UAE: To buy into Dubai?

United Arab Emirates: land of opportunity or a bubble about to burst? By Rob Walker, of Euromonitor

Spirits consumption in the United Arab Emirates (UAE) grew by a bullish 17.2% last year, which was the second steepest curve in the world, according to data from Euromonitor International. At the core of the growth story is a burgeoning class of Western expatriates, including upwards of 120,000 UK nationals, who, like 21st century gold prospectors, have flocked feverishly to the region in search of their fortune. Dubai is the hub of the activity, with some 85% of its 1.6 million inhabitants born abroad. This cosmopolitan emirate has marketed itself as the Western capital of the Middle East and as a beacon of high living. But is the UAE really a land of opportunity, or a potential capitalist casualty of global financial contagion? For spirits companies looking to carve a bigger piece of the action Euromonitor International assesses the upside and downside implications.

Tweaking Islamic law
For any spirits company eyeing up opportunity in the UAE, a potential deal breaker is that Islamic law bans the purchase and consumption of alcoholic beverages by Muslims, which account for roughly three-quarters of the country’s 4.8m residents. That would seem to leave a feeble consumer base on which to build any significant strategic investment. The silver lining and, in effect, the root of the opportunity for international spirits companies, is that the government of the UAE perceives its Western expatriate and non-Muslim tourism enclaves as critical engines of economic prosperity.

As a result, it has set up opportunistic provisos to the alcohol ban in key emirates, whereby non-Muslims can apply for licences that enable them to buy and consume alcoholic drinks through controlled channels. It is a respectful, albeit perhaps reluctant, legislative nod to the liberal social consumption culture of the West by an otherwise conservative ruling sheikdom.

To regulate the operating environment of alcoholic drinks a duopoly was set up in the form of Maritime & Mercantile International LLC and African & Eastern NE BVI Ltd. Alcoholic drinks are not permitted to be produced in the country under any circumstances, but these two companies have the task of overseeing all avenues of the formal route to market for international brands, meaning they act as importers, wholesalers and retailers. They are also referees in the granting of liquor licences to non-Muslim residents. It is, in real terms, a closed shop, and spirits companies have little option but to operate as best they can within its narrow confines.

The advertising of spirits brands, for example, is banned in mainstream print and broadcast media as well as on outside placards. The only viable advertising channels are glossy English-speaking magazines, sold mainly in hotels, and low-impact POP material in bars and clubs. Entrances to bars and specialist retailers are obliged to be discreet. Some are almost hidden from sight, like the Prohibition speakeasies of 1920s America. On paper it looks like a hostile playing field for the world’s spirits companies, so what, if any, is the attraction of doing business?

Premium opportunity
The pulse of the attraction is a strong appetite for premium and super-premium products, fuelled by high per capita consumer spending, especially among Western expatriates. Even in the context of global financial turbulence, anyone visiting the UAE’s oil-rich desert landscape is likely to experience, at least on the surface, a tangible affluence. For a comparatively small city, Dubai, for example, is awash with designer labels and high-performance sports cars, and the vast numbers of cranes that punctuate its skyline are testimony to the billions of dollars of construction projects waiting to be completed.

Everywhere you look there are infrastructure superlatives in waiting: the Burj Dubai, set to be the tallest building in the world; Dubai World Central, set to be the most expensive airport in the world; Palm Islands, set to be the largest artificial island in the world; Dubai Mall, set to become the largest shopping complex in the world; and Dubailand, set to be the biggest children’s entertainment centre in the world. This is a city that boasts shamelessly of betting big. Indeed, there is, perhaps, no other country in the world that flexes so many muscles of promised opportunity.

And where better to develop the profile and penetration of premium and super-premium spirits than a niche consumer market hungry for Porsche, Prada and Jimmy Choo? Volume returns might be modest but spirits companies, like frontrunner Diageo, can target a sweet spot of attractive value returns, while as a shop window to the largely untapped potential of the Middle East, this is the place to be seen.

Covert consumption
The penchant for luxury goods is not purely a characteristic of Western expatriates. There are, without doubt, an influential number of well-to-do Muslim residents who exhibit equally high aspirational inclinations. This has spilled into a growing taste for alcoholic drinks, particularly for prestige brands such as Johnnie Walker Black Label and Chivas Regal. Bucket loads of cheap credit in recent years have made many luxury items readily accessible, but because alcohol for Muslims is banned there has inevitably been a build-up in covert consumption.

Until recently, it was relatively easy for Muslims living in Dubai and Abu Dhabi, the main consumption bases, to buy bottles of spirits in the northern emirates of Ajman and Ras-al-Khaimah, which operated less stringent controls on the sale of alcohol to non-residents. The Barracuda outlet in Ajman, for example, is a one-hour drive from Dubai and has historically been a popular purchase point for outlawed spirits consumers. The risk for anyone running this route surfaces on the return journey. Specifically, midway on the road connecting the north and south emirates is Shariah, where Islamic law is stricter and alcohol consumption is completely banned. Vehicles could be stopped and subjected to checks by Shariah police and the penalties for contraband would often be severe.

In spite of the risks, this inter-emirate parallel activity has flourished and become an important niche driver of spirits consumption in the UAE. In May this year, however, the government tightened up consumption loopholes in the affected northern emirates. This legislative clampdown has visibly slowed the illicit traffic, but there is evidence that the volume of spirits purchased in the on-trade has grown sharply in the intervening months, implying that upwardly mobile Muslim consumers in Dubai and Abu Dhabi are turning increasingly to under-the-counter consumption in the bar and restaurant scene.

In fact, even before the clampdown in the northern emirates, it was a striking feature of the market that the rapidly expanding on-trade, especially in Dubai, fuelled a dominant share in formal sales of spirits. Last year, for example, the on-trade accounted for some 97% of total volume. And it is widely recognised that bars have long absorbed illicit as well as legal consumption. The important point is that, through its recent action, the government has made clear its intent to take a stricter line on illegal consumption, which means that on-trade channels could become vulnerable to tighter regulations in the future.

Uncertain future
For international spirits companies looking to increase brand penetration in the UAE, a bigger concern will be the economy’s mounting consumer debt crisis. Specifically, as the world takes stock of the most seismic global financial turmoil in decades, it has become increasingly clear that consumers in the UAE have been spending money they simply do not have. The situation has been compounded by rapidly rising inflation, spurred by the pegging of the local currency to the US dollar.

The UAE is a consumer market weighted heavily with imported goods, hence as international currencies have appreciated against the US dollar, so the cost of imports has risen. The average price of a glass of Johnnie Walker Black Label, for example, has gone up by around 15% in the on-trade over the past year. As belts get tightened, it seems likely that demand for this type of luxury product will be squeezed, at least over the short term.

There has also been the ominous sign of increased social tension in the UAE, with workers staging protests against the rising cost of living and unpaid wages. Many of the lowest-salaried segments of the population are Indian and South Asian migrants who have effectively formed the backbone of the country’s booming construction industry. Most send money home to their own countries on a monthly basis, so the instability of the economy and, above all, the reduction in real wages, could realistically trigger a reversal of the migration.

Without the core of its labour force, it would be hard to see how Dubai, the UAE’s financial crown jewel, could complete the multitude of construction projects that are still in progress. If the cranes stop working, they will start to look more like huge question marks, dotting the skyline like symbols of an uncertain future. And for the spirits industry, the fulfilment of the construction promise, and more specifically its allure to migrants from the West, is crucial. It determines whether or not consumption culture continues to evolve favourably and lies at the heart of the opportunity, as well as the risk.

Rob Walker is a senior alcoholic drinks analyst at Euromonitor International 

db © November 2008