Supply Chain Special – What’s the impact on spirits?

Supply chain issues may not be the sexiest subject for the world’s distillers to discuss in public, but a familiar refrain has emerged in the past few months – whatever the scale of the operation. As the senior VP for public affairs at the Distilled Spirits Council of the United States (DISCUS), Lisa Hawkins, puts it: “The spirits industry, like numerous others, is being impacted by supply chain disruptions, inflation and labour shortages. Approximately 40% of distilled spirits on US package store shelves are imported.

“The congestion at the ports, exacerbated by shortages of pallets, containers and truck drivers, continues to create challenges for distillers of all sizes.”

The issue has multiple strands – from shipping delays to the costs of energy and raw materials, as well as simple availability of product or glass – and it resonates around the world.

Are supply chain challenges really impacting everyone equally, regardless of size? The short answer is no.

Larger businesses have typically fatter margins, deeper pockets and higher levels of efficiency and flexibility than smaller, craft-focused operations. Some of the latter – already disproportionately impacted by the COVID-19 pandemic – could go out of business if the situation doesn’t change, and change fast.

This becomes evident when comparing the conversations around the multinationals’ results announcements to the anecdotes and experiences of small independent operations. Of course, publicly-quoted companies don’t want to spook the markets and overstate the problems, but they are also far better equipped to hedge their way through such a difficult time.

At Diageo’s half-year results announcement in January, CFO Lavanya Chandrasekhar admitted that supply constraints were affecting business in North America – but was at pains to point out that volumes in the US were still up by 3% in the last six months of 2021, and 1%-to-2% higher than pre-COVID levels. Some of the issues for Diageo revolve around the availability of aged liquid – especially for Crown Royal and Tequila – which is one of the perennial challenges for any aged spirits brand, and not strictly relevant to the current supply chain maelstrom (although it hardly helps).

Otherwise, Diageo has a specific problem sourcing the bespoke bottles for Bulleit Bourbon. Even here, the group expects the issue to be resolved within months. “Because of the strategic relationships that we have with key suppliers, in North America, as an example, the procurement organisation has been able to bring in new suppliers to the market,” Chandrasekhar told analysts. “This has allowed us to increase our glass capacity by almost 25%.”

Of course, Diageo isn’t entirely immune to the broader cost increases for commodities, energy and logistics, as well as the inherent delays associated with this. However, as Chandrasekhar pointed out: “We have a natural buffer against inflation just because a large percentage of what we are selling today, we actually laid down the liquid several years ago, more than a decade ago in many cases.”

This natural buffer would apply to all aged spirits, but obviously not to vodka, gin and anything else that’s relatively fresh off the still. Bear in mind also that smaller distillers are often under financial pressure to release younger liquid into the market to generate cash flow.

At Pernod Ricard’s half-year results presentation, CEO Alex Ricard was frank in his admission that, like everyone else, the company was experiencing supply chain tensions “across all countries”, highlighting increased lead times, truck driver shortages and the availability of shipping.

“This is generating some tension, this is generating some pressure, and I don’t see this going away any time soon,” he added. “It’s not going to go away in the next few months.”

Zooming in on Pernod’s Chivas Brothers business, CEO Jean-Etienne Gourgues told Just Drinks earlier this year that transportation in North America is “still tricky”, particularly in terms of finding truck drivers, but added that there had been some recovery. “The challenge remains mostly with shipping containers by boat to far export markets,” he added. “We’re still suffering disruption at ports … In Scotland, we operate out of the ports of Grangemouth and Greenock – they’re almost at full capacity. We would like to see investment in ports and deep-sea freight supported at a government level. There is the potential, but we need to raise the bar in terms of operations.”

This is an important point in the longer term: The current crisis is merely the severe exacerbation of pre-existing supply chain issues that have been neglected or ignored for far too long. But, long-term problems require long-term solutions and investment – they can’t address what’s happening in 2022.

What’s happening in 2022 to smaller distillers is quite scary. According to Michael Langan, head of distillery at Yellow Rose Distilling in Texas, the shipping cost for his glass bottles has risen by 800% over the past four years. Last year, the prices of raw materials that the company uses for bottling were 20% above what it had budgeted for.

On top of that, the product that has cost far more to make is also taking a lot longer to get to market, and that can have serious long-term impacts on business relationships. “Getting product on ships for export is taking an extra two-to-four weeks, on average,” says Langan. “While we haven’t seen any sales cancel their orders, we do notice that, if we’re not able to ship, new orders don’t materialise.”

Amir Peay, owner/operator of James Pepper Distilling Co in Kentucky, sounds a similar refrain. “Every material manufacturer we work with (bottles, bar tops, labels, shippers, barrels) is facing production delays, rising input costs and/or constrained capacity, either due to surging demand, or labour shortage, or their own supply chain problems,” he explains.

“We’re also facing delays in overseas container shipping and domestic trucking. All of this results in super-long lead times to get what we need for manufacturing, rising prices and an inability to get as much materials as we would like.”

How do companies respond to this multiplicity of challenges? Many, says Hawkins at DISCUS, have had to seek out new suppliers, or change their bottles, often necessitating new labels, closures and packaging – which will, in turn, be more expensive, and potentially hard to obtain. That’s a particularly vicious circle.

“We’re purchasing in bulk more than ever before to make sure we have what we need to get us through these times, whether glass, labels, grain, barrels,” says Dr Sonat Birnecker Hart, president of Koval in Chicago. “We’re trying to be certain that we will not have any interruptions going forward. This is costly, but also provides some peace of mind.”

Both Langan and Peay are pursuing similarly proactive strategies, but at some cost. “By and large, we’re abandoning the ‘just-in-time’ model of procurement,” says Langan – which effectively means tying up capital in unused raw materials. “It’s set to be a challenging year.”

The obvious effect of all of this is rising prices for the consumer, and it’s clear that these are coming, or have already arrived. Diageo has so far cannily lifted prices on in-demand Tequila (by about 4.5%) and on supply-constrained Crown Royal expressions. The group is cagier about doing the same for Smirnoff and Captain Morgan, where demand for the product is less robust.

Among smaller operators, Yellow Rose expects to put prices up by US$1-to-$2 per bottle later this year, while Peay says modest price rises for James Pepper are “inevitable” in the current climate.

But, there’s a risk associated with that, as Dr Birnecker Hart points out. “One has to weigh carefully whether one wants to price oneself out of the market at a time when large companies have made extreme amounts of money compared to smaller craft brands,” she says. “We still need to compete and, while we don’t have money for ads during the Super Bowl, we still need to compete on the same shelves.”

It’s clear that the supply chain crisis will make 2022 tough for all distillers. For some – coming on top of a fiendishly difficult pandemic that saw the closure of on-premise and cellar door sales – it could prove terminal, especially as state aid packages are gradually withdrawn.

“I’ve heard some pretty bad stories about smaller craft players,” says Peay. “It’s been a rough road and probably still is. I’d imagine some may hang it up, but can’t say for sure.

“The federal stimulus monies/support is still propping up a lot of businesses, I think. When that fades away, we might see things get worse.”