Indian liquor industry Regulatory hangover to continue

The Indian liquor industry is a high-risk industry, primarily on account of the high taxes and innumerable
regulations governing it. As a result, liquor companies suffer from low pricing flexibility and have inefficient
capacities, which, in turn, have led to low margins and weak financial profiles. Moreover, even though the two
large liquor groups in the country enjoy a majority market share, the price-sensitive nature of the industry has
ensured a high degree of competition, which is exacerbated by the low export potential. Hence, while several
strong brands have come up and the industry has exhibited healthy volume growth over the last few years (for
instance, the Indian-made foreign liquor (IMFL) segment has registered a 8-10% compounded annual
aggregate growth rate (CAGR) over the last three-four years), its high-risk profile continues to dog the
industry.
Like the international liquor industry, the Indian one too has seen players with strong brands, diversified
portfolios and large operations achieve market leadership positions. Given the regulatory constrictions,
however, an added key success factor for Indian players is the need to have operations across various states.
Both because of the inherent nature of liquor and because of the politically-sensitive issue of molasses, a key
raw material for spirits1, the Indian liquor industry has been subjected to a high degree of governmental
interference. To boot, it is a major revenue contributor to the state governments, most of which are cashstrapped today. Hence, it is unlikely that the level of taxes or control exerted by the various governments
would reduce in the medium term. So the regulatory risk is expected to remain high.
Nor is the industrys risk profile expected to change significantly with the entry of multinational players or the
implementation of commitments made to the World Trade Organisation (WTO). In fact, courtesy the high duty
levels, the Indian market has not been flooded with cheap imports or consequently, witnessed greater
competitive pressures, belying industry fears.
Yet, the market continues to be attractive to the multinationals, especially in the scotch whisky and beer
segments. While most of the multinational scotch whisky manufacturers have already established a presence in
the country over the last seven to eight years, the beer segment has witnessed greater interest in recent years in
anticipation of higher growth here. As a result, the pace of acquisitions and joint-ventures has picked up even
as established domestic players try to consolidate their market position. Hence, the industry is expected to
witness a shake-out with large players and those with strong parent support likely to survive in the medium to
long term.
Structure of the Indian liquor industry
The Indian liquor industry comprises the IMFL, foreign liquor bottled in India (BII), foreign liquor bottled in
origin (BIO), country liquor, beer and wine segments. The estimated 80 million case2 per annum IMFL
segment primarily includes molasses-based whisky, rum, brandy, gin and vodka. This segment is dominated by
whisky, which accounts for about 60% of its volumes, followed by rum at about 25%. The BII and BIO
segments are very small in comparison. Put together, they are estimated to be less than one million cases per
annum. The country liquor segment, estimated to be one-and-a-half to two times the size of the IMFL segment,
is, however, characterised by fragmented capacities with a number of small players focused on the highconsumption rural areas. The beer market is estimated to be about 70-75 million cases per annum while the
wine segment, estimated at less than three million cases a year, is, again, small.

Liquors that are produced using the distillation process and have a high alcoholic content (generally above 40% by
volume) are referred to as spirits. Spirits include whisky, rum, vodka, brandy and the like. Beer, on the other hand,
is produced using the brewing process in a brewery, and generally has alcoholic content of 5% to 15%.
2
Case is defined as 12 bottles of 750 ml for distilled spirits (IMFL, BII & BIO) and 12 bottles of 650 ml for beer.

The Indian liquor market is concentrated in the southern part of the country, with this region accounting for
about 60% of total IMFL sales and 45% of beer sales. Andhra Pradesh is the largest consumer of both while
Karnataka and Maharashtra are the second-largest consumers of IMFL and beer respectively.
Flavour wise segmentation of
IMFL
Gin
2%

Key IMFL Consuming States

Vodka
0.5%

CSD
4%

Rum
24%

Others
12 %

Karnataka
18 %

R ajasthan
4%
Uttar Pradesh
3%

Kerala
P unjab

Brandy
14%

8%

3%

Whisky
60%

Haryana
3%
Delhi
A nd h r a P r a d e s h

3%

18 %

M aharashtra
Tamil Nadu

5%

16 %
Bombay
3%

Source: Information from industry players

The domestic industry is dominated by two large groups, the Vijay Mallya-controlled UB group and the Shaw
Wallace group, which is controlled by the late Manu Chhabrias family. The two enjoy a combined market
share of about 55% in IMFL and about 70% in beer. The UB group is larger with about 37% share in IMFL
(through McDowell & Company and Herbertsons) and about 45% share in the beer segment (with BrewCo,
the recently hived brewing arm of United Breweries Limited).
High level of risk on account of regulatory environment
Government regulations at every level have affected the Indian liquor industry, introducing structural rigidities.
Apart from the high level of taxes and levies (that account for up to 65% of the consumer price), regulations
pertaining to licensing, creation or expansion of brewing/distilling and bottling capacities, manufacturing
processes (grain-based or molasses-based), distribution and advertising impinge on the industry. Further,
liquor being a state subject, every state has different regulations (including those on distribution) and tax rates
for the industry apart from restrictions as well as levies on the inter-state movement of liquor.
These regulations have impacted the industry on all fronts. The high level of taxes and levies and the fact that
companies have little control over distribution systems mean limited pricing flexibility. Consequently, players
have low margin levels. Then, as a result of the restrictions on capacity expansions and inter-state movement
of liquor, large players have either acquired or entered into contract manufacturing and bottling agreements
with local players in various states. This means fragmented capacities with high overheads and poor economies
of scale, which has further impacted margins. Restrictions on advertising have seen the industry resort to
surrogate advertising besides earmarking high budgets for promotional activities and point of purchase
campaigns and offering discounts and commissions to retailers. Besides, in the past, when some states imposed
prohibition, these markets virtually dried up overnight.
The state governments face a dilemma when it comes to liquor policies. The Indian Constitution says that the
state shall endeavor to bring about prohibition of the consumption of intoxicating drinks. But the liquor

industry is one of the large contributors to state revenues, the loss of which can severely affect their cash flows.
Also, it is difficult to enforce prohibition given the nature of the demand for liquor. In fact, this encourages
consumption of often fatal illicit liquor. Moreover, since huge power subsidies and the impact of the Fifth Pay
Commission have weakened state finances, it is unlikely that any state government could afford to lose this
revenue contributor. So it is unlikely that these governments would lower controls on manufacturing and
selling liquor in the short to medium term.
Weak financial profile
Typically, Indian liquor companies have a weak financial profile with low margins, large working capital
requirements, high gearing and low interest coverage indicators. As mentioned before, low margins are a
manifestation of limited pricing flexibility, and high overheads and advertising/promotion expenses. Working
capital requirements are large because of the high level of work-in-progress due to the long processing period
for fermentation and distillation. At times, this is reflected as loans and advances since most companies fund
the working capital requirement of their contract manufacturers. Both large working capital requirements and
the capital expenditure required to modernise old facilities or set up new ones has resulted in a high level of
debt and gearing. Further, breweries are highly capital-intensive. In fact, the two main beer companies have
gone in for debt-funded acquisitions to increase capacities, which has resulted in a further increase in gearing
levels. With low margins and high gearing, interest coverage indicators too have been low.
In addition, domestic liquor companies are known for their poor accounting policies with auditors qualifying
the accounts. So it is often difficult to make any meaningful interpretations from their reported numbers. This
is changing, however, as most players are scouting for foreign partners and so have initiated the process of
cleaning up their balance sheets. This will improve transparency in the sector and may also result in better
access to funds from the capital markets.
Key financials of major liquor players
Company
United Breweries McDowell & Company
Shaw Wallace
Year ended
31/03/01 30/03/00 31/03/01 30/03/00 31/03/01 30/06/00
Operating Income

Rs. Mn.

3380.8

2655.3

8547.5

8250.3

5053.5

7106.2

%
%

-2.6%
0.9%

-16.9%
4.1%

7.0%
2.6%

8.2%
3.0%

1.1%
0.4%

6.4%
0.7%

Gearing
Times
1.8
0.9
0.6
0.5
2.1
PBDIT Interest Coverage
Times
1.4
1.7
2.4
2.9
1.17
Note: Figures derived from annual reports
Figures for Shaw Wallace for the period ended 31/03/2001 are for a nine-month period

2.6
1.09

Operating Profit Margin

Net Profit Margin

Healthy growth in overall volumes despite high price elasticity of demand

The IMFL as well as the beer segments of the Indian liquor industry have demonstrated a healthy CAGR of
about 8-10% over the last three to four years. But the growth has not been uniform across different price
segments as the liquor market is highly price-sensitive. In the liquor industry, price sensitivity does not
necessarily entail declining volumes; rather, it results in downtrading, that is consumers tend to switch to
cheaper brands in face of price increase or recessionary conditions. For instance, since 1999, while there has
been a marginal de-growth in the regular whisky segment, the cheap-to-medium-priced whisky segment has
witnessed high growth. In the beer segment too, this phenomenon is evident in the higher growth rate achieved
by strong beers, which provide a higher amount of alcohol per rupee. The price elasticity of demand also
results in intense competition as players drop prices in a bid to retain or increase their market shares.

Characteristics of the Indian liquor market

Molasses base
Internationally, whisky and gin are made from grain spirit, brandy from fruit spirit (primarily grapes), rum
from sugarcane spirit (through the molasses route) and vodka from grain/potatoes/sugarcane spirit or a mix of
these. Indian liquors are predominantly molasses-based, however, with a portion of the appropriate grain/fruit
spirit being added to them. Thats also the reason why they have not yet been accepted in the international
market where spirits are defined in terms of their raw material content and ageing norms, which Indian liquors
do not satisfy. Thus, Indian liquor exports are limited. The dependence on molasses also adds to the regulatory
risks as there are restrictions on the inter-state movement of molasses.
Spirits vs. beer and wine, and dark vs. white spirits
Globally, especially in the western markets, the consumption of drinks with lower alcoholic content (beer and
wine) not only exceeds that of spirits but is also showing higher growth. Further, within the spirits segment,
there is a shift in global demand from dark spirits (such as whisky, dark rum and brandy) towards white spirits
(such as vodka, white rum and gin). In India, on the other hand, consumption of spirits exceeds that of beer and
wine due to their lower cost per unit of alcohol. The ratio in favour of spirits would be even higher if country
liquor were included. Also, in India and in other Asian countries, there is growing demand for dark spirits,
especially whiskies.
Low margin levels
Globally, large liquor multinationals enjoy high margins. For instance, the average net margins for the last
three years for three of the largest global liquor players were above 10%. Although these companies have other
businesses (primarily food-related) as well, these margins can be taken to be representative of the alcoholic
beverage business as this is the largest contributor to these companies revenues and profits. The high margins
are driven by the profits generated by the strong brands that these companies have either developed or acquired
over a period of time. This is in stark contrast with the low margins of Indian liquor companies.
Key revenue financials of the three leading players in the world
Allied Domecq
Company
Diageo
Pernod Ricard
Year ended
30/06/01 30/06/00 31/08/01 31/08/00 31/12/01 31/12/00
Total Revenue
Mn. UK 12821
Net Profit (post tax) before exceptional items Mn. UK 1445

11870
1265

2879
347

2602
312

2782
84

2765
157

Revenue from liquor business

Operating Profit from liquor business

7117
1286

2571
505

2297
414

1171
210

1111
190

Mn. UK
Mn. UK

7580
1432

Net Profit Margin for company

%
11%
11%
12%
12%
3%
6%
Operating Profit Margin for liquor business
%
19%
18%
20%
18%
18%
17%
Note: Pernod Ricards net profit margin is low on account of its low-margin soft drinks and transportation
businesses that have operating margins of less than 5%, and that together account for about 60% of the companys
revenues.

Key success factors in the Indian liquor industry

Brands hold the key
Liquor is a consumer good. Hence, brand salience is extremely important for building a strong and sustainable
market position. Strong brands not only lead to customer loyalty but also allow the owner to charge a
premium. Established brands also act as a significant entry barrier for new players/ brands in this industry due
to the restrictions on advertising. A companys brand strength is measured in terms of the number of

millionaire brands (brands with sales of more than a million cases a year) that it owns, and the actual
volumes (number of million cases) sold.
Geographical diversity of production as well as sales
Given the restrictions and high duties applicable on inter-state movement of liquor, players whose production
facilities and sales are spread over a greater number of states enjoy a competitive advantage. This diversity
also helps them to withstand any changes in state policies. Sales to the canteen stores depot (CSD) of the
defence services, which accounts for a major portion of institutional liquor sales in the country, also add to this
diversity.
Presence across spirits and price bands
Apart from geographical diversification, a diversified presence across different spirits and price segments is
another competitive advantage as such a company is in a better position to withstand the impact of changes in
consumer preferences or of a downturn in any particular segment. Along with a diversified portfolio, having a
significant presence in the whisky segment, the largest liquor segment in the country, is also essential for
building an overall strong market position.
Size of operations
Size not only helps to reduce distribution overheads but also increases a players bargaining power with
distributors. This is especially important in states where distributors, by virtue of their monopolistic position,
are very strong and can control not only pricing but also the brands that will be sold in their regions.
Raw material linkages
The key raw material for IMFL players is molasses, which is a by-product of sugar. Molasses is processed and
distilled to produce rectified spirit (ethanol). Players with primary distillation facilities directly consume
molasses while others purchase ethanol. Supply of molasses primarily depends on sugarcane production levels,
which show cyclicality since sugarcane itself is a cash crop with its production showing cyclicality. This
cyclicality also imparts a commodity nature to molasses. As molasses demand arises only from ethanol
demand, the demand-supply scenario for ethanol determines the raw material price for IMFL players. Ethanol
is consumed by the liquor industry and to produce industrial alcohol, each segment accounting for roughly half
the ethanol consumption.
Ethanol demand is expected to rise in future when the commercial blending of ethanol with petrol (for
producing gasohol) takes off. In the long term, however, the supply is also expected to increase as more sugar
manufacturers are expected to set up primary distilling facilities and as new sugar mills are expected to come
up in the form of integrated plants with cogeneration and distilling facilities. Thus, while molasses/spirit prices
are likely to increase after the commercial production of gasohol starts, they are likely to come down from the
increased levels in the long term.
For beer and grain-based spirits, the base raw material is barley, which is a foodgrain. Its production is thus
linked to climatic conditions.
Indian market attractive for multinational suitors
Whisky demand has been declining in the western markets in recent years. Simultaneously, demand is rising in
India and in other Asian countries. This, coupled with rising disposable incomes in the region, has made Asian
countries attractive markets for MNCs with strong whisky brands. Further, beer volumes in India are expected
to register high growth in the coming years both because of the latent demand potential per capita beer
consumption is extremely low in India compared to the west and even China and liberalisation of beer sales
by de-linking it with IMFL. Some state governments like Uttar Pradesh, Himachal Pradesh and Maharashtra
have already liberalized beer sales. The wine industry too is hoping to tap the potential and has accordingly

been fighting to be de-linked from the IMFL industry. It has already achieved success in Maharashtra, where
wine sales are expected to rise.
Multinational players still in infancy
Most of the large MNCs such as Diageo and Allied Domecq already have a presence in India through jointventures, and they have introduced some of their global scotch whisky brands through the BII route, by
importing the scotch concentrate. Their leading brands are only available through the BIO route, however, and
these sales are expected to increase only after a significant decline in basic customs duties and countervailing
duties.
Players with multinational parents enjoy support in the form of access to established brands, blending
technology for developing domestic brands, global marketing campaigns and managerial expertise. On the
financial side too, they have access to both fund-based and non-fund-based support (guarantee or letter of
comfort/awareness covering the Indian companys borrowings). Despite this support, foreign players have not
been able to make a dent in the domestic players market share, and the latter continue to dominate the
domestic liquor industry. Thats because most foreign players are either focused on niche, high-value segments
that have low volumes currently or they have a small presence, if any, in the high-volume, low-margin regularto-low end of the IMFL segment. Their relatively recent entry in the Indian market (last five to six years for
most players) is another reason for their small market share.
The credit profile of the Indian subsidiaries factors in the demonstrated support and willingness as well as
ability of the parent to financially support its Indian venture in times of distress. But the applicability and
extent of this credit enhancement critically depends on the parents business as well as financial risk profile.
Life continues as usual after WTO
According to Indias WTO commitments, quantitative restrictions (QRs) on BIO liquor had to be removed by
April 2001 and the basic import duty on liquor has to be brought down to 150% by April 2004 in a phased
manner. The QRs on BIO have been removed with effect from April 1, 2001 and the basic duty on beer and
wines (at 100%) is already below the bound rate. Also, the basic duty rate on distilled spirits has been reduced
from 210% earlier to 182% in the 2002-03 budget.
There were fears that the Indian market would be flooded with cheap BIO liquor after the QRs were removed,
resulting in increased competition and lower realizations and margins at the higher end of the market. In order
to provide a level playing field to domestic manufacturers, who are subject to excise and other levies, however,
the government imposed countervailing duties (CVDs) on imported BIO liquor. Three slabs of CVDs have
been applied with the highest duty on lower-priced imports to prevent dumping. As a result, the removal of
QRs has not significantly impacted the domestic players high-end sales since the high landed cost of BIO
liquor has made it prohibitively expensive for most domestic consumers. Further, it is unlikely that even with
lowered tariffs, imported liquor would be able to provide competition to domestic players in the regular or
cheap segments, which account for a major portion of the market.
Consolidation in the Indian industry
While the international spirits industry has witnessed a number of brand acquisitions and consolidation over
the past few years, the Indian industry has not gone through any similar churning albeit the MNCs have
increased their equity stake in their Indian joint-ventures in recent years following an increase on the limit on
the foreign partners shareholding.
The beer segment, on the other hand, has witnessed both the entry of MNC players and a lot of consolidation
in the recent past. In the capital-intensive brewery business, ownership of brewing capacity is a big entry
barrier. Existing players have been trying to consolidate their position in the industry, primarily by acquiring

brewing capacity. The MNCs also view the Indian market as a potentially large and high-growth market, and
players like Fosters, Strohs, SAB and Scottish & Newcastle have entered over the last few years. Some of
these players have acquired or set up brewing facilities (Fosters & SAB) while others have entered into jointventures with domestic players. Other major international players like Anheuser Busch (makers of Budweiser),
Heineken, Interbrew and Carlsberg have also expressed an interest in entering the Indian market. This is likely
to result in further acquisitions and joint-venture activity in future.
In the long term, the liquor industry is expected to witness a shakeout and further consolidation, with weaker
players exiting the industry. Large players and those with strong parent support are likely to survive. But given
the politically-sensitive nature of the industry, the plethora of regulations governing it would continue and
thereby, restrict such activity to some extent.