Diageo move is about more than just job cuts

The headlines following Diageo’s announcement of a review of its operating model were inevitably about the imminent wave of job cuts that will hit the company’s staff, particularly in the UK and Ireland, but look at the move from a strategic business perspective and you can see that the world’s biggest drinks firm has made a shrewd decision.

Prior to last week’s announcement, Diageo’s marketing, sales and distribution of its brands were organised across four geographic regions: North America, Europe, Asia Pacific and International, which included Latin America, the Caribbean and Africa.

Yet with the pace of growth in emerging markets across regions such as Africa and Latin America, placing an equal emphasis on generating growth in slower, more established markets would not be particularly justifiable.

Chief executive Paul Walsh stated in the announcement that he wanted to ensure the company’s resources were “deployed closer to the market and in those areas where the potential for growth is greatest”. As a result, Diageo’s international business will henceforth have two autonomous regions: Latin America & Caribbean, and Africa, with effect from 1 July.

The markets met the announcement with an oddly luke-warm response. Traders should be encouraged that the company appears to be aiming to accelerate its growth rate in emerging markets by increasing the resources allocated, while also making further savings by reducing its cost base in Europe. The decentralised model, such as that successfully employed by Pernod Ricard, will allow Diageo to be a much more flexible, reactive operator.

Diageo’s move to shrink its position in ex-growth markets surfaced in February when chief executive Paul Walsh admitted he was reviewing operations in countries including Spain, Greece and Ireland. The company wants to move from 35% of revenues in emerging markets to 50% within three years.

Walsh’s decision to focus resources away from ex-growth markets is not particularly unique, either within the drinks industry or others. Across a spectrum ranging from energy and IT companies to consumer goods and service providers, corporations have been re-adjusting their strategic outlook to take advantage of the unprecedented growth rates currently found in the so-called Bric (Brazil, Russia, India, China) countries in recent years.

Diageo wants to capitalise upon the rapidly-growing middle classes in increasingly prosperous emerging economies, which has led to rising demand for its whisky brands in South America, while African consumers’ thirst is, in the main, for the group’s beers.

The impact was clear to see in Diageo’s half-year results for the six months to 31 December: operating profits from the Asia-Pacific region rose 18% on an organic basis, while those from the international division were 15% higher. North America delivered more sedate growth of 5%, but operating profits in Europe dropped by 9%.

Diageo’s international division head Stuart Fletcher, who will stand down from the company as a result of the review, outlined the potential in Latin America and Africa, saying that he expects to see sales and profits growth of over 10% this year.

According to Fletcher, growth markets in Brazil, Mexico, Nigeria, Kenya and South Africa have driven sales up 18% in the first three months of this year.

The core of his region – Latin America and Africa – have both doubled the size of their business in the last five years, driven by aspirational Scotch brands such as Johnnie Walker and Buchanan’s in Latin America and by Guinness in Africa.

Walsh and his management team have pushed sentiment to one side and taken a wholly objective view of the global markets in which they operate before coming to the conclusions announced last week.

Though we will have to wait until the company announces its full-year results in August to be briefed on the full ramifications of the review, observers should not focus on the impending job losses until we know the scale of the cuts, but instead on the astute reaction of Diageo to a rapidly changing global landscape.

Finance on Friday, 03.06.2011