A marriage made in heaven

...or one they will regret? Richard Halstead examines the GrandMet- Guinness deal

It was, Tony Greener says, inevitable. For the past three years the chairman of Guinness has been thinking about a merger with another major player in the world alcoholic beverages market. His thoughts kept returning to Grand Met. It had brands he was interested in, market presences that were complementary with Guinness (big in the US and small in Asia, against Guinness's relatively low US presence and its extensive Asian interests). It was a way of delivering some cost savings, and thus bottom line growth, in the companies' respective spirits businesses, both suffering from stagnating consumption and high marketing costs.

"It has long been apparent that we needed to consolidate in the spirits industry," says Mr. Greener. "It was not a matter of if, but how and when."

Mr Greener will become joint chairman with George Bull of Grand Met of the combined entity GMG Brands when the pounds 24bn deal goes through, and then sole chairman after Mr Bull retires next summer. He has staked both his own and his company's future on the philosophy that the only entity that will work in the branded food and alcoholic drinks market is an aggressive brand management vehicle with a significant presence in all the world's major consumer goods markets.

Before that happens, of course, regulatory issues must be overcome, with the distinct possibility that one or more of the joint companies' spirits brands will have to be sacrificed to satisfy the authorities in the US. There GMG will have a quarter of the spirits market and well over half the Scotch whisky market, with Seagram's Chivas Regal the only serious competitor.

While Mr Greener, who did the deal over dinner with Mr Bull a month ago, having rejected the idea of a hostile approach 12 months previously, is naturally a cheerleader for GMG, opinion in the City is squarely divided. "This industry has been consolidating for 10 years, and it has not done a damn thing for value," says John Wakely, a food and drink analyst at Lehman Brothers. "To say that this merger will suddenly solve everyone's problems is naive. This deal is swung on having power over the retailers, and it does nothing for the consumer. Plus the company will have too many brands to manage at a time when other companies are trying to focus their brand portfolios down."

Ron Littleboy of Nomura takes entirely the opposite view. "The deal is a master stroke," he says. "It is going to steal a march on all their rivals in the drinks business, and raises questions over the continued independence of companies like Allied Domecq."

So what is the real story? It is worth looking more closely at whether the philosophy of a brand "warehouse" company with global market presence is worth having. First, the reasons for the merger have very little to do with the Guinness brewing operations, though their extensive Asian distribution network will prove invaluable. Nor is it much to do with Burger King and Pillsbury, the restaurant and food businesses respectively, which may enjoy peripheral benefits from being under the same roof as the Guinness drinks portfolio, but it is hard to judge this before the fact.

The key to the merger is combining spirits brands brought to the party by Grand Met through its International Distillers and Vintners subsidiary, and by Guinness through United Distillers.

In the renamed UDV, GMG will have enviable brand portfolios: household names such as Bell's, Johnnie Walker, J&B, Gordon's, Smirnoff and Bailey's, to name but a few. When merged, GMG will have five out of the top 10 spirits brands by sales in the world. No other drinks company will be able to touch them for size or market presence in all but a few corners of the world.

The logic of some kind of tie-up in this area is easy to fathom - some synergies, access to new markets for some of the brands, and incredible clout in the trade. But why a full-scale merger between the two leading companies? Why not a strong player taking over a weak player? One answer appears to be the renewed importance of brand management to both companies in the spirits market, which is under pressure from declining consumption and erosion by own brand competition in its traditional markets.

The brand in this case will not be the corporate GMG Brands - a mouthful that does not seem to have caught on with the shareholders, judging from the Guinness AGM last week. Guinness sources suggest it may get changed in any case for something more palatable before the merger itself is consummated. It will be the ability of the salespeople for UDV to lock trade customers into long-term deals (including agreements to take on new products when required) and apply large-scale marketing muscle - both in advertising and point of sale - that will freeze the competition out. With such an extensive brand portfolio, the thinking goes, and a presence in every world region, the company can tailor its offering for each market.

"We want to be a premier league brand player, on a par with Unilever and Procter & Gamble," says Mr Greener. "We are talking scale and reach here in management and marketing that no other drinks company will have."

The importance of such a development cannot be overstated, according to Raymond Perrier, director of Interbrand, the branding consultancy. ''The merger shows that brands are back on the agenda, and that creating a framework to exploit them as you would any other asset is worthwhile," he says.

The difference between this approach and a corporate-brand led effort, according to Mr Perrier, "is that the customer is not unnecessarily confused. People who drink a particular Scotch brand, or even those who go to Burger King, are not going to be interested in who is the ultimate owner. They just want a good hamburger or a good glass of Scotch whisky, and are using the brand as a convenient short-cut to making the best buying decision." Corporate brands, he adds, only matter to trade buyers, who are looking for reliability and sophistication in their suppliers.

This is the philosophy long espoused by such titans of the consumer goods world as Unilever and Procter & Gamble. Unilever, under Niall Fitzgerald, has recently reaffirmed its commitment to becoming a manager of consumer goods brands. However according to Mr Perrier, not everyone has bought in: "The airlines are still hung up on this corporate branding, and you can see the kind of confusion that will result when I want to travel from Budapest to Chicago on United Airlines and find myself on Lufthansa, Sabena, and AN Other instead."

It is worth noting, however, that this brand warehouse philosophy is not a catch-all method for adding value. Pepsico, having built up such an entity with global drinks, food and restaurant brands, recently decided to withdraw from its KFC, Taco Bell and Pizza Hut restaurant businesses, citing the need to focus on its cola battle with Coca-Cola, and the cashflow problems caused by startup costs in China and other Far East countries.

Another approach to the logic of the deal comes from the maturity of the spirits market itself. The arguments put forward by Mr Greener and Mr McGrath centre on the belief that the future of the spirits industry lies in Asia, the most consistently growing spirits market in the world, and just about the only area of any significance where spirits companies can see opportunities for enhancing their profits. The barriers to entry here are high, and the onus is on getting into the market as early as possible.

"It is clear that drinks brands will need to succeed in Asia, and the lessons from recent years show that a brand that establishes itself early in the market tends to dominate it," says Mr Littleboy. He points to the Indian and Chinese markets, and adds that any company looking to get into Asia will have to balance its marketing spend there against the kind of income it can derive from maturing western markets to fund it. The balance will be a hard one to strike without depressing earnings, but once again, size will win out: "Whichever way you look at it, having the two strongest players in the market coming together has got to be good news for them and bad news for everyone else."

However, the Asian markets, while lumped together in statistics, are not uniform in their drinking tastes, according to Liz Dunning, a consultant at branding consultancy Tutssels who has worked with both Grand Met and Guinness on branding strategies for their spirits in Asia. Nor are they conventional markets in the western sense. "What works in Taiwan or Korea, for example, does not work in Thailand or Japan," she says. Brands such as Old Parr, a United Distillers (Guinness) super-premium Scotch brand that would be hard to find in most Western bars, is a huge success in Japan but nowhere else. Ditto premium Johnnie Walker products such as Blue Label and Gold Label, which are very popular with the newly-affluent of China. "Culturally and socially it is a much more difficult market to do business in. The initial boom in spirits sales came from premium duty free offerings, but now we see discount and own-label brands coming into the market, and more value-conscious consumers. Experience of the market, and the ability to respond quickly to changing tastes will be essential if a brand is to succeed."

Sentiment over the joining of two huge drinks players into a monolithic global company is bound to oscillate between enthusiasm over the possibilities and fears over the pitfalls as the merger between Grand Met and Guinness slowly takes shape in the coming months. There are many questions still unanswered. While the European competition authorities are expected to wave the deal through with the outside chance that GMG will have to undertake to divest a brand or two, the American authorities - either the Federal Trade Commission or the Department of Justice - are likely to extract a heavier price, possibly the sale of a leading Scotch brand like Dewar's (which is a market leader in the US but nowhere else) and a gin brand.

GMG maintains that all the regulatory hurdles will be overcome. "There is no way we were going to go into this without having done our homework," says Mr Greener. It would be unrealistic, however, to think that that homework did not include a contingency plan whereby one or more brands in the US market might be sold to satisfy monopoly issues. Once the regulation question is out of the way - and the process could take a year or more - the new management team will have the chance to prove its philosophy. Then the spotlight will turn on delivering the kind of shareholder value that the City has come not to expect from the food and drink sector.