Online Extra: Diageo's Potent Profit Cocktail

CEO Paul Walsh has made the alcoholic-beverage outfit's growth sparkle by focusing on top brands and spinning off new drinks

By Kerry Capell

When Paul Walsh took the helm of Britain's Diageo in January, 2001, it needed help. At the time, Diageo, which was formed by the December, 1997, merger of International Distillers & Vintners and United Distillers, had some of the world's best known alcohol brands, such as Johnnie Walker, Smirnoff, and Guinness.

But it also owned Pillsbury and Burger King, neither of which produced the same kind of lucrative profit margins as alcohol. Walsh, the former head of Pillsbury Food, recognized that in consumer products -- whether it's booze or Band-Aids -- "you either need to be a niche player, or you want to be the big kid on the block."


  Walsh wanted Diageo to be the latter. So he promptly set about creating the world's largest alcoholic-beverage concern, selling off Pillsbury and acquiring the Seagram spirits business for $5.3 billion in 2001. A year later, Walsh sold ailing Burger King to Texas Pacific Group for $2.3 billion. "It was my belief that in every category other than alcohol, we had missed the boat," Walsh says. "No matter how much cash Diageo poured into packaged food, we would never catch up to the Unilevers, Nestlés, and Krafts of this world."

Turns out that Walsh made some smart moves. Diageo, ranked 58 in BusinessWeek's listing of top European companies, based on the Standard & Poor's Europe 350, is now the world's leading premium-drinks business. It's also the world's largest producer of distilled spirits, with a 15.5% global market share, more than double that of its nearest rival, Pernod Ricard. Analysts estimate that Diageo will post a pretax profit for the year ending in June of $3.6 billion, on turnover of nearly $16 billion.

"Diageo is focused on new-product development and marketing effort on eight global priority brands," says David Hallam, an analyst with Williams de Broe in London. "This scale gives Diageo a critical mass in sales and distribution that's unmatched by its competitors."


  Those priority brands are household names worldwide. They include Johnnie Walker (the world's No. 1 Scotch whisky), Baileys, Tanqueray gin, Smirnoff, Cuervo tequila, Guinness stout, and Captain Morgan rum. Together, these brands achieved 8% volume growth in the last year and accounted for 57% of Diageo's overall sales.

Walsh's biggest success has been the launch three years ago of so-called ready-to-drink (RTD) products, such as Smirnoff Ice, a low-alcohol bottled drink. Smirnoff Ice is now a $1 billion brand and one of Diageo's biggest coups in recent years. In addition to creating a whole new drink for Diageo to sell, RTDs are also breathing new life into existing holdings by creating greater brand awareness. Diageo now has 31 RTD products in 39 markets.

"The marketing behind the RTD products continues to create a halo effect for the parent brand," Walsh says. He's also boosting sales of brands like Smirnoff by introducing line extensions, such as Smirnoff Twist fruit-flavored vodkas.


  Walsh is betting that Diageo's portfolio of RTDs will help it exceed the industry's weak 2% annual growth rate by winning market share from brewers and winemakers, especially in the U.S. If he is to succeed, he'll need to change the way liquor is sold in the U.S., where regulations for alcohol sales have changed little since the Prohibition. Distillers are required to sell their brands through independent distributors, and having to go through an extra layer of middlemen is costly.

However, rather than stick with the industry standard of relying on a small network of operators, Diageo has pitted liquor wholesalers against suppliers, forcing them to bid for exclusive rights to market Diageo's brands in a particular state. It's a move Walsh hopes will lead to reduced costs and better efficiency.

Diageo, under Walsh, is shaking up the booze business by taking a page from the play books of beer brewers such as Anheuser-Busch (BUD ). "Now what we have put in place is a system where we put all brands together and give them to one distributor," Walsh says. "The beer guys have been doing this for the last decade."


  Diageo's strategy of rolling out dedicated sales teams in the U.S. since the beginning of this year is also hailed by analysts as a powerful marketing tool. "Sales forces will be incentivized to sell Diageo's products and no one else's, replacing a system where a distributor's sales force markets a whole range of products from numerous producers," says Williams de Broe's Hallam.

Besides improving distribution, Walsh is concentrating Diageo's marketing on just a handful of brands these days. "Spending more on fewer brands gives you more absolute dollars per brands. This gives you more media impact," he says.

Under Walsh, Diageo will continue searching for ways to revitalize top-selling brands while testing the waters with an array of new ones. "If you always do what you always did, you always get what you always got," Walsh says. But this focused business is doing things differently, and interested investors likely would benefit from what Walsh is doing at Diageo.

Capell writes for BusinessWeek in the Paris bureau

EDITED BY Edited by Beth Belton

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