Alcohol industry in better spirits

Australia imports most of the spirits it consumes. Domestic manufacturing represents a relatively small proportion of the estimated $5.2 billion retail value of spirits consumed in Australia. For many products, some degree of transformation occurs domestically, particularly in the case of ready-to-drink (RTD) beverages.

The main spirit manufactured domestically is rum, made from sugar cane, while spirits that are mixed or blended locally are also considered to be manufactured in Australia. Therefore, many industry participants are engaged in transforming high-proof spirits to low-proof products such as RTDs and liqueurs.

The Spirit Manufacturing industry witnessed moderate growth in the three years ending 2007-08, buoyed by strong growth in consumption of RTD spirits. This run of growth came to an end in late 2008, as the Federal Government increased excise on RTDs and a deteriorating economic climate saw sales of these products slump. The industry should enjoy a better year in 2010-11, as the strengthening economy underpins rising sales of spirits. IBISWorld estimates industry revenue will increase at an average annualised rate of 0.8% over the five years to 2010-11.

The industry is in better spirits heading into 2010-11, with demand from liquor retailers, restaurants, pubs and bars expected to increase as the economy returns to strong growth. Manufacturers should benefit from a number of trends, especially the rise of ‘cocktail culture’ and the premiumisation of the beverage market to boost demand for pre-mixed cocktail drinks and higher value added bottled spirits.

Possible changes to alcohol excise will have a major impact on industry participants. The growing presence in liquor retailing of supermarket giants Woolworths and Coles, and competition from cider, beer and wine loom as the major threats to industry revenue over the next five years.

IBISWorld estimates industry revenue will increase at an average annualised rate of 2.1% over the five years to 2015-16.

Spirit manufacturers should experience better conditions from 2011-12 onwards, with the strengthening economy and favourable consumer trends driving demand for industry products. Demand for ready-to-drink (RTD) beverages should pick up during 2011-12, as producers introduce new ranges of premium spirit brands and pre-mixed cocktail drinks.

Industry volumes are expected to grow moderately over the next five years, alongside marginal growth in per capita alcohol consumption. IBISWorld forecasts industry revenue will increase at an average annualised rate of 2.1% over the five years to 2015-16.

Producers in better spirits

The industry is expected to demonstrate solid growth over 2011-12, in line with the broader economy. While other developed economies struggle under the weight of high public debt, the legacy of the financial crisis, resilient unemployment and ageing demographics, the domestic economy should return to well above average growth over the year. Rising consumption expenditure will underpin strong demand for spirits from liquor retailers, wholesalers and the on-trade. Demand for RTDs should lift further over the year, with consumers returning to these products due to elements of convenience.

Producers are expected to launch a number of new light-spirit RTDs and ready-to-serve cocktail products; these will be mainly targeted at younger, particularly female, drinkers. Examples of such products include Diageo’s Smirnoff Mule RTD, and Beam Global’s Appletini and Lazy RTDs. Bottled spirit sales are also expected to lift as consumers loosen their purse strings. Diageo Australia’s relatively new Bundaberg brands Bundaberg Red, Bundaberg 101 and Bundaberg Premium, should encourage some drinkers to try spirits for the first time and help rum increase its share of the spirit retailing market.

There is also likely to be an increasing push towards premium, higher value products across both bottled spirits and RTDs, which will help producers increase profit margins. Producers will continue to face competitive pressure from other alcohol classes; particularly cider as it tends to target the same young, female drinkers as some RTD products. More benign economic conditions are also expected to facilitate some substitution from private labels back to branded products during 2011-12, reversing to some extent the trend towards private labels in recent years.

However, this trend is not expected to last, with supermarkets expected to continue exploiting their growing dominance in the liquor retailing market to expand and push private labels. Industry profitability should also increase over 2011-12, underpinned by rising demand for spirits and RTDs and changing consumer preference for higher value, premium products. Profitability will weaken later in the next five-year period as competition increases both from within and outside the industry. The rising dollar should make imported bottled spirits relatively cheaper, while packaging, marketing and labour costs should all rise.

International trade and taxes

Spirit imports are expected to continue to grow over the next five years. However, imports could fall as a share of domestic demand due to potentially greater investment in Australian production following the entry of Pacific Beverages into the industry. Any additional player entering domestic spirit manufacturing will see a reduced reliance on imports into the industry. The value of exports is forecast to be flat as a general long-term trend.

However, there is expected to be continued year-on-year volatility in the value of international trade in spirits, given its exposure to exchange rate fluctuations. The Australian dollar is forecast to remain relatively strong over the next five years, putting competitive pressure on exports and facilitating greater growth in imports.

Taxation reform will continue to play a major role on the industry’s fortunes over the next five years. The Federal Government’s taxation inquiry, the Henry report, recommended a single, fixed price, volumetric tax on alcoholic beverages; fixed on the full-strength packed beer rate of $41.68 per litre of pure alcohol.

Under current rules beer, wine and spirits are subject to excise at different rates, with spirits incurring a significantly higher rate of excise. In 2009, excise on spirits and RTDs was $0.88 per standard drink, compared with $0.27 for full-strength beer and $0.29 for bottled wine. A flat-rate tax would be a major boon for spirit manufacturers still reeling from the Federal Government’s decision to increase excise on RTDs by 70% in 2008.

However, IBISWorld believes the chances of this being passed by either sides of parliament to be unlikely. This would constitute a stunning volte-face for a government committed to reducing the incidence of teen drinking; while the more powerful beer and wine industries would also fiercely lobby against reform that would likely steal market share.

Product trends

A new product expected to show growth is ready-to-drink (RTD) or pre-mixed cocktails. This segment has shown robust growth in the United States and Europe over the past two years, where liquor producers have turned people entertaining at home to make up for weak demand for spirits in restaurants and bars.

With the economy set to return to steady growth and disposable incomes to rise again, cocktails are likely to become more popular in Australia. Spirit manufacturers stung by the government’s alcopops laws see RTD cocktail drinks as a strong growth market. Diageo Australia recently introduced a new range of pre-mixed vodka based cocktails including Smirnoff Mojito, Smirnoff Tuscan Lemonade and Smirnoff Grand Cosmopolitan. Growing interest in these products could also spark stronger sales of other RTD drinks.

Another significant trend that has been observed in overseas markets, particularly the United States, has been the rise of super premium products. ‘Premiumisation’ as it has been dubbed by industry participants, is a shift in consumer preferences towards higher quality products. Consumers have begun to associate their chosen spirit with social status and are increasingly using their beverage choices to signal class and sophistication.

This concept is being further cultivated by marketing strategies that portray drinkers as chic, trendy or cultured. The limited extent of price growth in the Australian industry indicates that Australian consumers are as yet trading up to a significant extent, however this may become a factor later into the next five-year period. The dominance of RTDs in the local market limits the impact on manufacturers, with trading up more likely to impact sales and margins on bottled spirits. Diageo Australia has been quick to capitalise on this trend with the 2009 launch of Bundaberg Red and Premium.

The industry is expected to face increasing competition from beverages that are marketed in a similar way to spirits, but are made from either wine-based or malt-based drinks. The main driver of this change will be the tax differential between spirits and other beverages. For example, cider has demonstrated spectacular growth since 2008 and is expected to continue this trend in the short to medium-term. This will have an adverse affect on spirits, particularly on the RTD segment of this industry

Key success factors

• Guaranteed supply of key inputs: Ability to ensure adequate quantities of suitable raw materials is paramount to success in this industry.
• Product is sold at high-profile outlets: Having products prominently displayed at key bars and hotels provides an advantage to industry firms. For example, when bar staff use a particular brand as a default spirit this provides a distinct advantage over competitors in the same category.
• Effective product promotion: Marketing and brand positioning is essential to sales success in this highly competitive world market.
• Development of new products: Product innovation can occasionally reap the rewards of increased sales, however new product launches are expensive and carry a risk of failure.
• Economies of scope: Scope economies through production of other beverages, especially wine, spreads risk since per capita spirit consumption in Australia is far less than for overseas markets.
• Financial structure of the company: The debt level of a firm and the way in which it is financed will affect cashflow.

Barriers to entry

Barriers to entry in this industry are high and are steady. The production process for spirits is highly capital-intensive and economies of scale are substantial. This has the effect of allowing larger producers to produce at low costs, and channel revenue into advertising and maintaining brand image. It also allows larger producers to sell their product at a lower cost than smaller producers.

Therefore, to compete successfully on price, producers need large-scale operations that are associated with significant capital investment.

At the same time, opportunities exist to compete on the basis of quality rather than price, which would allow for small-scale production as long as consumers are willing to pay a premium for the product.

There have been a number of examples of such entry, however as yet their effect on the overall industry has been limited. The long lead times between commencing production and the final product being available can also act as a barrier to entry. While some products can be distilled over shorter periods of time, it generally takes over a year to produce a quality product. With some products such as bourbon and brandy, there is a correlation between quality and the age of the spirit, making it difficult for new producers to compete at the premium end.

The industry is currently dominated by a small number of firms with a wide range of beverages and pre-existing distribution systems. The high number of products already available may make it difficult for a new producer to differentiate its product. The strength of incumbent producers’ distribution networks puts new entrants at a competitive disadvantage.

Regulation of the industry also provides a barrier to entry. New entrants must understand and comply with all regulations before commencing production. This imposes a cost of compliance on producers in addition to the already significant costs of production. Producers must be licensed with the Australian Taxation Office before distilling spirits.

Robert Bryant is the general manager of business information firm IBISWorld.