The new Sauza: after its recent takeover by U.S. Fortune Brands, the world's second best-selling tequila aims to get premium.

On July 26, the French Pernod Ricard and the American Fortune Brands combined forces in the US$ 12.8 billion takeover of Allied Domecq, from United Kingdom. Currently, these distilled spirits titans, ranked 2nd and 4th globally, are in the process of dividing up Allied Domecq's coveted brands in order to enhance their product portfolios.

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This deal is crucial for Mexico because Fortune has acquired the rights to Sauza, the world's second best-selling tequila brand and Pernod Ricard has captured the country's leading brandies, Presidente and Don Pedro. According to Euromonitor, a market research firm, 2004 tequila sales in Mexico amounted to US$ 4 billion, 48% of total spirits revenues (US$ 8.3 billion), compared with only 22% or US$1.8 billion in the brandy/cognac segment.

The takeover also provides both companies with global brands and more than a dozen national ones whose most avid consumers are in the U.S. and Europe, rather than Mexico. On the one hand, Fortune has won the rights to Canadian Club whisky, Courvoisier cognac and Maker's Mark bourbon. On the other, Pernod Ricard inherits the Malibu rum, Stolichnaya vodka, Ballantine's whisky and Beefeater gin brands. These acquisitions costed Fortune US$ 4.9 billion and Pernod Ricard US$ 7.9 billion.

Although all of the brands are strategically important, none compares with Sauza in terms of earnings potential, exports and overall impact on Mexico. This is because of tequila's dominant position in the distilled spirits sector and because of the drink's rapid international growth, particularly in the United States.

Ultimately, four factors account for the success or failure of tequila companies:

(1) the supply and hence price of Agave Tequiliana Weber (blue agave), the plants from which sugars are extracted, fermented and distilled into tequila;

(2) global distribution channels capable of accessing the lucrative U.S. market, as well as Mexico;

(3) differentiation among tequila brands by agave content (100% vs. 51%), taste and image;

(4) changing consumer preferences or switching among substitute products, i.e. vodka and mezcal.

For generations the tequila industry has been prone to abrupt changes in the supply of blue agave plants. This volatility has profoundly affected production and consumption. For example, between 2000 and 2003, the last industry shortage, tequila output dropped by 29%, from 20.2 million 9-liter cases to 15.6 million cases, according to the official statistics of the Tequila Regulatory Council (CRT), located in Guadalajara.

Inevitably, the resulting shortages led to sharply escalating prices. Instead of 1, 2 or 3 pesos per kilo prices skyrocketed to 17 pesos. Obviously, manufacturers like Sauza, Cuervo and Herradura either had to cut costs or change their product mixes, i.e. the percentage of their tequilas that were made from 100% agave sugars (more expensive) vs. those that consisted of only 51% agave sugars. Also, they had to reallocate their output from Mexico to growing export markets, where price differentiation among tequila products was much more sophisticated.

Product mix

All of the companies unanimously decided to increase exports, primarily to U.S., and between 2001 and 2003 exports increased from 51% to 72% of industry production. However, when it came to product mix, Sauza and Herradura responded to the shortage by developing defensive strategies that focused their output on tequilas mixtos (51% agave), in order to prevent domestic sales from plummeting. While Cuervo, the world leader but only 3rd in Mexico, was more aggressive. By contrast, it implemented a program that concentrated on selling 100% tequilas because its executives were convinced that such a strategy would increase profitability, market share and image.

These decisions have produced very different results, and Cuervo has emerged as the big winner. In fact, its policy has been so successful that archrivals Sauza and Herradura will now implement a similar model, although this time around the primary stimulus for such a change are plummeting agave prices that began in 2004 and are likely to persist for several more years. Arturo Sardaneta, marketing director for Sauza tequilas, said to BUSINESS MEXICO Cuervo's Mexican market shares for the first five months of 2005 are 25% in value and 18% in volume, compared with Herradura's 21% and 19% and Sauza's 16% and 17%, respectively.

The latest panorama of plummeting prices that began last year is simply a repetition of what occurred during the last tequila glut of 1993-1998, when a surplus in blue agave caused growers to prune planting programs and allow their fields to lie fallow rather than accept paltry market prices. Their action was predicated on the hope of stimulating a shortage that would trigger rising prices. This response was partially successful. Indeed, it produced the 2000-2003 shortage and a phenomenal spike in prices that encouraged them to plant 60 million new agaves, double the number needed to satisfy current demand.

As a result of these zealous programs the current price of agave has plunged to historically low levels--about 1.5 pesos per kilo--and this change, once again, is forcing tequila manufacturers to redesign strategies in order to increase profitability, market share and image.

Measuring success

The spirits industry in general, and the tequila segment in particular, evaluate success in consumer and company terms. For instance, from the vantage point of the consumer, value is measured at retail sales prices, i.e. at the prices paid by the final consumer at his point of purchase.

By contrast, the success of tequila producers or suppliers is not measured in terms of revenues generated directly from consumers, but rather by sales to importers in foreign countries or to local intermediaries at manufacturer sales prices.

These two methods of measuring success can produce very different conclusions concerning the monetary value of markets to tequila producers or suppliers as opposed to their distributors, who are more directly connected with final consumers.

At the beginning of the last agave shortage in 2001, U.S. replaced Mexico as the world's largest tequila market, as measured in volume terms, a position it has continued to widen. Last year, 8.3 million 9-liter cases were sold there, compared with 6.7 million cases in Mexico. These two countries accounted for 81% of the world's total--45% for U.S. and 26% for Mexico.

From the vantage point of volume share Mexico's top five companies--Herradura, Cuervo, Sauza, Centinela and Bacardi--account for almost 70% of sales.

When calculated in value terms the situation between the countries was reversed. For example, in 2004 Mexican tequila sales of US$ 4 billion represented 49% of the world's total, compared with US$ 2.3 billion or 28% for U.S. The reason for such a discrepancy in Mexico's favor despite its lower sales volume resides in the fact that Mexicans purchase almost 75% of their tequila at bars, restaurants and hotels, prefer drinking 100% agave tequilas and pay higher taxes on their spirits than Americans. By contrast, almost 67% of Americans consume their tequila as a mixed drink, especially margaritas that are made with only 51% agave sugars.

Although Mexico's retail sales of tequila are larger than U.S. revenues, the opposite it true for tequila suppliers who have discovered that the American market is much more lucrative for them.

Developing Distribution Channels

The Distilled Spirits Council of the United States (Discus) reported that in 2004 the dollar value of tequila supplier sales in U.S. increased by 7.4%, from US$ 962 million in 2003 to 1.034 billion dollars. By comparison, Sardaneta stated that 2004 Mexican supplier sales totaled approximately US$ 600 million. Put in perspective these figures suggest that 62% of the combined supplier revenues in the two countries were earned in U.S. and 38% in Mexico.

The greater revenue potential of the U.S. market for specifically Mexican suppliers was also borne out in an interview with Juan Domingo Beckmann, president and CEO of Jose Cuervo. Beckmann stated that in 2004 Cuervo brand exports, primarily to U.S., amounted to US$ 160 million, excluding Gran Centenario and 1800, two separate brands that it also owns. By comparison, his company's sales in Mexico were only US$ 90 million.

Sardaneta was not at liberty to discuss a similar breakdown of Sauza tequila sales because of legal restraints associated with the recent Fortune takeover of the brand. Nevertheless, he could say unequivocally that the U.S. market represented a great opportunity for Sauza, especially in the super-premium segment in which individual bottles of tequila retail at approximately US$ 50.

Apparently, falling agave prices will spur a conversion of Sauza mixtos to puros tequilas, and this should boost its earnings which have lagged its volume growth. While Sauza's 2nd best 2004 U.S. market share (volume) of 15% was barely one-third of Cuervo's, its growth rate of 16% per year since 1999 is three times faster than its toughest competitor. Yet, volume growth is one thing and value growth quite another. Sauza's new owners must also wean the company from its strategy of competing on price in Mexico (67% of its sales), represented by the 100 Anos brand at the low end of the market.

By contrast, Cuervo's success is based on its broad and profitable portfolio in the U.S. and Mexico, and the incomparable support of its distribution partner, Diageo, the largest and most profitable marketer of distilled spirits in the world. The Fortune takeover of Sauza augurs well for the mexican brand in the U.S. because it is the 2nd leading spirits company after Diageo and should be able to increase distribution of its products and add focus to its brand image.

According to the CRT, Mexico produced 12.2 million 9-liter cases during the first six months of the year: 6.8 million cases (56%) were for export and 5.4 million cases (44%) were for Mexican consumption. Approximately, 67% were mixtos and 33% puros.

It is interesting to observe the differences between Mexican and world preferences, primarily American tastes. For example, only 18% of the tequila produced for export was 100% agave and 82% mixto, because the vast majority of Americans prefer drinking tequila in the form of margaritas. However, at the same time the number of connoisseurs who demand more expensive 100% tequilas there is growing quickly rapidly.

By contrast, 56%, or three times as much of the tequila produced for sale in Mexico, was made from 100% agave sugars. These figures suggest that the falling agave prices are in fact leading to major change among tequila producers like Herradura and Sauza, who are changing the composition of specific brands like El Jimador from 51% mixtos to 100% agave tequilas or simply increasing the output of their already existing 100% agave brands like Hornitos and Tres Generaciones.

Between 2004 and 2009, Euromonitor predicts tequila sales will increase by 45%. If this figure is accurate, then the US$ 400 million in 2004 Mexican exports to U.S. should spur to nearly US$ 600 million in order to support new brand launches of super-premium tequilas from companies like Sauza.

Still, there are dangers lurking ahead. New competitors like mezcal could accelerate their growth and harm tequila sales or plant diseases might seriously damage crops, as in the past. But, the most likely threat is that with continually falling prices over the next few years an increasing number of consumers may prefer 51% mixtos to 100% agave tequilas. This is particularly true in U.S. where a rapidly growing Mexican immigrant population in California, Texas and the Southwest has been driving growth for a decade.

Marc Scheinman is a professor of international marketing at Pace University (N.Y.) and a Fullbright professor in Mexico, Brazil and Argentina.

Illustrations by Jorge Del Angel

RELATED ARTICLE: Arturo Sardaneta, marketing coordinator of Sauza tequilas (Allied Domeq)

"We Have a Really Big Opportunity in the U.S."

What are Sauza's best selling brands?

100 Anos is our top seller. It accounts for 67% of Sauza's total volume and 63% of its value sales in the domestic market. We offer 100 Anos in three presentations: blanco, mixto and reposado. The first two are made from 51% agave sugars and the last one is 100% agave.

Which 100% tequilas are Sauza's top brands?

Our best-selling 100% tequila is Sauza's Hornitos Reposado. It is also our leading export brand. In addition, our top-of-the line brand, Tres Generaciones, is offered as a blanco, reposado and anejo.

What is the percentage of tequila mixtos vs. puros that Sauza sells?

Our marketing mix is approximately 60% mixtos and 40% puros, but the drop in agave prices will enable us to change the mix in favor of 100% agave tequilas this year.

What brands will get the major push from this initiative?

Undoubtedly, our big winner will be Hornitos, the brand we will push in both domestic and export markets, and Tres Generaciones too. Export markets, especially the U.S., will be our major focus. Last year we sold 1.2 million 9-liter cases of tequila in the U.S. (slightly less than half our sales) and achieved a 15% market share, second only to Cuervo. We believe that with America's increasing preference for 100% tequilas we have a really big opportunity there.

Although you have Hornitos and Tres Generaciones as puros, you really do not have any super premium brands to compete with the likes of Cuervo's Reserva de la Familia. Do you have any plans to fill this gap?

This is one of our top priorities. In the next year we will introduce a new super premium tequila aimed directly at Reserva de la Familia.

What are the strengths of the major Mexican tequila producers?

Cuervo's strengths are its focus on Tradicional, its leading 100% tequila, and, of course, the power of its on-premise distribution channels (hotels, bars and restaurants). Herradura's competitive advantage is its targeting the 100% reposado segments. By sharp contrast, Bacardi's emphasis and strength is price and distribution, particularly its Cazadores brand (100% agave,) which it is aggressively marketing in both U.S. and Mexico.

Lastly, our competitive advantages at Sauza are the increasing preference of consumers for our brands. For example, last year in U.S. our case sales increased by 10%, twice the rate of the market leader, Cuervo. Today, we are the fastest growing tequila company and the 2nd largest in the world. We should be able to fuel future growth by concentrating on reposados and super premium tequilas.

Where do you envision the fastest growth?

In export markets. Aside from U.S., we see important opportunities in Russia and Japan.

Do you see mezcal as an important competitor?

Personally, I believe that in a very short period mezcal will become a significant competitor. Their sales already are increasing rapidly.

Tequila and Mezcal Sales

(in millions of 9-liter cases)

        2000  2001  2002  2003  2004

World   20.8  18.6  17.1  17.6  18.6
U.S.     7.4   6.9   7.4   7.9   8.3
Mexico   9.7   8.2   6.3   6.3   6.7

(in US$ billions)

World    7.1   6.9   6.9   7.5   8.2
U.S.     1.8   1.7   2.0   2.1   2.3
Mexico   3.8   3.6   3.3   3.6   4.0

Source: Euromonitor.

10 Leading Tequila Brands in U.S.

(in millions of 9L cases, 2004)

Jose Cuervo           3,408
Sauza                 1,225
Moctezuma               600
Juarez                  420
Patron                  347
1800 Reposado           345
Margaritaville          205
Cazadores               195
Rio Grande              172
El Jimador              123
Total leading brands  7,040
Others                1,232
Total tequila         8,272

Source: Adam's Liquor Communications, Handbook Advance, Annual 2005 and
2004.