A Thirst For Growth

BOGOTA, Colombia — These are tough times even for the champagne of beers. But global beer giant SABMiller continues to toast its 2005 acquisition of Colombian brewer Grupo Empresarial Bavaria for providing a crucial foothold in the dynamic Latin American spirits market.

“This is the most successful integration we’ve ever had,” said Barry J. Smith, SABMiller’s Latin America chief, speaking about his company’s $9 billion purchase of Bavaria, then the region’s second largest brewer, from Colombia’s Santo Domingo family.

“There was good growth throughout Latin America up until 12 or 18 months ago,” Smith said during a recent interview in his office in Bogotá. “But since then, like everyone else, we’ve not had the performance we anticipated.”

Bavaria beer sales have been flat through the end of summer in the four countries where its brands dominate – Colombia, Peru, Ecuador and Panama – and 2008 sales declined by a “mid-single digit,” Smith said.

The global economic crisis has crimped beer consumption from Kalamazoo to Cartagena, as well as Cape Town. At the same time, rising costs of hops, glass and energy have hurt profits. Since the acquisition, London-based SABMiller has had to spend serious dollars upgrading certain operations at Bavaria, such as exchanging what Smith calls “scruffy bottles” – those that failed to live up to the SABMiller standards – with new ones.

The new owner has also built a new $220 million brewery near Cali in Colombia’s southwest and broadened Bavaria’s line-up to introduce several premium beers, for which marketing efforts try to position them as “haute” brands for high-end consumers.

But the fundamental rationale for the deal still applies and makes eminent economic sense, Smith said. Industry analysts agree, saying the purchase of Bavaria gave SABMiller entrée to a region where population growth, economic expansion and per-capita disposable income are all trending upward, factors that make emerging markets the promised land for brewers.

In 2007, before the global economic crisis hit with full force, beer consumption was rising on average by 5 percent in areas such as China, India, Brazil, Eastern Europe and Colombia. Many in the industry expect that pace to resume once the crisis is over.

Meanwhile, beer sales have barely grown 1 percent annually over the last decade in the United States and other “mature” industrialized markets as consumption has flattened out, said Ben Steinman, editor of Beer Marketer’s Insights, an industry newsletter based in Nanuet, NY.

U.S. mega brewers have been hit by changing consumer tastes, among them a shift to locally brewed “craft” beers that use traditional methods, as well as to other spirits. The average U.S. beer consumption has fallen to 90 liters per capita per year from 100 liters two decades ago, Steinman said. Given those trends, BEVMARK, a Santa Barbara-based consulting firm to the food and beverage industry, estimates that beer sales will barely increase through 2013, edging up by just 0.4 percent, in the United States and seven other industrialized nations.

The past year or so has been especially tough for most brewers.

“U.S. beer volume is down 1 percent so far in 2009 after being flat for most of the decade,” Steinman said “The United States is a slow-growth market, or even no-growth this year. But it’s still highly profitable so the big players can take profits to fund operations in emerging markets.”

With the stale growth outlook for the United States and other developed countries, global brewers are resorting to mergers to increase revenue and to spread out marketing and distribution costs.

At the forefront of the trend in 2002, South Africa’s SAB and Milwaukee-headquartered Miller Brewing Co. merged. In 2007, it doubled down on its bet to become a global player when it formed a new joint venture with Molson Coors to boost its operations in the United States

In 2004, Belgium-based InterBrew ascended into the ranks of global brewers when it acquired AmBev of Brazil for $11.2 billion and took the name of InBev. InBev went on to become the world’s largest brewer last year when it swallowed up Anheuser Busch in a $52 billion deal that formed mega-player AB InBev.
In the United States, consolidation has resulted in an effective duopoly. AB InBev and SABMiller control 80 percent of all beer sales, said Tom Pirko, president of BEVMARK.

And the consolidation wave is not over, said Pirko. FEMSA, the Mexican brewer and bottler that controls the Tecate, Dos Equis and Bohemia brands, is thought to be a target, as are Foster’s Group of Australia and Heineken, the Dutch giant.

“Everyone is consolidating, trying to get bigger and bigger and to close out smaller competitors and growing if not organically then by incorporating the sales of smaller groups through mergers,” Pirko said. “The industry is trying to understand the basic physics of globalization and capitalize on them.”

Smith, a 25-year veteran of the South African brewer, cautioned that there is a learning curve in emerging markets. China boasts 50 percent more sales by volume than the United States. Yet SABMiller, a leading player there with its Snow brand, generates minimal profits in the market because beer there is still a “commodity product,” said Smith. The challenge is to encourage consumers to trade up to higher-margin premium brands as the population becomes more affluent, much as Bavaria is trying to do in Colombia.

SABMiller was attracted to Colombia because of Bavaria’s near-monopoly with its Águila, Club Colombia and Costeña brands, which together have a 98 percent market share. At the same time, Colombian consumption of beer, about 45 liters per capita per year, was relatively small and offered room for growth. Per capita beer consumption in Mexico and Venezuela, for example, is roughly twice the Colombian rate. Moreover, beer enjoys an unusually high share – about 60 percent – of all liquor consumed.

Some possible rival suitors of Bavaria, which are said to have included Heineken, were skeptical of the market potential given Colombia’s security issues related to ongoing drug and guerrilla wars, and high murder and kidnapping rates. But the situation has improved dramatically under President Alvaro Uribe, and Colombia registered stellar economic growth up until last year.

Since closing the deal, SABMiller’s guiding philosophy has been to protect Bavaria’s market dominance by keeping price hikes to a minimum while dressing up the brands with better packaging. But replacing Bavaria’s old containers with larger and newer ones has led to higher than expected costs, Smith said.
The parent company has also introduced three new premium brands: Águila Light, Redd’s and Peroni, the latter imported from Italy. Despite 20 percent international price hikes for hops and other ingredients, SABMiller has kept price increases in Colombia to under the inflation rate, Smith said.

The brewer has kept a lid on prices knowing that competitors such as AB InBev would love to enter the Colombian beer market and price hikes would open the door. AB InBev has already moved into the neighboring Andean markets of Peru and Ecuador.

“Instead of exploiting pricing because of our dominant position, we manage prices down since our success depends on affordability,” Smith said.
The company has cut costs by laying off 10 percent of the Bavaria workforce, which now stands at 8,000 workers.

The deal seems to have worked out well for the sellers, the Santo Domingo family, whose members received $180 million in cash and a 15 percent stake in SABMiller. Those shares have since risen 50 percent, Smith said.

Will it work out for SABMiller?

Smith is confident. The company sells beer in 40 countries.

“There are similarities between Colombians and South Africans,” he said. “They are resilient and robust. And as security and the economy improve, more Colombians will have access to beer.”