The post-Brexit hangover: One big headache for Diageo

Days before the Brexit vote, Ivan Menezes, CEO of Diageo, one of the largest producers and exporters of alcohol in the world, urged his UK employees to vote to ‘stay’ in the EU. Diageo couldn’t risk the uncertainty of losing access to the favorable free trade provisions that the EU had secured. But the vote didn’t go Diageo’s way. So what next?

Diageo’s biggest cause for concern is the potential for increased tariffs on its exported products.

As a member of the EU, Diageo, and other UK-domiciled companies, have enjoyed access to one of the world’s largest networks of preferential trade deals, with over thirty free trade or cooperation agreements currently in place.[1] Post-Brexit, it is likely that the UK will lose access to these agreements, such as the one recently negotiated with Vietnam, which reduced alcohol import tariffs from 45% down to zero.

Fortunately, the impact may not be as pronounced, with Diageo still able to access zero tariffs in its key export markets such as the US and Canada under WTO rules. However, the Company will still need to renegotiate with important markets such as Korea and South Africa.[2]

Even its most famous Irish export, Guinness, may be affected. Diageo estimates that Guinness kegs cross the border between the Republic of Ireland and the UK over 13,000 times a year; short delays between 30 minutes and an hour are estimated to cost the Company over US$1.7m per year.[3] Upstream supply chain costs could also increase, with the Company reliant on raw materials including dairy for its famous ‘Bailey’s Irish Cream’, which accounts for almost 5% of the Republic of Ireland’s total dairy output each year.[4]

To make matters worse, the Company faces a raft of other potential issues, including changes to drink labelling and quality standards and the loss of talent due to restrictions on the free movement of labor.[5] [6]

Brexit on Management’s agenda

Brexit is clearly on the agenda for Diageo, listing it as one of the key risks in its most recent annual report[7].

Over the short to medium-term, the Board is undertaking a range of initiatives to mitigate against these risks, including[8]:

  1. Developing on-the-ground market and country intelligence;
  2. Maintaining a cross-functional steering group to monitor risks associated with Brexit;
  3. Initiating a market-sensitive, multi-country investment and capacity expansion strategy, and local sourcing strategy; and
  4. Ensuring that the CEO and other senior executives review local strategies.

Outside of these initiatives, Diageo is working with its industry associations, such as the Scotch Whisky Association (SWA) to secure a positive deal for the Company.[9] The key priority for the SWA in the short-term includes lobbying for a ‘transitional adoption’ of benefits secured through EU trade deals, followed by the negotiation of more ambitious FTA agreements by the UK. Diageo and the broader industry are also calling for a ‘frictionless’ border between the Republic of Ireland and the UK, which would allow for the free movement of goods and labor.[10]

What else should Diageo be doing?

As a global company with a global supply chain, Diageo’s board and management must be vigilant in understanding and mitigating areas in its supply chain that are vulnerable to regulatory change.

Over the short-term, the Company should continue to take an active position in monitoring and lobbying for open trade policies that reduce import taxes, using the strength of its brand and influence in international markets where it employs over 20,000 people[11].

Over the medium-term, Diageo should consider whether a ‘localized’ or ‘global’ sourcing and distribution strategy is preferable in light of the regulatory risk. For many of its brands, including Guinness, Diageo issues companies with licenses to brew its product in their local market. The Company might consider expanding this strategy to a broader range of its brands in order to reduce the risk of increases in import tariffs.

Some outstanding questions…

Despite being domiciled in the UK, Diageo has operating entities across the globe that could be affected by changes to large free trade agreements, such as the Trans-Pacific Partnership (TPP) or the North American Free Trade Agreement (NAFTA).

Two questions remain for Diageo as it navigates the challenges of protectionist policies:

With these policies incentivizing companies to ‘localize’ their laborforce, what impact might a loss of international talent have on Diageo’s competitiveness?

Furthermore, investment in global supply changes has been a driving factor in improving standards of living for many people across the world. What responsibility does Diageo have to contribute to the communities in which it serves, by employing local talent and/or manufacturing locally in developing markets?

 

 

[1] EFTA, “Free Trade Agreements and Trade Relations by Country,” http://www.efta.int/free-trade/free-trade-agreements, accessed November 2017.

[2] “Brexit – what now for Scotch Whisky?” Scotch Whisky Association, August 3, 2016, http://www.scotch-whisky.org.uk/news-publications/news/brexit-what-now-for-scotch-whisky/#.Wgz4uWhSw2x, accessed November 2017.

[3] “Why Brexit could mean a pricier pint of Guinness,” The Economist, July 15, 2017, https://www.economist.com/news/britain/21724934-harder-irish-border-would-cause-delays-and-add-costs-many-agri-food-products-why-brexit, accessed November 2017.

[4] Simon Marks, “Brexit is (maybe) the ruin of Irish Whisky,” Politico, March 3, 2017, https://www.politico.eu/article/trouble-at-the-border-brexit-threatens-irish-supply-chains/, accessed November 2017.

[5] The Scottish Parliament, “European and External Relations Committee 3rd Meeting 2016, Session 5” (PDF file), downloaded from The Scottish Parliament website, http://www.parliament.scot/parliamentarybusiness/report.aspx?r=10496&mode=pdf, accessed November 2017.

[6] Willis Towers Watson, “Chronic labor shortage forecast for UK food and drink industry post Brexit,” Willis Towers Watson Wire (blog), June 8, 2017, https://blog.willis.com/2017/06/chronic-labour-shortage-forecast-for-u-k-food-and-drink-industry-post-brexit/, accessed November 2017.

[7] Diageo, 2017 Annual Report, p. 20, https://www.diageo.com/pr1346/aws/media/3960/diageo-2017-annual-report.pdf, accessed November 2017.

[8] Ibid.

[9] Ibid., p. 19.

[10] Provision Trade Federation, “Early agreement on trade with Ireland” March 3, 2017, http://www.provtrade.co.uk/article/early-agreement-on-trade-with-ireland-27.aspx, accessed November 2017.

[11] Diageo, 2017 Annual Report, p. 20, https://www.diageo.com/pr1346/aws/media/3960/diageo-2017-annual-report.pdf, accessed November 2017.

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19 thoughts on “The post-Brexit hangover: One big headache for Diageo

  1. Melissa, I agree with your recommendations of lobbying and licensing in order to avoid unfavorable tariffs. Unfortunately, none of the other major alcohol producers are headquartered in the UK and similarly impacted by Brexit as Diageo. AB InBev is in Belgium, Pernod Ricard is in France, Heineken is in the Netherlands, Constellation is in the US, etc. Diageo may be going it alone or leading the charge in its UK lobbying efforts. Thus, Diageo may need to rely on licensing or sourcing locally, even though that step may lead to lower quality and efficiency.

  2. Though I hope that SWA negotiations will not fall through, I am concerned given Scotland’s vote for independence that there could be murky waters ahead. Furthermore, the border debates with Ireland are raging currently and so both of Diageo’s primary whisky channels are under great risk! It is ironic that given the above difficulties they face further afield, that some of their biggest issues may still come from their dealings with old friends…

  3. Melissa — thanks for sharing your insights on how Diageo is navigating the uncertainties around Brexit! I’m interested to learn more about how restrictions on the free movement of labor will impact Diageo’s development of managerial talent going forward, as well as that of its key peers competing in the United Kingdom. It seems hugely punitive and detrimental to the company’s future competitiveness, as you mentioned, and could potentially impact even mundane day-to-day issues such as business travel restrictions.

  4. Though I think Brexit will have a significant impact on Diageo’s profitability I think we are still a while away from establishing clear regulations on what the new tax regime might be. Additionally, there will be a significant lead time between formulation and implementation – particularly for such a complex process. I believe Diageo will be seriously reconsidering relocating its headquarters out from the UK and into the EU (Paris? Dublin?) to continue to enjoy its free trade benefits.

  5. Terrific post, Melissa. I enjoyed the deep dive into the liquor business and how isolationism can impact a global leader such as Diageo. I found your suggestion of having other companies manufacture the beverages in foreign countries as a means to avoid expensive tariffs to be an interesting proposal. I do wonder whether there would be backlash associated consuming a beverage that is purportedly native to an area if found to be produced elsewhere. Further, if prices were to increase on a pint of Guinness due to increased tariffs, that could serve to weaken the positioning of Diageo and ultimately hurt U.K. businesses, resulting in the exact opposite intended effect. Isolationism could ultimately negatively effect home-country businesses with global operations which I doubt was the intention when developing rationale for Brexit and other isolationism strategies. I think the second- and third-order effects of isolationism moves are fascinating and you expertly gave us an one overview of one in this post, Melissa.

  6. Hey Melisa! It’s a well-researched and interesting post. I think I might be more pessimistic about Diageo’s long-term prospects than you are. First, the alcohol industry is already highly regulated and difficult to navigate. I’m worried about a single company’s ability to negotiate international deals anywhere near as profitable as they got in the EU. Second, Diageo will have a difficult time lobbying for special consideration within the UK with so many other issues going on.
    I do believe that your suggestions are good, however. But Diageo may have to considering scaling back for the next few years.

  7. @mbergin – Great post, though I agree with the more pessimistic sentiment of @dcook8872 above, especially because of the challenging regulatory conditions for the alcoholic beverage industry which make trade negotiations even more difficult. I wonder how strong Diageo’s domestic UK market is and if it could see opportunities for further growth there while it whethers the uncertainties of Brexit, or, as @KaiTan suggests, they try to move their headquarters to an EU member country.

  8. Great article, Melissa! I wonder what changes Diageo will make to their core operating model, as in the past it has relied heavily on acquiring companies internationally and leveraging their scale to increase the asset’s operational efficiency. It seems to me that they will have to move their headquarters to another country in the EU or to make significant changes to the way the company operates and creates value.

  9. SO interesting!! I’m ashamed to say that I had not put much thought into how Brexit would impact import and export in the UK. It was really interesting to read the multitude of ways in which companies like Diageo have been impacted though. I thought your note on lobbying made a lot of sense and is a necessary measure. I saw Pratik’s comment on the potential roadblocks and I wonder if they could ban together with companies outside of the alcohol industry (perhaps other big name food and beverage brands have been impacted) in their fight?

  10. Such an interesting topic! Melissa, to be a bit extreme, I wonder if one option Diageo has is to move headquarters if post-Brexit negotiations, the tariffs are actually high enough to be destructive to its business. We’ve seen companies move/select headquarters for tax benefits, but I haven’t considered it for recent government policies.

  11. Compelling and concerning as alcohol consumption transcends all age groups, and can go from bars to churches to the dinner table. I am curious if there can be lessons learned from pre EU days that are applicable now? Perhaps if they are co-located in multiple countries they can avoid the tariffs and maintain a presence in the UK?

  12. I wonder if acquisition may be a possible strategy to mitigate the effects of higher tariffs due to Brexit. As you noted, Diageo currently issues licenses with companies to brew their products in the local market. As tariffs increase, and hinder supply in export markets, Diageo could consider filling gaps in those markets by acquiring local brands and producers that make a similar product. Of course, in doing so, they would limit their ability to capitalize on the brand equity of names such as ‘Guinness’, but would be able to maintain the presence held by the overall Diageo organization in these markets.

  13. I found your post very insightful and relevant given my interest in the effects of Brexit on global markets and publicly traded companies. Indeed, Diageo was one of the more vocal companies in voicing its concerns about Brexit, and as you concisely delineated was impacted negatively in many ways. This being said, Diageo also benefited from Brexit in that the depreciation of the British Pound helped fuel greater profits in overseas sales (Source: https://www.campaignlive.co.uk/article/brexit-bonanza-diageo-weak-pound-leads-surge-profits-revenue/1440630). I therefore wonder how the longer term likelihood for depreciation in the British Pound (particularly in the event of a “Hard-Brexit”) might adversely impact Diageo’s profitability.

  14. Very interesting topic Melissa! I agree with your suggestions to lobby for tariff reductions/open trade as well as the option to open new or purchase existing production sites outside of the UK or license production to an external party outside of the UK. I also agree with Angel’s comment regarding the option of moving the headquarters outside of the UK if the costs of moving it vs. paying the tariffs makes sense in the long run. An additional lever would obviously be raising prices but customers would not appreciate that especially since so many other alcoholic beverage companies will not be effected and will be able to maintain prices – all other things equal.

  15. Great post Melissa. I am interested to see how companies will deal with tariff implications of Brexit. It seems very natural that Diageo would pair up with industry associations to lobby for better deals. I would even suggest that they team up with their competitors as well.

  16. Great work! You really lay out the problem well and give some solid ways that management can combat this extremely important issue. I think the loss of international talent can’t be understated. It’s important that their lobbyist spend not only go to alcohol tarrif lobbyists, but to trade lobbyists as well that can hopefully have an impact on the new hiring rules that will go into effect post-Brexit. Also, I think regardless of Brexit, it would be wise to continue manufacturing products near their end markets with satellite plants. With current global trends, it’s very likely that other countries may enact isolationist trade policies and the more prepared Diageo can be for the unknown, the better.

  17. Great post, Melissa! Watching the fallout from Brexit play out in the private sector has been such an illuminating experience in regard to global supply chains.

    To the questions you ended with, I believe all companies have a responsibility to positively impact the communities in which they reside. That being said, companies also have a responsibility to shareholders and stakeholders alike to bring in the best talent in order to make the best product and thus increase profits and longevity. I wonder if having a small talent pool to choose from will act as a catalyst to reinvest and expand their current training programs as a way to keep the same quality of workers they enjoyed when their access to talent was much larger. It will be interesting to see how expensive it becomes to retain their level of competitiveness through talent in the new system.

  18. Melissa, thank you so much for the insights! I agree with your recommendation on lobbying in order to avoid unfavorable tariffs would be the most important actions that Diageo should take to combat the issue. Given its significance and contribution to UK (# of employees, pride as a British company, technologies, tax income etc), I would be fairly optimistic about government’s effort to avoid the tariffs. In the end, what the government would need to avoid is companies like Diageo moving its HQ to other locations where it could enjoy its free trade benefits. As Pratik correctly pointed out, Diageo could be the only one alcohol producer who will be impacted, so I would recommend Diageo to team up with other industries where such unfavorable tariff could be implemented as the result of Brexit (Pharmaceutical, finance, etc) to lobby together, in order to increase the influence to the new regulations.

    Though I think Brexit will have a significant impact on Diageo’s profitability I think we are still a while away from establishing clear regulations on what the new tax regime might be. Additionally, there will be a significant lead time between formulation and implementation – particularly for such a complex process. I believe Diageo will be seriously reconsidering relocating its headquarters out from the UK and into the EU (Paris? Dublin?) to continue to enjoy its free trade benefits.

  19. Melissa, I appreciate your essay as it enlightened me on some of the implications of Brexit that I had not considered. Specifically, I had not thought of the costs of changing drink labeling and delays crossing borders. I did not realize how much cross border activity Diageo even has with Ireland. One thing that surprised me was management’s response. It seems like most of their response centers around research within different departments. I agree with you that they require a more global sourcing strategy to deal with the implication of Brexit.

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