BEVERAGE & FOOD DYNAMICS INTERVIEW

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Charles (“Chuck”) Phillips is the president and chief executive officer of United Distillers & Vintners, North America. He joined the beverage alcohol industry a little more than two years ago following a successful 27-year career at Kraft Foods, which included a stint as president of Maxwell House Coffee.

UDV is the spirits, wine and beer operating company of Diageo, PLC, which was created by the merger of Guinness and Grand Met in December 1997. Earlier this year, Diageo sold its Dewar’s Scotch and Bombay Gin to Bacardi. Additional changes in UDV’s brand portfolio are expected. In July, UDV put in place a new corporate structure for North America with six regional offices, each with its own president. It also moved its corporate headquarters from Hartford to Stamford, CT.

Diageo is the largest beverage alcohol company in the world. It has 85,000 employees and trades in more than 200 countries. Diageo has a market capitalization of about $40 billion and annual turnover of about $25 billion. In addition to UDV (which encompasses Schieffelin & Somerset, itself a joint-venture with Moet Hennessey, as well as the former Heublein, Paddington and Carillon companies and United Distillers), Diageo also owns Guinness Brewing, Pillsbury and Burger King.

Beverage & Food Dynamics publisher John A. Pennacchio and editor-at-large Nicolas Furlotte recently visited Chuck Phillips in his Stamford office to discuss his views on the beverage alcohol industry and his plans and priorities for 1999 and beyond. Excerpts of that discussion appear below. You can read the interview in its entirety on our web site at www.bfdynamics.com.

Beverage & Food Dynamics: Let’s start with a broad topic as we look ahead to 1999: What are your priorities and objectives for the company with regard to organizational and management issues and also in terms of the brand portfolio focus and distributor lineup.

Chuck Phillips: We have just put our new organizational structure in place, that became effective July 1st. We are still in the startup phase and relocation effort. The first challenge we have for the next 12 months, from an organizational standpoint, is to solidify that organization, get it stabilized and demonstrate to ourselves and others that there is a benefit to doing that as opposed to doing things the old fashioned way. I think that’s probably our biggest internal challenge as we look forward. I’m confident that will happen. It’s just a matter of will it happen in two months or twelve months? The faster the better and I think we’re all running very fast to make that happen.

From a portfolio standpoint, we’ve said from the get-go that we have a very large portfolio, each of us had a very large portfolio going in and that if we’re going to be successful going forward we’re going to have to find a way to focus on those brands which really are going to be the drivers of the consumer in the future and our profitability in the future. So I think the industry is awaiting some level of refinement of our portfolio, shall we say, and that’s on track.

We had an internal timetable for that and I think in the very near future, hopefully by the time this interview is published, we will have announced at least a first set of culling opportunities. I won’t take it much further than that because there’s lots of ways that one can cull and a sale is not the only way that that occurs. So I think that we do know what we want to do — that part is fairly clear to us. How we go about doing that is totally dependent upon how we can maximize the value of those things that we see no longer fitting in our portfolio. That will take us, I won’t say 12 months, but certainly a period of time to actually complete that exercise to its final stage.

The third piece, which is actually the piece where I think there will be much more focus in the future than there has been in the past, both on my part personally as well as on the part of the company, is in this whole area of external affairs. I think that topic is broad enough to accommodate both our relationship with strategic partners be they wholesalers, be they distributors, be they retailers, or be they, quite candidly, other elements within the supplier level as well; be they government, be they regulators, be they public service groups who are out there who have agendas of their own.

I really do think it is time for the industry in its totality, and I’ll include within that the entire adult beverage industry, which is an appropriate way to think about this group — it’s not just the spirits group, it’s not just the wine group it’s not just the beer group — we are all adult beverages and I think it’s appropriate that we think of ourselves that way. It’s time for us to step up to the plate and try to address some of the issues that are out there for all of us. I think there has been a lot of inter-category squabbling between beer, wine and spirits which quite candidly may benefit one or the other of those segments for a short period of time. But what we’re doing is we’re setting ourselves up for an incredible problem in the future. You kind of see it occur every day when the debate starts to take place about media advertising — well, it’s okay to do some, it’s not okay to do others. Or you talk about social responsibility or drunk driving or underage drinking or any of those issues that plague us out there. We’re not going to do well if we try and set up one segment as worse than the other segments because all of us share some very positive attributes and we all share exactly the same risk of abuse, and I think it’s up to us to make sure that abuse doesn’t occur.

Beverage & Food Dynamics: What lessons should this industry draw from the trials and travails of the tobacco companies, if any?

Chuck Phillips: I do think the industry has spent a lot of time separating themselves in a way from the sins of the tobacco industry, if you will, where tobacco said, we don’t have any of those problems. I think all of us have been very upfront by saying, yes there is a possibility that people can abuse these products and they ought not to do that and we ought to try to put safeguards in place.

Having said that, I think the thing we haven’t done well is educate the consumer as to how they themselves can participate in that. We’ve kind of said you can do one of two things: you can drink or you cannot drink, and that seems relatively absolute to me. I think what we’ve got to do is to have people understand that you can drink, but you should only drink so much — that there is a level of moderation that’s important. And that’s not any different for our industry than it is for the red meat industry, the milk industry or any of those other industries that have elements that if abused or over-used is going to create some kind of a problem. So I think that whole area of trying to get the total industry to pull together against both some antiquated laws and regulations as well as some antiquated views by regulators and the public at large is what we have got to find a way to do. And I haven’t got all the answers but I do know that if we try to go it alone, either as a company or as a segment, we’ll end up exactly where tobacco is.

Beverage & Food Dynamics: Over the years there have been many calls for industry unity, although principally those calls were aimed at retailers, wholesalers and suppliers within a category, as well as responsible drinking initiatives and public service advertising by various suppliers going all the way back to Repeal. What is it that you see at this point that will change the thinking of various suppliers in the different beverage alcohol categories? How are they persuaded that their best interests are served by the strategy you’ve outlined?

Chuck Phillips: I think there’s two places that we need to look. One of them is positive and one is negative. On the positive side, we have an incredible opportunity to increase the profitability of the total adult beverage category when we look at both what’s happening with the graying of America as well as what’s happening with the growth of the LDA-plus-5 age group over the next 10 to 15 years.

I think we’re at a point where the industry, if we tackle that opportunity the right way, tackle it responsibly, have a huge opportunity to start the totality growing again. Right now we see big pockets of growth but we don’t see the total growing as much as we’d like to. And I think we can do that in a very responsible fashion. I think there are a lot of folks out there who could increase their consumption, whether it goes from zero to one or from one to two, and do that well within dietary guidelines and all the things that we believe are safe levels of consumption.

On the other hand, from a negative standpoint, we need to do this because after tobacco, all the rumors are out there that it’s adult beverages that are next. I think we’re very, very different from tobacco so I think that in some ways we’re less at risk. But having said that, someone’s got to be next and it’s highly likely it’s going to be us. If it is, we need to find a way to make sure that you’re getting the right kind of information out into the consumers’ hands and into the regulators’ hands and into the governments’ hands about what this category is all about. It’s not: they’re good, they’re bad. It’s not the French Paradox on red wine and the hard booze guys on the other side.

Alcohol is alcohol is alcohol. We can argue about how that gets communicated, we can argue about what that means, we can argue about metabolism rates with or without food, etc., but nonetheless all forms of alcohol ultimately have the same physiological effect on people. So it’s incredibly important to understand that the physiological effect is positive up to a point.

Beverage & Food Dynamics: There were some real, concerted and very serious efforts made going back at least 10 years in this regard. Efforts to get spirits, wine and beer suppliers to work together on the same track and it never fully came to fruition.

Chuck Phillips: Again, if we thought about having every adult consuming the minimum dietary guideline recommendation, this business would be how many times bigger? Hundreds. Now, I’m not suggesting that that’s what we need to do, but I am suggesting there’s a huge opportunity out there.

I think we can take one of two mentalities: We can take the siege mentality, which is largely the one the industry has taken, we kind of waited for things to come to us and then said, oh no, no, it’s not us, it’s not me. Or we can take the approach that says we are a good, wholesome, legal product category that can play a rightful role in society. Now, we have to help define that and we have to help monitor that and we have to help guide that. But if you do that, I think there’s nothing but good.

You’re right in that a lot of people have tried to step up to this in various ways and that doesn’t mean I’ll be any more successful than they have been necessarily, other than the fact that I’ve taken this on with a fervor because quite candidly, with our size we’ll grow, there’s no doubt about that. By being in beer, wine and spirits as a corporation, we’ll have unique advantages in how we view the consumer. But just growing, as opposed to declining at two percent, is not going to transform my business and I need this business to grow like a rocket. If I’m going to make it grow like a rocket, I need for that to be driven by the industry, not by me trying to continue to compete for share with the industry.

Beverage & Food Dynamics: Your business plan going forward is largely predicated on the growth of consumption? That’s a big premise.

Chuck Phillips: Everybody wins. In the past, while there’s been pleading to try and get people to move forward together, I don’t think you’ve ever been able to coalesce people around vested self-interest other than some of those siege mentality kind of activities and even then it’s been kind of saying, look we’re not as bad as they are so if you really want to take somebody on, take on them.

Beverage & Food Dynamics: There’s not enough seats in the lifeboat, in other words.

Chuck Phillips: Exactly.

Beverage & Food Dynamics: You’re faced with a basic proposition: what can you do to increase profitability? You can only realize so much from cost-cutting.

Chuck Phillips: Once cost gets to zero there’s no more cost-cutting.

Beverage & Food Dynamics: Which means you’ve either got to increase sales or increase margin, or both. And in the current environment, as you’ve indicated, it’s mostly a battle for share.

Chuck Phillips: Today, we have a business process, a three-tier system if you like, which works a certain way and which creates cost and therefore defines profitability. We think of this business as being of a certain size and yet we tend to define that size either by supplier sales or wholesaler sales or by retailer or restaurant sales. What we don’t tend to define it by is consumer purchases. How many dollars in total is the consumer purchase?

And then what’s the actual cost of the procurement and manufacture, whether it’s distillation, fermentation or brewing, of adult beverages? If I take that as the primary cost and take what consumers spend out of their pocket whether it’s $7 for a glass of wine or $5 for a Scotch on-the-rocks or $3 for beer, do you know how much money there is in that? We’re talking billions and billions of dollars. You don’t have to look at my P&L or Augie Busch’s P&L or Robert Mondavi’s P&L or Harvey Chaplin’s P&L to know that when you add up all those things, we’re missing a lot of money. It isn’t in our pockets, it’s in this business system. My gosh, if we just kind of revamped the business system, couldn’t we find a lot of money in that?

It doesn’t mean you have to get rid of the three-tier system. When you think about it, almost any business system has three tiers: you have manufacturers and suppliers, it has someone who does intermediary work and it has some kind of retailing operation. They may cross more than they cross today. Certainly, the food industry 20 years ago looked very much like a three-tier system with large wholesalers, etc. That’s tended to change with the times. You’ve had consolidation at the retail level who’s taken on the wholesale activity. But I just think that having come from the food business and having gone through all the activity, just that concept is foreign to this industry.

Beverage & Food Dynamics: Well, you can make some people very nervous by discussing anything that has to do with potentially changing the three-tier system. There’s an ingrained resistance to considering anything like that.

Chuck Phillips: It’s like direct shipment. It’s the same kind of an issue. We think of direct shipment as someone will pick up and call an 800-number and get it shipped from the factory to their door bypassing the wholesale tier and retail tier. That doesn’t have to be the definition of direct shipment. It can be home delivery. When you think about almost any of our categories out there today, we have home delivery. The whole catalog sales business, while it may have been started by people who didn’t own retail stores, today there’s not a retail chain out there of any significance that doesn’t have a catalog operation as well.

So I really think that when we think of the future, we need to look outside of our industry and see how the consumer operates their everyday life. We can play this one of two ways. We can say, the regulations and restrictions prohibit us from doing that, or we can say, if we want to grow this business we need the consumer to have a better feeling for us and be better able to utilize us in their life and that may require that we change some of those antiquated systems. Not to loosen up the intent of the regulation, but recognize that the way society operates today is very different than 1933, and yet the regulations aren’t.

Beverage & Food Dynamics: What is being played back to you on this from your own distributors?

Chuck Phillips: I think that everybody plays back two contradictory comments. One of them is, oh, if only it could be — i.e. pigs could fly. On the other hand, it’s kind of like, how long will this take and can you really make it happen and do I really want to participate and what’s in it for me and how will I be disadvantaged? All the normal things that go through people’s minds.

When we get people thinking about how they can do this in a fashion that advantages them, not necessarily competitively advantages them, but advantages them along with everybody else, that raises the playing field from level A to level B so that everybody benefits without having to give anything up, then I think we’ll start to make some progress.

This is not about me taking away from Seagram or me taking away from Bacardi or Allied Domecq or Brown-Forman or anybody else. It also ought not to be about one wholesaler taking away from another. It ought to be finding a way to take all this incredible amount of cost that is in the business system, take that out and put it back into the business system in a fashion that adds value, because clearly the stuff that we do today doesn’t add value.

If we could ever get everybody thinking about the consumer and recognize that the consumer’s pretty smart and what we ought to be doing is marketing our way to the consumer. Having the consumer understand that a need they have can be solved by beer, it can be solved by wine, it can be solved by spirits, depending upon the environment in which they find themselves, what their taste is in that daypart, etc.

There is no beer consumer versus wine consumer versus spirits consumer. We all know from our personal experience that we consume all three. And we do them for different reasons at different times. So once we break away from that paradigm, then I think we’ll start to make some real progress.

Beverage & Food Dynamics: What specific areas or particular practices within the distribution system have you identified as ones that you believe don’t make sense long term, or are you addressing this in a more general way?

Chuck Phillips: We’ve actually made a considerable amount of progress in breaking down what all of the tasks are that occur and what quote, value, they might add both in our system as well as in what I’ll call the second tier. You know we use ‘distributor’ and ‘wholesaler’ interchangeably because they perform both of those tasks but they are two basic and fundamentally different tasks and we need to understand that as well.

Wholesaling is a selling and merchandising operation and distribution is a physical moving from point A to point B operation. We’ve given both of those steps to the same individuals although not necessarily because the regulations require it, it’s just kind of developed that way in a lot of cases. And not necessarily because they have exactly the same competency in both those — those are both two very different activities.

I’m not at this point prepared to spend a lot of time talking about it because we’re still a ways away from being able to go to people and say, look let me show it to you. But we are partnering with some people to understand that system.

Beverage & Food Dynamics: Consolidation among wholesalers and distributors has obviously resulted in bulging — some might suggest almost unmanageable — brand portfolios for the largest of them. And few would claim that the system is perfect. Yet, understandably, no one wants to be a guinea pig.

Chuck Phillips: I think we’re caught in the same paradigm. And that is on the one hand, the distributor knows that they have a portfolio that doesn’t allow them to focus. They have a portfolio some of which is incredibly profitable and some of which is incredibly unprofitable. In some cases they know which part of the portfolio is which and in some cases they don’t know. But nobody wants to give up a case. In fact, they want more cases even if those cases are unprofitable. They know that’s the wrong system but they don’t have another system to go to. So it’s continued to be: compete against the old standards because consumption is declining and therefore I can’t afford to give up any of the consumption that is out there.

If we got rid of some of that stuff. Took some of that cost out, took some of that loss out, if you will, and reinvested it back into increasing consumption in total, everybody benefits. A rising tide lifts all ships.

The critical thing, I think, I find this the most astonishing thing. We go to some places where there were five distributors 10 years ago. And now there are two distributors. But each of those distributors has three divisions because the portfolios are so big. Now, do we have two distributors or do we have six distributors? Have we really changed the paradigm? Have we gone beyond scale on the distribution side where it was nice to finally get a truck that could go on an efficient route, you now have to send two trucks on that same route and therefore you’re all the way back to zero again because you don’t have the margin structure in some of those brands to support that. Some of the laws, you’re required to sell one bottle, so you go through the whole pick and pack operation, etc., I mean, why?

I know the right answer to that — it may well have been the right answer at a point in time when you were trying to say to people, I don’t want you to force people to buy more than they need because what will happen is they’ll consume it because it’s there, so I don’t want you to force all of this. Okay, but aren’t there lots of places out there in these days and times where that just isn’t true anymore. And yet to still be able to provide them the opportunity to buy one bottle of a brand and deliver it to them everyday seems antiquated. Now, maybe I can’t change the law, or maybe I can. But maybe I can certainly find a way within the law to provide them the benefit of not having to come to them everyday. Now I can’t offer them a discount to buy three, but maybe there are other ways in which I can change the system.

I know there are a lot of very smart people out there who have thought about this. But my experience in the industry the last two years, and what I’ve been told prior to that, is there hasn’t been a lot of talk around the industry in all of the tiers about how to break that paradigm. It’s either the retailers’ problem, or it’s the wholesalers’ problem, or it’s the suppliers’ problem. But if a retailer has a problem, guess what? Somewhere there’s costs in my chain helping him solve that. And if I’ve got a problem, somewhere there’s costs in his chain unbeknownst to me and perhaps unbeknownst to him.

We just haven’t taken this as a holistic supply chain or business system and we haven’t looked at it from a beer, wine and spirits standpoint because today those are very different chains. And yet they don’t necessarily have to be.

Beverage & Food Dynamics: Transforming an industry, or a business system, is a pretty tall order.

Chuck Phillips: We ought to be very clear that this is not something that I’m going to look back on in 1999 or the year 2000 and say, well, I cracked that one what’s the next secret? This is a lifelong kind of an activity for all of us. We only have to look at other industries which have transformed themselves and it’s great to be able to look at that transformation and to look back and see how it occurred. But all too often we fail to figure out, how long did that take and who were the leaders and how long did those leaders have to stand out there on a pulpit and preach this gospel?

I think it’s going to be a very long journey for us. Because of the way the adult beverage industry is organized, both within tiers as well as within sectors as well as by state, this is something that’s not going to come out of Congress. This is something we’re going to have to go and take on not only state by state but in some cases precinct by precinct. But I think we have to do that and you have to get your victories where you can and you have to let them accumulate over time and at some point someone will look back and say, look what happened in this industry in the second 50 years, there was so much bigger of a change than occurred in the first 50 years.

Beverage & Food Dynamics: You’ve obviously brought a unique perspective to the beverage alcohol business. Is that perspective, and a shared experience from the foodservice industry, among the things that is driving the recruitment of people from Kraft and elsewhere?

Chuck Phillips: We are looking for people who can come into all of our businesses within Diageo and bring some different points of view.

We talk a lot in society about diversity and we tend to think of that as fairness and making sure that people of color and ethnicity and gender will have a fair chance. The great thing about diversity is that it brings different points of view, different experiences and different opinions. The thing we need is challenge. We’ve always tended, at least within our company, within this industry, to hire from either other adult beverage companies or from other beverage companies because of similar distribution systems.

You know, we don’t hire a lot from fashion. Well, we need to be hiring a lot from fashion. Because fashion is one of those great industries where someone says, what’s the trend for the future? How do you define the trend so we can bring clothes out? That’s not how fashion works. The fashion industry defines the trend and then consumers come and buy that trend. We don’t tend to do that. We’re always trying to find that new emerging need and fill it with product as opposed to driving that new trend. Entertainment is the same way. Entertainment doesn’t just occur. Entertainment gets driven.

If we’re in the entertainment business, if we’re in the hospitality business, if we’re in the fashion business as we are with the upper-tier brands, why are we acting like that? Why are we acting like we are some heavily regulated industry that has all of these issues and people don’t want us. Why don’t they want us? Because we keep telling them how bad we are. Well, I’m not actually as bad as they are, but we’re all kind of bad. And we’re not bad. For goodness sakes, the government says we’re not bad. Science says we’re not bad. And hundreds and hundreds of years of consumption of beverage alcohol all around the world tells us we’re not bad. And all of us who consume adult beverages know it’s not bad.

Beverage & Food Dynamics:Action versus reaction is an adroit observation. The industry has largely tended to respond rather than innovate, although clearly there have been some innovative products. But many of the industry’s marketers do seem to search yesterday’s news for tomorrow’s headlines. It’s somewhat of an unfair overstatement, but it’s almost as if marketers want to mix up a batch of trend lines and bottle them.

Chuck Phillips: That’s absolutely right. I’ve spent a lot of time in the coffee business and was the president of Maxwell House Coffee. We were at a point in my early career in coffee where consumption was declining about 2% a year. It was all of the health issues about caffeine so you ought to drink decaff. Then it was the decaffeination that was bad for you so everyone changed the decaffeination process. Then decaff period was bad for you, but caffeine was good for you.

We went through this whole kind of thing that adult beverages are going through today. Consumption was declining because it wasn’t relevant to consumers lives anymore. We struggled for years trying to figure out how to change this and what happened? Starbucks. And what happened to coffee consumption?

It’s there. The consumer is ready. We just have to figure out how to go out and do it.

Beverage & Food Dynamics: You’ve criticized much of the adult beverage brand advertising as a headlong rush for the safe, soft, center — the middle of the mainstream that neither repels nor particularly appeals to consumers. It’s all of that enormously contrived and totally implausible lifestyle advertising that is overly driven by research and ad testing. It’s advertising that attempts to cover all bases at once and therefore covers none especially well.

Chuck Phillips: We want to be all things to all people and we can’t be. Brands can’t be all things to all people and I think one of the advantages with our portfolio is that we can segment. We can segment within our industry, we can segment within time of day, we can segment within image versus non-image, functionality, etc. and it leads us to think about the consumer in a holistic fashion and to understand that the consumer is really made up of many, many parts. So how can we now provide the right product for each one of those parts, if you will?

Clearly with our portfolio, both with segment breadth as well as breadth within each of those segments, we ought to be able to do that better than anybody else. And I think it’s our obligation to share that. To have people understand how we as an industry can drive consumption. We’re all going to benefit. If all we do is use it to gain share, that’s not secret. For us to get the kind of growth that we would need, you’d have to get like an 80 share over the next five years. That’s probably not going to occur. So we’re going to have to find some other way to get that to occur.

So I think that’s part of the obligation of being big, and I hate to use the term, leadership role, because it’s so assuming, if you will. You can’t just assume leadership, you have to step out and hope people will agree with you and follow you. But that’s part of the obligation of large companies within large industries and to try to do it in a way that isn’t self-serving.

Beverage & Food Dynamics: Off the track a little, but there was an interesting article in the Wall Street Journal recently about marketing beverage alcohol to seniors. It’s a market segment that’s often dismissed by marketers who say that by the time someone gets to be 55 or older their brand preferences, their brand loyalty is firmly established. Do you see that as a viable market segment?

Chuck Phillips: I think it is. One of the things we know about consumers is that an individual’s consumption trends down as they age to a certain point and then starts to trend up again. Every kind of population bubble that’s come through, the trend has been a little further down and a little less up. But that trend continues to be the same.

I think with more and more people retiring early, with more and more people who don’t retire but have more leisure time, with the amount of disposable income that’s out there, with the amount of sociability that gets put around that dis

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