scotch Whisky Association (SWA). More significant has been the 46% collapse in shipments to Singapore – the spirit’s third most valuable foreign market and a key export hub for China. Euromonitor analyst, Spiros Malandrakis, talks of a perfect storm featuring China’s economic slowdown, the government purge on conspicuous consumption and moves to break alleged links between the on-trade and prostitution. “In my view we’re not looking at a very short-lived blip, but more of a prolonged slowdown,” he explains. While he believes growth will return to China, he says: “The slowdown will definitely endure longer than Diageo and Pernod have been saying.”

The contraction in China is mirrored by falls in the US, Germany, Mexico and Brazil, and offset by gains in Taiwan, India and the Gulf. Overall, the total value of Scotch exports fell 11% in the first half of 2014, and while it’s the worst drop since 1999, the SWA’s CEO, David Frost, shows no sign of panic.

Positive outlook

“The last time exports fell was 10 years ago. Since then they’ve doubled, so that’s the context we’re working in. The mood in the industry is still pretty buoyant to be honest, and our growth has tracked emerging market growth pretty constantly. As long as those markets continue to grow, we feel things are going to be good for us.”

As for China, he believes: “The austerity campaign perhaps lasted longer than many people thought. What we saw in the last year or two was a bit of a bubble based on very strong levels of gifting.” Instead of Royal Salute or deluxe expressions of Johnnie Walker, today’s politically correct gift is a caddy of vintage Chinese tea. So rather than chase what Malandrakis calls “Beijing’s burgeoning billionaires”, Scotch is having to become more mainstream, which is where Beckham comes in.

“Our goal with Haig Club is to build it into the at-home and in-meal occasion, and in parts of Southern China we’ll be going together with Shui Jing Fang on the distribution front,” said Ivan Menezes, Diageo’s CEO, while announcing the firm’s preliminary results in July – Shui Jing Fang being the troubled Baijiu brand it acquired during 2012. The country’s dominant spirit has been decimated by a price war and the austerity campaign at the top end, but Diageo believes it could be the key to unlocking the off-trade for Scotch whisky as consumers switch to international brands that have similar price points. Any volumes gained won’t compensate for the value lost through the anti-extravagance drive, at least in the short-term, but it may give Scotch a more solid base for the future.

David Beckham and Diageo’s Haig Club single grain Scotch whisky has helped push more mainstream brands in Asia

Twain is ‘bright spot’

Over in Taiwan, while volumes remained unchanged at 9m cases, value soared by 39% as consumers continue to trade up. As Chivas Bothers’ then commercial director, Paul Scanlon, told SB last May: “Blends have definitely slowed down significantly, with deluxe blends now in decline, however malts have grown exponentially in the last five to eight years.” Edrington has been a major benefactor through The Macallan – the country’s leading single malt by value. Gerry O’Donnell, the group’s corporate affairs director, calls Taiwan “a bright spot in Asia, where our brands are doing very well and prices are holding up.” Although he admits that The Macallan has suffered in China, it’s “not to the same magnitude as some of our competitors”. The most exposed is Pernod Ricard, whose Chinese sales have accounted for as much as 15% of the company’s profits.

Of course shipments and depletions are never quite the same, especially in markets with long distribution chains. The Singapore-based wholesalers who play a major role in distributing Scotch across China and South East Asia are notoriously sensitive to any bad news stories on the economy. Diageo has suffered significant de-stocking in the region which is one reason its sales to emerging markets dropped 2% in the year to June. The following month Menezes told investment analysts of his desire to create “a sell-out culture, particularly in the emerging markets.” As a result, monthly performance goals for those on the frontline will be based around depletions.

Mixed bag

Overall it’s a mixed picture in Asia with encouraging growth in Japan and news from the SWA that trade barriers may soon ease in Vietnam, offset by a volatile situation in Thailand. The great unknown remains in India, where shipments are growing despite punitive import tariffs of 150%. “We haven’t even scratched the surface of India, and there’s a temptation to say the same about Africa,” says Billy Walker, the former boss of Burn Stewart who now runs the Benriach Distillery Company. The self-styled “ultimate optimist”, says: “Some of the markets we’re now engaging with we could never have imagined 12 years ago. It’s almost that the only market that has a total barrier to entry is North Korea.”

That said, Scotch whisky is taxed beyond the reach of most Indian consumers thanks to their government’s protectionism. Efforts to level the playing field have currently stalled as part of wider negotiations on a Free Trade Agreement, but the SWA remains hopeful. “The domestic politics appear to be changing a bit with domestic producers now openly lobbying to cut the tariffs,” says Frost, who accepts there is a risk of local state taxes simply rising to plug any drop in the national levy. If the barriers do come down, then all bets are off for Scotland’s distilleries whose entire inventory could be drained in one giant Indian gulp.

Opinion is divided in the industry on the long-term prospects of flavoured American whiskey, but the category is certainly booming at the moment

Status symbol

Still, it’s unlikely to happen overnight. “If you look at penetration in some of the big emerging markets, in India it’s 1% of the market, Brazil around 2-3%, and Russia 5%, so there’s a long way to go,” says Frost. “People come into the middle classes and often use Scotch whisky as a kind of status symbol. When people have a bit more money they tend to reach for foreign brands, and Scotch whisky tends to be the best-known foreign spirit.” While that may be true in broad terms, there is talk of some ambivalence towards Western brands in parts of Latin America. Yet Dr Nick Morgan, Diageo’s head of whisky outreach, insists otherwise. “In those economies where there is a significant rise in GDP in the emerging middle class, Scotch whisky is something that people do look to as an aspirational sign that they’ve arrived at a different stage of their lives.”

Moving to the States – the category’s most valuable market by some distance, shipments fell 12% in volume and 16% in value in the first six months of 2014. “To be honest we’re not totally sure why,” says Frost. “And to be equally honest we’re not really worried because the fundamental drivers seem so strong. The attractiveness of the category in recent years, the strong interest in malts, the premiumisation in the US – none of that seems to have changed.”

While mainstream blends face ever fiercer competition from Irish and American whiskeys, Morgan believes there is still plenty of space for growth. “Penetration of spirits in the US is still relatively low against the adult drinking population,” he says, adding that the likes of Jameson’s and Jack Daniel’s may be aimed at a different demographic. “You could say that they’re recruiting people to a whiskey category who, as they mature, are likely to come to Scotch whisky.”

Challenge from flavours

Time will tell, but Spiros Malandrakis believes the Irish and Americans have the upper hand right now, and that Bourbon distillers have shown themselves to be much more inventive and experimental. “They have embraced the trend around craft distilling, expanded with flavours and tapped into the whole Americana-Prohibition thing, and they’ve also massively premiumised the category,” he says. “When Red Stag and Jack Daniel’s Tennessee Honey came along, Scotch whisky was looking in awe and fear from the corner of the bar.” As well it might if John Hayes, Jack Daniel’s Master Distiller, is proved correct. Last month he told The Spirits Business: “By the end of this year, the flavoured American whiskey category will be bigger than Scotch in the USA.”

Morgan sounds unconvinced. “I think the jury’s out on how robust and enduring the flavoured whisky market will be,” he retorts. That said, Diageo is now playing across all three strains of the new category – American, Irish and Scotch, having launched J&B Urban Honey in Spain this spring. Presumably it will soon be appearing in America to join Dewar’s Highlander Honey which pioneered the flavoured “Scotch” category last year. The appearance of such lines suggests the industry accepts, at least privately, that its previous innovations have not been enough to satisfy the craving for novelty among some US consumers.

Back to those SWA stats and Billy Walker feels the declines are a temporary blip. “Sometimes people get frightened by a wild statistic but I suspect that’s all it is.” His confidence is not necessarily shared by his fellow passengers on the good ship Scotch. Diageo, which is set to hit an estimated 100m lpa in malt whisky capacity, having been at 73m just five years ago, has paused its investment programme to “ensure the right balance between supply and demand”. With their investment in increasing capacity in the billions, let’s hope there are no icebergs ahead.