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Weekly UpdatesFive years ago, the tequila industry was in dire straits, but it was a good news-bad news scenario.
The bad news: a rare frost in 1998, coupled with a bacteria and fungus that invaded the Jalisco region--which produces the blue agave from which tequila is distilled--drove the price of the pinas from US$43 a ton to US$430.
The good news was that a boom in popularity contributed to overproduction, which in turn added to the shortage in the blue agave. Sales were climbing at a rate of over 30 percent a year in the United States and, in Mexico, sales had risen by over 30 percent since 1995.
It takes eight to 12 years for an agave to mature. Crops were hastily replanted and production was back to normal within a couple years.
This situation led to a concern for the authenticity of tequila. Industry experts worried that consumers might see a lower quality product if immature plants were harvested or lower percentages of agave were used in blends.
In a September 2000 report, Lloyds evaluated the situation thusly: "In summary, the industry appears to have been far more successful at self-regulation and at global marketing than at long-range planning."
But the massive replanting programs proved successful and the new agaves will soon be ready to harvest. The tequila industry avoided a major disaster and the spirits of margarita drinkers everywhere have been lifted.
The industry has re-established its footing and anticipates sustained growth in both the short term and the long term.
Industry Leaders
Tequila production and sales are dominated by Jose Cuervo (100-percent Mexican-owned) and its global distribution partner, Diageo (United Kingdom).
This formidable combination has eviscerated the competition, particularly in the United States, the largest and fastest growing market for the past 15 years. The same is true in Mexico, the world's second most important market.
Cuervo's U.S. market share in 2004 was 41.2 percent (3.4 million 9-liter cases), or nearly three times that of its nearest competitor, according to Adams Beverage Research.
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In dollar terms, Cuervo brands (Cuervo Especial, Clasico, Tradicional and Reserva de la Familia) garnered approximately US$425 million of the US$1 billion in wholesale revenues earned by all tequila suppliers in the United States. These revenues represented the combined sales (exports) of Jose Cuervo to Diageo and of Diageo to its wholesalers.
Between 1990 and 2004, U.S. tequila consumption nearly doubled in volume, from 4.4 million 9-liter cases to 8.3 million, an average of 6 percent per year. This rapid growth rate was spiked by an influx of Mexican immigrants to the U.S. Southwest--Texas, California, Arizona, New Mexico, Colorado, Nevada and Washington.
Gerald Reid, Diageo's senior vice president for tequila, has suggested that this group accounts for 35 percent of Cuervo's total U.S. sales. If not for the 2000-2003 shortage of blue agaves, the plants from which sugars and juices are extracted, fermented and distilled, then growth would have been still more robust.
For example, although tequila volume decreased by 15 percent globally and by a whopping 38 percent in Mexico during the past five years, it actually increased by 15 percent in the United States.
From the vantage point of revenue generation, U.S. performance was even more impressive. U.S. tequila sales (retail), as measured in constant 2004 dollars, increased by 23 percent, from US$1.9 billion in 1999 to US$2.3 billion in 2004, amidst the scarcity of blue agaves and skyrocketing tequila prices (see Table 1). In contrast, global tequila sales increased by a miniscule 0.4 percent globally, while plummeting by 38 percent in Mexico during the same period (see Table 2).
Since the shortage of blue agaves has ended, prices for the plants and tequila are dropping for the first time in a decade. Last year, retail tequila prices fell 15 percent, spurred by the overzealous planting projects of tequila producers and independent Mexican farmers. It appears increasingly likely that such decreases will accelerate, as blue agaves begin flooding the market in 2006.
This trend in rapidly falling prices is terrific for consumers. However, it will confront Mexico's most prestigious suppliers like Cuervo, Sauza and Herradura--and their U.S. distributors, Diageo, Allied Domecq and Sazerac, respectively--with unprecedented challenges.
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Competitive pressures will be especially intense from U.S. distributors like Constellation Brands and David Sherman who target consumers that prefer their cheaper national brands (Montezuma, Juarez and Margaritaville) to the more expensive global labels provided by Cuervo, Sauza and Herradura.
Looking Back
Before examining the impacts of continued price changes on Cuervo and other industry players and offering an outlook for 2004-2009, it is useful to review the 1999-2004 timeframe from the perspective of company strategy.
In other words, how do firms allocate sales between domestic and foreign markets, segment products according to price and content and forge strategic alliances. In addition, short descriptions of industry nomenclature and regulations are helpful in defining the industry's operating environment.
This analysis of the tequila industry concludes with an interview with Juan Domingo Beckmann, president and CEO of Jose Cuervo, the world's largest and most profitable tequila company. Beckmann and his father are part of a long lineage. They represent the fourth and fifth generations of owner-managers descended directly from the family of Jose Maria Guadalupe Cuervo, the company founder, who received the first royal license to commercialize tequila from King Carlos IV of Spain, in 1795.
Although tequila production is restricted to five Mexican states--Jalisco, Michoacan, Tamaulipas, Nayarit and Guanajuato--95 percent of overall production is from Jalisco, the birthplace of Jose Cuervo and the center of the industry.
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Like cognac and champagne, the right to commercially use the name "tequila" is protected under international law (intellectual property rights). As such, it only can be applied legally to the alcoholic drink produced from blue agaves that grow in the five Mexican states, the so-called territory of designated origin (TDO).
Regulating Tequila
In Mexico, tequila manufacturing, marketing and distribution are regulated by the powerful National Tequila Board (CRT), located in Guadalajara. This organization is responsible for protecting the interests of an industry that directly or indirectly affects the livelihood of 300,000 Mexicans. They are charged with ensuring that only legitimate tequilas enter the marketplace.
Specifically, the CRT classifies tequila in terms of blue agave content (100 percent or 51 percent) and maturation process.
There are two types of tequilas: pure and mixed. According to the CRT, the first is made entirely from the juices and sugars of blue agaves and their suppliers are required to bottle them on Mexican premises--located within the TDO--and label them as 100-percent agave. The alcoholic content of these drinks is 40 percent by volume.
By comparison, the second type of tequila is produced by adding sugars and juices not extracted from blue agaves. The CRT specifies 51 percent blue agave content as a minimum for these tequilas that do not have to be bottled in Mexico. Most are shipped by truck (in huge tankards) to the United States, where they are bottled, labeled and ultimately consumed in the form of margaritas. Their alcoholic content is 38 percent by volume.
The CRT further distinguishes between tequilas in terms of four age categories: (1) Blanco is not aged, but bottled immediately after the fermentation process, (2) Reposado is aged for a minimum of two months in oak or pine barrels which impart yellow color and soften the tequila's taste, (3) Anejo is aged at least one year in oak or pine barrels whose capacity cannot exceed 600 liters, (4) Joven is a blanco that is mixed partially with reposado or anejo to provide a gold color and smoother taste.
These different tequila regulations and classifications are crucial sources of corporate strategy. However, their application must be combined with policies that accurately measure global market trends and changing consumer preferences, the real keys to long-term growth and profitability.
In 2004, the United States and Mexico accounted for 81 percent of global tequila revenues (retail) and 76 percent of volume. Increasingly, revenues and profitability are dependent on brand equity, market segmentation and distribution.
Today, the brands of only six companies and their strategic allies--Cuervo-Diageo, Sauza-Allied Domecq, Herradura-Sazerac, Cazadores-Bacardi, Montezuma-Constellation and Margaritaville-1800-David Sherman--account for 75 percent of global volume.
Among these top six strategic alliances the Cuervo-Diageo combination is clearly dominant. Its market share is 26 percent greater than that of its closest competitor, Sauza-Allied Domecq, and its profitability is equally superior.
Cuervo's success is predicated on global growth and an unswerving focus on brands that compete in premium (US$14-US$19 per 750ml bottle) and super-premium price segments (US$25-US$50 per bottle), primarily in the United States.
Long-Term Partners
The strategic alliance between US$400 million Jose Cuervo, the world's leading tequila producer, and US$16 billion Diageo, the largest premium brand spirits company, has thrived because of complementary interests.
The companies have been partners for a long time. Before 2002, Diageo owned a 45-percent stake in Cuervo and Cuervo enjoyed sole distribution rights to Diageo's brands in Mexico.
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