Strategy

Toast of the Town

CFO Nick Rose is quickly turning London-based drinks company Diageo into a global dynamo. Here's how.
Justin WoodNovember 22, 2001

“I’m an impatient man,” says Nick Rose, the group finance director of Diageo. “And so is the CEO, Paul Walsh.”

Rose isn’t kidding. The two Diageo executives haven’t been in their current roles for long — Rose was appointed in June 1999, and Walsh in September 2000. But already they’ve left their mark on the $18 billion (E20.5 billion) food and drinks group.

First they unveiled a radical strategy to refocus the London-based company. Then they went into the market and crafted some of the boldest deals in their sector. They’ve also set out to improve the internal workings of Diageo. A prime example: They’ve provided the company with a uniform way to measure its return on marketing investments (see “The Marketing Matrix,” at the end of this article).

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But while Diageo has certainly come a long way in a short time, not everything has gone smoothly. In particular, Diageo’s deal-making has bumped up against anti-trust regulators — most recently on October 23. What’s more, some of the company’s greatest challenges may still lie ahead, and are certain to test the patience of Diageo’s CEO-CFO team.

To understand what drives Walsh and Rose, it’s worth looking back to the winter of 1997. That’s when Diageo was born, following a merger between Guinness and GrandMet. The combination created a business based on four legs. A wine and spirits division was created by combining the whisky and gin brands of Guinness with the vodka and liqueur brands of GrandMet. A beer operation — which centred on the Guinness brand name — was left largely untouched. The other two divisions were Pillsbury, a U.S.-based packaged foods business, and Burger King, the fast-food chain.

The rationale for the deal, asserted executives at the time, was impeccable. Not only did the portfolio of brands at each company lock together with little overlap, but the companies’ distribution networks were equally complementary. As a result, merger synergies and cost savings were expected to be substantial. On top of that, they drew attention to the fact that consolidation in the drinks industry was inevitable so it made sense to lead the field. On the whole, investors agreed and gave the union their blessing.

Two years later, however, Diageo’s vision seemed to be past its sell-by date. Chris Wickham, a beverage analyst at Lehman Brothers, explains: “Towards the end of 1999 there was a lot of pressure from the market for Diageo to rethink itself. Why would a global premium beverage alcohol business be grouped together with a U.S. food group and a U.S. fast-service restaurant?”

A New Cocktail

Behind the scenes, senior managers at Diageo agreed and set about drawing up plans to change dramatically the direction of the group. In July 2000 they went public with their ideas. The focus for the future, they announced, would be the company’s top drinks brands, and to that end Diageo would combine all its spirits, wine, and beer businesses into a single unit. As for the food side of the business, both Pillsbury and Burger King would be sold.

For Rose, the logic behind the plan was simple: “By almost any measure, premium drinks are our most advantaged business.” Diageo’s results for the 2001 financial year (ended June 30) bear out his assertion. The company’s drinks business posted a return on capital employed of almost 28 percent — more than twice that of either Pillsbury or Burger King.

What’s more, rather than concentrating on all its products, Diageo would single out eight “global priority brands,” such as Johnnie Walker and Smirnoff, to be the engine of future growth. Behind these top names would sit another 30 “local priority brands” — drinks that were dominant in one or two markets rather than globally. And finally, Diageo would continue to own another 450 or so smaller brands. This third tier of labels, Walsh and his team decided, was needed to support the economics of the rest of the business — they account for around 30 percent of the sales volume of Diageo’s drinks division.

Analysts and investors alike welcomed the new plan. Philip Morrisey, an analyst at UBS Warburg, comments: “The market was looking for focus. and rewarding on that basis, so the strategy was a good one. It played to the company’s strengths.”

The markets were all the more pleased because Diageo also presented plans to divest its unwanted food operations. Pillsbury, which owns brands such as Doughboy baking products and Haagen Dazs ice cream, would be sold to General Mills, a U.S. food company, for $10.5 billion (E11.6 billion). Under the terms of the deal, General Mills would assume Pillsbury’s debt and issue $5.4 billion of new shares. Diageo would end up with a 33 percent stake in the enlarged General Mills, which it would then sell off over 10 years. Meanwhile, Burger King would be carved out and floated as a separate company.

From Rose’s perspective, this was the tough part. “Deciding to move from being a four-business company to being a single-focus premium drinks group was relatively simple,” he insists. “The more challenging question was working out how best to exit the food business.”

Challenging is the right word. With Pillsbury, Rose and his colleagues spent months reviewing major food firms. They weren’t only assessing which ones would be most interested in buying Pillsbury, they also recognised that this was unlikely to be a cash deal, so Diageo had to be comfortable owning stock in the buyer. In General Mills, Rose felt he had found the perfect partner, and so did shareholders who happily approved the deal.

Food for Thought

One party, however, was opposed to it — the Federal Trade Commission (FTC). Rose had known in advance that the deal would raise antitrust concerns in the U.S., and he had taken pre-emptive action. In particular, Rose had recognized that the General Mills/Pillsbury combination would become overly dominant in certain product areas such as baking mixes. His solution was to sell the offending brands to a third company, International Multifoods.

The trouble was, the FTC wasn’t impressed, arguing that International Multifoods wouldn’t be a strong enough competitor and that consumers would suffer. Months and months of negotiations followed, and instead of having the deal cleared by Christmas 2000 as Diageo hoped, it still hasn’t been approved.

On October 23, however, the FTC voted not to take action against the deal. Diageo isn’t in the clear yet, but its chances of selling Pillsbury according to the original plan now look good.

Rose concedes that the whole episode has been “frustrating.” Equally troubling has been Diageo’s inability to divest Burger King. Since announcing its plan to spin it off, the performance of the fast-food business has slipped badly, in part due to poor management, and in part due to the foot and mouth scares earlier this year.

Simon Hales, an analyst at HSBC Securities, reckons the value of the business has tumbled from around $2.5 billion back in June 2000 to $2 billion today and “is still falling.” All of which makes divestment tricky. Not that Diageo is being complacent. Company management acknowledges that it needs to turn around Burger King and has installed a new management team with a new strategy. Results coming through this quarter, says Rose, show they are making good progress.

Of course, divestments are only part of the picture. Diageo hasn’t forgotten where its future lies — in premium drinks. Here, too, the company has been busy doing deals. Most notably, in December last year Diageo announced that it had agreed to buy the spirits and wine business of The Seagram Co., a Canadian drinks and media group owned by France’s Vivendi Universal.

But this was no run-of-the-mill acquisition. Knowing that he would once again bump up against antitrust concerns, Rose, who personally negotiated the deal, decided to make his bid in partnership with a rival. The partner he chose was Pernod Ricard, the French drinks group. Together, they bid $8.15 billion for Seagram — and won. Diageo would pay $5 billion, Pernod would pay the rest, and they would then split Seagrams’ brands between them.

Rose’s decision to make his bid with a partner was a bold move. “People said at the time they thought working with a partner would be a recipe for disaster,” recalls Rose. “But we knew we couldn’t bid on our own. The FTC and the European Commission wouldn’t allow us to buy the whole thing and then find buyers at a later date for the parts of the business that we couldn’t have. The deal was too big and the outcome too uncertain.”

Having now won the bid, Rose is pleased to have proved his critics wrong. The key to his success, he says, was getting a framework agreement signed at the outset of the partnership that outlined how the deal would work. “It was crucial to be absolutely clear about who would get what on a market-by-market basis, who would take care of which parts of the integration process and so on,” he asserts.

Once again, however, it looks as if Rose’s patience will be tested. On the same day that the FTC ruled not to block Diageo’s Pillsbury transaction, it decided to challenge the Seagram deal.

For Diageo, the true gem in the deal was Seagram’s Captain Morgan brand of rum, which would fit neatly with its other eight “global priority brands.” Diageo also owns Malibu, however, a coconut-flavoured rum. The FTC believes that combining the two brands would give Diageo too big a share of the U.S. rum market — if such a thing is possible. One solution may be for Diageo to sell Malibu in favor of the bigger-selling Captain Morgan brand. Negotiations are ongoing.

Mother’s Milk, Mother Brands

Externally, then, Diageo has had a tough time of it. Internally, however, the company has chalked up a number of triumphs. One of the biggest has been with its ready-to-drink (RTD) products. Built around strong “mother brands,” these are pre-mixed cocktails sold in single-serving bottles and consumed neat. Smirnoff Ice is a recent example, a vodka and lemon drink built on the Smirnoff Red brand.

In a spirits market that is expanding slowly, RTD products have been a big part of Diageo’s recent growth. Take Smirnoff vodka. In the U.S. last year, although volume of the neat spirit declined by 4 percent, the overall quantity of Smirnoff consumed grew by 11 percent, thanks to Smirnoff Ice.

Still, some observers see a flaw with the RTD sector. “Smirnoff Ice has given Diageo some very sexy growth in the short-term,” notes Hales of HSBC. “But what about the long-term?” His concern is that RTD brands tend to target younger customers who, by their nature, are fickle and prone to follow fads. “Just look at the experience of Bacardi Breezer in the U.S.,” he points out, referring to a rum-based RTD competitor to Smirnoff Ice. “In the 1990s it saw big growth for two or three years, and then sales fell away.”

Rose brushes aside such concerns. He believes Diageo has learned from mistakes in the RTD sector and now knows how to manage such brands more competently, particularly when it comes to marketing. Indeed, marketing is probably the key to success for the whole group. Lehman Brothers’ Wickham observes that, in the past, Diageo hasn’t invested enough in marketing. Today, that’s changing. In the last financial year, for example, while net sales in Diageo’s premium drinks division grew by around 6 percent, marketing investment increased by 10 percent, up to 17.4 percent of revenue.

Nevertheless, Rose wants to see Diageo generate a better overall return on its investment in advertising. As such he has rolled out an innovative program to help Diageo get the biggest bang from its marketing buck (see “The Marketing Matrix,” below). “As a company, our single most important investment is in marketing,” Rose notes. “So we’re trying to apply the same sort of rigor in assessing our marketing expenditure that most firms would apply to their capital expenditure.”

These are the sorts of steps that analysts say they like to see at the company. Above all, analysts are looking for organic growth at Diageo. A ratcheting up of the company’s marketing could help bring that about. For Rose, however, such growth can’t happen soon enough. He is, after all, an impatient man.

Justin Wood is the managing editor of CFO Europe.

The Marketing Matrix

Diageo has put in place an innovative plan to measure its return on investment in advertising and promotion. “The question of how you measure marketing effectiveness is the holy grail for most consumer-goods companies,” says Nick Rose, group finance director of Diageo. “It’s certainly the Holy Grail for their CFOs.”

It’s easy to see why the issue is so close to Rose’s heart. For one, the $18 billion (E20.5 billion) food and drinks group has more than 500 brands. For another, it spends a fortune on advertising and promotion. In the 2001 financial year, for example, marketing expenditure was Diageo’s second-biggest cost after raw materials, totaling $2.8 billion. That’s a lot of money to spend without knowing the return on the investment.

As such, Rose has crafted a plan to help Diageo improve the way it monitors its brand-building. For several years — before Rose was appointed to his current role — Diageo has had cross-functional teams of sales, marketing, and finance staff working together to add financial rigour to advertising decisions. The problem was that different teams in different markets had all developed their own techniques. Thus, there was no way of comparing one business or brand with another.

The solution, Diageo decided, was to roll out one simple, companywide methodology for measuring marketing effectiveness. Ian Simpson, a senior manager in Diageo’s finance team, has spent the past year helping to set it up. “If all our marketing efforts are measured in the same way, then different parts of the group can share knowledge more easily about what has worked and what hasn’t,” Simpson explains.

The methodology they settled on was a simple two-by-two matrix. Along the vertical axis is a return on investment measure. This is calculated by taking the five-year discounted economic profit generated by a particular marketing activity, subtracting the post-tax costs of the activity, and then dividing it by the post-tax costs of the activity. The midpoint of the axis represents zero economic profit. Along the horizontal axis is a measure of consumer impact. That’s calculated in more fuzzy ways — say, by comparing consumer attitudes toward a brand before and after a marketing drive to see if it has had any effect.

“While the financial measure ensures that we maximize the financial return on our marketing spend, it’s equally important that we continue to enhance our long-term brand loyalty,” says Simpson. “So it’s vital to measure brand health with a consumer impact metric.”

The matrix produces four boxes. Marketing projects that end up in the top right-hand box are best because they create both economic profit and brand loyalty. Those that appear in the top left-hand box are fine, but only if they are designed to boost short-term volume growth. Projects in the bottom right-hand box are good for consumer loyalty, but they don’t make money and therefore need to be fixed. Anything in the bottom left-hand box hasn’t worked at all.

Now, all advertising and promotion expenditure above a certain threshold — for example, £100,000 in the U.K. — must be evaluated by a sales, marketing, and finance team according to this matrix before it can be approved. And after the marketing has taken place, the project must then be reassessed using the same matrix to see if it has lived up to its expectations. The results are all stored on a central intranet site so that everyone in the company can see the results — and apply what they’ve learned to future marketing campaigns.

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