How Diageo plc Makes Money

What’s the secret of Diageo plc’s (LON:DGE) success?

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We all have a broad idea of what the companies in our portfolios do. But how much do you really know about their products and their markets, or how much each of their activities contributes to the bottom line? Understanding how a company makes its money can help you decide whether it’s a good investment.

Diageo (LSE: DGE) (NYSE: DEO.US) describes itself as the world’s leading premium drinks company with brands across spirits, beer and wine. In reality wine forms a small part of the business, and its beer interests are in quite narrow segments. But it has an impressive 27% share of the global premium spirits market.

What’s your tipple?

Diageo forensically analyses its markets into nine categories: scotch, other whisky, vodka, rum, liqueurs, tequila, gin, local spirits and beer; and five price points: ultra premium, super premium, premium, standard and value. That makes for 35 category/price point combinations, and Diageo has products that serve 29 of them.

Thirteen internationally recognisable strategic brands, such as Johnny Walker, Smirnoff, Guinness and Captain Morgan, contribute two thirds of sales and receive three quarters of marketing spend. Scotch, beer and vodka account for 29%, 21% and 12% of revenues respectively: other categories are in single figures.

Completing the line-up, Diageo owns a third of Champagne and brandy maker Moet Hennessy.

Drinks at a premium

Have you noticed the word ‘premium’ yet? Shifting customer up the quality ladder is core to Diageo’s strategy.

You can see examples of premiumisation in the multiple price points of Johnny Walker Red, Black and Blue labels, and in a the launch last year of a limited edition of just 100,000 bottles globally of Tanqueray Malacca gin, used to leverage trade interest to promote the broader Tanqueray brand portfolio.

The strategy plays particularly well in emerging markets such as Africa, where international brands appeal to increasingly wealthy and sophisticated consumers in preference to local products of varying quality.

World domination

Diageo has grown global reach by acquisition, simultaneously buying distribution-power for its existing brands in new markets and acquiring new products to distribute internationally.  By the end of 2015 Diageo expects half its sales to come from the faster-growing emerging markets of Latin America, Africa, Asia, Eastern Europe and Turkey.

North America is Diageo’s most important market, providing 40% of operating profits. In the US by law it must distribute via third-party distributors but even with that restriction its brand-recognition, driven by marketing spend, and massive scale gives it a large competitive advantage. Western Europe contributes 18% of profits.

Integrated

Diageo produces three quarters of its products itself, including brewing beer in Ireland and Africa. With its own distribution channels outside the US, it’s a highly vertically integrated operation.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

 > Tony owns shares in Diageo.

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